As filed with the Securities and Exchange Commission on March 23, 2006
SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549
Date of event requiring this shell company report .................
GILAT SATELLITE NETWORKS LTD. (Exact name of Registrant as specified in its charter)
ISRAEL (Jurisdiction of incorporation or organization)
Gilat House, 21 Yegia Kapayim Street, Kiryat Arye, Petah Tikva, 49130 Israel (Address of principal executive offices)
Securities registered or to be registered pursuant to Section 12(b) of the Act: None
Securities registered or to be registered pursuant of Section 12(g) of the Act:
Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act: None
Indicate the number of outstanding shares of each of the issuer’s classes of capital or common stock at the close of the period covered by the annual report:
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes oNo x
If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.
Yes o No x
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes xNo o
Indicate by check mark which financial statement item the Registrant elected to follow:
Item 17 oItem 18 x
If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
This report on Form 20-F is being incorporated by reference into our Registration Statements on Form S-8 (Registration Nos. 333-123410, 333-113932, 333-08826, 333-10092, 333-12466 and 333-12988) and Form F-3 (Registration Nos. 333-113950 and 333-12698).
- 2 -
We are a leading provider of products and services for satellite-based communications networks. During the third quarter of 2005, we began to operate under three business units: (i) Gilat Network Systems, often referred to as GNS, which is a provider of network systems and associated professional services to service providers and operators; (ii) Spacenet, which provides managed services for enterprises and businesses through our U.S. Subsidiary, Spacenet Inc and for consumers through our U.S. subsidiary, StarBand Communications Inc.; and (iii) Spacenet Rural Communications, which provides communication services including internet, telephony and data transmissions for rural communities, primarily in Latin America. In its most recent available report published in 2005,Comsys, a specialized consulting company that analyzes the satellite communications industry, reported that Gilat is the second-largest manufacturer of very small aperture terminals, referred to in the network communications industry as VSATs. We were incorporated in Israel in 1987 and are subject to the laws of the State of Israel. Gilat’s corporate headquarters, executive offices and research and development, engineering and manufacturing facilities are located at Gilat House, 21 Yegia Kapayim Street, Kiryat Arye, Petah Tikva 49130, Israel. Our telephone number is (972) 3-925-2000.
The name “Gilat™” and the names “TwoWay™,” “OneWay™,” “FaraWay™,” “DialAw@y IPTM,” “SkySurfer™,” “SkyWay™,” “Skydata®,” “SkyEdge™", “Clearlink™", “SkyBlaster ™", “Skystar Advantage®” and StarBand™ appearing in this annual report on Form 20-F are trademarks of Gilat and its subsidiaries. See Item 4: “Information on the Company – Products and Services.” Other trademarks appearing in this annual report on Form 20-F are owned by their respective holders.
Except for the historical information contained in this annual report, the statements contained in this annual report are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 with respect to our business, financial condition and results of operations. Actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including all the risks discussed in Item 3: “Key Information–Risk Factors” and elsewhere in this annual report.
We urge you to consider that statements which use the terms “believe,” “do not believe,” “expect,” “plan,” “intend,” “estimate,” “anticipate” and similar expressions are intended to identify forward-looking statements. These statements reflect our current views with respect to future events and are based on assumptions and are subject to risks and uncertainties. Except as required by applicable law, including the securities laws of the U.S., we do not intend to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.
Our consolidated financial statements appearing in this annual report are prepared in U.S. dollars and in accordance with U.S. generally accepted accounting principles, or U.S. GAAP. All references in this annual report to “dollars” or “$” are to U.S. dollars and all references in this annual report to “NIS” are to New Israeli Shekels. The representative exchange rate between the NIS and the dollar as published by the Bank of Israel on March 21, 2006 was NIS 4.659 per $1.00.
As used in this annual report, the terms “we”, “us”, “Gilat” and “our” mean Gilat Satellite Networks Ltd. and its subsidiaries, unless otherwise indicated.
Statements made in this annual report concerning the contents of any contract, agreement or other document are summaries of such contracts, agreements or documents and are not complete descriptions of all of their terms. If we filed any of these documents as an exhibit to this annual report or to any registration statement or annual report that we previously filed, you may read the document itself for a complete description.
- i -
- ii -
Not Applicable.
The selected consolidated statement of operations data set forth below for the years ended December 31, 2003, 2004 and 2005, and the selected consolidated balance sheet data as of December 31, 2004 and 2005 are derived from our audited consolidated financial statements that are included elsewhere in this Report. These financial statements have been prepared in accordance with U.S. generally accepted accounting principles or U.S. GAAP. The selected consolidated statement of operations data set forth below for the years ended December 31, 2001 and 2002 and the selected consolidated balance sheet data as of December 31, 2001, 2002 and 2003 are derived from our audited consolidated financial statements that are not included in this Report.
The selected consolidated financial data set forth below should be read in conjunction with Item 5: “Operating and Financial Review and Prospects” and the Consolidated Financial Statements and Notes thereto included in Item 18 in this annual report on Form 20-F for the year ended December 31, 2005.
- 3 -
- 4 -
Beginning January 2005, we began operating our business under two business units. During the third quarter of 2005, we further modified this change and are now operating under three business units. It is not yet certain that this change in our operations will be efficient or successful.
Beginning January 1, 2005, we began to operate under two business units: Gilat Network Systems and Spacenet. This division was made as part of the Company’s growth strategy aiming to increase sales for solution driven markets as well as the expansion of its services and operations business. During the third quarter of 2005, we divided the Spacenet business unit into two separate units: Spacenet Inc., which provides managed services for enterprise, business and consumers in the U.S. and Spacenet Rural Communications, which offers rural telephony and internet access solutions to remote areas, primarily in Latin America. While the intention is to enable and encourage each business unit to enhance its business strategy, it is possible that the division will cause competition within our company and lead to confusion in the market.
We have incurred major losses in recent years and may never achieve net income profitability.
We incurred a loss of approximately $100.6 million in 2003 (excluding the gain from restructuring of debt), a loss of approximately $11.5 million in 2004 and a loss of approximately $ 3.7 million in 2005. While we achieved operating profitability of approximately $1 million in the fourth quarter, we cannot assure you that we can operate profitably in the future or achieve a positive net income. If we do not achieve profitability, the viability of our company will be in question and our share price could decline.
If commercial wireless communications markets fail to grow as anticipated, our business could be materially harmed.
A number of the commercial markets for our products in the wireless communications area, including our broadband products, have only in recent years been developed. Because these markets are relatively new, it is difficult to predict the rate at which these markets will grow, if at all. If the markets for commercial wireless communications products fail to grow, or grow more slowly than anticipated, our business could be materially harmed. Conversely, to the extent that growth in these markets results in capacity limitations in the wireless communications area, it could materially harm our business and impair the value of our shares. Specifically, we derive virtually all of our revenues from sales of VSAT communications networks and provision of services related to these networks. A significant decline in this market or the replacement of VSAT technology by an alternative technology could materially harm our business and impair the value of our stock.
- 5 -
Trends and factors affecting the telecommunications industry are beyond our control and may result in reduced demand and pricing pressure on our products.
There are trends and factors affecting the telecommunications industry which are beyond our control and may affect our operations. These trends and factors include:
Economic conditions affecting the telecommunications industry, which affect market conditions in the telecommunications and networking industry, in the United States and globally, affect our business. Reduced capital spending and/or negative economic conditions in the North America, Europe, Asia, Latin America and/or other areas of the world could result in reduced demand for or pricing pressure on our products.
Because we compete for large-scale contracts in competitive bidding processes, losing a relatively small number of bids could have a significant adverse impact on our operating results.
A significant portion of our sales revenue is derived from our being selected as the supplier of networks based on VSATs, under large-scale contracts that we are awarded from time to time in a competitive bidding process. These large-scale contracts typically involve the installation of between 2,000 and 10,000 VSATs. The number of major bids for these large-scale contracts for VSAT-based networks in any given year is limited and the competition is intense. Losing or defaulting on a relatively small number of bids each year could have a significant adverse impact on our operating results.
- 6 -
Many of our large-scale contracts are with governments or large enterprises in Latin America and other parts of the world; any instability in the exchange rates or in the political or economic situation or any unexpected unilateral termination could have a significant adverse impact on our business.
In recent years, a significant portion of our revenues has been from large-scale contracts, including those in Peru, Colombia, Mexico and Brazil. Agreements with the governments in these countries typically include unilateral early termination clauses and other risks such as the imposition of new government regulations and taxation that could pose additional financial burdens on us. In addition, the foreign exchange risks in these countries are often significant due to possible fluctuations in local currencies relative to the U.S. dollar. Any termination of business in any of the aforementioned countries or any instability in the exchange rates could have a significant adverse impact on our business.
In addition, in November 2002, we were awarded two large projects by the Colombian Government, including the installation and operation of approximately 550 telecenters to provide Internet connectivity and telephony services in cities and towns throughout Colombia and a second site of approximately 3,300 public rural satellite telephony network. The total value of the contracts is approximately $65 million. If we do not meet certain minimum equity requirements, this customer may assert that we would be in breach of our contract with them. Any early unilateral termination by the Colombian Government could have a significant adverse impact on our operating results.
If we are unable to develop, introduce and market new products, applications and services on a cost effective and timely basis, our business could be adversely affected.
The network communications market, to which our services and products are targeted, is characterized by rapid technological changes, new product introductions and evolving industry standards. If we fail to stay abreast of significant technological changes, our existing products and technology could be rendered obsolete. Historically, we have enhanced the applications of our existing products to meet the technological changes and industry standards. For example, in February 2004, we introduced the SkyEdge product family, which offers a comprehensive platform to deliver data, voice and video services over a single platform. Until then, each of these applications demanded a separate hub. In addition, in 2005, in order to meet the demands of utility companies and government customers, we introduced our Armadillo VSAT, a durable, environmentally controlled broadband satellite router system suitable for use in outdoor environments and extreme weather conditions.
Our success is dependent upon our ability to continue to develop new products, applications and services and meet developing market needs.
To remain competitive in the network communications market, we must continue to be able to anticipate changes in technology and industry standards and to develop and introduce new products, applications and services, as well as enhancements to our existing products, applications and services. If we are unable to respond to technological advances on a cost-effective and timely basis, or if our new products or applications are not accepted by the market, then our business, financial condition and operating results could be adversely affected.
A decrease in the selling prices of our products and services could materially harm our business.
The average selling prices of wireless communications products historically decline over product life cycles. In particular, we expect the average selling prices of our products to decline as a result of competitive pricing pressures and customers who negotiate discounts based on large unit volumes. We also expect space segment prices to decline, in particular in the United States where two of our competitors have announced plans to launch extended Ka-band satellites. We also expect that competition in this industry will continue to increase. To offset these price decreases, we intend to rely primarily on obtaining yield improvements and corresponding cost reductions in the manufacturing process of existing products, on the introduction of new products with advanced features and on offering turn key and other solutions to communications operators that are higher up in the value chain. However, we cannot assure you that we will be able to obtain any yield improvements or cost reductions or introduce any new products in the future or reach the higher value chain we strive to sell to. To the extent that we do meet any or all of these goals, it could materially harm our business and impair the value of our shares.
- 7 -
If we are not able to fill our backlog of orders, our business will be adversely affected.
At present, we have a backlog of orders, consisting of network service contracts, generally for three to five years, and of new orders for products and services. As of December 31, 2005 our aggregate backlog for equipment sales and for services under service contracts for our VSAT products was $206 million. If we are unable to satisfy the entire backlog of orders, we will not be able to fully recognize the revenues expected from this backlog and we could lose the contracts from which these backlog of orders arise, either of which could have a material adverse effect on our business. In addition, an inability to supply equipment and services could lead to our default on contracts and the subsequent exercise of performance guarantees by customers and could subject us to penalties and fines.
If we lose existing contracts and orders for our products are not renewed, our ability to generate revenues will be harmed.
Some of our existing contracts could be terminated due, among others, to any of the following reasons:
The termination or non-renewal of our contracts could have a material adverse effect on our business, financial condition and operating results. A vast majority of our business generated in 2005 was from recurring customers. If we are not able to gain new customers and retain our present customer base, our revenues will decline significantly. In addition, if we have a higher than anticipated subscriber churn for customers from StarBand and from Spacenet Inc., this could materially adversely affect our financial performance.
We are dependent upon a limited number of suppliers for key components to build our VSATs, and may be significantly harmed if we are unable to obtain the hardware necessary for our hubs and VSATs on favorable terms or on atimely basis.
Several of the components required to build our VSATs and hubs are manufactured by a limited number of suppliers. In the past, we have not experienced any difficulties with our suppliers with respect to availability of components. However, we cannot assure you of the continuous availability of key components or our ability to forecast our component requirements sufficiently in advance. Our research and development and operations groups are continuously working with our vendors and subcontractors to obtain components for our products on favorable terms in order to reduce the overall price of our products. If we are unable to obtain the necessary volumes of components at desired favorable terms or prices, we may be unable to produce our products at desired favorable terms or prices. As a result, sales of our products may be lower than expected, which could have a material adverse effect on our business, financial condition and operating results. In addition, in the past year the lead-time for product delivery requested by our customers has shortened significantly. Our supplies are not always able to meet our requested lead times. If we are unable to satisfy these customer’s needs, we could lose their business.
- 8 -
The terms on which we are able to obtain components for our products are also affected by our relationship with our suppliers. In this regard, we entered into a non-exclusive Supply Chain Management agreement with Arrow/Rapac Ltd., or Arrow, a part of Arrow Electronics, Inc., to purchase certain components necessary for the manufacture of our products as well as to provide comprehensive logistic services. The agreement is intended to ensure JIT (just in time) inventory and to reduce prices currently paid by us for components. In addition, regarding components purchased in bulk by Arrow for other customers, we are entitled to enjoy existing lower prices. Arrow is to purchase components on our behalf based upon rolling forecasts provided by us. While this agreement is intended to guarantee the supply of our products and reduce prices, it also increases our reliance on a single sub-contractor. Any inability on their part to substantively perform under the agreement could have an adverse effect on our operations.
We operate in the highly competitive network communications industry. We may be unsuccessful in competing effectively against many of our competitors who have substantially greater financial resources.
We operate in a highly competitive industry of network communications, both in the sales of our products and our services. As a result of the rapid technological changes that characterize our industry, we face intense worldwide competition to capitalize on new opportunities, to introduce new products and to obtain proprietary and standard technologies that are perceived by the market as being superior to those of our competitors. Some of our competitors have substantially greater financial resources, providing them with greater research and development and marketing capabilities. These competitors may also be experienced in obtaining regulatory approvals for their products and services and in marketing them. Our relative position in the network communications industry may place us at a disadvantage in responding to our competitors’ pricing strategies, technological advances and other initiatives. Our SkyEdge family line includes both proprietary VSATs and a VSAT that is DVB-RCS compliant. Our principal competitors in the supply of VSAT networks are Hughes Network Systems, Inc., or HNS, ViaSat Inc., iDirect Technologies, IPStar, EMS Technologies, Inc. and Nera ASA.
There are other manufacturers of products that compete with one or more of our products such as Alcatel Space, NDSatcom, Newtech and Polarsat. Another potential for product standardization in the VSAT industry is known as DOCSIS (Data Over Cable Service Interface Specification) for satellite communications. This concept is embedded in a product produced and sold by ViaSat directly in the international markets. In the United States, ViaSat delivers the same technology to the WildBlue consumer program that was launched in June 2005. This product is designed to be a low cost VSAT. This standardization could pose a threat to the acceptance in the market of our current and future non-DOCSIS for satellite products and could have an adverse effect on the market price for VSATs industry-wide.
HNS introduced its own standard called IPoS (IP over satellite) which relies on the installed base of their DirecWay System. If accepted by other companies in the industry, this could have an adverse affect on the acceptance of our products. HNS is also expected to launch their SpaceWay Ka satellite program in the United States in 2006, which, if successful, could increase our competition and lower prices.
We also compete with various mobile satellite communications companies such as Iridium, Globalstar, Asia Cellular Satellite (known as ACeS) and Thuraya Satellite Communications Company and companies that offer communication network systems based on other non-satellite technologies such as terrestrial lines (including cable, DSL, fixed wireless, ISDN lines, cellular GPRS and fiber optics), frame relay, radio and microwave transmissions. These technologies can often be cheaper than VSAT technology in some applications while still providing a sufficient variety of the features required by customers.
Our actions to protect our proprietary VSAT technology may be insufficient to prevent others from developing products similar to our products.
Our business is based mainly on our proprietary VSAT technology and related products and services. We establish and protect proprietary rights and technology used in our products by the use of patents, trade secrets, copyrights and trademarks. We also utilize non-disclosure and intellectual property assignment agreements. Because of the rapid technological changes and innovation that characterize the network communications industry, our success will depend in large part on our ability to protect and defend our intellectual property rights. Our actions to protect our proprietary rights in our VSAT technology and related products may be insufficient to prevent others from developing products similar to our products. In addition, the laws of many foreign countries do not protect our intellectual property rights to the same extent as the laws of the United States. If we are unable to protect our intellectual property, our ability to operate our business and generate revenues as expected may be harmed.
- 9 -
We depend on a single facility in Israel and are susceptible to any event that could adversely affect its condition.
Most of our laboratory capacity, our principal offices and principal research and development facilities are concentrated in a single location in Israel. Fire, natural disaster or any other cause of material disruption in our operation in this location could have a material adverse effect on our business, financial condition and operating results. As discussed above, to remain competitive in the network communications industry, we must respond quickly to technological developments. Damage to our facility in Israel could cause serious delays in the development of new products and services and, therefore, could adversely affect our business. In addition, the particular risks relating to our location in Israel are described below.
Our international sales expose us to changes in foreign regulations and tariffs, tax exposures, political instability and other risks inherent to international business, any of which could adversely affect our operations.
We sell and distribute our products and provide our services internationally, particularly in the United States, Asia, Africa, Europe and Latin America. A component of our strategy is to continue to expand into new international markets. Our operations can be limited or disrupted by various factors known to affect international trade. These factors include the following:
- 10 -
Any decline in commercial business in any country can have an adverse effect on our business as these trends often lead to a decline in technology purchases or upgrades by private companies. We expect that in difficult economic periods, countries in which we do business will find it more difficult to raise financing from investors for the further development of the telecommunications industry. Any such changes could adversely affect our business in these and other countries.
We may face difficulties in obtaining regulatory approvals for our telecommunication services, which could adversely affect our operations.
Our telecommunication services require licenses and approvals by the Federal Communications Commission, or FCC, in the United States, and by regulatory bodies in other countries. In the United States, the operation of satellite earth station facilities and VSAT systems such as ours are prohibited except under licenses issued by the FCC. We must also obtain approval of the regulatory authority in each country in which we propose to provide network services or operate VSATs. The approval process in Latin America and elsewhere can often take a substantial amount of time and require substantial resources.
In addition, any approvals that are granted may be subject to conditions that may restrict our activities or otherwise adversely affect our operations. Also, after obtaining the required approvals, the regulating agencies may, at any time, impose additional requirements on our operations. We cannot assure you that we will be able to comply with any new requirements or conditions imposed by such regulating agencies on a timely or economic basis.
Our lengthy sales cycles could harm our results of operations if forecasted sales are delayed or do not occur.
The length of time between the date of initial contact with a potential customer or sponsor and the execution of a contract with the potential customer or sponsor may be lengthy and vary significantly depending on the nature of the arrangement. During any given sales cycle, we may expend substantial funds and management resources and not obtain significant revenue, resulting in a negative impact on our operating results.
Possible need for additional funds.
Our cash and cash equivalents at December 31, 2005 were approximately $74.9 million. We currently expect our cash and cash equivalents to be sufficient for use in our current operations. If we choose to expand our business by acquiring a complementary business or businesses, we may be required to raise additional funds to finance such activities. There can be no assurance that we will be able to raise necessary funds or that we will be able to do so on terms acceptable to us. Any such additional funding may result in significant dilution to existing shareholders
Our operating results may vary significantly from quarter to quarter and these quarterly variations in operating results, as well as other factors, may contribute to the volatility of the market price of our shares.
Our operating results may vary significantly from quarter to quarter. The causes of fluctuations include, among other things:
The quarterly variation of our operating results, may, in turn, create volatility in the market price for our shares. Other factors that may contribute to wide fluctuations in our market price, many of which are beyond our control, include, but are not limited to:
- 11 -
In addition to the volatility of the market price of our shares, the stock market in general and the market for technology companies in particular have been highly volatile and at times, thinly traded. Investors may not be able to resell their shares following periods of volatility.
We may at times be subject to claims by third parties alleging that we are infringing their intellectual property rights. We may be required to commence litigation to protect our intellectual property rights. Any intellectual property litigation may continue for an extended period and may materially adversely affect our business, financial condition and operating results.
There are numerous patents, both pending and issued, in the network communications industry. We may unknowingly infringe a patent. We may from time to time be notified of claims that we are infringing on the patents, copyrights or other intellectual property rights owned by third parties. While we do not believe that we have in the past or are at present infringed on any intellectual property rights of third parties, we cannot assure you that we will not be subject to such claims.
In addition, we may be required to commence litigation to protect our intellectual property rights and trade secrets, to determine the validity of and scope of the proprietary rights of others or to defend against third-party claims of invalidity. An adverse result in any litigation could force us to pay substantial damages, stop designing or manufacturing, using and selling the infringing products, spend significant resources to develop non-infringing technology, discontinue using certain processes or obtain licenses to use the infringing technology. In addition, we may not be able to develop non-infringing technology, nor might we be able to find appropriate licenses on reasonably satisfactory terms. Any such litigation could result in substantial costs and diversion of resources and could have a material adverse effect on our business, financial condition and operating results.
Potential product liability claims relating to our products could have a material adverse effect on our business.
We may be subject to product liability claims relating to the products we sell. Potential product liability claims could include those for exposure to electromagnetic radiation from the antennas we provide. Our agreements with our business customers generally contain provisions designed to limit our exposure to potential product liability claims. We also maintain a product liability insurance policy. However, our insurance may not cover all relevant claims or may not provide sufficient coverage. To date, we have not experienced any material product liability claims. Our business, financial condition and operating results could be materially adversely affected if costs resulting from future claims are not covered by our insurance or exceed our coverage.
Our insurance coverage may not be sufficient for every aspect or risk related to our business.
Our business includes many risks, only some of which are covered by our insurance. For example, in many of our satellite capacity agreements, we do not have a back up for satellite capacity, nor do we have indemnification or insurance in the event that our supplier’s satellite malfunctions or is lost. In addition, we are not covered by our insurance for acts of fraud or theft. Our business, financial condition and operating results could be materially adversely affected if significant costs resulting from these exposures are incurred.
- 12 -
We are involved in litigation alleging violations of the federal securities laws that may have an adverse effecton our business.
On May 13, 2003, a complaint was filed with the United States District Court for the Eastern District of New York against the Company and certain of its officers and directors asserting claims under Section 10(b) of the Securities Exchange Act of 1934. The complaint was the result of the court-ordered consolidation of nine separate similar actions filed in March 2002 in the United States District Courts. In addition, a request was made to file a class action lawsuit in the Tel Aviv, Israel, District Court, but this action was stayed pending the outcome of the class action proceedings in the United States. The Complaint asserts the claims of purchasers of our securities from February 9, 2000 and through May 29, 2002, and alleges violations of the federal securities laws and claims that we issued material misrepresentations to the market. We have filed a motion to dismiss the amended complaint, and on September 19, 2005, the court dismissed certain of the plaintiff’s claims. The plaintiffs have provided Gilat with a discovery demand. A conference with the plaintiffs has been scheduled for March to agree on the schedule and scope of the discovery.
We believe that the allegations against us and certain of our current and former officers and directors are without merit and intend to contest them vigorously. However, these legal proceedings are in the preliminary stages and we cannot predict their outcome. The litigation process is inherently uncertain. While we hold insurance coverage, if we are not successful in defending these legal proceedings, we could incur substantial monetary judgments or penalties in excess of the available insurance coverage. In addition, regardless of the outcome of the litigation, the process could result in damage to our reputation. The proceedings could result in substantial costs not covered by our insurance coverage and the process may occupy a significant amount of time and attention of our senior management.
In the past twelve months we have experienced significant changes in management and our board of directors. The changes in top leadership of the Company may have an ongoing adverse effect on our business.
In June 2006, Mr. Erez Antebi rejoined the company as the Chief Executive Officer of our Gilat Network Systems business unit. In addition, in July 2005, in connection with the assignment of a Gilat loan by Bank Hapoalim B.M. to York Capital Management, six out of seven of our board members resigned and were replaced by new members. In addition, Shlomo Rodav, our then-Chairman of the Board and Chief Executive Officer resigned. At that time, Mr. Amiram Levinberg, a co-founder and former President of our Company who had left following the restructuring of our Company in March 2003, returned as our Chief Executive Officer and Chairman of the Board. The many changes in management in the past year could materially adversely affect our business, financial condition and operating results.
We face competition for personnel, particularly for employees with technical expertise. Our business, financial condition and operating results could be materially adversely affected if we cannot hire and retain suitable personnel.
We may engage in acquisitions that could harm our business, results of operations and financial condition, and dilute our stockholders’ equity.
As part of our management changes which have occurred over the past three quarters, we have added a business development team, whose goal is to pursue new business opportunities. This team will pursue growth opportunities through internal development and through the acquisition of complementary businesses, products and technologies. We are unable to predict whether or when any prospective acquisition will be completed. The process of integrating an acquired business may be prolonged due to unforeseen difficulties and may require a disproportionate amount of our resources and management’s attention. We cannot assure you that we will be able to successfully identify suitable acquisition candidates, complete acquisitions, integrate acquired businesses into our operations, or expand into new markets. Further, once integrated, acquisitions may not achieve comparable levels of revenues, profitability or productivity as our existing business or otherwise perform as expected. The occurrence of any of these events could harm our business, financial condition or results of operations. Future acquisitions may require substantial capital resources, which may not be available to us or may require us to seek additional debt or equity financing. Future acquisitions by us could result in the following, any of which could seriously harm our results of operations or the price of our stock:
- 13 -
Our failure to manage growth effectively could impair our business, financial condition and results of operations.
The implementation of SFAS No. 123R, which requires us to record compensation expenses in connection with equity share based compensation may reduce our profitability significantly.
On December 16, 2004, the Financial Accounting Standards Board (FASB) issued Statement No. 123 (revised 2004), Share-Based Payment (“SFAS No. 123R”), which is a revision of SFAS No. 123. Generally, the approach in SFAS 123(R) is similar to the approach described in Statement 123. However, SFAS No. 123 permitted, but not required, share-based payments to employees to be recognized based on their fair values while SFAS No. 123(R) requires, as of the first quarter of 2006, all share-based payments to employees to be recognized based on their fair values. SFAS No. 123R 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 adoption of SFAS No. 123R may have a significant effect on our results of operations. In addition, such adoption could also limit our ability to continue to use stock options as an incentive and retention tool, which could, in turn, hurt our ability to recruit employees and retain existing employees. Had we adopted SFAS 123(R) in 2005, the impact of that standard would have approximated $7 million, as described in the disclosure of pro forma net income and earnings per share in our consolidated financial statements.
Our share price has been highly volatile, has experienced a significant decline, and may continue to be volatile and decline.
The trading price of our shares has fluctuated widely in the past and may continue to do so in the future as a result of a number of factors, many of which are outside our control. In addition, the stock market has experienced extreme price and volume fluctuations that have affected the market prices of many technology companies, particularly telecommunication and Internet-related companies, and that have often been unrelated or disproportionate to the operating performance of these companies. These broad market fluctuations could adversely affect the market price of our shares. In the past, following periods of volatility in the market price of a particular company’s securities, securities class action litigation has often been brought against that company. Securities class action litigation could result in substantial costs and a diversion of our management’s attention and resources.
- 14 -
We have never paid cash dividends and have no intention to pay dividends in the foreseeable future.
We have never paid cash dividends on our shares and do not anticipate paying any cash dividends in the foreseeable future. We intend to continue retaining earnings for use in our business, in particular to fund our research and development, which are important to capitalize on technological changes and develop new products and applications. In addition, the terms of some of our financing arrangements restrict us from paying dividends to our shareholders.
One of our controlling shareholders is also a major creditor of the Company.
In July 2005, York Capital Management was assigned the substantial loan that we had from Bank Hapoalim B.M. York also has a proxy to vote approximately 15% of our shares. The interests of York as a major creditor of our company may conflict at times with the interests of our other shareholders. In addition, as per the terms of the amended loan agreement with York approved in December 2005, York may convert the loan into shares and become a dominating shareholder with approximately 32% of our outstanding shares. The interests of such a major potential shareholder may not be inherently the same as those of shareholders with a smaller ownership in our company.
Our ordinary shares are traded on more than one market and this may result in price variations.
Our ordinary shares are traded primarily on the Nasdaq National Market and on the Tel Aviv Stock Exchange. Trading in our ordinary shares on these markets is made in different currencies (US dollars on the Nasdaq National Market, and New Israeli Shekels on the Tel Aviv Stock Exchange), and at different times (resulting from different time zones, different trading days and different public holidays in the United States and Israel). Consequently, the trading prices of our ordinary shares on these two markets often differ. Any decrease in the trading price of our ordinary shares on one of these markets could cause a decrease in the trading price of our ordinary shares on the other market.
We have historically relied, and in the future intend to rely, upon tax benefits from the state of Israel on our taxable income. The termination or reduction of these tax benefits would significantly increase our costs and could have a material adverse effect on our financial condition and results of operations.
Under the Israeli Law for Encouragement of Capital Investments, 1959, some of our Israeli facilities qualify as “Approved Enterprises.” As a result, we have been eligible for tax benefits for the first several years in which we generated taxable income. Our historical operating results reflect substantial tax benefits, including tax exemptions and decreased tax rates up to December 31, 2000. In, 2003, 2004 and 2005, we had substantial losses for tax purposes and a decrease in revenues and therefore could not realize any tax benefits. On April 1, 2005, an amendment to the Investment Law came into effect (“the Amendment”) and has significantly changed the provisions of the Investment Law. The Amendment enacted major changes in the manner in which tax benefits are awarded under the Investment Law so that companies no longer require Investment Center approval in order to qualify for tax benefits. The amendment will be applied to new approved enterprises. Our financial condition and results of operations could suffer if the Israeli government terminated or reduced the current tax benefits available to us.
In addition, in order to receive these tax benefits, we must comply with two material conditions. We must invest specified amount in property and equipment in Israel, and at least 25% of each new “Approved Enterprise” income should be derived from export. We believe we have complied with these conditions, but we have not received confirmation of our compliance from the government. If we fail in the future to comply in whole or in part with these conditions, we may be required to pay additional taxes and would likely be denied these tax benefits in the future, if and when we are profitable, which could harm our financial condition and results of operations.
- 15 -
We benefit from Israeli Government grants. The termination or reduction of these grants could have a material adverse effect on our ability to develop new products and applications.
Research and development grants from the Office of the Chief Scientist of the Israeli Ministry of Industry and Commerce, or the Chief Scientist during 2003, 2004 and 2005 amounted to approximately $3.5 million, $2.2 million, and $ 1.3 million, respectively. These grants enable us to develop new technologies to use in new products and applications. However, they also impose certain restrictions on us, as discussed below. Israeli authorities have indicated that the grant program may be reduced in the future. The termination or reduction of these grants to us could have a material adverse effect on our ability to develop new products and applications, which could harm our business.
The transfer and use of some of our technology and its production is limited because of the research and development grants we received from the Israeli Government to develop such technology. Such limitations may restrict our business growth and profitability.
Our research and development efforts associated with the development of our OneWay VSAT product and our DialAw@y IP product and our SkyBlaster product have been partially financed through grants from the Chief Scientist. We are subject to certain restrictions under the terms of the Chief Scientist grants. Specifically, the products developed with the funding provided by these grants may not be manufactured, nor may the technology which is embodied in our products be transferred outside of Israel without appropriate governmental approvals and/or fines. These restrictions do not apply to the sale or export from Israel of our products developed with this technology. These restrictions could limit or prevent our growth and profitability.
As a foreign private issuer whose shares are listed on the NASDAQ National Market, we may follow certain home country corporate governance practices instead of NASDAQ requirements.
As a foreign private issuer whose shares are listed on the NASDAQ National Market, we are permitted to follow certain home country corporate governance practices instead of certain requirements of the NASDAQ Marketplace Rules, including the composition of our Board of Directors, director nomination procedure, compensation of officers, distribution of annual reports to shareholders, and quorum at shareholders meetings. In addition, we may follow Israeli law instead of the NASDAQ Marketplace Rules that require that we obtain shareholder approval for certain dilutive events, such as for the establishment or amendment of certain equity based compensation plans, an issuance that will result in a change of control of our company, certain transactions other than a public offering involving issuances of a 20% or more interest in our company and certain acquisitions of the stock or assets of another company.
Compliance with changing regulation of corporate governance and public disclosure may result in additional expenses.
Changing laws, regulations and standards relating to corporate governance and public disclosure, including the Sarbanes-Oxley Act of 2002, new Securities and Exchange Commission regulations and Nasdaq Stock Market rules, are creating uncertainty for companies such as ours. We are committed to maintaining high standards of corporate governance and public disclosure. As a result, we intend to invest reasonably necessary resources to comply with evolving standards, and this investment may result in increased general and administrative expenses and a diversion of management time and attention from revenue-generating activities to compliance activities, which could harm our operating results and business prospects.
- 16 -
Political and economic conditions in Israel may limit our ability to produce and sell our products. This could result in a material adverse effect on our operations and business.
We are incorporated under the laws of the State of Israel, where we also maintain our headquarters and most of our research and development and manufacturing facilities. Political, economic and security conditions in Israel directly influence us. Since the establishment of the State of Israel in 1948, Israel and its Arab neighbors have engaged in a number of armed conflicts. A state of hostility, varying in degree and intensity, has led to security and economic problems for Israel. Major hostilities between Israel and its neighbors may hinder Israel’s international trade and lead to economic downturn. This, in turn, could have a material adverse effect on our operations and business.
Since October 2000, there has been substantial deterioration in the relationship between Israel and the Palestinian Authority that has resulted in increased violence. The future effect of this deterioration and violence on the Israeli economy and our operations is unclear. In August 2005, Israel evacuated all Israeli settlements in the Gaza Strip and four settlements in the West Bank. The implications of this action cannot at this time be foreseen. Ongoing violence between Israel and the Palestinians as well as tension between Israel and the neighboring Syria and Lebanon may have a material adverse effect on our business, financial conditions or results of operations.
In addition, 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. Following the passage by the Israeli Parliament of laws to implement the economic measures, the Israeli trade unions have threatened further strikes or work-stoppages, and these may have a material adverse effect on the Israeli economy and on us.
You may not be able to enforce civil liabilities in the United States against our officers and directors.
Most of our executive officers are non-residents of the United States. A significant portion of our assets and the personal assets of most of our directors and executive officers are located outside the United States. Therefore, it may be difficult to effect service of process upon any of these persons within the United States. In addition, a judgment obtained in the United States against us, and most of our directors and executive officers, including but not limited to judgments based on the civil liability provisions of the U.S. federal securities laws, may not be collectible in the United States.
Generally, it may also be difficult to bring an original action in an Israeli court to enforce liabilities based upon the U.S. federal securities laws against us and most of our directors and executive officers. Subject to particular time limitations, executory judgments of a United States court for liquidated damages in civil matters may be enforced by an Israeli court, provided that:
- 17 -
Furthermore, if a foreign judgment is enforced by an Israeli court, it will be payable in Israeli currency.
Current terrorist attacks in Israel and globally may have a material adverse effect on our operating results.
Terrorist attacks, such as the attacks that occurred in New York and Washington, D.C. on September 11, 2001, terrorist attacks in Israel and other acts of violence or war may affect the markets on which our shares trade, the markets in which we operate, and our operations and profitability. We cannot assure you that there will not be further terrorist attacks against the United States or Israel, or against American or Israeli businesses. These attacks or subsequent armed conflicts resulting from or connected to them may directly impact our physical facilities or those of our suppliers or customers. Furthermore, these terrorist attacks may make travel and the transportation of our supplies and products more difficult and more expensive and ultimately affect the sales of our products in the United States and overseas. Also, the ongoing armed conflicts around the world such as in Iraq could have a further impact on our sales, our profitability, our supply chain, our production capability and our ability to deliver product and services to our customers.
Our operating results would be adversely affected if inflation in Israel is not offset on a timely basis by adevaluation of the new Israeli shekel (NIS) against the U.S. dollar.
Our international sales expose us to fluctuations in foreign currencies. Most of our sales are denominated in U.S. dollars. When the Israeli inflation rate exceeds the rate of the NIS devaluation against foreign currencies, our NIS expenses increase to the extent of the difference between the rates. A significant disparity of this kind may have a material adverse effect on our operating results.
The rights and responsibilities of our shareholders are governed by Israeli law and differ in some respects from the rights and responsibilities of shareholders under U.S. law.
We are incorporated under Israeli law. The rights and responsibilities of holders of our ordinary shares are governed by our articles of association and by Israeli law. These rights and responsibilities differ in some respects from the rights and responsibilities of shareholders in typical U.S. corporations. In particular, a shareholder of an Israeli company has a duty to act in good faith toward the company and other shareholders and to refrain from abusing his power in the company, including, among other things, in voting at the general meeting of shareholders on certain matters. Israeli law provides that these duties are applicable in shareholder votes on, among other things, amendments to a company’s articles of association, increases in a company’s authorized share capital, mergers and interested party transactions requiring shareholder approval. In addition, a shareholder who knows that it possesses the power to determine the outcome of a shareholder vote or to appoint or prevent the appointment of a director or executive officer in the company has a duty of fairness toward the company. However, Israeli law does not define the substance of this duty of fairness. Because Israeli corporate law has undergone extensive revision in recent years, there is little case law available to assist in understanding the implications of these provisions that govern shareholder behavior.
Israeli law may delay, prevent or make difficult a merger with or an acquisition of us, which could prevent achange of control and therefore depress the price of our shares.
Provisions of Israeli law may delay, prevent or make undesirable a merger or an acquisition of all or a significant portion of our shares or assets. Israeli corporate law regulates acquisitions of shares through tender offers and mergers, requires special approvals for transactions involving significant shareholders and regulates other matters that may be relevant to these types of transactions. These provisions of Israeli law could have the effect of delaying or preventing a change in control and may make it more difficult for a third party to acquire us, even if doing so would be beneficial to our shareholders. These provisions may limit the price that investors may be willing to pay in the future for our ordinary shares. Furthermore, Israeli tax considerations may make potential transactions undesirable to us or to some of our shareholders.
- 18 -
Under current Israeli law, we may not be able to enforce covenants not to compete and therefore may be unable to prevent our competitors from benefiting from the expertise of some of our former employees.
We currently have non-competition clauses in the employment agreements of nearly all of our employees. The provisions of such clauses prohibit our employees, if they cease working for us, from directly competing with us or working for our competitors. Recently, Israeli courts have required employers, seeking to enforce non-compete undertakings against former employees, to demonstrate that the competitive activities of the former employee will cause harm to one of a limited number of material interests of the employer recognized by the courts (e.g. the confidentiality of certain commercial information or a company’s intellectual property). In the event that any of our employees chooses to go and work for one of our competitors, we may be unable to prevent our competitors from benefiting from the expertise of our former employees obtained from us, if we cannot demonstrate to the court that harm would be caused to us.
We are a leading provider of products and services for satellite-based communications networks. The products that we develop, manufacture and install are known as VSATs, or very small aperture terminals. VSATs provide highly reliable, end-to-end satellite communications with guaranteed quality of service regardless of the number of sites or their geographic location. In its most recent report published in October 2005, Comsys, a specialized consulting company that analyzes the satellite communications industry, reported that Gilat is the second-largest manufacturer of VSATs.
Since the third quarter of 2005, we have operated under three business units:
(i) Gilat Network Systems (GNS), which is a provider of VSAT-based network systems and associated professional services to service providers and operators worldwide;
(ii) Spacenet, which is a service provider for data communication via satellite. Spacenet’s customers are enterprises, businesses and consumers primarily located in the United States.
(iii) Spacenet Rural Communications, which is a service provider for Internet, telephony and data communications for rural communities, primarily in Latin America.
Gilat shipped its initial product, a first generation receive only (OneWay) VSAT, in 1989. Since then, we have devoted significant resources to developing and enhancing our VSAT applications and establishing strategic alliances, primarily with major telecommunications companies and equipment suppliers.
- 19 -
In 1991, we began marketing our second-generation OneWay VSAT. In 1992, we began marketing our interactive (TwoWay) VSAT with Spacenet Inc., a company engaged in providing VSAT-based network services, as part of Spacenet’s Skystar Advantage VSAT service offering. Over the years, we experienced significant growth in orders, sales and earnings including from our OneWay and Skystar Advantage products. By an agreement in 1992, COMSAT RSI, Inc. became our joint venture partner to develop, manufacture and market two-way rural telephony VSAT products (FaraWay). We began marketing the FaraWay VSAT in 1994. At the end of 1996, we began marketing the DialAw@y IP VSAT, another rural telephony product outside of the scope of that joint venture.
In December 1998, we acquired Spacenet Inc. from SES Americom (formerly known as GE Americom) and certain affiliates.
In 1999, we began marketing our interactive consumer (SkyBlaster) VSAT . The SkyBlaster is a two-way IP-based product for broadband Internet services via satellite. One of the first SkyBlaster models was the 360, designed for consumers and home offices and small business users. In 2001, we completed development of the next generation interactive (SkyStar 360E) VSAT, geared toward the enterprise, small business, SME and SOHO markets, that enables broadband networking between a central hub and up to thousands of locations.
In 2004, we introduced our SkyEdge family of VSAT products, which offers a comprehensive satellite communications platform to deliver data, voice and video services over a unified, powerful system. This product family is also used for satellite integrated communication applications and solutions.
Financing Transactions. In February 2000, we completed a private offering of $350 million of convertible subordinated notes due 2005, or the old notes. In December 2000, we entered into a facility agreement with Bank Hapoalim, under which we borrowed $108 million to finance our general corporate activities including our working capital. In June 2002, we paid part of the initial $6 million principal payment that was then due.
In September 2001, Bank Leumi lent us $30 million to be repaid in a single installment on April 5, 2003. The loan was secured by a lien on our buildings in Petah Tikva, Israel. In March 2003, as part of the arrangement detailed below, the terms of the loan made by Bank Leumi were revised.
In October 2002, to permit completion of a complex restructuring arrangement, with the holders of the old notes, and certain other creditors, we filed with the Israeli Court a petition under Section 350 of the Israeli Companies Law – 1999 for a stay of proceedings on actions by holders of the old notes and our bank lenders. In March 2003, after negotiating with both the holders of the old notes, our lending banks and our major creditors, we received the approval of the Israeli courts, and completed a plan of arrangement, or the Arrangement with our bank lenders, holders of the old notes and certain other creditors. Pursuant to the Arrangement, our old notes were cancelled and the holders of the old notes were issued a combination of 4.00% Convertible Notes due 2012, or the new notes, and ordinary shares. Additional new notes and ordinary shares were also issued in exchange for a portion of our bank debt and debt to another financing creditor. The arrangement reduced our debt by approximately $309 million, secured new agreements with our banking creditors, and significantly reduced our overall financing costs. As part of the arrangement, we entered into a new agreement with SES Americom, Spacenet’s major supplier of satellite transponder capacity in the United States.
In October 2003, we distributed an offering circular to the holders of our new notes and offered to exchange our ordinary shares for the new notes at a conversion rate of $8 per share. In November 2003, we accepted approximately $73.7 million of the new notes for exchange and issued an additional 9,208,270 ordinary shares.
In March 2003, as part of the Arrangement, we amended our agreement with Bank Hapoalim. The loan was again amended in April 2004. In July 2005, the loan was assigned by Bank Hapoalim to York Capital Management and in December 2005, the loan agreement was amended for a third time. For more details, please see Item 5 “Operating and Financial Review and Prospects – Commitments and Contingencies.”
- 20 -
As of March 1, 2006, 22,589,698 of our ordinary shares were outstanding.
Capital Expenditures and Divestitures. In 2003, 2004 and 2005, our property and equipment purchases amounted to approximately $14.7 million, $6.2 million and $3.6 million respectively. These amounts do not include the reclassification of inventory to property and equipment made during 2003, 2004 and 2005 in the amount of approximately $6.8 million, $21.7 million and $7.3 million respectively. For more details, see Item 4 – “Property and Equipment.” In 2004, we completed the sale of our Argentinean subsidiary, Servicio Satelital S.A. to a third party. In 2005, we completed the sale of Deterministic Networks Inc. to some of its employees, we purchased the remaining shares of StarBand and our shareholdings in Satlynx were diluted from approximately 40.6% to 0.17%. Please see Item 8: “Significant Changes”.
We were incorporated in Israel in 1987 and are subject to the laws of the State of Israel. Our corporate headquarters, executive offices and research and development, engineering and manufacturing facilities are located at Gilat House, 21 Yegia Kapayim Street, Kiryat Arye, Petah Tikva 49130, Israel. Our telephone number is (972) 3-925-2000.
Overview
VSATs enable reliable transmission of data via satellite. A typical VSAT network consists of: (1) several dozens to several thousands of remote sites with small antennas; (2) a large central earth station called a hub, which includes a large antenna radio transmitter/receiver equipment (also known in the industry as RF) and baseband equipment to enable the connection of all the VSATs in the network; and (3) the capability to communicate with a specified satellite.
There are generally two key parts to the communication process: (i) the earth segment, consisting of the equipment at the hub and at the remote locations; and (ii) the space segment, which is the link to and from the satellite.
The remote terminal equipment consists of two units: the ODU, or outdoor unit which is placed outdoors and consists of a small antenna with a feed system, transmitter and low noise converter and the IDU, or indoor unit which fits on a desktop (much like a modem) and contains the circuitry that activates a communications link between the user’s equipment and the satellite. The space segment is comprised of communication transponders on satellites that are located in a geostationary orbit.
VSATs enable connectivity via satellite for various applications, such as broadband, Internet, video and voice. This rapidly deployed technology is often used to bring reliable, cost-effective communications to remote locations. In addition, VSATs provide a highly secure and reliable network and service availability across wide geographic areas. The shared nature of the satellite communications resource enables VSATs to provide cost-effective communications solutions for a large number of sites per network, each of which uses a variety of services. VSAT networks support a wide spectrum of capabilities and customer applications such as e-mail, virtual private networks, or VPN, video, voice, Internet access, distance learning, content distribution and financial transactions.
The value chain
We believe that the value chain of the satellite communications industry consists of the following elements:
- 21 -
Gilat’s primary market segments
The networks we establish are used within the following markets:
Enterprise: The enterprise market includes companies, both large and small, small medium enterprises (SME) and SOHO end users and government entities. For enterprises, VSAT networks offer network connectivity that carries applications such as networks within corporations (known as corporate intranets), Internet connections for data, video and voice (known as broadband), transaction based connectivity to enable on-line data delivery such as point-of-sale (credit and debit card authorization), inventory control and real time stock exchange trading.
Rural telecommunications: The rural telecommunications market is comprised of rural communities throughout the world that require telephone, facsimile and Internet access in areas that are underserved by the existing telecommunications services and/or are in remote locations without service. This market segment is comprised of “Build-Operate” (BO) projects, in which governments subsidize the establishment and the operation of a rural network to be served by a certain satellite service provider who is selected via a bid process. In other instances, local communications operators have universal service obligations (USOs) which require them to serve rural areas lacking terrestrial infrastructure. In this model, known as “Built-Operate-Transfer” (BOT) projects, the network is established and made operational by a third party service provider and then transferred to the operator.
Consumer: The consumer market consists of single resident users. These users require a high-speed Internet connection which enables the transmission of data, audio and video, similar to a DSL (digital subscriber line) or cable modem service.
Through our GNS business unit, we provide VSAT communication equipment and solutions to service providers in each of the three market segments, detailed above.
- 22 -
GNS sells VSAT communications networks and bundled solutions primarily to service providers. The service providers are mainly serving the enterprise and rural communication market segments.
Enterprise service providers use the networks for broadband, transaction data, video and voice connectivity for applications such as credit card authorization, online banking, corporate intranet, interactive distance learning, lottery transactions, retail point of sale, inventory control, and Supervisory Control and Data Acquisition (SCADA) services. Examples of service providers to whom GNS sells VSAT networks are StarOne in Brazil whose end users include franchises such as O’Boticario, a major Brazilian cosmetics chain, HCL in India whose end users include stock exchange dealers, and Spacenet Inc., whose end users include lottery service providers such as Scientific Games International.
Service providers serving the rural communications market are typically public telephony and internet operators providing telephony and Internet services through public call offices, telecenters, internet cafes or pay phones. Examples of rural telecom customers of GNS include Telkom, in South Africa; China Unicom and Embratel in Brazil. Recently GNS has begun to sell a new cellular backhaul solution called the SkyAbis, based on our SkyEdge product to Global System Mobile (GSM) cellular operators that deploy cellular base-stations in remote areas.
VSAT networks also provide underserved areas with a high-speed internet connection to single resident users. This market consists of service providers that provide a DSL-like service using our VSAT technology. Examples of customers in this area to whom we sell our products are Spacenet, which delivers satellite communications to consumers in North America through StarBand, StarOne in Brazil and Optus in Australia.
Through our equipment sales arm which provides full solutions to its customers, we have achieved and sustained the following competitive advantages:
- 23 -
We intend to strengthen our business and organically grow our market share by continuing to leverage our position as a technologically advanced and cost-effective provider of VSAT solutions. In addition, we intend to grow in complimentary directions by “moving up the value chain” and selling higher-valued solutions. The principal elements of this strategy are to:
- 24 -
We use both direct and indirect sales channels to market our products, solutions and services. Our GNS equipment sales division has geographically organized its marketing activities by geographical areas, with groups, subsidiaries or affiliates covering all regions of the world. We have thirteen regional sales offices around the world and GNS sales representatives in our Spacenet Inc. and Spacenet Rural Telecommunications offices. Our sales teams are comprised of account managers and sales engineers, who are the primary account interfaces and work to establish account relationships and determine technical and business requirements for the network. These teams also support the other distribution channels with advanced technical capabilities and application experience. Sales cycles in the VSAT network market vary significantly, with some sales requiring 18 months from an initial lead through signing of the contract and others stemming from an immediate need for product delivery within 2 to 3 months. The sales process includes several network design iterations, network demonstrations, and on occasion, software development, and integrations with third-party equipment for complete solution offerings.
We currently offer our VSATs to the three markets described above. In 2005, we offered the following satellite networks, VSATs and solutions described below:
SkyEdge Family of Products
We have designed the SkyEdge VSATs and hub to support multiple services on a single platform. Our advanced access scheme and quality of service (QoS) implementation enables delivering these services simultaneously in an efficient manner and at high quality. The SkyEdge can support various services, such as toll-quality voice, video, Internet access, transactional data on the same platform. In addition, multiple network topologies can be deployed with the same platform; star (hub and spokes), mesh and multi-star. This enables improved user-experience and reduced operational expenses.
Providing Solutions
Our VSAT based networks often serve as a platform for the delivery of a complete system, providing a versatile, flexible and custom tailored solution. We offer integrated solutions that bring value to our customers. For example, in 2005, we released an integrated solution called the Sky-Abis, which supports a backhaul application for GSM cellular-based stations. We also provide turn-key projects that include installation, operation and third party peripheral equipment. End-to-end solutions include a variety of markets, such as communication infrastructure solutions, post offices, military and defense, transportable VSATs and GSM trunking.
The network communications industry is highly competitive and the level of competition is increasing. As a provider of satellite network products, GNS competes with a large number of telecommunications equipment vendors. This increasingly competitive environment has put pressure on prices and margins and has led to pressures for industry-wide standardization, which would enable multi-vendor networks. To compete effectively, we emphasize the price competitiveness of our products as compared to products offered by terrestrial and other satellite service providers, the advantages of satellite networks in general, our network quality, our customization capability, our offering of end-to-end solutions and our provision of a single point of contact for products and services.
Our principal competitor in the supply of VSAT satellite networks is Hughes Network Systems which also offers a line of VSAT products. In competing with HNS, we emphasize particular technological features of our products, the long-term reliability of our products, our ability to customize networks and perform desired development work and the quality of our customer service In addition; we face competition from ViaSat, Inc. and iDirect Technologies, both of whom manufacture their own VSATs.
We believe that our major competitors have the resources to develop products with features and functions competitive with those offered by us. In addition, the entry of new companies into the market or the expansion by existing competitors of their product lines could have an adverse effect on us. However, we believe that our primary competitive advantage is our ability to provide products with relatively low overall cost and high functionality. We also compete on the basis of the performance characteristics of our products and our ability to customize certain network functions. We cannot assure that our competitors will not develop such features or functions, that we will be able to maintain a cost advantage for these products or that new companies will not enter these markets.
- 25 -
The satellite industry currently has two open standards for the return channel, DVB-RCS (Digital Video Broadcast – Return Channel via Satellite) and IPoS (Internet Protocol over Satellite). The first is an ETSI (European Telecommunications Standards Institute) standard backed by a consortium of satellite operators and vendors, including Gilat. The second is an ETSI and TIA (Telecommunication Industry Association) standard, backed primarily by HNS. Other companies offer technologies that can be standardized, such as DOCSIS (Data Over Cable Service Interface Specification) by ViaSat, but these are currently not open standards. We may see increased competition from other DVB-RCS vendors, such as Advantech and Nera, and price pressure as a result of these open standards. Acceptance of DVB-RCS or other standards, as well as interoperability of multi-vendor VSAT systems, can further increase competitive intensity and price pressures. In October 2005, Gilat’s SkyEdge DVB-RCS, was certified as DVB-RCS compliant by Satlabs.
We are facing increasing competition from terrestrial telecommunications service providers that use frame relay, fiber optic networks and digital network switching to provide competitive network offerings. The increase of cellular coverage and development of General Pocket Radio Service (GPRS) technology, Universal Mobile Telecommunication System (UMTS) and Code Division Multiple Access 2000 (CDMA2000) is also proving to be a competitive technology for low-medium bit rate applications. In addition, we are facing increasing completion from Worldwide Interoperability for Microwave Access (WiMAX) and similar wireless technologies.
Our VSAT networks generally have an advantage over terrestrial networks where the network must reach many locations over large distances, where the customer has a “last mile” or congestion problem that cannot be solved easily with terrestrial facilities and where there is a need for transmission to remote locations or emerging markets. By comparison, terrestrial facilities (e.g., fiber optic cables) often have an advantage for carrying large amounts of bulk traffic between a small number of fixed locations. However, a customer’s particular circumstances, the pricing offered by suppliers and the effectiveness of the marketing efforts of the competing suppliers also play a key role in this competitive environment.
We provide VSAT communication services and solutions to enterprises and consumers in North America through our subsidiary, Spacenet Inc. and its wholly-owned subsidiary, StarBand Communications Inc.
Spacenet’s primary business is delivering private-hub and shared-hub managed VSAT networks and applications to enterprise and government end customers in North America. These customers contract directly with Spacenet for VSAT equipment and associated network services to be deployed at customer locations (which may or may not include installation and maintenance), typically for a contract term between 36 and 60 months. Spacenet also resells managed terrestrial connectivity equipment and services from facilities-based Local Exchange Carrier (LEC) partners. In certain markets, Spacenet sells equipment-only solutions with no recurring service component. Spacenet also provides VSAT equipment and Internet access service to residential/small-office customers through Starband Communications Inc.
Spacenet serves more than 50,000 enterprise and government customer sites with its managed network services. Notable Spacenet enterprise customers include Dollar General, Goodyear, Intercontinental Hotels Group, Valero, Countrywide Home Loans, Kroger and many other Fortune 1000 companies. A 2005 study of the North American enterprise VSAT marketplace by industry analyst Comsys showed that Spacenet ranked second in the North American market share with 20.5%, more than four times greater share than the third-ranked provider.
- 26 -
Spacenet’s enterprise services target several key markets.
Spacenet has achieved the following strengths:
- 27 -
- 28 -
Spacenet’s strategy is focused on five primary areas.
Spacenet sells its Connexstar enterprise and government services directly as well as through a network of more than 30 authorized enterprise channel partners. Spacenet’s direct sales efforts are based in its McLean, Virginia headquarters, with field sales offices in the Midwest, Southwest and California. Sales cycles to these key enterprise markets are typically long (9-18 months) and complex, involving extensive pre-sales testing and competitive bidding. Spacenet gathers leads in these target markets through a comprehensive outreach program that includes direct marketing, public relations and media relations, advertising, web seminars and conferences/events. In furtherance of its strategy, Spacenet is increasingly focusing its sales and marketing efforts on opening new markets where it has strengths and a strong value proposition.
Spacenet’s subsidiary, Spacenet Government Services Inc., is dedicated to serving civilian and military US government customers. Spacenet does not currently directly service government organizations; instead, it typically works through established government contractors and system integrators to form part of a complete solution.
Spacenet’s StarBand residential/small office services are sold directly and through approximately 400 active residential dealers, which are typically direct-to-home (DTH) satellite TV resellers and/or satellite Internet service resellers. In late 2005 and early 2006, Spacenet undertook a successful program to remove non-productive dealers from the program and boost the resources available to high-volume dealers.
- 29 -
The Connexstar service portfolio includes a broad variety of commercial-grade satellite and hybrid terrestrial managed connectivity services. Connexstar SE, based on the SkyEdge VSAT platform, offers full-time shared-hub services with excellent performance characteristics (up to 2 Mbps inbound data rates), strong security and competitive pricing. Connexstar On-Demand delivers usage-based shared-hub services designed for backup/disaster recovery and part-time applications. Connexstar EP and enterprise solutions offer “virtual hub” or complete managed private hub solutions with total customizability for large networks. Connexstar hybrid services deliver mixed terrestrial and satellite networks completely managed by Spacenet, including both network-level and site-level hybrids. These Connexstar services are all provided with service level agreements or SLAs and advanced network monitoring/reporting, and can be delivered through multiple hardware platforms including transportable VSAT systems, ruggedized all-weather units or router-integrated network modules. Spacenet¹s StarBand services provide competitive VSAT-based internet access packages, focusing on high-performance options for small office/home office and small business users.
In addition to its narrowband and broadband connectivity services, Spacenet offers a variety of network management and application services. Spacenet provides comprehensive program management and network implementation services to its enterprise customers, as well as help desk, network management and field maintenance support. Spacenet’s SmartCare services range from network monitoring to complete IT/network outsourcing solutions. Spacenet’s Prysm services use a custom hardware and software platform to provide firewall/security, network failover and VSAT acceleration solutions. Spacenet’s SmartSource value-added services deliver first-party integrated applications including in-store digital content, transaction support and multicast content delivery. Spacenet’s enterprise connectivity and management services are offered in North America directly by Spacenet, and internationally through Spacenet’s Global Services Alliance.
In support of its service offerings, Spacenet operates three network operation centers (NOC)in the United States: McLean, Virginia; Chicago, Illinois and Marietta, Georgia. Spacenet’s operations staff supervises network implementation and installation quality assurance (QA); manages shared-hub and private-hub networks; provides first-level and escalated help desk/problem resolution; manages inventory and shipping; and dispatches field service/maintenance technicians. The Chicago NOC facility specializes in operation of high-availability networks on legacy VSAT platforms. The Marietta NOC facility operates the newer Connexstar and StarBand services as well as providing the first- and second-level call center. The McLean headquarters facility provides pilot and disaster recovery hub operations, third-tier network escalation and advanced network management services.
In all of its markets (enterprise/government and residential/small office), Spacenet competes with both satellite and terrestrial service providers.
Enterprise competition. The North American enterprise WAN market is extremely competitive, with a number of established terrestrial and VSAT providers vying for nearly all contracts. Most of these service providers are larger than Spacenet in terms of revenue and resources, and Spacenet must leverage all of its technical and business strengths to compete effectively.
The United States enterprise VSAT market has traditionally been a near-duopoly of Spacenet and Hughes Network Systems (HNS), and these two companies regularly compete head-to-head for customer contracts. HNS has a larger market share as a service provider than does Spacenet in North America. Service providers using VSAT platforms from ViaSat and iDirect are also competitive in some situations. iDirect and ViaSat have been successful selling to the government market, and represent the major source of competition in that market. Spacenet seeks to differentiate itself on broader standards than VSAT technical capabilities and bandwidth pricing, so elements like managed networks capability and hybrid services are intended to diminish price pressure in the future.
- 30 -
Spacenet’s primary competitors in the enterprise WAN market are large terrestrial carriers such as AT&T, Verizon and Qwest; recently announced consolidation of these players has strengthened their competitive positions. While private line/frame relay services once dominated the terrestrial enterprise WAN landscape, emerging technologies are eclipsing these platforms and increasing the degree of terrestrial competition in Spacenet’s traditional markets. DSL services have decreased in price, and increased in reliability and geographic availability over the past five years. Although these services are not typically able to deliver the same level of reliability as private line or enterprise VSAT solutions, DSL services (especially higher-end consumer services) are able to deliver much lower prices and adequate services for some customers. Similarly, cable Multi-Service Operators (MSOs) are increasing the availability of cable modem services with comparable characteristics to DSL. To counter this competition, Spacenet began offering DSL services in 2004 and is able to provide these services to enterprise customers. However, Spacenet will likely not be able to match Incumbent Local Exchange Carrier (ILEC) or large Competitive Local Exchange Carrier (CLEC) providers on pure commodity connectivity pricing; therefore it is focusing on business where its added value can provide a competitive advantage, such as reliability and additional value added services.
Frame relay and private line solutions continue to be popular, as they deliver very high levels of service availability (albeit at a generally significantly higher cost than VSAT) and continue to be the platform of choice for customers that are willing to pay a premium for reliability. Spacenet has adapted its stance in these accounts to position VSATs as an additive backup/network augmentation technology as well as a potential replacement for private line networks.
Spacenet is carefully monitoring the development of new terrestrial wireless network technologies such as WiMAX, GPRS and CDMA2000 Evolution Data Optimized/Evolution Data and Voice (EVDO/EVDV) being deployed by wireless phone operators.
Residential/small office competition. The residential/small office Internet access market is very large and highly competitive. Because of lower prices, ILECs and MSOs deploying broadband Internet services have effectively removed satellite broadband from competition in the areas where DSL and cable are available. Satellite accounts for only a tiny percentage of overall broadband subscribers in the United States (according to FCC statistics current as of July 2005, satellite/wireless subscribers accounted for 1.48% of total broadband users).
However, according to MBC Research 2005 estimates, there are 10-15 million homes and businesses in the United States without access to terrestrial broadband connectivity, which is the addressable market for satellite Internet services. HNS DirecWay and Spacenet’s StarBand were the only two significant players in this market until the mid-2005 launch of the WildBlue service. Since then, these three services have comprised close to 100% of the market, with StarBand accounting for approximately 10% of this market.
The DirecWay service uses HNS’ VSAT terminals and standard Ku-band RF technology, and is sold primarily through DirecTV marketing and the network of DirecTV resellers. StarBand uses Gilat’s VSAT terminals with Ku-band technology, and is sold primarily through its network of dealers/agents. The WildBlue service uses ViaSat VSAT terminals with Ka-band RF technology, and is sold through National Rural Telecommunications Coalition members and independent dealers. Entry of Wildblue as a new competitor for consumer services has resulted in increased price pressures in this market.
- 31 -
Our Spacenet Rural Communications business unit is a service provider for Internet, telephony and data communications for rural communities, primarily in Latin America.
Spacenet Rural Communications’ primary business is providing public telephone services to rural areas in Latin America. In addition, this business unit provides data communication, computer and other related services such as Internet access, telecenters and remote learning centers. Spacenet Rural Communications also provides VSAT services, such as hub operation, dedicated network services and shared hub services. These typically utilize the infrastructure of existing rural telecom projects and leverage experience from these operations.
Public Rural Telecom Services
In a large number of remote, rural and semi urban areas, primarily in developing countries, there is limited or no telephone or Internet service, due to inadequate terrestrial telecommunications infrastructure. In these areas, VSAT networks are able to utilize existing satellites to rapidly provide high-quality, cost-effective telecommunications solutions. In contrast to terrestrial networks, VSAT networks are simple to reconfigure or expand, relatively immune to difficulties of topography and can be situated almost anywhere. Additionally, VSATs can be installed and connected to a network quickly without the need to rely on local infrastructure, such as electricity. A proportion of the VSATs are typically required to be powered by solar energy, without any reliance on existing power infrastructure. Lastly, VSATs deliver reliable service, seldom require maintenance and repair is relatively simple.
As a result of the above advantages, there is a demand for VSAT-based bundled services of fixed telephony and Internet access. This market consists primarily of government subsidized projects and projects deployed by public telephone operators that need to fulfill Universal Service Obligations (USO) worldwide. Many of these government-funded projects have been expanded to provide not only telephony services and Internet access, but to also provide telecenters that can serve the local population. These telecenters typically include PCs, printers, fax machines, photocopiers, VCRs and TVs (for educational programs). Additional revenue may be received, both in the form of subsidies and direct revenues from the users, when these additional services are provided. Examples of rural telecom government customers include Compartel in Colombia and FITEL in Peru.
VSAT services to Public Telephony Operators (PTO)
In some markets, existing PTOs are mandated by the government to provide universal services. Providing these services in remote areas is a challenge to these PTOs, and they typically outsource these services to rural telecom service providers. The exact nature of these outsourcing projects varies, but they are typically of a “Build and Transfer” model or a “Build, Operate and Transfer” model. In the first option the PTO requires a fully functional and operating network to be provided. In the second option, Spacenet Rural Communications builds the network, operates it for a certain period of time and then transfers a fully operational network to the PTO. An example of a Spacenet Rural Communication PTO customer, is Cable & Wireless in Panama.
Commercial enterprise and government agencies
Spacenet Rural Communications also provides private network services to large companies or government agencies. These customers contract directly with Spacenet Rural Communications for VSAT equipment and associated network services to be deployed at customer locations (which may or may not include installation and maintenance), typically for a contract term of 36-60 months. Spacenet Rural Communications also resells managed terrestrial connectivity equipment and services from facilities-based Local Exchange Carrier (LEC) partners. Customers include Venezuela – CNE (Electoral Nacional Council) and Banco de la Nacion in Peru.
- 32 -
Spacenet Rural Communications has consistently aimed to achieve and sustain competitive advantages by:
- 33 -
Spacenet Rural Communications intends to strengthen its business and grow using the following strategy:
Spacenet Rural Communications uses direct sales channels to market its services. It sales team is comprised of account managers and sales engineers, who are the primary account interfaces and work to establish account relationships and determine technical and business demands. There are a small number of identified government subsidized projects and USO deals in any given year and in Latin America in particular. The sales team spends anywhere from 6 to 12 months on the preparation of proposals for these projects. Some of the larger government bids in Latin America include service provision for up to ten years.
- 34 -
In countries in which Spacenet Rural Communications operates its own rural telephony and Internet networks, the services are sold to the local population, either directly or indirectly through resellers. The services rendered to the population are usage of public phones in order to make local, national and international calls and calls to cellular networks, and Internet access, or per usage for peripheral equipment such as printers and scanners. Spacenet Rural Communications predominantly sells its products pre-paid, so as to minimize the potential negative impact of unsuccessful collection.
VSAT Services
Spacenet Rural Communications’ VSAT service portfolio includes a variety of commercial-grade satellite service based on the SkyEdge VSAT platform. This platform offers full-time, shared-hub services with excellent performance characteristics (up to 2 Mbps inbound data rates), strong security and competitive pricing. Its services are all provided with service level agreements (SLAs) and advanced network monitoring/reporting, and can be delivered through multiple hardware platforms including transportable VSAT systems, ruggedized all-weather units or router-integrated network modules.
Spacenet Rural Communications also offers a variety of network management and application services. It provides comprehensive program management and network implementation services to its enterprise customers, as well as help desk, network management and field maintenance support.
BT and BOT projects
Spacenet Rural Communications offers a variety of “Build and Transfer” and “Build, Operate and Transfer” projects. These include full network design, installation, commissioning and operations. Some projects include a period where it operates the network and receive revenues directly from the end customers, or it may operate and receive revenues from the network owner, typically a PTO. These projects may also be extended by additional periods for operation of the VSAT network.
As a public rural telecom operator, Spacenet Rural Communications typically encounters competition from various service providers, system integrators and consortiums that offer competitive bids. Some of these are based on VSAT technology (either based on Gilat VSATs or based on competitive VSATs), some on terrestrial technology (typically Cellular, WLL, WiMAX or WiFi) and some on hybrid solutions with both satellite and terrestrial technology. We believe that Spacenet Rural Communications’ operational experience and Gilat technology give it a technological advantage in some of these tenders. In its operation stage, Spacenet Rural Communications encounters increased competition from terrestrial technologies, especially Cellular and WiMAX service providers.
The Latin American WAN market is competitive, with a number of established terrestrial and VSAT providers vying for nearly all contracts. Some of these service providers are larger than Spacenet Rural Communications in terms of revenue and resources, and it must leverage all of its technical and business strengths to compete effectively. The economies of scale we enjoy from our public rural telecom services has advantages over some of our competitors and can enable us to offer lower priced service.
- 35 -
The following table sets forth our revenues by geographic area for the periods indicated below as a percent of our total sales and includes countries in which revenues exceeded 10% in any of the reporting years:
(1)Includes revenues from related parties of 4.0%, and 1.2% and 0.8% for the years ended December 31, 2003, 2004 and 2005, respectively.
We have acquired certain entities and established certain key strategic marketing relationships and joint ventures, including the following:
Spacenet Inc. In December 1998, we acquired Spacenet Inc., a company engaged in providing VSAT-based network services, from SES Americom (formerly known as GE Americom) and certain affiliates.
As part of the Spacenet Inc. acquisition, we entered into several significant agreements with SES Americom. See Item 7: “Major Shareholders and Related Party Transactions — Related Party Agreements.” The acquisition of Spacenet Inc. has enabled us to expand from primarily manufacturing and selling VSAT equipment to becoming a provider of complete end-to-end telecommunications and data networking solutions based on VSAT satellite earth stations.
StarBand. In March 2000, we established a joint venture named StarBand Communications Inc.(formerly known as Gilat-to-Home, Inc.) with MSN, EchoStar and ING, to provide broadband Internet access via satellite to residential, SOHO and small business customers in North America. MSN and EchoStar originally invested $50 million each and ING invested $25 million in cash in StarBand in exchange for both senior convertible preferred and common shares, of the outstanding capital of StarBand. Following an additional investment by EchoStar, Gilat, through Spacenet Inc., owned approximately 35.0% of StarBand’s outstanding shares.
On May 31, 2002, StarBand filed a voluntary petition for reorganization under Chapter 11 of the U.S. Bankruptcy Code. In November 2003, StarBand emerged from bankruptcy and we held 49.1% of StarBand. Upon StarBand’s emergence from Chapter 11, and in consideration of the 49.1% shares issued to us at that time, we forgave approximately $84 million of debt provided by us to StarBand and we entered into three agreements with StarBand: (i) the restated master agreement for the supply of equipment and services upon the terms described above; (ii) a note and loan agreement providing for repayment of $14 million of “debtor in possession” financing supplied by us to StarBand during the Chapter 11 proceeding, bearing 3.5% annual interest and with quarterly payments to be made between March 31, 2004 and December 31, 2008 and principal payments to be made between March 31, 2006 and December 31, 2008; and (iii) a financing agreement for the provision of up to $7.5 million in revolving financing and trade credit, subject to various restrictions and reductions, through the end of 2009. In March 2005, we purchased the remaining 50.9% of StarBand shares then held by certain Israeli banks in consideration for $600,000. In addition, in the event certain events occur before December 31, 2007, including the sale of StarBand shares, the sale of substantially all of StarBand’s assets to a third party, the merger with a third party or the dissolution of StarBand, we have agreed to pay the banks an amount equal to fifty percent of the consideration received by us, directly or indirectly, as a result of such events. We have consolidated StarBand into our financial statements as of January 1, 2004.
- 36 -
Deterministic Networks Inc. In July 2000, we acquired all of the shares of Deterministic Networks, Inc. (“Deterministic”), a privately held company based in California. Deterministic is a supplier of policy-based networking products and toolkits to several major technology companies, providing quality of service, network management and Internet security capabilities that enhance the products and services of its customers. In September, 2005 we sold our ownership in this California-based subsidiary for an immaterial amount.
rStar. In January 2001, following a tender offer, we became the owner of 51% of the outstanding shares of rStar (a then publicly traded NASDAQ company ) at a cost of approximately $51 million. In May 2001, rStar issued 19,396,552 shares of its Common Stock to us in full satisfaction of its outstanding capital lease obligations to Spacenet Inc. in the amount of approximately $45 million, which resulted in our increasing our shareholdings in rStar to approximately 66%. In August 2002, we completed a transaction in which we acquired additional shares of rStar, increasing our ownership interest to approximately 85%. As part of this transaction, we sold to rStar the exclusive rights in certain Latin American countries to (i) implement, operate and market broadband Internet access services and voice services to residential consumers and SOHO subscribers, (ii) provide a bundled product with direct-to-home television service using a single satellite dish, and (iii) provide such new technologies and products related to the foregoing as we may in the future develop or make available to StarBand, which shall be offered to rStar upon commercially reasonable terms. Under the acquisition agreement, rStar purchased the outstanding capital stock of StarBand Latin America in exchange for 43,103,448 shares of its common stock. StarBand Latin America was created to provide, through local subsidiaries, two-way always on, high-speed Internet access and telephony to residential and SOHO customers in Latin America.
In December 2003, we entered into an agreement with certain rStar stockholders to acquire an additional 9.3% of rStar’s shares for $0.60 per share. In April 2004, immediately following such transaction, we effected a short-form merger and acquired the shares held by all other rStar stockholders. rStar is a holding company for most of our service entities in Latin America.
Satlynx S.A. In April 2002, together with SES Global SA (formerly known as SES Finance SA), we announced the formation of a new company that provides two-way satellite broadband communications services to enterprises, consumers and SOHO users throughout Europe. We and SES Global contributed cash and in kind contributions, which included existing facilities, transponder capacity, hubs, terminals, other technology and technical as well as marketing assistance. Gilat transferred six of its European subsidiaries (in Italy, Germany, the Czech Republic, England, Holland and France). As a result, substantially all of the service-providing business of Gilat in Europe was transferred to this joint venture. The transaction between Gilat and SES Global was completed on May 24, 2002. In June 2003, and in March 2004, Alcatel Space and Skybridge (Alcatel subsidiaries) invested cash and in-kind contributions in Satlynx. Subsequent to these transactions, we held approximately 40.6% of Satlynx’s issued shares. In April, 2005, following a restructuring of Satlynx’s obligations our holdings were reduced to 17%. In December 2005, following a conversion by SES of loans provided to Satlynx into Satlynx shares, our shareholdings were further reduced to less than 1%. Please see “Significant Changes”.
- 37 -
The 2005 year-end backlog for equipment sales and revenues from multi-year service contracts for our VSAT products was approximately $206 million, up from approximately $191 million at the year-end 2004. Backlog does not include revenues from future traffic on our rural networks, future revenues from subscribers from our consumer and enterprise operation and other cancelable agreements. Backlog is not necessarily indicative of future sales. Many of our contracts can be terminated at the convenience of the customer. In addition, some of our contracts may include product specifications that require us to complete additional product development. Any inability to meet the specifications or complete the product development could lead to a termination of the related contract.
We currently rely on a combination of patent, trade secret, copyright and trademark law, together with non-disclosure agreements and technical measures, to establish and protect proprietary rights in our products. Our patent portfolio includes 55 patents issued (24 U.S. and 31 foreign patents), 12 U.S. patent applications pending and 13 foreign applications pending. All of the patents and applications that were developed and/or owned by our subsidiaries have been formally transferred to the parent company and are now controlled by us. In addition, we have filed patent applications with respect to our SkyEdge family of products, as well as patents concerning a range of other inventions. As part of our patent program, Gilat intends to file additional patent applications on an ongoing basis.
We believe that our patents are important to our business. We also believe that the improvement of existing products, reliance upon trade secrets and unpatented proprietary know-how as well as the development of new products are generally as important as patent protection in establishing and maintaining a competitive advantage. We believe that the value of our products is dependent upon our proprietary software and hardware remaining “trade secrets” or subject to copyright protection. Generally, we enter into non-disclosure and invention assignment agreements with our employees, subcontractors and certain customers and other business partners. However, we cannot assure that our proprietary technology will remain a trade secret or that others will not develop a similar technology or use such technology in products competitive with those offered by us.
While we do not believe we are currently infringing any intellectual property rights of third parties, we cannot assure that other companies will not, in the future, pursue claims against us with respect to the alleged infringement of patents, copyrights or other intellectual property rights owned by third parties. In addition, litigation may be necessary to protect our intellectual property rights and trade secrets, to determine the validity of and scope of the propriety rights of others, or to defend against third-party claims of invalidity. Any litigation could result in substantial costs and diversion of resources and could have a material adverse effect on our business, financial condition and operating results.
We cannot assure that additional infringement, invalidity, right to use or ownership claims by third parties, or claims for indemnification resulting from infringement claims will not be asserted in the future. If any claims or actions are asserted against us, we may seek to obtain a license under a third party’s intellectual property rights. We cannot assure, however, that a license will be available under terms that are acceptable to us, if at all. The failure to obtain a license under a patent or intellectual property right from a third party for technology used by us could cause us to incur substantial liabilities and to suspend the manufacture of the product covered by the patent or intellectual property right. In addition, we may be required to redesign our products to eliminate infringement if a license is not available. Such redesign, if possible, could result in substantial delays in marketing of products and in significant costs. In addition, should we decide to litigate such claims, such litigation could be extremely expensive and time consuming and could materially adversely affect our business, financial condition and operating results, regardless of the outcome of the litigation.
- 38 -
The international telecommunications environment is highly regulated. As a provider of communications services in the United States, we are subject to the regulatory authority of the United States, primarily the FCC. We are also subject to regulation by the national communications authorities of other countries in which we provide service. Each of these entities can potentially impose operational restrictions on us. The changing policies and regulations of the United States and other countries will continue to affect the international telecommunications industry. We cannot predict the impact that these changes will have on our business or whether the general deregulatory trend in recent years will continue. We believe that continued deregulation would be beneficial to us, but also could reduce the limitations facing many of our existing competitors and potential new competitors.
We are required to obtain approvals from numerous national and local authorities in the ordinary course of our business in connection with most arrangements for the provision of services. The necessary approvals generally have not been difficult for us to obtain in a timely manner. However, the failure to obtain particular approvals has delayed, and in the future may delay our provision of services. Moreover, it is possible that any approvals that may be granted may be subject to materially adverse conditions.
All entities that use radio frequencies to provide communications services in the United States are subject to the jurisdiction of the FCC under the Communications Act of 1934, as amended, or the Communications Act. The Communications Act prohibits the operation of satellite earth station facilities and VSAT systems such as those operated by us except under licenses issued by the FCC. Major changes in earth station or VSAT operations require modifications to the FCC licenses, which must also be approved by the FCC. The licenses we hold are granted for ten-year terms. The FCC generally renews satellite earth station and VSAT licenses routinely, but we cannot guarantee that our licenses will be renewed at their expiration dates or that such renewals will be for full terms. In addition, certain aspects of our business may be subject to state and local regulation including, for example, local zoning laws affecting the installation of satellite antennas.
We must comply with the applicable laws and obtain the approval of the regulatory authority of each country in which we propose to provide network services or operate VSATs. The laws and regulatory requirements regulating access to satellite systems vary from country to country. Some countries have substantially deregulated satellite communications, while other countries maintain strict monopoly regimes. The application procedure can be time-consuming and costly, and the terms of licenses vary for different countries. In addition, in some countries there may be restrictions on our ability to interconnect with the local switched telephone network. In certain countries, there are maximum tariffs and fees set by the regulatory authority maximizing the fees that can be charged for the use of telephony services that we provide.
Israel is a member of the World Trade Organization and is a signatory of the General Agreement on Trade in Services and to the Agreement on Basic Telecommunications Services. Israel is a signatory to the General Agreement on Tariffs and Trade, which provides for the reciprocal lowering of trade barriers among its members. In addition, Israel has been granted preferences under the Generalized System of Preferences from the United States, Australia, Canada and Japan. These preferences allow Israel to export the products covered by such programs either duty-free or at reduced tariffs.
Israel and the European Union concluded a Free Trade Agreement in July 1975 that confers certain advantages with respect to Israeli exports to most European countries and obligates Israel to lower its tariffs with respect to imports from these countries over a number of years. In June 2000, Israel was admitted as an Associate Member of the European Union. In 1985, Israel and the United States entered into an agreement to establish a Free Trade Area that has eliminated all tariff and certain non-tariff barriers on most trade between the two countries. On January 1, 1993, Israel and the European Free Trade Association, or EFTA, entered into an agreement establishing a free-trade zone between Israel and the EFTA nations. In recent years, Israel has established commercial and trade relations with a number of other nations, (including Russia, the People’s Republic of China, India and nations in Eastern Europe and Asia), with which Israel had not previously had such relations.
- 39 -
We own a number of subsidiaries and affiliated companies that provide marketing and sales support, sell our VSAT products or provide related services. The following table sets forth our significant subsidiaries, as of March 15, 2006:
Our products are primarily designed, assembled, manufactured and tested at our facility in Petah Tikva, Israel. The net book value of the facilities in Petah Tikva is $67.7 million.
Our manufacturing facilities have sufficient capacity to handle current demand. We continuously adjust our capacity based on our production requirements. We also work with third party vendors for the development and manufacture of components integrated into our products, as well as for assembly of components for our products. We have implemented a multifaceted strategy focused on meeting customer demand for our products and reducing production costs. Our operations group, together with our research and development group, is working with our vendors and subcontractors to increase development and production efficiency in order to obtain higher component quantities at reduced prices.
We have network operations centers at Marietta, Georgia and shared hub facilities in Chicago, Illinois, Peru and Colombia, from which we perform network services and customer support functions 24 hours a day, 7 days a week, 365 days a year. The network operations centers allow us to perform diagnostic procedures on customer networks and to reconfigure networks to alter data speeds, change frequencies and provide additional bandwidth.
Our offices in McLean, Virginia comprise approximately 137,000 square feet, portions of which we sublease, such that our current monthly rental cost is approximately $318,120. These offices house our personnel and also contain one of our U.S. shared hub centers. In June 2000, we purchased the land and building facilities used by Spacenet Inc. for a purchase price of approximately $24.3 million. In March 2001, we sold these premises for approximately $31.5 million (net of related costs of approximately $1.5 million) and entered into a 15-year lease for this space, at an initial annual rent of approximately $3.7 million. In addition, we lease additional office space in McLean comprising approximately 42,500 square feet at a monthly rental of approximately $61,000. We also maintain space in Marietta, Georgia, Chicago, Illinois and Houston, Texas for sales and operations.
In 2000 and 2002, we purchased and developed facilities on approximately 140,400 square feet of land in Backnang, Germany, for approximately $13 million. In June 2001, we entered into a mortgage and loan agreement with a German bank, secured by our Backnang facilities. The mortgage is for approximately Euro 5.2 million, of which (i) approximately one-fifth bears interest at 5.86% and is repayable over 5 years commencing July 2001 and (ii) approximately four-fifths bears interest at 6.3% and is repayable quarterly over 20 years commencing July 2006. Since May, 2002, these facilities are leased to Satlynx.
We also maintain facilities in Santa Cruz, California; Austin, Texas; Atlanta, Georgia; and in South America in Brazil, Colombia, Mexico, and Peru, along with representative offices in Beijing, Melbourne, Pretoria, New Delhi, Almaty, Jakarta and Moscow and small facilities in other locations throughout the world.
- 40 -
Not applicable.
We are a leading provider of products and services for satellite-based communications networks. During the years ended December 31, 2003 and 2004, we operated under a single reportable business segment. As of January 2005, we changed our business reporting to reflect operation under two business units: Gilat Network Systems, or GNS, and Spacenet. During the third quarter of 2005, we further modified our segment reporting by dividing the Spacenet segment into two segments, and our Company’s 2005 financial statements reflect operation under three business units:
(i) Gilat Network Systems, a provider of network systems and associated professional services to service providers and operators; (ii) Spacenet, which provides managed services of data for enterprises, businesses and internet connectivity for consumers, primarily in the United States; and (iii) Spacenet Rural Communications, which provides telephone and internet access as an operator of networks in rural communities, primarily in Latin America.
Our reportable segments are differentiated by whether the nature of the transaction is dominated by an equipment sale, a GNS transaction, by the operation of an enterprise or consumer network, a Spacenet Inc. transaction or by the operation of a rural network in Latin America, a Spacenet Rural Communications transaction. Each of the segments is managed separately. For more detail, please see “Item 4: Information on the Company, Our Services Segments – Spacenet Inc. and Spacenet Rural Communications”
This discussion and analysis of our financial condition and results of operations is based upon our audited consolidated financial information included in this Form 20-F, and which has been prepared in accordance with accounting principles generally accepted in the United States.
The currency of the primary economic environment in which most of our operations are conducted is the U.S. dollar and, therefore, we use the U.S. dollar as our functional and reporting currency. Transactions and balances originally denominated in U.S. dollars are presented at their original amounts. Gains and losses arising from non-U.S. dollar transactions and balances are included in the consolidated statements of operations. The financial statements of foreign subsidiaries, whose functional currency has been determined to be their local currency, have been translated into U.S dollars. Assets and liabilities have been translated using the exchange rates in effect at the balance sheet date. Statements of operations amounts have been translated using the a specific exchange rate for each transaction. The resulting translation adjustments are reported as a component of shareholders’ equity in accumulated other comprehensive income (loss).
The preparation of the financial information in conformity with generally accepted accounting principles requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, mainly related to account receivables, inventories, deferred charges, long-lived assets, restructuring charges, revenues and contingencies. We base our estimates on historical experience and on various other assumptions, including assumptions of third parties, that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
- 41 -
We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our audited consolidated financial information included in this Form 20-F:
Revenues. A significant portion of our revenues is derived from the sale of products and services for satellite-based communications networks. Sale of products includes mainly the sale of VSAT’s and hubs. Services revenues include access to and communication via satellites (“space segment”), installation of network equipment, telephony services, internet services, consulting, on-line network monitoring, network maintenance and repair services. We sell our products primarily through a direct sales force and indirectly through resellers. Sales consummated by our sales force and sales to resellers are considered sales to end-users.
Revenues from 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. We do not grant rights of return. Service revenues are recognized ratably over the contractual period or as services are performed.
We record a significant amount of revenue from arrangements that involve the delivery or performance of multiple products, services and/or rights to use assets. A multiple-element arrangement is separated into more than one unit of accounting if the functionality of the delivered element(s) is not dependent on the undelivered element(s), there is vendor-specific objective evidence, or VSOE of fair value of the undelivered element(s) and delivery of the delivered element(s) represents the culmination of the earnings process for those element(s).
If these criteria are not met, the revenue is deferred until such criteria are met or until the period in which the last undelivered element is delivered. If there is VSOE for all units of accounting in an arrangement, the arrangement consideration is allocated to the separate units of accounting based on each unit’s VSOE.
Revenues from products under sales-type-lease contracts are recognized upon installation or upon shipment, in cases where the customer obtains its own or others installation services. The net investments in sales-type-leases are discounted at the interest rates implicit in the leases. The present values of payments due under sales-type-lease contracts are recorded as revenues at the time of shipment or installation, as appropriate. Future interest income is deferred and recognized over the related lease term as financial income.
Revenue from products and services under operating leases of equipment are recognized ratably over the lease period.
Cost of Revenues. Cost of revenues, for both products and services, includes the cost of system design, equipment, satellite capacity, customer service, interconnection charges and third party maintenance and installation. Generally, for equipment contracts, cost of revenues is expensed as revenues are recognized. For network service contracts, cost of revenues is expensed as revenues are recognized over the term of the contract. For maintenance contracts, cost of revenues is expensed as the maintenance cost is incurred or over the term of the contract. At each balance sheet date, we evaluate our inventory balance for excess quantities and obsolescence. This evaluation includes an analysis of sales levels by product and projections of future demand. In addition, we write off inventories that are considered obsolete. Remaining inventory balances are adjusted to the lower of cost or market value. If future demand for our old or new products or market conditions are less favorable than our projections, inventory write-offs may be required and would be reflected in cost of revenues for such period.
- 42 -
Accounts Receivable and Allowance for Doubtful Accounts. We are required to estimate our ability to collect our trade receivables. A considerable amount of judgment is required in assessing their ultimate realization. We provided allowance for our receivables relating to customers that were specifically identified by our management as having difficulties paying their respective receivables. This provision is in addition to a general allowance which we have provided to cover additional potential exposures. If the financial condition of our customers deteriorates, resulting in their inability to make payments, additional allowances may be required. These estimates are based on historical bad debt experience and other known factors. If the historical data we used to determine these estimates does not properly reflect future realization, additional allowances may be required. See “Restructuring Charges, Write-Offs and Other Significant Charges” below.
Inventory Valuation. We are required to state our inventories at the lower of cost or market price. In assessing the ultimate realization of inventories, we are required to make judgments as to future demand requirements and compare that with the current or committed inventory levels.
Impairment of Goodwill, Intangible Assets, Long-Lived Assets, and Investment in Affiliated Companies. Our business acquisitions resulted in goodwill and other intangible assets. We periodically evaluate our goodwill, intangible assets, long-lived assets and investments in affiliates for potential impairment indicators. Our judgments regarding the existence of impairment indicators are based on legal factors, market conditions and operational performance of our acquired businesses and investments.
Our long-lived assets are reviewed for impairment annually and whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of the assets to the future undiscounted cash flows expected to be generated by the assets. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. In measuring the recoverability of assets, we are required to make estimates and judgments in assessing our five year forecast and cash flows, which is the estimated useful life of our current primary asset, and compare that with the carrying amount of the assets. Additional significant estimates used by management in the methodologies used to assess the recoverability of our long-lived assets include estimates of future short-term and long-term growth rates, market acceptance of products and services, our success in wining bids and other judgmental assumptions, which are also affected by factors detailed in our risk factors section in this annual report. If these estimates or the related assumptions change in the future, we may be required to record impairment charges for our long-lived assets.
Our investments in other companies are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an investment may not be recoverable.
For all of the above, see “Restructuring Charges, Write-Offs and Other Significant Charges” below.
Future events could cause us to conclude that impairment indicators exist and that additional intangible assets associated with our acquired businesses and our long-lived assets are impaired. Any resulting impairment loss could have a material adverse impact on our financial condition and results of operations.
Restructuring and Other Non-Recurring Charges. During fiscal year 2003, we recorded significant charges in connection with our restructuring plans. These restructuring charges include estimates pertaining to contractual obligations, primarily facilities-related operating leases, resulting from our actions. We estimated facility exit costs for certain under-utilized facilities and made assumptions regarding a sublessee’s future rental rate, as well as the amount of time required to identify a sublessee. Such liabilities were recorded at fair value and are updated for any charges in fair value every period. Our restructuring charge would have been higher had we assumed a lower future rental rate or a longer period of time required to identify a sublessee.
- 43 -
Legal and Other Contingencies. We are currently involved in certain legal and other proceedings and are also aware of certain tax and other legal exposures relating to our business. We are required to assess the likelihood of any adverse judgments or outcomes of these proceedings or contingencies as well as potential ranges of probable losses. A determination of the amount of accruals required, if any, for these contingencies is made after careful analysis. The accounting treatment for such proceedings is prescribed by the Statement of Financial Accounting Standards No. 5, “Accounting for Contingencies” (“SFAS No. 5”). SFAS No. 5 defines a contingency as “an existing condition, situation, or set of circumstances involving uncertainty as to possible gain or loss to an enterprise that will ultimately be resolved when one or more future events occur or fail to occur.” In accordance with SFAS 5, accruals for exposures or contingencies are being provided when the expected outcome is probable. It is possible, however, that future results of operations for any particular quarter or annual period could be materially affected by changes in our assumptions, the actual outcome of such proceedings or as a result of the effectiveness of our strategies related to these proceedings.
The following disclosure provides in-depth background for each financial year which will enable a better analysis of our financial condition and results of operations.
2003. In October 2002, we commenced an arrangement to restructure our debt with holders of our convertible bonds, bank lenders and other creditors, which was successfully completed in March 2003. In 2003, our financial weakness in the early part of the year continued to impact our orders globally and in particular in the United States. At that time, our management went through significant change, with the resignation of our CEO and President (founders of our company) and the resignation of the CEO of Spacenet Inc. On April 15, 2003, our shareholders elected an almost entirely new board of directors and Chief Executive Officer and President. Also, during 2003, our COO, CFO, and other members of senior management resigned. In June 2003, new management imposed an additional set of lay-offs and budget cuts and embarked on an effort to streamline our operations in order to increase efficiency and reduce costs. This effort included a variety of measures including organizational and structural changes and office consolidation as well as the involuntary termination of 88 employees worldwide. The reductions have resulted in a decrease in annual expenses of approximately $16 million. In November 2003, we concluded an exchange offer pursuant to which the majority of the holders of our new notes (that were issued in March 2003 as partial consideration for the exchange of $350 million of 4.25% convertible subordinated notes) converted their new notes into equity. As a result of all of the above factors, we recorded the following charges in 2003:
Based on our periodic review of the carrying value of our long-lived assets we recorded the following impairments:
- 44 -
In addition, we reversed $3.3 million of the impairment of our investment in a Brazilian company due to an option exercise related to our investment in such company.
Details Regarding the Restructuring of Our Debt in 2003. In March 2003, an Israeli court approved an arrangement with our creditors that provided for the restructuring of our debts, which included the following changes to our current commitments and the creation of new commitments:
As part of the arrangement approved by the Israeli court, we granted to the banks referred to above, in addition to existing security interests in their favor, a first priority security interest consisting of a floating charge on all of our assets and we pledged for their benefit all of the shares that we own in Spacenet Inc. We granted a second priority security interest in the same collateral to the holders of the new notes.
In March 2003, we finalized the financial restructuring arrangement described above. As a result, we reduced our principal debt by approximately $309 million, which included $12 million of accrued interest. The arrangement significantly increased our shareholders’ equity, reduced our debt and reduced our financing costs. We recorded an increase in our shareholder capital in the amount of $55.2 million (net of expenses in the amount of $2.8 million) and a gain of approximately $185.6 million (net of related expenses in the amount of approximately $11.9 million) and $5.7 million in tax expenses. The related expenses included settlement payments to outgoing management in the amount of $2.4 million and debenture issuance expenses in the amount of $4.1 million.
In October 2003, we improved our financial condition by consummating an exchange offer to the holders of our new notes and exchanging the majority of the notes for ordinary shares at a rate of 125 of our ordinary shares for each $1,000 principal amount of our new notes. In November 2003, we closed the exchange offer with the participation of a majority of our note holders, reducing our debt by approximately $76.0 million, which included $2.3 million of accrued interest. We recorded an increase in our shareholders’ equity in the amount of $45 million and an additional gain relating to this completed debt restructuring of approximately $58.6 million.
- 45 -
We accounted for the first debt restructuring included in the arrangement on the basis of a combination of types of restructuring and on the basis of modification of terms as part of a troubled debt restructuring, and for the debt to equity conversion on the basis of equity interest in full settlement in accordance with SFAS 15. As a result of the arrangements, we recorded the shares issued at their fair value in our shareholders’ equity at the date of the closing. In addition, we recorded the estimated future interest payments to be made in connection with the repayments of the new notes and the loans in our consolidated balance sheet, and recorded a capital gain from restructuring of debt in our consolidated statements of operations.
2004.
In November 2003, upon StarBand’s emergence from Chapter 11, we determined that we did not control StarBand since we did not hold the majority of its voting interest and could not gain control in any other way over such company. In the first quarter of 2004, we evaluated the applicability of FIN 46 on our investment in StarBand. Fin 46 requires consideration and estimates of a significant number of possible future outcomes of the Variable Interest Entity, or a VIE, as well as the probability that each of the outcomes will occur. The results of each possible outcome are allocated to the parties holding interests in the VIE and a calculation is performed to determine which party, if any, has a majority of potential negative outcome (expected losses) or a majority of the potential positive outcomes (expected residual returns). That party, if any, is the VIE’s primary beneficiary and is required to consolidate the VIE.
As of January 1, 2004, we analyzed whether StarBand was able to finance its activities without additional subordinated financial support from other parties and concluded that the equity investment at risk was not greater than the expected losses of the entity. Accordingly we concluded that StarBand is a VIE. Through our analysis, we concluded that we were the primary beneficiary of StarBand, and as such, we consolidated StarBand into our consolidated financial statements.
In addition, we analyzed whether Satlynx could finance its activities without additional financial support from other parties and concluded that the equity investment at risk was not greater than the expected losses of the entity. Accordingly, we believed that Satlynx is a VIE. As such, we performed an analysis and concluded that we did not absorb the majority of Satlynx’s expected losses and we would not receive the majority of the residual return. Accordingly, we believed that we were not the primary beneficiary of Satlynx, and therefore Satlynx was not consolidated into our consolidated financial statements. In addition, we have not provided any undertaking or commitment to finance the losses of Satlynx. For more details, see “2005".
In April 2004, we further revised the terms of our loan from Bank Hapoalim, to whom we owed a principal debt amount of $71.4 million. As part of this amendment, we granted Bank Hapoalim a right to receive a warrant or warrants for the purchase of our ordinary shares. The maximum exercise amount to be paid under the warrant is equal to the then-outstanding balance on the loan due by us. The modification of the loan terms was accounted for as a debt extinguishment due to the addition of a conversion option to the debt instrument which was considered substantial. The fair value of the amended loan was recorded, and the book value of the old loan was removed from our financial statements. Since Bank Hapoalim is a related party, the extinguishment gain of approximately $15.5 million was recorded as an equity contribution. For the repayment terms of this loan and current warrant information, please see details of the further revisions to this loan described in “2005” below.
In April of 2004, we also completed the short-form merger of rStar and we recorded a gain of $ 0.2 million from a derecognition of liabilities (see “Item 4 – Strategic Alliances, Joint Ventures and Acquisitions”.)
- 46 -
In June 2004, our then CEO and President resigned and was replaced by Mr. Shlomo Rodav who served as CEO and Chairman of the Board of Directors until July 2005.
In the third quarter of 2004, as a result of decreased future undiscounted cash flow from a certain customer and in accordance with FAS 144, we decreased the carrying value of an asset and recorded an impairment of property and equipment in an amount of approximately $2.2 million.
In September 2004, we closed an agreement for the sale of Spacenet International Services, Inc. and its only subsidiary, Servicio Satelital S.A., an Argentinean company. The consideration received was $0.6 million paid upon the closing and an additional amount of $0.5 million to be paid in installments through September 2006. We recorded a loss from this transaction in the amount of $0.2 million.
2005.
At the beginning of 2005, we purchased the minority shares of StarBand for $ 0.6 million and consolidated the operation of this entity with Spacenet Inc.
In addition, during 2005, our holding in Satlynx was diluted to 0.17% from 41.6% at the end of 2004. For information about our further dilution in Satlynx, please see Item 8: “Significant Changes”.
We also sold our 100% ownership in Deterministic Networks Inc., a California-based subsidiary, for an immaterial amount. We recorded a capital loss of $0.2 million associated with this transaction.
In July 2005, Bank Hapoalim assigned our outstanding loan to York Capital Management Ltd. As part of that transaction, Bank Hapoalim and an additional shareholder, Mivtach Shamir, granted a proxy to York to vote a portion of their shares in our Company. Following the assignment and the related transactions, York is considered a related party. At that time, six out of seven of our board members resigned and were replaced by new board members. In addition, our CEO and chairman of the board resigned and was replaced by our co-founder Amiram Levinberg. For more details, please see “Item 7: Major Shareholders and Related Party Transactions”.
In December 2005, we again revised the terms of the loan with Bank Hapoalim (now assigned to York). Under the amendment, York agreed to defer $19.35 million of principal payments due in installments from January 5, 2006 through January 1, 2008. The new payment schedule provides that: (i) no principal payments will be due in 2006, 2007 or January 2008 (with those payments being deferred until July 2012) (ii) approximately $4.5 million will be paid on July 1, 2008; (iii) approximately $9 million will be paid in semi-annual installments on January 1 and July 1 of 2009, 2010 and 2011; and (iv) approximately $39 million will be paid in 2012.
- 47 -
In consideration for the above, we agreed to revise the terms of the warrant issuable to York (formerly issuable to Bank Hapoalim) for the period until September 30, 2006. During this period, the exercise price of the warrant is $6.75 per share. In addition, during this period we have been granted the right to require the conversion of the outstanding loan from York at $6.75 in the event that our average closing share price of our ordinary shares as published by NASDAQ over twenty consecutive trading days will exceed $9.00, or the Triggering Price, provided that the aggregate trading volume during this twenty day period is a minimum of 1,700,000 ordinary shares. Beginning October 1, 2006, the exercise price of the warrant will revert to the original terms, which is equal to the average closing sale price of our shares, as published by the NASDAQ Stock Market over the thirty (30) consecutive trading days immediately preceding the day of the notice of exercise by the warrant holder plus 1%, however, in no event shall the per share price be less than $7.50 or in excess of $40.00. In addition, in the event that in the three-year period in which York can request the issuance of the warrant, we complete a private placement investment by a third party in Gilat for an amount which exceeds $20 million, we are required to enable the holder of the warrant to exercise such warrant based on the same price offered in the private placement. Once issued to a holder, the warrant is exercisable for a thirty-day period only. The warrant can be issued at any time at the request of York between July 1, 2004 and June 30, 2007. As set forth in the loan agreement, the proceeds payable to Gilat from the exercise of a warrant will be applied to reduce all future installments of the principal due to York, on a pro-rata basis.
The following provides information about our business during 2003, 2004 and 2005. The information is presented as if our business was operating under the new business segments since 2003. The financial information was extracted, from a practical prospective, from the consolidated results reported for those years.
- 48 -
Revenues in 2005 were derived 42.4% from equipment and 57.6% from services. In 2004, our revenues were derived 41.5% from equipment and 58.5% from services. The decrease in service revenues in 2005 is attributed to the following factors: (i) a decrease of approximately $17 million in revenues from Spacenet Rural Communications as a result of the closure of our operation of the GESAC network in Brazil which had a low operational margin, offset by an increase in subsidy and traffic revenues from the Compartel project in Colombia; and (ii) a decrease in the sale of services in our GNS operation. The decrease in equipment sales is attributed to: (a) an increased number of sales in 2005 which are comprised of transactions that include the provision of bundled equipment, solutions and services, which are recognized over the period in which services are provided; (b) overall industry-wide price reductions.
- 49 -
Gross profit:
The increase in our gross profit margin from 31.9% in 2004 to 36.4% in 2005 can be attributed mainly to the following factors: (i) reduced operating expenses in our Spacenet Inc. operations, mainly relating to lower space segment expenses, the operational merger of StarBand and Spacenet Inc. and lower depreciation and amortization expenses, ; (ii) in Spacenet Rural Communications, since the GESAC project embedded a very low margin, the shut down of its operation, increased our services gross margin; (iii) in our GNS segment, we experienced higher profit margins and decreased wages and overhead costs due to a reduction in headcount worldwide in 2005 and (iv) also in GNS, in 2004, we wrote off $2 million of excess inventory in GNS as part of our cost of goods sold compared to approximately $0.5 million in 2005.
When reported by segment, the results of Spacenet Inc. and Spacenet Rural Communications are presented based upon transfer prices. The consolidation line reflects the intercompany profits that have been realized in order to adjust the transfer price to Gilat’s cost.
- 50 -
Net research and development costs increased slightly in 2005 primarily due to a lower amount of grants received from (a) SES Global, due to the completion of the research and development project performed on their behalf; and (b) the Office of the Chief Scientist (due to a decrease in their overall budget), offset by (i) the transfer of the remaining research and development operations from Spacenet Inc. to our GNS segment in Israel at the beginning of 2005, which eliminated research and development in costs in Spacenet Inc. and did not significantly increase research and development costs in Israel; (ii) a decrease in the level of depreciation and amortization; and (iii) the sale of Deterministic Networks Inc. in September 2005.
Selling, marketing, general and administrative expenses decreased in 2005 by $9.1 million. The decrease can be attributed mainly to (i) given that overall sales in 2005 were reduced, selling expenses related thereto were also reduced by approximately $4.5 million; (ii) a reduction in depreciation and amortization expenses of approximately $1.4 million; (iii) the completion of the GESAC project resulted in layoffs and reduced expenses in an amount of approximately of $1.2 million; (iv) a reduction of lease expenses in an amount of $1.2 million due to increased subleasing of our premises in Israel and additional reduced expenses due to having closed or reduced the size of certain regional offices; and (v) legal expenses of $0.5 million incurred in 2004 in connection with the emergence of StarBand from Chapter 11.
Financial Expenses, Net. In 2005, we had financial expenses of approximately $2.7 million compared to approximately $0.3 million in 2004. The sharp increase in our financial expenses is mainly attributed to (i) an increase in the LIBOR interest rate, to which some of Gilat’s loans are linked; and (ii) the modification of the Bank Hapoalim loan in April 2004 which led to an increase in the overall financial expenses recorded in 2005
Taxes on Income. Taxes on income decreased by approximately $1.3 million to approximately $3.1 million in 2005 compared to approximately $4.4 million in 2004, primarily due to a decrease in tax expenses in our Brazilian subsidiaries caused by a reduction of our activities in Brazil, offset by additional expenses recorded in connection with our Israeli tax settlement in 2005.
- 51 -
Equity in Earnings of Affiliated Companies. Equity in earnings of affiliated companies was approximately $0.4 million in 2005, compared to approximately $1.2 million in 2004.The equity in earnings includes the collection of amounts reserved in prior years.
Revenues in 2004 were derived 41.5% from equipment and 58.5% from services. In contrast, in 2003, our revenues were derived 63.5% from equipment and 36.5% from services. The increase in service revenues in 2004 is attributed to the following factors: (i) an increase in our service revenues from our Spacenet Inc. operation; (ii) the consolidation of StarBand, which increased our service revenues by approximately $26 million; (iii) a significant increase in our rural operation as a result of the progress in the implementation of the Compartel projects in Colombia, the operation of the GESAC network in Brazil and increased traffic on the networks in both Colombia and Peru; and (iv) an increase in the sale of services in our GNS segment. The decrease in equipment sales is attributed to: (a) a decline in sales to large-scale customers when compared to the prior year in our Spacenet Inc. operation; (b) the completion of installation of equipment in the Fitel projects in Peru in 2003; and (c) overall industry-wide price reductions and a decline in the number of large-scale sales to customers in our GNS segment. The decrease in equipment sales was offset by the consolidation of StarBand which increased our equipment revenues by approximately $2.4 million.
- 52 -
The increase in our gross profit margin in 2004 can be attributed to the following factors: (i) an increase in gross profits from our rural operations, primarily due to the implementation of the Compartel project and better efficiency in the maintenance of our network operations; (ii) in our GNS segment, higher profit margins in 2004 than in past years and a decrease in the amount of inventory write-offs from approximately $6.4 million in 2003 to approximately $2.0 million in 2004; and (iii) cost reductions attributed to the implementation of our restructuring plan in June 2003 which led to a decrease in personal and other related expenses in all of our segments. When reported by segment, Spacenet Inc. and Spacenet Rural Communication results are presented based upon transfer prices. The consolidation line reflects the effect of unrealized profits derived from the transactions between GNS, Spacenet, and Spacenet Rural Communications in order to adjust the transfer price to Gilat’s cost.
Our service cost of revenues decreased due to higher levels of business efficiency within the Company. Specifically, while our cost of service revenues increased on an absolute US Dollar basis, the cost decreased as a percentage of service revenues in 2004, due to the following factors: (i) certain significant expenses were reduced as part of our restructurings in 2003, such as transponder capacity costs which were reduced due to the renegotiation of the agreement with our major provider; (ii) depreciation expenses were reduced due to an impairment of long-lived assets in 2003 in accordance with FASB 144; (iii) wages and overhead costs decreased due to a reduction in headcount; and (iv) as described above, we had higher profit margins and more revenue streams in 2004.
- 53 -
Net research and development costs decreased in 2004 primarily due to the transfer of research and development operations from Spacenet Inc. to Israel, which resulted in significant decrease in costs in Spacenet Inc. and no relative significant increase in research and development costs in Israel. Grants for research and development received by us remained approximately the same and reflect an increase of approximately $1.5 million of grants received from SES Global, offset by a decrease of approximately $1.3 million of Chief Scientist grants.
Selling, marketing, general and administrative expenses decreased in 2004 by $3.2 million. The decrease can be attributed mainly to overall staff reductions which led to a decrease in the salaries and related expenses in the amount of approximately $3.5 million, reduced depreciation and amortization expenses of approximately $1.4 million, reduced professional fees and legal claims of approximately $2.5 million and the going-private of rStar which reduced fees associated with being a public company including directors and officers insurance, on-going public filing fees by approximately $1.0 million and lower levels of write-offs of doubtful accounts of approximately $0.7 million.. The decrease was offset by the consolidation of StarBand, in the amount of approximately $5.8 million and by lower levels of write offs of doubtful accounts in the amount of approximately $0.7 million.
Impairment of Goodwill, Tangible and Intangible Assets. In 2004, as a result of decreased future undiscounted cash flow from a certain customer, we decreased the carrying value of an asset and recorded an impairment of property and equipment in an amount of approximately $2.2 million. In 2003, our sales decreased as a result of both the continued economic slowdown and due to our focus on the restructuring of our debt and as a result, we recorded an impairment of tangible and intangible assets of approximately $31.9 million.
Financial Expenses, Net. In 2004, we had financial expenses of approximately $0.3 million compared to approximately $3.3 million in 2003. The sharp decrease in our financial expenses is explained primarily by (i) the successful completion of the restructuring of our debt in March and November 2003, which led to a sharp decrease in interest expenses associated with our debt; and (ii) in 2004, we had an increase in our interest income due to the increase in our cash balances.
- 54 -
Taxes on Income. Taxes on income decreased by approximately $5.3 million to approximately $4.4 million in 2004 compared to approximately $9.7 million in 2003 primarily due to the taxes accrued in 2003 in relation to the restructuring of our debts, which were not accrued in 2004.
Equity in Earnings of Affiliated Companies. Equity in earnings of affiliated companies was approximately $1.2 million in 2004, compared to approximately $0.5 million in 2003.The 2003 amount includes both Satlynx and StarBand while in 2004, due to the consolidation of StarBand, only Satlynx is included.
Minority Interest in Losses of a Subsidiary. Minority interest in losses of a subsidiary was approximately $0.2 million in 2004, compared to approximately $0.9 million in 2003. The 2004 figure reflects the minority share of rStar until April 2004, at which time we effected a short-form merger and as such, became the 100% owner of rStar.
Our revenues and profitability may vary from quarter to quarter and in any given year, depending primarily on the sales mix of our family of products and the mix of the various components of the products (i.e. the volume of sales of remote terminals versus hub equipment and software and add-on enhancements), sale prices, and production costs, as well as entering into new service contracts, the termination of existing service contracts, or different profitability levels between different service contracts. Sales of our products to a customer typically consist of numerous remote terminals and related hub equipment and software, which carry different sales prices and margins.
Annual and quarterly fluctuations in our results of operations may be caused by the timing and composition of orders by our customers and the timing of our ability to recognize revenues. Our future results also may be affected by a number of factors, including our ability to continue to develop, introduce and deliver new and enhanced products on a timely basis and expand into new product offerings at competitive prices, to anticipate effectively customer demands and to manage future inventory levels in line with anticipated demand. Our results may also be affected by currency exchange rate fluctuations and economic conditions in the geographical areas in which we operate. In addition, our revenues may vary significantly from quarter to quarter as a result of, among other factors, the timing of new product announcements and releases by our competitors and us. We can not be certain that revenues, gross profit and net income (or loss) in any particular quarter will not be vary from the preceding or comparable quarters. Our expense levels are based, in part, on expectations as to future revenues. If revenues are below expectations, operating results are likely to be adversely affected. In addition, a substantial portion of our expenses is fixed (i.e. space segment, lease payments,) and adjusting the expenses in cases where revenues drop unexpectedly often takes considerable time. As a result, we believe that period-to-period comparisons of our results of operations are not necessarily meaningful and should not be relied upon as indications of future performance. Due to all of the foregoing factors, it is possible that in some future quarters our revenues or operating results will be below the expectations of public market analysts or investors. In such event, the market price of our shares would likely be materially adversely affected.
Our business historically has not been affected by seasonal variations.
Since inception, our financing requirements have been met through cash from funds generated by private equity investments, public offerings, issuances of convertible notes bank loans, operations, as well as funding from research and development grants. In addition, we also finance our operations through available credit facilities as discussed below. We have used available funds primarily for working capital, capital expenditures and strategic investments. While we are likely to seek additional sources of funding for our operations through bank lenders or equity financing, we believe that we have sufficient funds to operate our business in 2006 and 2007. Thereafter, if we do not have available sufficient cash to finance our operations, we may be required to obtain additional debt or equity financing. We cannot be certain that we will be able to obtain, if required, additional financing on acceptable terms, or at all. If we are to raise additional funding through an equity investment, any such transaction will dilute the holdings of our present shareholders.
- 55 -
As of December 31, 2005, we had cash and cash equivalents of $74.9 million, short-term bank deposit of $3.3 million, short-term and long-term restricted cash of $22.5 million, short-term and long-term restricted cash held in trustees’ accounts of $20.3 million and short-term bank credit of $8.2 million. As of December 31, 2004, we had cash and cash equivalents of $75.8 million, short-term and long-term restricted cash of $21.7 million, restricted cash held in trustees’ accounts of $29.6 million and short-term bank credits of $4.2 million.
Our cash and cash equivalents decreased in 2005 by $0.9 million as a result of the following:
Operating activities. In 2005, cash provided by operating activities was approximately $3.7 million and was comprised of amounts provided by: (i) a decrease in other assets (including short-term, long-term and deferred charges) in the amount of $6.7 million; (ii) an increase in other accounts payable and other long-term liabilities in the amount of $3.5 million; (iii) an increase in trade payables in the amount of $2.9 million; and (iv) net cash provided by other operating activities in the amount of $13.3 million, net of (a) an increase in advances from a customer held by trustees (including long-term) in the amount of $10.4 million; (b) a decrease in inventories in the amount of $5.2 million; (c) a decrease in accrued expenses in the amount of $4.7 million (net of a $5.1 million payment made in the settlement of our 1998-2003 tax assessments in Israel and $5.6 million in interest payments for our long term debt); and (d) an increase in trade receivables in the amount of $2.4 million.
Investing activities. In 2005, cash used in investing activities was approximately $1.3 million, and was comprised of: (i) investments in restricted cash held by trustees in the amount of $3.3 million net of $13.1 million cash that was released from a trust account; (ii) the purchase of property and equipment in the amount of $3.6 million; (iii) loans to employees, net in an amount of approximately $3.6 million; (iv) a net investment in short-term bank deposits in the amount of $3.3 million; (v) net investments in short-term and long-term restricted cash in the amount of $0.8 million; and (vi) net cash received from the disposal of a subsidiary in the amount of $0.2 million, net of a $0.4 million return on an investment.
Financing activities. In 2005, cash used in financing activities was approximately $3.6 million, and was comprised mainly from principal payments on loans and convertible loan in the amount of $8.8 million, net of (i) proceeds from short term bank credit in the amount of $4 million; and (ii) proceeds from the exercise of options in the amount of $1.2 million.
The $20.3 million of restricted cash held in a trustee’s account relates to funds collected from our largest project in Colombia. The release of these funds from the trust is dependent both on a schedule of payments and on the achievement of operational milestones. In 2005, we released from the trust account approximately $13.1 million (irrespective of the $20.3 currently held in the trust). Based on the milestones and scheduling of payment set forth in the project contract, we expect to collect from restricted cash approximately $6.6 million in 2006. However, in the remote event that we do not meet certain milestones, or if the bids are terminated unilaterally by the government of Colombia, we may be unable to receive this restricted cash.
Our inventory levels decreased significantly in 2003 and 2004 and increased slightly in 2005. In 2006, we expect to increase our inventory levels in an effort to respond to heightened short-term needs for products.
We repaid $4 million in principal to Bank Leumi in 2005. The loan is scheduled to be repaid by principal payments of $4 million annually during each of the years 2006 through 2011.
- 56 -
In July 2005, Bank Hapoalim assigned our outstanding loan in the amount of $70.4 million to York Capital Management Ltd. Please see “2005” above.
The deed of pledge securing our obligations to Bank Leumi and an additional Israeli bank sets forth events which entitle the banks to declare their respective outstanding amounts due and payable. Our obligations include a loan from Bank Leumi for $24 million and an informal credit facility for guarantees aggregating $13.2 million from the banks.
Our credit agreements contain various restrictions and limitations that may impact us. These restrictions and limitations relate to incurrence of indebtedness, contingent obligations, liens, mergers and acquisitions, asset sales, dividends and distributions, redemption or repurchase of equity interests, certain debt payments and modifications of loans and investments.
As of December 31, 2005, our short and long term obligations were as follows:
(*) In December 2005, we revised the terms of our loan with York. The fair value of the change in the conversion feature of the loan in the amount of $3.8 million was recorded as a reduction of the loan and an increase in the shareholder’s equity. The fair value will be amortized to financial expenses over the term of the loan.
(**) Future interest payments are not included due to variability in interest rates.
At times, we guarantee the performance of our work to some of our customers (primarily government entities). Guarantees are often required for our performance during the installation and operational periods of long-term rural telephony projects such as in Latin America, and for the performance of other projects (government and corporate) throughout the rest of the world. The guarantees typically expire when certain operational milestones are met.
At December 31, 2005, the aggregate amount of bank guarantees provided in order to secure our performance obligations is approximately $15.4 million, comprised mainly of performance guarantees provided on behalf of our subsidiary in Peru in an amount of approximately $9.1 million. We have restricted cash as collateral for these guarantees in an amount of approximately $7.4 million.
In addition, we have provided corporate and bank guarantees for certain leases throughout the world, lines of credit and capital lease agreements for an aggregate amount of approximately $21.5 million. We have restricted cash as collateral for these guarantees in an amount of approximately $5.7 million.
From time to time, our parent company provides corporate guarantees to guarantee the performance of our subsidiaries, including for example, a currently outstanding guarantee for projects in Colombia of approximately $ 60.1 million. We have not recorded any liability for the above amounts, as we expect that our performance will be acceptable. No guarantees have ever been exercised against us.
- 57 -
While most of our sales and service contracts are in U.S. dollars and most of our expenses are in U.S. dollars and NIS, portions of our projects in Latin America are linked to their respective local currencies. The foreign exchange risks are often significant due to fluctuations in local currencies relative to the U.S. dollar.
The U.S. dollar cost of our operations in Israel is influenced by the extent to which any increase in the rate of inflation in Israel is not offset (or is offset on a lagging basis) by a devaluation of the NIS in relation to the U.S. dollar. The influence on the U.S. dollar cost of our operations in Israel relates primarily to the cost of salaries in Israel, which are paid in NIS and constitute a substantial portion of our expenses in NIS. In 2005, there was inflation in Israel of 2.4% while the NIS depreciated in relation to the U.S. dollar at a rate of 6.8%, from NIS 4.3 per $1 on December 31, 2004 to NIS 4.6 per $1 on December 31, 2005. In 2004 inflation in Israel was 1.2% while the NIS appreciated in relation to the U.S. dollar at a rate of 1.6%. In 2003, the rate of deflation in Israel was 1.9% while the NIS appreciated in relation to the U.S. dollar at a rate of 7.6%. If future inflation in Israel exceeds the devaluation of the NIS against the U.S. dollar or if the timing of such devaluation lags behind increases in inflation in Israel, our results of operations may be materially adversely affected.
Regarding the changes in the value of other foreign currencies in relation to the U.S. dollar, our monetary balances that are not linked to the U.S. dollar impacted our financial expenses during the twelve-month periods ended December 31, 2005 and 2004. This is due to heavy fluctuations in currencies in certain regions of Latin America in which we do business. There can be no assurance that in the future our results of operations may not be materially adversely affected by other currency fluctuations. See Item 11: “Quantitative and Qualitative Disclosures About Market Risk.”
We do not engage in hedging transactions to manage our exposure to interest rate and currency fluctuations.
Israeli companies are generally subject to income tax at the rate of 34% of taxable income in 2005. However, most of our production facilities in Israel have been granted Approved Enterprise status under Israeli law for Encouragement of Capital Investments, 1959, and consequently are eligible for certain tax benefits for the first several years in which they generate taxable income. We currently have nine Approved Enterprises. Income derived from the nine Approved Enterprises is entitled to tax benefits for periods of seven years (in the case of two of the enterprises) or ten years (for the remaining seven enterprises), from the first year in which we generate income from the respective Approved Enterprise, on the basis of the nature of the incentives selected by us. The main tax benefits are a tax exemption for two or four years and a reduced tax rate of 15% to 25% for the remainder of the benefits period depending upon the level of foreign ownership of us.
In 2003, we had a loss for tax purposes mainly due to recognition of StarBand bad debts and a ruling we obtained from the Israeli tax authorities regarding the gain from restructuring of debts. In 2004 and 2005 we also had losses for tax purposes and therefore could not realize any tax benefits. We anticipate that we will not have to pay taxes relating to 2006 tax year for most of our entities due to current and/or carry forward tax losses. Cash outlays for income taxes in the future might be different from tax expenses mainly due to cash tax payments for previous years that might be triggered by tax audits in the various tax jurisdictions, deferred tax expenses and payments usually made in arrear for annual taxes in profitable years.
- 58 -
On January 1, 2003, a comprehensive tax reform took effect in Israel. Pursuant to the tax reform, resident companies are subject to Israeli tax income accrued or derived in Israel or abroad. In addition, the concept of a “controlled foreign corporation” was introduced, according to which an Israeli company may become subject to Israeli taxes on certain income of a non-Israeli subsidiary if the subsidiary’s primary source of income is passive income (such as interest, dividends, royalties, rental income or capital gains). The tax reform also substantially changed the system of taxation of capital gains. Following the reform, the capital gains tax rate applicable to us was decreased from 36% to 25%, while the allocation of the gain between the two periods is proportional to the holding periods until December 31, 2002, and after December 31, 2002. In 2005, the tax reform did not have any material effect on our liquidity, financial condition and results of operations.
We devote significant resources to research and development projects designed to enhance our VSAT products, to expand the applications for which they can be used and to develop new products. We intend to continue to devote research and development resources to complete development of certain features, to improve functionality, including supporting higher throughput, to improve space segment utilization, and to reduce the cost of our products.
We devoted significant research and development resources in 2003, 2004 and 2005 to the development of our SkyEdge family of products. We develop our own network software and software for our VSATs. We generally license our software to customers as part of the sale of our network products and services. We also license certain third party software for use in our products.
Our software and our internally developed hardware are proprietary and we have implemented protective measures both of a legal and practical nature. We have obtained and registered patents in the United States and in various other countries in which we offer our products and services. We rely upon the copyright laws to protect against unauthorized copying of the object code of our software and upon copyright and trade secret laws for the protection of the source code of our software. We derive additional protection for our software by licensing only the object code to customers and keeping the source code confidential. In addition, we enter into confidentiality agreements with our customers and other business partners to protect our software technology and trade secrets. We have also made copyright, trademark and service mark registrations in the United States and abroad for additional protection of our intellectual property. Despite all of these measures, it is possible that competitors could copy certain aspects of our software or hardware or obtain information that we regard as a trade secret in violation of our legal rights.
In June 2003, we entered into two development agreements with SES Global which entitled us to an aggregate of $6 million for the development of certain ODU (outdoor unit) technology, all of which funding has been received In addition, we are required to pay SES Global a royalty of 10% calculated based upon the purchase price for each Ka-band transmitter contained within each VSAT sold and 10% of the purchase price for each Ka-band antenna and feed contained within each VSAT sold by Gilat up to a total recoupment by SES Global of its investment and thereafter, the royalties decrease to 5% per unit. Royalties will be payable for some of the sales of product units which include components developed under the agreements. As of December 31, 2005 we have not begun selling these units and, as such, no royalties have been paid or accrued. Please see “Item 8: Significant Changes.”
- 59 -
The following table sets forth, for the years indicated, our gross research and development expenditures, the portion of such expenditures which was funded by royalty-bearing and non-royalty bearing grants and the net cost of our research and development activities:
* Consists of funding from SES Global. Please see Item 8: "Significant Changes".
In the past few years and at present, the satellite communications market has experienced increasing competition both from within its sector and from competing satellite communication technologies. Specifically, the expansion of cellular coverage in rural areas worldwide, increased terrestrial infrastructures as well as the advancement of wireless technologies, increases the options for our potential and existing customers. In addition, the number of satellite communications providers in the market has increased and prices of technologies continue to decline. Further, many of the VSAT manufacturers have adopted certain standards for products, such as that known as DVB-RCS. If these standards become more accepted in the industry, it is likely that non-conforming products will be less attractive in the market. Another development in our industry is the increasing demand for complete solutions which encompass far more than a single platform of a communications solution.
In 2006, our inventory levels will be higher than in past years. In addition, we estimate that the political environment in Israel could continue to prevent certain countries from doing business with Gilat and this, in addition to the increased competition and reduced prices in the telecommunications industry overall, may have adverse effects on our business. Given all of the above, we cannot guarantee or predict what our sales will be, what trends will develop and if any changes in our business and marketing strategy will be implemented.
In November 2004, the FASB issued Statement of Financial Accounting Standard No. 151, “Inventory Costs, an Amendment of ARB No. 43, Chapter 4.” (“SFAS No. 151”). 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 the allocation of fixed production overhead to the costs of conversion be based on the normal capacity of the production facilities. SFAS No. 151 is effective for inventory costs incurred during fiscal years beginning after September 15, 2005. As of December 31, 2005, we do not expect that the adoption of SFAS No. 151 will have a material effect on our financial position or results of operations.
In May 2005, the FASB issued Statement of Financial Accounting Standard No. 154 (“SFAS No. 154”), “Accounting Changes and Error Corrections”, a replacement of APB No. 20, “Accounting Changes” and SFAS No. 3, “Reporting Accounting Changes in Interim Financial Statements”. SFAS No. 154 provides guidance on the accounting for and reporting of accounting changes and error corrections. APB No. 20 previously required that most voluntary changes in accounting principles be recognized by including in net income for the period of change the cumulative effect of changing to the new accounting principle. SFAS No. 154 requires retroactive application to prior periods’ financial statements of a voluntary change in accounting principles unless it is impracticable. SFAS No. 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005.
- 60 -
On December 16, 2004, the Financial Accounting Standards Board (FASB) issued FASB Statement No. 123 (revised 2004), “Share-Based Payment” (“statement 123R”), which is a revision of FASB Statement No. 123, Accounting for Stock-Based Compensation. Statement 123(R) supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees, and amends FASB Statement No. 95, Statement of Cash Flows. Generally, the approach in Statement 123(R) is similar to the approach described in Statement 123. However, Statement 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair values. Pro forma disclosure is no longer an alternative. Early adoption was permitted in periods in which financial statements have not yet been issued. We adopted Statement 123(R) effective January 1, 2006.
Statement 123(R) permits public companies to adopt its requirements using one of two methods: A “modified prospective” method in which compensation cost is recognized beginning with the effective date (a) based on the requirements of Statement 123(R) for all share-based payments granted after the effective date and (b) based on the requirements of Statement 123 for all awards granted to employees prior to the effective date of Statement 123(R) that remain unvested on the effective date.
A “modified retrospective” method which includes the requirements of the modified prospective method described above, but also permits entities to restate based on the amounts previously recognized under Statement 123 for purposes of pro forma disclosures all prior periods presented. We adopted Statement 123(R) using the modified prospective method.
- 61 -
Amiram Levinberg, age 50, co-founded our company and served as a director on our board since its inception and until April 2004. Since July 18, 2005, Mr. Levinberg has served as our Chairman of the Board and Chief Executive Officer. From July 1995 and until April 15, 2003, he served as our President. Until 2002, Mr. Levinberg also served as our Chief Operations Officer. Until July 1995, he served as our Vice President of Engineering. In this capacity, he supervised the development of the OneWay and Skystar Advantage VSATs. From 1977 to 1987, Mr. Levinberg served in a research and development unit of the Israel Defense Forces, where he managed a large research and development project. He was awarded the Israel Defense Award in 1988. Mr. Levinberg holds a B.Sc. in Electrical Engineering and Electronics and a M.Sc. degree in Digital Communications from the Technion – Israel Institute of Technology. Mr. Levinberg serves on the board Cardboard Industries and Kargal, a cardboard manufacturer in Israel and serves on the on the board of Kasamba, an internet company offering online professional expert advice.
Haim Benjamini, age 67, has served on our board as an external director since February, 2005. Mr. Benjamini currently serves as an advisor to Teva Pharmaceutical Industries Ltd.‘s CEO, board and management. He served as the Corporate Vice President of Human Resources of Teva from 1988 until December 31, 2004. From 1982 to 1988, Mr. Benjamini served as the Corporate Vice President of Human Resources at Scitex Corporation. Mr. Benjamini served as a guest lecturer at Tel Aviv University from 1997 to 2003 as part of the Masters of Arts program in Labor Studies. Mr. Benjamini holds a M.A. (Organizational Behavior) from the University of Chicago and a B.A (Social Sciences, Sociology and Political Science) from the Hebrew University. Mr. Benjamini is a Brigadier General (Ret) in the Israel Defense Force and served in various command staff and training roles from 1957 until 1982.
Jeremy Blank, age 27, is the sole principal of J Blank Management Ltd, a company which provides advisory services to York Capital Management (“York”). Previously, Mr. Blank served as a Vice President within York. York is a private investment fund based in New York with approximately $7.5 billion in assets under management. York was founded in 1991 and specializes in value oriented and event driven equity and credit investments. In addition, Mr. Blank worked as a vice president within Morgan Stanley’s fixed income department and earlier in his career in Morgan Stanley’s mergers and acquisitions department. Mr. Blank graduated from Yeshiva University in New York City with a Bachelor’s degree in Finance. Mr. Blank has served on our board since July, 2005
Udi Ganani, age 54, has served on our board since July, 2005. Dr. Ganani currently serves as Chairman of the boards of several companies, all in the security and defense markets: Trace Guard Technologies Inc., (OTCBB:TCGD), Aeronautics Defense Systems and 3D ACT Ltd. He served as the Chief Executive Officer of Israel Military Industries from 2002-2005. Prior to that he served in various senior positions in Rafael Armament Development Authority, the last of which was as Vice President of Marketing and Business Development from 1997-2002. Dr. Ganani holds a Doctorate of Science in chemical engineering from Washington University and a Bachelor of Science in Chemical Engineering from the Technion – Israel Institute of Technology in Haifa, Israel.
Dr. Leora (Rubin) Meridor , age 58, is a business and financial consultant and serves on the boards of Teva Pharmaceutical Industries and Nice Systems. Between 2001 and 2004, Dr. Meridor served as chair of the board of Poalim Capital Markets Ltd. and between 2001 and 2005, as chair of the boards of Bezeq International and Walla! Communications Ltd. Between 1996 and 2000 she served as Senior Vice President, Head of Credit & Risk Mgmt. Div. of the First International Bank. From 1992 to 1996 she served as Head of Research at the Bank of Israel. Dr. Meridor has a Ph.D in Economics, an M.Sc in Mathematics and B.Sc in Mathematics and Physics, all from the Hebrew University in Jerusalem. Her studies include a post doctoral year at M.I.T.
Karen Sarid, age 54, has served on our board since July, 2005. Ms. Sarid has served as a General Manager of Orex Computed Radiography Ltd., a Kodak Company focusing on advanced radiography systems for the digital x-ray market since September 2000. From September 1999 until September 2000, Ms. Sarid served as Chief Financial Officer and a member of the Board of Directors of Forsoft Ltd., a software solutions provider and a subsidiary of the Formula Group. From 1996 until August 1999, Ms. Sarid was Chief Financial Officer and a member of the Board of Directors of ESC Medical Systems Ltd., a medical laser manufacturer that is traded on NASDAQ Stock Market. She was Chief Financial Officer of LanOptics Ltd. (NASDAQ: LNOP) from 1993 through 1996. Ms. Sarid currently serves as a director of LanOptics and as chair of its audit committee. Ms Sarid also serves as a director of Oridion Ltd (SWXNM: ORIDN). Ms. Sarid received a B.A. in Economics and Accounting from Haifa University, and was awarded the CFO of the Year award in 1998 by the Association of Chief Financial Officers in Israel.
- 62 -
Izhak Tamir, age 52, has served on our board since July, 2005. Mr. Tamir has been President and a Director of Orckit since its founding in 1990. Orckit Communications Ltd. (NASDAQ: ORCT) is a leading provider of advanced telecom equipment targeting high capacity packetized broadband services. Mr. Tamir has served as a Director of of Scopus Video Networks since 2005. From 1987 until 1989, Mr. Tamir was employed by Comstream Inc., in San Diego, California. From 1985 until 1987, he was vice president of A.T. Communication Channels Ltd., a subsidiary of Bezeq. From 1978 to 1985, he was a senior engineer in the Israeli Government. Mr. Tamir holds an engineering degree from the Technion – Israel Institute of Technology and an M.B.A. from Tel Aviv University. Mr. Tamir has been chairman of the board of directors of Tikcro Technologies Ltd. since January 2000 and its chief executive officer since August 2003.
The executive officers and key executives of our company and its subsidiaries as of March 15, 2006, are as follows:
Erez Antebi, age 47, was appointed as Chief Executive Officer of Gilat Networks Systems on June 1, 2005. Prior to that time, Mr. Antebi served as our Chief Operating Officer from October 2002 until September 2003, when he left to serve as Chief Executive Officer of Clariton Networks Ltd.. From the beginning of 1998 until being appointed our Chief Operating Officer, Mr. Antebi served as our Vice President, General Manager for Asia, Africa and Pacific Rim. From September 1994 until the beginning of 1998, he served as Vice President and General Manager of Gilat Inc. Mr. Antebi joined our company in May 1991 as product manager for the Skystar Advantage VSAT product. From August 1993 until August 1994, he served as Vice President of Engineering and Program Management of Gilat Inc. Prior to joining us, Mr. Antebi worked for a private importing business from 1989 to 1991, after having served from 1987 to 1989 as marketing manager for high frequency radio communications for Tadiran Limited, a defense electronics and telecommunications company, and as a radar systems development engineer at Rafael, the research and development and manufacturing arm of the Israel Defense Forces, from 1981 to 1987. Mr. Antebi holds a B.Sc. and an M.Sc. Electrical Engineering from the Technion – Israel Institute of Technology.
Rocio del Carmen del Campo, age 43, joined Gilat to Home Peru S.A in 2000 as its General Manager. In June 2003, Ms. Del Campo was appointed General Manager of Gilat Colombia as well. Since January 2005, Ms. del Campo has served as the president of our rural operations business, Spacenet Rural Communications.. Before coming to Gilat, Ms. del Campo served as General Manager of Acer Peru, S.A. Ms. Del Campo holds a B.Sc. degree in Industrial Engineering from the University of Lima.
- 63 -
Bill Gerety, age 47, joined Spacenet Inc. as its President in July 2003. Prior to joining Spacenet Inc., from August 2000 until January 2002, Mr. Gerety served as acting Chief Executive Officer and Chief Operating Officer of Astrolink International, a broadband satellite venture headed by Liberty Media, Lockheed Martin, TRW and Telespazio. His experience also includes holding the COO position at telecom service provider World Access/Facilicom International and leading international network sales efforts for GTE and Sprint Communications. In addition to his telecommunications industry experience, Mr. Gerety has had a distinguished career as a senior officer in the U.S. Army, and continues to serve as a colonel in the U.S. Army Reserve. Mr. Gerety holds a B.S. in Engineering from the U.S. Military Academy at West Point, an M.S. in Strategic Studies from the U.S. Army War College, an M.S. in Contracts and Acquisition Management and an M.B.A. from the Florida Institute of Technology. As of September 2004, Mr. Gerety serves as a director of StarBand Communications Inc. and Satlynx S.A.
Yoav Leibovitch, age 48, rejoined our company in his current position as Executive Vice President of Corporate Development in September 2005. Prior thereto during2004, Mr. Leibovitch served as a consultant for business development in Kasamba Ltd. and assisted in the initial public offering of Scopus Ltd. Mr. Leibovitch first joined our company in early 1991 as Vice President of Finance and Administration and Chief Financial Officer, a position he held until December 2003. From 1989 to 1990, Mr. Leibovitch worked in the United States at Doubleday Books and Music Clubs, a subsidiary of Bertelsmann, A.G., as special advisor for new business development. From 1985 to 1989, he was the Financial Officer of a partnership among Bertelsmann, A.G., a large German media and communications company; Clal Corporation, a major Israeli industrial holding company; and Yediot Aharonot, an Israeli daily newspaper. Mr. Leibovitch holds a B.A. (Economics and Accounting) and a M.B.A. (Finance and Banking) from the Hebrew University of Jerusalem. Mr. Leibovitch is a Certified Public Accountant in Israel.
Josuha Levinberg, age 52, a co-founder of Gilat, rejoined our company as Executive Vice President of Corporate Business Development & Strategy in August 2005. From June 1999 until 2003, he served as Senior Vice President for Business Development of our company, having previously served in that position from 1994 to April 1998. At that time, Mr. Levinberg became Chief Executive Officer of GTH LA Antilles, then the parent company of Global Village Telecom (GVT), until June 1999. From 1989 until September 1994, he served as Executive Vice President and General Manager of Gilat Satellite Networks, Inc. in the U.S. From 1987 until the formation of Gilat Satellite Networks, Inc. in 1989, Mr. Levinberg was Vice President of Marketing & Business Development of our company. From 1985 to 1987, Mr. Levinberg held various positions, including Manager of System Development and Marketing Manager at the Israeli subsidiary of DSP Group Inc., a U.S. company specializing in digital signal processing. Mr. Levinberg holds a B.Sc. (Electrical Engineering and Electronics) from Tel Aviv University. Amiram Levinberg and Joshua Levinberg are brothers.
Tal Payne, age 34, was appointed Chief Financial Officer of our company in May 2005. Before that, Ms. Payne served as our Vice President of Finance starting January 2004. Prior to holding this position and since July 1999, Ms. Payne served as our Financial Director. Prior to joining us, Ms. Payne, a CPA, was employed as a Manager for Kesselman & Kesselman, PriceWaterhouseCooper’s Israel office from 1994 to 1999. She holds a B.A. in Economics and Accounting, as well as advanced studies in accounting from Tel Aviv University.
The following table sets forth the aggregate compensation paid to or accrued on behalf of all of our directors and officers as a group for the year ended December 31, 2005:
- 64 -
* Also includes bonuses and stock option compensation accrued in 2005.
Prior to the closing of the transaction pursuant to which Bank Hapoalim assigned its Gilat loan to York Capital Management, York, Bank Hapoalim and Mivtach Shamir Finance Ltd., paid $100,000 to a company controlled by Mr. Amiram Levinberg and his brother, Mr. Joshua Levinberg, to perform due diligence on Gilat. In addition, Mr. Amiram Levinberg has a right to certain benefits from options held by York in Gilat shares owned by Bank Hapoalim. For further information on Mr. Levinberg’s relationship with York, please see the Principal Shareholder table and the footnote on York.
Mr. Amiram Levinberg, our Chairman and Chief Executive Officer has a three year employment agreement with us which will terminate July 2008. As per the terms of this agreement, Mr. Levinberg is entitled to (i) a salary of 100,000 NIS per month; (ii) options to purchase 915,000 ordinary shares of the Company; (iii) a “transaction bonus” equal to 0.82% of the market value of the Company in a transaction or series of related transactions following which a company, person or a group of persons or companies acting together will purchase from the Company’s shareholders, in a bona fide, arms length transaction, 50% or more of the Company’s then outstanding share capital subject to Mr. Levinberg complying with certain prior conditions; and (iv) entitlement to participate in the Company’s annual bonus plan, subject to the specific approval of the shareholders.
By resolutions adopted by our shareholders, the directors of Gilat who are not employees are entitled to receive annual compensation of $20,000 and an additional $300 for each board or committee meeting attended for up to four hours, and an additional $300 for each board or committee meeting which extends beyond four hours. In addition, board members are compensated for telephone participation in board and committee meetings in an amount of 50% of what would be received for physical attendance. Each current and future non-employee director is entitled to receive options to purchase 20,000 of our ordinary shares, which options vest over a three-year period, and are exercisable for so long as such optionee remains a director of Gilat.
Our Articles of Association as adopted at a shareholders meeting on April 15, 2003, provide that our board of directors shall consist of not less than five and not more than nine directors as shall be determined from time to time by a majority vote at the general meeting of our shareholders. Unless resolved otherwise by our shareholders, our board of directors will be comprised of (i) nine directors, if four directors are appointed by beneficial owners of 7% or more of our issued and outstanding ordinary shares (as set forth below), or (ii) seven directors, if fewer than four directors are so appointed by beneficial owners of 7% or more of our ordinary shares.
Pursuant to our Articles of Association, each beneficial owner of 7% or more of our issued and outstanding ordinary shares is entitled to appoint, at each annual general meeting of our shareholders, one member to our board of directors, provided that a total of not more than four directors are so appointed. In the event that more than four qualifying beneficial owners notify us that they desire to appoint a member to our board of directors, only the four shareholders beneficially owning the greatest number of shares shall each be entitled to appoint a member to our board of directors. So long as our ordinary shares are listed for trading on Nasdaq, we may require that any such appointed director qualify as an “independent director” as provided for in the Nasdaq rules then in effect. Our board of directors has the right to remove any such appointed director when the beneficial ownership of the shareholder who appointed such director falls below 7% of our ordinary shares.
- 65 -
Our Articles of Association provide that a majority of the voting power at the annual general meeting of our shareholders will elect the remaining members of the board of directors, including external directors as required under the Companies Law. At any annual general meeting at which directors are appointed pursuant to the preceding paragraph, the calculation of the vote of any beneficial owner who appointed a director pursuant to the preceding paragraph shall not take into consideration, for the purpose of electing the remaining directors, ordinary shares constituting 7% of our issued and outstanding ordinary shares held by such appointing beneficial owner.
Each of our directors (except external directors) serve, subject to early resignation or vacation of office in certain circumstances as set forth in our Articles of Association, until the adjournment of the next annual general meeting of our shareholders next following the general meeting in which such director was elected. The holders of a majority of the voting power represented at a general meeting of our shareholders in person or by proxy will be entitled to (i) remove any director(s), other than external directors and directors appointed by beneficial holders of 7% or more of our issued and outstanding ordinary shares as set forth above, (ii) elect directors instead of directors so removed, or (iii) fill any vacancy, however created, in the board of directors. Our board of directors may also appoint additional directors, whether to fill a vacancy or to expand the board of directors, who will serve until the next general meeting of our shareholders following such appointment.
Our Articles of Association further provide that the board of directors may delegate all of its powers to committees of the board of directors as it deems appropriate, subject to the provisions of applicable law.
Our Articles of Association provide that a director may appoint, by written notice to us and subject to the consent of the board of directors, any person qualified to serve as a director to serve as an alternate director (provided such person does not already serve as a director or an alternate director). An external director may not be appointed as an alternate director, unless otherwise permitted in the Companies Law. An alternate director shall have all of the rights and obligations of the director appointing him or her, except the power to appoint an alternate (unless otherwise specifically provided for in the appointment of such alternate). An alternate director may not act at any meeting at which the director appointing him or her is present and he is not entitled to remuneration. Unless the time period or scope of any such appointment is limited by the appointing director, such appointment is effective for all purposes and for an indefinite time, but will expire upon the expiration of term or vacation of office of the appointing director. Currently, no alternate directors have been appointed.
Under the Companies Law, public companies are required to elect two external directors who must meet specified standards of independence. Companies that are registered under the laws of Israel and whose shares are listed for trading on a stock exchange outside of Israel, such as Gilat, are treated as public companies with respect to the external directors’ requirement. External directors may not have during the two years preceding their appointment, directly or indirectly through a relative, partner, employer or controlled entity, any affiliation with (i) the public company, (ii) those of its shareholders who are controlling shareholders at the time of appointment, or (iii) any entity controlled by the company or by its controlling shareholders. The term “affiliation” includes an employment relationship, a business or professional relationship maintained on a regular basis, control and services as an office holder. No person can serve as an external director if the person’s other positions or business creates or may create conflicts of interest with the person’s responsibilities as an external director. Until the lapse of two years from termination of office, a company may not engage an external director as an employee or otherwise.
- 66 -
External directors serve for a three-year term, which may be renewed for only one additional three-year term. External directors can be removed from office only by the court or by the same special percentage of shareholders that can elect them, and then only if the external directors cease to meet the statutory qualifications with respect to their appointment or if they violate their fiduciary duty to the company. The court may additionally remove external directors from office if they were convicted of certain offenses by a non-Israeli court or are permanently unable to fulfill their position. If, when an external director is elected, all members of the board of directors of a company are of one gender, the external director to be elected must be of the other gender.
If delegated any authority of the board of directors, any committee of the board of directors must include at least one external director. An external director is entitled to compensation as provided in regulations adopted under the Companies Law and is otherwise prohibited from receiving any other compensation, directly or indirectly, in connection with such service.
The Companies Law requires external directors to submit to the company, prior to the date of the notice of the general meeting convened to elect the external directors, a declaration stating their compliance with the requirements imposed by Companies Law for the office of external director. External Directors are required to have professional ability or financial and accounting expertise, as long as at least one of the External Directors is a financial and accounting expert.
The election of external directors requires the affirmative vote of a majority of our ordinary shares voted on in person or by proxy at a meeting of the shareholders, provided that such majority includes at least one-third of the votes of the non-controlling shareholders of the company who are voting on this matter at the meeting. This approval requirement need not be met if the aggregate shareholdings of those non-controlling shareholders who vote against the election of the external directors represent one percent or less of all the voting power of the company. “Controlling” for the purpose of this provision means the ability to direct the acts of the company. Any person holding one half or more of the voting power of the company or of the right to appoint directors or the chief executive officer is presumed to have control of the company.
Our external directors are Dr. Leora Meridor and Mr. Haim Benjamini. Dr. Meridor was elected at the Special General Meeting held on August 30, 2005, and Mr. Benjamini was elected at the Special General Meeting held on February 10, 2005.
The Companies Law provides that publicly traded companies must appoint an audit committee. The responsibilities of the audit committee include identifying irregularities in the management of the company’s business and approving related party transactions as required by law. An audit committee must consist of at least three members, and include all of the company’s external directors. However, the chairman of the board of directors, any director employed by the company or providing services to the company on a regular basis, any controlling shareholder and any relative of a controlling shareholder may not be a member of the audit committee. An audit committee may not approve an action or a transaction with an officer or director, a transaction in which an officer or director has a personal interest, a transaction with a controlling shareholder and certain other transactions specified in the Companies Law, unless at the time of approval two external directors are serving as members of the audit committee and at least one of the external directors was present at the meeting in which an approval was granted.
Pursuant to the current listing requirements of the NASDAQ Stock Market, we are required to maintain an audit committee, at least a majority of whose members are independent of management. Pursuant to the Sarbanes-Oxley Act of 2002, the Securities and Exchange Commission, or the SEC, has issued rules which required NASDAQ to impose independence requirements on each member of the audit committee. Such requirements came into effect July 31, 2005.
- 67 -
Presently, our audit committee consists of Mr. Benjamini, Dr. Meridor, Dr. Sarid and Mr. Tamir. We believe that these appointments comply with the requirements of the Companies Law and with the SEC and NASDAQ rules, and that Dr. Meridor qualifies to serve as the audit committee’s financial expert, as required by the SEC and NASDAQ.
Pursuant to the current listing requirements of the NASDAQ National Market, we are required to have at least two independent directors on our board of directors. Under Nasdaq rules, the majority of the members of the board directors need to be independent as of July 31, 2005. Effective March 3, 2005, Nasdaq revised the rules so that a foreign private issuer (such as our company) may follow home country practice in lieu of complying with this rule.
Based on representations from our current directors, we believe that all of our directors except Mr. Levinberg and Mr. Blank comply with the independence standards set forth above.
As of December 31, 2005, we had approximately 929 full-time employees, including 151 employees in engineering, research and development, 384 employees in manufacturing, operations and technical support, 129 employees in marketing and sales, 146 employees in administration and finance and 119 in other departments. Of these employees, 387 employees were based in our facilities in Israel , 251 were employed in the United States, 235 were employed in Latin America and 62 in Asia, the Far East and other parts of the world. We also utilize temporary employees, as necessary, to supplement our manufacturing and other capabilities. We believe that our relations with our employees are satisfactory.
We and our employees are not parties to any collective bargaining agreements. However, certain provisions of the collective bargaining agreements between the Histadrut (General Federation of Labor in Israel) and the Coordination Bureau of Economic Organizations (including the Manufacturers’ Association of Israel) are applicable to all Israeli employees by order of the Israeli Ministry of Labor and Welfare. These provisions principally concern the length of the work day and the work week, minimum wages for workers, contributions to a pension fund, insurance for work-related accidents, procedures for dismissing employees, determination of severance pay and other conditions of employment. Furthermore, pursuant to such provisions, the wages of most of our employees are automatically adjusted based on changes in the Israeli CPI. The amount and frequency of these adjustments are modified from time to time.
Israeli law generally requires severance pay upon the retirement or death of an employee or termination of employment without due cause. Our ongoing severance obligations are partially funded by making quarterly payments to approved severance funds or insurance policies, with the remainder accrued as a long-term liability in our consolidated financial statements. In addition, Israeli employees and employers are required to pay specified sums to the National Insurance Institute, which is similar to the U.S. Social Security Administration. Since January 1, 1995, such amounts also include payments for national health insurance. The payments to the National Insurance Institute are approximately 16.31% of wages (up to a specified amount), of which the employee contributes approximately 64% and the employer contributes approximately 36%. The majority of our permanent employees are covered by life and pension insurance policies providing customary benefits to employees, including retirement and severance benefits. For Israeli employees, we contribute 13.33% to 15.83% (depending on the employee) of base wages to such plans and the permanent employees contribute 5% of base wages.
We have a number of savings plans in the United States that qualify under Section 401(k) of the U.S. Internal Revenue Code. Our U.S employees may contribute up to 100% of their pretax salary, but not more than statutory limits. We contribute one dollar for each dollar a participant contributes in this plan, in an amount of up to 3% of a participant’s earnings and in addition, we contribute fifty cents for each dollar a participant voluntarily contributes in this plan, up to an additional 3% of a participant’s earnings. Matching contributions in 2003, 2004 and 2005 for all the plans were $ 0.5 million, $ 0.7 million and $ 0.7 million, respectively. Matching contributions are invested in proportion to each participant’s voluntary contributions in the investment options provided under the plan.
- 68 -
In January 2005, we provided certain Israeli employees with interest-free three-year loans in amounts equal to thirty or one-hundred percent (30-100%) of the amount of the severance compensation owing to them upon separation by us if their service is terminated without cause. The loans were provided as a benefit to certain employees and are secured by a contractual pledge over each respective employee’s severance payment. Loans were granted to approximately 260 employees, none of whom are executive officers. The aggregate amount of loans granted to was approximately $4 million and the highest amount loaned to any single employee is approximately $130,000.
See table under Item 7: “Major Shareholders and Related Party Transactions” below.
In June 1995, we adopted the 1995 Stock Option Plan (Incentive and Restricted Stock Options), or the 1995 ISO/RSO Plan, the 1995 Section 102 Stock Option/Stock Purchase Plan, or the 1995 Section 102 Plan, and the 1995 Advisory Board Stock Option Plan, or the 1995 Advisory Board Plan. The 1995 Plans expired on June 29, 2005.
As of December 31, 2005, we had granted options to purchase a total of 134,882 ordinary shares under the 1995 Plans. The exercise prices for such options vary from $7.8 to $3,197.5 and all such options expire at various times from November 2003 to February 2013. As of December 31, 2005, a total of 41,963 options have been exercised under the 1995 Plan.
In September 2003, we adopted the 2003 Stock Option Plan (Incentive and Restricted Stock Options), or the 2003 ISO/RSO Plan and the Section 102 Stock Option Plan 2003, or the 2003 Section 102 Plan and collectively, the “2003 Plans”. In February 2005, our shareholders increased the pool for the 2003 Plans by 1,135,000 shares and in December 2005, our shareholders further increased the pool by 3,500,000 shares, such that the 2003 Plans provide for the granting of options of up to an aggregate of 6,135,000 ordinary shares to our officers, directors, employees or service providers or any of the employees of service providers of our subsidiaries. As of December 31, 2005, options to purchase a total of 5,073,141 ordinary shares under the 2003 Plans were outstanding, and 212,586 shares were exercised.
The purpose of the 2003 Plans is to enable us to attract and retain qualified persons as employees, officers, directors, consultants and advisors and to motivate such persons by providing them with an equity participation in Gilat. The 2003 Section 102 Plan is designed to afford qualified optionees certain tax benefits under the Israel Income Tax Ordinance.
The 2003 Plans are administered by the Compensation/Stock Option Committee appointed by our board of directors. The Stock Option Committee, comprised of Dr. Meridor, Mr. Benjamini, Mr. Tamir and Dr. Sarid, has broad discretion, subject to certain limitations, to determine the persons entitled to receive options, the terms and conditions on which options or rights to purchase are granted and the number of shares subject thereto. The Stock Option Committee also has discretion to determine the nature of the consideration to be paid upon the exercise of an option and/or right to purchase granted under the 2003 Plans. Such consideration generally may consist of cash or, at the discretion of the Board, cash and a recourse promissory note. All grants of options pursuant to the 2003 Section 102 Plan are subject to the approval of the board of directors.
Stock options issued as incentive stock options pursuant to the 2003 ISO/RSO Plan will only be granted to the employees of Gilat or its subsidiaries. The exercise price of incentive stock options issued pursuant to the 2003 ISO/RSO Plan must be at least equal to the fair market value of the ordinary shares as of the date of the grant (and, in the case of optionees who own more than 10% of the voting stock, the exercise price must equal at least 110% of the fair market value of the ordinary shares as of the date of the grant). Unless otherwise provided in an option agreement, the exercise price per share under options awarded pursuant to the 2003 Plans shall be the higher of (i) $5.00 per share; and (ii) the fair market value of the shares, as of the date of the option grant.
- 69 -
Options are exercisable and restrictions on disposition of shares lapse according to the terms of the individual agreements under which such options were granted or shares issued.
In December 2005, our shareholders adopted a new plan, the 2005 Stock Incentive Plan with a pool of 1.5 million shares. This plan is designed to enable the board of directors to determine various forms of incentives for all forms of service providers and, when necessary, adopt a Sub-plan in order to grant specific incentives. Among the incentives that may be adopted are share options, performance share awards, performance share unit awards, restructured shares, restricted share unit awards and other share based awards. To date, we have not made any grants under this plan.
The following table sets forth certain information with respect to the beneficial ownership of our ordinary shares as of March 1, 2006 (including options exercisable within 60 days of March 1, 2006) with respect to: (i) each person who is believed by us to be the beneficial owner of more than 5% of the ordinary shares; (ii) each director or officer who holds more than 1% of the ordinary shares, and (iii) all directors and officers as a group. Except where otherwise indicated, we believe, based on information furnished by the owners, that the beneficial owners of the ordinary shares listed below have sole investment and voting power with respect to such shares, subject to any applicable community property laws. The shareholders listed below do not have any different voting rights from any other shareholders of Gilat, except to the extent that they hold more than 7% and as such, they will have a right to appoint a director, subject to certain conditions in our Articles of Association. None of the directors, officers or key executives listed in the Directors and Senior Management table appearing in Item 6 above, owns 1% or more of Gilat’s outstanding share capital.
The information in this table is based on 22,589,698 ordinary shares outstanding as of March 1, 2006. Except where otherwise indicated, we believe, based on information furnished by the owners, that the beneficial owners of the ordinary shares listed below have sole investment and voting power with respect to such shares, subject to any applicable community property laws.
- 70 -
In April 2004, we revised the terms of our loan from Bank Hapoalim, to whom we owed the principal debt amount of $71.4 million. In July 2005, Bank Hapoalim assigned the loan to York Capital Management. In December 2005, we further revised the terms of this loan. Please see “Item 5: Liquidity and Capital Resources – Financing Activities”.
Any proceeds paid to us from the exercise of a warrant will be applied to reduce future installments of the principal, on a pro-rata basis.
In March 2003, SES Americom agreed to terminate its transponder agreements with Spacenet Inc. that relate to StarBand (which is partially owned by Spacenet Inc.) and to enter into a new transponder capacity agreement directly with StarBand. SES Americom also agreed to allow Spacenet Inc. to defer an outstanding debt of $3.5 million to 2003, and to defer payment of certain transponder capacity charges due in 2003 and 2004 with payment of those deferred charges to commence in 2005. The agreement reduced the aggregate amount payable to SES Americom in 2003 from $26.9 million to $16.5 million (including the $3.5 million which was deferred from 2002 to 2003 and paid by Spacenet Inc. in full in 2003). With respect to the deferred 2003 and 2004 transponder capacity charges, Spacenet Inc. paid $0.6 million to SES Americom in 2005 as scheduled.
In addition, we have entered into two development agreements with SES Global S.A. Please see Item 5: “Third Party Funding” and Item 8: “Significant Changes.”
We are a party to an investment agreement in Satlynx S.A. with SES. For additional information, please see “Item 4: Strategic Alliances, Joint Ventures and Acquisitions” and “Item 8: Significant Changes”.
- 71 -
In 2003, we entered into a consulting agreement with Israel Literage & Supply Co. Ltd., a company under the ownership and control of Shlomo Rodav, formerly the Chairman of our board of directors. This agreement was terminated in July 2005.
See “Item 18: Financial Statements.”
Our primarily manufacturing facilities are based in Israel. Most of our products are exported out of Israel. For information on Gilat’s revenues breakdown by geographic market for the past three years, see Item 5: “Operating and Financial Review and Prospects.”
We are a party to various legal proceedings incident to our business. Except as noted below, there are no material legal proceedings pending or, to our knowledge, threatened against us or our subsidiaries, and we are not involved in any legal proceedings that our management believes, individually or in the aggregate, would have a material adverse effect on our business, financial condition or operating results.
In the first half of 2002, a number of securities class action lawsuits were filed against us and certain of our officers and directors in the United States District Court for the Eastern District of New York and in the United States District Court for the Eastern District of Virginia, and a request to file a class action lawsuit was filed in the Tel-Aviv, Israel District Court. The class action suits allege violations of the federal securities laws and claim that we issued material misrepresentations to the market. The class action suits in the U.S. have been consolidated into a single action in the United States District Court for the Eastern District of New York and an amended complaint has been filed. During September, 2004 the plaintiffs filed a motion to further amend the claim. We filed a motion to dismiss the amended complaint, and on September 19, 2005, the court dismissed certain of the plaintiff’s claims. The plaintiffs have provided us with a discovery demand and a conference with the plaintiffs has been scheduled for March to agree on the schedule and scope of the discovery.
The Israeli court granted a motion to stay the proceedings of the Israeli action pending the outcome of the U.S. class action proceeding. We believe the allegations against us and our officers and directors in the class action suits are without merit and are contesting them vigorously.
In September 2003, Nova Mobilcom S.A., or Mobilcom, filed a lawsuit against Gilat do Brasil for specific performance of a Memorandum of Understanding which provided for the sale of Gilat do Brasil, and specifically the GESAC project, to Mobilcom for an unspecified amount. Gilat do Brasil is vigorously defending itself against the claims presented therein.
The Brazilian tax authority has filed a claim against a subsidiary of Spacenet Inc. in Brazil, for alleged taxes due of approximately $4 million. In January 2004, the subsidiary received notice of an administrative ruling reducing the amount of the claim, and the subsidiary filed an appeal of such ruling. In December 2005, this appeal was denied and at present, the subsidiary faces a payment of taxes in an amount of approximately $6.1 million (the amount has increased due to interest and the exchange rate of the Brazilian Reias). The subsidiary denies such claim and is at present preparing to file a petition known as a “Ação Anulatória” in the State Courts of the State of São Paulo, Brazil
- 72 -
In December 2003 and October 2004, we received tax assessments for the tax years 1998 and 1999-2001, respectively for approximately $45 million plus $7 million in penalties mainly based on various claims of the Israeli Tax Authorities. In May 2005, we reached a settlement agreement in connection with the above. According to the settlement agreement, the tax assessments for the years 1998-2003 were closed in consideration of our payment of approximately $6 million, including interest and indexation. In addition, our carry forward tax losses as of December 31, 2003, were set at $68 million.
In 2004, we received a notice from the Israeli Stamp Tax authorities requiring us to disclose all documentation which may be subject to Stamp Tax duties for the period from June 2003 to date. The authorities’ right to demand Stamp Tax duty is pending deliberation by Israel’s High Court. We intend to challenge any demands for payments received from the Stamp Tax authorities should such demands be received.
From time to time, we are notified of claims that we may be infringing patents, copyrights or other intellectual property rights owned by third parties. While we do not believe we are currently infringing any intellectual property rights of third parties, we cannot assure that other companies will not, in the future, pursue claims against us with respect to the alleged infringement of patents, copyrights or other intellectual property rights owned by third parties. In addition, litigation may be necessary to protect our intellectual property rights and trade secrets, to determine the validity of and scope of the propriety rights of others or to defend against third-party claims of invalidity. Any litigation could result in substantial costs and diversion of resources and could have a material adverse effect on our business, financial condition and operating results.
If any claims or actions are asserted against us, we may seek to obtain a license under a third party’s intellectual property rights. We cannot assure, however, that a license will be available under terms that are acceptable to us, if at all. The failure to obtain a license under a patent or intellectual property right from a third party for technology used by us could cause us to incur substantial liabilities and to suspend the manufacture of the product covered by the patent or intellectual property right. In addition, we may be required to redesign our products to eliminate infringement if a license is not available. Such redesign, if possible, could result in substantial delays in marketing of products and in significant costs. In addition, should we decide to litigate such claims, such litigation could be extremely expensive and time consuming and could materially adversely affect our business, financial condition and operating results, regardless of the outcome of the litigation.
We are also a party to various regulatory proceedings incident to our business. To the knowledge of our management, none of such proceedings is material to us or to our subsidiaries.
We have never paid cash dividends on our ordinary shares and cannot anticipate paying any cash dividends in the foreseeable future. We have decided to reinvest permanently the amount of tax-exempt income derived from our “Approved Enterprises” and not to distribute such income as dividends. See notes 12 and 14 of the notes to consolidated financial statements included in this annual report on Form 20-F. We may only pay cash dividends in any fiscal year out of “profits,” as determined under Israeli law. In addition, the terms of some of our financing arrangements restrict us from paying dividends to our shareholders.
In the event we declare dividends in the future, we will pay those dividends in NIS. Because exchange rates between NIS and the dollar fluctuate continuously, a U.S. shareholder will be subject to currency fluctuation between the date when the dividends are declared and the date the dividends are paid.
On March 1, 2006 Gilat and SES executed an agreement whereby Gilat has agreed to transfer its remaining 0.17% holdings in Satlynx to SES. The actual transfer of shares will occur upon request by SES. In consideration, as part of this agreement, Gilat will receive a waiver from SES on any royalty payments which may be due by Gilat to SES in accordance with development agreements signed between the parties in 2002 and SES will provide a corporate guarantee to cover Satlynx’s obligations towards Gilat.
- 73 -
The following table sets forth, for the periods indicated, the range of high and low closing sale price for the ordinary shares, as reported by NASDAQ. All of the reported prices have been adjusted to reflect a twenty for one share reverse stock split which became effective April 16, 2003.
- 74 -
Our ordinary shares are quoted on the Nasdaq National Market under the symbol “GILTF.”. Our ordinary shares were listed on the NASDAQ National Market in connection with our initial public offering in December 1993.
Gilat Satellite Networks Ltd. is an Israeli company registered with the Israel companies register, registration No. 52-003893-6.
- 75 -
Under the Companies Law, a company may define its purposes as to engage in any lawful business and may broaden the scope of its purposes to the grant of reasonable donations for any proper charitable cause, even if the basis for any such donation is not dependent upon business considerations. Article 3A of our Articles of Association provides that Gilat’s purpose is to engage in any business permitted by law and that Gilat can also grant reasonable donations for any proper charitable cause.
Under the Companies Law, a company may amend its articles of association by the affirmative vote of a majority of the shares voting and present at the general meeting of shareholders or by a different voting if so provided by the company’s articles of association. Article 3 of our Articles of Association provides that the Articles of Association may be amended by a resolution approved by holders of a majority of the shares represented at a general meeting and voting on such resolution, if such amendment is recommended by the board of directors; in any other case, by a resolution approved by holders of at least 75% of the shares represented at a general meeting and voting on such resolution.
Israeli law further provides that any amendment to the articles of association of a company that obligates a shareholder to acquire additional shares or to increase the extent of his liability shall not obligate the shareholder without his prior consent.
Companies that were incorporated prior to the effective date of the Companies Law, such as Gilat, may amend their memorandum of association to authorize future amendments to the memorandum of association by any required voting. On November 9, 2000, Gilat’s shareholders approved an amendment to Gilat’s Memorandum of Association, by adding a provision that will authorize Gilat to amend its Memorandum of Association by the affirmative vote of a majority of the ordinary shares present and voting at the meeting.
Under the Companies Law, for the purpose of a shareholder vote, the record date for companies traded outside of Israel, such as Gilat, can be set between four and forty days before the date of the meeting. Article 20 of our Articles of Association therefore provides that the board of directors may set in advance a record date, which shall not be more than forty nor less than four days before the date of such meeting (or any longer or shorter period permitted by law).
The Companies Law provides that a company whose shares are traded on an exchange must give notice of a general meeting to its shareholders of record at least twenty-one days prior to the meeting, unless the company’s articles provide that a notice need not be sent. Accordingly, Article 25(a) of our Articles of Association provides that not less than 21 days’ prior notice shall be given to shareholders of record of every General Meeting (i.e. Annual General Meetings and Special General Meetings). It further provides that notice of a General Meeting shall be given in accordance with any law and otherwise as the board of directors may determine. In addition, Article 25(c) of our Articles of Association provides that no shareholder present, in person or by proxy, at the commencement of a General Meeting shall be entitled to seek the revocation of any proceedings or resolutions adopted at such General Meeting on grounds of any defect in the notice of such meeting relating to the time or the place thereof.
Under the Companies Law, an annual meeting of the shareholders should be held once in every calendar year and not more than fifteen months from the last annual meeting. The Companies Law Israeli provides that a special meeting of shareholders must be called by the board of directors upon the written request of (i) two directors, (ii) one-fourth of the serving directors, (iii) one or more shareholders who hold(s) at least five percent of the issued share capital and at least one percent of the voting power of the company, or (iv) one or more shareholders who have at least five percent of the voting power of the company. Within twenty one days of receipt of such demand, the board of directors is required to convene the special meeting for a time not later than thirty five days after notice has been given to the shareholders. Article 24 of our Articles of Association provide that our board of directors may call a special meeting of the shareholders at any time and shall be obligated to call a special meeting as specified above.
- 76 -
In 2005, we had four shareholders meetings, one annual shareholders meeting and three special shareholders meetings. At the meeting held in February 2005, the following resolutions were among those adopted: the nomination of a new external director, Mr. Binjamini, the approval of increase of the number of shares granted under the 2003 Stock Option Plan, the nomination of Shlomo Rodav, former chairman of the board of directors as CEO as of July, 2004, the approval of and increase in directors’ compensation and the approval of an increase in directors’ and officers’ insurance policy coverage. In May 2005, we held our annual general meeting and the following resolutions were among those adopted: reelection of the board members and approval of an amendment to the Articles of Association reducing the minimum quorum of shareholders required at a meeting from 33.3% to 25%. At the meeting held in August 2005, the following resolutions were among those adopted: the election of Ms. Leora Meridor, a new external director, the election of five board members to fill vacancies and the approval of the nomination of Mr. Amiram Levinberg, Chairman of the board of directors and CEO. In our most recent shareholders meeting held in December 2005, the following resolutions were among those adopted: an increase of the authorized share capital of the Company, the approval of amendment to the Company’s March, 2003 loan agreement with York Capital Management (assigned to York by Bank Hapoalim B.M.), the approval of Mr. Amiram Levinberg’s employment agreement and the approval of an increase in the number of shares granted under the 2003 Stock Option Plan.
Under Article 26(b) of our Articles of Association, the required quorum for any general meeting of shareholders and for any class meeting is two or more shareholders present in person or by proxy and holding at least twenty five percent (25%) of the issued shares (or of the issued shares of such class in the event of a class meeting). The required quorum in a meeting that was adjourned because a quorum was not present, shall be two shareholders present in person or by proxy. Under Article 26(c) of our Articles of Association, if the adjourned meeting was called by a shareholder(s), the quorum in the adjourned meeting shall be one or more shareholders, present in person or by proxy and holding the number of shares required to call a meeting.
Article 28(b) of our Articles of Association provides for voting by a written ballot only. In addition, Article 28(c), in accordance with the Companies Law, provides that the declaration of the Chairman of the Meeting as to the results of a vote is not considered to be conclusive, but rather prima facie evidence of the fact.
Under our Articles of Association, any resolution of the shareholders, except a resolution for a voluntary liquidation of the company and, in certain circumstances, a resolution to amend our Articles of Association, shall be deemed adopted if approved by the vote of the holders of a majority of the voting power represented at such meeting in person or by proxy.
Article 31 of our Articles of Association provides that every shareholder shall have one vote for each share held by him of record or, in accordance with the definition of “shareholder” in the Companies Law, in his name with an “exchange member” and held of record by a “nominee company”, as such terms are defined in the Companies Law.
We do not have cumulative voting provisions for the election of directors or for any other matter.
- 77 -
Under our Articles of Association, the ordinary shares do not have cumulative voting rights in the election of directors. A director is not required to retire at a certain age and need not be a shareholder of Gilat. Under the Companies Law, a person cannot serve as a director if convicted of certain offenses or been declared bankrupt.
Under our Articles of Association, our board of directors shall consist of not less than five and not more than nine directors as shall be determined from time to time by a majority vote at the general meeting of our shareholders. Unless resolved otherwise, our board of directors is be comprised of nine directors, if four directors are appointed by beneficial owners of seven percent or more of our issued and outstanding ordinary shares as set forth below, or seven directors, if fewer than four directors are appointed by beneficial owners of seven percent or more of our issued and outstanding ordinary shares as set forth below.
Our Articles further provide that each beneficial owner of seven percent or more of our issued and outstanding ordinary shares shall be entitled to appoint, at each annual general meeting of our shareholders, one member to our board of directors (an “Appointed Director”), provided that a total of not more than four Appointed Directors are so appointed. In the event more than four such qualifying beneficial owners notify us that they desire to appoint an Appointed Director, only the four shareholders beneficially owning the greatest number of shares shall each be entitled to appoint an Appointed Director.
For the purposes of the preceding paragraph, a “beneficial owner” of ordinary shares means any person or entity who, directly or indirectly, has the power to vote, or to direct the voting of, such ordinary shares. All ordinary shares beneficially owned by a person or entity, regardless of the form which such beneficial ownership takes, shall be aggregated in calculating the number of ordinary shares beneficially owned by such person or entity. All persons and entities that are affiliates (as defined below) of each other shall be deemed to be one person or entity for the purposes of this definition. For the purposes of the preceding paragraph, an “affiliate” means, with respect to any person or entity, any other person or entity controlling, controlled by, or under common control with such person or entity. “Control” shall have the meaning ascribed to it in the Israeli Securities Law – 1968, i.e. the ability to direct the acts of a company. Any person holding one half or more of the voting power of a company of the right to appoint directors or to appoint the Chief Executive Officer is presumed to have control of the company.
The Articles further stipulate that as a condition to the appointment of an Appointed Director, any appointing shareholder that delivers to the Company a letter of appointment shall, prior to such delivery, be required to file with the SEC a Schedule 13D, or an amendment to its Schedule 13D if there is any change in the facts set forth in its Schedule 13D already on file with the SEC which discloses any such change in its holdings of ordinary shares, regardless of whether any filing or amendment is required to be filed under the rules of the Securities Exchange Act of 1934, as amended, and the rules and regulations promulgated thereunder. In addition, any Appointing Shareholder shall be obligated to notify the Company in writing of any sale, transfer, assignment or other disposition of any kind of ordinary shares by such appointing shareholder that results in the reduction of its beneficial ownership to below the percentage indicated above, immediately after the occurrence of such disposition of shares but in any event not later than the earliest of (i) ten (10) days thereafter, or (ii) the next Annual General Meeting. Without derogating from the foregoing, so long as an Appointed Director serves on the board of directors, the appointing shareholder which appointed such Appointed Director shall provide the Company, upon its written request at any time and from time to time, with reasonable evidence of its beneficial ownership in the Company.
Under our Articles of Association, so long as our ordinary shares are listed for trading on Nasdaq, we may require that any Appointed Director qualify as an “independent director” as provided for in the Nasdaq rules then in effect. In addition, in no event may a person become an Appointed Director unless such person does not, at the time of appointment, and did not, within two years prior thereto, engage, directly or indirectly, in any activity which competes with the Company, whether as a director, officer, employee, contractor, consultant, partner or otherwise.
- 78 -
Under our Articles of Association, the annual general meeting of our shareholders, by the vote of the holders of a majority of the voting power represented at such meeting in person or by proxy, will elect the remaining members of the board of directors. At any annual general meeting at which Appointed Directors are appointed as set forth above, the calculation of the vote of any beneficial owner who appointed a director pursuant to the preceding paragraph shall not take into consideration, for the purpose of electing the remaining directors, ordinary shares constituting seven percent of our issued and outstanding ordinary shares held by such appointing beneficial owner.
Appointed Directors, as set forth above, may be removed by our board of directors when the beneficial ownership of the shareholder who appointed such Appointed Director falls below seven percent of our ordinary shares. In addition, the office of an Appointed Director will expire upon the removal of the Appointed Director by the shareholder who appointed such Appointed Director or when the Appointed Director ceases to qualify as an “independent director” as set forth above.
Article 39 of our Articles of Association further provides that the affirmative vote of a majority of the shares then represented at a general meeting of shareholders shall be entitled to remove director(s) other than Appointed Directors from office (unless pursuant to circumstances or events prescribed under the Companies Law), to elect directors instead of directors so removed or to fill any vacancy, however created, in the board of directors. Subject to the foregoing and to early resignation or ipso facto termination of office as provided in Article 42 of our Articles of Association, each director shall serve until the adjournment of the of the Annual General Meeting next following the Annual General Meeting or General Meeting at which such director was elected.
Our directors may, at any time and from time to time, appoint a director to temporarily fill a vacancy on the board of directors or in addition to their body (subject to the number of directors in the board of directors as set forth above), except that if the number of directors then in office constitutes less than a majority of the number provided for entire board of directors, as set forth above, they may only act in an emergency, or to fill the vacancy up to the minimum number required to effect corporate action or in order to call a general meeting for the purpose of electing directors.
See Item 6: “Directors, Senior Management and Employees – Alternate Directors”.
See Item 6: “Directors, Senior Management and Employees – External Directors”.
Article 40 of our Articles of Association provides that no person shall be disqualified to serve as a director by reason of him not holding shares in the Company or by reason of him having served as director in the past. Our directors are not subject under the Companies Law or our Articles of Association to an age limit requirement. Under the Companies Law, a person cannot serve as a director if he been convicted of certain offenses, unless specifically authorized by the court, or has been declared bankrupt.
Article 46 of our Articles of Association provides that the board of directors may meet and adjourn its meetings and otherwise regulate such meetings and proceedings as the directors think fit. Any director may convene a meeting of the board of directors, upon notice of not less than 7 days.
Consistent with the Companies Law, Article 46 of our Articles of Association provides that no director present at the commencement of a meeting of the board of directors shall be entitled to seek the revocation of any proceedings or resolutions adopted at such meeting on account of any defect in the notice of such meeting relating to the time or the place thereof.
- 79 -
Article 47 of our Articles of Association provides that unless unanimously decided otherwise by the board of directors, a majority of the directors then in office shall constitute a quorum for meetings of the board of directors. No business shall be transacted at a meeting of the board of directors unless the requisite quorum is present.
Our board of directors may elect directors as a Chairman and a Co-Chairman. The Companies Law provides that the Chairman of the Board of a company shall have a casting vote in the event of a tied vote, unless the company’s articles of association provides otherwise. Article 48 of our Articles of Association provides that neither the Chairman nor the Co-Chairman of the Board shall have a casting or additional vote.
The Companies Law authorizes the board of directors of a company, among other things, to determine the credit limit of the company and to issue bonds. Article 35(b) of our Articles of Association states that our board of directors may, from time to time, at its discretion, cause Gilat to borrow or secure the payment of any sum or sums of money, and may secure or provide for the repayment of such sum or sums in such manner, at such times and upon such terms and conditions as it deems fit.
The Companies Law provides that transactions between a company and its “office holders”, which are not “extraordinary transactions” (as both terms are defined below), require the approval of the board of directors, unless another manner of approval is provided by the articles of association. See “Item 10: Additional Information–Interested Parties Transactions.” Accordingly, to provide Gilat’s Chief Executive Officer flexibility in hiring officers (other than directors), Article 50(b) of our Articles of Association authorizes Gilat’s Chief Executive Officer to appoint the officers and employees of Gilat (other than directors) and to determine their remuneration as long as the board of directors did not do so, and provides further that the remuneration of the four highest salaried personnel of the Company shall be approved by either the board of directors, the Audit Committee or the Compensation Committee.
An “extraordinary transaction” is defined in the Companies Law as a transaction which is not in the company’s ordinary course of business, or is not on market terms, or that may materially affect the company’s profitability, assets or liabilities.
An “office holder” is defined in the Companies Law as a director, general manager, chief business manager, deputy general manager, or any other person assuming the responsibilities of any of the foregoing positions without regard to such person’s title, and any other manager directly subordinate to the general manager.
Fully paid ordinary shares are issued in registered form and may be freely transferred pursuant to the Articles of Association, unless such transfer is restricted or prohibited by another instrument.
The Companies Law provides that an acquisition of shares in the Company must be made by means of a tender offer, if, as a result of the acquisition, the purchaser would become a holder of twenty five percent or more of the voting rights in the Company. This rule does not apply if there is already another holder of twenty five percent of the voting rights. Similarly, the Companies Law provides that an acquisition of our shares must be made by means of a tender offer, if, as a result of the acquisition, the purchaser would become a holder of forty five percent of the voting rights in the Company, unless there is another person holding at that time more than fifty percent of the voting rights of the Company.
- 80 -
Regulations under the Companies Law provide that the Companies Law’s tender offer rules do not apply to a company whose shares are publicly traded either outside of Israel or both in and outside of Israel if, pursuant to the applicable foreign securities laws and stock exchange rules, there is a restriction on the acquisition of any level of control of the company or if the acquisition of any level of control of the company requires the purchaser to make a tender offer to the public shareholders.
The Companies Law, subject to certain limitations, allows companies under certain circumstances to repurchase their own shares. Article 10(b) of our Articles of Association provides that Gilat may at any time, and from time to time, subject to the Companies Law, purchase back or finance the purchase of any shares or other securities issued by Gilat, in such manner and under such terms as the board of directors shall determine, whether from one or more shareholders. Such purchase shall not be deemed a payment of dividends and no shareholder will have the right to require Gilat to purchase his shares or offer to purchase shares from any other shareholders.
Neither our Articles of Association nor Israeli law restrict in any way the ownership of our ordinary shares by nonresidents of Israel, or restrict the voting or other rights of nonresidents of Israel. Notwithstanding, nationals of certain countries that are, or have been, in a state of war with Israel may not be recognized as owners of ordinary shares, without a special government permit.
The Companies Law provides for mergers between Israeli companies, if each party to the transaction obtains the appropriate approval of its board of directors and shareholders. A “merger” is defined in the Companies Law as a transfer of all assets and liabilities (including conditional, future, known and unknown liabilities) of a target company to another company, the consequence of which is the dissolution of the target company in accordance with the provisions of the Companies Law. For purposes of the shareholder vote of each merging entity, unless a court rules otherwise, the merger requires the approval of a majority of the shares of that entity that are not held by the other entity or are not held by any person who holds 25% or more of the shares or the right to appoint 25% or more of the directors of the other entity. Article 69A of our Articles of Association provides that a merger requires the approval of the holders of a majority of the shares voting thereon.
Our ordinary shares are entitled to the full amount of any cash or share dividend declared, in proportion to the paid up nominal value of their respective holdings. In the event of liquidation, after satisfaction of liabilities to creditors, our assets will be distributed to the holders of our ordinary shares in proportion to the paid up nominal value of their respective holdings. Such rights may be affected by the grant of preferential dividend or distribution rights to the holders of a class of shares with preferential rights that may be authorized in the future by the shareholders.
Generally, pursuant to the Companies Law, the decision to distribute dividends and the amount to be distributed, whether interim or final, is made by the board of directors. Accordingly, under Article 52 of our Articles of Association, our board of directors has the authority to determine the amount and time for payment of interim dividends and final dividends.
- 81 -
Under the Companies Law, dividends may be paid only out of its net profits for the two years preceding the distribution of the dividends, calculated in the manner prescribed in the Companies Law. Pursuant to the Companies Law, in any distribution of dividends, our board of directors is required to determine that there is no reasonable concern that the distribution of dividends will prevent us from meeting our existing and foreseeable obligations as they become due. Our Articles of Association provide that no dividends shall be paid otherwise than out of our profits and that any such dividend shall carry no interest. In addition, upon the recommendation of our board of directors, approved by the shareholders, we may cause dividends to be paid in kind.
The rights attached to any class of shares (unless otherwise provided by the terms of issue of such class), such as voting, dividends and the like, may be modified by the affirmative vote of a majority of the issued shares of the class at a general meeting of the holders of the shares of such class.
The Companies Law requires that certain transactions, actions and arrangements be approved by the Audit Committee as well as by our board of directors. In certain circumstances, in addition to Audit Committee and board of directors’ approval, approval by our shareholders at a general meeting is also required. Specifically, the approval of our Audit Committee, board of directors and shareholders is required with respect to the following:
The approval of our shareholders would be required in addition to the approval of our board of directors, in (i) any transaction in which the majority of our directors have a personal interest, and (ii) a private placement of securities that will increase the holdings of a shareholder that holds five percent or more of our outstanding share capital, or that will cause any person to become, as a result of the issuance, a holder of more than five percent of our outstanding share capital.
For the purpose of approvals of interested parties transactions, a “controlling shareholder” is defined under the Companies Law as: (i) a shareholder having the ability to direct the acts of the company (for this purpose, any person holding one half or more of the voting power of the company or of the right to appoint directors or the Chief Executive Officer is presumed to have control of the company); or (ii) the holder of twenty five percent or more of the voting rights at the general meeting of the company, if there is no other person holding more than fifty percent of such rights (for this purpose, two or more holders having a personal interest in the transaction shall be deemed to be joint holders).
The Companies Law requires a special majority of shareholder votes in approving the transactions with a controlling shareholder referenced in paragraphs (2) and (3) above. The special majority approval must comply with one of the following: (a) it must include at least one-third of all of the votes of the shareholders voting at the meeting who do not have a personal interest in the transaction, or (b) the total number of opposing votes from amongst the shareholders who do not have a personal interest in the transaction does not exceed one percent of all of the voting power of the Company.
The disclosure provisions of the Companies Law require certain disclosure to be made to the Company in connection with interested parties transactions, as follows:
- 82 -
In addition, a director who has a personal interest in a transaction, except a transaction with an office holder or in which an office holder has a personal interest but which is not an extraordinary transaction, may not be present or vote at a meeting of the Audit Committee or the board of directors, unless a majority of directors in the Audit Committee or the board of directors, as applicable, have a personal interest in the transaction.
The Companies Law describes the fiduciary duty of an office holder as a duty to act in good faith and for the benefit of the company, including by refraining from actions in which he has a conflict of interest or that compete with the company’s business, refraining from exploiting a business opportunity of the company in order to gain a benefit for himself or for another person, and disclosing to the company any information and documents which are relevant to the company and that were obtained by him in his or her capacity as an office holder. The duty of care is defined as an obligation of caution of an office holder that requires the office holder to act at a level of competence at which a reasonable office holder would have acted in the same position and under the same circumstances, including by adopting reasonable means for obtaining information concerning the profitability of the act brought for his approval.
Under the Companies Law, a company may not exempt an office holder from liability with respect to a breach of his fiduciary duty, but may exempt in advance an office holder from his liability to the company, in whole or in part, with respect to a breach of his duty of care.
Pursuant to the Companies Law, a company may indemnify an office holder against a monetary liability imposed on him by a court, including in settlement or arbitration proceedings, and against reasonable legal expenses in a civil proceeding or in a criminal proceeding in which the office holder was found to be innocent or in which he was convicted of an offense which does not require proof of a criminal intent. The indemnification of an office holder must be expressly allowed in the articles of association, under which the company may (i) undertake in advance to indemnify its office holders with respect to categories of events that can be foreseen at the time of giving such undertaking and up to an amount determined by the board of directors to be reasonable under the circumstances, or (ii) provide indemnification retroactively at amounts deemed to be reasonable by the board of directors.
A company may also procure insurance of an office holder’s liability in consequence of an act performed in the scope of his office, in the following cases: (a) a breach of the duty of care of such office holder, (b) a breach of the fiduciary duty, only if the office holder acted in good faith and had reasonable grounds to believe that such act would not be detrimental to the company, or (c) a monetary obligation imposed on the office holder for the benefit of another person.
A company may not indemnify an office holder against, nor enter into an insurance contract which would provide coverage for, any monetary liability incurred as a result of any of the following:
- 83 -
In addition, under the Companies Law, indemnification of, and procurement of insurance coverage for a company’s office holders, must be approved by the company’s audit committee and board of directors and, in specified circumstances, by the company’s shareholders.
Our Articles of Association allow us to exempt any office holder to the maximum extent permitted by law, before or after the occurrence giving, rise to such exemption. Our Articles of Association also provide that we may indemnify any past or present office holder, to the maximum extent permitted by law, against any liabilities he or she may incur in such capacity, limited with respect (i) to the categories of events that can be foreseen in advance by our board of directors when authorizing such undertaking and (ii) to the amount of such indemnification as determined retroactively by our board of directors to be reasonable in the particular circumstances. Similarly, we may also agree to indemnify an office holder for past occurrences, whether or not we are obligated under any agreement to provide such indemnification. We have obtained directors’ and officers’ liability insurance covering our officers and directors and those of our subsidiaries for certain claims. In addition, as of August 30, 2005, we have provided our directors and officers with letters providing them with indemnification to the full extent permitted under Israeli law.
Our Articles of Association also allow us to procure insurance covering any past or present officer holder against any liability which he or she may incur in such capacity, to the maximum extent permitted by law. Such insurance may also cover the Company for indemnifying such office holder.
Israeli Taxation
The following is a short summary of certain Israeli income tax and capital gains tax consequences for nonresidents and residents of Israel holding our ordinary shares. The summary is based on provisions of the Israeli Income Tax Ordinance (new version) and additional and complementary tax regulations promulgated thereunder, and on administrative and judicial interpretations, all as currently in effect, and all of which are subject to change (possibly with retroactive effect) and to differing interpretations. There might be changes in the tax rates and in the circumstances in which they apply, and other modifications which might change the tax consequenses to you. The summary is intended for general purposes only, not exhaustive of all possible tax considerations. The discussion is not intended and should not be construed as legal or professional tax advice and is not exhaustive of all possible tax considerations. This summary does not discuss all aspects of Israeli income and capital gain taxation that may be applicable to investors in light of their particular circumstances or to investors who are subject to special status or treatment under Israeli tax law.
FOR THE FOREGOING AND OTHER REASONS, YOU ARE URGED TO CONSULT YOUR OWN TAX ADVISOR REGARDING THE TAX CONSEQUENCES OF YOUR HOLDINGS. GILAT IS NOT MAKING ANY REPRESENTATIONS REGARDING THE PARTICULAR TAX CONSEQUENCES AS TO ANY HOLDER, NOR IS GILAT OR ITS ADVISORS RENDERING ANY FORM OF LEGAL OPINION OR PROFESSIONAL TAX ADVICE AS TO SUCH TAX CONSEQUENCES.
- 84 -
Nonresidents of Israel are subject to income tax on income accrued or derived from sources in Israel or received in Israel. These sources of income include passive income such as dividends, royalties and interest, as well as non-passive income from services rendered in Israel. Gilat is required to withhold income tax on such payments to non-residents. Israel presently has no estate or gift tax.
Israeli law imposes a capital gains tax on capital gains derived from the sale of securities and other Israeli capital assets, including shares in Israeli resident companies, unless a specific exemption is available or unless a treaty between Israel and the country of the non-resident provides otherwise. The capital gain or loss amount is equal to the consideration received by the holder for the shares less the holder’s tax basis in the shares. Gains from sales of our ordinary shares will be tax exempted for nonresidents of Israel if the shares are quoted on the Nasdaq National market or listed for trading on a stock exchange recognized by the Israeli Ministry of Finance so long as the gains are not derived through a permanent establishment that the non-resident maintains in Israel. If our shares are delisted, gains from sales of ordinary shares will be subject to 20% capital gain tax (25% if the seller is a “substantial shareholder,” generally a shareholder with 10% or more of the right to profits, right to nominate a director and voting rights), on the capital gain derived since December 31, 2002, and certain withholding obligations may apply unless a reduced rate or an exemption is provided under any tax treaty applicable to the specific holder.
For residents of the United States holding less than 10% of our shares at any time in the twelve months before the sale, under the treaty between Israel and the U.S., capital gains from the sale of capital assets are generally exempt from Israeli capital gains tax with respect to the exeptions stated in the treaty.
Nonresidents of Israel are subject to income tax on income accrued or derived from sources in Israel. These sources of income may include dividends on our ordinary shares. On distribution of dividends other than bonus shares or stock dividends, income tax is withheld at source, at the rate of 20% for dividends paid to an individual or a foreign corporation who is not a substantial share holder, 25% for dividends paid to a substantial shareholder, and 15% for dividends generated by an approved enterprise, unless in each case a different rate is provided in a treaty between Israel and shareholder’s country of residence. Under the U.S.-Israel tax treaty, the maximum tax on dividends paid to a holder of ordinary shares who is a U.S. resident will be 25%. However, the maximum tax rate on dividends not generated by an approved enterprise paid to a US corporation holding at least 10% of our voting power is 12.5%. For residents of other countries, unless a different rate is provided in a treaty between Israel and the stockholder’s country of residence, the maximum tax on dividends paid that Gilat is required to withhold is 25%.
Nonresidents of Israel are subject to income tax on income accrued or derived from sources in Israel. These sources of income may include passive income, such as interest paid on our convertible notes. For residents of the United States, under the treaty between Israel and the U.S., the maximum tax on interest paid to a U.S. resident (as defined in the treaty) holding our convertible notes that Gilat is required to withhold is 17.5%. For residents of other countries, unless a different rate is provided in a treaty between Israel and the country of residence of such holder of our convertible notes, the maximum tax that Gilat is required to withhold is 25% on all distributions of interest.
A nonresident of Israel who receives interest, dividend or royalty income derived from or accrued in Israel, from which tax was withheld at the source, is generally exempt from the duty to file tax returns in Israel with respect to such income, provided such income was not derived from a business conducted in Israel by the taxpayer.
- 85 -
Israeli law imposes a capital gains tax on capital gains derived from the sale of securities and other Israeli capital assets, including shares by Israeli residents. The capital gain or loss amount is equal to the consideration received by the holder for the shares less the holder’s tax basis in the shares. Under current law, effective commencing January 1, 2006, gains from sales of ordinary shares incurred after December 31, 2002, are subject to 20% capital gains tax (25% for substantial shareholder) for individuals and Israeli companies not subject to the Income Tax Law (Inflation Adjustments) – 1985 (the “Adjustment Law”) and 31% (29% in 2007, 27% in 2008, 26% in 2009 and 25% in 2010 and thereafter) capital gain tax for Israeli companies subject to the Adjustment Law if the ordinary shares are quoted on the Nasdaq National market or listed on a stock exchange recognized by the Israeli Ministry of Finance. The tax rate on capital gains from publicly traded shares applicable to gains that were realized in 2005, was 15% (in 2003 and 2004 15% for publicly traded shares of Israeli companies and 35% for publicly traded shares of foreign companies). Gains incurred until December 31, 2002, are exempt from capital gains tax for so long as (i) the ordinary shares are listed on a stock exchange recognized by the Israeli Ministry of Finance and (ii) Gilat Qualifies as an Industrial Company or Industrial Holding Company under the law for Encouragement of Industry (Taxes)- 1969. We believe that we qualify as an Industrial Company under the law for Encouragement of Industry (Taxes)- 1969. Gains incurred until December 31, 2002 are subject to 36% capital gains tax for Israeli companies subject to the adjustment law. If our shares are delisted, gains from sales of ordinary shares will be subject to 20% capital gain tax on the capital gain derived since December 31, 2002 (25% for substantial shareholder and for companies subject to the Adjustment Law).Certain withholding obligations may apply on the sale of Gilat shares.
Dividend income generated by an Approved Enterprise is subject to income tax at a rate of 15%. The distribution of dividend income generated by other sources, other than bonus shares (stock dividends), to Israeli residents who purchased our Shares will generally be subject to income tax at a rate of 20% for individuals (25% for substantial shareholder) and will be exempt from income tax for corporations. Gilat may be required to withhold income tax at the maximum rate of up to 25% (0% for corporations) on all such distributions (15% for dividends generated by an Approved Enterprise).
Residents of Israel are subject to income tax on their worldwide income. These sources of income may include passive income, such as interest paid on our convertible notes. The interest accrued and paid after January 1, 2006, is generally subject to 20% tax (25% for substantial shareholder) for individuals and 31% (29% in 2007, 27% in 2008, 26% in 2009 and 25% in 2010 and thereafter) for companies. We may be required to withhold income tax at a rate of up to 35% on all distributions of interest.
The following discussion is a general summary of certain U.S. federal income tax considerations applicable to U.S. Holders (as defined below) of ordinary shares, who hold such ordinary shares as capital assets (generally, property held for investment). This summary is based on provisions of the U.S. Internal Revenue Code, or the Code, existing and proposed U.S. Treasury regulations and administrative and judicial interpretations in effect as of the date of this annual report and the U.S. – Israel Tax Treaty. All of these authorities are subject to change (possibly with retroactive effect) and to differing interpretations. In addition, this summary does not discuss non-U.S. tax implications or U.S. state tax implications, no does it discuss all aspects of U.S. federal income taxation that may be applicable to investors in light of their particular circumstances or to investors who are subject to special treatment under U.S. federal income tax law, including:
- 86 -
If a partnership or an entity treated as a partnership for U.S. federal income tax purposes owns ordinary shares, the U.S. federal income tax treatment of a partner in such a partnership will generally depend upon the status of the partner and the activities of the partnership. A partnership that owns ordinary shares and the partners in such partnership should consult their tax advisors about the U.S. federal income tax consequences of holding and disposing of ordinary shares.
THE FOLLOWING SUMMARY DOES NOT ADDRESS THE IMPACT OF A U.S. HOLDER’S INDIVIDUAL TAX CIRCUMSTANCES. ACCORDINGLY, EACH U.S. HOLDER IS URGED TO CONSULT HIS OR HER TAX ADVISOR AS TO THE PARTICULAR TAX CONSEQUENCES TO HIM OR HER OF AN INVESTMENT IN THE ORDINARY SHARES, INCLUDING THE EFFECTS OF APPLICABLE STATE, LOCAL OR NON-U.S. TAX LAWS AND POSSIBLE CHANGES IN THE TAX LAWS.
As used herein, the term “U.S. Holder” means a beneficial owner of an ordinary share who is, for U.S. federal income tax purposes:
- 87 -
Subject to the discussion of the passive foreign investment company or PFIC rules below, a U.S. Holder generally will be required to include in gross income as ordinary dividend income the amount of any distributions paid on the ordinary shares (including the amount of any Israeli taxes withheld) to the extent that such distributions are paid out of Gilat’s current or accumulated earnings and profits as determined for U.S. federal income tax purposes. Distributions in excess of Gilat’s earnings and profits as so determined will be applied against and will reduce the U.S. Holder’s tax basis in its ordinary shares and, to the extent they are in excess of such tax basis, will be treated as gain from a sale or exchange of such ordinary shares. Gilat’s dividends will not qualify for the dividends-received deduction otherwise available to U.S. corporations. In the event that Gilat pays cash dividends, such dividends will be paid in Israeli currency. Dividends paid in NIS (including the amount of any Israeli taxes withheld therefrom) will be includible in the gross income of a U.S. Holder in a U.S. dollar amount calculated by reference to the exchange rate in effect on the day they are received by the U.S. Holder. Any gain or loss resulting from currency exchange fluctuations during the period from the date the dividend is includible in the income of the U.S. Holder to the date such payment is converted into U.S. dollars generally will be treated as U.S. source ordinary income or loss.
Subject to certain limitations, “qualified dividend income” received by a non-corporate taxpayer generally is subject to U.S. federal income tax at a reduced maximum tax rate of 15 percent through December 31, 2008. Dividends received with respect to ordinary shares should qualify for the 15 percent rate provided that either: (i) Gilat is entitled to benefits under the income tax treaty between the United States and Israel; or (ii) the ordinary shares currently are readily tradeable on an established securities market in the U.S. (the “Treaty”). Gilat believes that it is entitled to benefits under the Treaty and that the ordinary shares currently are readily tradable on an established securities market in the U.S. No assurance can be given that the ordinary shares will remain readily tradable. The rate reduction does not apply to dividends received from PFICs, see discussion below, or in respect of certain short-term or hedged positions in common stock or in certain other situations. The legislation enacting the reduced tax rate contains special rules for computing the foreign tax credit limitation of a taxpayer who receives dividends subject to the reduced tax rate, see discussion below. U.S. Holders of ordinary shares should consult their own tax advisors regarding the effect of these rules in their particular circumstances.
Subject to complex limitations, any Israeli withholding tax imposed on dividends paid by Gilat will be a foreign income tax eligible for credit against a U.S. Holder’s U.S. federal income tax liability (or, alternatively, for deduction against income in determining such tax liability). The limitations set out in the Code include computational rules under which foreign tax credits allowable with respect to specific classes of income cannot exceed the U.S. federal income taxes otherwise payable with respect to each such class of income. Dividends generally will be treated as foreign-source passive income or, in the case of certain U.S. Holders, financial services income for United States foreign tax credit purposes. U.S. Holders should note that recently enacted legislation eliminates the “financial services income” category with respect to taxable years beginning after December 31, 2006. Under this legislation, the foreign tax credit limitation categories will be limited to “passive category income” and “general category income.” Further, there are special rules for computing the foreign tax credit limitation of a taxpayer who receives dividends subject to a reduced tax, see discussion above. A U.S. Holder will be denied a foreign tax credit with respect to Israeli income tax withheld from dividends received on the ordinary shares to the extent such U.S. Holder has not held the ordinary shares for at least 16 days of the 30-day period beginning on the date which is 15 days before the ex-dividend date or to the extent such U.S. Holder is under an obligation to make related payments with respect to substantially similar or related property. Any days during which a U.S. Holder has substantially diminished its risk of loss on the ordinary shares are not counted toward meeting the 16-day holding period required by the statute. The rules relating to the determination of the foreign tax credit are complex, and you should consult with your personal tax advisors to determine whether and to what extent you would be entitled to this credit.
Subject to the discussion of passive foreign investment company rules below, upon the sale or other disposition of ordinary shares, a U.S. Holder generally will recognize capital gain or loss equal to the difference between the amount realized on the disposition and such holder’s adjusted tax basis in the ordinary shares disposed of. Gain or loss upon the disposition of ordinary shares will be long-term capital gain or loss if, at the time of the disposition, the U.S. Holder’s holding period for the ordinary shares disposed of exceeds one year. In general, any gain that you recognize on the sale or other disposition of ordinary shares will be U.S.-source for purposes of the foreign tax credit limitation; losses, will generally be allocated against U.S. source income. Deduction of capital losses is subject to certain limitations under the Code.
- 88 -
In the case of a cash basis U.S. Holder who receives NIS in connection with the sale or disposition of ordinary shares, the amount realized will be based on the U.S. dollar value of the NIS received with respect to the ordinary shares as determined on the settlement date of such exchange. A U.S. Holder who receives payment in NIS and converts NIS into United States dollars at a conversion rate other than the rate in effect on the settlement date may have a foreign currency exchange gain or loss that would be treated as ordinary income or loss.
An accrual basis U.S. Holder may elect the same treatment required of cash basis taxpayers with respect to a sale or disposition of ordinary shares, provided that the election is applied consistently from year to year. Such election may not be changed without the consent of the Internal Revenue Service , or the IRS. In the event that an accrual basis U.S. Holder does not elect to be treated as a cash basis taxpayer (pursuant to the Treasury regulations applicable to foreign currency transactions), such U.S. Holder may have a foreign currency gain or loss for U.S. federal income tax purposes because of differences between the U.S. dollar value of the currency received prevailing on the trade date and the settlement date. Any such currency gain or loss would be treated as ordinary income or loss and would be in addition to gain or loss, if any, recognized by such U.S. Holder on the sale or disposition of such ordinary shares.
For U.S. federal income tax purposes, Gilat will be considered a PFIC for any taxable year in which either (i) 75% or more of its gross income is passive income, or (ii) at least 50% of the average value of all of its assets for the taxable year produce or are held for the production of passive income. For this purpose, passive income includes dividends, interest, royalties, rents, annuities and the excess of gains over losses from the disposition of assets which produce passive income. If Gilat were determined to be a PFIC for U.S. federal income tax purposes, highly complex rules would apply to U.S. Holders owning ordinary shares. Accordingly, you are urged to consult your tax advisors regarding the application of such rules.
Based on Gilat’s current and projected income, assets and activities, Gilat believes that it is not currently a PFIC. However, because the determination of whether Gilat is a PFIC is based upon the composition of its income and assets from time to time, there can be no assurances that Gilat will not become a PFIC for any future taxable year.
- 89 -
If you make either a timely QEF election or a timely mark-to-market election in respect of your ordinary shares, you would not be subject to the rules described above. If you make a timely QEF election, you would be required to include in your income for each taxable year your pro rata share of Gilat’s ordinary earnings as ordinary income and your pro rata share of Gilat’s net capital gain as long-term capital gain, whether or not such amounts are actually distributed to you. You would not be eligible to make a QEF election unless Gilat complies with certain applicable information reporting requirements.
Alternatively, if the ordinary shares are considered “marketable stock” and if you elect to “mark-to-market” your ordinary shares, you will generally include in income any excess of the fair market value of the ordinary shares at the close of each tax year over your adjusted basis in the ordinary shares. If the fair market value of the ordinary shares had depreciated below your adjusted basis at the close of the tax year, you may generally deduct the excess of the adjusted basis of the ordinary shares over its fair market value at that time. However, such deductions generally would be limited to the net mark-to-market gains, if any, that you included in income with respect to such ordinary shares in prior years. Income recognized and deductions allowed under the mark-to-market provisions, as well as any gain or loss on the disposition of ordinary shares with respect to which the mark-to-market election is made, is treated as ordinary income or loss.
Payments in respect of ordinary shares may be subject to information reporting to the U.S. Internal Revenue Service and to U.S. backup withholding tax at a rate equal to the fourth lowest income tax rate applicable to individuals (which, under current law, is 28%). Backup withholding will not apply, however, if you (i) are a corporation or come within certain exempt categories, and demonstrate the fact when so required, or (ii) furnish a correct taxpayer identification number and make any other required certification.
Backup withholding is not an additional tax. Amounts withheld under the backup withholding rules may be credited against a U.S. Holder’s U.S. tax liability, and a U.S. Holder may obtain a refund of any excess amounts withheld under the backup withholding rules by filing the appropriate claim for refund with the IRS.
Any U.S. holder who holds 10% or more in vote or value of our ordinary shares will be subject to certain additional United States information reporting requirements.
We are subject to the reporting requirements of the Securities Exchange Act of 1934, as amended, as applicable to “foreign private issuers” as defined in Rule 3b-4 under the Exchange Act, and in accordance therewith, we are required to file annual and interim reports and other information with the Securities and Exchange Commission.
As a foreign private issuer, we are exempt from certain provisions of the Exchange Act. Accordingly, our proxy solicitations are not subject to the disclosure and procedural requirements of Regulation 14A under the Exchange Act, transactions in our equity securities by our officers and directors are exempt from reporting as are the “short-swing” profit recovery provisions contained in Section 16 of the Exchange Act. We make our Securities and Exchange Commission filings electronically and they are available on the Securities and Exchange Commission’s website. We began filing through the EDGAR system beginning in November 2002. We are not required under the Exchange Act to file periodic reports and financial statements as frequently or as promptly as United States companies whose securities are registered under the Exchange Act. However, we will distribute annually to our shareholders an annual report containing financial statements that have been examined and reported on, with an opinion expressed by, an independent public accounting firm.
This annual report and the exhibits thereto and any other document that we have to file pursuant to the Exchange Act may be inspected without charge and copied at prescribed rates at the Securities and Exchange Commission public reference room at 450 Fifth Street, N.W., Judiciary Plaza, Room 1024, Washington, D.C. 20549. You may obtain information on the operation of the Securities and Exchange Commission’s public reference room in Washington, D.C. by calling the Securities and Exchange Commission at 1-800-SEC-0330 and may obtain copies of our filings from the public reference room by calling (202) 942-8090.
- 90 -
Information about us is also available on our website at http://www.gilat.com. Such information on our website is not part of this annual report.
The currency of our primary economic environment is the dollar. However, we have balances and activities in other currencies. We are therefore exposed to market risks arising from changes in currency exchange rates. We are also exposed to market risks arising from changes in interest rates.
Our functional currency and that of most of our subsidiaries is the dollar. Accordingly, we attempt to protect ourselves against exposure arising from the difference between assets and liabilities in each currency other than the dollar, or “Balance Sheet Exposure”. We strive to limit our exposure through “natural” hedging, i.e., attempting to maintain similar levels of assets and liabilities in any given currency, to the extent possible. However, this method of “natural” hedging is not always achievable.
Due to the existence of assets and liabilities with different interest rates and maturity dates, we are exposed to changes in interest rates.
- 91 -
The table below details the balance sheet exposure by currency and interest rates:
- 92 -
For details regarding long-term restricted cash, please see “Item 5: Liquidity and Capital Resources.”
For details regarding long-term loans from banks and the convertibles notes, please see “Item 4: Details Regarding the Restructuring of our Debt in 2003".
Our management, including our chief executive officer and chief financial officer, evaluated the effectiveness of our disclosure controls and procedures (as defined in Securities Exchange Act Rule 13a-15(e)) as of the end of the period covered by this Form 20. Based upon that evaluation, our chief executive officer and chief financial officer have concluded that, as of such date, our disclosure controls and procedures were effective to ensure that information required to be disclosed by our company in reports that we file or submit under the U.S. Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms and that such information was made known to them by others within the company, as appropriate to allow timely decisions regarding required disclosure.
All internal control systems no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective may not prevent or detect misstatements and can provide only reasonable assurance with respect to financial statement preparation and presentation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
- 93 -
Our board of directors has determined that Dr. Meridor and Dr. Sarid meet the definition of an audit committee financial expert, as defined in Item 401 of Regulation S-K.
We have adopted a Code of Ethics for executive and financial officers, that also applies to all of our employees. The Code of Ethics is publicly available on our website atwww.gilat.com. Written copies are available upon request. If we make any substantive amendments to the Code of Ethics or grant any waivers, including any implicit waiver, from a provision of this code to our chief executive officer, principal financial officer or corporate controller, we will disclose the nature of such amendment or waiver on our website.
The following table sets forth, for each of the years indicated, the fees billed to us by our independent auditors and the percentage of each of the fees out of the total amount paid to the auditors.
Our Audit Committee has adopted a policy and procedures for the approval of audit and non-audit services rendered by our independent auditors, Kost Forer Gabbay & Kasierer, a Member of Ernst & Young Global. The policy generally requires the Audit Committee’s approval of the scope of the engagement of our independent auditor or on an individual engagement basis. The policy prohibits retention of the independent auditors to perform the prohibited non-audit functions defined in Section 201 of the Sarbanes-Oxley Act of 2002 or the rules of the SEC, and also considers whether proposed services are compatible with the independence of the public auditors.
- 94 -
In the year 2005, we did not engage in the purchase of any of our own shares.
The Consolidated Financial Statements and related notes required by this item are contained on pages F-1 through F-61 hereof.
- 95 -
- 96 -
The registrant hereby certifies that it meets all of the requirements for filing on Form 20-F and that it has duly caused and authorized the undersigned to sign this annual report on its behalf.
Date: March 23, 2006
- 97 -
We have audited the accompanying consolidated balance sheets of Gilat Satellite Networks Ltd. (the “Company”) and its subsidiaries as of December 31, 2004 and 2005, and the related consolidated statements of operations, changes in shareholders’ equity (deficiency) and cash flows for each of the three years in the period ended December 31, 2005. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements, based on our audits. We did not audit the financial statements of a consolidated subsidiary, whose statements reflect total assets of approximately 2.4% and 3.0% as of December 31, 2004 and 2005, respectively, and total revenues of approximately 11.7% and 12.5% for the years ended December 31, 2004 and 2005, respectively, of the related consolidated totals. Those financial statements were audited by other auditors, whose reports have been furnished to us, and our opinion, insofar as it relates to amounts included for this subsidiary, is based solely on the reports of the other auditors.
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. We were not engaged to perform an audit of the Company’s internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s 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. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits and the reports of the other auditors provide a reasonable basis for our opinion.
In our opinion, based on our audits and the reports of other auditors, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of the Company and its subsidiaries as of December 31, 2004 and 2005, and the consolidated results of their operations and cash flows, for each of the three years in the period ended December 31, 2005, in conformity with U.S. generally accepted accounting principles.
As discussed in Note 1c to the consolidated financial statements, the Company adopted FASB Interpretation No. 46 “Consolidation of Variable Interest Entities” effective in 2004.
F - 2
The accompanying notes are an integral part of the consolidated financial statements.
F - 3
F - 4
F - 5
F - 6
F - 7
F - 8
F - 9
F - 10
F - 11
F - 12
F - 13
F - 14
F - 15
F - 16
F - 17
F - 18
F - 19
F - 20
F - 21
F - 22
F - 23
F - 24
F - 25
F - 26
F - 27
F - 28
F - 29
F - 30
F - 31
F - 32
F - 33
F - 34
F - 35
F - 36
F - 37
F - 38
F - 39
F - 40
F - 41
F - 42
F - 43
F - 44
F - 45
F - 46
F - 47
F - 48
F - 49
F - 50
F - 51
F - 52
F - 53
F - 54
F - 55
g. Long-term convertible loan:
F - 56
F - 57
F - 58
F - 59
F - 60
F - 61
F - 62
F - 63
F - 64
F - 65
To the Board of Directors
We have audited the accompanying balance sheets of StarBand Communications Inc. as of December 31, 2005 and 2004, and the related statements of operations, shareholders’ equity (deficit) and cash flows for the years then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of StarBand Communications Inc. as of December 31, 2005 and 2004, and the results of its operations and its cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America.
MAYER HOFFMAN MCCANN P.C.Bethesda, MarylandJanuary 19, 2006