At the closing of the
Business Combination, we purchased 16% of Ability Security Systems Ltd. (“ASM”) from its former sole shareholder, Eyal
Tzur. On January 24, 2016, Eyal Tzur exercised his put option and we purchased the remaining shares of ASM, following which ASM
became our wholly-owned subsidiary. For additional information, see “Item 4A. Information on the Company – Merger Agreement
– JV Share Purchase Agreement.”
In this Annual Report
on Form 20-F (the “Annual Report”), unless the context indicates otherwise, references to “U.S. dollars,”
“$” or “dollars” are to United States dollars and to “NIS” are to New Israeli Shekel, the legal
currency of Israel, the terms “we,” “us,” “our,” or the “Company” refer to Ability
Inc. and our wholly-owned subsidiaries, Ability and ASM, and the term “customer” refers to customers and users, as
applicable.
Unless otherwise noted,
NIS amounts presented in this Annual Report are translated at the rate of $1.00 = NIS 3.467 the exchange rate published by the
Bank of Israel on December 31, 2017.
PART
I
Item 1.
|
Identity
of Directors, Senior Management and Advisers
|
Not
applicable.
Item 2.
|
Offer Statistics and Expected Timetable
|
Not
applicable.
A.
|
Selected Financial Data
|
The
following selected financial data should be read in conjunction with “Item 5 Operating and Financial Review and Prospects”
and the Financial Statements and Notes thereto included elsewhere in this Annual Report.
We
have derived the consolidated statement of operations data for the years ended December 31, 2017, 2016 and 2015 and the
balance sheet data as of December 31, 2017 and 2016 from our audited financial statements included elsewhere in this Annual
Report. We have derived the balance sheet data as of December 31, 2015, 2014 and 2013 and the consolidated statement of
operations data for the years ended December 31, 2014 and 2013 from our audited financial statements not included in this
Annual Report. Our financial statements have been prepared in accordance with U.S. GAAP.
In our consolidated
financial statements for the year ended December 31, 2015, our consolidated financial statements as of December 31, 2014 and for
the two years in the period then ended were restated to reflect correction of errors with respect to previously unrecognized commissions
due to a vendor on revenues that were recognized in 2014, 2013 and 2012; improper allocation and timing of revenue recognition
from connection to supportive infrastructure in multiple element sale transactions recognized in the years ended December 31,
2014, 2013 and 2012; and previously unrecognized commissions due to a third party on cost of revenues that were recognized in
the year ended December 31, 2014.
Certain
factors that affect the comparability of the information set forth in the following table are described in “Item 5 Operating
and Financial Review and Prospects” and the Financial Statements and related notes thereto included elsewhere in this Annual
Report.
|
|
Year
Ended December 31,
|
|
|
|
2017
|
|
|
2016
|
|
|
2015
|
|
|
2014
|
|
|
2013
|
|
|
|
(U.S.
dollars; in thousands, except per share data)
|
|
Consolidated
Statements of Operations Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues
|
|
$
|
2,972
|
|
|
$
|
16,508
|
|
|
$
|
52,151
|
|
|
$
|
21,444
|
|
|
$
|
5,903
|
|
Cost
of revenues
|
|
|
2,957
|
|
|
|
8,617
|
|
|
|
29,654
|
|
|
|
13,968
|
|
|
|
4,785
|
|
Gross
profit
|
|
|
15
|
|
|
|
7,891
|
|
|
|
22,497
|
|
|
|
7,476
|
|
|
|
1,118
|
|
Selling
and marketing expenses
|
|
|
3,033
|
|
|
|
5,323
|
|
|
|
3,305
|
|
|
|
3,064
|
|
|
|
665
|
|
General
and administrative expenses
|
|
|
6,016
|
|
|
|
9,662
|
|
|
|
1,317
|
|
|
|
469
|
|
|
|
419
|
|
Operating
income (loss)
|
|
|
(9,034
|
)
|
|
|
(7,094
|
)
|
|
|
17,875
|
|
|
|
3,943
|
|
|
|
34
|
|
Financial
expenses (income), net
|
|
|
77
|
|
|
|
(127
|
)
|
|
|
99
|
|
|
|
(269
|
)
|
|
|
371
|
|
Income
(loss) before income tax
es
|
|
|
(9,111
|
)
|
|
|
(6,967
|
)
|
|
|
17,776
|
|
|
|
4,212
|
|
|
|
(337
|
)
|
Income
tax expenses (benefit)
|
|
|
-
|
|
|
|
1,086
|
|
|
|
3,023
|
|
|
|
1,090
|
|
|
|
(57
|
)
|
Net
and comprehensive income (loss)
|
|
$
|
(9,111
|
)
|
|
$
|
(8,053
|
)
|
|
$
|
14,753
|
|
|
$
|
3,122
|
|
|
$
|
(280
|
)
|
Weighted-average
ordinary shares outstanding - basic and diluted(1)
|
|
|
2,459,088
|
|
|
|
2,459,088
|
|
|
|
2,459,088
|
|
|
|
2,459,088
|
|
|
|
2,459,088
|
|
Basic
and diluted income (loss) per share(1)(2)
|
|
$
|
(3.71
|
)
|
|
$
|
(3.27
|
)
|
|
$
|
6.00
|
|
|
$
|
1.27
|
|
|
$
|
(0.11
|
)
|
Dividends
paid(3)
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
(14,951
|
)
|
|
$
|
(817
|
)
|
|
$
|
(2
31
|
)
|
(1)
|
On
December 27, 2017, we implemented a 1-for-10 consolidation of our ordinary shares, with
a market effective date of March 23, 2018, which was applied retrospectively for the
calculation of the basic and diluted earnings (loss) per ordinary share.
|
(2)
|
We
compute basic earnings or loss per share by dividing net income by the weighted-average
number of ordinary shares outstanding during the period. However, consistent with the
accounting for the Business Combination as a reverse merger, the calculation of the weighted-average
number of ordinary shares (i) includes 2,459,088 ordinary shares assumed to be outstanding
as of January 1, 2013 (which include 48,000 ordinary shares that were issued to the former
ASM shareholder upon exercise of his put option in respect of the ASM shares that were
not acquired by us at the consummation of the Business Combination); and (ii) excludes
117,327 outstanding ordinary shares that are subject to the put option of Messrs. Hurgin
and Aurovsky. For purposes of diluted income (loss) per share, as our outstanding warrants
to purchase 855,744 ordinary shares are “out- of- the- money” and the issuance
of up to 845,000 additional ordinary shares pursuant to the earn-out under the merger
agreement was not probable at any given period, such shares and warrants were excluded
from the calculation of diluted income (loss) per share. For additional information,
see Note 2.l. to the audited consolidated financial statements for the year ended December
31, 2017 included elsewhere in this Annual Report.
|
(3)
|
Dividends
paid by Ability prior to the consummation of the Business Combination on December 23,
2015.
|
|
|
December 31,
|
|
|
|
2017
|
|
|
2016
|
|
|
2015
|
|
|
2014
|
|
|
2013
|
|
|
|
(U.S. dollars; in thousands,
except per share data)
|
|
Balance Sheet Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents
|
|
$
|
1,944
|
|
|
$
|
11,840
|
|
|
$
|
25,829
|
|
|
$
|
11,709
|
|
|
$
|
376
|
|
Total current assets
|
|
|
6,482
|
|
|
|
30,247
|
|
|
|
33,820
|
|
|
|
14,262
|
|
|
|
2,977
|
|
Total non-current assets
|
|
|
13,531
|
|
|
|
1,588
|
|
|
|
12,769
|
|
|
|
870
|
|
|
|
1,007
|
|
Total assets
|
|
|
20,013
|
|
|
|
31,835
|
|
|
|
46,589
|
|
|
|
15,132
|
|
|
|
3,984
|
|
Total current liabilities
|
|
|
7,038
|
|
|
|
21,888
|
|
|
|
16,552
|
|
|
|
13,150
|
|
|
|
4,972
|
|
Total non-current liabilities
|
|
|
12,384
|
|
|
|
245
|
|
|
|
12,282
|
|
|
|
257
|
|
|
|
409
|
|
Total liabilities
|
|
|
19,422
|
|
|
|
22,133
|
|
|
|
28,834
|
|
|
|
13,407
|
|
|
|
5,381
|
|
Total shareholders’ equity (capital deficiency)
|
|
|
591
|
|
|
|
9,702
|
|
|
|
17,755
|
|
|
|
1,725
|
|
|
|
(1,397
|
)
|
Total liabilities and shareholders’ equity (net of capital deficiency)
|
|
$
|
20,013
|
|
|
$
|
31,835
|
|
|
$
|
46,589
|
|
|
$
|
15,132
|
|
|
$
|
3,984
|
|
Even though our functional currency is the U.S. dollar, we earn revenues, pay expenses, own assets and
incur liabilities in the NIS.
The
following table sets forth information regarding the exchange rates of U.S. dollars per NIS for the periods indicated. Average
rates are calculated by using the daily representative rates as reported by the Bank of Israel on the last day of each month during
the periods presented.
NIS
per U.S. dollars
Year
|
|
High
|
|
|
Low
|
|
|
Average
|
|
|
Period End
|
|
2017
|
|
|
3.860
|
|
|
|
3.467
|
|
|
|
3.599
|
|
|
|
3.467
|
|
2016
|
|
|
3.983
|
|
|
|
3.746
|
|
|
|
3.832
|
|
|
|
3.845
|
|
2015
|
|
|
4.053
|
|
|
|
3.761
|
|
|
|
3.884
|
|
|
|
3.902
|
|
2014
|
|
|
3.994
|
|
|
|
3.402
|
|
|
|
3.577
|
|
|
|
3.889
|
|
2013
|
|
|
3.728
|
|
|
|
3.471
|
|
|
|
3.601
|
|
|
|
3.471
|
|
The
following table sets forth the high and low daily representative rates for the NIS as reported by the Bank of Israel for each
of the prior six months. Average rates are calculated by using the daily representative rates as reported by the Bank of Israel
on the last day of each month during the periods presented.
NIS per U.S. dollars
|
|
Month
|
|
High
|
|
|
Low
|
|
|
Average
|
|
|
Period End
|
|
April 2018 (through April 15, 2018)
|
|
|
3.537
|
|
|
|
3.506
|
|
|
|
3.520
|
|
|
|
3.506
|
March 2018
|
|
|
3.514
|
|
|
|
3.431
|
|
|
|
3.468
|
|
|
|
3.514
|
February 2018
|
|
|
3.535
|
|
|
|
3.427
|
|
|
|
3.494
|
|
|
|
3.485
|
|
January 2018
|
|
|
3.460
|
|
|
|
3.388
|
|
|
|
3.423
|
|
|
|
3.405
|
|
December 2017
|
|
|
3.550
|
|
|
|
3.467
|
|
|
|
3.503
|
|
|
|
3.467
|
|
November 2017
|
|
|
3.544
|
|
|
|
3.499
|
|
|
|
3.517
|
|
|
|
3.499
|
|
October 2017
|
|
|
3.542
|
|
|
|
3.491
|
|
|
|
3.512
|
|
|
|
3.521
|
|
September 2017
|
|
|
3.584
|
|
|
|
3.504
|
|
|
|
3.537
|
|
|
|
3.529
|
|
On
April 27, 2018, the closing representative rate was $1.00 to NIS 3.597, as reported by the Bank of Israel.
B.
|
Capitalization and Indebtedness
|
Not
applicable.
C.
|
Reasons for the Offer and Use of Proceeds
|
Not
applicable.
You
should consider carefully the risks and uncertainties described below, together with all of the other information in this Annual
Report, including the consolidated financial statements and the related notes included elsewhere in this Annual Report. The risks
and uncertainties described below are not the only ones we face. Additional risks and uncertainties that we are unaware of, or
that we currently believe are not material, may also become important factors that adversely affect our business. If any of the
following risks actually occurs, our business, financial condition, results of operations and future prospects could be materially
and adversely affected.
Risks
Related to our Financial Position
We
have incurred net losses and negative cash flows in the years ended December 31, 2017 and 2016 and can provide no assurance of
our future operating results.
We
currently have limited product revenues. We have experienced net losses and negative cash flows from operating activities during
the years ended December 31, 2017 and 2016. For the years ended December 31, 2017 and 2016, we incurred net losses of $9.1 million
and $8.1 million, respectively. As of December 31, 2017, we had an aggregate accumulated deficit of $18.0 million. We
expect to incur additional operating losses for the foreseeable future. There can be no assurance that we will be able to achieve
sufficient revenues to support our operations or be profitable in the future.
The
report of our independent registered public accounting firm contains an explanatory paragraph regarding substantial doubt about
our ability to continue as a going concern.
Our
audited financial statements for the year ended December 31, 2017 were prepared under the assumption that we would continue our
operations as a going concern. Our independent registered public accounting firm has included a “going concern” explanatory
paragraph in its report on our financial statements for the year ended December 31, 2017, indicating that there is a substantial
doubt about our ability to continue as a going concern. As of December 31, 2017, we had total cash and cash equivalents of $1.9
million and negative working capital of $556,000. See “Item 5.B Liquidity and Capital Resources”. If we are unable
to improve our liquidity position, by, among others things, increasing our revenues, raising capital through public or private
offerings or reducing our expenses, we may exhaust our cash resources and will be unable to continue our operations. If we cannot
continue as a viable entity, our shareholders would likely lose most or all of their investment in us.
We
will need significant additional capital, which we may be unable to obtain.
Revenues
generated from our operations are not presently sufficient to sustain our operations. Without materially curtailing our operations,
we estimate that we have sufficient capital to finance our operations through the next two months from the date of this Annual
Report. On April 11, 2018, we obtained a six-month bank line of credit of NIS 11 million ($3.1 million) secured by our controlling
shareholders, Anatoly Hurgin, who is also our Chief Executive Officer and Chairman, and Alexander Aurovsky, who is also our Chief
Technology Officer and a director. If we utilize the line of credit in full, we estimate that this will finance our operations
for a further four to six months. Therefore, we will need to raise additional capital to continue our operations. There can be
no assurance that additional funds will be available when needed from any source or, if available, will be available on terms
that are acceptable to us. We may be required to pursue sources of additional capital through various means, including debt or
equity financings. Future financings through equity investments are likely to be dilutive to existing stockholders. Also, the
terms of securities we may issue in future capital transactions may be more favorable for new investors. Newly issued securities
may include preferences, superior voting rights, the issuance of warrants or other derivative securities, and the issuances of
incentive awards under equity employee incentive plans, which may have additional dilutive effects. Further, we may incur substantial
costs in pursuing future capital and/or financing, including investment banking fees, legal fees, accounting fees, printing and
distribution expenses and other costs. We may also be required to recognize non-cash expenses in connection with certain securities
we may issue, such as convertible notes and warrants, which will adversely impact our financial condition. Our ability to obtain
needed financing may be impaired by such factors as the capital markets, our history of losses, and our litigations
and SEC investigation which could impact the availability or cost of future financings. If the amount of capital we are able to
raise from financing activities, together with our revenues from operations, is not sufficient to satisfy our capital needs, even
to the extent that we reduce our operations accordingly, we may be required to cease operations.
Risks
Related to our Business
Our
revenues highly depend on the successful implementation and customer adoption of ULIN, the customer adoption of which has been
limited.
In
November 2015, we introduced ULIN, a product based on a new technology allowing for the interception of communication in GSM,
UMTS and LTE cellular networks without, in most cases, the involvement of mobile network operators. We expected that ULIN would
be a major growth driver of our sales and revenues. However, since the introduction of ULIN, customer adoption of ULIN has been
much slower than we had anticipated, and while we have seen significant interest in ULIN and its advanced capabilities, during
the year ended December 31, 2016, we only completed one ULIN sale (which was our first ULIN sale), and in January 2018 we completed
an additional sale. We believe that the limited customer adoption to date of ULIN, notwithstanding its competitive advantages
over tactical interception solutions, is primarily due to its increased costs compared to such tactical interception solutions,
as well as the market’s desire for a product capable of intercepting data communication in addition to the content of voice
calls and SMS, and ULIN’s inability to intercept cellular communication within some network operators. We believe that continued
increase in usage of new communication channels and the technological developments in the cellular communications industry (such
as an increased number of cellular networks, mobile operators and frequencies), which have resulted in tactical cellular interception
systems becoming more complex and expensive, will contribute to the competitive strength and distinctiveness of ULIN, which in
turn will result in an increased demand for ULIN. However, we cannot assure you that the market or demand for ULIN will grow as
we believe (if at all). See “Item 5D. Trend Information” for a more complete discussion regarding the changes in the
cellular interception industry.
Furthermore,
ULIN sales cycles have taken longer than expected to complete. We believe that the significant increase in the length of the ULIN
sales cycle, compared to our legacy tactical interception solutions is primarily due to the difficulties described above and the
lengthy purchasing approval processes for ULIN, oftentimes requiring the approval of the most senior levels of government.
Our
ULIN offering has and will continue to require significant attention from our management and other key personnel and may require
expansion of our sales network to accommodate the higher value and complexity of ULIN sales as well as the currently expected
demand.
Furthermore,
since the introduction of ULIN, while we have continued to offer our legacy tactical cellular interception solutions, we have
experienced a significant decline in sales of our existing portfolio of solutions and products within the cellular interception
category and we cannot assure you that ULIN will not render a substantial percentage of our existing product portfolio obsolete.
In addition, increased usage of new communication channels and technological developments in the cellular communications industry
(such as an increased number of cellular networks, mobile operators and frequencies) have resulted in cellular interception systems
becoming more complex, expensive and limited in their interception capabilities, which we believe in turn have also had an adverse
effect on sales of our legacy tactical cellular interception solutions. If we are unable to achieve increased customer adoption
of ULIN, our business, financial condition and results of operations would be materially adversely affected.
Slow
customer adoption and extended sales cycles of ULIN, as well as decline in sales of our existing portfolio of solutions and products,
resulted in a 82% decrease in revenues for the year ended on December 31, 2017 compared to the year ended on December 31, 2016,
as well as a 68% decrease in revenues compared to the year ended on December 31, 2015 For more information, see “Item 5.
Operating and Financial Review and Prospects.”
ULIN
sales are dependent on a reseller agreement with one supplier, which automatically terminates in October 2018.
Our
ULIN sales are based on a reseller agreement granting us a worldwide exclusive right to sell ULIN, which agreement automatically
terminates in October 2018 and may be terminated by either party under certain specific circumstances. We may not be able to extend
the agreement or may not be able to do so on terms favorable to us. See “Item 4. Information on the Company - Business Overview
- Manufacturing and Suppliers” for a description of the agreement. The ULIN supplier is a third party supplier and, as such,
we have no ability to exert any influence over the business or employees of the supplier. Further, the supplier is a recently
established corporation with a short operating history and is unknown in the industry. If the supplier ceases operations or is
unable to deliver ULIN in the quantities and requisite quality required by us, is unable to attract or retain its key personnel
or fails to adequately upgrade and develop ULIN in order for it to remain competitive, our business, financial condition and results
of operations could be materially adversely affected. In addition, under the reseller agreement and during its term, at the end
of each contract year in which we sell less than $10.0 million of products resulting in less than $5.0 million payments to the
supplier, we are required to pay the supplier a 15% penalty against the shortfall amount. Accordingly, for the years ended December
31, 2017 and 2016, we paid penalty payments to the supplier $1.8 million and $1.5 million, respectively, and are currently paying
penalty payments of $125,000 per month. Further, during the term of the reseller agreement, we must obtain the supplier’s
consent to, among other things, manufacture, sell or market any product which is competitive with ULIN. If the supplier does not
give its timely consent to any such action, our business, financial condition and results of operations would be materially adversely
affected.
We
are under an investigation by the SEC, which could divert management’s focus, result in substantial investigation expenses, monetary
fines and other possible remedies and have an adverse impact on our reputation and financial condition and results of operations.
As
we disclosed in our Report on Form 6-K furnished with the SEC on February 16, 2017, we received a subpoena from the SEC.
The subpoena requests, among other things, information regarding the transaction with Cambridge, the restatement that occurred in May 2016, and financial and business information. In furtherance of the
investigation, the SEC has been obtaining testimony from the Company’s officers among others. The Company and its officers are
fully cooperating with the investigation. As a result of the investigation, we may incur significant legal and
accounting expenses. Furthermore, we cannot predict what, if any, actions the SEC may take against us or any of our officers,
or the timing or duration of the investigation. While the SEC has informed us that this investigation and the subpoena do not
mean that the SEC has concluded that anyone has broken the law or that the SEC has a negative opinion of any person, entity
or security, publicity surrounding the foregoing, or any SEC enforcement action or settlement as a result of the
SEC’s investigation, even if ultimately resolved favorably for us, could have an adverse impact on our reputation,
business, financial condition, results of operations or cash flows.
Adverse
outcomes in our outstanding litigation matters, or in new litigation matters that arise in the future, could
negatively affect our business, results of operations, financial condition and cash flows.
We
and our officers are defendants in multiple lawsuits (see “Item 8A. Financial Information — Consolidated
Statements and Other Financial Information — Legal Proceedings”). We intend to engage in a vigorous defense of
the lawsuits. In certain circumstances, we are obliged to indemnify our current and former officers who are named as
defendants in these lawsuits. However, we are unable to predict the outcome of any of these matters at this time. Any
conclusion of these matters in a manner adverse to us could have a material adverse effect on our business, results of
operation, financial condition and cash flows. For example, we may be required to pay substantial damages, incur payments of
fines and penalties, incur substantial costs not covered by our directors’ and officers’ liability insurance,
suffer a significant adverse impact on our reputation, and management’s attention and resources may be diverted from
other priorities, including the execution of business plans and strategies that are important to our ability to grow our
business, any of which could have a material adverse effect on our business. In addition, we recently entered into an
agreement with our insurer pursuant to which we agreed to discharge our insurer from liability with respect to any U.S.
claims (excluding the Ladragor Litigation in Israel, as described further in “Item 8A. Financial Information — Consolidated Statements and Other Financial Information — Legal Proceedings”
below) in consideration for an aggregate settlement amount of $5.0 million, of which $2.5 million is to be used for
settlement of the New York Class Action Litigation and the remaining amount is to be used to cover various defense and legal
costs. Accordingly, no insurance proceeds will be available for any U.S. claims other than with respect to the settlement of
the New York Class Action Litigation. If we do not have sufficient funds to settle or pay any damages and costs with respect
to any U.S. claims not covered by insurance, this would have a material adverse effect on our business, financial condition
and results of operation.
We
face risks relating to government spending and contracts with governments and governmental agencies.
All
of our revenues to date have been generated from engagements with various governments around the world, including national, regional
and local governmental agencies, either directly or through resellers or integrators. We expect that sales to governments and
governmental agencies, including through resellers or integrators, will continue to be the primary source of our revenues for
the foreseeable future. Slowdowns, recessions, economic instability, political unrest, government changes, armed conflicts or
natural disasters around the world may cause governments and governmental agencies to delay, reduce or even cancel planned spending,
reduce the scope of or terminate projects, even if already budgeted, or decide to change priorities and reallocate budgets, all
of which could adversely affect our business.
Sales
to governments and governmental agencies, including through resellers or integrators, are subject to special risks, such as delays
in funding, termination of contracts or sub-contracts at the convenience of the government or applicable governmental agency,
reduction or modification of contracts or sub-contracts in the event of changes in the government’s policies or priorities,
as a result of budgetary constraints or for other reasons, collection difficulties, increased or unexpected costs resulting in
losses or reduced profits under fixed price contracts, and governmental agencies’ right to audit and investigate government
contractors.
In
addition, the market for the solutions and products we sell is highly dependent on the spending cycle and scope of federal, state,
local and municipal governments, as well as those of security organizations in international markets. We cannot assure you that
these spending cycles will materialize as we expect and that we will be positioned to benefit from these potential opportunities.
Furthermore,
our engagements provide for customer acceptance of our solutions with a right of return, regardless of any previous partial acceptance.
Failure to obtain customer acceptance for the complete solutions or if the customer exercises its right of return, or, generally,
termination of the engagement, would generally not entitle us to reimbursement for our incurred costs for work performed. While
such occurrences have not happened in the past, we cannot be certain that we will not experience problems in the future in our
performance of such government engagements.
For
most solutions and products, we rely on third party suppliers, manufacturers and partners, and if these relationships are interrupted
we may not be able to obtain substitute suppliers, manufacturers or partners on favorable terms or at all and we may be subject
to other adverse effects.
We rely on non-affiliated
suppliers and original equipment manufacturer, or OEM, partners for most non-standard products or components which may be critical
to our solutions, including both hardware and software, and on manufacturers of assemblies that are incorporated into our solutions.
During the years ended December 31, 2017, 2016 and 2015, expenses incurred with respect to our three largest suppliers comprised
27%, 72% and 70% of our cost of revenues, respectively, and one supplier accounted for 17%, 40% and 43% of our cost of revenues
in such years, respectively.
In October 2015, we entered
into an agreement with a third party supplier who designs and licenses ULIN. This agreement may in the future account for a significant
portion of our vendor costs as well as our revenue generation. See the risk factor
“ULIN sales are depended on a reseller
agreement with one supplier, which automatically terminates in October 2018.”
Our
competitiveness, business and future growth is highly dependent on our ability to retain access to these suppliers and contractors
as well as their technology. Our reliance on a limited number of suppliers involves risks. In the event that a key supplier, including
in particular the supplier of ULIN, ceases operations or otherwise ceases to do business with us, it may take a substantial amount
of time and expense for us to secure substitute suppliers. Certain of our suppliers also offer products that compete with our
solutions. We may also purchase technology, license intellectual property rights and oversee third party development and localization
of certain products and components, in some cases, by or from companies that may compete with us or work with our competitors.
In addition, in certain cases, we may be dependent on sole-source suppliers for some components. If any of these sole-source suppliers
fails to meet our needs, we may not have readily available alternatives. Our ability to fill our supply needs could jeopardize
our ability to satisfactorily and timely complete our obligations under our government and other contracts.
If
these suppliers, manufacturers or partners experience financial, operational, manufacturing capacity or quality assurance difficulties,
cease production and sale of the products we buy from them entirely, or there is any other disruption, including loss of license,
OEM or distribution rights, including as a result of the acquisition of a supplier or partner by a competitor, we may be required
to locate alternative sources of supply or manufacturing, to internally develop the applicable technologies, or to redesign and/or
remove certain features from the products and solutions we offer, any of which would be likely to increase expenses, create delivery
delays and negatively impact our sales. Although we endeavor to put in place contracts with key providers, and attempt to identify
redundant suppliers, we may not be able to enter into such contracts or purchase from redundant suppliers. If we are able to enter
into such contracts, we may not be successful in obtaining adequate protections, these agreements may be short-term in duration
and the counterparties may be unwilling or unable to stand behind such protections. Moreover, these types of contractual protections
offer limited practical benefits to us in the event our relationship with a key provider is interrupted. In addition, by utilizing
third party suppliers, manufacturers and partners, we run the risks that the reputation and competitiveness of the products, solutions
and services we offer may deteriorate as a result of the reduction of our control over quality and delivery schedules and the
consequent risk that we will experience supply interruptions and be subject to escalating cost; and our competitiveness may be
harmed by the failure of our subcontractors to develop, implement or maintain manufacturing methods appropriate for our product
portfolio and our customers.
Further,
as suppliers discontinue their products, modify them in manners incompatible with our current use or use manufacturing processes
and tools that could not be easily migrated to other vendors, we could have significant delays in product availability, which
would have a significant adverse impact on our results of operations and financial condition. Although we believe that we can
obtain alternative sources of supply in the event our suppliers are unable to meet our requirements in a timely manner, we cannot
assure you that our alternative sources of supply would be sufficient to avoid a material interruption or delay in deliveries
and in availability.
If
we cannot retain and recruit key personnel, our business may suffer and our ability to operate and grow our business may be impaired.
We
depend on the continued service and performance of our senior management and key personnel, including Anatoly Hurgin, our Chief
Executive Officer, and Alexander Aurovsky, our Chief Technology Officer, to run and grow our business. As of December 31, 2017,
we employed 17 individuals on a full-time basis and 2 individuals on a part-time basis, comprised of administrators, marketing
and technical personnel. We may not be able to continue to retain and attract such personnel and the loss of the services of these
persons could adversely affect our business. Members of our senior management team may resign at any time (subject to applicable
contractual advance notice periods). At present, the pending litigations to which we and our executives and certain of our former
directors are a party and the SEC investigation, as well as the implementation of procedures relating to compliance with the United
States Foreign Corrupt Practices Act, or FCPA, require significant management
time and could divert the attention of our management from our business operations.
To
remain successful and to grow, we also need to retain existing employees and attract new employees who understand and/or have
experience with the solutions and products we offer and our markets, especially new markets and growth areas we may enter. As
we grow, we must also enhance and expand our management team to execute on new and larger agendas and challenges and recruit and
retain qualified personnel, such as project managers, to execute, commercialize, market and sell the solutions and products we
offer. The market for qualified personnel is limited in the areas of emerging technology and recruitment of qualified personnel
is competitive in the geographic markets in which we operate. We may be at a competitive disadvantage to companies with greater
brand recognition or financial resources in recruiting. An inability to attract and retain highly qualified employees may have
a material adverse effect on our results of operations and financial position. Moreover, if we are not able to properly balance
investment in personnel with growth in our business, our profitability may be adversely affected. There can be no assurance that
we will be able to successfully recruit and integrate new employees. There is often intense competition to recruit highly skilled
employees in the technology industry, and we may not be able to offer current and potential employees a compensation package that
is satisfactory in order to retain or recruit them.
We
face risks related to the concentration of customers with whom we do business and, if we are unable to establish and maintain
our relationships with such customers, our business and ability to grow could be materially adversely affected.
We
conduct business with a relatively small number of customers, including third party resellers and agents, each of which could
be material to our business. With respect to sales in many regions and countries, we sell to third party resellers that, in turn,
resell the products and solutions we offer to various security and intelligence agencies, military forces, law enforcement agencies
and homeland security agencies. For example, in the years ended December 31, 2017, 2016 and 2015, one significant reseller accounted
for 45%, 47% and 66% of our revenues, respectively, and one other reseller in each such periods accounted for 25%, 32% and 13%
of our revenues, respectively. Our sales to relatively few significant resellers and customers could continue to account for a
substantial percentage of our sales in the foreseeable future. There can be no assurance that we will be able to retain these
key resellers and customers or that such resellers and customers will not cancel purchase orders, reschedule or decrease their
level of purchases. Loss, cancellation, deferral of business by, or failure to receive new contracts, renewals or follow-on contracts
from, such resellers and customers could have a material adverse effect on our business and operating results.
To
remain successful, we must maintain our existing relationships as well as identify and establish new relationships with other
customers, including third party resellers and agents. We must often compete with other suppliers for these relationships and
our competitors often seek to establish exclusive relationships with these sales channels or to become a preferred partner for
them. Our ability to establish and maintain our relationships is based on, among other things, factors that are similar to those
on which we compete for end customers, including features, functionality, ease of use, installation, maintenance and price.
As
our market opportunities change, our reliance on particular distribution channels may increase or we may need to create new channels
to address changing market needs, which may negatively impact our growth and gross margins. Certain of our current distribution
channels currently compete with us or may enter into markets in competition with us, which could result in the termination of
our relationship with them or lead to a significant reduction in sales through such channels. There can be no assurance that we
will be successful in maintaining, creating or expanding these distribution channels.
In
addition, the execution of our growth strategy also depends on our ability to create new alliances with certain market players
in certain markets. Even if we are able to enter into such alliances, it may be under terms that are not favorable to us, or we
may not be able to realize the benefits that are anticipated through such alliances. If we are not successful at these efforts,
we may lose sales opportunities, customers and market share, which may have a material adverse effect on our business and results
of operations.
The
industry in which we operate is characterized by rapid technological changes, evolving industry standards and changing market
potential from area to area, and if we cannot anticipate and react to such changes, our financial results may suffer.
The
markets for the products and solutions we sell are characterized by rapidly changing technology and evolving industry standards.
The introduction of products and solutions embodying new technology, new delivery platforms and the commoditization of older technologies,
together with the emergence of new industry standards, technological hurdles and protection measures, can exert pricing pressure
on existing products and solutions and/or render them unmarketable or obsolete. For example, new industry standards for cellular
networks are introduced from time to time, such as the proposed 5G networks. Moreover, the market potential and growth rates of
the markets we serve are not uniform and are rapidly evolving.
It
is critical to our success that we are able to anticipate and respond to changes in technology and industry standards and new
customer challenges by consistently offering new, innovative, high-quality products and solutions that meet the changing needs
of our customers. See the risk factor “
For most solutions and product
s
, we rely on third party suppliers, manufacturers
and partners, and if these relationships are interrupted we may not be able to obtain substitute suppliers, manufacturers or partners
on favorable terms or at all and we may be subject to other adverse effects.
” We must also successfully identify, enter
into and prioritize areas of growing market potential, including by launching and driving demand for new and enhanced solutions
and products. If we are unable to execute on these strategic priorities, or if our competitors are able to do so more rapidly,
we may lose market share or experience slower growth, and our profitability and other results of operations may be materially
adversely affected.
We
cannot assure you that the market or demand for the products and solutions we sell will grow (if at all), that we will successfully introduce new products or solutions, or new applications for existing products and
solutions, that such new products, solutions or applications will achieve market acceptance or that the introduction of new products
or technological developments by others will not render the products and solutions in our current portfolio obsolete. See the
risk factor “
Our revenues depend on the successful implementation and customer adoption of ULIN, the customer adoption
of which has been limited.”
In addition, certain of the solutions and products we sell must readily integrate with major
third party security, telephone, front-office and back-office systems. Any changes to these third party systems could require
such products to be redesigned, and any such redesign might not be possible on a timely basis or may not achieve market acceptance.
Furthermore, some of the solutions and products we sell rely on weaknesses of commonly used protocols and if such weakness were
identified and patched and we were unable to respond to such technological challenges in a timely manner, our business may be
adversely affected. If we are unable to offer solutions and products that are competitive in technology and price and responsive
to customer needs, there would be a material adverse effect on our business, financial condition and results of operations.
Our
solution has the ability to intercept cellular communication. However, ways of communication continue to change and evolve in
such a way that parties are able to communicate via mobile applications rather than via standard cellular communication protocols.
Communication via mobile applications has become more common, as has the use of such applications over WiFi networks. The challenges
this poses are twofold; the applications are encrypted and so too are the WiFi network connections. This has resulted in communication
becoming more secure and therefore interception with the use of our products has become increasingly difficult. Should this trend
continue to rise, our products might become more redundant.
In
order to successfully compete in all sectors of our business, including security projects awarded through competitive bids, we
may commit to provide certain technologies and solutions which are still under development or which will have to be developed
(including by third parties), licensed or acquired specifically for that customer. This may increase the risk of technological
difficulties that may prevent us from complying with our contractual obligations, expose us to possible penalties and legal claims,
and affect the profitability of a project, which may have a negative impact on our business, financial condition and results of
operations.
If
we do not have access to the most current technology, we may not be able to market our products and services.
The
security industry is constantly changing to meet new requirements, which result from new threats to government and industry, both
from potential threats to persons and property, to industrial and governmental espionage, as well as general concern about personal
and family safety. In order to meet these needs we must both anticipate problems and develop methods for reducing the potential
risk. We rely primarily on the performance and design characteristics of our products in marketing our products, which requires
access to state-of-the art technology in order to be competitive. Our business could be impaired if we cannot obtain licenses
for such updated technology or develop state-of-the-art technology ourselves. If we cannot meet the developing challenges, we
will not be able to market our interception and geolocation products successfully.
We
face risks relating to large projects.
The
larger and more complex our customers’ projects are, the greater the risks associated with such projects. Moreover, these
risks are increased due to our need to custom design our solutions to meet each customer’s specific needs. These risks may
include exposure to penalties and liabilities resulting from a breach of contract, inability to fully integrate the needed products
with any third party products and inability to effectively combine various technologies into customized solutions. In some of
these projects we may use domestic or foreign subcontractors for various planning aspects, solution development, integration,
delivery and successful and timely completion. We may be held liable for the failure of our subcontractors, from whom we may have
no or limited recourse. Additionally, to the extent that we cannot engage such subcontractors, partners or specialists or cannot
engage them on a competitive basis, our ability to complete a project in a timely fashion or at a profit may be impaired.
We
may experience fluctuations in being selected for such large projects, which correspondingly may result in substantial fluctuations
in our income and results of operations, as revenues from large projects are likely to be a single occurrence and nonrecurring.
In addition, there may be fluctuations in cash collection and revenue recognition with respect to such projects due to, among
other things, a substantial period of time often elapsing from the time we enter into negotiations until we actually sell the
project to the specific customer.
The
sophisticated nature of the solutions and products we sell, customization of solutions based on specific customer needs, sales
cycle and unpredictable sales terms and timing may create uncertainty in, or negatively impact, our operating results and make
such results more volatile and difficult to predict.
The
timing of our sales cycle ranges from as little as a few weeks to more than a year. Our larger sales, which we emphasize in our
sales strategy, typically require a minimum of a few months to consummate. As the length or complexity of a sales process increases,
so does the risk of not successfully closing the sale. Larger sales are often made by competitive bid, which also increases the
time and uncertainty associated with such opportunities. In addition, because many of our solutions are sophisticated, customers
may also require education on the value and functionality of our solutions as part of the sales process, further extending the
time frame and uncertainty of the process. Longer sales cycles, competitive bid processes, customizing solutions based on specific
customer needs and the need to educate customers means that:
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There
is greater risk of customers deferring, scaling back or cancelling sales as a result of, among other things, their receipt
of a competitive proposal, changes in budgets and purchasing priorities or the introduction or anticipated introduction of
new or enhanced products and solutions either by us or our competitors during the process.
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We
may make a significant investment of time and money in opportunities that do not come to fruition, which investment may not
be usable or recoverable in future projects.
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We
may be required to bid on a project in advance of the completion of its design or be required to begin implementation of a
project in advance of finalizing a sale, in either case, increasing the risk of unforeseen technological difficulties or cost
overruns.
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We
face greater downside risks if we do not correctly and efficiently deploy limited personnel and financial resources and convert
such sales opportunities into orders.
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Additionally,
after the completion of a sale of a specific solution or a more sophisticated product, our customers may need assistance from
us in making full use of the functionality of these solutions or products, in realizing all of their benefits or in implementation
generally. If we are unable to assist our customers in realizing the benefits they expect from the solutions and products that
we sell, demand for such solutions and products may decline and our operating results may be adversely affected.
Our
uneven sales patterns could significantly impact our revenues and earnings.
The
timing in which transactions are entered into may shift from one quarter to another, due to, among other things, a shifting by
our buyers of their buying decisions, resulting in the shifting of bookings and revenues from one quarter to another. Additionally,
because we emphasize larger transactions with a higher value in our sales strategy, a substantial period of time often elapses
from the time we enter into negotiations until we actually sell the product to the specific customer, and the deferral or loss
of one or more significant orders or a delay in a large implementation could therefore materially adversely affect our operating
results, especially in a given quarter.
In
addition to the foregoing, our ability to forecast our operating results from quarter to quarter and from year to year is impacted
by the fact that pricing, margins and other deal terms may vary substantially from transaction to transaction, especially across
business lines. The extended time frame and uncertainty associated with many of our sales opportunities also make it difficult
for us to accurately forecast our revenues (and attendant budgeting and guidance decisions) and increases the volatility of our
operating results from period to period. In addition, in light of the fact that ULIN is a relatively new solution with unpredictable
sales cycles, with multiple pricing models, our revenue visibility is significantly reduced, which makes it harder to provide
adequate forecasts. Until we have clarity on the sales cycle, and a better understanding of the timing and implementation for
a relatively small number of larger deals, we shall not provide forecasts.
We
have not always met, and we might not meet in the future, our expectations or those of industry analysts in a particular future
quarter or a fiscal year, including as a result of the factors described in these Risk Factors.
We
are subject to complex, evolving regulatory requirements that may be difficult and expensive to comply with and that could negatively
impact our business.
Our
business and operations are subject to regulatory requirements in Israel and elsewhere, including, among other things, with respect
to government contracts, export control, labor, tax, anti-bribery, anti-corruption, data privacy and protection, and communications
monitoring and interception. Regulatory requirements are subject to constant change that may have a material impact on our operations.
Compliance with these regulatory requirements may be onerous, time-consuming, and expensive, especially where these requirements
vary from jurisdiction to jurisdiction or where the jurisdictional reach of certain requirements is not clearly defined or seeks
to reach across national borders. Regulatory requirements in one jurisdiction may make it difficult or impossible to do business
in another jurisdiction. We may also be unsuccessful in obtaining permits, licenses or other authorizations required to operate
our business, such as for the marketing or sale or import or export of products, solutions and services that we offer.
We
cannot assure you that our methods of and policies for doing business will be adequate for new markets, including the United States,
or that we will be able to modify such methods or policies in a manner that allows us to enter into specific markets, including
the United States. Violations of applicable laws or regulations, including by our officers, employees, contractors or agents,
may harm our reputation and deter governments and governmental agencies and other existing or potential customers or partners
from purchasing our solutions. Furthermore, non-compliance with applicable laws or regulations could result in fines, damages
and criminal sanctions against us, our officers or our employees, restrictions on the conduct of our business, and damage to our
reputation.
Our
business, results of operations and financial condition could be materially adversely affected by changes in the legal and regulatory
environment.
Our
business, results of operations and financial condition could be materially adversely affected if laws, regulations or standards
relating to our business (including the solutions and products that we offer), the Company or our employees (including labor laws
and regulations) are implemented or changed. Among these laws and regulations, there are requirements in Israel and other territories
in relation to import and export controls, data privacy and protection, anti-bribery and anti-corruption, labor, tax and environmental
and social issues. While we make efforts to comply with such requirements, we cannot assure you that we will be fully successful
in our efforts. Failure to comply with applicable laws and regulations could result in fines, damages, civil liability and criminal
sanctions against us, our officers and our employees and prohibit us from conducting our business and damage our reputation.
The
occurrence of privacy or information security breaches (or the belief that any such breach has occurred) in the operation of our
business, or by third parties using a product or solution obtained through us, could harm our business, financial condition and
operating results. Some of our customers use the solutions and products that we offer to compile and analyze highly sensitive
or confidential information. We may come into contact with such information or data when we perform service or maintenance functions
for our customers. The perception or fact that any of our employees has improperly handled sensitive information of a customer
or a customer’s end user could negatively impact our business. If, in handling this information, we fail to comply with
applicable privacy legislation or procedures, we could incur civil liability to governments or governmental agencies or any customers
and individuals whose privacy was compromised.
Further,
governments around the world are adopting a growing number of compliance and regulatory initiatives that are driven by events
and concerns such as accounting scandals, security threats and economic conditions. We cannot assure you that we will be successful
in our efforts to effectively respond to new initiatives and standards, that such changes will not negatively affect the demand
for the products, solutions and services we offer, or that our competitors will not be more successful or prepared than us in
responding to these new initiatives and standards.
We
may be limited in our ability to transfer or outsource certain aspects of our business to certain jurisdictions, and may be limited
in our ability to undertake development activities in certain jurisdictions, which may impede our efficiency and adversely affect
our business results of operations.
Our
solutions may contain defects or may be vulnerable to cyber-attacks, which could expose us to both financial and non-financial
damages.
Many
of our existing solutions are, and future solutions are expected to be, sophisticated and may develop operational problems. New
products and new product versions, and the incorporation of third party products into our solutions, also give rise to the risk
of defects or errors. These defects or errors may relate to the operation or the security of the products and solutions we sell
and could result in product returns, loss of or delay in market acceptance of the products and solutions, loss of our competitive
position or claims by customers or others, which would seriously harm our revenues, financial condition and results of operations.
Moreover, even well-designed and tested products and solutions may be vulnerable to cyber-attacks. If we do not discover and remedy
such defects, errors or other operational or security problems until after a product or solution has been released to customers,
we may incur significant costs to correct such problems and/or become liable for substantial damages for product liability claims
or other liabilities. Furthermore, correcting and repairing such errors, failures or defects could also require significant expenditures
of our capital and other resources and could cause interruptions, delays or cessation of our product licensing. The identification
of errors in the products and solutions we sell, the detection of bugs by our customers, or a successful cyber-attack on one of
the products and solutions even absent a defect or error, may damage our reputation in the market as well as our relationships
with existing customers, which may result in our inability to retain our customers or attract new customers, which could have
a material adverse effect on our results or financial condition.
We
are dependent on the efforts of contractors for projects in which we serve as subcontractor.
For
certain projects, we act as subcontractors and depend on the conduct of and our relationship with the relevant general contractor.
If one or more of these contractors experience financial or operational difficulties, we could experience an interruption in our
operations. There is a risk that we may have disputes with our contractors arising from, among other things, the quality and timeliness
of work performed by us, in which case our operating results could temporarily suffer until such disputes are resolved. Furthermore,
disagreements with our contractors could lead to the assertion of rights and remedies under their contracts and increase the cost
of the project or result in a contractor’s unwillingness to perform further work on the project. If any contractor is unable
or unwilling to perform according to the negotiated terms and timetable of its own agreement for any reason or terminates the
agreement, we may be required to be engaged by a substitute contractor in order to continue our work on the project, which would
likely result in significant project delays and increased costs.
Our
employees or other third parties may engage in misconduct or other improper activities, including noncompliance with regulatory
standards and requirements, which could cause significant liability for us, harm our reputation or otherwise result in other consequences
that may have a material adverse effect on our business, financial condition and results of operations.
We
are exposed to the risk that our employees, resellers, agents or independent contractors may engage in fraudulent conduct or other
illegal activities. Misconduct by these parties could include intentional, reckless and/or negligent conduct or disclosure of
unauthorized activities to us that violates export control laws or other regulations or manufacturing standards. Furthermore,
the protection of our proprietary data and that of our customers is critical to our reputation and the success of our business.
Our customers have a high expectation that we will adequately protect their confidential information. If any person, including
any of our employees, negligently disregards or intentionally breaches our established controls with respect to such data or otherwise
mismanages or misappropriates that data, we could be subject to monetary damages, fines and/or criminal prosecution. Unauthorized
disclosure of sensitive or confidential data, whether through systems failure, employee negligence, fraud or misappropriation,
could damage our reputation and cause us to lose customers.
We
are subject to the FCPA, which generally prohibits U.S. companies, as well as foreign companies with a class of securities listed
on a national securities exchange in the United States or quoted on the over-the-counter market in the United States, such as
us, from engaging in bribery or other prohibited payments to foreign officials for the purpose of obtaining or retaining business.
We operate in parts of the world that are recognized as having governmental and commercial corruption and in certain circumstances,
strict compliance with anti-bribery laws may conflict with local customs and practices. We cannot assure you that our internal
policies and procedures will always protect us from improper conduct by our employees, resellers, agents or independent contractors.
In the event that we believe or have reason to believe that our employees or agents have or may have violated applicable laws,
including anti-corruption laws, we may be required to investigate or have outside counsel investigate the relevant facts and circumstances,
which can be expensive and require significant time and attention from senior management. Any such violation could result in substantial
fines, sanctions, civil and/or criminal penalties, and curtailment of operations in certain jurisdictions, and might adversely
affect our business, financial condition or results of operations. In addition, actual or alleged violations could damage our
reputation. Furthermore, detecting, investigating, and resolving actual or alleged violations is expensive and can consume significant
time and attention of our senior management.
In
connection with ongoing implementation of internal controls to comply with applicable anti-corruption laws regarding distributors,
resellers and agents, we identified press reports that one of our resellers in Latin America may be subject to local law enforcement
investigations concerning price manipulation and corruption in the reseller’s sale of software products to government entities,
although the local press reports do not identify us and we have not been able to confirm the investigations or whether any investigations
implicate sales of our solutions. Following our own review of the reseller, we ceased accepting orders from the reseller.
The
confidential nature of our engagements and the technologies incorporated into the products and solutions we sell may restrict
us in our public disclosures and marketing efforts.
To
date, all our revenues have been generated from engagements with governments and governmental agencies, including through resellers
or integrators. Such governments and governmental agencies restrict us from identifying them as our customers due to the sensitive
nature of the products and solutions that we sell and the projects we undertake on their behalf. Furthermore, our engagements
with such governments and governmental agencies, or with the applicable resellers or integrators, oftentimes contain information,
including information concerning specific aspects of the technologies incorporated into the products and solutions we sell, which
information is either classified or sensitive, in each case, due to ongoing military operations, homeland security issues or criminal
prevention activity and is largely classified under such governments’ and governmental agencies’ guidelines. Accordingly,
in our marketing and sales materials, we may not be able to identify our customers, the purpose for which certain products or
solutions were sold or the projects we are involved in. Moreover, the classified nature of our engagements may require us to be
more conservative in our public disclosures regarding such engagements, and in some instances apply for confidential treatment
under Rule 24b-2 of the Exchange Act. These limitations could adversely affect our marketing and sales efforts.
We
are subject to risks associated with doing business globally.
The
countries and regions in which we have our most significant operations include Latin America, Asia and Africa, and we intend to
continue to expand our operations internationally. We sell throughout the world and intend to continue to increase our penetration
of international markets. Our operations are subject to risks inherent in conducting business globally and under the laws, regulations
and customs of various jurisdictions and geographies. We believe our business may suffer if we are unable to successfully expand
into new regions, as well as maintain and expand our existing foreign operations. In addition to risks related to currency exchange
rate fluctuations, risks that affect our foreign operations include changes in exchange controls, changes in taxation and potentially
adverse tax consequences in operating in certain countries, import limitations, policies and procedures that protect local suppliers,
recruitment and retention of foreign employees, export control restrictions, changes in or violations of applicable law or regulations,
economic and political instability, disputes between countries, diminished or insufficient protection of intellectual property,
competition in foreign countries, product customization or localization issues, challenges in collection of accounts receivable
and longer payment cycles, and disruption or destruction of operations in a significant geographic region regardless of cause,
including war, terrorism, riot, civil insurrection or social unrest. Any of these risks could have an adverse effect on our business,
results of operations and financial condition.
As
we continue to explore the expansion of our global reach, an increasing focus of our business may be in emerging markets. In many
emerging markets we may face risks that are more significant than if we were to do business in developed countries, including
risks relating to underdeveloped legal systems, unstable governments and economies, and potential governmental actions affecting
the flow of goods and currency. We cannot assure you that one or more of these factors will not have a material adverse effect
on our international operations, business, financial condition and results of operations.
We
are subject to extensive government regulations, which if violated, could prohibit us from conducting a significant portion of
our business and result in criminal liability.
Regulatory
agencies in the countries where we have significant operations may have laws and/or regulations concerning the exporting and importing
of security devices, which may restrict sales of certain products to bona fide law enforcement agencies in these countries. If
we violate any of these laws or regulations, we may be subject to civil or criminal prosecutions. If we are charged with any such
violations, regardless of whether we are ultimately cleared, we may be unable to sell our products.
Intense
competition in our markets and competitors with greater resources than us may limit our market share, profitability and growth.
We
face aggressive competition from numerous and varied competitors in all of our markets, making it difficult to maintain our market
share, remain profitable, invest and grow. We will also encounter new competitors as we expand into new markets. Our competitors
may be able to more quickly develop or adapt to new or emerging technologies, better respond to changes in customer needs or preferences,
better identify and enter into new areas of growth or devote greater resources to the development, promotion and sale of their
products. Some of our competitors have, in relation to us, longer operating histories, larger customer bases, longer standing
relationships with customers, superior brand recognition and significantly greater financial, technical, marketing, customer service,
public relations, distribution or other resources, especially in new markets we may enter. Consolidation among our competitors
may also improve their competitive position. In addition, system integrators, as well as infrastructure vendors, may decide in
the future to enter our market space and compete with us by comprehensive solutions. We also face competition from solutions developed
independently by our customers. To the extent that we cannot compete effectively, our market share and, therefore, results of
operations could be materially adversely affected.
Because
price and related terms are key considerations for many of our customers, we may, from time to time, have to accept less-favorable
payment terms, lower our sales prices, and/or reduce our cost structure. If we are forced to take these kinds of actions to remain
competitive in the short-term, such actions may adversely impact our ability to compete in the long-term.
New
potential entrants to our markets may lead to the widespread availability and standardization of some of the products, solutions
and services we offer, which could result in the commoditization of such products, solutions and services and drive us to lower
our prices.
Incorrect
or improper use of the products and solutions in our portfolio or failure to properly provide professional services and maintenance
services could result in negative publicity and legal claims.
The
products and solutions we sell are complex and are deployed in a wide variety of network environments. The proper use of these
products and solutions requires training and, if the products and solutions are not used correctly or as intended, insufficient
results may be produced. The products and solutions may also be intentionally misused or abused by our customers. The incorrect
or improper use of these products and solutions or our failure to properly provide professional services and maintenance services,
including installation, training, project management, product customizations and consulting to our customers may result in losses
suffered by our customers, which could result in negative publicity or other legal claims against us. Furthermore, the use of
our solutions by a government to conduct interception in violation of such government’s laws could result in negative publicity
or even legal claims against us.
For
certain solutions, we rely on software from third parties. If we lose the right to use that software, we would have to spend additional
capital to either redesign our existing solutions or acquire new software from third parties.
We
integrate and utilize various third party software products as components of our solutions. Our business could be disrupted if
functional versions of these software products were either no longer available to us on commercially reasonable terms or at all.
In addition, some of our third party vendors use proprietary technology and software code that could require significant redesign
of our solutions in the case of a change in vendor. If we lost the right to use such third party software, we would be required
to spend additional capital to either redesign our solutions, or acquire or license new software from third parties. As a result,
we might be forced to limit the features available in our current or future offerings and commercial releases of our solutions
could be delayed.
Furthermore,
if we were required to or otherwise determined to utilize software components from certain jurisdictions, such as Israel, local
export control laws would impose a regulatory burden that may materially affect our business and operations.
Political
or public perception factors may adversely affect our business.
We
may experience negative publicity or other adverse impacts on our business if we sell to countries that are considered disfavored
by the media or political or social rights organizations even though such transactions may be permissible under applicable law.
Our
business may be impacted by changes in general economic conditions.
Our
business is subject to risks arising from changes in domestic and global economic conditions, and adverse economic conditions
in markets in which we operate may harm our business. If our clients significantly reduce spending in areas in which our solutions
are utilized, or prioritize other expenditures over our solutions, our business, results of operations and financial condition
would be materially adversely affected.
Disruption
to the global economy could also result in a number of follow-on effects on our business, including a possible slow-down resulting
from lower customer expenditures; inability of customers to pay for products, solutions or services on time, if at all; more restrictive
export regulations which could limit our potential customer base; negative impact on our liquidity, financial condition and share
price, which may impact our ability to raise capital in the market, obtain financing and secure other sources of funding in the
future on terms favorable to us.
In
addition, the occurrence of catastrophic events, such as hurricanes, storms, earthquakes, tsunamis, floods and other catastrophes
that adversely affect the business climate in any of our markets could have a material adverse effect on our business, financial
condition and results of operations. Some of our operations are located in areas that have been in the past, and may be in the
future, susceptible to such occurrences.
Our
future success depends on our ability to enhance our existing operations, execute on our growth strategy and properly manage investment
in our business and operations.
A
key element of our strategy is to continue to invest in, enhance and secure our business and operations and grow organically.
Investments in, among other things, new markets, new solutions, technologies, infrastructure and systems, geographic expansion
and headcount may all be considered in order to execute this strategy. Our ability to implement this portion of our growth strategy
is dependent on our ability to market solutions and products on a larger scale, increase our brand recognition and enter into
distribution and other strategic arrangements with third party suppliers and distributors, as well as manage growth in administrative
overhead and distribution costs likely to result from our possible geographic expansion.
However,
such investments and efforts may not be successful, especially in new areas or new markets in which we have little or no experience,
and even if successful, may negatively impact our profitability. Our success depends on our ability to effectively and efficiently
enhance our existing operations and execute on our growth strategy, balance the extent and timing of investments with the associated
impact on expenses and profitability, balance our focus between new areas or new markets and the operation and servicing of our
legacy businesses and customers, capture efficiencies and economies of scale and compete in the new areas or new markets and with
the new solutions in which we have invested. If we are unable to effectively and efficiently enhance our existing operations,
execute on our growth strategy and properly manage our investments, focus and expenditures, our results of operations and market
share may be materially adversely affected.
Acquisition
and investment activities present certain risks to our business, operations and financial position.
Acquisitions
and investments may be a part of our growth strategy. Successful execution following the closing of an acquisition or investment
is paramount to achieving the anticipated benefits of the transaction. The process for acquiring a company may take from several
months up to a year and costs can vary greatly. We may also compete with others to acquire companies, and such competition may
result in decreased availability of, or an increase in price for, suitable acquisition candidates. In addition, we may not be
able to consummate acquisitions or investments that we have identified as crucial to the implementation of our strategy for other
commercial or economic reasons. As a result, it may be more difficult for us to identify suitable acquisition or investment targets
or to consummate acquisitions or investments on acceptable terms or at all. If we are not able to execute on any acquisition,
we may not be able to achieve a future growth strategy and may lose market share.
The
process of integrating an acquired company’s business or new technologies is challenging and may result in expected or unexpected
operating or compliance challenges, which may require significant expenditures and a significant amount of our management’s
attention that would otherwise be focused on the ongoing operation of our business.
Acquisitions
and/or investments may also result in the expenditure of available cash and amortization expenses or write-downs related to intangible
assets such as goodwill, any of which could have a material adverse effect on our operating results or financial condition. Investments
in immature businesses with unproven track records and technologies have an especially high degree of risk, with the possibility
that we may lose the value of our entire investment or incur additional unexpected liabilities. Large or costly acquisitions or
investments may also diminish our capital resources and liquidity or limit our ability to engage in additional transactions for
a period of time.
All
of the foregoing risks may be magnified as the cost, size or complexity of an acquisition or acquired company increases, or where
the acquired company’s products, market or business are materially different from ours, or where more than one integration
is occurring simultaneously or within a concentrated period of time.
We
may not be able to obtain the necessary regulatory approvals, including those of antitrust authorities and foreign investment
authorities, in countries where we seek to consummate acquisitions or make investments. For those and other reasons, we may ultimately
fail to consummate an acquisition, even if we announce the intended acquisition.
In
addition, we may require significant financing to complete an acquisition or investment, whether through bank loans, raising of
debt or otherwise. We cannot assure you that such financing options will be available to us on reasonable terms, or at all. If
we are not able to obtain such necessary financing, it could have an impact on our ability to consummate a substantial acquisition
or investment and execute a future growth strategy. Alternatively, we may issue a significant number of shares as consideration
for an acquisition, which would have a dilutive effect on our existing shareholders.
The
mishandling or the perceived mishandling of sensitive information could harm our business.
The
products we sell are in some cases used by customers to compile and analyze highly sensitive or confidential information and data,
including information or data used in intelligence gathering or law enforcement activities. While our customers’ use of
the products in no way affords us access to the customer’s sensitive or confidential information or data, we or our partners
may receive or come into contact with such information or data, including personally identifiable information, when we are asked
to perform services or support functions for our customers. We or our partners may also receive or come into contact with such
information or data in connection with the use of our solutions. While employee contracts generally contain standard confidentiality
provisions, we cannot assure the proper handling or processing of sensitive or confidential data by our employees. The improper
handling of sensitive or confidential data, or even the perception of such mishandling (whether or not valid), or other security
lapses by us or our partners or within the products, could reduce demand for such products or otherwise expose us to financial
or reputational harm or legal liability.
We
may consider entering into the U.S. market, which may expose our business to additional risks.
We
may consider entry into the U.S. market. The entrance into the U.S. market would subject us to U.S. regulatory requirements, including
regarding customer use of our solutions. As we anticipate that our future sales in the United States would be made primarily to
U.S. governmental agencies, we would be further exposed to all of the risks related to government contracts. See the risk factor
“
We face risks relating to government spending and contracts with governments and governmental agencies
” above.
We would also need to develop a strategy to differentiate the solutions we offer for sale within the United States from those
outside of the United States so that any non-U.S. products do not fall under U.S. export control restrictions. There can be no
assurance that we will develop a successful strategy to enter the U.S. market, or that we will be able to enter or successfully
compete in that market. As a result of the foregoing, we plan to be conservative in our approach to the U.S. market.
Risks
related to Intellectual Property and Data/Systems Security
The
products and solutions we sell may infringe or may be alleged to infringe on the intellectual property rights of others, which
could lead to costly disputes or disruptions for us and may require us to indemnify our customers and resellers for any damages
they suffer.
The
technology industry is characterized by frequent allegations of intellectual property infringement. Any allegation of infringement
against us could be time consuming and expensive to defend or resolve, result in substantial diversion of management resources,
cause shipment delays or force us to enter into royalty or license agreements. If patent holders or other holders of intellectual
property initiate legal proceedings against us either with respect to our own intellectual property or intellectual property we
license from third parties, we may be forced into protracted and costly litigation, regardless of the merits of these claims.
On November 12, 2015, a lawsuit alleging patent infringement, violation of a non-disclosure agreement, trade secret misappropriation
and unjust enrichment, was submitted to the Lod District Court in Israel by a company and an individual against Ability and our
controlling shareholders. The amount sought in the lawsuit for registration fee purposes is NIS 5 million (approximately $1.4
million), however the plaintiffs did not specify the amount of the compensation demanded. The plaintiffs allege that certain GSM
interception and decryption systems sold by Ability apparently fall within the claim of an Israeli patent owned by the plaintiffs.
Furthermore, the plaintiffs demanded that Ability and/or its controlling shareholders immediately cease any patent infringement
as well as cease from any further use of the claimed technology, including the further manufacture, export, sale or marketing
of the alleged infringing products. See “Item 8A. Financial Information — Consolidated Statements and Other Financial
Information — Legal Proceedings.” We may not be successful in defending such litigation, including the pending litigation,
in part due to the complex technical issues and inherent uncertainties in intellectual property litigation, and may not be able
to procure any required royalty or license agreements on terms acceptable to us, or at all.
Third
parties may also assert infringement claims against our customers. We sometimes undertake to indemnify our customers and resellers
for infringement by our products of the proprietary rights of third parties, which, in some cases, may not be limited to a specified
maximum amount and for which we may not have sufficient insurance coverage or adequate indemnification in the case of intellectual
property licensed from a third party. If any of these claims succeed, we may be forced to pay damages, be subject to injunction
with respect to the use or sale of certain products and solutions, be required to obtain licenses for the products our customers
or partners use, which may not be available on reasonable terms, or incur significant expenses in developing non-infringing alternatives.
We
face risks relating to our use of certain “open source” software tools.
Certain
of the products and solutions we sell may contain a limited amount of open source code. Open source code is code that is covered
by a license agreement that permits the user to liberally use, copy, modify and distribute the software without cost, provided
that users and modifiers abide by certain licensing requirements. The original developers of the open source code provide no warranties
on such code. As a result, we could be subject to suits by parties claiming ownership of what we believe to be open source code
and we may incur expenses in defending claims that we did not abide by the open source code license. In addition, third party
licensors do not provide intellectual property protection with respect to the open source components of their products, and therefore
we may not be indemnified by such third party licensors in the event that we or our customers are held liable in respect of the
open source software contained in such third party software. If we are not successful in defending against any such claims that
may arise, we may be subject to injunctions and/or monetary damages or the open source code would need to be removed from the
products and solutions we sell. Such events could disrupt our operations and the sales of such products and solutions, which would
negatively impact our revenues and cash flow.
Moreover,
under certain conditions, the use of open source code to create derivative code may obligate us to make the resulting derivative
code available to others at no cost. The circumstances under which the use of open source code would compel the offer of derivative
code at no cost are subject to varying interpretations. If we are required to publicly disclose the source code for such derivative
products or to license our derivative products that use an open source license, our previously proprietary software products may
be available to others without charge. If this happens, our customers and our competitors may have access to our products without
cost to them, which could harm our business. The use of such open source code, however, may ultimately subject some of our
products to unintended conditions so that we are required to take remedial action that may divert resources away from our development
efforts.
We
may be subject to information technology system failures or disruptions that could harm our operations, financial condition or
reputation.
We
rely extensively on information technology systems to operate and manage our business and to process, maintain and safeguard information,
including information belonging to our customers, partners, and personnel.
These
systems may be subject to failures or disruptions as a result of, among other things, natural disasters, accidents, power disruptions,
telecommunications failures, new system implementations, acts of terrorism or war, physical security breaches, computer viruses,
or other cyber-attacks. Cyber-attacks are becoming increasingly sophisticated and in many cases may not be identified until a
security breach actually occurs. We have experienced cyber-attacks in the past and may experience them in the future, potentially
with greater frequency. While we are continually working to maintain secure and reliable systems, our security, redundancy, and
business continuity efforts may be ineffective or inadequate. We must continuously improve our design and coordination of security
controls. Despite our efforts, it is possible that our security controls and other procedures that we follow may not prevent systems
failures or disruptions. Such system failures or disruptions could subject us to delays in our ability to process orders, delays
in our ability to provide products, solutions and services to customers, delays or errors in financial reporting, compromise,
disclosure, or loss of sensitive or confidential information or intellectual property, destruction or corruption of data, financial
losses from remedial actions, theft, liabilities to customers or other third parties, or damage to our reputation. Information
system failures at one of our suppliers or partners may also result in similar adverse consequences.
Any
of the foregoing could harm our competitive position, result in a loss of customer confidence and materially and adversely affect
our results of operations or financial condition.
Risks
Related to our Operations in Israel
Conditions
in Israel affect our operations and may limit our ability to produce and sell our products.
Our headquarters are located in Israel. In addition, all of our senior management and directors are residents of Israel.
Accordingly, political, economic and military conditions in Israel may directly affect our business. Since the
establishment of the State of Israel in 1948, a number of armed conflicts have taken place between Israel and its neighboring
countries. In recent years, these have included hostilities between Israel and Hezbollah in Lebanon and Hamas in the Gaza
strip, both of which resulted in rockets being fired into Israel, causing casualties and disruption of economic activities.
In addition, Israel faces threats from more distant neighbors, in particular, Iran. Our commercial insurance does not cover
losses that may occur as a result of an event associated with the security situation in the Middle East. Although the Israeli
government is currently committed to covering the reinstatement value of direct damages that are caused by terrorist attacks
or acts of war, we cannot assure you that this government coverage will be maintained, or if maintained, will be sufficient
to compensate us fully for damages incurred. Any losses or damages incurred by us could have a material adverse effect on
our business. Any armed conflict involving Israel could adversely affect our operations and results of operations.
Further,
our operations could be disrupted by the obligations of personnel to perform military service. As of April 15, 2018, we had 17
employees based in Israel, certain of whom may be called upon to perform military reserve duty until they reach the age of 40
(and in some cases, depending on their specific military profession, up to 45 or even 49 years of age) and, in certain emergency
circumstances, may be called to immediate and unlimited active duty. Our operations could be disrupted by the absence of a significant
number of employees related to military service, which could materially adversely affect our business and results of operations.
Additionally,
several countries, principally in the Middle East, still restrict doing business with Israel and Israeli companies, and additional
countries and groups have imposed or may impose restrictions on doing business with Israel and Israeli companies if hostilities
in Israel or political instability in the region continues or increases. These restrictions may limit our ability to obtain manufactured
components and raw materials from these countries or sell our products to companies in these countries. Furthermore, the Boycott,
Divestment and Sanctions Movement, a global campaign attempting to increase economic and political pressure on Israel to comply
with the stated goals of the movement, may gain increased traction and result in a boycott of Israeli products and services. Any
hostilities involving Israel or the interruption or curtailment of trade between Israel and its present trading partners, or significant
downturn in the economic or financial condition of Israel, could adversely affect our business, results of operations and financial
condition.
We
are subject to stringent export control regulations.
The
Israeli government has adopted and amended laws and regulations regarding military and defense export controls, as well as the
export of “dual use” items, and many of our suppliers are subject to national export regimes. Some of the solutions
we offer incorporate decryption technology, which is subject to Israeli export control and may also be subject to non-Israeli
export control when supplied from non-Israeli suppliers. If the required government approvals are not obtained, our ability to
market, sell and export the products could be negatively impacted, which would result in a reduction in our revenues.
Certain
of our activities are exempt from Israeli export control under the current export control regime as these activities do not involve
the export of Israeli-controlled items from Israel, but rather the sale by us of items of non-Israeli origin to non-Israeli entities,
which items are not exported from Israel (these activities are referred to as “Brokerage” under the Israeli Defense
Export Control Law, 2007 (the “2007 Law”). This exemption is due to the fact that the chapter of the 2007 Law
relating to Brokerage transactions has not entered into force to date. If such chapter were to enter into force and apply to Brokerage
transactions (even if such Brokerage does not involve the export of controlled goods from Israel), we may be required to obtain
additional licenses or modify our method of doing business in the future. If we are unable to obtain such licenses or modify our
method of doing business, our business, results of operations and financial condition could be adversely affected.
The
tax benefits that are available to Ability under Israeli law require it to meet various conditions and may be terminated or reduced
in the future, which could increase its Israeli tax liability.
Ability
is eligible for certain tax benefits provided to “Preferred Enterprises” under the Israeli Law for the Encouragement
of Capital Investments, 1959 (the “Investment Law”). The standard corporate tax rate for Israeli companies was 26.5%
for 2015 and was reduced to 25% for 2016, 24% for 2017 and 23% for 2018 and thereafter. Due to Ability’s “Preferred
Enterprise” status, Ability expects to benefit from a reduced tax rate of 14.6% in 2015 and 2016 (based on a blended tax
rate) and a reduced tax rate, not yet determined (but up to 16%), in 2017 and thereafter with respect to taxable income generated
by the Preferred Enterprise, and all other taxable income will be subject to the standard corporate tax rate. If these tax benefits
are reduced, cancelled or discontinued, for whatever reason, including lack of compliance with the requirements of the Investment
Law, Ability’s Israeli taxable income would be subject to standard Israeli corporate tax rates and it may be required to
pay incremental taxes over the reduced tax rates under the Preferred Enterprise, plus indexation, interest and possibly penalties
thereon. Additionally, if Ability increases its activities outside of Israel through acquisitions, for example, Ability’s
expanded activities outside of Israel might not be eligible for inclusion in future Israeli tax benefit programs. The Israeli
government may furthermore independently determine to reduce, phase out or eliminate entirely the benefits available under the
Investment Law, which could also adversely affect Ability’s global tax rate and the results of its operations.
Exchange
rate fluctuations between the U.S. dollar and the New Israeli Shekel currencies may negatively affect our earnings.
Our
functional currency is the U.S. dollar. We incur expenses in U.S. dollars and New Israeli Shekels. As a result, we are exposed
to the risks that the NIS may appreciate relative to the U.S. dollar, or, if the NIS devalues relative to the U.S. dollar, that
the inflation rate in Israel may exceed such rate of devaluation of the NIS, or that the timing of such devaluation may lag behind
inflation in Israel. In any such event, the U.S. dollar cost of our operations in Israel would increase and our U.S. dollar-denominated
results of operations would be adversely affected. The average exchange rate for the year ended December 31, 2017 was $1.00 =
NIS 3.467. We cannot predict any future trends in fluctuation of the exchange rate, if any, of the NIS against the U.S. dollar.
Risks
Relating to Incorporation in the Cayman Islands
As
we are a Cayman Islands exempted company, it could be difficult for investors to effect service of process on and recover against
us or our directors and officers, and our shareholders may face difficulties in protecting their interest and rights through the
U.S. federal courts.
We
are a Cayman Islands exempted company, and our officers and directors are residents of various jurisdictions outside the United
States. A substantial portion of our assets and the assets of our officers and directors, at any one time, are and may be located
in jurisdictions outside the United States. Further, we have no agent for service of process within the United States, which would
make it difficult for investors to effect service of process in the United States on us or our directors and officers who reside
outside the United States, or to recover against us or our directors and officers on judgments of U.S. courts, including judgments
predicated upon the civil liability provisions of U.S. federal securities laws.
Our
corporate affairs are governed by our charter documents, consisting of our amended and restated memorandum and articles of association,
by the Companies Law (2018 Revision) of the Cayman Islands (as supplemented or amended from time to time) (the “Companies
Law”) and the common law of the Cayman Islands. The rights of our shareholders and the fiduciary responsibilities of our
directors are governed by Cayman Islands law and are different as under statutes or judicial precedent in jurisdictions such as
the United States. The common law of the Cayman Islands is derived, in part, from relatively limited judicial precedent in the
Cayman Islands as well as from English common law, the decisions of whose courts are of persuasive authority, but are not binding
in the Cayman Islands. In particular, the Cayman Islands has a different body of securities laws compared to the United States,
and certain states, such as Delaware, may have more fully developed and judicially interpreted bodies of corporate law. While
there is some case law in the Cayman Islands on these matters, it is not as developed as, for example, in the United States. In
addition, the laws of the Cayman Islands relating to the protection of the interests of minority shareholders differ in some respects
from those established under statutes or judicial precedent in the United States. Such differences may mean that our minority
shareholders may have less protection than they would have had under the laws of the United States. The less protective nature
of such laws in the Cayman Islands may make it more difficult for our shareholders to protect their interests in the face of actions
by our management or directors than shareholders of a corporation incorporated in other jurisdictions. In addition, Cayman Islands
companies may not have standing to initiate a shareholders derivative action in a federal court of the United States.
We
have been advised by our Cayman Islands legal counsel that the courts of the Cayman Islands are unlikely (i) to recognize or enforce
against us judgments of courts of the United States predicated upon the civil liability provisions of the federal securities laws
of the United States or any state; and (ii) in original actions brought in the Cayman Islands, to impose liabilities against us
predicated upon the civil liability provisions of the federal securities laws of the United States or any state, so far as the
liabilities imposed by those provisions are penal in nature. In those circumstances, although there is no statutory enforcement
in the Cayman Islands of judgments obtained in the United States, the courts of the Cayman Islands will recognize and enforce
a foreign money judgment of a foreign court of competent jurisdiction without retrial on the merits based on the principle that
a judgment of a competent foreign court imposes upon the judgment debtor an obligation to pay the sum for which judgment has been
given provided certain conditions are met. For a foreign judgment to be enforced in the Cayman Islands, such judgment must be
final and conclusive and for a liquidated sum, and must not be in respect of taxes or a fine or penalty, inconsistent with a Cayman
Islands judgment in respect of the same matter, impeachable on the grounds of fraud or obtained in a manner, and or be of a kind
the enforcement of which is, contrary to natural justice or the public policy of the Cayman Islands (awards of punitive or multiple
damages may well be held to be contrary to public policy). A Cayman Islands Court may stay enforcement proceedings if concurrent
proceedings are being brought elsewhere.
As
a result of all of the above, our shareholders may have more difficulty in protecting their interests in the face of actions taken
by management, members of the board of directors or controlling shareholders than they would as shareholders of a U.S. company.
If
we are deemed or become a passive foreign investment company, or PFIC, for U.S. federal income tax purposes in 2017 or in
any prior or subsequent years, there may be negative tax consequences for U.S. taxpayers that are holders of our shares.
We
will be treated as a passive foreign investment company, or PFIC, for U.S. federal income tax purposes in any taxable year
in which either (i) at least 75% of our gross income is “passive income” or (ii) on average at least 50% of our assets
by value produce passive income or are held for the production of passive income. Passive income for this purpose generally includes,
among other things, certain dividends, interest, royalties, rents and gains from commodities and securities transactions and from
the sale or exchange of property that gives rise to passive income. Passive income also includes amounts derived by reason of
the temporary investment of funds, including those raised in a public offering. In determining whether a non-U.S. corporation
is a PFIC, a proportionate share of the income and assets of each corporation in which it owns, directly or indirectly, at
least a 25% interest (by value) is taken into account.
We believe we were not
a PFIC for 2017. Because the PFIC determination is highly fact intensive, there can be no assurance that we will not be a PFIC
for 2018 or for any other taxable year. If we were to be characterized as a PFIC in any taxable year during which a
U.S. shareholder owns our ordinary shares, and such U.S. shareholder does not make an election to treat us as a “qualified
electing fund,” or QEF, or make a “mark-to-market” election, then “excess distributions” to such
U.S. shareholder and any gain realized on the sale or other disposition of our shares will be subject to special rules. Under
these rules: (i) the excess distribution or gain would be allocated ratably over the U.S. shareholder’s holding period for
shares; (ii) the amount allocated to the current taxable year and any period prior to the first day of the first taxable year
in which we were a PFIC would be taxed as ordinary income; and (iii) the amount allocated to each of the other taxable
years would be subject to tax at the highest rate of tax in effect for the applicable class of taxpayer for that year, and an
interest charge for the deemed deferral benefit would be imposed with respect to the resulting tax attributable to each such other
taxable year. In addition, if the U.S. Internal Revenue Service determines that we are a PFIC for a year with respect
to which we have determined that we were not a PFIC, it may be too late for a U.S. shareholder to make a timely QEF or mark-to-market
election. U.S. shareholders who hold our shares during a period when we are a PFIC will be subject to the foregoing
rules, even if we cease to be a PFIC in subsequent years, subject to exceptions for U.S. shareholders who made a timely
QEF or mark-to-market election. A U.S. shareholder can make a QEF election by completing the relevant portions of and filing IRS
Form 8621 in accordance with the instructions thereto. A QEF election generally may not be revoked without the consent of the
IRS. If an investor provides reasonable notice to us that it has determined to make a QEF election, we shall endeavor to timely
provide annual financial information to such investor as may be reasonably required for purposes of filing United States federal
income tax returns in connection with such QEF election.
Certain
provisions of our amended and restated memorandum and articles of association may make it difficult for shareholders to change
the composition of our board of directors and may discourage, delay or prevent a merger or acquisition that some shareholders
may consider beneficial.
Certain
provisions of our amended and restated memorandum and articles of association may have the effect of delaying or preventing changes
in control if our board of directors determines that such changes in control are not in the best interests of us and our shareholders.
The provisions in our amended and restated memorandum and articles of association include, among other things, those that:
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authorize
our board of directors to issue preference shares and to determine the price and other terms, including preferences and voting
rights, of those shares without shareholder approval;
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establish
advance notice procedures for nominating directors or presenting matters at shareholder meetings; and
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limit
the persons who may call extraordinary general meetings of shareholders.
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While
these provisions have the effect of encouraging persons seeking to acquire control of us to negotiate with our board of directors,
they could enable the board of directors to hinder or frustrate a transaction that some, or a majority, of the shareholders may
believe to be in their best interests and, in that case, may prevent or discourage attempts to remove and replace incumbent directors.
These
provisions may frustrate or prevent any attempts by our shareholders to replace or remove our current management members by making
it more difficult for shareholders to replace members of our board of directors, which is responsible for appointing the members
of our management.
We
are a foreign private issuer and, as a result, we are not subject to U.S. proxy rules and are subject to the Securities Exchange
Act of 1934 reporting obligations that, to some extent, are more lenient and less frequent than those applicable to a U.S. issuer
.
We
report under the Securities Exchange Act of 1934, or the Exchange Act, as a foreign private issuer. Because we qualify as a foreign
private issuer under the Exchange Act, we are exempt from certain provisions of the Exchange Act that are applicable to U.S. public
companies, including (i) the sections of the Exchange Act regulating the solicitation of proxies, consents or authorizations in
respect of a security registered under the Exchange Act; (ii) the sections of the Exchange Act requiring insiders to file public
reports of their stock ownership and trading activities and liability for insiders who profit from trades made in a short period
of time; and (iii) the rules under the Exchange Act requiring the filing with the SEC of quarterly reports on Form 10-Q containing
unaudited financial and other specified information, or current reports on Form 8-K, upon the occurrence of specified significant
events. We intend to furnish quarterly reports to the SEC on Form 6-K for so long as we are subject to the reporting requirements
of Section 13(g) or 15(d) of the Exchange Act, although the information we furnish may not be the same as the information that
is required in quarterly reports on Form 10-Q for U.S. domestic issuers. In addition, while U.S. domestic issuers that are not
large accelerated filers or accelerated filers are required to file their Annual Reports on Form 10-K within 90 days after the
end of each fiscal year, foreign private issuers are not required to file their Annual Report on Form 20-F until 120 days after
the end of each fiscal year. Foreign private issuers are also exempt from the Regulation Fair Disclosure, aimed at preventing
issuers from making selective disclosures of material information. Accordingly, you may not have the same protections afforded
to shareholders of companies that are not foreign private issuers.
As
a foreign private issuer, we are permitted to follow certain home country corporate governance practices instead of otherwise
applicable NASDAQ requirements, which may result in less protection than under rules applicable to domestic U.S. issuers
.
As
a foreign private issuer, we are permitted to follow certain home country corporate governance practices instead of those otherwise
required under the Listing Rules of the NASDAQ Stock Market for domestic U.S. issuers. For instance, we have elected to follow
home country practice in the Cayman Islands with regard to quorum requirements at general meetings of our shareholders. In addition,
we have elected to follow our home country law instead of the Listing Rules of the NASDAQ Stock Market that require us to obtain
shareholder approval for certain dilutive events, such as the establishment or amendment of certain equity based compensation
plans, an issuance that will result in a change of control of the Company, certain transactions other than a public offering involving
issuances of a 20% or greater interest in the company, and certain acquisitions of the stock or assets of another company. We
may also elect in the future to follow home country practice in the Cayman Islands with regard to the number of independent directors
appointed to our board of directors and maintaining compensation and nominating committees of the board of directors. Following
our home country governance practices as opposed to the requirements that would otherwise apply to a United States company listed
on NASDAQ may provide less protection to you than what is accorded to investors under the Listing Rules of the NASDAQ Stock Market
applicable to domestic U.S. issuers.
Risks
Related to our Ordinary Shares and Warrants
Our
ordinary shares could be delisted from the NASDAQ Capital Market if we fail to regain compliance with the NASDAQ’s stockholders’
equity continued listing standards on the schedule required by the NASDAQ Capital Market or if our ordinary shares do not regain
compliance with NASDAQ’s minimum bid price requirements. Our ability to publicly or privately sell equity securities and
the liquidity of our ordinary shares could be adversely affected if we are delisted from the NASDAQ Capital Market.
On
October 11, 2017, we received notification from the Listing Qualifications Department of The NASDAQ Stock Market (the “Staff”)
that we were not in compliance with the minimum bid price requirement set forth in NASDAQ Listing Rule 5550(a)(2). NASDAQ Listing
Rule 5550(a)(2) requires listed securities to maintain a minimum bid price of $1.00 per share and NASDAQ Listing Rule 5810(c)(3)(A)
provides that a failure to meet the minimum bid price requirement exists if the deficiency continues for a period of 30 consecutive
business days. Based on the closing bid price of our ordinary shares for the 30 consecutive business days ended October 10, 2017,
we no longer met the minimum bid price requirement. In accordance with NASDAQ Listing Rule 5810(c)(3)(A), we had an initial grace
period of 180 calendar days, or until April 9, 2018 (the “Minimum Bid Price Compliance Period”), to regain compliance
with the minimum bid price requirement.
On
December 27, 2017, we implemented a 1-for-10 consolidation of our ordinary shares with a market effective date of March 23, 2018.
One of the primary intents for the consolidation was that the anticipated increase in the price of our ordinary shares immediately
following and resulting from a reverse stock split due to the reduction in the number of issued and outstanding shares of ordinary
shares would help us meet the price criteria for continued listing on the NASDAQ Capital Market. On April 9, 2018, we received
a notification from the Staff that we had regained compliance with the NASDAQ Listing Rule 5550(a)(2).
On January 12, 2018,
we received a notification from the Staff that we are not in compliance with NASDAQ Listing Rule 5550(b)(1) due to our
failure to maintain a minimum of $2,500,000 in shareholders’ equity (the “Minimum Shareholders’ Equity Requirement”)
or any alternatives to such requirement. In order to maintain our listing on the NASDAQ Capital Market, we submitted a plan of
compliance addressing how we intended to regain compliance, which was accepted by the Staff on March 7, 2018. We have until July
11, 2018, to evidence compliance with the Minimum Shareholders’ Equity Requirement.
We
believe, based on our current estimate, we will be required to complete one or more offerings that will provide us with gross
proceeds of approximately $5 million prior to July 11, 2018, in order to regain compliance with Minimum Shareholders’ Equity
Requirement and demonstrate to the Staff that our estimated stockholder’s equity will be at least $2.5 million as of July
11, 2018. Even if the net proceeds from our future capital raises provide us with sufficient stockholders’ equity to regain
compliance with the Minimum Shareholders’ Equity Requirement by July 11, 2018, we will be subject to ongoing review for
compliance with NASDAQ’s continuing listing requirements, and there can be no assurance that we will continue to remain
in compliance with this standard. If we do not regain compliance by July 11, 2018, or fail to remain in compliance anytime thereafter,
or if we do not maintain our progress consistent with the plan during the applicable plan period, NASDAQ will initiate delisting
proceedings.
Previously,
on April 19, 2017, we received notification from the Staff that as a result of the resignation of all of our independent
directors from our board of directors in April 2017, we were no longer in compliance with NASDAQ Listing Rules 5605(b)(1),
5605(c)(2), 5605(d)(2) and 5605(e) as the board was no longer comprised of a majority of independent directors nor does it
have an audit committee, compensation committee or nominating committee. On May 18, 2017, NASDAQ notified us that we regained
compliance following the appointment of Levi Ilsar, Brigadier General (Ret.) Eli Polak and Nimrod Schwartz to our board of
directors and the audit, compensation and nominating committees thereof. In addition, on June 6, 2017 we received
notification from the Staff that we were not in compliance with the minimum bid price requirement set forth in NASDAQ’s
Listing Rule 5550(a)(2). On June 23, 2017, we received a notification from the Staff that we had regained compliance with
NASDAQ Listing Rule 5550(a)(2).
If
we are delisted from the NASDAQ Capital Market, our ordinary shares may be eligible for trading on an over-the-counter
market in the United States. In the event that we are not able to obtain a listing on another U.S. stock exchange or
quotation service for our ordinary shares, it may be extremely difficult or impossible for shareholders to sell their
ordinary shares in the United States. Moreover, if we are delisted from the NASDAQ Capital Market, but obtain a substitute
listing for our ordinary shares in the United States, it will likely be on a market with less liquidity, and therefore
experience potentially more price volatility than experienced on the NASDAQ Capital Market. Shareholders may not be able to
sell their ordinary shares on any such substitute U.S. market in the quantities, at the times, or at the prices that could
potentially be available on a more liquid trading market. As a result of these factors, if our ordinary shares are delisted
from the NASDAQ Capital Market, the price of our ordinary shares is likely to decline. Delisting also could have other
negative results, including the potential loss of confidence by employees, the loss of institutional investor interest and
fewer business development opportunities. Moreover, if our ordinary shares were delisted from NASDAQ, we will no longer be
exempt from certain provisions of the Israeli Securities Law, and therefore will have increased disclosure
requirements.
The
recent consolidation of our ordinary shares may decrease the liquidity of the shares of our ordinary
shares.
The
liquidity of our ordinary shares may be affected adversely by the recent 1-10 consolidation of our ordinary shares given the
reduced number of shares that were outstanding following the ordinary shares. In addition, the consolidation increased the
number of shareholders who own odd lots (less than 100 shares) of our ordinary shares, creating the potential for such
shareholders to experience an increase in the cost of selling their shares and greater difficulty effecting such
sales.
We
are a “controlled company” within the meaning of NASDAQ listing standards and, as a result, qualify for exemptions
from certain corporate governance requirements.
As
a result of the number of shares jointly owned by Messrs. Hurgin and Aurovsky, we are a “controlled company” under
the NASDAQ corporate governance rules. A “controlled company” is a company of which more than 50% of the
voting power for the election of director is held by an individual, group or another company. Pursuant to the “controlled
company” exemption, we may elect not to comply with the requirements that a majority of our board of directors consists
of independent directors and that we have a compensation committee and a nominating committee, in each case, composed entirely
of independent directors with a written charter addressing each committee’s purpose and authorities. Although we qualified
for the “controlled company” exemption, we have not relied on such exemption. However, we may in the future rely on
such exemption. Relying on the “controlled company” exemption, as opposed to the requirements that would otherwise
apply, may provide less protection to our investors than what is accorded to investors under the Listing Rules of the NASDAQ Stock
Market applicable to issuers which do not qualify as “controlled companies”.
A
limited public market exists for our securities and we cannot assure you that our securities will continue to be listed on the
NASDAQ Capital Market or any other securities exchange or that an active trading market will ever develop for any of our securities.
Our
ordinary shares were approved for listing and began trading on the NASDAQ Capital Market under the symbol “ABIL” upon
the closing of the Business Combination. An active trading market for our shares has not developed and, even if it does, it may
not be sustained. In addition, we cannot assure you that we will be successful in meeting the continuing listing standards
of the NASDAQ Capital Market and cannot assure you that our ordinary shares will be listed on a national securities exchange.
If an active market for our stock does not develop or is not sustained, it may be difficult for investors to sell their shares
without depressing the market price for the shares or at all. Further, an inactive market may also impair our ability to raise
capital and may impair our ability to enter into strategic partnerships or acquire companies or products by using our ordinary
shares or ordinary shares as consideration.
We
have received various requests for advancement and indemnification from present and former officers, directors and service providers.
We
have received various requests for advancement and indemnification from present and former officers, directors and service providers
of ours in connection with the various ongoing investigations and legal proceedings to which such officers, directors and service
providers were either named as defendants or were requested to take actions. See “Item 8A. Financial Information —
Consolidated Statements and Other Financial Information — Legal Proceedings.” If found to be indemnifiable pursuant
to our engagements with such officers, directors and service providers, these claims may be significant.
We
are an “emerging growth company” and we intend to take advantage of reduced disclosure and governance requirements
applicable to emerging growth companies, which could result in our ordinary shares being less attractive to investors.
We
are an “emerging growth company” as defined in the Jumpstart Our Business Startups Act, (the “JOBS Act”),
and we intend to continue to take advantage of certain exemptions from various reporting and governance requirements that are
applicable to other public companies that are not emerging growth companies, including, but not limited to, not being required
to comply with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act of 2002. Investors
may find our ordinary shares less attractive because we rely on such exemptions. We may take advantage of these reporting and
governance exemptions until we are no longer an emerging growth company.
In addition, Section 107
of the JOBS Act also provides that an emerging growth company can take advantage of the extended transition period provided in
Section 7(a)(2)(B) of the Securities Act of 1933, as amended (the “Securities Act”), for complying with new or
revised accounting standards. In other words, an emerging growth company can delay the adoption of certain accounting standards
until those standards would otherwise apply to private companies. However, we have chosen to “opt out” of such extended
transition period, and, as a result, we will comply with new or revised accounting standards on the relevant dates on which adoption
of such standards is required for companies that are not “emerging growth companies.” Section 107 of the JOBS Act
provides that our decision to opt out of the extended transition period for complying with new or revised accounting standards
is irrevocable.
We
have identified
material weaknesses
in our internal controls over financial reporting and
if we fail to establish and maintain an effective system of internal control over financial reporting, we may not be able to accurately
report our financial condition, results of operations or cash flows, which may adversely affect investor confidence in us.
The Sarbanes-Oxley Act
of 2002 requires, among other things, that we maintain effective internal control over financial reporting and disclosure controls
and procedures. In particular, we are required, under Section 404 of the Sarbanes-Oxley Act of 2002, to perform
system and process evaluations and testing of our internal control over financial reporting to allow management to report on the
effectiveness of our internal control over financial reporting. This assessment must include disclosure of any material weaknesses in
our internal control over financial reporting identified by our management. A material weakness is a control deficiency, or combination
of control deficiencies, in internal control over financial reporting that results in more than a reasonable possibility that
a material misstatement of annual or interim consolidated financial statements will not be prevented or detected on a timely basis.
Section 404 of the Sarbanes-Oxley of 2002 Act also generally requires an attestation from our independent registered
public accounting firm on the effectiveness of our internal control over financial reporting. However, for as long as we remain
an emerging growth company as defined in the JOBS Act, we intend to take advantage of the exemption permitting us not to comply
with the independent registered public accounting firm attestation requirement. See risk factor “We are an “emerging
growth company” and we intend to take advantage of reduced disclosure and governance requirements applicable to emerging
growth companies, which could result in our ordinary shares being less attractive to investors.” At the time when we are
no longer an emerging growth company, our independent registered public accounting firm may issue a report that is adverse in
the event it is not satisfied with the level at which our controls are documented, designed or operating. Our remediation efforts
may not enable us to avoid a material weakness in the future.
We
identified material weaknesses in our internal control over financial reporting, and concluded that our
internal control over financial reporting was not effective as of December 31, 2017, as in the prior years 2016 and 2015.
See “Item 15. Controls and Procedures.” Due to lack of resources, during 2017, we were unable to implement our
remediation plans and expect to have material weaknesses in our internal control over financial reporting for the foreseeable
future. Any failure to maintain internal control over financial reporting could severely inhibit our ability to accurately
report our financial condition, results of operations or cash flows. If we are unable to remedy the material
weaknesses and conclude that our internal control over financial reporting is effective, or if our independent
registered public accounting firm determines we have a material weakness or significant deficiency in our internal control
over financial reporting, we could lose investor confidence in the accuracy and completeness of our financial reports, the
market price of our ordinary shares could decline, and we could be subject to sanctions or investigations by the NASDAQ Stock
Market, the SEC or other regulatory authorities. Failure to remedy any material weakness in our internal control over
financial reporting, or to implement or maintain other effective control systems required of public companies, could also
restrict our future access to the capital markets.
Material
weaknesses were noted in our financial reporting closing process for the year ended December 31, 2015 with respect to cut-off
procedures relating to expenses and revenue recognition in multiple element transactions, which resulted in a restatement to our
consolidated financial statements as of December 31, 2014 and for the two years in the period then ended and as of June 30 and
September 30 in 2015 and 2014 and for the six and nine month periods then ended, respectively.
As
part of our financial reporting closing process for the year ended December 31, 2015, material weaknesses in our internal
control over financial reporting were identified with respect to cut-off procedures relating to expenses, as certain amounts
due to two third parties had not been timely expensed, and revenue recognition in multiple element sale transactions had not
been properly allocated and timely deferred, which resulted in a restatement of the financial statements in our Annual Report
on Form 20-F for the year ended December 31, 2015 and the consolidated financial statements as of December 31, 2014 and for
the two years in the period then ended and as of June 30 and September 30 in 2015 and 2014 and for the six and nine month
periods then ended, respectively. Further, it was discovered that certain amounts were outstanding as of December 31, 2015,
which could be deemed a violation of Section 402 of the Sarbanes-Oxley Act of 2002. The outstanding balance was repaid in
full by our controlling shareholders. Further, in the year ended December 31, 2015, Ability was a victim of fraud
committed by an outside, unrelated third party resulting in an unauthorized outgoing transfer of $0.5 million.
Our
management has concluded that our disclosure controls and procedures were ineffective, and due to inherent limitations, there
can be no assurance that our system of disclosure and internal controls and procedures will be successful in preventing all errors
or fraud or in informing management of all material information in a timely manner in the future.
Our
management has concluded that our disclosure controls and procedures for the fiscal year ended December 31, 2017,
were ineffective, as in the prior years 2016 and 2015. See “Item 15. Controls and Procedures.” Our disclosure
controls and internal controls and procedures may not prevent all errors and all fraud. A control system, no matter
how well-conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control
system are met. Further, the design of a control system reflects that there are resource constraints, and the benefits
of controls must be considered relative to their costs. Because of the inherent limitations in all control systems,
no evaluation of controls can provide absolute assurance that all our control issues and instances of fraud, if any, have
been or will be detected. These inherent limitations include the realities that judgments in decision-making can be
faulty and that breakdowns can occur simply because of error or mistake. Additionally, controls can be circumvented by
the individual acts of some persons, by collusion of two or more people or by circumvention of the internal
control procedures. The design of any system of controls also is based in part upon certain assumptions about the
likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under
all potential future conditions; over time, a control may become inadequate because of changes in conditions, or the degree
of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a
cost-effective control system, misstatements due to error or fraud may occur and may not be detected.
The
price of our ordinary shares may be volatile.
The
price of our ordinary shares may fluctuate due to a variety of factors, including:
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actual
or anticipated fluctuations in our quarterly and annual results and those of other public companies in our industry;
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any adverse outcome in any litigation against us or
in the SEC investigation;
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initiation
or settlement of litigation by or against us or the threat of potential litigation;
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any delisting or threat of delisting from the
NASDAQ Capital Market;
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mergers
and strategic alliances in the intelligence gathering and cyber security industries;
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market
prices and conditions in the intelligence gathering and cyber security markets;
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changes
in government regulation;
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potential
or actual military conflicts or acts of terrorism;
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the
failure of securities analysts to publish research about us, or shortfalls in our operating results compared to levels forecast
by securities analysts;
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announcements
concerning us or our competitors; and
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the
general state of the securities markets.
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These
market and industry factors may materially reduce the market price of our ordinary shares, regardless of our operating performance.
Our
international operations subject us to currency exchange risk.
We
earn revenues, pay expenses, own assets and incur liabilities in countries using currencies other than the U.S. dollar, including
(among others) the NIS and Euro. Because our functional currency is the U.S. dollar, we must translate revenues, expenses, assets
and liabilities denominated in non-U.S. dollar functional currencies into U.S. dollars using currency exchange rates in effect
during or at the end of each reporting period. Therefore, changes in currency exchange rates affect our consolidated operating
income. In addition, our net income is further impacted by the revaluation and settlement of monetary assets and liabilities denominated
in currencies other than the functional currency, gains or losses on which are recorded within income (expense), net.
Our
income tax rate is complex and subject to uncertainty.
Computations
of our taxes on income and withholding obligations are complex because they are based on the laws of numerous tax jurisdictions.
These computations require significant judgment on the application of complicated rules governing accounting for tax provisions
under GAAP. The international nature of our structure and operations creates uncertainties. Taxes on income for interim periods
are based on a forecast of Ability’s reduced tax rate of 14.6% in 2015 and 2016 and a reduced tax rate of up to 16% in 2017
and thereafter with respect to its income generated by its Preferred Enterprise, which includes forward looking financial projections.
Such financial projections are based on numerous assumptions, including the expectations of profit and loss. We may not accurately
forecast the various items that comprise the projections.
From
time to time, we may be subject to income and other tax audits (including in Israel), the timing of which are unpredictable. While
we believe we comply with applicable tax laws, there can be no assurance that a governing tax authority will not have a different
interpretation of the law and assess us with additional taxes. Any additional taxes could have a material adverse effect on our
results of operations and financial condition.
In
recent years, we have seen changes in tax laws resulting in an increase in applicable tax rates, in part stemming from public
pressure to increase tax liabilities of corporations and to limit the ability to gain from strategic tax planning, with a focus
on international corporations. Such legislative changes in one or more jurisdictions in which we operate may have implications
on our tax liability and have a material adverse effect on our results of operations and financial condition. In 2014 and 2015,
the Israeli corporate tax rate increased until its reduction in 2016 and thereafter. Furthermore, the Israeli government may determine
to reduce, phase out or eliminate entirely tax benefits currently available under certain government programs. If corporate tax
rates increase or the tax benefits under such government programs were to be reduced or eliminated, our effective tax rate may
increase, which could have a negative impact on our results of operations.
Our
shareholder composition may make it difficult for shareholders to significantly influence the decisions of the general meeting.
As
of the date of this Annual Report, more than 64.6% of our ordinary shares are held by our controlling shareholders, Anatoly Hurgin,
our Chief Executive Officer, and Alexander Aurovsky, our Chief Technology Officer. Consequently, Messrs. Hurgin and Aurovsky may
have the ability, either acting alone or jointly, to significantly influence or determine the outcome of specific matters submitted
to the general meeting for approval, including amendments to our articles of association and election of members to our board
of directors, and may make it difficult for other shareholders to significantly influence the outcome of a general meeting.
On
April 9, 2017, we received letters from each of Amnon Dick, Efraim Halevy, Amos Malka, Meir Moshe and Shalom Singer, representing
all our former independent directors, tendering their resignation as a member of our board of directors and committees thereof,
effective immediately. At the time of their resignations, Mr. Dick was Chairman of our board of directors and a member of the
audit and compensation committees; Mr. Halevy was a member of the nominating committee; Mr. Malka was a member of the compensation
committee; Mr. Moshe was Chairman of the audit committee and Chairman of the nominating committee; and Mr. Singer was Chairman
of the compensation committee and a member of the audit and nominating committees. Each of Messrs. Dick, Malka, Moshe and Singer
stated in their respective resignation letter that their resignation was due to his approach to risk assessment and management
of our affairs not being aligned with that of our founding directors and controlling shareholders, which made them unable to contribute
to us in a productive way. Each noted that, in view of the various challenges that we are currently facing, a shared vision and
broad cooperation among our controlling shareholders and directors is required and that in view of the foregoing, and especially
as they served as a director for only a few months, they do not believe it would be appropriate to continue to serve as a director.
Mr. Halevy did not state any reason for his resignation in his resignation letter. Following the resignation of the former independent
directors, on May 15, 2017 we appointed Levi Ilsar, Brigadier General (Ret.) Eli Polak and Nimrod Schwartz to serve as independent
directors on our board of directors and the audit, compensation and nominating committees thereof, in each case effective as of
May 17, 2017. However, on June 29, 2017, Levi Ilsar, Eli Polak and Nimrod Schwartz, representing all of our independent directors,
tendered their written resignations with immediate effect.
Each of Messrs. Ilsar, Polak and Schwartz stated in his respective
resignation notice that his resignation was due, among other things, to the lack of cooperation by management which prevented
him from fulfilling his duties as an independent director. On July 5, 2017, our board appointed three new independent directors,
Avraham Dan, Naftali Granot and Limor Beladev, effective immediately. On July 24, 2017 and October 15, 2017, our board appointed
additional independent directors, Brigadier General (Ret.) Yair Cohen and Joseph Tenne, respectively, effective immediately.
The
interests of our major shareholders may not always be aligned with those of our other shareholders. In addition, conflict of interests
may exist or occur between our major shareholders. Any material conflicts of interests between our major shareholders and other
stakeholders may have a material adverse effect on our future performance, results of operations, cash flows and financial position.
We
incur significant costs and obligations as a result of being a public company.
As
a publicly traded company, we will incur significant legal, accounting and other expenses, particularly after we are no longer
an “emerging growth company” as defined under the JOBS Act. In addition, new and changing laws, regulations and standards
relating to corporate governance and public disclosure, including the Dodd Frank Wall Street Reform and Consumer Protection Act
and the rules and regulations promulgated and to be promulgated thereunder, as well as under the Sarbanes-Oxley Act of 2002, the
JOBS Act, and the rules and regulations of the SEC and the NASDAQ Stock Market have created uncertainty for public companies and
increased the costs and the time that our board of directors and management must devote to complying with these rules and regulations.
We expect these rules and regulations to increase our legal and financial compliance costs and lead to a diversion of management
time and attention from revenue generating activities, which could prevent us from improving our business, results of operations
and financial condition.
If
we are unable to develop and implement adequate required accounting practices and policies, we may be unable to provide the financial
information required of a U.S. publicly traded company in a timely and reliable manner.
As
a U.S. publicly traded company, the implementation of all required accounting practices and policies and the hiring of additional
financial staff will increase our operating costs and could require significant time and resources from our management and employees.
If we are unable to develop and maintain effective internal controls and procedures and disclosure procedures and controls, we
may be unable to provide financial information and required SEC reports that a U.S. publicly traded company is required to provide
in a timely and reliable fashion. Any such delays or deficiencies could penalize us, including by limiting our ability to obtain
financing, either in the public capital markets or from private sources and hurt our reputation and could thereby impede our ability
to implement our growth strategy. In addition, any such delays or deficiencies could result in our failure to meet the requirements
for continued listing of our ordinary shares on the NASDAQ Capital Market.
Reports
published by analysts, including projections in those reports that differ from our actual results, could adversely affect the
price and trading volume of our ordinary shares.
Securities
research analysts may establish and publish their own periodic projections for our business. These projections may vary widely
and may not accurately predict the results we actually achieve. Our share price may decline if our actual results do not match
the projections of these securities research analysts. Similarly, if one or more of the analysts who write reports on us downgrades
our stock or publishes inaccurate or unfavorable research about our business, our share price could decline. If one or more of
these analysts ceases coverage of us or fails to publish reports on us regularly, our share price or trading volume could decline.
While we do expect research analyst coverage, if no analysts choose to cover us, the trading price and volume for our ordinary
shares could be adversely affected.
We
may issue additional ordinary shares or other equity securities without shareholder approval, which would dilute your ownership
interests and may depress the market price of our ordinary shares.
We
may issue additional ordinary shares or other equity securities of equal or senior rank in the future in connection with, among
other things, our equity incentive plan or future vessel acquisitions or repayment of outstanding indebtedness, without shareholder
approval, in a number of circumstances.
Issuance
of additional ordinary shares or other equity securities of equal or senior rank would have the following effects:
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dilution
of our existing shareholders’ proportionate ownership interest;
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the
amount of cash available per share, including for payment of dividends, may decrease;
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the
relative voting strength of each previously outstanding ordinary share may be diminished; and
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the
market price of our ordinary shares may decline.
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We
currently do not intend to declare or pay cash dividends in the near future. Any return on investment may be limited to the value
of our securities.
We
currently do not anticipate declaring or paying cash dividends on our ordinary shares in the near future. Our board of directors
has discretion to declare and pay dividends on our ordinary shares and will make any determination to do so based on a number
of factors, such as our operating results, financial condition, current and anticipated cash needs and other business and economic
factors that our board of directors may deem relevant. In accordance with the laws of the Cayman Islands, no dividend or other
distribution shall be paid except out of our realized or unrealized profits, out of the share premium account or as otherwise
permitted by law. If we do not pay dividends, our ordinary shares may be less valuable because a return on your investment will
only occur if the trading price of our securities appreciates. You should not rely on an investment in us if you require dividend
income from your investments.
Future
resales of our ordinary shares issued to our controlling shareholders may cause the market price of our securities to drop significantly,
even if our business is performing well.
Under
the Business Combination agreement, Messrs. Hurgin and Aurovsky received, among other things, an aggregate of: (i) 1,621,327 of
our ordinary shares; (ii) $18,150,000 in cash; and (iii) an additional number of ordinary shares to be issued upon and subject
to Ability achieving certain net income targets. See “Item 4A. Information on the Company - History and Development
of the Company - Our History - Lock-Up Agreements.” The ordinary shares held by Messrs. Hurgin and Aurovsky are “restricted
securities” as defined under Rule 144 promulgated under the Securities Act and may only be sold pursuant to an effective
registration statement or an exemption from registration, if available. Messrs. Hurgin and Aurovsky may rely on the exemption
from registration provided by Rule 144, if available, in which case, resales must meet the criteria and conform to the requirements
of the rule, including compliance with the applicable holding period, volume limitations and availability of current public information.
Thus, upon satisfaction of the requirements of Rule 144, Messrs. Hurgin
and Aurovsky may sell large amounts of our shares in the open market or in privately negotiated transactions, which could have
the effect of increasing volatility in our share price or putting significant downward pressure on the price of our shares.
Item 4.
|
Information on the Company
|
A.
|
History and Development of the Company
|
Our
History
We
were incorporated under the laws of the Cayman Islands under the name “Cambridge Holdco Corp.”, as an exempted company
on September 1, 2015. We were formed as a wholly-owned subsidiary of Cambridge, a company formed in order to effect a merger,
capital stock exchange, asset acquisition or other similar business combination with one or more businesses or entities. Cambridge
was incorporated under the laws of Delaware on October 1, 2013. On December 23, 2013, Cambridge closed its initial public offering
and a simultaneous private placement.
On
December 23, 2015, Cambridge merged with and into Holdco with Holdco surviving the merger and becoming the public entity, and
Holdco consummated the Business Combination by acquiring Ability, following which Ability became a wholly-owned subsidiary of
Holdco, as further described below.
Effective
as of the closing of the Business Combination, Holdco changed its name to “Ability Inc.” We are now a holding company
operating through our wholly-owned subsidiaries Ability and ASM. Upon the closing of the Business Combination, our ordinary shares
and warrants began trading on the NASDAQ Capital Market under the symbol “ABIL” and “ABILW,” respectively.
Our warrants were delisted on April 18, 2016 and since such date have traded on the OTC Pink under the symbol “ABIWF.”
Our ordinary shares have been listed for trading on the Tel Aviv Stock Exchange since January 12, 2016 under the symbol “ABIL.”
We
are subject to the provisions of the laws of the Cayman Islands. Our principal executive offices are located at Yad Harutzim 14,
Tel Aviv, Israel, 6770007, our telephone number is +972-3-6879777, and our website is www.interceptors.com (the information contained
therein or linked thereto shall not be considered incorporated by reference into this Annual Report). We have no U.S. agent for
service of process.
Merger
Agreement
On
December 23, 2015, Cambridge merged with and into Holdco in the Redomestication Merger with Holdco surviving the merger and becoming
the public entity, and Holdco consummated a business combination whereby it acquired Ability by way of the Share Exchange, following
which Ability became a wholly-owned subsidiary of Holdco, pursuant to Agreement and Plan of Reorganization, dated as of September
6, 2015 (the “Merger Agreement”).
In
the Redomestication Merger, Holdco issued one ordinary share for each outstanding share of Cambridge and as of the closing of
the Redomestication Merger, each outstanding warrant of Cambridge automatically represents the right to purchase one ordinary
share of Holdco in lieu of one share of Cambridge common stock. Additionally, upon consummation of the Business Combination, (i)
the holders of outstanding unit purchase options of Cambridge, which represented the right to acquire up to 420,000 ordinary shares
and 420,000 warrants of Cambridge, exchanged such unit purchase options for an aggregate of 150,000 ordinary shares of Holdco
and (ii) the holder of outstanding promissory notes of Cambridge converted the entire principal amount of notes into an aggregate
of 35,000 ordinary shares and 35,000 warrants of Holdco in accordance with the terms of such promissory notes. Upon consummation
of the Redomestication Merger, holders of 213,676 shares of Cambridge common stock sold in its initial public offering converted
those shares, at their election, to cash at a conversion price of approximately $101.0 per share, or an aggregate of approximately
$21.6 million. The aggregate conversion price was paid out of Holdco’s trust account, which had a balance immediately prior
to the closing of the Business Combination of approximately $81.3 million. Of the remaining funds in the trust account: (i) approximately
$2.0 million was used to pay Ability’s transaction expenses in connection with the Business Combination, (ii) $18.1 million
was used to pay the cash portion of the merger consideration payable to Messrs. Hurgin and Aurovsky, as described below, (iii)
$11.9 million is being reserved and was deposited in escrow for the put option of Messrs. Hurgin and Aurovsky, as described below,
(iv) approximately $7.8 million was used to pay the outstanding accounts payable and accrued expenses of Cambridge, (v) $0.9 million
was used to purchase 16% of the shares in ASM from Eyal Tzur, as described below, and (vi) the balance of approximately $19 million
was released to Ability.
In
connection with the Share Exchange, as consideration for their outstanding ordinary shares of Ability, Messrs. Hurgin and Aurovsky
received an aggregate of 1,621,327 of our ordinary shares and $18.1 million in cash. In addition, Messrs. Hurgin and Aurovsky
have (or had) the right to receive an additional number of our ordinary shares to be issued upon and subject to us achieving certain
net income targets in the fiscal years ending December 31, 2015, 2016, 2017 and 2018, as set forth in table below.
In
the event that we fail to satisfy the net income target for any fiscal year but net income for such fiscal year is ninety percent
(90%) or more of the net income target for such fiscal year, then we shall issue to Messrs. Hurgin and Aurovsky, in the aggregate,
such number of our ordinary shares equal to the product obtained by (x) the number of our ordinary shares that would have been
issued to Messrs. Hurgin and Aurovsky had the net income target been achieved
multiplied by
(y) the quotient obtained by
(A) the net income for such fiscal year
divided by
(B) the net income target for such fiscal year.
Under
the Merger Agreement, in the event that the 2015 net income target is not achieved but the 2016 net income target is achieved,
then we shall issue to Messrs. Hurgin and Aurovsky, in addition to the ordinary shares required to be issued by us as a result
of us achieving the 2016 net income target, the ordinary shares relating to the 2015 net income target. In addition, if the 2015
net income target is not achieved and net income is less than ninety percent (90%) of the 2015 net income target but net income
for 2016 is ninety percent (90%) or more of the 2016 net income target, then we shall issue to Messrs. Hurgin and Aurovsky, in
addition to the pro rata of ordinary shares relating to the 2016 net income target, such number of our ordinary shares for 2015
based on the same percentage of net income for 2016 as compared to the 2016 net income target. The net income targets for 2015,
2016 and 2017 were not achieved.
To
the extent any ordinary shares are issuable to Messrs. Hurgin and Aurovsky upon Ability’s achievement of the above-described
net income targets, 3% of such shares shall be issuable to each of (i) Migdal Underwriting & Business Initiatives Ltd. as
an additional portion of its fee in connection with the Business Combination, and (ii) Mr. Tzur as further consideration for the
exercise of the put right related to ASM. Accordingly, the number of ordinary shares issuable to Messrs. Hurgin and Aurovsky in
the Business Combination shall be reduced ratably between Messrs. Hurgin and Aurovsky by the total number of ordinary shares issuable
to Mr. Tzur and Migdal Underwriting & Business Initiatives Ltd.
The
following table sets forth the net income targets and the number of our ordinary shares issuable upon the achievement of such
targets:
|
|
|
|
|
Number of Ordinary Shares
|
|
Year Ending December 31,
|
|
Net
Income
Target
|
|
|
Messrs. Hurgin and Aurovsky
|
|
|
Migdal Underwriting &
Business Initiatives Ltd
|
|
|
Eyal Tzur
|
|
|
Total
|
|
2015
|
|
$
|
27,000,000
|
|
|
|
338,400
|
|
|
|
10,800
|
|
|
|
10,800
|
|
|
|
360,000
|
|
2016
|
|
$
|
40,000,000
|
|
|
|
173,900
|
|
|
|
5,550
|
|
|
|
5,550
|
|
|
|
185,000
|
|
2017
|
|
$
|
60,000,000
|
|
|
|
188,000
|
|
|
|
6,000
|
|
|
|
6,000
|
|
|
|
200,000
|
|
2018
|
|
$
|
80,000,000
|
|
|
|
94,000
|
|
|
|
3,000
|
|
|
|
3,000
|
|
|
|
100,000
|
|
Under
the Merger Agreement, each of Messrs. Hurgin and Aurovsky had the right, on one occasion during January 1, 2018 through March
1, 2018 (the “Put Option Period”), to put to us all or part of his pro rata portion of 117,327 of our ordinary
shares that he received in the Share Exchange for an amount in cash equal to (1) (x) the number of shares being put multiplied
by (y) $101.0 per share plus (2) his pro rata portion of interest, if any, and subject to the pre-ruling granted by the Israel
Tax Authority, as generated in the put option escrow account that was established. Pursuant to an escrow agreement dated December
23, 2015 among the Company, Anatoly Hurgin and Alexander Aurovsky (together as shareholders) and the Bank Leumi Le-Israel Trust
Company Ltd. as escrow agent, $11.9 million was deposited into an escrow account, referred to as the put option escrow account,
by us at closing of the Business Combination to fund the payment of the purchase price for the put if it is exercised. On November
13, 2017, the parties amended the escrow agreement to change the Put Option Period to the period commencing on January 1, 2019
and ending on March 1, 2021.
Indemnity
Escrow Agreement
Of
our ordinary shares issued to Messrs. Hurgin and Aurovsky as consideration for the Share Exchange, an aggregate of 94,852 of
such shares (the “Escrow Shares”) were placed in escrow at the closing of the Business Combination pursuant to an
indemnity escrow agreement, dated as of December 23, 2015 (the “Indemnity Escrow Agreement”), by and among us,
Messrs. Hurgin and Aurovsky, Mr. Ben Gordon in his capacity as a representative of ours (the “Company
Representative”) and Continental Stock Transfer & Trust Company, as escrow agent. The Escrow Shares were set aside
to fund post-closing indemnification claims related to breaches of representations and warranties made by, or breaches of
covenants and other obligations of, Ability in the Merger Agreement. The Escrow Shares are our sole and exclusive remedy for
our rights to indemnification under the Merger Agreement. No indemnification claims are payable from the Escrow Shares until
the aggregate amount of our damages exceeds a $1,500,000 deductible. Once the aggregate amount of our damages exceeds such
$1,500,000 deductible, all our damages in excess of such amount are reimbursable, subject to certain exceptions. According to
the Indemnity Escrow Agreement, on December 23, 2016, fifty percent (50%) of the Escrow Shares were to be released to Messrs.
Hurgin and Aurovsky, less amounts previously applied in satisfaction of, or reserved with respect to indemnification claims
made prior to that date. The remaining Escrow Shares would be released on the date that is the earlier of (x) June 23, 2017
and (y) the thirtieth (30th) day after we file our Annual Report on Form 20-F for the year ended December 31, 2016 with the
SEC.
Pursuant
to a tolling agreement, dated as of November 30, 2016, by and among us, Messrs. Hurgin and Aurovsky, the Company Representative
and the Escrow Agent, as amended on June 23, 2017, Messrs. Hurgin and Aurovsky agreed to delay the release of the Escrow Shares
until December 31, 2017 in order to, among other things, allow our board of directors or an authorized committee thereof an opportunity
to review certain specified claims, including certain restatements of our financial reports filed with the SEC, certain alleged
discrepancies between our financial projections and our actual results, certain of our disclosures provided to investors relating
to our pipeline and backlog and certain of our disclosures related to ULIN.
JV
Share Purchase Agreement
In
connection with and as a condition to the consummation of the Merger Agreement, Cambridge, Holdco, Ability, Messrs. Hurgin and
Aurovsky, ASM and Eyal Tzur, ASM’s sole shareholder, entered into a share purchase agreement (the “JV Share Purchase
Agreement”), dated as of September 6, 2015, pursuant to which (a) at the closing of the Business Combination, Holdco purchased
16 shares, or 16%, of ASM for $900,000 in cash and (b) Mr. Tzur had the right to put all, but not less than all, of the remaining
shares of ASM to us (or our designated entity) during the 14 month period following the closing of the Business Combination in
exchange for 48,000 of our ordinary shares, plus 3% of any earn-out consideration (i.e., the net income shares) that may otherwise
become payable to Messrs. Hurgin and Aurovsky under the terms of the Merger Agreement following the consummation of the Business
Combination. If this right was not exercised by Mr. Tzur, then we had the right exercisable during the 90 days immediately following
the put option period, to call all, but not less than all, of the remaining ASM shares in exchange for 43,200 of our ordinary
shares. The parties entered into an escrow agreement, pursuant to which all of the shares of ASM, other than those purchased at
the closing of the Business Combination, were placed in escrow to secure the obligations of Mr. Tzur under the terms of the JV
Share Purchase Agreement prior to exercise of the put or call rights thereunder. In addition, the parties entered into an escrow
agreement with respect to our ordinary shares issuable to Mr. Tzur upon exercise of the put or call rights, under which (a) all
of the up to 48,000 ordinary shares issuable to him upon exercise of such rights were placed in escrow at the closing of the Business
Combination and (b) 5% of any such ordinary shares issued to him upon exercise of the put or call right shall be held in escrow
for not less than one year following closing of the put or call right to secure his indemnification obligations under the JV Share
Purchase Agreement. On January 24, 2016, Mr. Eyal Tzur exercised his put option, as a result of which 48,000 of our ordinary shares
were released from escrow to Mr. Tzur, and ASM became our wholly-owned subsidiary. Upon the closing of the Business Combination,
the JV Share Purchase Agreement was terminated while maintaining its terms for the existing projects.
Lock-Up
Agreements
At
the closing of the Business Combination, Messrs. Hurgin and Aurovsky entered into lock-up agreements pursuant to which they agreed
not to sell any of our ordinary shares that they received as a result of the Business Combination (subject to limited exceptions)
until the second anniversary of the closing of the Business Combination.
Principal Capital Expenditures and Divestitures
We have not had material
commitments for capital expenditures and divestitures as of December 31, 2017, 2016 and 2015.
Overview
We
are a holding company operating through our wholly-owned subsidiaries, Ability and ASM, which provide advanced interception, geolocation
and cyber intelligence products and solutions that serve the needs and increasing challenges of security and intelligence agencies,
military forces, law enforcement agencies and homeland security agencies worldwide. We believe that our advanced comprehensive
capabilities in both the areas of interception of communications and geolocation set us apart from our competitors.
Founded
in 1994, Ability has 17 years of proven experience in the fields of interception and geolocation. We specialize in off-air interception
of voice, SMS and data communication from both cellular (GSM/CDMA/UMTS/LTE) and satellite communication networks and deciphering
solutions for both cellular and satellite communications.
Our
portfolio of cellular communications solutions includes, in addition to interception of voice, SMS, and data, an advanced geolocation
system and cyber solutions. The geolocation solutions we offer geographically target mobile phones and are sold independently
or as an additional feature within other systems. The cyber solutions provide the user with the ability to extract and view information
from mobile phones. We also offer a system that can detect the existence of active interception systems (such as active cellular
interception systems, fake SMS advertising systems and IMSI/IMEI catchers), can prevent interception by such systems and “intercept
the interceptor,” allowing the user to listen to and manipulate the intercepted information.
Our
portfolio of satellite solutions includes advanced interception systems for Iridium, Thuraya, IsatPhone and VSAT communications.
Both
our cellular and satellite interception solutions can be used either as portable stand-alone tactical systems or can be integrated
into larger scale fixed strategic systems.
We
believe that the products and solutions we offer enable security agencies, law enforcement agencies and armed forces to gain a
tactical and situational advantage over highly mobile and covert adversaries and we believe that we are among the few companies
with an offering and suite of solutions that targets all segments of the lawful interception market.
We
sell to our customers a variety of products and also offer customized solutions designed to meet their specific needs. Our solutions
include both tactical and strategic systems. We work closely with our customers to design solutions for their specific configuration
needs, including facilitating integration with larger scale systems. Most of these systems are scalable in functionality, capacity,
coverage area and communications protocol types in order to meet the budgets and needs of our customers. The systems are available
either as tactical, transportable solutions or as strategic, fixed installations and can be installed in many fixed or transportable
configurations, including in vehicles, ships, aerial platforms and on personnel.
Our
headquarters, operations and sales office are located in Tel Aviv, Israel.
Industry
The
increasing threat of global terrorism as well as ordinary criminal activity over the past few decades has created a demand for
the increased ability of military intelligence agencies and law enforcement agencies to intercept communications upon which such
activity is based and to decipher these communications. We believe interception of communications has become the most crucial
task in intelligence and surveillance. Reliable, portable, robust solutions are critical to the success of any such operation.
In
response to this need, we have integrated solutions to cover the many facets of communications interception and decryption. We
provide solutions to a variety of customer needs, with both off-the-shelf and customized systems for customers around the world.
Our
customers’ operational demands are becoming increasingly diverse and extensive due to advances in technology of the targeted
communications, requiring industry participants to enhance their offerings to include advanced location and cyber solutions as
well as solutions for new generations of cellular communications, such as 4G/LTE and the proposed 5G networks.
The
tactical lawful interception industry is dominated by a limited number of international suppliers, including us. We believe that
entry into this market by new participants is limited due to the nature of the government agencies that comprise the market and
its customers. Although this market has continually grown, we believe that the number of suppliers has not grown materially due
to the significant barriers to entry into the market as a result of the nature of governmental agencies, privacy laws and the
complexity of the required technology.
Our
Portfolio of Solutions and Products
In
the area of cellular communications, we offer turnkey integrated solutions for all cellular communications standards (GSM, CDMA,
UMTS and LTE). These solutions provide real-time interception, robust, ultra-portable design and user-friendly operations. We
offer strategic and tactical cellular interception systems, which are used for intercepting mobile phone traffic and tracking
mobile phone users.
With
respect to satellite communications, we offer field-proven, cutting-edge solutions for Iridium, Thuraya, IsatPhone Pro and other
satellite links.
Cellular
Interception and Geolocation
ULIN
ULIN
(Ultimate Interceptor), which was introduced in November 2015, is we believe to be the first-to-market SaaS strategic system for
interception and geolocation in GSM, UMTS and LTE cellular networks. Unlike any other strategic lawful interception system known
to us, ULIN does not require, in most cases, the involvement of mobile network operators. Unlike tactical interception systems,
ULIN does not need to be in the vicinity of intercepted targets. In most instances, ULIN requires only the mobile device’s
phone number or IMSI to start the interception, however, there are some network operators for which ULIN is currently not capable
of intercepting cellular communication. ULIN detects dialing/dialed phone numbers and provides the geographic location of participating
mobile devices. ULIN incorporates our legacy Hunter geolocation solution. All our ULIN sales are based on a reseller agreement
granting us a worldwide exclusive right to sell ULIN, which automatically terminates in October 2018 and may be terminated by
either party under certain specific circumstances. See “Item 4. Information on the Company - Business Overview - Manufacturing
and Suppliers” for a description of the agreement.”
ULIN
represents a new technological approach to cellular interception and provides operational capabilities that we believe did not
previously exist, primarily the ability to intercept cellular communications without the need to be in the vicinity of intercepted
targets. During the year ended December 31, 2016, we completed our first ULIN sale, and in January 2018 we completed an additional
sale. While we have seen significant interest in ULIN and its advanced capabilities, we believe that the limited customer adoption
to date of ULIN, notwithstanding its competitive advantage over tactical interception solutions, is primarily due to its increased
costs compared to tactical interception solutions, as well as the market’s desire for a product capable of intercepting
data communication in addition to cellular communication, and ULIN’s inability to intercept cellular communication within
some network operators. For additional information, see “Item 3D. Risk Factors - Key Information -O
ur revenues depend
on the successful implementation and customer adoption of ULIN, the customer adoption of which has been limited.
” and
“Item 5D. Operating and Financial Review and Prospects - Trend Information.”
IBIS
IBIS
(In-Between Interception System) is a tactical stand-alone solution used for off-air interception of GSM, UMTS and LTE cellular
communications in a seamless way, without requiring involvement from the cellular network provider on which the targeted mobile
device is operated. IBIS is an advanced integrated solution that includes all relevant sub-systems in a single unit, allows the
user to scan, analyze, monitor, record, track and intercept cellular mobile devices for voice, SMS, data traffic and call-related
information, regardless of implemented encryption type.
The
IBIS system can operate with a variety of power sources, which enables it to be installed and operated in many types of applications
and environments, in fixed or transportable installations, including in vehicles, and ships, or can be carried in backpacks. We
also provide an IBIS system compatible for airborne platforms. Applications of the IBIS airborne system include surveillance missions,
border control, tracking of kidnappers and drug dealers and detection of active mobile devices in disaster areas. The latest version
of IBIS incorporates all the technological capabilities and functionalities of our legacy TouchDown solution.
ACIS
ACIS
(Advanced CDMA Interception System) is a fast, reliable, portable and undetectable interception device for cellular CDMA network
traffic that intercepts and records off-the-air voice communication, SMS and other call-related data. ACIS automatically searches
for active CDMA cellular network frequencies and active channels. Cooperation from network providers is not required. ACIS works
with all CDMAone and CDMA 2000 networks and supports all CDMA frequency bands, including 450 MHz, 800 MHz and 1900 MHz.
IMSI
Catchers
We
offer a variety of GSM/UMTS/LTE/IMSI catchers, in different installations and configurations, which can be customized to customer
needs.
AGIS
AGIS
(Advanced GSM Interception System) provides real-time GSM interception. The AGIS system is integrated into a small unit, making
it easily portable, and be installed and operated in many types of applications and environments, either in fixed or transportable
installations, including in vehicles, ships, helicopters and on personnel.
Satellite
Interception
IRIS
IRIS
(Iridium Interception System) is a portable tactical system that intercepts voice, SMS and data in Iridium communication channels.
The Iridium satellite is a system of active communication satellites in orbit and on the ground, which allows voice and data communications
across the globe. IRIS is completely passive and does not interfere with satellite communication. IRIS can be easily installed
in vehicles, ships, helicopters and on personnel.
ATIS
ATIS
(Advanced Thuraya Interception System) intercepts information transmitted through Thuraya network channels. The Thuraya network
is an advanced communication network of two satellites that covers the majority of Europe, Asia and Africa. ATIS provides interception
of voice, facsimile, SMS, data and call-related information, as well as a determination of the geographical position of Thuraya
terminals.
ATIS
intercepts uplink and downlink, and accordingly, both sides of a satellite call can be monitored, depending on interception conditions.
All communications intercepted by ATIS and related data are stored in the system database for off-line analysis and playback.
In addition to the call-related data, when an uplink is intercepted, the user can obtain the handset location. ATIS is offered
in both tactical (L-band only) and strategic configuration (C-band with one or multiple L-band posts) and can be provided in various
portable, remote control and fixed formats.
SLIS
SLIS
(Satellite Link Interception System) monitors information transmitted through satellite communication channels. The information
monitored by this system includes the satellite systems Intelsat, Eutelsat, Arabsat, Domsat, Indosat and other global or regional
satellite communication operators. SLIS has the capacity to intercept the following communication links:
|
●
|
E1/T1
standard, and their derivatives with various types of compression, including DCME and many others;
|
|
●
|
public
and private computer networks;
|
|
●
|
different
standards of the global VSAT system; and
|
|
●
|
GSM-operators,
including GSM-A and Abis.
|
The
type of information that can be monitored from these sources include voice communications, facsimile messages (analogue or digital),
SMS, videoconferences and communication sessions using the Internet or private networks.
Cyber
Our
IBIS solution incorporates offensive cyber capabilities. IBIS can remotely control mobile devices and extract information that
is not typically transmitted over cellular networks.
Intellectual
Property
General
As
a company that operates within a rapidly changing technological environment, the protection of the proprietary technology embedded
in the products and solutions that we sell may have a significant impact on our business. We and our suppliers and technology
providers rely on a both trade secret laws and confidentiality and non-disclosure restrictions to protect the proprietary interests
in the products and solutions that we sell.
On
November 12, 2015, a lawsuit was submitted to the Lod District Court in Israel by a company and an individual against Ability
and our controlling shareholders. The lawsuit amount for registration fee purposes is NIS 5 million (approximately $1.4 million),
however the plaintiffs did not specify the demanded compensation amount. The plaintiffs allege that certain of Ability’s
GSM interception and decryption systems apparently fall within the claim of an Israeli patent owned by the plaintiffs. Furthermore,
the plaintiffs demand that Ability and or its shareholders immediately cease any patent infringement as well as cease from any
further use of the claimed technology, including the further manufacture, export, sale or marketing of the alleged infringing
products. For additional information see “Item 3D. Key Information - Risk Factors - Intellectual Property and Data/Systems
Security
- The products and solutions we sell may infringe or may be alleged to infringe on the intellectual property rights
of others, which could lead to costly disputes or disruptions for us and may require us to indemnify our customers and resellers
for any damages they suffer
” and “Item 8A. Consolidated Statement and Other Financial Information - Legal Proceedings”.
Defending against infringement claims or other intellectual property claims could involve substantial costs and diversion of management
resources. In addition, to the extent we are not successful in defending such claims, we may be subject to injunctions with respect
to the use or sale of certain of the products in our portfolio or to liabilities for damage and may be required to obtain licenses
which may not be available or available on reasonable terms.
Licenses
We
engage in inbound licensing of certain components for our solutions. While it may be necessary in the future to seek or renew
licenses relating to various aspects of the solutions we offer, we believe, based on industry practice, such licenses generally
could be obtained from alternative sources on commercially reasonable terms.
Trademarks
and Service Marks
We
have not registered any trademarks or service marks.
Customers
The
principal customers for our solutions are governments and governmental agencies, such as security and intelligence agencies, military
forces, law enforcement agencies and homeland security agencies worldwide. We have sold to governments and government agencies
in over 50 countries, many of which are repeating customers.
The
following unaudited table presents our revenues for the years ended December 31, 2017, 2016 and 2015 by geographical region.
(U.S. dollars; in thousands)
|
|
Year Ended December 31,
|
|
Region
|
|
2017
|
|
|
2016
|
|
|
2015
|
|
Asia
|
|
$
|
555
|
|
|
$
|
9,230
|
|
|
$
|
8,373
|
|
Latin America
|
|
|
754
|
|
|
|
5,320
|
|
|
|
34,603
|
|
Europe
|
|
|
210
|
|
|
|
1,750
|
|
|
|
495
|
|
Israel
(1)
|
|
|
1,325
|
|
|
|
—
|
|
|
|
8,365
|
|
Other
|
|
|
128
|
|
|
|
208
|
|
|
|
315
|
|
Total
|
|
$
|
2,972
|
|
|
$
|
16,508
|
|
|
$
|
52,151
|
|
(1)
|
Sales
in Israel during 2017, 2016 and 2015 include sales to Israeli integrators that have been sold to end users in Asia and Africa,
which represented 45%, 0% and 16% of revenues during such periods, respectively.
|
For
the years ended December 31, 2017, 2016 and 2015, one significant reseller accounted for 45%, 47% and 66% of our revenues, respectively,
and one other reseller in each such fiscal period accounted for 25%, 32% and 13% of our revenues, respectively. Our sales to relatively
few significant resellers and customers could continue to account for a substantial percentage of our sales in the foreseeable
future.
Substantially
all of our resellers and customers do not permit us to identify them due to the sensitive nature of the solutions we sell to them
and projects we undertake on their behalf. Accordingly, we are not able to identify our customers in our marketing and sales materials
or the specific purpose for which certain solutions were sold or projects were undertaken. Moreover, we are unable to use substantially
all of our customers as referral sources. These limitations could adversely affect our marketing and sales efforts.
The
timing in which transactions are entered into may shift from one quarter to another
.
Among other things, this is due to
our customers choosing to shift their buying decisions, which may result in the shifting of bookings and revenues from one quarter
to another.
Customer
Service
We
typically provide our customers with on-site training for our products and solutions. Our standard warranty period is 12 months
and is included in the price. Support and maintenance is offered upon the expiry of the warranty period to the customer on an
annual basis for a fee equal to between 7% and 15% of the price. This technical support is provided over the phone, by email or
by remote access (subject to end user consent) in the first instance and, if an issue is not resolved, technical teams are sent
to the customer’s premises.
Selling and
Marketing
Sales
are generated through three principal channels:
(i)
Sales through resellers in various regions. We have a network of independent sales representatives active in most regions in which
we sell.
(ii)
A direct sales channel. Our direct sales efforts are led by our Chief Executive Officer, Chief Technology Officer and two additional
senior sales executives on a worldwide basis from our Tel Aviv headquarters.
(iii)
Sales to integrators as a component of larger projects, in which case we act as subcontractor to the integrator who acts as the
prime contractor.
Our
wholly-owned subsidiary, ASM, an Israeli company registered with the Israeli Defense Export Controls Agency as a certified exporter,
promotes and executes sales of our solutions that involve technologies controlled by the Israeli Defense Export Controls Agency.
In October 2013, Ability entered into a joint venture agreement with ASM, pursuant to which ASM exclusively provided contract
management services to Ability. At the closing of the Business Combination, we acquired 16% of ASM from Eyal Tzur, formerly ASM’s
sole shareholder, and Mr. Tzur had the right to put all, but not less than all, of the remaining shares of ASM to us (or our designated
entity) during the 14 month period following the closing of the Business Combination in exchange for 48,000 of our ordinary shares
and, if same was not exercised by Mr. Tzur, then, we had the right exercisable during the 90 days immediately following the foregoing
option period, to purchase all of the remaining ASM shares in exchange for 43,200 of our ordinary shares. On January 24, 2016,
Mr. Eyal Tzur exercised the foregoing put option, as a result of which ASM became our wholly-owned subsidiary, in exchange for
48,000 of our ordinary shares that were released from escrow to Mr. Tzur. Upon the closing of the Business Combination, the joint
venture agreement was terminated.
Competition
We
believe that the solutions and products we sell have several competitive advantages, including:
|
●
|
product
performance, functionality and portability;
|
|
●
|
product
quality, stability and reliability;
|
|
●
|
customization
of solutions to meet customer demands;
|
|
●
|
breadth
of product portfolio;
|
|
●
|
global
presence and high-quality, responsive customer service and support;
|
|
●
|
specific
industry knowledge and experience; and
|
We
believe that our flexibility and ability to react quickly to our customers’ requirements and needs provide us with a competitive
advantage.
Despite
these competitive advantages, we face competition in most of our markets. In each of our markets, we face competition from companies
with products that compete with the solutions or products we sell.
In
the cellular interception market, our principal competitors include Neosoft Technologies, Inc. and Verint Systems, Inc.
In
the satellite interception market, our principal competitors include Arpege Defence SAS, L3 TRL Technology Ltd. and Rohde &
Schwarz GmbH & Co KG.
In
the cyber market, our principal competitors include Gamma International GmbH, Hacking Team S.r.L., Magen Ltd., NSO Group Wintego
Systems Ltd. and several others.
Certain
of these competitors are also suppliers and/or customers of ours. We believe that our competitive success depends primarily on
our ability to provide technologically advanced and cost-effective solutions and services.
Research
and Development
We
do not conduct any research and development by ourselves, however, oftentimes, we assist and are involved in research and development
performed by third parties, mainly suppliers or contractors of ours. Such assistance and involvement may enable us to gain access
to new and advanced products, strengthens our relationships with our suppliers and contractors and ultimately introduce to the
market more suitable and advanced products and solutions, as well as enhance our existing products and solutions.
We
believe that the introduction of advanced products and solutions and the enhancement of existing products and solutions are essential
to our future success and depend on a number of factors, including among others, our ability to:
|
●
|
attract,
recruit and retain highly skilled and experienced personnel, as well as engaging suitable contractors and suppliers;
|
|
●
|
identify
and respond to emerging technological trends and areas of growth in our markets; and
|
|
●
|
continue
to offer and maintain competitive solutions and enhance our existing solutions to respond to our customers’ changing
needs and challenges and differentiate our solutions from those of our competitors.
|
Our
business strategy involves rolling out initial releases of the products and solutions in our portfolio and typically over time
features are added or enhanced. Product feedback received from our customers is incorporated into the development process.
Manufacturing
and Suppliers
During
the years ended December 31, 2017, 2016 and 2015, expenses incurred with respect to our three largest suppliers
comprised 27%, 72% and 70% of our cost of revenues, respectively, and one supplier accounted for 17%, 40% and 43% of our
costs of revenues in such periods, respectively.
On
October 20, 2015, we entered into an agreement with a third party supplier who develops and licenses ULIN. This agreement may
account for a significant portion of our vendor costs, see “Item 5F. Operating and Financial Review and Prospects—Tabular
Disclosure of Contractual Obligations,” as well as a significant part of our revenues, see “Item 3D. Key Information
- Risk Factors -
Our revenues depend on the successful implementation and customer adoption of ULIN, the customer adoption
of which has been limited”
and “Item 3D. Key Information - Risk Factors -
ULIN sales are depended on a reseller
agreement with one supplier, which automatically terminates in October 2018
.” According to the agreement, the supplier
(an unrelated company) granted us an exclusive and non-transferable right and license to market, promote, advertise, sell and
distribute its products, none of which is sold or marketed under the supplier’s trademark, directly to customers worldwide
in consideration for 50% of our revenue relating to those sales, net of commissions. The agreement provides for minimum annual
sales of ULIN by Ability in the amount of $10 million revenues, net of commissions. If we do not satisfy this minimum commitment
at the end of any contract year, we are required to pay such supplier a 15% penalty against any shortfall, up to a maximum penalty
of $1.5 million per year. Under the agreement, we are required to pay the supplier $125,000 each month on account of the minimum
commitment (which may be set-off against any sales over the duration of the three-year contract term). The agreement has a three
year term and automatically terminates in October 2018, and may be terminated by a party in case of the other party’s material
breach, bankruptcy, insolvency, creditor assignment, liquidation, receivership or loss of control of all or substantially all
of its business. We may not be able to extend the agreement or may not be able to do so on terms favorable to us. Further, during
the term of the agreement, we must obtain the supplier’s consent to, among other things, manufacture, sell or market any product
which competes with ULIN.
During
the year ended December 31, 2016, we completed our first ULIN sale, and in January 2018 we completed an additional sale. In connection
with the first ULIN sale the supplier waived its right to receive its payment equal to the excess of the 50% of the net revenues,
in order to support marketing efforts of ULIN in the relevant region.
Our
reliance on a limited number of suppliers involves risks. In the event that a key supplier ceases operations or otherwise ceases
to do business with us, it may take a substantial amount of time and expense for us to secure other suppliers.
We
have long-term relationships with most of our suppliers. Although we do not have redundant and immediate procurement solutions
for ULIN, we do have such solutions for most of the other products and solutions we sell. To date, we have been able to obtain
adequate supplies of all components in a timely manner from our suppliers or alternative sources, when necessary.
Our
quality management system is certified under the ISO 9001:2015 standards promulgated by the International Organization for Standardization
for assembling (installation) of interception systems.
Export
Control Regulatory Matters
General
We
and some of our suppliers are subject to export control regulations in countries from which they export goods and services. These
controls may apply by virtue of the country from which the products or components are exported. If the export controls of a particular
country apply, the level of control generally depends on the nature of the goods and services in question as well as the identity
of the end user.
Applicable
Israeli Laws
Israeli
Defense Export Regime.
The Israeli Defense Export Control Law, 2007 (the “2007 Law”) regulates the marketing
and export of certain defense equipment, software, technology, services and the transfer of defense know-how (collectively, “Defense
Products”), taking into account national security considerations, foreign relations considerations, international obligations
and other interests of the State of Israel. The 2007 Law provides that the marketing, sale and export of Defense Products require
a license from the Israeli Ministry of Defense (“IMOD”) via the Israeli Defense Export Controls Agency (“DECA”).
These licenses are issued by the IMOD for a certain period of time and are non-transferable. Fines and criminal sanctions may
be imposed for non-compliance with the 2007 Law. The 2007 Law also includes the regulation of brokerage activity relating to Defense
Products; however, these regulations have not been implemented, as required, by executive order, and therefore have not entered
into force to date. The IMOD issued the Export Control Order (Military Equipment), 2008, which lists all of the items that are
controlled pursuant to the 2007 Law. The Ministry of Economy (“MOE”) has also promulgated the Export Control Order
(Dual-Use Controlled Equipment), 2008 (the “Dual Use Order”), which refers to commercial items that may also be used
for either military or defense purposes. The export of all these items are ordinarily regulated by the MOE, except in the case
of government end-users, in which case the IMOD (DECA) regulates the marketing and export of such items. The Dual Use Order also
incorporates annually the updated lists from Wassenaar Arrangement on Export Controls for Conventional Arms and Dual-Use Goods
and Technologies.
Israeli
Encryption Order.
Our activities may also be subject to the Order Governing the Control of Commodities and Services (Engagement
in Encryption Items), 1974, as amended in 1998 (the “Encryption Order”) and the Declaration Regarding the Control
of Commodities and Services (Engagement in Encryption Items) 1974, as amended in 1998 (the “Declaration”), both of
which were issued under the authority of the Minister of Defense derived from the Law Governing the Control of Commodities and
Services, 1957 (the “1957 Law,” and collectively, the “Encryption Order”). The Encryption Order
regulates all activities relating to encryption and decryption in Israel and/or by Israelis, including the development of encryption
technology, as well as the marketing, import, export, sale and license of encryption products.
Applicable
Export Practices
Overview
.
ASM, a wholly-owned subsidiary of ours, is an Israeli company registered with DECA as a certified exporter. Our solutions that
are subject to export control pursuant to the 2007 Law, as well as the Dual Use Order, are marketed, sold and exported exclusively
by ASM. Notwithstanding the foregoing, Ability and ASM apply directly to IMOD for encryption permits, as required.
Encryption
Items
. Our interception systems that contain decryption capabilities are subject to the Encryption Order. Even though our
activities in this area rely on non-Israeli suppliers and are not developed in or exported from Israel (or related to Israeli
know-how), Ability has determined that all of its decryption items are regulated by the Israeli Encryption Order and each of Ability
and ASM requests and obtains the necessary licenses as needed on an ongoing basis.
Non-Israeli
Components
. Any components that are manufactured outside of Israel (and would be deemed Defense Products under the 2007 Law
if they were imported into Israel) are “drop-shipped” to the customers directly by the foreign suppliers of such components,
which are located outside of Israel. In cases where Ability and/or its non-Israeli suppliers supply foreign-sourced components
to an integrator in Israel and the export from Israel to the end-user is performed by the Israeli integrator, the integrator assumes
full responsibility to apply for the required marketing and export licenses from DECA.
Israeli
Components
. Any systems that include components that are imported into Israel and/or manufactured in Israel and are Defense
Products pursuant to the 2007 Law, are marketed and sold exclusively by ASM, except in certain cases as described above under
“Non-Israeli Components.”
Non-Israeli
Aspects
If
we expand our geographic scope, we may also be subject to applicable export control regulations in other countries from which
we export goods and services, including the United States. Such regulations may apply with respect to product components that
are developed or manufactured in, or shipped from, the United States. In the event that the products and services we offer are
subject to such additional controls and restrictions, we may be required to obtain an export license or authorization and comply
with other applicable requirements pursuant to such regulations.
Any
regulatory aspects of the export of goods and services by non-Israeli suppliers in relation to non-Israeli regulatory requirements
is the responsibility of the foreign supplier.
C.
|
Organizational
Structure
|
We are a holding company operating through our wholly-owned subsidiaries,
Ability and ASM, both Israeli companies.
At
the closing of the Business Combination, we purchased 16% of ASM from its former sole shareholder, Eyal Tzur. On January 24, 2016,
Eyal Tzur exercised his put option and we purchased the remaining shares of ASM, following which ASM became our wholly-owned subsidiary.
For additional information, see “Item 4A. Information on the Company – Merger Agreement – JV Share Purchase
Agreement.”
D.
|
Property,
Plants and Equipment
|
We
do not own any real property. We have entered into lease agreements for our headquarters and laboratory, each on the
7th
f
loor of 14 Yad Harutzim Street, Tel Aviv,
Israel, and installation and our quality assurance facility at 10/28-30 HaAvoda Street, Ariel, Israel.
The
lease details are as follows:
Headquarters
:
4300 square feet. The term of the lease was originally from December 1, 2012 through November 30, 2017, with an option to extend
for an additional 60 months. The rent for the headquarters is NIS 25,000 (approximately $7,210) per month.
Laboratory
:
3,875 square feet. The term of the lease was originally from May 1, 2015 through November 30, 2017, with an option to extend for
60 months. The rent for the laboratory is NIS 16,350 (approximately $4,715) per month.
Both options of the
headquarters and laboratory leases were exercised on terms of monthly rent in the aggregate amount of NIS 44,430 (approximately
$12,815), for additional five years, up to November 30, 2022.
Installation and Quality Assurance Facility
:
645 square feet. The initial term of the lease was from August 15, 2015 through August 15, 2016 and the term was extended until
August 15, 2018. We have an option to extend the lease until August 15, 2019. The monthly rent for the facility for the initial
term and the option period is NIS 5,000 (approximately $1,442).
Item 4A.
|
Unresolved Staff Comments
|
Not
applicable.
Item 5.
|
Operating and Financial
Review and Prospects
|
The
following discussion of our financial condition and results of operations should be read in conjunction with “Item 3. Key
Information—Selected Financial Data” and our consolidated financial statements and the related notes to those statements
included elsewhere in this Annual Report. In addition to historical consolidated financial information, the following discussion
and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. Our actual results and timing
of selected events may differ materially from those anticipated in these forward-looking statements as a result of many factors,
including those discussed under “Item 3. Key Information—D. Risk Factors” and elsewhere in this Annual Report.
The
audited consolidated financial statements for the years ended December 31, 2017, 2016 and 2015 in this Annual Report have been
prepared in accordance with U.S. GAAP.
Overview
We
are a holding company operating through our wholly-owned subsidiaries, Ability and ASM, which provide advanced interception, geolocation
and cyber intelligence products and solutions that to serve the needs and increasing challenges of security and intelligence agencies,
military forces, law enforcement agencies and homeland security agencies worldwide. We believe that our advanced comprehensive
capabilities in both the area of interception of communications and geolocation set us apart from our competitors.
Founded
in 1994, Ability has 17 years of proven experience in the fields of interception and geolocation. We specialize in off-air interception
of voice, SMS and data communication from both cellular (GSM/CDMA UMTS/LTE) and satellite communication networks and deciphering
solutions for both cellular and satellite communications. Our portfolio of cellular communications solutions includes, in addition
to interception of voice, SMS, and data, an advanced geolocation system and cyber solutions. The geolocation solutions we offer
geographically target mobile phones and are sold independently or as an additional feature within other systems. The cyber solutions
provide the user with the ability to extract and view information from mobile phones. We also offer a system that can detect the
existence of active interception systems (such as active cellular interception systems, fake SMS advertising systems and IMSI/IMEI
catchers), can prevent interception by such systems and “intercept the interceptor,” allowing the user to listen to
and manipulate the intercepted information. Our portfolio of satellite solutions includes advanced interception systems for Iridium,
Thuraya, IsatPhone and VSAT communications. Both our cellular and satellite interception solutions can be used either as portable
stand-alone tactical systems or can be integrated into larger scale fixed strategic systems. We believe that the products and
solutions we offer enable security agencies, law enforcement agencies and armed forces to gain a tactical and situational advantage
over highly mobile and covert adversaries and believe that we are among the few companies with an offering and suite of solutions
that targets all segments of the lawful interception market.
Accounting
Treatment of the Business Combination
We
were incorporated under the laws of the Cayman Islands under the name “Cambridge Holdco Corp.”, as an exempted company
on September 1, 2015. We were formed as a wholly-owned subsidiary of Cambridge, a company formed in order to effect a merger,
capital stock exchange, asset acquisition or other similar business combination with one or more businesses or entities. Cambridge
was incorporated under the laws of Delaware on October 1, 2013. On December 23, 2013, Cambridge closed its initial public offering
and a simultaneous private placement.
On
December 23, 2015, Cambridge merged with and into Holdco with Holdco surviving the merger and becoming the public entity, and
Holdco consummated the Business Combination by acquiring Ability, following which Ability became a wholly-owned subsidiary of
Holdco. For a more detailed description of the Business Combination, see “Item 4A. Information on the Company – History
and Development of the Company – Merger Agreement.”
The
Business Combination was accounted for as a reverse merger, whereby Cambridge is treated as the “acquired” company
for financial reporting purposes. This determination is primarily based on Ability comprising the ongoing operations of the combined
company, Ability’s senior management comprising the senior management of the combined company and Ability’s former
shareholders being the controlling shareholders of the combined company after the Business Combination. The Business Combination
is considered to be a capital transaction in substance. Accordingly, for accounting purposes, the Business Combination is treated
as the equivalent of Ability issuing shares for the net assets of Cambridge, accompanied by a recapitalization. The net assets
of Cambridge are stated at historical cost, with no goodwill or other intangible assets recorded. Operations prior to the Business
Combination are those of Ability; therefore, the historical consolidated financial statements presented are the historical consolidated
financial statements of Ability and the ordinary shares and the corresponding capital amounts pre-merger have been retroactively
restated as ordinary shares reflecting the exchange ratio in the merger.
Historically,
Ability’s financial statements include the financial information of ASM, which was viewed as a variable interest entity
of Ability prior to our acquisition of the remaining 84% of the shares of ASM in January 2016. For additional information, see
Note 1 to the audited consolidated financial statements for the year ended December 31, 2017 included elsewhere in this Annual
Report.
Restatement
of Previous Financial Statements
In our Annual Report on Form 20-F for the year ended
December 31, 2015, our consolidated financial statements for the year ended December 31, 2015, our consolidated financial statements
as of December 31, 2014 and for the two years in the period then ended were restated to reflect correction of errors with respect
to previously unrecognized commissions due to a vendor on revenues that were recognized in the years ended December 31, 2014,
2013 and 2012; improper allocation and timing of revenue recognition from connection to supportive infrastructure in multiple
element sale transactions recognized in the years ended December 31, 2014, 2013 and 2012; and previously unrecognized commissions
due to a third party on cost of revenues that were recognized in the year ended December 31, 2014.
We conducted an internal investigation, overseen by our audit committee, into the facts and circumstances surrounding the restatement.
The audit committee was assisted by external consultants. The SEC subsequently sent a subpoena requesting, among other things,
information regarding the transaction with Cambridge Capital Acquisition Corporation, the restatement that occurred in May 2016,
and financial and business information. See the risk factor “
We are under an investigation by the SEC, which could divert
management’s focus, result in substantial investigation expenses, monetary fines and other possible remedies and have an
adverse impact on our reputation and financial condition and results of operations
.” and “Item 8 Financial Information
– Legal Proceedings”.
Summary
of Critical Accounting Policies
The
preparation of consolidated financial statements in conformity with GAAP require management
to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets
and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting
period. Critical accounting policies are those that are the most important to the portrayal of our financial condition and results
of operations, and that require our most difficult, subjective and complex judgments. While our significant accounting policies
are described in more detail in the notes to our financial statements, our most critical accounting policies, discussed below,
pertain to revenue recognition and income taxes. Estimates, by their nature, are based upon judgments and information currently
available to us. The estimates that we make are based upon historical factors, current circumstances and the experience and judgment
of management. We evaluate our assumptions and estimates on an ongoing basis.
Revenue
recognition
We
generate revenues from sales of products, which include hardware, software, connection to supportive infrastructure, integration
services, training and warranty, as well as revenues from Software as a Service, or SaaS. We sell products and
provide services directly to end users and resellers and also participate as a subcontractor of prime contractors in joint projects
and as a prime contractor in projects with resellers.
Products
and Services
. Revenues from sales of products of which the final acceptance of the product is specified by the customer, and
the acceptance is deemed substantive, are recognized when we delivered the products to the customer and received final acceptance,
the revenue can be reliably measured and collectability of the receivables is reasonably assured. Revenues from sales of services
are recognized ratably in the period in which the services are rendered. Services generally include connection to a networked
infrastructure for a period of at least one year.
Projects
.
Revenues from projects are recognized upon final acceptance from the customers as such acceptance deemed substantive.
Under
such method, costs are accumulated on the balance sheet until final acceptance is received. Similarly, amounts billed to
customers are also deferred until final acceptance received. To the extent that the amount of accumulated costs exceeds the
amount of advance (or progress) payments received or billed by us, the excess should be reflected on the balance sheet as a
current asset, separated from inventory. To the extent that the amount of advance (or progress) payments received or billed
by us exceeds the amount of accumulated costs, the excess is reflected as a liability on the balance sheet.
In
instances where revenues are derived from sales of third party vendors’ products or services, revenues are recognized on
a gross basis and the related costs are recognized within cost of revenues when we have the following indicators for gross reporting:
(i) we are the primary obligor of the sales arrangements; (ii) we are subject to inventory risks of physical loss; (iii) we have
latitude in establishing prices; and (iv) we have discretion when selecting suppliers and assume credit risks on receivables from
customers.
SaaS Revenues
.
Our SaaS multiple-element arrangements are typically comprised of subscription and support fees from customers accessing our software
and set-up fees. We do not provide the customer the contractual right to take possession of the software at any time during the
hosting period under these arrangements. We recognize revenue for subscription and support services over the arrangement period
originating when the subscription service is made available to the customer and the contractual hosting period has commenced.
Usage based fees
.
Revenues are recognized in the period in which subscribers use the related services.
Other Multiple elements
arrangements.
When a sale arrangement contains multiple elements, we allocate revenues to each element based on a selling price
hierarchy. The selling price for a deliverable is based on its vendor-specific objective evidence (“VSOE”), if available,
third party evidence (“TPE”), if VSOE is not available, or estimated selling price (“ESP”), if neither
VSOE nor TPE is available. We establish VSOE of selling price using the price charged for a deliverable when sold separately. When
VSOE cannot be established, we attempt to establish selling price of each element based on TPE. TPE is determined based on competitor
prices for similar deliverables when sold separately. Generally, our go-to-market strategy typically differs from that of our peers
and our offerings contain a significant differentiation such that the comparable pricing of products with similar functionality
cannot be obtained. Furthermore, we are unable to reliably determine what similar competitor products’ selling prices are
on a standalone basis. Therefore, we are typically not able to determine TPE. The best ESP is established considering several external
and internal factors including, but not limited to, historical sales, pricing practices and geographies in which we offer products
for sale. The determination of ESP is based on the application of significant judgment in evaluating such factors.
Income Taxes
Deferred tax asset
and liability accounts’ balances are determined based on differences between the financial reporting and tax bases of assets
and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected
to reverse. Ability accounts for deferred taxes on non-distributed income that are subject to income taxes once distributed and
when there is an intent to distribute them.
Ability applies the
two-step approach in recognizing and measuring uncertain tax positions. The first step is to evaluate the tax position taken or
expected to be taken in a tax return by determining if the weight of available evidence indicates that it is more likely than not
that, on an evaluation of the technical merits, the tax position will be sustained on audit, including resolution of any related
appeals or litigation processes. The second step is to measure the tax benefit as the largest amount that is more than 50% likely
to be realized upon ultimate settlement.
Recent Accounting Pronouncements
For information with respect
to recent accounting pronouncements, see Note 2n to the audited consolidated financial statements for the year ended December
31, 2017 included elsewhere in this Annual Report.
The
following table sets forth a summary of our operating results:
(U.S. dollars; in thousands, except per share data)
|
|
Year Ended December 31,
|
|
|
|
2017
|
|
|
2016
|
|
|
2015
|
|
Revenues
|
|
$
|
2,972
|
|
|
$
|
16,508
|
|
|
$
|
52,151
|
|
Cost of revenues
|
|
|
2,957
|
|
|
|
8,617
|
|
|
|
29,654
|
|
Gross profit
|
|
|
15
|
|
|
|
7,891
|
|
|
|
22,497
|
|
Selling and marketing expenses
|
|
|
3,033
|
|
|
|
5,323
|
|
|
|
3,305
|
|
General administrative expenses
|
|
|
6,016
|
|
|
|
9,662
|
|
|
|
469
|
|
Operating income (loss)
|
|
|
(9,034
|
)
|
|
|
(7,094
|
)
|
|
|
17,875
|
|
Financial expenses (income), net
|
|
|
77
|
|
|
|
(127
|
)
|
|
|
99
|
|
Income (loss) before income taxes
|
|
|
(9,111
|
)
|
|
|
(6,967
|
)
|
|
|
17,776
|
|
Income tax expenses
|
|
|
-
|
|
|
|
1,086
|
|
|
|
3,023
|
|
Net and comprehensive income (loss)
|
|
$
|
(9,111
|
)
|
|
$
|
(8,053
|
)
|
|
$
|
14,753
|
|
Basic and diluted income (loss) per share (1)
|
|
$
|
(3.71
|
)
|
|
$
|
(3.27
|
)
|
|
$
|
6.00
|
|
(1)
|
On December 27, 2017, we implemented a
1-for-10 consolidation of our ordinary shares, with a market effective date of March 23, 2018, which was applied retrospectively
for the calculation of the basic and diluted earnings (loss) per ordinary share.
|
Year
ended December 31, 2017, compared to year ended December 31, 2016
Revenues
Revenues
for the year ended December 31, 2017 were $3 million, a decrease of $13.5 million, or 82%, compared to total revenues of $16.5
million for the year ended December 31, 2016.
The
table below sets forth Ability’s revenues by geographical regions for the periods presented:
(U.S. dollars; in thousands)
|
|
Year Ended
December 31,
|
|
Region
|
|
2017
|
|
|
2016
|
|
Asia
|
|
$
|
555
|
|
|
$
|
9,230
|
|
Latin America
|
|
|
754
|
|
|
|
5,320
|
|
Europe
|
|
|
210
|
|
|
|
1,750
|
|
Israel (1)
|
|
|
1,325
|
|
|
|
—
|
|
Other
|
|
|
128
|
|
|
|
208
|
|
Total
|
|
$
|
2,972
|
|
|
$
|
16,508
|
|
(1)
|
Sales in Israel during 2017 and 2016 include sales to Israeli integrators that have been sold to end users in Asia and Africa,
which represented 45% and 0% of revenues during such periods, respectively.
|
Revenues for the years
ended December 31, 2017 and 2016 were primarily attributed to sales of legacy tactical cellular interception systems and during
the year ended December 31, 2016, we completed one ULIN sale to a reseller in Latin America (which was our first ULIN sale), the
revenues for which were recognized ratably over a one year period commencing September 2016. The decrease in revenues for the
year ended December 31, 2017 was primarily due to the ongoing transition to a revenue stream more focused on ULIN, which we introduced
in November 2015 and due to the fact that during the year ended December 31, 2017 we suspended recognizing revenues from one of
our customers due to collectability issues which resulted in lower revenues than anticipated.
We expected that ULIN
would be a major growth driver of our revenues. However, since the introduction of ULIN, customer adoption of ULIN has been much
slower than we had anticipated. While we have seen significant interest in ULIN and its advanced capabilities, during the year
ended December 31, 2016, we only completed one ULIN sale (which was our first ULIN sale), and in January 2018 we completed an additional
sale. We believe that the limited customer adoption to date of ULIN, notwithstanding its competitive advantage over tactical interception
solutions, is primarily due to its increased costs, compared to other tactical interception solutions, as well as the market’s
desire for a product capable of intercepting data communication in addition to cellular communication, and ULIN’s inability
to intercept cellular communication within some network operators. We believe that continued increase in usage of new communication
channels and the technological developments in the cellular communications industry (such as an increased number of cellular networks,
mobile operators and frequencies), which have resulted in tactical cellular interception systems becoming more complex and expensive,
will contribute to the competitive strength and distinctiveness of ULIN, which in turn will result in an increased demand for ULIN.
We believe that the significant increase in the length of the ULIN sales cycle compared to our legacy tactical interception solutions
is primarily due to the difficulties described above and lengthy purchasing approval processes for ULIN, oftentimes requiring the
approval of the most senior levels of government. Furthermore, since the introduction of ULIN, while we have continued to offer
our legacy tactical cellular interception solutions, we have experienced a significant decline in sales of our existing portfolio
of solutions and products within the cellular interception category and we cannot assure you that ULIN will not render a substantial
percentage of our existing product portfolio obsolete. In addition, increased usage of new communication channels and technological
developments in the cellular communications industry (such as an increased number of cellular networks, mobile operators and frequencies)
have resulted in cellular interception systems becoming more complex, expensive and limited in their interception capabilities,
which we believe in turn have also had an adverse effect on sales of our legacy tactical cellular interception solutions. However,
we cannot assure you that the market or demand for ULIN will grow as we believe (if at all).
Although
with respect to certain periods in the past we provided guidance and projections, given that we were unable to accurately predict
our revenues during such periods, due to, among others things, the pricing, margins and other deal terms of our engagements which
may vary substantially from transaction to transaction, the extended time frame and uncertainty associated with many of our sales
opportunities, and the unpredictable sales cycles of ULIN, we ceased to, and shall not in the foreseeable future, provide guidance
or forecasts.
Cost
of Revenues
Cost
of revenues for the year ended December 31, 2017 were $3 million, a decrease of $5.6 million, or 66%, compared to cost of revenues
of $8.6 million for the year ended December 31, 2016. The decrease in cost of revenues was primarily due to decreased costs for
components for our solutions corresponding to the decrease in revenues year over year.
Gross
Profit
Gross
profit for the year ended December 31, 2017 was $15,000, a decrease of $7.9 million, compared to gross profit of $7.9
million for the year ended December 31, 2016. Gross profit as a percentage of total revenues decreased to 0.5% for the year ended
December 31, 2017, compared to 48% for the year ended December 31, 2016, primarily due to the significant lower revenue year over
year.
Selling
and Marketing Expenses
Selling and
marketing expenses for the year ended December 31, 2017, were $3.0 million, a decrease of $2.3 million, or 43%, compared to $5.3
million for the year ended December 31, 2016. The decrease in selling and marketing expenses was primarily due to reduced commission
of $1.0 million as a result of the lower revenue year over year, $0.5 million of expense on account of our minimum commitment
under the agreement with the ULIN supplier (during the year ended December 31, 2016 we recorded $0.4 million for the fourth quarter
of 2015 which was initially recorded as current assets as of December 31, 2015 and subsequently allocated to selling and marketing
expenses in the absence of substantial ULIN sales that could be offset against the minimum commitment amount), and $0.5 million
accrual on account of a discretionary bonus to one of our sales executives that was recorded during the year ended December 31,
2016.
General
and Administrative Expenses
General
and administrative expenses for the year ended December 31, 2017 were $6.0 million, a decrease of $3.6 million, or 38%, compared
to $9.7 million for the year ended December 31, 2016. The decrease in general and administrative expenses was primarily due to
a $2.0 million refund in connection with the Discharge Agreement (see “Item 8A. Financial Information — Consolidated
Statements and Other Financial Information — Legal Proceedings” below for additional information), that was received
in February 2018 and due to an additional $2.0 million for a provision that was recorded during the year ended December 31, 2016
on account of an approved arbitration settlement (see “Item 8A. Financial Information — Consolidated Statements and
Other Financial Information — Legal Proceedings” below for additional information) that was not recorded in the year
ended December 31, 2017.
Operating Loss
We had an operating
loss of $9.0 million for the year ended December 31, 2017, an increase of $1.9 million, or 27%, compared to operating loss of $7.1
million for the year ended December 31, 2016. The increase in the operating loss was primarily due to the $13.5 million decrease
in revenues, partially offset by a decrease of $5.6 million in cost of revenues, $2.3 million in selling and marketing expenses
and $3.6 million in general and administrative expenses.
Financial Expenses (Income), Net
Financial expenses,
net for the year ended December 31, 2017, was $77,000, an increase of $204,000 compared to financial income, net of $127,000 for
the year ended December 31, 2016. The change in financial expenses (income), net, related primarily to fluctuations in the exchange
rate between the U.S. dollar and the New Israeli Shekel.
Income Tax Expenses
There were no income
tax expenses for the year ended December 31, 2017 compared to $1.1 million for the year ended December 31, 2016. We did not record
any tax expenses during the year ended December 31, 2017, as we applied a full valuation allowance for the deferred tax assets
primarily on account of the accumulated deficit as of December 31, 2017, as a result of the substantial doubt about our ability
of our company to continue as a going concern (see “Item 3D. Key Information - Risk Factors - Risks Related to our Business
and Our Financial Position - “
The report of our independent registered public accounting firm contains an explanatory
paragraph regarding substantial doubt about our ability to continue as a going concern.”
and Note 1f to the audited consolidated
financial statements for the year ended December 31, 2017 included elsewhere in this Annual Report). The income tax expense during
the year ended December 31, 2016 consisted of a one-time tax expense of $1.1 million that we incurred in connection with a tax
assessment agreement for the three years ended December 31, 2014, reached on May 30, 2016, between the Israel Tax Authority and
Ability. In addition, we applied a full valuation allowance for the deferred tax assets previously recorded due to the reason mentioned
above.
Net and Comprehensive Loss
Net and comprehensive
loss was $9.1 million, or a loss of $3.71 per basic and diluted share, for the year ended December 31, 2017, an increase of $1.0
million, compared to net and comprehensive loss of $8.1 million, or loss of $3.27 per basic and diluted share, for the year ended
December 31, 2016. The increase in net and comprehensive loss was primarily due to the $1.9 million increase in operating loss
and $0.2 million in financial expenses, net, partially offset by the decrease of $1.1 million in income tax expenses.
Year ended December 31, 2016, compared to year ended December
31, 2015
Revenues
Revenues for the year
ended December 31, 2016 were $16.5 million, a decrease of $35.7 million, or 68%, compared to total revenues of $52.2 million for
the year ended December 31, 2015.
The table below sets forth Ability’s
revenues by geographical regions for the periods presented:
(U.S. dollars; in thousands)
|
|
Year Ended
December 31,
|
|
Region
|
|
2016
|
|
|
2015
|
|
Asia
|
|
$
|
9,230
|
|
|
$
|
8,373
|
|
Latin America
|
|
|
5,320
|
|
|
|
34,603
|
|
Europe
|
|
|
1,750
|
|
|
|
495
|
|
Israel (1)
|
|
|
—
|
|
|
|
8,365
|
|
Other
|
|
|
208
|
|
|
|
315
|
|
Total
|
|
$
|
16,508
|
|
|
$
|
52,151
|
|
(1)
|
Sales in Israel during 2016 and 2015 include sales to Israeli integrators that have been sold to end users in Asia and Africa,
which represented 0% and 16% of revenues during such periods, respectively.
|
Revenues
for the years ended December 31, 2016 and 2015 were primarily attributed to sales of legacy tactical cellular interception systems
and during the year ended December 31, 2016, we completed one ULIN sale to a Latin American reseller (which was our first ULIN
sale), the revenues for which were recognized ratably over a one year period commencing September 2016. The decrease in revenues
for the year ended December 31, 2016 was primarily attributable to the project-oriented nature of our business and the completion
of a number of large projects in Latin America and Israel in year ended December 31, 2015, as well as the ongoing transition to
a revenue stream more focused on ULIN, which we introduced in November 2015. We expected that ULIN would be a major growth driver
of our revenues. However, since the introduction of ULIN, customer adoption of ULIN has been much slower than we had anticipated,
and while we have seen significant interest in ULIN and its advanced capabilities, we had only completed one ULIN sale as of December
31, 2016 (which was our first ULIN sale). We believe that the limited customer adoption to date of ULIN, notwithstanding its competitive
advantage over tactical interception solutions, is primarily due to its increased costs compared to such tactical interception
solutions, as well as the market’s desire for a product capable of intercepting data communication in addition to cellular
communication, and ULIN’s inability to intercept cellular communication within some network operators. We believe that continued
increase in usage of new communication channels and the technological developments in the cellular communications industry (such
as an increased number of cellular networks, mobile operators and frequencies), which have resulted in tactical cellular interception
systems becoming more complex and expensive, will contribute to the competitive strength and distinctiveness of ULIN, which in
turn will result in an increased demand for ULIN. We believe that the significant increase in the length of the ULIN sales cycle
compared to our legacy tactical interception solutions is primarily due to the difficulties described above and lengthy purchasing
approval processes for ULIN, oftentimes requiring the approval of the most senior levels of government. Furthermore, since the
introduction of ULIN, while we have continued to offer our legacy tactical cellular interception solutions, we have experienced
a significant decline in sales of our existing portfolio of solutions and products within the cellular interception category and
we cannot assure you that ULIN will not render a substantial percentage of our existing product portfolio obsolete. In addition,
increased usage of new communication channels and technological developments in the cellular communications industry (such as
an increased number of cellular networks, mobile operators and frequencies) have resulted in cellular interception systems becoming
more complex, expensive and limited in their interception capabilities, which we believe in turn have also had an adverse effect
on sales of our legacy tactical cellular interception solutions
.
Although with respect
to certain periods in the past we provided guidance and projections, given that we were unable to accurately predict our revenues
during such periods, due to, among others things, the pricing, margins and other deal terms of our engagements which may vary
substantially from transaction to transaction, the extended time frame and uncertainty associated with many of our sales opportunities,
and the unpredictable sales cycles of ULIN, we ceased to, and shall not in the foreseeable future, provide guidance or forecasts.
Cost
of Revenues
Cost
of revenues for the year ended December 31, 2016 were $8.6 million, a decrease of $21.1 million, or 71%, compared to cost of revenues
of $29.7 million for the year ended December 31, 2015. The decrease in cost of revenues was primarily due to decreased costs for
components for our solutions corresponding to the decrease in revenues in the year and also due to reduced cost of revenues
in connection with the first sale of ULIN in the year ended December 31, 2016, due to the waiver of the ULIN supplier to its right
to the excess of the 50% of the net revenues generated from such sale over the annual $1.5 million minimum commitment amount such
supplier was entitled to.
Gross
Profit
Gross
profit for the year ended December 31, 2016 was $7.9 million, a decrease of $14.6 million, or 65%, compared to gross profit of
$22.5 million for the year ended December 31, 2015. Gross profit as a percentage of total revenues increased to 48% for the year
ended December 31, 2016, compared to 43% for the year ended December 31, 2015, primarily due to the absence of cost of revenues
in connection with the first sale of ULIN in the year ended December 31, 2016, due to the waiver of the ULIN supplier to its right
to the excess of the 50% of the net revenues generated from such sale over the annual $1.5 million minimum commitment amount such
supplier was entitled to.
Selling and Marketing
Expenses
Selling and marketing
expenses for the year ended December 31, 2016, were $5.3 million, an increase of $2.0 million, or 61%, compared to $3.3 million
year ended December 31, 2015. The increase in selling and marketing expenses was primarily due to the $1.9 million expense on account
of our minimum commitment under the agreement with the ULIN supplier (including $1.5 million for the year ended December 31, 2016
and $0.4 million for the fourth quarter of 2015 which was initially recorded as current assets as of December 31, 2015 and subsequently
allocated to selling and marketing expenses in the absence of substantial ULIN sales that could be offset against the minimum commitment
amount) and a $0.5 million accrual on account of a discretionary bonus to one of our sales executives, which was partially offset
by a decrease in commissions accrued on revenues for the year ended December 31, 2016 due to the decrease in revenues year over
year.
General and Administrative Expenses
General and administrative
expenses for the year ended December 31, 2016 were $9.7 million, an increase of $8.4 million, or 634%, compared to $1.3 million
for the year ended December 31, 2015. The increase in general and administrative expenses was primarily due a $8.3 million increase
in legal and professional services fees, including $2.6 million of legal expenses incurred in connection with the internal investigation
we conducted that was overseen by our audit committee, as well as a $2.0 million provision recorded on account of an approved settlement
in connection with a legal proceeding and related legal expenses.
Operating Income
We had an operating
loss of $7.1 million for the year ended December 31, 2016, a decrease of $25.0 million, compared to operating income of $17.9 million
for the year ended December 31, 2015. The decrease in operating income was primarily due to the $35.7 million decrease in revenues
and the increase of $2.0 million in selling and marketing expenses and $8.4 million in general and administrative expenses, partially
offset by the $21.1 million decrease in cost of revenues.
Financial Expenses (Income), Net
Financial income, net
for the year ended December 31, 2016, was $127,000, an increase of $226,000 compared to financial expenses, net of $99,000 for
the year ended December 31, 2015. The change in financial expenses (income), net, related primarily to fluctuations in the exchange
rate between the U.S. dollar and the New Israeli Shekel.
Income Tax Expenses
Income tax expenses
for the year ended December 31, 2016 were $1.1 million, a decrease of $1.9 million, compared to $3.0 million for the year ended
December 31, 2015. This decrease was primarily due to the loss before income taxes we incurred for the year ended December 31,
2016. The 2016 income tax expenses consist of a one-time tax expense of $1.1 million that we incurred for the year ended December
31, 2016, in connection with a tax assessment agreement for the three years ended December 31, 2014, reached on May 30, 2016,
between the Israel Tax Authority and Ability. In addition, we applied a full valuation allowance for the deferred tax assets previously
recorded, primarily on account of the net loss in the current period, as a result of the substantial doubt about our ability to
continue as a going concern (see “Item 3D. Key Information - Risk Factors - Risks Related to our Business and Our Financial
Position - “
The report of our independent registered public accounting firm contains an explanatory paragraph regarding
substantial doubt about our ability to continue as a going concern.”
and Note 1.f. to the audited consolidated financial
statements for the year ended December 31, 2016 included elsewhere in this Annual Report).
Net
and Comprehensive Income (Loss)
Net and comprehensive
loss was $8.1 million, or a loss of $3.27 per basic and diluted share, for the year ended December 31, 2016, a decrease of $22.9
million, compared to net and comprehensive income of $14.8 million, or income of $6.0 per basic and diluted share, for the year
ended December 31, 2015. The decrease in net and comprehensive income (loss) was primarily due to the $25 million decrease in
operating income, partially offset by the decrease of $0.2 million in financial expense (income) and $1.9 million in income tax
expenses.
Government
Policies
We
are incorporated in the Cayman Islands and our headquarters, operations and sales office are located in the State of Israel.
Due
to the nature of our operations, we are subject to stringent requirements in terms of export controls for military, defense and
“dual use” items. See “Item 3D. Key Information – Risk Factors – Risks Relating to our Business
and Risk Relating to our Operations in Israel” and “Item 4B. Information on the Company – Business Overview
– Export Control Regulatory Matters” for a description of governmental, economic, fiscal, monetary and political policies
or factors that have materially affected or could materially affect our operations.
Government
Contracts
All
of our revenues to date have been generated, directly and indirectly, from contracts with national, regional and local governmental
agencies, authorities and security organizations, many of which have complex and time consuming procurement procedures. A substantial
period of time often elapses from the time we enter into negotiations until we actually deliver the product to the specific customer.
Government contracts are further subject to special risks, such as delays in funding, termination of contracts at the convenience
of the government, reduction or modification due to changes in the government’s policies or priorities. Our sales to these
customers are directly affected by their budgetary constraints, the priority given to the procurement of products and services
from us and the government’s normal spending cycle. A decrease or delay in governmental funding would adversely affect our
results of operations. This risk is heightened during periods of global economic slowdown, recession, economic instability, political
unrest, armed conflicts or natural disasters.
Preferred
Enterprise Program
We
are managed and controlled from Israel and are considered by the Israel Tax Authority as a company domiciled in Israel and subject
to Israeli corporate tax, capital gains tax and any other relevant taxes. The Israeli corporate tax rate was 26.5% in 2014 and
2015. Beginning January 1, 2016, the Israeli corporate tax rate was reduced to 25%, beginning January 1, 2017 the corporate tax
rate was reduced to 24% and beginning January 1, 2018 the corporate tax was reduced to 23%. Under the Investment Law, Ability
expects to be eligible for certain tax benefits provided to “Preferred Enterprises,” including a reduced tax rate
of 14.6% in 2015 and 2016 and a reduced tax rate, not yet determined (but up to 16%), in 2017 and thereafter, with respect to
taxable income generated by the Preferred Enterprise. All other taxable income will be subject to the standard Israeli corporate
tax rate. See “Item 10E. Additional Information – Taxation – Israeli Taxation” and “Item 3D. Key
Information – Risk Factors – Risks Relating to our Operations in Israel” for further details.
B.
|
Liquidity
and Capital Resources
|
Liquidity
As of December 31, 2017, we had an accumulated deficit of $18.0 million, cash and cash
equivalents of $1.9 million and a negative working capital of $556,000, compared to accumulated deficit of $8.9 million, cash
and cash equivalents of $11.8 million and working capital of $8.4 million as of December 31, 2016. Due to a
significant decline in revenues and an increase in legal and professional services fees, we have suffered losses from
operations, and we have an accumulated deficit that, among other reasons, raises substantial doubt about our ability to
continue as a going concern. Our independent registered
public accounting firm, in their report on our audited financial statements for the year ended December 31, 2017 expressed
substantial doubt about our ability to continue as a going concern. Our ability to continue as a going concern is dependent
upon, among other things, cash flow from customers for ongoing projects, increase in sales, the controlling
shareholders’ financial support of us, a decrease in litigation costs, our ability to remain listed on the NASDAQ
Capital Market and favorable resolution of the pending lawsuits and SEC investigation. We expect to continue incurring losses
and negative cash flows from operations in the foreseeable future. As a result of these expected losses and negative cash
flows from operations, along with our current cash position, we only have sufficient cash on our balance sheet to finance our
operations for a period of up to two months from the date of filing of this Annual Report. On April 11, 2018, we
obtained a six-month bank line of credit of NIS 11 million ($3.1 million) secured by our controlling shareholders, Anatoly
Hurgin, who is also our Chief Executive Officer and Chairman, and Alexander Aurovsky, who is also our Chief Technology
Officer and a director. If we utilize the line of credit in full, we estimate that this will finance our operations for a
further four to six months.
Management is investing
significant marketing efforts in order to generate additional revenue and simultaneously is continuing to decrease its expenses,
primarily its legal and professional services fees in order to regain profitability. Additionally, we plan to raise capital through
the sale of equity securities or debt and settling certain of the lawsuits that are pending.
On February 21,
2018, Messrs. Hurgin and Aurovsky executed an Irrevocable Undertaking (the “Undertaking’) for our benefit.
According to the Undertaking, Messrs. Hurgin and Aurovsky agreed to make available to us from, March 1, 2018, a $3 million
line of credit or loan in favor of ASM. The Undertaking provides that the term of the line of credit or loan is to be for a
period of no less than six months. The line of credit or loan will not bear any interest and Messrs. Hurgin and Aurovsky may
not demand repayment, reduce or otherwise impair the line of credit or the loan. The Undertaking further provides that at the
end of the term of the line of credit or loan, the board of directors will determine whether repayment of the line of credit
or loan will compromise our ability to meet our obligations. Messrs. Hurgin and Aurovsky undertook to renew the line of
credit or extend the term of the loan on the same terms for an additional period of no less than six months in accordance
with a resolution of the board of directors with respect to the necessity of the support of Messrs. Hurgin and Aurovsky. As
described above, on April 11, 2018, we obtained a six-month line of credit from an Israeli commercial bank in the amount of
NIS 11 million ($3.1 million). On amounts drawn under the line of credit, an interest rate in an amount to be determined at the time
of draw down shall apply in addition to a semi-annual bank commission of NIS 27,500. Subsequently at a meeting of the board of
directors on April 23, 2018, it was resolved to amend the terms of the Undertaking to provide that we will bear the costs and interest
of the line of credit.
There is no assurance,
however, that we will be successful in obtaining the level of financing needed for our operations. If we are unsuccessful in selling
our products, raising capital, and settling certain lawsuits we may need to further reduce activities, curtail or cease operations.
Cash Flows
Operating Activities
Net cash used in operating
activities for the year ended December 31, 2017 was $10.0 million, a decrease of $0.6 million, compared to net cash used in operating
activities of $10.6 million for the year ended December 31, 2016, a decrease of $20.8 million, compared to net cash provided by
operating activities of $10.2 million for the year ended December 31, 2015.
Net cash used in operating
activities for the year ended December 31, 2017, consisted primarily of net loss of $9.1 million, an increase in other receivables
of $1.8 million and a decrease in trade payables, accrued expenses and other accounts payable and accrued expenses and accounts
payable with respect to projects of $0.9 million and $2.2 million, respectively, partially offset by a decrease in restricted deposits
and accounts receivable of $1.8 million and $1.2 million, respectively and an increase in progress payments in excess of accumulated
costs with respect to projects of $0.5 million. Non-cash expenses during the year ended December 31, 2017 consisted primarily of
amortization and depreciation of $0.3 million and $0.2 million, respectively.
Net cash used in operating
activities for the year ended December 31, 2016, consisted primarily of net loss of $8.1 million and decreases in income tax payable,
accrued expenses and accounts payable with respect to projects and progress payments in excess of accumulated costs with respect
to projects of $2.7 million, $2.2 million and $1.2 million, respectively, and an increase in restricted deposits of $1.4 million,
partially offset by an increase of trade accounts payable, accrued expenses and other accounts payable of $3.1 million and a decrease
of other receivables of $1.5 million. Non-cash expenses during the year ended December 31, 2016 consisted primarily of impairment
of inventory, amortization, depreciation and impairment of fixed assets of $0.2 million, $0.2 million, $0.1 million and $0.1 million,
respectively.
Net
cash provided by operating activities for the year ended December 31, 2015, consisted primarily of net income of $14.8 million
and increases in income taxes payable and accrued expenses and accounts payable with respect to projects of $2.4 million and $3.1
million, respectively, partially offset by an increase in accounts receivable and progress payments in excess of accumulated costs
with respect to projects of $3.8 million and $5.3 million respectively. Non-cash expenses during the year ended December 31, 2015
consisted primarily of $0.1 million of depreciation.
Investing
Activities
Net
cash used in investing activities for the year ended December 31, 2017 was $63,000, a decrease of $109,000, compared to net cash
used in investing activities of $172,000 for the year ended December 31, 2016, a decrease of $0.7 million compared to net cash
provided by investing activities of $0.5 million for the year ended December 31, 2015.
Net
cash used in investing activities for the year ended December 31, 2017, consisted of purchase of property and equipment of $187,000,
partially offset by proceeds from sale of property and equipment of $124,000.
Net
cash used in investing activities for the year ended December 31, 2016, consisted primarily of $0.2 million of purchases of property
and equipment.
Net
cash provided by investing activities for the year ended December 31, 2015, consisted of a $0.7 million loan repayment by Alan
Ltd. (“Alan”), a company wholly-owned by our controlling shareholder Anatoly Hurgin, and $0.2 million proceeds from
the sale of property and equipment, partially offset by $0.4 million of purchases of property and equipment.
We
have no material commitments for capital expenditures as of December 31, 2017.
Financing
Activities
Net
cash provided by financing activities for the year ended December 31, 2017 was $0.2 million, an increase of $3.4 million, compared
to net cash used in financing activities of $3.2 million for the year ended December 31, 2016, a decrease of $6.6 million, compared
to net cash provided by financing activities of $3.4 million for the year ended December 31, 2015.
Net
cash provided by financing activities for the year ended December 31, 2017, consisted of $0.2 million due from controlling shareholders
on account of an arbitration proceeding.
Net
cash used in financing activities for the year ended December 31, 2016, consisted of $3.4 million of withholding taxes in respect
of dividends distributed to our controlling shareholders, Messrs. Anatoly Hurgin and Alexander Aurovsky, in 2015 and an additional
$1.0 million of withholding taxes on such distribution to the controlling shareholders paid by us to the Israel Tax Authority
according the tax assessment agreement for the three years ended December 31, 2014, reached between Ability and the Israel Tax
Authority on May 30, 2016, which was offset in part by $0.8 million paid to us by the controlling shareholders on account of their
outstanding tax obligation in connection with the 2015 dividend distributions following the tax assessment agreement, $0.2 million
due from controlling shareholders accrued on account of an arbitration proceeding and $0.6 million that was repaid to us by our
controlling shareholders on account of outstanding withdrawals.
Net
cash provided by financing activities for the year ended December 31, 2015, consisted of the $19 million proceeds from the Business
Combination, net of transaction costs, which was partially offset by $15 million of dividends distributed to our controlling shareholders
and $0.6 million in amounts withdrawn by the controlling shareholders during the period.
C.
|
Research
and Development, Patents and Licenses, etc.
|
For
a description of our research and development activities, see “Item 4B. Information on Our Company—Business Overview—Research
and Development.”
The
threat of global terrorism is a key driver in our growth, and the technological focus on counter-terrorism, as well as combating
ordinary criminal activity, supports our confidence in our business. Around the world, demand for the ability to locate, intercept
and decipher communications and encrypted data is strong. We believe that interception of communications is one of the most important
tasks within intelligence and surveillance.
Over
the last few years, cellular interception systems have become more complex and expensive as a result of increased usage of new
communication channels and technological developments in the cellular communications industry, such as an increased number of
cellular networks, mobile operators and frequencies. We believe that these developments had an adverse impact on sales of our
legacy tactical cellular interception solutions during 2017 and 2016, which significantly declined in those periods.
The
ULIN,
a strategic cellular interception system that we introduced in November 2015, has strategic capabilities allowing for the
interception of all generations of cellular communication. We expected that ULIN would be a major growth driver of our
revenues and continue to believe that our revenues for 2018 will be weighted towards ULIN sales; however, customer adoption
of ULIN has been much slower than we had anticipated. While we have seen significant interest in ULIN and its advanced
capabilities, for the year ended December 31, 2016, we completed one ULIN sale (which was our first ULIN sale), and in
January 2018 completed an additional sale. We believe that the limited customer adoption to date of ULIN, notwithstanding its
competitive advantage over tactical interception solutions, is primarily due to its increased costs compared to such tactical
interception solutions, as well as the market’s desire for a product capable of intercepting data communication in
addition to cellular communication, and ULIN’s inability to intercept cellular communication within some network
operators. We believe that continued increase in usage of new communication channels and the technological developments in
the cellular communications industry (such as an increased number of cellular networks, mobile operators and frequencies),
which have resulted in tactical cellular interception systems becoming more complex and expensive, will contribute to the
competitive strength and distinctiveness of ULIN, which in turn will result in an increased demand for ULIN. Furthermore,
ULIN sales cycles have taken longer than expected to complete. We believe that the significant increase in the length of the
ULIN sales cycle compared to our legacy tactical interception solutions is primarily due to the difficulties described above
and lengthy purchasing approval processes for ULIN, oftentimes requiring the approval of the most senior levels of
government.
Our non-operational
expenses increased significantly during the years ended December 31, 2017 and 2016, primarily due to legal and professional expenses.
We expect non-operational expenses to remain elevated in 2018, primarily due to legal expenses related to the pending SEC investigation
and pending legal proceedings.
E.
|
Off-balance
Sheet Arrangements
|
We
have no material off-balance sheet arrangements.
F.
|
Tabular
Disclosure of Contractual Obligations
|
The
following table summarizes our contractual obligations as of December 31, 2017:
|
|
Payments due by period (U.S.
dollars in thousands)
|
|
|
|
Total
|
|
|
Less than
1 Year
|
|
|
1-3 Years
|
|
|
4-5 Years
|
|
|
More than 5-Years
|
|
Obligations
with respect to minimum purchases
1
|
|
$
|
1,125
|
|
|
$
|
1,125
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
Lease Obligations
2
|
|
|
766
|
|
|
|
163
|
|
|
|
308
|
|
|
|
295
|
|
|
|
-
|
|
Others
|
|
|
20
|
|
|
|
20
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Total
|
|
$
|
1,911
|
|
|
$
|
1,308
|
|
|
$
|
308
|
|
|
$
|
295
|
|
|
$
|
-
|
|
1
|
Relates
to minimum commitments under an agreement with a third party supplier entered into on October 20, 2015. For additional information,
see “Item 4B. Information on the Company—Business Overview—Manufacturing and Suppliers.”
|
2
|
Relates
to obligations under lease agreements for our headquarters and laboratory. For
additional information, see “Item 4D. Information on the Company—Property,
Plants and Equipment.”
|
Item
6.
|
Directors,
Senior Management and Employees
|
A.
|
Senior
Management and Directors
|
The
following table sets forth certain information relating to our senior management and directors as of the date of this Annual Report.
Name
|
|
Age
|
|
Position
|
Anatoly
Hurgin
|
|
59
|
|
Chief
Executive Officer and Chairman of the Board of Directors
|
Alexander
Aurovsky
|
|
65
|
|
Chief
Technology Officer and Director
|
Avi
Levin
|
|
43
|
|
Chief
Financial Officer
|
Avraham
Dan (1)
|
|
73
|
|
Director
|
Naftali
Granot (2)(3)
|
|
67
|
|
Director
|
Limor
Beladev (1)(2)(3)
|
|
47
|
|
Director
|
Yair
Cohen (2)
(3)
|
|
63
|
|
Director
|
Joseph
Tenne (1)
|
|
62
|
|
Director
|
(1)
|
Member
of audit committee
|
(2)
|
Member
of nominating committee
|
(3)
|
Member
of compensation committee
|
Anatoly
Hurgin
has served as our Chief Executive Officer and a director since the closing of the Business Combination, and
has served as the Chief Executive Officer and a director of Ability since 1994. Mr. Hurgin currently serves as our Chairman, having served in that position from the Business Combination
until December 2016, and from July 2017 to present. Mr. Hurgin has served as a director of ASM since March 2016. Additionally, Mr. Hurgin has served as
Chief Executive Officer of Active Intelligence Labs Ltd., a company that develops solutions for the cyber security market,
since August 2011, and Chief Executive Officer of UAB Communication Technologies Ltd., a company formed for the purpose of
purchasing equipment from a Cypriote supplier, since September 2013. Mr. Hurgin holds a Master’s degree in radio
electronics from the High Military College of Radio-electronics of Air Defense Troops in Vilnius, Lithuania.
Alexander
Aurovsky
has served as our Chief Technology Officer and a director since the closing of the Business Combination, and
has served as the Chief Technology Officer and a director of Ability since 1994. Mr. Aurovsky has served as a director of ASM
since March 2016. Mr. Aurovsky holds a Master’s degree in radio electronics from the Bonch-Bruevich Saint Petersburg State
University of Telecommunications in Russia.
Avi
Levin
has served as our Chief Financial Officer since November 2015. Mr. Levin has served as a director of ASM since March
2016. Previously, Mr. Levin served as an investment banker at Credit Suisse Securities, a multinational financial services institution.
Prior to that, Mr. Levin served in corporate finance positions at Broadridge Financial Solutions, Inc. a software company that
provides services to banks and other financial institutions, and at Overseas Shipholding Group, Inc., a global company engaged
in ocean transportation of oil, natural gas. Mr. Levin started his career at the international accounting firm, PricewaterhouseCoopers,
where he worked at the Tel Aviv, Israel and San Jose, California offices. Mr. Levin is a CPA in the United States and Israel.
Mr. Levin has an undergraduate degree in Economics and Accounting from Ben-Gurion University of the Negev in Israel, and an MBA
degree from New York University Stern School of Business.
Avraham
Dan
joined our board on July 5, 2017. Mr. Dan chairs the audit committee. Mr. Dan is an entrepreneur with global experience
in various financial and business management. Mr. Dan’s experience includes strategic planning, accounting and control,
investments and business development, mergers and acquisitions, re-engineering and spin-offs. He served as a director in Pangae
Israel Ltd. and Amir-Marketing & Investment in Agriculture Ltd. Mr. Dan served as economic and financial advisor and managing
director in ICTS International N.V., an international company in the field of security. Mr. Dan provided strategic and financial
consultation to corporations in Israel and overseas. Mr. Dan is a CPA in Israel and holds an MBA from Pace University, New York.
Naftali
Granot
joined our board on July 5, 2017. Mr. Granot chairs the nominating committee and serves on the compensation
committee. Mr. Granot served with the Special Forces of the Israel Defense Forces (the “IDF”), retired as a Major and joined the Israeli Mossad in 1982 as field
operative, was nominated at 2002 as head of a certain division of the organization and in 2005 as deputy director, and
retired in 2007. During his tenure with the Mossad, Mr. Granot accumulated considerable managerial and intelligence
experience in various fields relevant to the Company’s activities. Since his retirement from the Mossad, Mr. Granot
worked as the CEO of a subsidiary of Bronfman-Fisher group of companies in Israel and was involved in various fields of
business in Africa and China, such as obtaining mining license on behalf of a Canadian firm Tau Capital and representing
Israeli security companies.
Limor
Beladev
joined our board on July 5, 2017. Ms. Beladev chairs the compensation committee and serves on both the audit committee
and the nominating committee. Ms. Beladev is an independent attorney, mostly practicing commercial and real estate law. She has
served as director in several public, government owned, and private companies in Israel and she has significant corporate governance
experience. Ms. Beladev serves as a member in several committees of the Israeli Bar Association. Ms. Beladev holds an LL.B. degree
in law from Netanya Academic College.
Brigadier General
(Ret.) Yair Cohen
joined our board on July 24, 2017. Brig Gen Cohen is a member of the compensation committee and the
nominating committee. He is an advisor for Cyber and Intelligence with 32 years of military service in the IDF. In his last position
in the military, Mr. Cohen headed the IDF’s Cyber and Sigint Intelligence unit (8200). Since his retirement from the military
in 2005, Mr. Cohen has held numerous positions in Israeli technology companies, in addition to being a director in several companies.
From 2005 to 2009, Mr. Cohen was Vice President of Elron Electronic Industries Ltd., a leading Israeli holding company dedicated
to build technology companies in diverse fields which trades on NASDAQ. From 2006 to 2009, Mr. Cohen was Chairman of ECtel Ltd.,
a company providing integrated revenue management solutions which was traded on NASDAQ. From 2009 to 2015, Mr. Cohen established
and was the first CEO of the Cyber Division in Elbit Systems Ltd. (NASDAQ: ESLT), the largest non-governmental defense company
in Israel. From 2015 to 2016 Mr. Cohen served as the CEO of the investment fund PeriTech for Investment and Technology where he
led investments in technology companies and currently still serves on the board of a number of portfolio companies. Mr. Cohen
also currently serves as director in Electra Consumer Products 1970 and Infinity Funds Ltd. Mr. Cohen holds a BA degree from Bar
Ilan University in Jewish History and Arabic Language and Literature and MA degree from ICAF, in the National Defense University
(NDU), Washington DC, in Management of National Resources, and is currently teaching Cyber for MA in Tel Aviv University and Bar
Ilan University.
Joseph Tenne
joined our board on October 15, 2017. Mr. Tenne is a member of the audit committee.
He serves as a financial consultant to Itamar Medical Ltd., an Israeli TASE-listed company, and from August 2014 to April 2017
served as vice president finance and chief financial officer of that company. Mr. Tenne also serves on the board of directors
of AudioCodes Ltd., an Israeli NASDAQ and TASE-listed company, Orbotech Ltd, an Israeli NASDAQ-listed company, MIND C.T.I. Ltd.,
an Israeli NASDAQ-listed company, Ratio Oil Explorations (Finance) Ltd., an Israeli TASE-listed company, OPC Energy Ltd., an Israeli
TASE-listed company and Orgenesis Ltd., an Israeli private company. From September 2013 to January 2018, Mr. Tenne served on the
board of directors of Enzymotec Ltd., which was an Israeli NASDAQ-listed company. From March 2014 to July 2014, Mr. Tenne served
as the chief financial officer of Orgenesis Inc., a U.S. company traded on the NASDAQ. From 2005 to 2013, Mr. Tenne served as
the chief financial officer of Ormat Technologies, Inc., a NYSE-listed company and from 2006 to 2013, also served as the chief
financial officer of Ormat Industries Ltd. Prior to that, from 2003 to 2005, Mr. Tenne was the chief financial officer of Treofan
Germany GmbH & Co. KG, a German company. From 1997 to 2003, Mr. Tenne was a partner in Kesselman & Kesselman, Certified
Public Accountants in Israel and a member of PricewaterhouseCoopers International Limited (PwC Israel). Mr. Tenne is a certified
public accountant in Israel and holds a bachelor’s degree in accounting and economics and master’s degree in business
administration from Tel Aviv University.
Arrangements
Concerning Election of Directors; Family Relationships
We
are not a party to, and are not aware of, any voting agreements among our shareholders. In addition, there are no family relationships
among our senior management and directors.
The
aggregate compensation incurred or accrued by us in relation to our Senior Management, for the year ended
December 31, 2017, was approximately $861,000
. This amount includes approximately $160,000 set aside or
accrued to provide pension, severance, retirement or similar benefits or expenses, but does not include business travel,
professional and business association dues and expenses reimbursed to executive officers.
We
accrued a bonus of NIS 135,000 (approximately $38,938) on account of Mr. Levin, our Chief Financial Officer for the
year ended on 2016, however such bonus was not paid as of the date of this report. Anatoly Hurgin, our Chief Executive
Officer, and Alexander Aurovsky, our Chief Technology Officer, are not entitled to an annual bonus for the year ended
December 31, 2017.
We
pay each of our directors (other than our executive directors) an annual fee of $55,000 and a per meeting fee of $2,000 for attendance
in person and $1,250 for attendance by telephone and for written consents. In addition, we pay the Chairman of our Audit
Committee an annual fee of $15,000 and pay all other members of our Audit Committee an annual fee of $6,000, and pay all members
of our Audit Committee a per meeting fee of $1,500 for attendance in person and $1,250 for attendance by telephone and for written
consents. We pay the Chairman of each of our Nominating Committee and Compensation Committee an annual fee of $5,000 and
pay all other members of such committees an annual fee of $3,000, and pay all members of such committees a per meeting fee of
$1,500 for attendance in person and $1,250 for attendance by telephone and for written consents. We pay such fees on a quarterly
basis. In addition, we reimburse directors for reasonable travel and other expenses in connection with the services rendered in
such capacity.
We
do not have any written agreements with our current or incoming directors providing for benefits upon the termination of such
director’s relationship with us.
To
our knowledge, there are no agreements and arrangements between our current or incoming directors and any third party relating
to compensation or other payment in connection with their candidacy or service on our board of directors.
Employment
Agreements with Senior Management
On
September 6, 2015, simultaneously with the execution of the Merger Agreement, Ability entered into an employment agreement with
each of (i) Anatoly Hurgin for Mr. Hurgin to serve as its Chief Executive Officer, and (ii) Alexander Aurovsky for Mr. Aurovsky
to serve as its Chief Technology Officer. Each of the employment agreements will remain in effect unless terminated as described
below. Pursuant to the employment agreements, the executives’ gross salary is NIS 120,000 (approximately $34,612) per month;
however, each of the executives agreed to a temporary 50% reduction in their salaries, effective as of May 2017. Each executive
is also entitled to receive the following benefits:
|
●
|
Ability
will pay to an insurance company or a pension fund for such executive, as amount equal to 8.33% of his salary which shall
be allocated to a fund for severance pay, and an additional 5% of salary in the case of an insurance policy (or an additional
6% in the case of a pension fund) which shall be allocated to a provident fund or pension plan. In addition, if the executive
elects to allocate his pension payments (5% of salary in case of an insurance policy or 5.5% in case of a pension plan, either
case, which will be deducted from the executive’s salary), Ability will contribute an amount up to 2.5% of the executive’s
salary for disability insurance, provided that such insurance is available for the executive;
|
|
●
|
Ability
will contribute to a recognized educational fund an amount equal to 7.5% of such month’s salary for the benefit of each
executive; and
|
|
●
|
Ability
will provide such executive with a luxury motor vehicle and pay or reimburse the executive for all reasonable expenses relating
to the use of the motor vehicle.
|
Each
employment agreement provides that the executive shall be entitled to receive an annual performance bonus of up to NIS 360,000
(approximately $103,836) based on annual performance goals agreed upon by Ability and the executive. Each employment agreement
may be terminated by Ability or the executive upon 120 days’ prior written notice, in which case the executive shall be
entitled to receive salary and benefits during such 120 days and for a period of eight months thereafter. The executive will be
entitled to accept new employment after the expiration of such eight month period. In addition, Ability, by resolution of its
board of directors, may terminate the employment agreements at any time by written notice for cause (as defined in the employment
agreements).
In
November 2015, Ability retained Avi Levin to serve as its Chief Financial Officer. Under the employment agreement entered into
with Mr. Levin in December 2015, effective as of November 8, 2015, Ability agreed to pay Mr. Levin a gross salary of NIS 45,000
(approximately $12,979) per month. In addition, Mr. Levin will be eligible to receive an annual performance-based bonus of up
to NIS 135,000 (approximately $38,938). Mr. Levin is also entitled to the following benefits:
|
●
|
Ability
will pay to an insurance company or a pension fund for Mr. Levin, as amount equal to 8.33% of his salary which shall be allocated
to a fund for severance pay, and an additional 5% of salary in the case of an insurance policy (or an additional 6% in the
case of a pension fund) which shall be allocated to a provident fund or pension plan. In addition, if Mr. Levin elects to
allocate his pension payments (5% of salary in case of an insurance policy or 5.5% in case of a pension fund, either case,
which will be deducted from Mr. Levin’s salary), Ability will contribute an amount up to 2.5% of Mr. Levin’s salary
for disability insurance, provided that such insurance is available for the executive;
|
|
●
|
Ability
will contribute to a recognized educational fund an amount equal to 7.5% of such month’s salary for the benefit of Mr.
Levin; and
|
|
●
|
Ability
will provide Mr. Levin with a motor vehicle and pay or reimburse him for all reasonable expenses relating to the use of the
motor vehicle.
|
The
employment agreement may be terminated by Ability or Mr. Levin upon 60 days’ prior written notice, in which case Mr. Levin
shall be entitled to receive salary and benefits during such 60 day period. In addition, Ability, by resolution of its board of
directors, may terminate the employment agreement at any time by written notice for cause (as defined in the employment agreement).
Board
Practices
Board
of Directors
Our
board of directors is currently comprised of seven directors. See “Item 6A – Directors and Senior Management”.
On
April 9, 2017, we received letters from each of Amnon Dick, Efraim Halevy, Amos Malka, Meir Moshe and Shalom Singer,
representing all our former independent directors, tendering their resignation as a member of our board of directors and
committees thereof, effective immediately. At the time of their resignations, Mr. Dick was Chairman of our board of directors
and a member of the audit and compensation committees; Mr. Halevy was a member of the nominating committee; Mr. Malka was a
member of the compensation committee; Mr. Moshe was Chairman of the audit committee and Chairman of the nominating committee;
and Mr. Singer was Chairman of the compensation committee and a member of the audit and nominating committees. Each of
Messrs. Dick, Malka, Moshe and Singer stated in their respective resignation letter that their resignation was due to his
approach to risk assessment and management of our affairs not being aligned with that of our founding directors and
controlling shareholders, which made them unable to contribute to us in a productive way. Each noted that, in view of the
various challenges that we are currently facing, a shared vision and broad cooperation among our controlling shareholders and
directors is required and that in view of the foregoing, and especially as they served as a director for only a few months,
they do not believe it would be appropriate to continue to serve as a director. Mr. Halevy did not state any reason for his
resignation in his resignation letter. Following the resignation of the former independent directors, on May 15, 2017 we
appointed Levi Ilsar, Brigadier General (Ret.) Eli Polak and Nimrod Schwartz to serve as independent directors on our board
of directors and the audit, compensation and nominating committees thereof, in each case effective as of May 17, 2017.
However, on June 29, 2017, Levi Ilsar, Eli Polak and Nimrod Schwartz, representing all of our independent directors, tendered
their written resignations with immediate effect.
Each of Messrs. Ilsar, Polak and Schwartz stated in his
respective resignation notice that his resignation was due, among other things, to the lack of cooperation by management
which prevented him from fulfilling his duties as an independent director.
On
July 5, 2017, our board appointed three new independent directors, Avraham Dan, Naftali Granot and Limor Beladev, effective immediately.
On July 24, 2017 and October 15, 2017, our board appointed additional independent directors, Brigadier General (Ret.) Yair Cohen
and Joseph Tenne, respectively, effective immediately. All of our directors were reelected by the General Meeting of the
Company held on December 27, 2017 and shall serve until our next annual general meeting, subject to our amended and restated memorandum
and articles of association.
Under
Cayman Islands law, directors owe the following fiduciary duties:
(i)
a duty to act in good faith in what the director believes to be in the best interests of the company as a whole;
(ii)
a duty to exercise powers for the purposes for which those powers were conferred and not for a collateral purpose;
(iii)
directors should not improperly fetter the exercise of future discretion; and
(v)
a duty not to put themselves in a position in which there is a conflict between their duty to the company and their personal interests;
In
addition to the above, directors also owe a duty of care, diligence and skill which is not fiduciary in nature. This duty has
been defined as a requirement to act as a reasonably diligent person having the general knowledge, skill and experience that may
reasonably be expected of a person carrying out the same functions as are carried out by that director in relation to the company
and the general knowledge, skill and experience which that director has.
As
described above, directors have a duty not to put themselves in a position of conflict and this includes a duty not to engage
in self-dealing, or to otherwise benefit as a result of their position. However, in some instances what would otherwise be a breach
of this duty can be forgiven and/or authorized in advance by the shareholders, provided that there is full disclosure by the directors.
This can be done by way of permission granted in the amended and restated memorandum and articles of association or alternatively
by shareholder approval at general meetings.
Audit
Committee
Our
audit committee is currently comprised of three members, Avraham Dan, Limor Beladev and Joseph Tenne. Mr. Dan chairs the audit
committee.
Under
SEC rules and the NASDAQ Listing Rules, we are required to maintain an audit committee consisting of at least
three independent directors, within the meaning of SEC rules and the NASDAQ Listing Rules, each of whom must be able to read
and understand fundamental financial statements, including the company’s balance sheet, income statement and cash
flow statement (and one of whom has had past employment experience in finance or accounting, requisite professional
certification in accounting or other comparable experience or background that leads to financial sophistication) and none of
whom has participated in the preparation of our or any of our subsidiary’s financial statements at any time during the
prior three years. All members who have been appointed to our audit committee meet the requirements for financial literacy
under the applicable rules and regulations of the SEC and the NASDAQ Listing Rules. Our board of directors has determined
that each of Mr. Dan and Mr. Tenne is an “audit committee financial expert,” as defined by SEC rules and has the
requisite financial sophistication required by the NASDAQ Listing Rules.
Our
audit committee generally provides assistance to our board of directors in fulfilling its legal and fiduciary obligations in matters
involving our accounting, auditing, financial reporting and internal control functions by reviewing the services of our independent
accountants and reviewing their reports regarding our accounting practices and systems of internal control over financial reporting.
Our audit committee also oversees the audit efforts of our independent accountants. Our board of directors has adopted an audit
committee charter setting forth the specific responsibilities of the audit committee consistent with the rules and regulations
of the SEC and the NASDAQ listing requirements, which include: retaining and terminating our independent registered public accounting
firm; pre-approval of audit and non-audit services to be provided by the independent registered public accounting firm; and reviewing
and recommending to the board of directors approval of our quarterly and annual financial reports.
Nominating
Committee
Our
nominating committee is currently comprised of three members, Naftali Granot, Limor Beladev, and Yair Cohen. Ms. Granot chairs
the compensation committee.
Under
the NASDAQ Listing Rules, director nominees must be either selected, or recommended for selection by the board of directors, by
a nomination committee comprised solely of independent directors within the meaning of the NASDAQ Listing Rules. Our board of
directors has affirmatively determined that each member of our nominating committee qualifies as an “independent director”
under the NASDAQ Listing Rules. The nominating committee is responsible for overseeing the selection of persons to be nominated
to serve on our board of directors. Our board of directors has adopted a nominating committee charter setting forth the specific
responsibilities of the compensation committee and addressing the nominating process, consistent with the requirements of the
NASDAQ Listing Rules.
The
nominating committee will consider persons identified by its members, management, shareholders, investment bankers and others.
The guidelines for selecting nominees, which are specified in the nominating committee charter, generally provide that persons
to be nominated:
|
●
|
should
be accomplished in his or her field and have a reputation, both personal and professional, that is consistent with our image
and reputation;
|
|
●
|
should
have relevant experience and expertise and would be able to provide insights and practical wisdom based upon that experience
and expertise; and
|
|
●
|
should
be of high moral and ethical character and would be willing to apply sound, objective and independent business judgment, and
to assume broad fiduciary responsibility.
|
The nominating committee
will consider a number of qualifications relating to management and leadership experience, background and integrity and professionalism
in evaluating a person’s candidacy for membership on the board of directors. The nominating committee may require certain
skills or attributes, such as financial or accounting experience, to meet specific board needs that arise from time to time and
will also consider the overall experience and makeup of its members to obtain a broad and diverse mix of board members. The nominating
committee will not distinguish among nominees recommended by shareholders and other persons.
Compensation
Committee
Our
compensation committee is currently comprised of three members, Limor Beladev, Naftali Granot and Yair Cohen. Ms. Beladev chairs
the compensation committee.
Under
the NASDAQ Listing Rules, we are required to maintain a compensation committee consisting of at least two directors, each of whom
is an independent director within the meaning of the NASDAQ Listing Rules. Our board of directors has affirmatively determined
that each member of our compensation committee qualifies as an “independent director” under the NASDAQ Listing Rules.
The purpose of the compensation committee is to review and approve compensation paid to our officers and directors and to administer
our incentive compensation plans, including the authority to make and modify awards under such plans. Our board of directors has
adopted a compensation committee charter setting forth the specific responsibilities of the compensation committee, consistent
with the requirements of the NASDAQ Listing Rules.
Indemnification
and Insurance of Officers and Directors
Cayman
Islands law does not limit the extent to which a company’s articles of association may provide for indemnification of officers
and directors, except to the extent that a provision may be held by the Cayman Islands courts to be contrary to public policy,
such as to provide indemnification against civil fraud or the consequences of committing a crime. Our amended and restated memorandum
and articles of association provide for indemnification of officers and directors for any liability, action, proceeding, claim,
demand, costs, damages or expenses, including legal expenses, whatsoever which they or any of them may incur as a result of any
act or failure to act in carrying out their functions other than such liability (if any) that they may incur by reason of their
own actual fraud or willful default. No indemnified person is liable to us for any loss or damage incurred by us as a result (whether
direct or indirect) of the carrying out of their functions unless that liability arises through the actual fraud or willful default
of such indemnified person. No person is found to have committed actual fraud or willful default unless or until a court of competent
jurisdiction has made a finding to that effect. Insofar as indemnification for liabilities arising under the Securities Act may
be permitted to our directors, officers or persons controlling us pursuant to these provisions, we have been informed that, in
the opinion of the SEC, this indemnification is against public policy as expressed in the Securities Act and therefore is unenforceable.
Under
our amended and restated memorandum and articles of association, our directors, on behalf of us, may purchase and maintain insurance
for the benefit of any director or other officer against any liability which, by virtue of any rule of law, would otherwise attach
to such person in respect of any negligence, default, breach of duty or breach of trust of which such person may be guilty in
relation to us. We have procured a directors’ and officers’ liability & company reimbursement insurance policy
for our officers and directors and our wholly-owned subsidiaries, with an aggregate limit of liability for all losses of $ 20
million.
As of December 31, 2017, we employed 17 employees
on a full-time basis and two employees on a part-time basis, comprised of administrators and marketing and technical personnel,
all of whom were located in Israel. In addition to our employees, we utilize the services of a number of independent contractors
worldwide for selling and marketing.
We
consider our relationship with our employees to be good and a critical factor in our success. While we are not a party to any
collective bargaining or other agreement with any labor organization in Israel, certain provisions of the collective bargaining
agreements between the Histadrut (General Federation of Laborers in Israel) and the Coordinating Bureau of Economic Organizations
(including the Manufacturers’ Association of Israel) may be applicable to our Israeli employees by virtue of expansion orders
of the Israeli Ministry of Industry, Trade and Labor.
Under
Israeli law, Israeli employees are required to make, and employers are required to pay and withhold, certain payments to the National
Insurance Institute (similar, to some extent, to the United States Social Security Administration), on account of social security
and health tax payments. In addition, Ability is required to maintain employee benefit plans for the benefit of its employees.
Each month, both Ability and its employees contribute sums to the employee benefit plans. The employee benefit plans provide a
combination of savings plan (for pension), insurance and severance pay to the Israeli employees. Some of the sums Ability contributes
monthly to the employee benefit plans are used to satisfy severance pay to which the employees may be entitled under Israeli law.
Since the end of 2015, Ability’s agreements with its employees are in accordance with Section 14 of Israel’s Severance
Pay Law, according to which its monthly contributions for severance pay for its employees are in lieu of its severance liability.
Ability has set aside additional reserves for severance pay of $241,000 as of December 31, 2017 for potential future obligations
to make severance payments to Ability’s employees with respect to periods prior to the application of Section 14 of Israel’s
Severance Pay Law.
Beneficial
Ownership
The
following table sets forth information regarding the beneficial ownership of our outstanding ordinary shares as of April 15, 2018
by the members of our senior management and board of directors individually and as a group. The beneficial ownership of ordinary
shares is based on the 2,576,415 ordinary shares outstanding as of April 15, 2018 and is determined in accordance with the rules
of the SEC and generally includes any ordinary shares over which a person exercises sole or shared voting or investment power.
For purposes of the table below, we deem shares subject to options or warrants that are currently exercisable or exercisable within
60 days of April 15, 2018, to be outstanding and to be beneficially owned by the person holding the options or warrants for the
purposes of computing the percentage ownership of that person but we do not treat them as outstanding for the purpose of computing
the percentage ownership of any other person.
Name of Beneficial Owner
|
|
Number of Ordinary Shares
|
|
|
Percentage of Class
|
|
Senior Management and Directors
|
|
|
|
|
|
|
Anatoly Hurgin
|
|
|
832,500
|
(1)
|
|
|
32.32
|
%
|
Alexander Aurovsky
|
|
|
832,500
|
(2)
|
|
|
32.32
|
%
|
Avi Levin
|
|
|
314
|
|
|
|
*
|
|
Avraham Dan
|
|
|
—
|
|
|
|
—
|
|
Naftali Granot
|
|
|
—
|
|
|
|
—
|
|
Limor Beladev
|
|
|
—
|
|
|
|
—
|
|
Yair Cohen
|
|
|
—
|
|
|
|
—
|
|
Joseph Tenne
|
|
|
—
|
|
|
|
—
|
|
All senior management and directors as a group (8 individuals)
|
|
|
1,665,314
|
|
|
|
64.65
|
%
|
*
|
Less
than 1%.
|
|
|
(1)
|
Does
not include ordinary shares which may become issuable to Anatoly Hurgin pursuant to the earn-out under the Merger Agreement.
|
|
|
(2)
|
Does
not include ordinary shares which may become issuable to Alexander Aurovsky pursuant to the earn-out under the Merger Agreement.
|
From
our incorporation on September 1, 2015 and until December 23, 2015, we were a wholly-owned subsidiary of Cambridge. On December
23, 2015, as part of completion of the Business Combination, we merged with Cambridge, and acquired Ability by way of a share
exchange. Effective as of the closing of the Business Combination, Mr. Hurgin, our Chief Executive Officer, and Mr. Aurovsky,
our Chief Technology Officer, each received 810,664 ordinary shares, corresponding to 31.5% of our issued and outstanding shares.
Between June 2016 and October 2016, Mr. Hurgin and Mr. Aurovsky purchased an aggregate 21,836 each, increasing each of their holdings
to 32.32% of our issued and outstanding shares as of such date. To our knowledge, there have been no other significant changes
in the percentage ownership held by any of our major shareholders since the Business Combination.
To
our knowledge, based on information provided to us by our transfer agent in the United States, as of April 15, 2018, we had 19
shareholders of record who are registered with an address in the United States, holding approximately 37
% of our outstanding
ordinary shares. Such number is not representative of the portion of our shares held in the United States nor is it representative
of the number of beneficial holders residing in the United States, since 829,935 ordinary shares or 32% of our outstanding ordinary
shares are held of record by one U.S. nominee company, CEDE & Co.
To
our knowledge, we are jointly controlled by Mr. Hurgin, our Chief Executive Officer, and Mr. Aurovsky, our Chief Technology Officer,
who hold a total of 1,665,000 ordinary shares, corresponding to 64.6% of our outstanding shares as of April 15, 2018. We are
not aware of any arrangement that may, at a subsequent date, result in a change of control of the Company.
2015
Long-Term Equity Incentive Plan
On
November 18, 2015, our board of directors approved and adopted a 2015 Long-Term Equity Incentive Plan (the “2015 Plan”),
which became effective upon the consummation of the Business Combination. On April 25, 2016, our board of directors approved and
adopted the Israeli Sub-Plan to the Ability Inc. 2015 Long-Term Equity Incentive Plan (the “Israeli Sub-Plan” and
together with the 2015 Plan, the “Plan”). The purpose of the Plan is to attract and retain personnel of the highest
caliber, provide incentive for officers, directors, employees and other key persons and to provide to officers, directors, employees,
consultants and other independent contractors who perform services for us, through the granting of stock options, restricted stock,
deferred stock or other stock-based awards, the opportunity to participate in the value and/or appreciation in value of the our
ordinary shares.
Awards.
The Plan provides for the grant of any or all of the following types of awards (collectively, “Awards”): (a)
stock options, (b) restricted stock, (c) deferred stock and (d) other stock-based awards. Awards may be granted singly, in combination,
or in tandem, as determined by our board of directors or the Committee (as defined below). Subject to anti-dilution adjustments
as provided in the Plan, (i) the Plan provides for a total of 8% of the outstanding ordinary shares following the closing of the
Business Combination to be available for distribution pursuant to the Plan and subject to the
provisions of the immediately preceding paragraph, all of such shares may be granted or measured to any participant under the
Plan during any calendar year or part thereof. If any outstanding Award is canceled, forfeited, delivered to us as payment for
the exercise price or surrendered to us for tax withholding purposes, ordinary shares allocable to such Award may again be available
for Awards under the Plan.
Administration.
The Plan may be administered by our board of directors or a committee (the “Committee”) consisting of two
or more members of the board of directors appointed by the board of directors. The board of directors or the Committee will determine,
among other things, the persons to whom Awards will be granted, the type of Awards to be granted, the number of shares subject
to each Award and the share price. The board of directors or the Committee will also determine the term of each Award, the restrictions
or limitations thereon, and the manner in which each such Award may be exercised or, if applicable, the extent and circumstances
under which ordinary shares and other amounts payable with respect to an Award will be deferred. The board of directors or Committee
may delegate some of the functions referred to above to our Chief Executive Officer or Chief Financial Officer. No Award shall
be granted pursuant to the Plan on or after the tenth anniversary of the effective date of the Plan.
Eligibility
and Participation.
Officers and other employees of the Company or any parent or subsidiary (but excluding any person whose
eligibility would adversely affect the compliance of the Plan with the requirements of Rule 16b-3) who are at the time of the
grant of an award under the Plan employed by us or any parent or subsidiary of ours, and who are responsible for or contribute
to the management, growth and/or profitability of our business or any parent or subsidiary of ours are eligible to be granted
options or other Awards under the Plan. In addition, non-qualified stock options and other Awards may be granted under the Plan
to any person, including, but not limited to, directors, independent agents, consultants and attorneys who the board of directors
or the Committee, as the case may be, believes has contributed or will contribute to our success. Eligibility under the Plan shall
be determined by our board of directors or the Committee, as the case may be. A participant’s right, if any, to continue
to serve as a director, executive officer, other key employee, or otherwise, will not be enlarged or otherwise affected by his
or her designation as a participant under the Plan. Participants may receive one or more Awards under the Plan.
Forms
of Awards
Stock
Options.
The Plan provides for the grant of incentive stock options and non-qualified stock options. The board of directors
or the Committee, as the case may be, shall determine those persons to whom stock options may be granted.
Incentive
stock options granted pursuant to the Plan are nontransferable by the optionee during his lifetime. Options granted pursuant to
the Plan will expire if not exercised within 10 years of the grant (five years in the case of incentive stock options granted
to an eligible employee owning stock possessing more than 10% of the total combined voting power of all our shares or the shares
of a parent or subsidiary of ours immediately before the grant (a “10% Stockholder”)), and under certain circumstances
set forth in the Plan, may be exercised within three (3) months following termination of employment (one year in the event of
death, retirement at normal retirement age or disability of the optionee), unless the term of the option, pursuant to the stock
option agreement, expires earlier or unless the board of directors or the Committee determines to shorten or extend the exercise
periods. Options may be granted to optionees in such amounts and at such prices as may be determined, from time to time, by the
board of directors or the Committee. The exercise price of an incentive stock option will not be less than the fair market value
of the shares underlying the option on the date the option is granted, provided, however, that the exercise price of an incentive
stock option granted to a 10% Stockholder may not be less than 110% of such fair market value. The exercise price of a non-qualified
stock option may be less than such fair market value on the date of grant.
Under
the Plan, we may not, in the aggregate, grant incentive stock options that are first exercisable by any optionee during any calendar
year (under all such plans of the optionee’s employer corporation and its “parent” and “subsidiary”
corporations, as those terms are defined in Section 424 of the Code) to the extent that the aggregate fair market value of the
underlying stock (determined at the time the option is granted) exceeds $100,000.
The
Plan contains anti-dilution provisions authorizing appropriate adjustments in certain circumstances. Shares subject to Awards
which expire without being exercised or which are cancelled as a result of the cessation of employment are available for further
grants. No ordinary shares may be issued upon the exercise of any option granted under the Plan until the full option price has
been paid by the optionee. The board of directors or the Committee may grant individual options under the Plan with more stringent
provisions than those specified in the Plan.
Options
become exercisable in such amounts, at such intervals and upon such terms and conditions as the board of directors or the Committee
provides. Stock options granted under the Plan are exercisable until the earlier of (i) a date set by the board of directors or
Committee at the time of grant or (ii) the close of business on the day before the tenth anniversary of the stock option’s
date of grant (the day before the fifth anniversary in the case of an incentive stock option granted to a 10% Stockholder).
Restricted
and Deferred Stock Awards
.
Under the Plan, the board of directors or the Committee may grant restricted ordinary shares
either alone or in tandem with other Awards. Restricted and deferred stock give the recipient the right to receive a specified
number of ordinary shares, subject to such terms, conditions and restrictions as the board of directors or the Committee deems
appropriate. Restrictions may include limitations on the right to transfer the stock until the expiration of a specified period
of time and forfeiture of the stock upon the occurrence of certain events such as the termination of employment prior to expiration
of a specified period of time. In addition, a participant in the Plan who has received a deferred stock Award may request, under
certain conditions, the board of directors or the Committee to defer the receipt of an Award (or an installment of an Award) for
an additional specified period or until the occurrence of a specified event.
Performance-Based
Awards and Performance Goals.
Certain Awards made under the Plan may be granted so that they qualify as “performance-based
compensation” (as this term is used in Code Section 162(m) and the regulations thereunder) and are exempt from the deduction
limitation imposed by Code Section 162(m) (these Awards are referred to as “Performance-Based Awards”). Under Code
Section 162(m), our tax deduction may be limited to the extent total compensation paid to the Chief Executive Officer, or any
of the four most highly compensated executive officers (other than the Chief Executive Officer) exceeds $1,000,000 in any one
tax year. Among other criteria, Awards only qualify as performance-based awards if at the time of grant the Committee is administrating
the Plan and the Committee is comprised solely of two or more “outside directors” (as this term is used in Section
162(m) of the U.S. Internal Revenue Code of 1986, as amended, (the “Code”) and the regulations thereunder). The board
of directors or the Committee may use certain performance measures set forth in the Plan (either individually or in any combination)
to set performance targets with respect to Awards intended to qualify as performance-based Awards.
All
stock options and certain stock Awards, performance Awards, and other Awards granted under the Plan, and the compensation attributable
to such Awards, are intended to (i) qualify as performance-based Awards or (ii) be otherwise exempt from the deduction limitation
imposed by Code Section 162(m).
Other
Stock Based Awards.
Other stock-based Awards, which may include performance shares and shares valued by reference to the performance
of the Company or any parent or subsidiary of the Company, may be granted either alone or in tandem with other Awards.
Effect
of a Change of Control.
Upon a “Change of Control” (as defined in the Plan), unless a majority of the board
of directors determines otherwise prior to such Change of Control, generally, all outstanding options which have been outstanding
for at least one year shall become exercisable in full, and shall remain exercisable in full until it expires pursuant to its
terms and all restrictions and deferral limitations contained in any restricted stock Award, deferred stock Award and other stock-based
Award granted under the Plan shall lapse. All restrictions and deferral limitations with respect to a 409A deferred stock Award
or with respect to a participant’s deferred restricted stock account shall not lapse unless the “Change of Control”
qualifies as a “409A Change” (as defined in the Plan).
Termination
of Employment.
The Plan provides for certain periods after termination of employment during which a participant may exercise
an option if the participant’s employment is terminated due to death or disability or normal retirement (as defined in the
Plan). A participant whose employment is terminated for any reason, including, without limitation, retirement, death or disability,
forfeits all unvested, unexercisable and unearned Awards granted to the participant. Except as set forth above, the board of directors
or Committee, as the case may be, determines the post-employment rights of a participant with respect to an Award that was vested
or earned prior to termination. The Plan’s provisions relating to termination of employment may be modified in the discretion
of the board of directors or the Committee.
Term
and Amendment.
The Plan became effective as of consummation of the Business Combination and no award will be granted more
than ten years after the effective date. The board of directors may at any time, and from time to time, amend any of the provisions
of the Plan, and may at any time suspend or terminate the Plan; provided, however, that no such amendment is effective unless
and until it has been duly approved by the holders of the outstanding shares if the failure to obtain such approval would adversely
affect the compliance of the Plan with the requirements of Rule 16b-3 or any other applicable law, rule or regulation. The board
of directors or the Committee, as the case may be, may amend the terms of any option or other Award granted under the Plan; provided,
however, that subject to certain provisions of the Plan, no such amendment may be made by the board of directors or the Committee,
as the case may be, which in any material respect impairs the rights of a participant without the participant’s consent,
except for such amendments which are made to cause the Plan to qualify for the exemption provided by Rule 16b-3. Moreover, no
option previously granted under the Plan may be amended to reduce the exercise price of the option. Additionally, the board of
directors or the Committee may amend the Plan in order to comply with local regulations as may be required for certain employees
in other jurisdictions.
Israeli
Sub-Plan
.
The Israeli Sub-Plan will apply to, and modify, awards granted to our employees, directors and officers
who are resident in the State of Israel (the “Israeli Participants”) so that any such Award granted under the
Plan will be governed by the terms of the Israeli Sub-Plan in order to comply with the requirements of Israeli law,
including, without limitation, Sections 102 and 3(i) of the Israeli Income Tax Ordinance (New Version) 1961 (the
“Ordinance”).
Awards
granted under the Israeli Sub-Plan to Israeli Participants who are employees or office holders of ours or our affiliates and who
are not controlling shareholders (within the meaning of the Ordinance) will be granted pursuant to the provisions of Section 102
of the Ordinance, and may be awarded either pursuant to (i) Section 102(b) of the Ordinance, in which case such Awards are granted
or issued to a trustee and are to be held by the trustee for at least two years from the date of grant. We may elect to designate
such Awards to qualify for either capital gains tax treatment or ordinary income tax treatment, and such election shall apply
to all Awards made pursuant to Section 102(b) of the Ordinance and cannot be changed until after the passage of time prescribed
in Section 102; or (ii) Section 102(c) of the Ordinance, which Awards are not required to be held in trust by a trustee. Under
the Israeli Sub-Plan, Israeli Participants who are either non-employee consultants, advisers or service providers of the Company
or our affiliates or controlling shareholders (within the meaning of the Ordinance) (whether or not an employee of ours or an
affiliate) may only be granted Awards under Section 3(i) of the Ordinance, which does not provide for similar tax benefits as
Section 102.
Item 7.
|
Major
Shareholders and Related Party Transactions
|
Except
as set forth in “Item 6. Directors, Senior Management and Employees—D. Share Ownership”, to the best of our
knowledge, no other person who we know beneficially owns 5% or more of our ordinary shares outstanding as of April 15, 2018.
None of our shareholders has different voting rights from other shareholders. Other than as described herein, to the best of our
knowledge, we are not owned or controlled, directly or indirectly, by another corporation, by any foreign government or by any
natural person or legal persons, severally or jointly, and we are not aware of any arrangement that may, at a subsequent date,
result in a change of control of our company.
B.
|
Related
Party Transactions
|
The
following is a summary description of the material terms of those transactions with related parties to which we, or our subsidiaries,
are party and which were in effect since January 1, 2017:
Merger Related Amendments
On November 13, 2017,
Messrs. Hurgin and Aurovsky, the Company and the Bank Leumi Le-Israel Trust Company Ltd. amended an escrow agreement to change
the Put Option Period to the period commencing on January 1, 2019 and ending on March 1, 2021. Additionally on June 23, 2017, Messrs.
Hurgin and Aurovsky entered into an amendment to a tolling agreement. See “Item 4A-History and Development of the Company-Our
History”.
Irrevocable
Undertaking
On February 21, 2018,
Messrs. Hurgin and Aurovsky executed an Irrevocable Undertaking for our benefit. See “Item 5B. Operating and Financial Review
and Prospects—Liquidity and Capital Resources—Liquidity.”
Settlement
Amount
In
connection with a settlement arising out of an arbitration proceeding, (see “Item 8A. Financial Information
— Consolidated Statements and Other Financial Information — Legal Proceedings”) on March 30, 2017, and as
clarified on April 13, 2017, a legal expert determined that a settlement amount of NIS 9,527,000 (approximately $2,747,908),
including VAT, shall be allocated as follows: 70% of the settlement amount and the VAT shall be paid by us and the remaining
30% of the settlement amount shall be paid by Messrs. Hurgin and Aurovsky. On April 19, 2017, each of Messrs. Hurgin and
Aurovsky paid to us NIS 376,410 (approximately $98,000), or a total of NIS 752,820 (approximately $196,000) in compliance
with the arbitral award.
Employment
Agreements
We
have entered into employment agreements with each of our senior management. See “Item 6B. Directors, Senior Management and
Employees — Compensation - Employment Agreements with Senior Management.”
Indemnification
Our
amended and restated memorandum and articles of association provide for indemnification of officers and directors for any liability,
action, proceeding, claim, demand, costs, damages or expenses, including legal expenses, whatsoever which they or any of them
may incur as a result of any act or failure to act in carrying out their functions other than such liability (if any) that they
may incur by reason of their own actual fraud or willful default. We have procured a directors’ and officers’ liability
& company reimbursement insurance policy for our officers and directors and our wholly-owned subsidiaries. See “Item
6.B. Directors, Senior Management and Employees — Compensation – Indemnification and Insurance of Officers and Directors”.
Item 8.
|
Financial
Information
|
A.
|
Consolidated
Statements and Other Financial Information.
|
Financial
Statements
Consolidated
financial statements are set forth under “Item 18. Financial Statements.”
Legal
Proceedings
SEC
Investigation
As
we disclosed in our Report on Form 6-K furnished with the SEC on February 16, 2017, we received a subpoena from
the SEC. The subpoena requests, among other things, information regarding the transaction with Cambridge Capital Acquisition
Corporation, the restatement that occurred in May 2016, and financial and business information. In furtherance of the
investigation, the SEC has been obtaining testimony from Company officers among others. The Company and its officers are
fully cooperating with the investigation. As a result of the investigation, we may incur significant legal and accounting
expenses. Furthermore, we cannot predict what, if any, actions the SEC may take against us or any of our officers, or the
timing or duration of the investigation.
Re.
Ability Inc. Securities Litigation
On
May 25, 2016, a purported class action lawsuit, captioned In re Ability Inc. Securities Litigation, Master File No. 16-cv-03893-VM
(S.D.N.Y) was filed against us, Anatoly Hurgin and Avi Levin in the Southern District of New York in the United States. The complaint
asserts claims pursuant to Section 10(b) and 20(a) of the Exchange Act and Rule 10b-5 promulgated thereunder on behalf of a putative
class of all purchasers of the Company’s ordinary shares between September 8, 2015 and April 29, 2016. The complaint broadly
alleges that certain of the Company’s public statements were false, and that the Company materially overstated its income
and failed to disclose that it had material weaknesses in its internal controls. The complaint does not specify the amount of
damages sought. On July 25, 2016, a second purported class action lawsuit was filed against the Company, Anatoly Hurgin and Avi
Levin in the Southern District of New York in the United States. The complaint asserts claims pursuant to Section 10(b) and 20(a)
of the Exchange Act and Rule 10b-5 promulgated thereunder on behalf of a putative class of all purchasers of our ordinary shares
between September 8, 2015 and April 29, 2016. The complaint broadly alleges that the Company’s financial statements were
false and misleading and were not prepared in conformity with GAAP, nor was the financial information a fair presentation of our
operations. The complaint does not specify the amount of damages sought. These two putative class actions have been consolidated
into one action and co-lead plaintiffs have been appointed. In accordance with a schedule adopted by the court, co-lead plaintiffs
filed an amended complaint on April 28, 2017. In the amended complaint, co-lead plaintiffs have added Benjamin Gordon and BDO
Ziv Haft as defendants. The amended complaint asserts claims pursuant to Section 10(b) of the Exchange Act and Rule 10b-5 promulgated
thereunder against all defendants, a claim pursuant to Section 20(a) of the Exchange Act against Messrs. Hurgin, Levin and Gordon,
a claim pursuant to Section 11 of the Securities Act against us, BDO Ziv Haft and Messrs. Hurgin and Gordon, and a claim pursuant
to Section 15 of the Securities Act against Messrs. Hurgin, Levin and Gordon on behalf of a putative class of all purchasers of
the Company’s ordinary shares between September 8, 2015 and April 29, 2016. The amended complaint does not specify the amount
of damages sought. The complaint broadly alleges that certain of the Company’s public statements were false, that it had
material weaknesses in its internal controls, that its financial statements were false and misleading and were not prepared in
conformity with GAAP, nor was the financial information a fair presentation of the Company’s operations, and that its registration
statement contained material misstatements and omissions. On August 17, 2017, the court ordered a stipulated schedule recognizing
that all parties had agreed to a mediation on October 17, 2017 and all deadlines were reset until after that mediation took place.
On
December 21, 2017, the Company entered into a Memorandum of Understanding (“MOU”) to memorialize an agreement in
principle to settle all claims of participating class members in the class actions consolidated in the lawsuit captioned In
re Ability Inc. Securities Litigation, No. 16-cv-03893 (VM), pending in the Southern District of New York (the “New
York Class Action Litigation”). The MOU provides for an aggregate settlement payment of $3.0 million, which includes
all plaintiffs’ attorneys’ fees and expenses, as well as any other class notice and administrative fees related
to the resolution of the New York Class Action Litigation. On April 25, 2018, the motion for settlement was filed with the
court. The settlement includes the dismissal of all claims against the Company and the named individuals in the New York
Class Action Litigation. It is expected that $250,000 of the $3.0 million settlement amount will be funded by the Company and
the remaining $2.75 million will be funded with the Company’s insurance proceeds or contributed by other defendants.
The ultimate impact of this class action settlement on the Levy Litigation (Case No. 2015-CA-003339), Pottash Litigation
(Case No. 502016CA013823), Hammel Litigation (Case No. 50-2018-CA-000762-MB-AG) and the Ladragor Litigation (C.A.
8482-05-16), each as further described herein, has yet to be determined, however, some or all of the claims raised in such
other actions may be deemed to be resolved, settled and disposed of as part of such class action settlement.
The
Company intends to continue to attempt to settle and resolve the litigation. There is no assurance that the court will approve the settlement.
In
connection with the entry into of the MOU, the Company entered into an agreement with its insurer (the “Discharge Agreement”)
pursuant to which the Company agreed to discharge the insurer from liability with respect to any U.S. claims (excluding the Ladragor
Litigation in Israel) in consideration for an aggregate settlement amount of $5.0 million, of which $2.5 million is to be used
for settlement of the New York Class Action Litigation and the remaining amount is to be used to cover various defense and legal
costs. Accordingly, no insurance proceeds will be available for any U.S. claims other than with respect to the settlement of the
New York Class Action Litigation.
Levy
Litigation
On
October 15, 2015, plaintiff Brian Levy, purportedly on behalf of himself and all others similarly situated, filed a first amended
class action and derivative complaint against Cambridge Holdco Corp., Ability, the individual members of the Cambridge board of
directors, and plaintiff also named Cambridge Capital Acquisition Corp. and the Company as nominal defendants. in case number
2015CA003339 in the Circuit Court of the 15
th
Judicial Circuit in Palm Beach County, Florida. The complaint generally
alleged, among other things, that the members of the Cambridge board of directors breached their fiduciary duties to Cambridge
stockholders by approving the contemplated merger with Ability, and that Ability was aiding and abetting the Cambridge board of
directors in the alleged breach of their fiduciary duties. The action sought injunctive relief, damages and reimbursement of fees
and costs, among other remedies. On February 17, 2016, Ability filed a motion and supporting memorandum of law to dismiss the
plaintiff’s amended complaint on the grounds that the Court lacks personal jurisdiction over Ability; the derivative aiding
and abetting claim was extinguished by the closing of the Business Combination and the claims against Ability are insufficiently
pleaded. On September 15, 2016, the Court granted the defendants’ motion to dismiss in its entirety without prejudice, and
the Judge dismissed the amended complaint. However, the court provided the plaintiff with 45 days within which to file a further
amended complaint. On October 22, 2016, a second amended complaint was filed by the plaintiff. On January 17, 2017, the defendants
filed a motion to dismiss the second amended complaint on multiple grounds, including various pleading deficiencies that the plaintiff
has failed to adequately correct. On March 9, 2017, the plaintiff filed a response to the motion to dismiss. On June 21, 2017,
the Judge entered an order (the “June 21 Order”) granting a partial motion to dismiss as to the counts against Ability
due to lack of personal jurisdiction over Ability. Ability was therefore dismissed from the case without prejudice, and it is
unclear at this stage whether the plaintiff will attempt to bring Ability directly back into the action in the future. On the
other hand, pursuant to the Judge’s ruling, the Company still remains as a necessary party and named defendant in the case. In
the June 21 Order, the Judge also partially denied the motion to dismiss the second amended complaint, and the purported class
action and derivative claims against the individual defendants for alleged breach of fiduciary duties, failure to disclose and
ultra vires
acts still remain pending.
On
July 21, 2017, the Company and each of the individual defendants filed their answer and affirmative defenses raising numerous
substantive and legal defenses to the alleged claims set forth in the second amended complaint. On August 7, 2017, plaintiff’s
counsel filed a motion for class certification and incorporated memorandum of law. The Company and defendants filed papers in
opposition to such motion, and on March 13, 2018, the Court entered an order
denying
plaintiff’s motion for class
certification and providing that the plaintiff may attempt to file a further amended complaint within 30 days after the order
denying the request for class certification.
Plaintiff
has now filed a verified third amended class action and derivative complaint attempting to assert the same type of claims raised
in the defective second amended complaint. The Company intends to vigorously defend against such claims, and to continue to explore
potential opportunities to settle and resolve the litigation. If the case does not settle, it is impossible to predict the probable
outcome of these legal proceedings at this time in light of the relatively early stage of the proceedings.
Pottash
Litigation
On
December 13, 2016, a complaint, captioned
Pottash v. Benjamin Gordon et. al.
, Case No. 50-2016-CA-013823, was filed in
the 15th Circuit, Palm Beach County, Florida in the United States, against us, our former director, Benjamin Gordon, BG Strategic
Advisors, LLC, Cambridge Capital, LLC and Jonathan Morris, in his capacity as trustee of the Gordon Family 2007 Trust. On January
23, 2017, the plaintiff filed an amended complaint. On March 2, 2017, the Company filed a motion to dismiss all of the claims
asserted against it in the amended complaint. On the same day, Mr. Gordon and BG Strategic Advisors also filed motions seeking
the dismissal of the amended complaint in its entirety. On November 27, 2017, the plaintiff filed a second amended complaint against
the Company Benjamin Gordon and Jonathan Morris. The complaint alleges violations of Florida State securities laws, common law
fraud, negligent misrepresentation and conspiracy. On January 17, 2018, the Company filed a motion to dismiss seeking the dismissal
of all claims asserted against it on various legal grounds. The co-defendants also filed motions seeking dismissal of the second
amended complaint. The Court will be scheduling a special set hearing on the pending motions to dismiss. The Company intends to
continue vigorously defend against this action. It is impossible to predict the probable outcome of these legal proceedings at
this time in light of the relatively early stage of the proceedings.
Hammel
Litigation
On
January 19, 2018, a complaint, captioned Hammel v. Benjamin Gordon et. al (Case No. 50-2018-CA-000762-MB-AG), was filed in the
15th Circuit, Palm Beach County, Florida in the United States, against the Company, Benjamin Gordon and Jonathan Morris. The complaint
alleges that the defendants, through a series of misrepresentations and omissions, induced the plaintiff, Robert Hammel, to invest
in the stock of Cambridge. Plaintiff alleges to have lost more than $1.6 million due to the defendants’ conduct. In a summons
issued in February 26, 2018, the Company was also named as one of the defendants. The Company has received a service copy of the
complaint, and will be filing a motion to dismiss the claims asserted in the complaint on or before May 1, 2018. The Company intends
to vigorously defend against this action. Given that these proceedings are in the preliminary stage, the timing or outcome of
this matter cannot be predicted at this time.
Patent
Infringement Litigation
On
October 27, 2015, Ability received a notice alleging that its GSM interception and decryption systems allegedly fall within
the claims of an Israeli patent owned by the claimant. The notice demands an accounting of all such products manufactured,
exported, sold or otherwise commercialized by Ability and/or any entity on its behalf. On November 12, 2015, a lawsuit,
captioned Dr. Elad Barkan et al. v. Ability Computer & Software Industries Ltd. et al. C.C. 29551-11-15, alleging patent
infringement, violation of a non-disclosure agreement, trade secret misappropriation and unjust enrichment, was filed with
the Central District Court in Israel by a company and an individual against Ability and its controlling shareholders. The
amount sought in the lawsuit for registration fee purposes is NIS 5.0 million (approximately $1.4 million), however the
plaintiffs have not yet quantified the amount of the compensation demanded. Furthermore, the plaintiffs demanded that Ability
and/or its controlling shareholders immediately cease any infringement of the patent as well as any further use of the
claimed technology, including the further manufacture, export, sale or marketing of the alleged infringing products. On April
5, 2016, Ability and its controlling shareholders filed a statement of defense, and on April 13, 2016 a preliminary hearing
was held. On May 23, 2016, the plaintiffs filed a petition to add the Company, Ability Limited, a company wholly-owned by
Anatoly Hurgin, and ASM as defendants and to amend the statement of claim. The parties then agreed to appoint a mediator in
an attempt to settle the dispute out of court, and agreed, with the approval of the court, on a stay of proceedings until
September 2016. However, the parties did not reach an agreement by that time. On October 9, 2016, upon the Company’s
application and with the plaintiffs’ consent, the court decided to stay the proceedings until a decision is handed down
on a related pending application to the Israeli Patent Registrar to revoke the patent in dispute. On August 23, 2017, the
Deputy Patent Registrar decided to reject the revocation application, and on August 28, 2017 the plaintiffs informed the
court of the deputy registrar’s decision, and requested to resume the proceedings and instruct the defendants (the
Company and its controlling shareholders) to file their response to the petition to join the Company, Ability Limited and ASM
as defendants (a response was filed on September 25, 2017, and a rejoinder was filed by the plaintiffs on October 22, 2017).
On December 25, 2017, the defendants filed a petition to order the plaintiffs to deposit a guarantee for costs of the trial
(a response was filed on January 14, 2018, and a rejoinder was filed on January 17, 2018). A second preliminary hearing was
held on January 17, 2018, in which the court decided that the plaintiffs were allowed to amend the statement of claim without
having the consent either of the defendants or of the Company, Ability Limited and ASM to the content of the amended
statement of claim, and without waiving the right to request dismissal of the amended suit (partially or completely). The
court also decided that the petition to order the plaintiffs to deposit a guarantee will be adjudicated after the statement
of case is amended. On March 15, 2018 the plaintiffs filed an amended statement of claims against the original defendants, as
well as against the Company, Ability Limited and ASM. The defendants are required to file an amended statement of defense by
May 15, 2018. A third preliminary hearing was set to June 13, 2018. The Company intends to continue vigorously defend against
this action.
We believe that the suit’s probability of success, as filed, is less than even, and we intend to
vigorously defend against it.
In
addition, after the Deputy Patent Registrar decided to reject the revocation application on August 23, 2017, the patentee, Dr.
Barkan, filed an amended version of certain claims on September 28, 2017. The amendment was subject to opposition by third parties
until December 28, 2017. On December 27, 2017, the Company filed with the Patent Registrar an opposition to the request to have
the specification of the patent amended. On March 15, 2018, the Company filed its statement of claims, arguing that the request
should be dismissed for various reasons. Dr. Barkan is required to file his statement of claims by June 15, 2018.
Ladragor
Litigation
On
May 4, 2016, the Company was served with a lawsuit and a motion for the certification of the lawsuit as class action, captioned
Ladragror v. Ability Inc. et al. C.A. 8482-05-16, in the Tel Aviv District Court in Israel, filed, against the Company, Anatoly
Hurgin, Alexander Aurovsky, and Benjamin Gordon and Mitchell Gordon. The claim alleges, among other things, that the Company misled
the public in our public filings with regard to its financial condition and included misleading information (or omitted to include
relevant information) in its financial statements published in connection with the January 12, 2016 listing of shares for trading
on the Tel Aviv Stock Exchange. In addition, the claim alleges that the defendant directors breached their fiduciary duty under
Israeli law towards the Company and its public shareholders. The claim alleges that the plaintiff suffered personal damages of
NIS 137.7 (approximately $39.7), and estimates that its shareholders suffered damages of approximately NIS 23.3 million (approximately
$6.72 million). On September 15, 2016, the Company filed a motion for a stay of proceedings, due to other pending class action
lawsuits in the United States that also relate (among other things) to the stated causes of action and based on similar claims.
The Court required the parties to update the Court on the status of the United States class actions by March 15, 2017. On March
15, 2017, the plaintiff filed an update and requested that proceedings be stayed until the completion of the internal investigation
of the audit committee. On the same day, the Company filed a separate update with respect to the United States class actions,
together with a motion for a stay of proceedings pending resolution of the consolidated United States class actions. On March
16, 2017, the Court held that the plaintiff must respond to the motion to stay proceedings pending resolution of the consolidated
United States class actions. On March 26, 2017, the plaintiff filed a partial response, requesting an extension until May 15,
2017 to file a full response, alleging that the publication of the Company’s annual financial statements, together with
the findings of the internal investigation, would affect its position on its motion to stay proceedings. On May 23, 2017, the
Court granted the plaintiff the requested extension. On May 15, 2017, the plaintiff filed a motion asking for an additional three
month extension to file a full response, among other things, as the Company had not filed its annual financial statements or published
the findings of the internal investigation. On August 14, 2017, the Company and Messrs. Hurgin and Aurovsky filed a notice regarding
their counsel substitution. In light of this, the judge decided on August 27, 2017 to recuse herself from the case. On August
21, 2017, the plaintiff filed a motion and an updated notice in which he claimed that the Company had not yet published the report
of the internal investigation, and hence the reasons for granting him a continuance to file his response to the motion to stay
of proceedings are still relevant. The plaintiff also informed the Court that in the U.S. proceedings, the parties agreed to mediation,
and the mediation meeting was scheduled in October 2017. The plaintiff asked the Court to file an update notice in 90 days. On
August 28, 2017, the Court ordered the parties to file an update notice on September 28, 2017. On September 28, 2017 and November
7, 2017 the plaintiff, the Company, and Messrs. Hurgin and Aurovsky updated the Court that the mediation process in the U.S. was
still pending. On November 8, 2017, the Court ordered the parties to file an update notice in 90 days. On February 7, March 7
and April 12, 2018, the parties updated the Court that they are holding negotiations in order to settle the case, and requested
extensions for filing the update notice. The parties are required to file the abovementioned notice on May 8, 2018. The Company
intends to attempt to settle and resolve the litigation. If the case does not settle, the Company intends to continue vigorously
defend against this action. Given that the proceeding is currently suspended, the timing or outcome
of this matter cannot be predicted at this time. As referenced above in Re. Ability Inc. Securities Litigation, the Ladragor Litigation is not subject to the Discharge Agreement.
Israeli Arbitration
In January 2015, Ability,
Messrs. Anatoly Hurgin and Alexander Aurovsky, and a third party plaintiff entered into an arbitration process, following a claim
filed with the Tel Aviv Magistrates Court in October 2014 by the plaintiff against Ability and its former shareholders, claiming
a right to review Ability’s accounts and reserving the right to file a monetary claim. On September 14, 2016, the plaintiff
presented the defendants with a settlement proposal for the resolution of all claims against the defendants and any entity affiliated
with them in exchange of the full and final payment of an amount of NIS 8,450,000 (approximately $2,437,265), which was subsequently
approved by the Company’s board of directors. On or about the time of the board meeting at which (among things) the settlement
proposal was approved, the plaintiff made claims that the proposal did not include VAT and that a settlement agreement has not
been entered into between the parties. This dispute was referred to a new arbitration process, at the conclusion of which, a settlement
was reached, according to which the parties agreed that the plaintiff would receive a total of NIS 8,142,000 (approximately $2,348,428),
plus VAT. Thereafter, on February 20, 2017, such settlement was approved by the arbitrator and was made an arbitral award. Following
the arbitral award and according to the determination of the Company’s board of directors, the Company appointed an independent
legal expert acting as an arbitrator to make a final determination as to the allocation of the settlement amount between the Company
and Messrs. Hurgin and Aurovsky. On March 30, 2017, and as clarified on April 13, 2017, the legal expert determined that the Company
shall be required to pay 70% of the settlement amount and the VAT and the remaining 30% of the settlement amount shall be paid
by Messrs. Hurgin and Aurovsky. During the year ended December 31, 2017, the Company paid the entire settlement amount which was
recorded during the year ended December 31, 2016 and in connection therewith, on April 19, 2017, each of Messrs. Hurgin and Aurovsky
paid to the Company NIS 376,410 (approximately $108,569), or a total of NIS 752,820 (approximately $217,138) constituting their
portion of the settlement amount.
Dividend
Policy
Our
board of directors currently intends to retain all earnings, if any, for use in our business operations and, accordingly, does
not anticipate declaring any dividends in the near future. Payment of dividends is within the discretion of our board of directors
and will be contingent upon our future revenues and earnings, if any, capital requirements and general financial condition. In
accordance with the laws of the Cayman Islands, no dividend or other distribution shall be paid except out of our realized or
unrealized profits, out of the share premium account or as otherwise permitted by law.
Payment
of dividends may be subject to Israeli withholding taxes. See “Item 10E. Additional Information—Taxation—Israeli
Taxation— Taxation of non-Israeli stockholders on receipt of dividends.”
Except
as disclosed elsewhere in this Annual Report, there have been no other significant changes in the period from December 31, 2017,
and until the date of the filing of this Annual Report.
Item
9.
|
The
Offer and Listing
|
On
December 24, 2015, our ordinary shares and warrants began trading on the NASDAQ Capital Market under the symbol
“ABIL” and “ABILW,” respectively. Our warrants were delisted on April 18, 2016 and since such date
have traded on “the OTC Pink” under the symbol “ABIWF.” Since January 12, 2016, our ordinary
shares are also traded on the Tel Aviv Stock Exchange under the symbol “ABIL.”
NASDAQ
Capital Market (Ordinary Shares)
The
following table sets forth, for the periods indicated, the high and low sales prices of our ordinary shares for the periods indicated.
On
December 27, 2017, we implemented a 1-for-10 consolidation of our ordinary shares with a market effective date of March 23, 2018.
Reported prices in the table below have been adjusted to give retroactive effect to the consolidation.
|
|
Ordinary
Shares ($)
|
|
|
|
High
|
|
|
Low
|
|
Annual:
|
|
|
|
|
|
|
2017
|
|
|
34.90
|
|
|
|
3.95
|
|
2016
|
|
|
101.60
|
|
|
|
26.00
|
|
2015 (from December 24, 2015)
|
|
|
99.00
|
|
|
|
90.00
|
|
|
|
|
|
|
|
|
|
|
Quarterly:
|
|
|
|
|
|
|
|
|
First Quarter 2018
|
|
|
5.60
|
|
|
|
3.28
|
|
Fourth Quarter 2017
|
|
|
8.24
|
|
|
|
3.95
|
|
Third Quarter 2017
|
|
|
12.00
|
|
|
|
5.90
|
|
Second Quarter 2017
|
|
|
19.00
|
|
|
|
5.70
|
|
First Quarter 2017
|
|
|
34.90
|
|
|
|
19.80
|
|
Fourth Quarter 2016
|
|
|
38.40
|
|
|
|
26.00
|
|
Third Quarter 2016
|
|
|
55.60
|
|
|
|
37.09
|
|
Second Quarter 2016
|
|
|
74.60
|
|
|
|
27.00
|
|
First Quarter 2016
|
|
|
101.60
|
|
|
|
60.20
|
|
|
|
|
|
|
|
|
|
|
Most Recent Six Months:
|
|
|
|
|
|
|
|
|
April 2018 (through April 27, 2018)
|
|
|
3.35
|
|
|
|
2.60
|
|
March 2018
|
|
|
4.10
|
|
|
|
3.28
|
|
February 2018
|
|
|
4.50
|
|
|
|
3.60
|
|
January 2018
|
|
|
5.60
|
|
|
|
4.50
|
|
December 2017
|
|
|
5.05
|
|
|
|
3.95
|
|
November 2017
|
|
|
6.52
|
|
|
|
5.10
|
|
October 2017
|
|
|
8.24
|
|
|
|
6.20
|
|
On
April 27, 2018, the last reported sale price of our ordinary shares on the NASDAQ Capital Market was $2.64.
Tel
Aviv Stock Exchange (Ordinary Shares)
The
following table sets forth, for the periods indicated since January 12, 2016, the reported high and low sales prices of our ordinary
shares on the TASE in NIS and U.S. dollars at the exchange rate published by the Bank of Israel on the date of the reported high
or low sales price, as applicable.
On
December 27, 2017, we implemented a 1-for-10 consolidation of our ordinary shares with a market effective date of March 23, 2018.
Reported prices in the table below have been adjusted to give retroactive effect to the consolidation.
|
|
NIS
|
|
|
$
|
|
|
|
Price Per Ordinary Share
|
|
|
Price Per Ordinary Share
|
|
|
|
High
|
|
|
Low
|
|
|
High
|
|
|
Low
|
|
Annual
|
|
|
|
|
|
|
|
|
|
|
|
|
2017
|
|
|
136.50
|
|
|
|
12.19
|
|
|
|
35.70
|
|
|
|
3.49
|
|
2016 (from January 12, 2016)
|
|
|
382.10
|
|
|
|
102.10
|
|
|
|
96.90
|
|
|
|
26.70
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarterly:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
First Quarter 2018
|
|
|
18.10
|
|
|
|
12.19
|
|
|
|
5.30
|
|
|
|
3.49
|
|
Fourth Quarter 2017
|
|
|
28.21
|
|
|
|
14.01
|
|
|
|
8.00
|
|
|
|
4.00
|
|
Third Quarter 2017
|
|
|
44.87
|
|
|
|
20.84
|
|
|
|
12.70
|
|
|
|
5.80
|
|
Second Quarter 2017
|
|
|
73.21
|
|
|
|
20.47
|
|
|
|
20.20
|
|
|
|
5.80
|
|
First Quarter 2017
|
|
|
136.50
|
|
|
|
77.40
|
|
|
|
35.70
|
|
|
|
21.40
|
|
Fourth Quarter 2016
|
|
|
133.10
|
|
|
|
102.10
|
|
|
|
34.70
|
|
|
|
26.70
|
|
Third Quarter 2016
|
|
|
171.00
|
|
|
|
144.70
|
|
|
|
45.40
|
|
|
|
38.30
|
|
Second Quarter 2016
|
|
|
166.50
|
|
|
|
108.30
|
|
|
|
43.20
|
|
|
|
28.00
|
|
First Quarter 2016 (from January 12, 2016)
|
|
|
382.10
|
|
|
|
231.90
|
|
|
|
96.90
|
|
|
|
60.60
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Most Recent Six Months:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
April 2018 (through April 29, 2018)
|
|
|
11.85
|
|
|
|
9.68
|
|
|
|
3.37
|
|
|
|
2.69
|
|
March 2018
|
|
|
13.86
|
|
|
|
12.19
|
|
|
|
4.00
|
|
|
|
3.49
|
|
February 2018
|
|
|
15.50
|
|
|
|
13.07
|
|
|
|
4.50
|
|
|
|
3.70
|
|
January 2018
|
|
|
18.10
|
|
|
|
15.82
|
|
|
|
5.30
|
|
|
|
4.70
|
|
December 2017
|
|
|
17.89
|
|
|
|
14.01
|
|
|
|
5.20
|
|
|
|
4.00
|
|
November 2017
|
|
|
23.22
|
|
|
|
17.22
|
|
|
|
6.60
|
|
|
|
4.90
|
|
October 2017
|
|
|
28.21
|
|
|
|
22.75
|
|
|
|
8.00
|
|
|
|
6.40
|
|
On
April 29, 2018, the last reported sale price of our ordinary shares on the TASE was NIS 9.68 per share, or $2.69 per
share (based on the exchange rate reported by the Bank of Israel on such date, which was NIS 3.597 = $1.00).
Not
applicable.
C.
|
Markets
for Ordinary Shares
|
On
December 24, 2015, our ordinary shares and warrants began to trade on the NASDAQ Capital Market under the symbol “ABIL”
and “ABILW,” respectively. Our warrants were delisted on April 18, 2016 and since such date have traded on the OTC
Pink under the symbol “ABIWF.” Since January 12, 2016, our ordinary shares have also traded on the Tel Aviv Stock
Exchange under the symbol “ABIL.”
Not
applicable.
Not
applicable.
Not
applicable.
Item 10.
|
Additional Information
|
Not
applicable.
B.
|
Memorandum
and Articles of Association
|
Registered
Office and Objectives
We
are registered with the Cayman Island’s Registrar of Companies under registration number 303448. The objects and purposes for
which the Company is established, as set forth in Article 3 of our amended and restated memorandum of association, are unrestricted
and we shall have full power and authority to carry out any object not prohibited by the laws of the Cayman Islands.
Ordinary
Shares
Voting
.
Holders of our ordinary shares have one vote per ordinary share on all matters submitted to a vote of shareholders at a shareholder
meeting. Shareholders may vote at shareholder meetings either in person or by proxy.
Transfer
of Shares
. Fully paid ordinary shares are issued in registered form and may be freely transferred under our amended and
restated articles of association unless the transfer is restricted or prohibited by another instrument, Cayman Islands law or
the rules of a stock exchange on which the shares are traded by an instrument of transfer-in the usual or common form or any other
form approved by our board of directors. Our board of directors may, in its absolute discretion, decline to register any transfer
of shares without assigning any reason therefor. If our board of directors refuses to register a transfer they shall notify the
transferee within two months of such refusal.
Variation
of Rights
. If at any time our share capital is divided into different classes of shares, all or any of the rights attached
to any class may be varied without the consent of the holders of the issued shares of such class where such variation is considered
by the board of directors not to have a material adverse effect upon such rights. Otherwise, any such variation shall be made
with either:
|
(i)
|
the
consent in writing of the holders of not less than two thirds of the issued shares of that class; or
|
|
(ii)
|
the
sanction of a resolution passed by a majority of not less than two thirds of the votes cast at a separate meeting of the holders
of the shares of that class. For any such meeting, the necessary quorum shall be one person holding or representing by proxy
at least one third of the issued shares of the class.
|
Alteration
of Capital
. We may by ordinary resolution: (a) increase our share capital; (b) consolidate and divide all or any of our
share capital into shares of larger amount than our existing shares; (c) convert all or any of our paid-up shares into stock,
and reconvert that stock into paid-up shares of any denomination; (d) by subdivision of our existing shares or any of them, divide
the whole or any part of our share capital into shares of smaller amounts or into shares without par value; and (e) cancel any
shares that at the date of the passing of the ordinary resolution have not been taken or agreed to be taken by any person and
diminish the amount of our share capital by the amount of the shares so cancelled.
Subject
to the provisions of the Companies Law, we may by special resolution reduce our share capital or any capital redemption reserve
fund.
Redemption
of Shares
. Subject to the provisions of the Companies Law, we may issue shares that are to be redeemed or are liable to
be redeemed at the option of the shareholder or us. The redemption of such shares shall be effected in such manner and upon such
other terms as we may, by special resolution, determine before the issue of the shares.
Call
on Shares and Forfeiture of Shares.
Subject to the terms of the allotment and issue of any shares, the directors may make
calls upon the shareholders in respect of any monies unpaid on their shares (whether in respect of par value or premium), and
each shareholder shall (subject to receiving at least 14 clear days’ notice specifying the time or times of payment) pay to us
at the time or times so specified the amount called on the shares. A call may be revoked or postponed, in whole or in part, as
the directors may determine. A person upon whom a call is made shall remain liable for calls made upon him notwithstanding the
subsequent transfer of the shares in respect of which the call was made.
If
a call or installment of a call remains unpaid after it has become due and payable, the directors may give to the person from
whom it is due not less than 14 clear days’ notice requiring payment of the amount unpaid together with any interest which may
have accrued and any expenses incurred by us by reason of such non-payment. The notice shall specify where payment is to be made
and shall state that if the notice is not complied with the shares in respect of which the call was made will be liable to be
forfeited.
Appointment
of Directors
Our
ordinary shares do not have cumulative voting rights for the appointed of directors. Rather, under our amended and restated articles
of association, our directors are appointed by the holders of a simple majority of our ordinary shares at a general shareholder
meeting (excluding abstentions). As a result, the holders of our ordinary shares that represent more than 50% of the voting power
represented at a shareholder meeting and voting thereon (excluding abstentions) have the power to appoint any or all of our directors
whose positions are being filled at that meeting. In addition, under our amended and restated articles of association, vacancies
on our board of directors may be filled by a vote of a simple majority of the directors then in office.
A
director is not required to hold any shares in the Company by way of qualification. A director may vote with respect to any contract,
proposed contract or arrangement in which he is materially interested (provided that such director has provided prior notice).
The directors may exercise all the powers of the Company to borrow money, mortgage its undertakings, property and uncalled capital,
and issue debentures or other securities whenever money is borrowed or as security for any obligation of the Company or of any
third party. The remuneration to be paid to the directors is determined by the board of directors, which has currently delegated
such authority to the compensation committee with respect to directors who are not independent directors. There is no age limit
requirement for directors.
Dividend
and Liquidation Rights
The
holders of our ordinary shares are entitled to receive the dividends that are declared and approved by the board of directors.
Dividends may be paid only out of profits, which include net earnings and retained earnings undistributed in prior years, and
out of share premium, a concept analogous to paid-in-surplus in the United States, subject to a statutory solvency test. Any dividend
or other distribution which cannot be paid to a member and/or which remains unclaimed after six months from the date on which
such dividend or other distribution becomes payable may, in the discretion of the directors, be paid into a separate account in
the Company’s name, provided that we shall not be constituted as a trustee in respect of that account and the dividend or
other distribution shall remain as a debt due to the shareholder. Any dividend or other distribution which remains unclaimed after
a period of six years from the date on which such dividend or other distribution becomes payable shall be forfeited and shall
revert to us.
On
liquidation, a liquidator may divide our assets, among the shareholders, in cash or in kind, in whole or in part, in a manner
proportionate to their shareholdings.
Shareholder
Meetings
Each
ordinary share entitles the holder thereof to one vote on a show of hands and one vote in respect to each ordinary share held
by that shareholder on a poll, on all matters upon which the ordinary shares are entitled to vote, including the election of directors.
Voting at any meeting of shareholders is by a poll. A poll shall be taken as the chairman directs, and the result of the poll
shall be deemed to be the resolution of the general meeting at which the poll was demanded. Votes may be cast either personally
or by proxy (or in the case of a corporation or other non-natural person by its duly authorized representative or proxy). A shareholder
may appoint more than one proxy or the same proxy under one or more instruments to attend and vote at a meeting. Where a shareholder
appoints more than one proxy the instrument of proxy shall state which proxy is entitled to vote on a show of hands and shall
specify the number of shares in respect of which each proxy is entitled to exercise the related votes.
No
business shall be transacted at any general meeting unless a quorum is present. Two shareholders being individuals present in
person or by proxy or, if a corporation or other non-natural person, by its duly authorized representative or proxy, shall be
a quorum unless we have only one shareholder entitled to vote at such general meeting in which case the quorum shall be that one
shareholder present in person or by proxy or (in the case of a corporation or other non-natural person) by its duly authorized
representative or proxy. If a quorum is not present within half an hour from the time appointed for the meeting to commence or
if during such a meeting a quorum ceases to be present, the meeting, if convened upon a shareholder’s requisition, shall
be dissolved and in any other case it shall stand adjourned to the same day in the next week at the same time and/or place or
to such other day, time and/or place as the directors may determine, and if at the adjourned meeting a quorum is not present within
half an hour from the time appointed for the meeting to commence, the shareholders present shall be a quorum. Under the amended
and restated memorandum and articles of association, we may, but are not obliged to (unless required by the Companies Law), in
each year hold a general meeting as our annual general meeting. However, we intend to hold shareholders’ meetings annually
and shareholders’ meetings may be convened by the board of directors on its own initiative. Subject to the amended and restated
memorandum and articles of association, advance notice of at least five clear days is required for the convening of shareholders’
meetings. Every notice shall specify the place, the day and the hour of the meeting and the general nature of the business to
be conducted at the general meeting
Any
ordinary resolution to be made by the shareholders requires the affirmative vote of a simple majority of the votes attaching to
the ordinary shares cast, while a special resolution requires the affirmative vote of at least two-thirds of the votes cast attaching
to the ordinary shares. Holders of ordinary shares have the power, among other things, to appoint directors, appoint auditors
and make changes in the amount of our authorized share capital.
Material
issues that require a special resolution of the shareholders under the Companies Law include resolutions to alter the amended
and restated memorandum of association with respect to any objects, powers or other matters specified therein, any alteration
of the amended and restated articles of association, any reduction of capital, any change of name, the appointment of an inspector
for examining the affairs of the Company, requiring the Company to be wound up by a court, any voluntary winding up, delegating
to creditors the power of appointing liquidators, making binding arrangements between the Company and its creditors, and sanctioning
the transfer of the business or property of the Company being wound up to another company whether established in the Cayman Islands
or in any other jurisdiction.
Inspection
of Books and Records.
No
holders of our ordinary shares who is not a director shall have any right of inspecting any of our accounts, books or documents
except as conferred by the Companies Law or authorized by the directors or by us in general meeting. However, we will make this
Annual Report, which contains our audited financial statements, available to shareholders
Differences
in Corporate Law
The
Companies Law of the Cayman Islands is modeled after that of England but does not follow recent United Kingdom statutory enactments
and differs from laws applicable to United States corporations and their shareholders. The following paragraphs are a summary
of the significant differences between the provisions of the Companies Law applicable to us and the laws applicable to companies
incorporated in the United States and to their shareholders.
Mergers
and Similar Arrangements
. The Companies Law provides that a merger or consolidation may occur between any of the following:
(a) one or more companies incorporated in the Cayman Islands under the Companies Law and one or more companies incorporated under
the laws of a jurisdiction outside the Cayman Islands; or (b) two or more companies incorporated in the Cayman Islands under the
Companies Law. For these purposes, (i) “merger” means the merging of two or more constituent companies and the vesting
of their undertaking, property and liabilities in one of such companies as the surviving company and (ii) “consolidation”
means the combination of two or more constituent companies into a consolidated company and the vesting of the undertaking, property
and liabilities of such companies to the consolidated company. Such a merger or consolidation does not need court approval for
a company limited by shares (but not segregated portfolio companies).
A
merger or consolidation will involve, amongst other things, the directors of each constituent company participating in a merger
or consolidation approving a written plan of merger or consolidation on behalf of that company which complies with the requirements
of the Companies Law. The written plan of merger or consolidation approved by the directors must generally be authorized by resolution
of the shareholders of each constituent company participating in the merger or consolidation, subject to and in accordance with
the Companies Law. The consent of each holder of a fixed or floating security interest of a constituent company participating
in a proposed merger or consolidation should also be obtained, although the courts of the Cayman Islands have a discretion to
waive such requirement upon such terms as to the security to be issued by the consolidated or surviving company as the court considers
reasonable.
A
dissenting member of a Cayman Islands company proposing to participate in a merger or consolidation has a limited entitlement
to provide a written objection to the proposed action and to receive payment of the fair value of his shares in accordance with
the provisions of the Companies Law.
If
a merger or consolidation is effected in accordance with the Companies Law:
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the
rights, property, business, undertaking, goodwill, benefits, immunities and privileges of each of the constituent companies
immediately vest in the surviving or consolidated company;
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subject
to any specific arrangements entered into by the relevant parties, the surviving or consolidated company is liable for and
subject, in the same manner as the constituent companies, to all mortgages, charges or security interests, and all contracts,
obligations, claims, debts, and liabilities of each of the constituent companies;
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an
existing claim, cause or proceeding, whether civil (including arbitration) or criminal pending at the time of the merger or
consolidation by or against a constituent company, is continued by or against the surviving or consolidated company; and
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a
conviction, judgment, ruling, order or claim, due or to become due, against a constituent company, applies to the surviving
or consolidated company instead of to the constituent company.
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Cayman
Islands law also provides statutory provisions which facilitate the reconstruction and amalgamation of companies, provided that
the arrangement in question is approved by a majority in number of each class of shareholders and creditors with whom the arrangement
is to be made, and who must in addition represent three-fourths in value of each class of shareholders or creditors, as the case
may be, that are present and voting either in person or by proxy at a meeting or meetings convened for that purpose. The convening
of the meetings and subsequently the arrangement must be sanctioned by the Grand Court of the Cayman Islands. While a dissenting
shareholder would have the right to express to the court the view that the transaction ought not to be approved, the court can
be expected to approve the arrangement if it satisfies itself that:
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the
parties have complied with the statutory provisions regarding majority vote;
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the
shareholders have been fairly represented at the meeting in question; and
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the
arrangement is one that a businessman would reasonably approve.
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When
a take-over offer is made and accepted by holders of 90% in value of the shares within four months, the offeror may, within a
two-month period require the holders of the remaining shares to transfer these shares on the terms of the offer. An objection
can be made to the Grand Court of the Cayman Islands but this is unlikely to succeed unless there is evidence of fraud, bad faith
or collusion.
If
the arrangement and reconstruction is approved, the dissenting shareholder would have no rights comparable to appraisal rights,
which would otherwise ordinarily be available to dissenting shareholders of United States corporations, providing rights to receive
payment in cash for the judicially determined value of the shares.
Shareholders’
Suits
. Our Cayman Islands counsel is not aware of any reported class action having been brought in a Cayman Islands court.
Derivative actions have been brought in the Cayman Islands courts, and the Cayman Islands courts have confirmed the availability
for such actions. In most cases, we will be the proper plaintiff in any claim based on a breach of duty owed to us, and a claim
against (for example) our officers or directors usually may not be brought by a shareholder. However, based on English authorities,
which would in all likelihood be of persuasive authority and be applied by a court in the Cayman Islands, exceptions to the foregoing
principle apply in circumstances in which:
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a
company is acting, or proposing to act, illegally or beyond the scope of its authority;
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the
act complained of, although not beyond the scope of the authority, could be effected if duly authorized by more than the number
of votes which have actually been obtained; or
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those
who control the Company are perpetrating a “fraud on the minority.”
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A
shareholder may have a direct right of action against us where the individual rights of that shareholder have been infringed or
are about to be infringed.
We
have not entered into any material contracts other than in the ordinary course of business and other than those described in “Item
4. Information on the Company” or elsewhere in this Annual Report.
Under
Cayman Islands law, non-residents of the Cayman Islands may freely hold, vote and transfer ordinary shares in the same manner
as Cayman Islands residents, subject to the provisions of the Companies Law and our amended and restated memorandum and articles
of association. There is no exchange control legislation in the Cayman Islands or any laws or regulations which affect the remittance
of dividends, interest or other payments to non-resident holders of our securities.
The
following description is not intended to constitute a complete analysis of all tax consequences relating to the acquisition, ownership
and disposition of our ordinary shares. You should consult your own tax advisor concerning the tax consequences of your particular
situation, as well as any tax consequences that may arise under the laws of any state, local, foreign or other taxing jurisdiction.
Cayman
Islands Taxation
The
Cayman Islands currently levies no taxes on individuals or corporations based upon profits, income, gains or appreciation and
there is no taxation similar to inheritance tax or estate duty. There are no other taxes likely to be material to us levied by
the Government of the Cayman Islands except for stamp duties that may be applicable on instruments executed in, or after execution
brought within, the jurisdiction of the Cayman Islands. There are no exchange control regulations or currency restrictions in
the Cayman Islands.
We
have received an undertaking from the Financial Secretary of the Cayman Islands that, in accordance with Section 6 of the Tax
Concessions Law (2018 Revision) of the Cayman Islands, for a period of 20 years from the date of the undertaking, no law which
is enacted in the Cayman Islands imposing any tax to be levied on profits, income, gains or appreciations shall apply to the Company
or its operations and, in addition, that no tax to be levied on profits, income, gains or appreciations or which is in the nature
of estate duty or inheritance tax shall be payable (i) on or in respect of the shares, debentures or other obligations of the
Company or (ii) by way of the withholding in whole or in part of a payment of dividend or other distribution of income or capital
by the Company to its members or a payment of principal or interest or other sums due under a debenture or other obligation of
the Company.
No
stamp duties are payable on the issue or transfer of shares. An agreement to transfer shares may be subject to stamp duty if the
agreement is executed in the Cayman Islands or, if executed outside the Cayman Islands, subsequently brought into the Cayman Islands.
The Stamp Duty Law (2013 Revision) does not provide who is liable to pay stamp duty on any document but, in practice, the person
who seeks to rely on the document in any civil court proceedings will be required to pay stamp duty in order to have the document
admitted in evidence.
United
States Federal Income Taxation
The following is a description
of the material U.S. federal income tax consequences to a U.S. Holder (as defined below) of the acquisition, ownership and disposition
of our ordinary shares. This description addresses only the U.S. federal income tax consequences to holders of our ordinary shares
in the United States that will hold our ordinary shares as capital assets (generally, property held for investment) for U.S. federal
income tax purposes. This description does not address many of the tax considerations applicable to holders that may be subject
to special tax rules, including, without limitation:
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banks,
certain financial institutions or insurance companies;
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real
estate investment trusts, regulated investment companies or grantor trusts;
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dealers
or traders in securities, commodities or currencies;
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certain
former citizens or long-term residents of the United States;
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persons
that received our shares as compensation for the performance of services;
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persons
that will hold our shares as part of a “hedging,” “integrated” or “conversion” transaction
or as a position in a “straddle” for U.S. federal income tax purposes;
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partnerships
(including entities classified as partnerships for U.S. federal income tax purposes) or other pass-through entities, or holders
that will hold our shares through such an entity;
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persons
whose “functional currency” is not the U.S. Dollar;
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persons
that own directly, indirectly or through attribution 10% or more of the voting power or value of our shares; or
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persons
holding our ordinary shares in connection with a trade or business conducted outside the United States.
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Moreover,
this description does not address the U.S. federal estate, gift or alternative minimum tax consequences, or any state, local or
foreign tax consequences, of the acquisition, ownership and disposition of our ordinary shares.
This description is based
on the U.S. Internal Revenue Code of 1986, as amended, (the “Code”), existing, proposed and temporary U.S. Treasury
Regulations and judicial and administrative interpretations thereof, in each case as available on the date hereof. All of the
foregoing is subject to change, which change could apply retroactively and could affect the tax consequences described below.
There can be no assurance that the U.S. Internal Revenue Service (“IRS”) will not take a different position concerning
the tax consequences of the acquisition, ownership and disposition of our ordinary shares or that the IRS’s position would
not be sustained.
For
purposes of this description, a “U.S. Holder” is a beneficial owner of our ordinary shares that, for U.S. federal
income tax purposes, is:
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a
citizen or resident of the United States;
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a
corporation (or other entity treated as a corporation for U.S. federal income tax purposes) created or organized in or under
the laws of the United States or any jurisdiction thereof; or
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an estate the income of which is subject to United States federal income taxation regardless of its source;
or
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a trust if (1) a court within the United States is able to exercise primary supervision over the administration
of the trust and one or more United States persons have the authority to control all of the substantial decisions of such trust;
or (2) such trust has a valid election in effect to be treated as a United States person for U.S. federal income tax purposes.
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If
a partnership (or any other entity treated as a partnership for U.S. federal income tax purposes) holds our ordinary shares, the
tax treatment of a partner in such partnership will generally depend on the status of the partner and the activities of the partnership.
Such a partner or partnership should consult its tax advisor as to its tax consequences.
Holders
should consult their tax advisors with respect to the U.S. federal, state, local and foreign tax consequences of acquiring, owning
and disposing of our ordinary shares.
Distributions
Subject to the discussion
below under “Passive Foreign Investment Company Considerations,” the gross amount of any distribution made to a U.S.
Holder with respect to our ordinary shares before reduction for any Israeli taxes withheld therefrom generally will be includible
in the U.S. Holder’s income as dividend income to the extent the distribution is paid out of our current or accumulated
earnings and profits as determined under U.S. federal income tax principles. Subject to the discussion below under “Passive
Foreign Investment Company Considerations,” non-corporate U.S. Holders may qualify for the lower rates of taxation with
respect to dividends on ordinary shares applicable to long-term capital gains (i.e., gains from the sale of capital assets held
for more than one year) provided that certain conditions are met, including certain holding period requirements and the absence
of certain risk reduction transactions. However, dividends on our ordinary shares will not be eligible for the dividends received
deduction generally allowed to corporate U.S. Holders. Subject to the discussion below under “Passive Foreign Investment
Company Considerations,” to the extent that the amount of any distribution by us exceeds our current and accumulated earnings
and profits as determined under U.S. federal income tax principles, it will be treated first as a tax-free return of tax basis
in our ordinary shares and thereafter as capital gain. We do not expect to maintain calculations of our earnings and profits under
U.S. federal income tax principles and, therefore, U.S. Holders should expect that the entire amount of any distribution generally
will be reported as dividend income.
Dividends paid to U.S.
Holders with respect to our ordinary shares will generally be treated as foreign source income, which may be relevant in calculating
a U.S. Holder’s foreign tax credit limitation. Subject to certain conditions and limitations, Israeli tax withheld on dividends
may be deducted from taxable income or credited against U.S. federal income tax liability. An election to deduct foreign taxes
instead of claiming foreign tax credits for a taxable year applies to all foreign taxes paid or accrued in such taxable year. The
limitation on foreign taxes eligible for credit is calculated separately with respect to specific classes of income. For this purpose,
dividends that we distribute generally should constitute “passive category income,” or, in the case of certain U.S.
Holders, “general category income.” A foreign tax credit for foreign taxes imposed on distributions may be denied if
certain minimum holding period requirements are not satisfied. The rules relating to the determination of the foreign tax credit
are complex, and U.S. Holders should consult their tax advisors to determine whether and to what extent they will be entitled to
this credit.
The amount of a distribution
will equal the U.S. dollar value of any foreign currency received, calculated by reference to the exchange rate in effect
on the date that distribution is received, whether or not a U.S. Holder in fact converts any such foreign currency received into
U.S. dollars at that time. If the foreign currency is converted into U.S. dollars on the date of receipt, a U.S. Holder generally
will not be required to recognize foreign currency gain or loss with respect to the distribution. A U.S. Holder may have foreign
currency gain or loss if the foreign currency is converted into U.S. dollars after the date of receipt, depending on the exchange
rate at the time of conversion. Any gains or losses resulting from the conversion of foreign currency into U.S. dollars generally
will be treated as ordinary income or loss, as the case may be, and generally will be treated as U.S. source.
Sale,
Exchange or Other Disposition of Ordinary Shares
Subject to the discussion
below under “Passive Foreign Investment Company Considerations,” U.S. Holders generally will recognize gain or loss
on the sale, exchange or other disposition of our ordinary shares equal to the difference between the amount realized on the sale,
exchange or other disposition and the holder’s tax basis in our ordinary shares, and any gain or loss will be capital gain
or loss. The tax basis in an ordinary share generally will be equal to the cost of the ordinary share. For non-corporate U.S.
Holders, capital gain from the sale, exchange or other disposition of ordinary shares is generally eligible for a preferential
rate of taxation in the case of long-term capital gain. The deductibility of capital losses for U.S. federal income tax purposes
is subject to limitations under the Code. Any gain or loss that a U.S. Holder recognizes generally will be treated as U.S. source
income or loss for foreign tax credit limitation purposes.
Passive
Foreign Investment Company Considerations
If
we were to be classified as a “passive foreign investment company” (“PFIC”), in any taxable year, a U.S.
Holder would be subject to special rules generally intended to reduce or eliminate any benefits from the deferral of U.S. federal
income tax that a U.S. Holder could derive from investing in a non-U.S. company that does not distribute all of its earnings on
a current basis.
A
non-U.S. corporation will be classified as a PFIC for U.S. federal income tax purposes in any taxable year in which, after applying
certain look-through rules, either
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at
least 75% of its gross income is “passive income”, or
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at
least 50% of the average quarterly value of its gross assets is attributable to assets that produce passive income or are
held for the production of passive income.
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Passive income for this
purpose generally includes dividends, interest, royalties, rents, gains from commodities and securities transactions, the excess
of gains over losses from the disposition of assets which produce passive income and amounts derived by reason of the temporary
investment of funds raised in offerings of our ordinary shares. If a non-U.S. corporation owns at least 25% by value of the stock
of another corporation, the non-U.S. corporation is treated for purposes of the PFIC tests as owning its proportionate share of
the assets of the other corporation and as directly receiving its proportionate share of the other corporation’s income.
A
foreign corporation’s PFIC status is an annual determination that is based on tests that are factual in nature, and our
status for any year will depend on our income, assets, and activities for such year. Based upon our review of our financial data,
we believe that we were not a PFIC for our 2017 taxable year. Because the PFIC determination is highly fact intensive, there can
be no assurance that we will not be a PFIC in 2018 or for any other taxable year.
Default PFIC Rules
.
If we are a PFIC for any tax year, a U.S. Holder who does not make a timely “qualified electing fund” election, or
“QEF election” or a mark-to-market election (as described below), referred to in this summary as a “Non-Electing
U.S. Holder,” will be subject to special rules with respect to (i) any “excess distribution” (generally, the
portion of any distributions received by the Non-Electing U.S. Holder on the ordinary shares in a taxable year in excess of 125%
of the average annual distributions received by the Non-Electing U.S. Holder in the three preceding taxable years, or, if shorter,
the Non-Electing U.S. Holder’s holding period for the ordinary shares), and (ii) any gain realized on the sale or other disposition
of such ordinary shares. Under these rules:
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the excess distribution or gain would be allocated ratably over the Non-Electing U.S. Holder’s holding period for such ordinary shares;
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the amount allocated to the current taxable year and any year prior to us becoming a PFIC would be taxed as ordinary income; and
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the amount allocated to each of the other taxable years would be subject to tax at the highest rate of tax in effect for the applicable class of taxpayer for that year, and an interest charge for the deemed deferral benefit would be imposed with respect to the resulting tax attributable to each such other taxable year.
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To the extent a distribution
on our ordinary shares does not constitute an excess distribution to a Non-Electing U.S. Holder, such Non-Electing U.S. Holder
generally will be required to include the amount of such distribution in gross income as a dividend to the extent of our current
or accumulated earnings and profits (as determined for U.S. federal income tax purposes) that are not allocated to excess distributions.
The tax consequences of such distributions are discussed above under “Distributions.”
If we are treated as a
PFIC for any taxable year during the holding period of a Non-Electing U.S. Holder, we will continue to be treated as a PFIC for
all succeeding years during which the Non-Electing U.S. Holder is treated as a direct or indirect Non-Electing U.S. Holder even
if we are not a PFIC for such years. A U.S. Holder is encouraged to consult its tax advisor with respect to any available elections
that may be applicable in such a situation, including the “deemed sale” election of Code Section 1298(b)(1) (which
will be taxed under the adverse tax rules described above).
We may invest in the equity
of foreign corporations that are PFICs or may own subsidiaries that own PFICs. If we are classified as a PFIC, under attribution
rules, U.S. Holders will be subject to the PFIC rules with respect to their indirect ownership interests in such PFICs, such that
a disposition of the ordinary shares of the PFIC or receipt by us of a distribution from the PFIC generally will be treated as
a deemed disposition of such ordinary shares or the deemed receipt of such distribution by the U.S. Holder, subject to taxation
under the PFIC rules. There can be no assurance that a U.S. Holder will be able to make a QEF election or a mark-to-market election
with respect to PFICs in which we invest. Each U.S. Holder is encouraged to consult its own tax advisor with respect to tax consequences
of an investment by us in a corporation that is a PFIC.
QEF Election
. Certain
of the adverse consequences of PFIC status can be mitigated if a U.S. Holder makes a QEF election with respect to our ordinary
shares. Generally, a shareholder making the QEF election is required for each taxable year to include in income a pro rata share
of the ordinary earnings and net capital gain of the QEF, subject to a separate election to defer payment of taxes, which deferral
is subject to an interest charge. Any gain on sale or other disposition of a U.S. Holder’s ordinary shares would be treated
as capital gain, and the interest penalty discussed above will not be imposed. If an investor provides reasonable notice to us
that it has determined to make a QEF election, we shall endeavor to timely provide annual financial information to such investor
as may be reasonably required for purposes of filing United States federal income tax returns in connection with such QEF election.
Mark-to-Market Election
.
Alternatively, if our ordinary shares are treated as “marketable stock,” a U.S. Holder may make a “mark-to-market”
election with respect to our ordinary shares, provided the U.S. Holder completes and files IRS Form 8621 in accordance with the
relevant instructions and related Treasury Regulations. If a mark-to-market election is made, the U.S. Holder generally would include
as ordinary income in each taxable year the excess, if any, of the fair market value of our ordinary shares at the end of the taxable
year over such holder’s adjusted tax basis in such ordinary shares. The U.S. Holder would also be permitted an ordinary loss
in respect of the excess, if any, of the U.S. Holder’s adjusted tax basis in our ordinary shares over their fair market value
at the end of the taxable year, but only to the extent of the net amount previously included in income as a result of the mark-to-
market election. A U.S. Holder’s tax basis in our ordinary shares would be adjusted to reflect any such income or loss amount.
Gain realized on the sale, exchange or other disposition of our ordinary shares would be treated as ordinary income, and any loss
realized on the sale, exchange or other disposition of our ordinary shares would be treated as ordinary loss to the extent that
such loss does not exceed the net mark-to-market gains previously included in income by the U.S. Holder, and any loss in excess
of such amount will be treated as capital loss. Amounts treated as ordinary income will not be eligible for the favorable tax rates
applicable to qualified dividend income or long-term capital gains.
Generally, stock will be
considered marketable stock if it is “regularly traded” on a “qualified exchange” within the meaning of
applicable Treasury Regulations. A class of stock is regularly traded on an exchange during any calendar year during which such
class of stock is traded, other than in de minimis quantities, on at least 15 days during each calendar quarter. To be marketable
stock, our ordinary shares must be regularly traded on a qualifying exchange (i) in the United States that is registered with the
SEC or a national market system established pursuant to the Exchange Act or (ii) outside the United States that is properly regulated
and meets certain trading, listing, financial disclosure and other requirements. Our ordinary shares are expected to constitute
“marketable stock” as long as they remain listed on the NASDAQ Capital Market and are regularly traded.
A mark-to-market election
will not apply to our ordinary shares held by a U.S. Holder for any taxable year during which we are not a PFIC, but will remain
in effect with respect to any subsequent taxable year in which we become a PFIC. Such election will not apply to any PFIC subsidiary
that we own. Each U.S. Holder is encouraged to consult its own tax advisor with respect to the availability and tax consequences
of a mark-to-market election with respect to our ordinary shares.
In addition, U.S. Holders
should consult their tax advisors regarding the IRS information reporting and filing obligations that may arise as a result of
the ownership of ordinary shares in a PFIC, including IRS Form 8621, Information Return by a Shareholder of a Passive Foreign Investment
Company or Qualified Electing Fund.
The U.S. federal income
tax rules relating to PFICs, QEF elections, and mark-to market elections are complex. U.S. Holders are urged to consult their
own tax advisors with respect to the purchase, ownership and disposition of our ordinary shares, any elections available with
respect to such ordinary shares and the IRS information reporting obligations with respect to the purchase, ownership and disposition
of our ordinary shares.
Backup
Withholding and Information Reporting Requirements
U.S.
backup withholding and information reporting requirements may apply to payments to holders of our ordinary shares. Information
reporting generally will apply to payments of dividends on, and proceeds from the sale of, our ordinary shares made within the
United States, or by a U.S. payor or U.S. middleman, to a holder of our ordinary shares, other than an exempt recipient (including
a corporation). A payor may be required to backup withhold from payments of dividends on, or the proceeds from the sale or redemption
of, ordinary shares within the United States, or by a U.S. payor or U.S. middleman, to a holder, other than an exempt recipient,
if the holder fails to furnish its correct taxpayer identification number or otherwise fails to comply with, or establish an exemption
from, the backup withholding tax requirements. Any amounts withheld under the backup withholding rules generally should be allowed
as a credit against the beneficial owner’s U.S. federal income tax liability, if any, and any excess amounts withheld under
the backup withholding rules may be refunded, provided that the required information is timely furnished to the IRS.
Additional
Medicare Tax
Certain U.S. Holders who
are individuals, estates or trusts may be required to pay an additional 3.8% Medicare tax on, among other things, dividends and
capital gains from the sale or other disposition of shares of common stock . For individuals, the additional Medicare tax applies
to the lesser of (i) “net investment income” or (ii) the excess of “modified adjusted gross income” over
$200,000 ($250,000 if married and filing jointly or $125,000 if married and filing separately). “Net investment income”
generally equals the taxpayer’s gross investment income reduced by the deductions that are allocable to such income. U.S.
Holders should consult with their own tax advisors regarding the application of the 3.8% Medicare tax to them as a result of their
investment in our ordinary shares.
Certain Reporting Requirements
Certain U.S. Holders
are required to file IRS Form 926, Return by U.S. Transferor of Property to a Foreign Corporation, and certain U.S. Holders may
be required to file IRS Form 5471, Information Return of U.S. Persons With Respect to Certain Foreign Corporations, reporting transfers
of cash or other property to us and information relating to the U.S. Holder and us. See also the discussion regarding Form 8621,
Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund, above.
In addition, certain
U.S. Holders must report information on IRS Form 8938, Statement of Specified Foreign Financial Assets, with respect to their investments
in certain “foreign financial assets,” which would include an investment in our ordinary shares, if the aggregate value
of all of those assets exceeds $50,000 on the last day of the taxable year (and in some circumstances, a higher threshold). This
reporting requirement applies to individuals and certain U.S. entities.
U.S. Holders who
fail to report required information could become subject to substantial penalties. U.S. Holders should consult their tax advisors
regarding the possible implications of these reporting requirements arising from their investment in our ordinary shares.
The
above description is not intended to constitute a complete analysis of all tax consequences relating to acquisition, ownership
and disposition of our ordinary shares. Holders should consult their tax advisors concerning the tax consequences of their particular
situations.
Israeli
Taxation
The
following is a brief summary of the material Israeli tax laws applicable to us and certain Israeli Government programs that benefit
us. This section also contains a brief discussion of material Israeli tax consequences concerning the ownership and disposition
of our securities by non-Israeli resident shareholders. This summary does not discuss all the aspects of Israeli tax law that
may be relevant to a particular investor in light of his or her personal investment circumstances or to some types of investors
subject to special treatment under Israeli law. The discussion below is subject to change, including due to amendments under Israeli
law or changes to the applicable judicial or administrative interpretations of Israeli law, which change could affect the tax
consequences described below.
Company
Taxation
-
Ability
Inc. is managed and controlled from Israel and is considered by the Israel Tax Authority as a company resident in Israel and
subject to Israeli corporate tax, capital gains tax and any other relevant taxes.
The
standard corporate tax rate for Israeli companies was 26.5% for 2015 and was reduced to 25% for 2016, 24% for 2017 and 23% for
2018 and thereafter.
Prior
to 2015, Ability was granted an “Approved Enterprise” status under the Investment Law for the ten years ended December
31, 2014. Ability received a deferral of corporate income tax on non-distributed income generated by the Approved Enterprise (“Approved
Income”). Distributed Approved Income is subject to 25% corporate income tax at the Ability level.
Beginning
January 1, 2015, Ability elected to participate in the “Preferred Enterprise” program under the amendment to the Investment
Law. Due to Ability’s “Preferred Enterprise” status, Ability expects to benefit from a reduced tax rate of 14.6%
in 2015 and 2016 (based on a blended tax rate) and a reduced tax rate, not yet determined (but up to 16%), in 2017 and thereafter
with respect to taxable income generated by the Preferred Enterprise (“Preferred Income”) regardless of whether such
Preferred Income is distributed, and all other taxable income will be subject to the standard corporate tax rate. If Ability does
not meet the requirements for a Preferred Enterprise, it will be subject to tax at the ordinary corporate income tax rate, which
is 24% in 2017 and may be required to pay incremental taxes over the reduced tax rates under the Preferred Enterprise as discussed
above, plus indexation, and interest thereon, and possibly penalties thereon.
Taxation
of non-Israeli shareholders on receipt of dividends
Shareholders
are expected to be subject to a 15% withholding tax with respect to dividends from Approved Income and 20% with respect to dividends
from Preferred Income, both subject to any applicable tax treaty between Israel and the country of residence of the shareholder.
Dividends distributed out of income which is not Approved Income or Preferred Income are expected to be subject to withholding
tax of 25% or 30%, subject to any applicable tax treaty between Israel and the country of residence of the shareholder.
Taxation
of non-Israeli shareholders on disposition of securities
Subject
to certain conditions set forth in the Ordinance (and any applicable tax treaty between Israel and the country of residence of
the shareholder), the disposition of our securities by non-Israeli resident shareholders should be exempt from tax in Israel.
F.
|
Dividends
and Paying Agents
|
Not
applicable.
Not
applicable.
You
may inspect our securities filings, including this Annual Report and the exhibits and schedules thereto, without charge at the
offices of the SEC at 100 F Street, N.E., Washington, D.C. 20549. You may obtain copies of all or any part of the Annual Report
from the Public Reference Section of the SEC, 100 F Street, NE, Washington, D.C. 20549 upon the payment of the prescribed fees.
You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains
a website at www.sec.gov that contains reports, proxy and information statements and other information regarding registrants like
us that file electronically with the SEC. You can also inspect the Annual Report on this website.
A
copy of each document concerning us that is referred to in this Annual Report is available for public view (subject to confidential
treatment of certain agreements pursuant to applicable law) at our principal executive offices.
I.
|
Subsidiary
Information
|
Not
applicable.
Item 11.
|
Quantitative and Qualitative
Disclosures About Market Risk
|
Foreign
Currency Exchange Risk
The U.S. dollar is our
functional and reporting currency. We conduct business primarily in U.S. dollars and to a lesser extent, in NIS and Euro. This
exposes us to risk associated with exchange rate fluctuations vis-à-vis the U.S. dollar. For example, salaries and related
expenses for Israeli employees and payables to Israeli suppliers are paid in NIS. A devaluation of the NIS in relation to the
U.S. dollar has the effect of reducing the U.S. dollar amount of our expenses and payables that are payable in NIS, unless those
expenses or payables are linked to the U.S. dollar. Conversely, any increase in the value of the NIS in relation to the U.S. dollar
has the effect of increasing the U.S. dollar value of our unlinked NIS expenses. On the other hand, we also own assets that are
denominated in NIS. A devaluation of the NIS in relation to the U.S. dollar has the effect of reducing the U.S. dollar amount
of our assets. Conversely, any increase in the value of the NIS in relation to the U.S. dollar has the effect of increasing the
U.S. dollar value of our NIS denominated assets. For the years ended December 31, 2017, 2016 and 2015, loss (gain) from currency
fluctuations was $(16,000), $(163,000) and $64,000, respectively. We expect that an increase of ten percent (10%) in the exchange
rate of the NIS to U.S. dollar will increase our operating expenses expressed in U.S. dollar terms by approximately $0.2 million
in 2018 and vice versa. For additional information see “Item 3D Key Information - Risk Factors – Risks Related to
our Company - Our international operations subject us to currency exchange risk.”
Item
12. Description of Securities Other Than Equity Securities
Not
applicable.
Not
applicable.
Not
applicable.
D.
|
American
Depositary Shares
|
Not
applicable.
Ability Inc.
Consolidated Balance Sheets
|
|
December 31,
|
|
|
|
2017
|
|
|
2016
|
|
|
|
(U.S. dollars in thousands)
|
|
LIABILITIES & SHAREHOLDERS’ EQUITY:
|
|
|
|
|
|
|
|
|
CURRENT LIABILITIES:
|
|
|
|
|
|
|
|
|
Accrued payroll and other compensation related accruals
|
|
$
|
135
|
|
|
$
|
270
|
|
Trade payables, accrued expenses and other accounts payable
|
|
|
4,056
|
|
|
|
4,952
|
|
Put option liability
|
|
|
-
|
|
|
|
11,900
|
|
Income tax payable
|
|
|
-
|
|
|
|
32
|
|
Accrued expenses and accounts payable with respect to Projects
|
|
|
2,541
|
|
|
|
4,734
|
|
Progress payments in excess of accumulated costs with respect to projects
|
|
|
306
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
Total Current Liabilities
|
|
|
7,038
|
|
|
|
21,888
|
|
|
|
|
|
|
|
|
|
|
NON-CURRENT LIABILITIES:
|
|
|
|
|
|
|
|
|
Put option liability
|
|
|
12,143
|
|
|
|
-
|
|
Accrued severance pay
|
|
|
241
|
|
|
|
245
|
|
|
|
|
|
|
|
|
|
|
Total Non-Current Liabilities
|
|
|
12,384
|
|
|
|
245
|
|
|
|
|
|
|
|
|
|
|
Total Liabilities
|
|
$
|
19,422
|
|
|
$
|
22,133
|
|
|
|
|
|
|
|
|
|
|
COMMITMENTS AND CONTINGENCIES
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
SHAREHOLDERS’ EQUITY
|
|
|
|
|
|
|
|
|
Ordinary shares $0.0001 par value, 20,000,000 shares authorized, 2,576,415 shares issued and outstanding at December 31, 2017 and 2016*
|
|
|
3
|
|
|
|
3
|
|
Preferred shares $0.001 par value, 5,000,000 shares authorized, no shares issued and outstanding at December 31, 2017 and 2016*
|
|
|
-
|
|
|
|
-
|
|
Additional paid-in-capital
|
|
|
18,560
|
|
|
|
18,560
|
|
Accumulate deficit
|
|
|
(17,972
|
)
|
|
|
(8,861
|
)
|
|
|
|
|
|
|
|
|
|
Total Shareholders’ Equity
|
|
|
591
|
|
|
|
9,702
|
|
|
|
|
|
|
|
|
|
|
Total Liabilities and Shareholders’ Equity
|
|
$
|
20,013
|
|
|
$
|
31,835
|
|
*
|
On December 27, 2017, the Company implemented a 1-for-10 consolidation of its ordinary shares with a market effective date of
March 23, 2018, which was applied retrospectively for the calculation of the basic and diluted earnings (loss) per ordinary share.
|
The accompanying notes are an integral part of the consolidated
financial statements.
Ability Inc.
Consolidated Statements of Operations and Comprehensive
Income (Loss)
|
|
Year Ended December 31,
|
|
|
|
2017
|
|
|
2016
|
|
|
2015
|
|
|
|
(U.S. dollars in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
Revenues
|
|
$
|
2,972
|
|
|
$
|
16,508
|
|
|
$
|
52,151
|
|
Cost of revenues
|
|
|
2,957
|
|
|
|
8,617
|
|
|
|
29,654
|
|
Gross profit
|
|
|
15
|
|
|
|
7,891
|
|
|
|
22,497
|
|
Selling and marketing expenses
|
|
|
3,033
|
|
|
|
5,323
|
|
|
|
3,305
|
|
General and administrative expenses
|
|
|
6,016
|
|
|
|
9,662
|
|
|
|
1,317
|
|
Operating income (loss)
|
|
|
(9,034
|
)
|
|
|
(7,094
|
)
|
|
|
17,875
|
|
Financial expenses (income), net
|
|
|
77
|
|
|
|
(127
|
)
|
|
|
99
|
|
Income (loss) before income taxes
|
|
|
(9,111
|
)
|
|
|
(6,967
|
)
|
|
|
17,776
|
|
Income tax expenses
|
|
|
-
|
|
|
|
1,086
|
|
|
|
3,023
|
|
Net and comprehensive income (loss)
|
|
$
|
(9,111
|
)
|
|
$
|
(8,053
|
)
|
|
$
|
14,753
|
|
Earnings (loss) per ordinary share - basic and diluted (U.S. dollars)*
|
|
$
|
(3.71
|
)
|
|
$
|
(3.27
|
)
|
|
$
|
6.00
|
|
* On December
27, 2017, the Company implemented a 1-for-10 consolidation of its ordinary shares with a market effective date of March 23, 2018,
which was applied retrospectively for the calculation of the basic and diluted earnings (loss) per ordinary share.
The accompanying notes are an integral part of the consolidated
financial statements.
Ability Inc.
Consolidated Statements of Changes in Shareholders’
Equity
|
|
Preferred
shares
|
|
|
Ordinary
Shares
|
|
|
Additional
paid-in-
|
|
|
Retained
earnings (accumulated
|
|
|
|
|
|
|
Shares*
|
|
|
Amount
|
|
|
Shares*
|
|
|
Amount
|
|
|
capital
|
|
|
deficit)
|
|
|
Total
|
|
|
|
|
|
|
(U.S. dollars in thousands)
|
|
|
|
|
|
(U.S. dollars in
thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance as
of January 1, 2015
|
|
|
-
|
|
|
$
|
-
|
|
|
|
2,528,415
|
|
|
$
|
3
|
|
|
$
|
32
|
|
|
$
|
1,690
|
|
|
$
|
1,725
|
|
Recapitalization of Cambridge
accumulated deficit and issuance of ordinary shares as part of the Reverse Merger
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
18,528
|
|
|
|
-
|
|
|
|
18,528
|
|
Dividends
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
(17,251
|
)
|
|
|
(17,251
|
)
|
Net
and comprehensive income
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
14,753
|
|
|
|
14,753
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance as of December 31, 2015
|
|
|
-
|
|
|
|
-
|
|
|
|
2,528,415
|
|
|
|
3
|
|
|
|
18,560
|
|
|
|
(808
|
)
|
|
|
17,755
|
|
Issuance
of shares as part of the Reverse Merger
|
|
|
-
|
|
|
|
-
|
|
|
|
48,000
|
|
|
|
**
|
|
|
|
-
|
|
|
|
-
|
|
|
|
*
|
|
Net
and comprehensive loss
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
(8,053
|
)
|
|
|
(8,053
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance as of December 31,
2016
|
|
|
-
|
|
|
|
-
|
|
|
|
2,576,415
|
|
|
|
3
|
|
|
|
18,560
|
|
|
|
(8,861
|
)
|
|
|
9,702
|
|
Net
and comprehensive loss
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
(9,111
|
)
|
|
|
(9,111
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance
as of December 31, 2017
|
|
|
-
|
|
|
$
|
-
|
|
|
|
2,576,415
|
|
|
$
|
3
|
|
|
$
|
18,560
|
|
|
$
|
(17,972
|
)
|
|
$
|
591
|
|
*
|
On December 27, 2017, the Company implemented a 1-for-10 consolidation of its ordinary shares with a market effective date of
March 23, 2018, which was applied retrospectively for the calculation of the basic and diluted earnings (loss) per ordinary share.
|
|
|
**
|
Less than $0.5 thousand
|
The accompanying notes are an integral part of the consolidated
financial statements.
Ability Inc.
Consolidated Statements of Cash Flows
|
|
Year Ended December 31,
|
|
|
|
2017
|
|
|
2016
|
|
|
2015
|
|
|
|
(U.S. dollars in thousands)
|
|
CASH FLOWS FROM OPERATING ACTIVITIES:
|
|
|
|
|
|
|
|
|
|
Net income (loss)
|
|
$
|
(9,111
|
)
|
|
$
|
(8,053
|
)
|
|
$
|
14,753
|
|
Adjustments to reconcile net
income or loss to net cash provided by (used in) operating activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation
|
|
|
168
|
|
|
|
149
|
|
|
|
132
|
|
Amortization
|
|
|
321
|
|
|
|
193
|
|
|
|
-
|
|
Impairment of inventory
|
|
|
-
|
|
|
|
201
|
|
|
|
-
|
|
Impairment of property and equipment
|
|
|
-
|
|
|
|
114
|
|
|
|
-
|
|
Capital (gain) loss from sale of property and equipment
|
|
|
30
|
|
|
|
(10
|
)
|
|
|
18
|
|
Changes in operating assets and liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Restricted deposits
|
|
|
1,758
|
|
|
|
(1,433
|
)
|
|
|
162
|
|
Accounts receivable
|
|
|
1,198
|
|
|
|
631
|
|
|
|
(3,756
|
)
|
Inventory
|
|
|
(50
|
)
|
|
|
(311
|
)
|
|
|
(799
|
)
|
Deferred tax
|
|
|
-
|
|
|
|
-
|
|
|
|
(423
|
)
|
Other receivables
|
|
|
(1,773
|
)
|
|
|
1,459
|
|
|
|
(1,180
|
)
|
Interest earned on restricted deposit for put option
|
|
|
128
|
|
|
|
(128
|
)
|
|
|
-
|
|
Accrued payroll and other compensation related accruals
|
|
|
(135
|
)
|
|
|
210
|
|
|
|
(291
|
)
|
Trade payables, accrued expenses and other accounts payable
|
|
|
(896
|
)
|
|
|
3,108
|
|
|
|
1,030
|
|
Income tax payable
|
|
|
73
|
|
|
|
(2,674
|
)
|
|
|
2,426
|
|
Accrued expenses and accounts payable with respect to Projects
|
|
|
(2,193
|
)
|
|
|
(2,233
|
)
|
|
|
2,618
|
|
Due to related company
|
|
|
-
|
|
|
|
(600
|
)
|
|
|
600
|
|
Progress payments in excess of accumulated costs with respect to Projects (accumulated costs with respect to Projects in excess of progress payments)
|
|
|
457
|
|
|
|
(1,170
|
)
|
|
|
(5,304
|
)
|
Accrued severance pay
|
|
|
(4
|
)
|
|
|
(25
|
)
|
|
|
171
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Adjustments
|
|
|
(918
|
)
|
|
|
(2,519
|
)
|
|
|
(4,596
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by (used in) operating activities
|
|
$
|
(10,029
|
)
|
|
$
|
(10,572
|
)
|
|
$
|
10,157
|
|
The accompanying notes are an integral part of the consolidated
financial statements.
Ability Inc.
Consolidated Statements of Cash Flows
|
|
Year Ended December 31,
|
|
|
|
2017
|
|
|
2016
|
|
|
2015
|
|
|
|
(U.S. dollars in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
CASH FLOWS FROM INVESTING ACTIVITIES:
|
|
|
|
|
|
|
|
|
|
|
|
|
Purchase of property and equipment
|
|
$
|
(187
|
)
|
|
$
|
(182
|
)
|
|
$
|
(353
|
)
|
Proceeds from sale of property and equipment
|
|
|
124
|
|
|
|
10
|
|
|
|
158
|
|
Loans repaid by related company, net
|
|
|
-
|
|
|
|
-
|
|
|
|
709
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by (used in) investing activities
|
|
|
(63
|
)
|
|
|
(172
|
)
|
|
|
514
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CASH FLOWS FROM FINANCING ACTIVITIES:
|
|
|
|
|
|
|
|
|
|
|
|
|
Proceeds from the Reverse Merger, net of transaction costs
|
|
|
-
|
|
|
|
-
|
|
|
|
18,995
|
|
Dividends paid
|
|
|
-
|
|
|
|
-
|
|
|
|
(14,951
|
)
|
Due from / to controlling shareholders, net
|
|
|
196
|
|
|
|
378
|
|
|
|
(595
|
)
|
Withholding tax paid by the Company on behalf of the controlling shareholders’ with respect to dividend distributed
|
|
|
-
|
|
|
|
(4,393
|
)
|
|
|
-
|
|
Withholding tax paid by the controlling shareholders’ to the Company with respect to dividend distributed, to be paid by the Company to the Israel Tax Authority
|
|
|
-
|
|
|
|
770
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by (used in) financing activities
|
|
|
196
|
|
|
|
(3,245
|
)
|
|
|
3,449
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net change in cash and cash equivalents
|
|
|
(9,896
|
)
|
|
|
(13,989
|
)
|
|
|
14,120
|
|
CASH AND CASH EQUIVALENTS AT BEGINNING OF THE YEAR
|
|
|
11,840
|
|
|
|
25,829
|
|
|
|
11,709
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CASH AND CASH EQUIVALENTS AT END OF THE YEAR
|
|
$
|
1,944
|
|
|
$
|
11,840
|
|
|
$
|
25,829
|
|
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
:
|
|
Year ended December 31,
|
|
|
|
2017
|
|
|
2016
|
|
|
2015
|
|
|
|
(U.S. dollars in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
Cash paid during the years for:
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest and banks’ charges
|
|
$
|
18
|
|
|
$
|
36
|
|
|
$
|
40
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income tax
|
|
$
|
7
|
|
|
$
|
3,758
|
|
|
$
|
568
|
|
The accompanying notes are an integral part of the consolidated
financial statements.
Ability Inc.
Notes to the Consolidated Financial Statements
NOTE 1 - organization
and business operation:
Ability Inc. (the
“Company” or “INC”) was incorporated under the laws of the Cayman Islands on September 1, 2015,
originally as Cambridge Holdco Corp., an exempted company. INC was formed as a wholly-owned subsidiary of Cambridge Capital
Acquisition Corporation (“Cambridge”), a special purpose acquisition corporation, incorporated under the laws of
Delaware on October 1, 2013. Cambridge closed its initial public offering and a simultaneous private placement on December
23, 2013. On December 23, 2015, upon a merger of Cambridge into INC, with INC surviving the merger and becoming the public
entity, INC consummated a business combination whereby it acquired Ability Computer & Software Industries Ltd., an
Israeli company (“ACSI”), by way of a share exchange (the “Reverse Merger”), following which ACSI
became INC’s wholly-owned subsidiary. Upon the closing of the Reverse Merger, INC’s ordinary shares and warrants
began trading on the NASDAQ Capital Market under the symbols “ABIL” and “ABILW”, respectively.
INC’s warrants were delisted on April 18, 2016 and since such date have traded on OTC Pink under the
symbol “ABIWF”. On January 12, 2016 INC’s ordinary shares were listed for trading on the Tel Aviv Stock
Exchange. The Company, ACSI and Ability Security Systems Ltd. (“ASM”) are jointly defined as the
“Group”. On December 27, 2017, the Company implemented a 1-for-10 consolidation of its ordinary shares with a
market effective date of March 23, 2018, the effect of such consolidation was applied retrospectively for all amount of
shares, warrants, related par value and others presented in the notes below.
|
1)
|
ACSI’s shareholders prior to the closing
of the Reverse Merger, Anatoly Hurgin and Alexander Aurovsky, (the “Controlling Shareholders”) received in the
Reverse Merger: 1,621,327 ordinary shares of INC (reflecting approximately 63% of INC’s issued and outstanding ordinary
shares immediately following the Reverse Merger); $18.1 million in cash and an additional number of ordinary shares of INC to
be issued upon and subject to ACSI achieving certain net income targets following the Reverse Merger, as described
below (the “Net Income Shares”), as consideration for their shares of ACSI. Furthermore, of the ordinary shares
received, each of the Controlling Shareholders have the right, on one occasion during the 60 day period following the third
anniversary of the closing of the Reverse Merger, to put to INC all or part of his pro rata portion of 117,327 ordinary
shares that he received in the share exchange for an amount in cash equal to (1) (x) the number of shares being put
multiplied by (y) $101.0 per share plus (2) his pro rata portion of interest, if any, on $11.9 million deposited into an
escrow account by INC to fund the payment of the purchase price for the put option if it is exercised. The put option
terms were updated subsequently, see Note 3 for additional information.
|
|
2)
|
Migdal Underwriting and Business Initiatives Ltd. (“Migdal”) received in the Reverse Merger: 48,000 ordinary shares of INC; $1.2 million in cash and up to 25,350 Net Income Shares, all in consideration for services provided by them with respect to the Reverse Merger.
|
Ability Inc.
Notes to the Consolidated Financial Statements
NOTE 1 - ORGANIZATION AND BUSINESS
OPERATION (CONT.):
|
b.
|
The Reverse Merger (cont.):
|
|
3)
|
INC acquired from the sole shareholder of ASM,
Eyal Tzur, (the “ASM Former Shareholder”) 16% of the shares of ASM, a variable interest entity with ACSI as its
primary beneficiary, for $0.9 million in cash and a put option to sell his remaining holdings to INC in exchange for 48,000
of INC’s ordinary shares and up to 25,350 Net Income Shares. The put option was exercised in January 2016.
|
|
4)
|
ACSI’s transaction costs with respect to the Reverse Merger were $6.3 million and include Migdal’s service fees ($1.2 million in cash and ordinary shares valued at $4.3 million as detailed above) and other consulting expenses (the “Transaction Costs”).
|
|
5)
|
The Controlling Shareholders, Migdal and ASM Former Shareholder are entitled to receive Net Income Shares based on ACSI’s achievement of specified net income targets in the fiscal years 2015 to 2018 as set out below:
|
|
|
|
|
|
|
Number of the Company’s ordinary shares
|
|
|
Year Ending December 31,
|
|
Net Income
Target
|
|
|
Controlling Shareholders
|
|
|
Migdal
|
|
|
ASM Former
Shareholder
|
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2015
|
|
$
|
27,000,000
|
|
|
|
338,400
|
|
|
|
10,800
|
|
|
|
10,800
|
|
|
|
360,000
|
|
|
2016
|
|
$
|
40,000,000
|
|
|
|
173,900
|
|
|
|
5,550
|
|
|
|
5,550
|
|
|
|
185,000
|
|
|
2017
|
|
$
|
60,000,000
|
|
|
|
188, 000
|
|
|
|
6,000
|
|
|
|
6,000
|
|
|
|
200,000
|
|
|
2018
|
|
$
|
80,000,000
|
|
|
|
94,000
|
|
|
|
3,000
|
|
|
|
3,000
|
|
|
|
100,000
|
|
In the event that the INC fails
to satisfy the net income target for any fiscal year but net income for such fiscal year is ninety percent (90%) or more of the
net income target for such fiscal year, then INC is required to issue to the Controlling Shareholders, Migdal and ASM Former Shareholder,
the pro rata portion of Net Income Shares relating to the percentage achieved.
The net income targets for the
years ended December 31, 2017, 2016 and 2015 were not achieved.
|
6)
|
The remaining funds in the restricted trust account of Cambridge amounted to $81.3 million of which: $21.6 million was paid to the holders of 213,676 ordinary shares of Cambridge who elected to convert their shares into cash upon consummation of the Reverse Merger; $18.1 million and $11.9 million were paid to the Controlling Shareholders and deposited in an escrow account to secure their put option, respectively; $0.9 million was paid to ASM Former Shareholder; $7.8 million was used to pay outstanding accounts payable and accrued expenses of Cambridge; $2 million was used to pay for the Company’s Transaction Costs. The balance of $19 million was released to ACSI.
|
Ability Inc.
Notes to the Consolidated Financial Statements
NOTE 1 - ORGANIZATION AND BUSINESS
OPERATION (CONT.):
The Group provides advanced
interception, geolocation, monitoring and cyber intelligence tools to serve the needs and increasing challenges of security and
intelligence agencies, military forces, law enforcement and homeland security agencies worldwide.
The Israeli Control Order
Regarding the Engagement in Encryption Items, 1998 regulated under the Encryptions Export Control Department in the Israeli
Ministry of Defense (the “IMOD”) controls development, import, export, and sale of all encrypted items (the
“Decryption Regime”).
The Israeli Defense Export Control
Law, 2007 (the “2007 Law”) regulated under DECA (the Defense Export Control Agency in IMOD) regulates the marketing
and export of defense equipment, transfer of defense know-how and the provision of defense services, taking into account national
security considerations, foreign relations considerations, international obligations and other interests of the State of Israel.
ACSI exports from Israel
certain products and components that are not subject to Israeli export control.
ASM, a wholly owned subsidiary
of the Company, is an Israeli company registered with DECA as a certified exporter for the marketing and export of “controlled”
products of Israeli origin, or “controlled” products that are exported from Israel.
However, for the most part,
the ACSI’s products are manufactured outside of Israel and therefore are not subject to the general provisions of the 2007
Law. Thus, ACSI strives to ensure that components of ACSI’s systems (that otherwise would be subject to DECA control) are
sent to the customers directly by the foreign suppliers of such components, which are located outside of Israel, and are installed
or integrated there by ACSI or others under its responsibility.
The interception systems that
contain decryption capabilities of ACSI and ASM may be subject to the Decryption Regime and therefore
have obtained necessary licenses thereunder.
ACSI
and the ASM Former Shareholder
were parties to a long-term agreement (the “JV Agreement”) pursuant to which ACSI contributed substantial business
efforts while ASM was responsible mainly for the regulatory aspects of pursuing business opportunities in the field of DECA controlled
products. The JV Agreement could be terminated and/or the activities could be transferred to ACSI’s full ownership at any
time, subject to ACSI’s exclusive discretion.
Ability Inc.
Notes to the Consolidated Financial Statements
NOTE 1 - ORGANIZATION AND BUSINESS
OPERATION (CONT.):
ACSI and the Controlling Shareholders
were significantly involved in the redesign of ASM’s operations, in such manner that in essence, the operations are conducted
only in favor of ACSI (ASM had no other activities other than on behalf of ACSI). Moreover, according to the JV Agreement, ASM
was required to negotiate and determine any project terms and sign contracts with the clients - all with full transparency, coordination
and advance consent from ACSI, as applicable. Upon the closing of the Reverse Merger, the JV Agreement was terminated while maintaining
its terms for the existing projects. As mentioned above, in January 2016, the ASM Former Shareholder exercised his put option,
resulting in ASM becoming a wholly-owned subsidiary of the Company. ACSI had the power to govern ASM’s operations through
the provision requiring its consent of any new client which ASM wishes to accept. ACSI was entitled to all but 3% commission (the
return that ASM Former Shareholder was entitled to as a service provider) of ASM’s net results which are transferred to the
Company, and was fully responsible for indemnifying ASM for any losses incurred as part of their joint operations (the ASM Former
Shareholder does not have any obligation to absorb ASM’s losses) or any negative consequences with respect to the performance
of a project.
When the activities of ASM commenced
(following conclusion of the JV Agreement) it did not have equity at risk (no equity and no subordinated loans). All the equity
that ASM has achieved is based on transactions involving ACSI. There were no restrictions on ASM’s assets. Any required financial
guarantees were provided by ACSI.
Given ACSI’s exposure
and rights to the outcome of ASM’s operations, among other factors described above, ACSI concluded that ASM was a variable
interest entity (“VIE”) prior to the time the ASM Former Shareholder exercised his put option and that ACSI was its
primary beneficiary. Therefore, the consolidated results for the year ended December 31, 2015 include the financial information
of all three entities (the Company, ACSI and ASM).
As of December 31, 2017, the Company
had an accumulated deficit of $17,972 thousand, cash and cash equivalents of $1,944 thousand, a negative working capital of $556
thousand and a net loss of $9,111 thousand for the year ended December 31, 2017. Due to a significant decline in revenues and an
increase in legal and professional services fees, the Company has suffered losses from operations, and it has an accumulated deficit
that, among other reasons, raises substantial doubt about its ability to continue as a going concern. The Company’s
independent registered public accounting firm, in their report on the Company’s audited financial statements for the year
ended December 31, 2017 expressed substantial doubt about the Company’s ability to continue as a going concern. The Company’s
ability to continue as a going concern is dependent upon, among other things, cash flow from customers for ongoing projects, the
Controlling Shareholders’ financial support of the Company, a decrease in litigation costs, the Company’s ability to
remain listed on the NASDAQ Capital Market and favorable resolution of the pending lawsuits and SEC investigation. The Company
expects to continue incurring losses and negative cash flows from operations in the foreseeable future. As a result of these expected
losses and negative cash flows from operations, along with the Company’s current cash position, the Company only has sufficient
cash on its balance sheet to finance its operations for a period of up to two months from the date of filing with the SEC of the
Company’s Annual Report on Form 20-F for the year ended December 31, 2017.
The accompanying consolidated financial
statements do not include any adjustments that might result relating to the recoverability and classification of the asset carrying
amounts or the amount and classification of liabilities that might result from the outcome of this risk and uncertainty.
Ability Inc.
Notes to the Consolidated Financial Statements
NOTE 1 - ORGANIZATION AND BUSINESS
OPERATION (CONT.):
|
f.
|
Going concern (Cont.):
|
The net loss for the year ended
December 31, 2017 includes significant legal and professional expenses.
Management is investing significant
marketing efforts in order to generate additional revenue and simultaneously is continuing to decrease its expenses, primarily
its legal and professional services fees in order to regain profitability. Additionally, the Company plans to raise capital through
the sale of equity securities or debt and settling certain of the lawsuits that are pending.
On February 21, 2018 the Controlling Shareholders executed an irrevocable undertaking (the “Undertaking”) for the
benefit of the Group. According to the Undertaking, the Controlling Shareholders agreed to make available to ACSI from, March
1, 2018, a $3.0 million line of credit or loan in favor of the Group. The Undertaking provided that the term of the line of credit
or loan is to be for a period of no less than six months. The Undertaking further provided that at the end of the term of the
line of credit or loan, the Company’ Board of Directors will determine whether repayment of the line of credit or the loan
will compromise the ability of the Group to meet its obligations during the twelve months following repayment. The Controlling
Shareholders undertook to renew the line of credit or extend the term of the loan on the same terms for an additional period of
no less than six months in accordance with a resolution of the Board of Directors with respect to the necessity of the support
of the Controlling Shareholders. On April 11, 2018, ACSI obtained a six-month line of credit from an Israeli commercial bank in
the amount of NIS 11 million (approximately $3.1 million). On amounts drawn under the line of credit, an interest rate in an amount
to be determined at the time of draw down shall apply in addition to a semi-annual bank commission of NIS 27,500. Subsequently
at a meeting of the board of directors on April 23, 2018, it was resolved to amend the terms of the Undertaking to provide that
the Company will bear the costs and interest of the line of credit.
There is no assurance however, that the
Company will be successful in regaining profitability or obtaining the level of financing needed for its operations. If the Company
is unsuccessful in generating additional revenue to support its operations or raising additional capital, it may need to further
reduce activities, curtail or cease operations.
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES:
|
a.
|
Basis
of presentation:
|
The accompanying consolidated
financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America
(“GAAP”) and include all adjustments necessary for the fair presentation of the Group’s financial position, results
of operations, changes in shareholders’ equity and cash flows for the periods presented.
The Reverse Merger was accounted
for as a reverse merger whereby the Company was treated as the “acquired” company for financial reporting purposes.
This determination was primarily based on ACSI comprising the ongoing operations of the combined company, ACSI’s senior management
comprising the senior management of the combined company, and that the former shareholders of ACSI are the controlling shareholders
of the Company after the Reverse Merger. The Reverse Merger was considered to be a capital transaction in substance. Accordingly,
for accounting purposes, the Reverse Merger was treated as the equivalent of ACSI issuing shares for the net assets of the Company,
accompanied by a recapitalization. The net assets of the Company were stated at historical cost, with no goodwill or other intangible
assets recorded. Operations prior to the Reverse Merger are those of ACSI, and therefore the historical consolidated financial
statements presented are the consolidated financial statements of ACSI and the ordinary shares and the corresponding capital amounts
pre-merger have been retroactively restated as ordinary shares reflecting the exchange ratio in the Reverse Merger.
Ability Inc.
Notes to the Consolidated Financial Statements
NOTE
2 - Summary of Significant Accounting Policies (Cont.):
|
b.
|
Principles
of consolidation:
|
The consolidated financial statements
include the accounts of the Company and its subsidiaries, ACSI and ASM. All intercompany accounts and transactions have been eliminated
in the consolidation.
The preparation of the consolidated
financial statements in conformity with GAAP requires management to make estimates, judgments and assumptions that affect the
amounts reported in the consolidated financial statements and accompanying notes. These estimates and assumptions are based on
management’s best estimates and judgment. Management evaluates its estimates and assumptions on an ongoing basis using historical
experience and other factors and adjusts such estimates and assumptions when facts and circumstances dictate. As future events
and their effects cannot be determined with precision, actual results could differ significantly from these estimates.
The currency of the primary
economic environment in which the operations of the Group is conducted is the U.S. dollar (“dollar” or “$”);
thus, the dollar is the functional currency of the Group. Therefore, the Group’s transactions and balances denominated in
dollars are presented at their original amounts, while non-dollar transactions and balances have been re-measured to dollars and
the relating gains and losses are reflected in the statements of comprehensive income (loss) as financial income or expenses, as
appropriate.
All amounts are presented in
dollars, unless otherwise indicated, and are rounded to the nearest thousand.
The Group generates revenues
from sales of products, which include hardware, software, connection to supportive infrastructure, integration services, training
and warranty, as well as revenues from Software as a Service (“SaaS”). The Group sells its products (the “Products”)
and provides services (the “Services”) directly to end users and resellers and also participates as a subcontractor
of prime contractors in joint projects and as a prime contractor in projects with resellers (the “Projects”).
Ability Inc.
Notes to the Consolidated Financial Statements
NOTE
2 - Summary of Significant Accounting Policies (Cont.):
|
e.
|
Revenue recognition (Cont.):
|
Products and Services:
Revenues from sales of Products
of which the final acceptance of the product is specified by the customer, and the acceptance is deemed substantive, are recognized
when the Group has delivered the Products to the customer and received final acceptance, the revenue can be reliably measured
and collectability of the receivables is reasonably assured. The revenues are deferred until the acceptance criteria have been
met.
Revenues from sales of Services
are recognized ratably in the period in which the services are rendered (connection to supportive infrastructure is generally
over one year).
The Group provides a one year
warranty for the majority of its Products. Based on the Group’s experience, the provision is de minims.
Projects:
Revenues from Projects are recognized
upon final acceptance from the customers, as such acceptance is deemed substantive.
Under such method, costs are
accumulated on the balance sheet until final acceptance is received. Similarly, amounts billed to customers are also deferred until
final acceptance is received. To the extent that the amount of accumulated costs exceeds the amount of advance (or progress) payments
received or billed by the Group, the excess is reflected on the balance sheet as a current asset, separated from inventory. To
the extent that the amount of advance (or progress) payments received or billed by the Group exceeds the amount of accumulated
costs, the excess is reflected as a liability on the balance sheet.
In instances where revenues
are derived from sales of third-party vendors’ products or services, revenues are recognized on a gross basis and the related
costs are recognized within cost of revenues, when the Group has the following indicators for gross reporting: (i) it is the primary
obligor of the sales arrangements; (ii) it is subject to inventory risks of physical loss; (iii) it has latitude in establishing
prices; and (iv) it has discretion in suppliers’ selection and assumes credit risks on receivables from customers.
Ability Inc.
Notes to the Consolidated Financial Statements
NOTE 2 - Summary
of Significant Accounting Policies (Cont.):
|
e.
|
Revenue recognition (Cont.):
|
SaaS
Revenues:
The Group’s SaaS multiple-element
arrangements are typically comprised of subscription and support fees from customers accessing the Group’s software and set-up
fees. The Group does not provide the customer the contractual right to take possession of the software at any time during the hosting
period under these arrangements. The Group recognizes revenue for subscription and support services over the arrangement period
originating when the subscription service is made available to the customer and the contractual hosting period has commenced.
Usage based fees:
Revenues are recognized in
the period in which subscribers use the related services.
Other multiple elements arrangements:
When a sale arrangement contains
multiple elements, the Group allocates revenues to each element based on a selling price hierarchy. The selling price for a deliverable
is based on its vendor-specific objective evidence (“VSOE”), if available, third party evidence (“TPE”)
if VSOE is not available, or estimated selling price (“ESP”) if neither VSOE nor TPE is available. The Group establishes
VSOE of selling price using the price charged for a deliverable when sold separately. When VSOE cannot be established, the Group
attempts to establish selling price of each element based on TPE. TPE is determined based on competitor prices for similar deliverables
when sold separately. Generally, the Group’s go-to-market strategy typically differs from that of its peers and its offerings
contain a significant differentiation such that the comparable pricing of products with similar functionality cannot be obtained.
Furthermore, the Group is unable to reliably determine what similar competitor products’ selling prices are on a standalone
basis. Therefore, the Group is typically not able to determine TPE. The best ESP is established considering several external and
internal factors including, but not limited to, historical sales, pricing practices and geographies in which the Group offers
its products. The determination of ESP is based on applying significant judgment to weigh such factors.
Advertising costs are expensed
as incurred. In 2017, 2016 and 2015, advertising expenses were $53 thousand, $24 thousand and $26 thousand, respectively.
Related parties include the
Controlling Shareholders and entities controlled by them.
|
h.
|
Fair
value measurements:
|
Fair value is defined as the
price that would be received by selling an asset or paid to transfer a liability (i.e. the ‘exit price’) in an arms’
length transaction between willing market participants at the measurement date. The applicable financial accounting rules establish
a hierarchy for inputs used in measuring fair value. The hierarchy is divided into three levels based on the reliability of inputs:
Level 1
- Valuations
based on quoted prices in active markets for identical assets or liabilities that the Group has the ability to access.
Level 2
- Valuations
based on quoted prices in markets that are not active but for which all significant inputs are observable, either directly or
indirectly.
Level 3
- Valuations
based on inputs that are unobservable and significant to the overall fair value measurement.
The Group’s financial
assets and liabilities as of December 31, 2017 and 2016 are measured based on Level 1 inputs.
Ability Inc.
Notes to the Consolidated Financial Statements
NOTE
2 - Summary of Significant Accounting Policies (Cont.):
The inventory items consist
of purchased systems and are stated at the lower of cost or market. Cost is determined using the “First-In, First-Out”
method of inventory accounting. The valuation of inventory items requires the Group to make estimates regarding excess or obsolete
inventories.
The purchased systems are utilized typically for one of the following purposes: (i) future projects; (ii)
demo; and (iii) spare parts for installed systems. The first utilization suggests that the systems should be classified as inventory
while the second and third suggest it should be classified as property and equipment. In order to reflect those utilizations appropriately
between the inventory and property and equipment line items, the Group performed an aggregated analysis which suggested that such
systems should be classified as inventory for the first year from purchase date, on such date tested for impairment and then classified
to property and equipment and amortized over four years from that date, see also below for the amortization period.
|
j.
|
Property
and equipment, net:
|
Property and equipment are stated
at cost, less accumulated depreciation and amortization. Upon the retirement or disposition of property and equipment, the related
costs and accumulated depreciation and amortization are removed and any related gain or loss is recorded in the statements of operations
and comprehensive income (loss). Repairs and maintenance that do not extend the life, or improve an asset are expensed in the periods
incurred.
The Group evaluates its property
and equipment for indicators of possible impairment when events or changes in circumstances indicate the carrying amount of an
asset may not be recoverable. Impairment exists if the carrying amounts of such assets exceed the estimates of future net undiscounted
cash flows expected to be generated by such assets. Should impairment exist, the impairment loss would be measured based on the
excess carrying value of the asset over the asset’s estimated fair value.
Ability Inc.
Notes to the Consolidated Financial Statements
NOTE
2 - Summary of Significant Accounting Policies (Cont.):
|
j.
|
Property and equipment, net
(Cont.):
|
Depreciation and amortization
are calculated using the straight-line method over the estimated useful lives of the assets, at the following annual rates:
|
|
%
|
|
Useful life (years)
|
|
|
|
|
|
|
Software systems (from classified date, see also above)
|
25
|
|
4
|
|
Vehicles
|
15
|
|
7
|
|
Leasehold improvements
|
10-20
|
|
5-10
|
|
Office furniture and equipment
|
7-10
|
|
10-14
|
|
Computers, electronics and related
|
15-33
|
|
3-7
|
Deferred tax asset and liability
accounts’ balances are determined based on differences between the financial reporting and tax bases of assets and liabilities
and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. The
Group accounts for deferred tax on non-distributed income that are subject to income tax once distributed and when there is an
intent to distribute them.
The Group applies the two-step
approach in recognizing and measuring uncertain tax positions. The first step is to evaluate the tax position taken or expected
to be taken in a tax return by determining if the weight of available evidence indicates that it is more likely than not that,
on an evaluation of the technical merits, the tax position will be sustained on audit, including resolution of any related appeals
or litigation processes. The second step is to measure the tax benefit as the largest amount that is more than 50% likely to be
realized upon ultimate settlement.
|
l.
|
Earnings
(loss) per share:
|
The Group calculates basic earnings
or loss per share by dividing net income or loss by the weighted-average number of ordinary shares outstanding during the year.
However, consistent with the reverse merger accounting, the calculation of the weighted-average number of ordinary shares includes
2,459,088 shares (which include also 48,000 ordinary shares that were issued to the ASM Former Shareholder upon exercise of its
put option on its remaining ordinary shares of ASM) assumed to be outstanding as of January 1, 2013. Further, the outstanding shares
subject to put options were excluded, consistent with the accounting treatment of a put option liability.
Ability Inc.
Notes to the Consolidated Financial Statements
NOTE
2 - Summary of Significant Accounting Policies (Cont.):
|
l.
|
Earnings (loss) per share
(Cont.):
|
Diluted earnings (loss) per
share would give effect to dilutive warrants and other potential ordinary shares outstanding during the period, considering the
treasury stock method. The outstanding warrants were “out-of-the-money” and the issuance of the Net Income Shares was
not probable at any given year and therefore excluded from the calculation.
Basic and diluted earnings
(loss) per ordinary share data were computed as follows:
|
|
|
Year Ended December 31,
|
|
|
|
|
2017
|
|
|
2016
|
|
|
2015
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss) (U.S. dollars in thousands)
|
|
$
|
(9,111
|
)
|
|
$
|
(8,053
|
)
|
|
$
|
14,753
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted-average ordinary shares outstanding - basic and diluted*
|
|
|
2,459,088
|
|
|
|
2,459,088
|
|
|
|
2,459,088
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings (loss) per ordinary basic and diluted (U.S. dollars)
|
|
$
|
(3.71
|
)
|
|
$
|
(3.27
|
)
|
|
$
|
6.00
|
|
|
*
|
On December 27, 2017, the Company implemented a 1-for-10 consolidation
of its ordinary shares with a market effective date of March 23, 2018, which was applied retrospectively for the calculation of
the basic and diluted earnings (loss) per ordinary share.
Refer to Note 7.b. for warrants assumed by the Company which
may result in an additional outstanding ordinary shares.
|
The Group is involved in various
commercial, government investigation and other legal proceedings that arise from time to time. The Group records accruals for these
types of contingencies to the extent that the Group concludes their occurrence is probable and that the related liabilities are
estimable. When accruing these costs, the Group will recognize an accrual in the amount within a range of loss that is the best
estimate within the range. When no amount within the range is a better estimate than any other amount, the Group accrues for the
minimum amount within the range. The Group records anticipated recoveries under existing insurance contracts that are virtually
certain of occurring at the gross amount that is expected to be collected. Legal costs are expensed as incurred.
Ability Inc.
Notes to the Consolidated Financial Statements
NOTE
2 - Summary of Significant Accounting Policies (Cont.):
|
n.
|
Recently
Issued Accounting Pronouncements:
|
Not yet
adopted in current period:
|
1)
|
In May 2014, the Financial Accounting Standards Board (the “FASB”) issued Accounting Standards Update (“ASU”) 2014-09, Revenue from Contracts with Customers (Topic 606). ASU 2014-09 supersedes the revenue recognition requirements in Accounting Standards Codification (“ASC 605”), Revenue Recognition, and requires entities to recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled to in exchange for those goods or services. As currently issued and amended, ASU 2014-09 is effective for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period. ASU 2014-09 permits the use of either a retrospective or cumulative effect transition method. The Group adopted ASU 2014-09 along with the related additional ASUs on Topic 606 (Collectively, “ASC 606”) on January 1, 2018, using the modified retrospective transition method. Contracts that are substantially completed will be excluded from the transition adjustment.
|
The Group has reviewed all
of its contracts with customers and has implemented the required process, data, and system changes to comply with the requirements
of ASC 606.
The Group did not have any material
cumulative-effect adjustment as a result of the adoption of ASC 606. In addition, the adoption of ASC 606 will not have any material
impact on the Group consolidated financial statement line items in the year of adoption. The Group will make the additional required
disclosures under Topic 606, starting with the Group’s consolidated financial statements that include the initial adoption
date.
|
2)
|
In November 2016, the FASB issued ASU
2016-18, Statement of Cash Flows (Topic 230): Restricted Cash (a Consensus of the FASB Emerging Issues Task
Force). ASU 2016-18 requires that a statement of cash flows explain the change during the period in the total of cash,
cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. Therefore, amounts
generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when
reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. This update also
requires an entity to disclose the nature of restrictions on its cash, cash equivalents, and amounts generally described as
restricted cash or restricted cash equivalents. ASU No. 2016-18 is effective for fiscal years beginning after December 15,
2017, including interim periods within those fiscal years with early adoption permitted, including adoption in an interim
period.
|
Ability Inc.
Notes to the Consolidated Financial Statements
NOTE
2 - Summary of Significant Accounting Policies (Cont.):
|
n.
|
Recently Issued Accounting
Pronouncements (Cont.):
|
The Group typically has restrictions
on certain amounts of cash and cash equivalents, primarily consisting of amounts used to secure bank guarantees in connection with
sales contract performance obligations, and expect to continue to have similar restrictions in the future. The Group currently
reports changes in such restricted amounts as cash flows from operating activities on its consolidated statement of cash flows.
This standard will change that presentation. The Group adopted ASU No. 2016-18 on January 1, 2018 and is currently reviewing it
to assess other potential impact on its consolidated financial statements.
|
3)
|
In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842), which will require lessees to recognize assets and liabilities for leases with lease terms of more than 12 months. Consistent with current GAAP, the recognition, measurement, and presentation of expenses and cash flows arising from a lease by a lessee primarily will depend on its classification as a financial or operating lease. However, unlike current GAAP, which requires only capital leases to be recognized on the balance sheet, the new guidance will require both types of leases to be recognized on the balance sheet. The new guidance is effective for all periods beginning after December 15, 2018. The Group is currently evaluating the effects that the adoption of ASU No. 2016-02 will have on its consolidated financial statements.
|
NOTE
3 - Restricted DEPOSITS:
The restricted deposits as of December
31, 2016 totaled NIS 6,760 thousand ($1,758 thousand) relates to a deposit in connection with one of the legal proceedings, see
Note 8.a.8. for additional information.
Regarding the restricted deposit in connection
with the put option provided to the Controlling Shareholders - on November 13, 2017, the Company, the Controlling Shareholders
and the Bank Leumi Le-Israel Trust Company Ltd., as escrow agent entered into an amendment (the “Amendment”) to the
escrow agreement among such parties dated December 23, 2015, the terms of such escrow agreement presented in Note 1.b.1. Pursuant
to the Amendment, the Put Option Period will now commence on January 1, 2019 and will end on March 1, 2021. Such change resulted
in a classification of the restricted deposit and the put option liability from current assets and current liabilities to non-current
assets and non-current liabilities, respectively as of December 31, 2017.
Ability Inc.
Notes to the Consolidated
Financial Statements
NOTE
4 - Property and Equipment, Net:
Composition:
|
|
December 31,
|
|
|
|
2017
|
|
|
2016
|
|
|
|
(U.S. dollars in thousands)
|
|
|
|
|
|
|
|
|
Cost:
|
|
|
|
|
|
|
|
|
Software Systems
|
|
$
|
1,361
|
|
|
$
|
1,105
|
|
Vehicles
|
|
|
554
|
|
|
|
606
|
|
Leasehold improvements
|
|
|
347
|
|
|
|
355
|
|
Office furniture and equipment
|
|
|
121
|
|
|
|
121
|
|
Computers, electronics and related
|
|
|
13
|
|
|
|
13
|
|
|
|
$
|
2,396
|
|
|
$
|
2,200
|
|
Less: accumulated depreciation and amortization
|
|
|
1,008
|
|
|
|
612
|
|
Property and equipment, net
|
|
$
|
1,388
|
|
|
$
|
1,588
|
|
NOTE 5 -
|
Accumulated costs with respect to projects in excess of progress payments (Progress payments in excess of accumulated costs with respect to Projects):
|
Composition:
|
|
December 31,
|
|
|
|
2017
|
|
|
2016
|
|
|
|
(U.S. dollars in thousands)
|
|
|
|
|
|
|
|
|
Accumulated costs
|
|
$
|
547
|
|
|
$
|
548
|
|
Advanced payments from customers
|
|
|
(853
|
)
|
|
|
(397
|
)
|
Accumulated costs with respect to projects in excess of progress payments (progress payments in excess of accumulated costs with respect to projects)
|
|
$
|
(306
|
)
|
|
$
|
151
|
|
Ability Inc.
Notes to the Consolidated
Financial Statements
NOTE
6 - Related Parties:
|
a.
|
Purchases from related parties,
loans to related parties and due from Controlling Shareholders
:
|
|
1.
|
Anatoly Hurgin owns 100% of Alan Ltd. (“Alan”) which holds a 60% interest in Active Intelligence Labs Ltd. (Israel) (“AIL”). ACSI purchased products which are integrated into its innovative tailored solutions totaling $780 thousand and $420 thousand from AIL in the years ended December 31, 2015 and 2014, respectively. The debt as of December 31, 2015 ($600 thousand) was repaid at August 2, 2016.
|
|
2.
|
In in the years ended December 31, 2014 and 2013, ACSI granted Alan loans in the aggregate amounts of $555 thousand and $205 thousand, respectively. The loans bore annual interest of 3.3%, linked to the Israeli consumer price index, and were repaid in December 2015.
|
|
3.
|
The amounts due from the Controlling
Shareholders as of December 31, 2016 were repaid to ACSI on April 19, 2017. See Note 8.a.8. for additional
information.
|
In the year ended December 31,
2011, ACSI declared dividends of NIS 10,760 thousand ($2,833 thousand) of which 15% income tax was withheld (the “Net Amount”)
and NIS 1,140 thousand ($300 thousand) and NIS 474 thousand ($125 thousand) were paid to the Israel Tax Authority in the years
ended December 31, 2013 and 2014, respectively. NIS 894 thousand ($197 thousand), NIS 1,379 thousand ($231 thousand), NIS 2,350
thousand ($817 thousand) and NIS 4,523 thousand ($1,163 thousand) of the Net Amount were paid to the Controlling Shareholders in
the years ended December 31, 2012, in 2013, 2014 and 2015, respectively.
Additionally, in the fourth
and the second quarters of 2015, ACSI declared dividends of NIS 42,825 thousand ($11,000 thousand) and NIS 23,560 thousand ($6,251
thousand), respectively, of which 20% income tax was withheld and outstanding as of December 31, 2015 (income tax of NIS 13,277
thousand ($3,404 thousand) was paid to the Israel Tax Authority in January 2016), while the net amounts were paid to the Controlling
Shareholders. It was agreed as part of ACSI’s tax assessments for the three years ended December 31, 2014 that were finalized
on May 30, 2016 that the Controlling Shareholders withholding tax for the 2015 dividends should be NIS 16,400 thousand ($4,260
thousand). ACSI paid the difference to the Israel tax authority and the Controlling Shareholders compensated ACSI for such difference.
Ability Inc.
Notes to the Consolidated Financial Statements
NOTE
6 - Related Parties (CONT.):
|
c.
|
Related parties’ employment
agreements and compensation:
|
|
1.
|
The Group entered into new employment agreements with each of its two Controlling Shareholders. One of the Controlling Shareholders is the Chairman of the Board of Directors and the Chief Executive Officer and the other is a member of the Board of Directors and the Chief Technology Officer. Each of the employment agreements will remain in effect unless terminated as described below. Pursuant to each employment agreement, the executive’s gross salary is NIS 120,000 ($31,200) per month commencing on January 1, 2016. Each executive is also entitled to receive social benefits: however, each of the executives agreed to a temporary 50% reduction in the salaries, effective as from May 2017.
|
Each employment agreement provides
that the executive is entitled to receive an annual performance bonus of up to NIS 360,000 ($93,600) based on annual performance
goals agreed upon by the Group and the executive (such performance goals were not met during the years ended December 31, 2017
and 2016 and therefore no performance bonus was recorded or paid). Each employment agreement may be terminated by the Group or
the executive upon 120 days’ prior written notice, in which case, the executive is entitled to receive salary and benefits
during such 120 days and for a period of eight months thereafter. The executive will be entitled to accept new employment after
the expiration of such eight month period. In addition, the Group, by resolution of the Company’s Board of Directors, may
terminate the employment agreements at any time by a written notice with cause (as defined in the employment agreements).
The Controlling Shareholders’
compensation related expenses in the years ended December 31, 2017, 2016 and 2015 amounted to NIS 2,391 thousand ($664 thousand),
NIS 3,562 thousand ($928 thousand) and NIS 487 thousand ($125 thousand), respectively.
|
2.
|
The Group entered into a new employment agreement with a Controlling Shareholder’s son commencing March 22, 2016 and was employed by the Group until June 20, 2016. Based on the agreement he was entitled to a monthly gross salary of NIS 10,000 ($2,600) and other related social benefits.
|
NOTE
7 - ordinary shares, PREFERRED shares and warrants:
The
Company is authorized to issue 20,000,000 ordinary shares with a par value of $0.001 per share, of which 2,528,415 were issued
and outstanding as of December 31, 2015. During January 2016, the Company issued 48,000 ordinary shares par value $0.001 in connection
with ASM Former Shareholder’s exercising his put option on his remaining shares in ASM. As a result the ordinary shares issued
and outstanding as of that that date and as of December 31, 2017 and 2016 were 2,576,415.
The
Company is authorized to issue 5,000,000 preferred shares with a par value of $0.001 per share, of which none were issued and outstanding
as of December 31, 2017 and 2016.
On December 27, 2017, the Company implemented a 1-for-10 consolidation of its ordinary shares with a market
effective date of March 23, 2018. The effect of such consolidation was applied retrospectively for all the amount of shares, warrants,
related par value and others presented in this note and elsewhere in the consolidated financial statements.
Ability Inc.
Notes to the Consolidated Financial Statements
NOTE
7 - ordinary shares, PREFERRED shares and warrants (CONT.):
Since
its inception, Cambridge issued 855,744 warrants which were assumed by the Company in the merger (see Note 1). Each warrant entitles
its holder to purchase one ordinary share at a price of $115.00 and expires on December 17, 2018. The Company may redeem the warrants
in the event that the traded ordinary share price is at least $175.00 per share (for any 20 trading days within a 30-day trading
period) on a “cashless basis”.
On
March 21, 2016, the Company received a letter from NASDAQ informing that its warrants did not meet the minimum 400 Round Lot Holder
requirement for initial listing on the NASDAQ and that the Staff had determined to initiate procedures to delist the Company’s
warrants from NASDAQ. As the Company did not appeal this determination, the Company’s warrants were delisted from NASDAQ
on April 18, 2016 and since such date have traded on the “OTC Pink” market under the symbol “ABIWF”.
NOTE
8 - commitments and contingencies:
|
1)
|
SEC
Investigation
|
|
|
|
|
|
As
the Company disclosed in its Report on Form 6-K furnished with the United States Securities and Exchange Commission (“SEC”),
on February 16, 2017, the Company received a subpoena from the SEC. The subpoena requests, among other things, information
regarding the transaction with Cambridge Capital Acquisition Corporation, the restatement that occurred in May 2016, and financial
and business information. In furtherance of the investigation, the SEC has been obtaining testimony from the Company’s
officers among others. The Company and its officers are fully cooperating with the investigation. As a result of the investigation,
the Company may incur significant legal and accounting expenses. Furthermore, the Company cannot predict what, if any, actions
the SEC may take against the Company or any of its officers, or the timing or duration of the investigation.
|
Ability Inc.
Notes to the Consolidated Financial Statements
NOTE
8 - commitments and contingencies (CONT.):
a.
|
Legal proceedings (Cont.):
|
|
2)
|
Re. Ability, Inc. Securities Litigation
|
|
|
|
|
|
On May 25, 2016, a purported class action lawsuit, captioned In re Ability Inc. Securities Litigation, Master File No. 16-cv-03893-VM (S.D.N.Y) was filed against the Company, Anatoly Hurgin and Avi Levin in the Southern District of New York in the United States. The complaint asserts claims pursuant to Section 10(b) and 20(a) of the Exchange Act of 1934 (the “Exchange Act”) and Rule 10b-5 promulgated thereunder on behalf of a putative class of all purchasers of the Company’s ordinary shares between September 8, 2015 and April 29, 2016. The complaint broadly alleges that certain of the Company’s public statements were false, and that the Company materially overstated its income and failed to disclose that it had material weaknesses in its internal controls. The complaint does not specify the amount of damages sought. On July 25, 2016, a second purported class action lawsuit was filed against the Company, Anatoly Hurgin and Avi Levin in the Southern District of New York in the United States. The complaint asserts claims pursuant to Section 10(b) and 20(a) of the Exchange Act and Rule 10b-5 promulgated thereunder on behalf of a putative class of all purchasers of the Company’s ordinary shares between September 8, 2015 and April 29, 2016. The complaint broadly alleges that the Company’s financial statements were false and misleading and were not prepared in conformity with GAAP, nor was the financial information a fair presentation of the Company’s operations. The complaint does not specify the amount of damages sought. These two putative class actions have been consolidated into one action and co-lead plaintiffs have been appointed. In accordance with a schedule adopted by the court, co-lead plaintiffs filed an amended complaint on April 28, 2017. In the amended complaint, co-lead plaintiffs have added Benjamin Gordon and BDO Ziv Haft as defendants. The amended complaint asserts claims pursuant to Section 10(b) of the Exchange Act and Rule 10b-5 promulgated thereunder against all defendants, a claim pursuant to Section 20(a) of the Exchange Act against Messrs. Hurgin, Levin and Gordon, a claim pursuant to Section 11 of the Securities Act against the Company, BDO Ziv Haft and Messrs. Hurgin and Gordon, and a claim pursuant to Section 15 of the Securities Act against Messrs. Hurgin, Levin and Gordon on behalf of a putative class of all purchasers of the Company’s ordinary shares between September 8, 2015 and April 29, 2016. The amended complaint does not specify the amount of damages sought. The complaint broadly alleges that certain of the Company’s public statements were false, that it had material weaknesses in its internal controls, that its financial statements were false and misleading and were not prepared in conformity with GAAP, nor was the financial information a fair presentation of the Company’s operations, and that its registration statement contained material misstatements and omissions. On August 17, 2017, the court ordered a stipulated schedule recognizing that all parties had agreed to a mediation on October 17, 2017 and all deadlines were reset until after that mediation took place.
|
Ability Inc.
Notes to the Consolidated Financial Statements
NOTE
8 - commitments and contingencies (CONT.):
a.
|
Legal proceedings (Cont.):
|
On December 21, 2017, the Company
entered into a Memorandum of Understanding (“MOU”) to memorialize an agreement in principle to settle all claims of
participating class members in the class actions consolidated in the lawsuit captioned In re Ability Inc. Securities Litigation,
No. 16-cv-03893 (VM), pending in the Southern District of New York (the “New York Class Action Litigation”). The MOU
provides for an aggregate settlement payment of $3.0 million, which includes all plaintiffs’ attorneys’ fees and expenses,
as well as any other class notice and administrative fees related to the resolution of the New York Class Action Litigation. On April 25, 2018, the motion for settlement was filed with the
court. The
settlement includes the dismissal of all claims against the Company and the named individuals in the New York Class Action Litigation.
It is expected that $250,000 of the $3.0 million settlement amount will be funded by the Company and the remaining $2.75 million
will be funded with the Company’s insurance proceeds or contributed by other defendants. The ultimate impact of this class
action settlement on the Levy Litigation (Case No. 2015-CA-003339), Pottash Litigation (Case No. 502016CA013823), Hammel Litigation
(Case No. 50-2018-CA-000762-MB-AG) and the Ladragor Litigation (C.A. 8482-05-16), each as further described herein, has yet to
be determined, however, some or all of the claims raised in such other actions may be deemed to be resolved, settled and disposed
of as part of such class action settlement.
The Company intends to
continue to attempt to settle and resolve the litigation. There is no assurance that the court will approve the settlement.
In connection with the entry
into of the MOU, the Company entered into an agreement with its insurer (the “Discharge Agreement”) pursuant to which
the Company agreed to discharge the insurer from liability with respect to any U.S. claims (excluding the Ladragor Litigation in
Israel) in consideration for an aggregate settlement amount of $5.0 million, of which $2.5 million is to be used for settlement
of the New York Class Action Litigation and the remaining amount is to be used to cover various defense and legal costs. Accordingly,
no insurance proceeds will be available for any U.S. claims other than with respect to the settlement of the New York Class Action
Litigation.
|
3)
|
Levy
Litigation
|
|
|
|
|
|
On October 15, 2015, plaintiff Brian Levy, purportedly on behalf of himself and all others similarly situated, filed a first amended class action and derivative complaint against Cambridge Holdco Corp., ACSI, the individual members of the Cambridge board of directors, and plaintiff also named Cambridge Capital Acquisition Corp. and the Company as nominal defendants in case number 2015CA003339 in the Circuit Court of the 15th Judicial Circuit in Palm Beach County, Florida.
|
Ability Inc.
Notes to the Consolidated Financial Statements
NOTE
8 - commitments and contingencies (CONT.):
a.
|
Legal proceedings (Cont.):
|
The complaint generally alleged,
among other things, that the members of the Cambridge board of directors breached their fiduciary duties to Cambridge stockholders
by approving the contemplated merger with ACSI, and that ACSI was aiding and abetting the Cambridge board of directors in the alleged
breach of their fiduciary duties.
The action sought injunctive
relief, damages and reimbursement of fees and costs, among other remedies. On February 17, 2016, ACSI filed a motion and supporting
memorandum of law to dismiss the plaintiff’s amended complaint on the grounds that the Court lacks personal jurisdiction
over ACSI; the derivative aiding and abetting claim was extinguished by the closing of the Business Combination and the claims
against ACSI are insufficiently pleaded. On September 15, 2016, the Court granted the defendants’ motion to dismiss in its
entirety without prejudice, and the Judge dismissed the amended complaint. However, the court provided the plaintiff with 45 days
within which to file a further amended complaint. On October 22, 2016, a second amended complaint was filed by the plaintiff. On
January 17, 2017, the defendants filed a motion to dismiss the second amended complaint on multiple grounds, including various
pleading deficiencies that the plaintiff has failed to adequately correct. On March 9, 2017, the plaintiff filed a response to
the motion to dismiss. On June 21, 2017, the Judge entered an order (the “June 21 Order”) granting a partial motion
to dismiss as to the counts against ACSI due to lack of personal jurisdiction over ACSI. ACSI was therefore dismissed from the
case without prejudice, and it is unclear at this stage whether the plaintiff will attempt to bring ACSI directly back into the
action in the future. On the other hand, pursuant to the Judge’s ruling, the Company still remains as a necessary party and
named defendant in the case. In the June 21 Order, the Judge also partially denied the motion to dismiss the second amended complaint,
and the purported class action and derivative claims against the individual defendants for alleged breach of fiduciary duties,
failure to disclose and ultra vires acts still remain pending.
On July 21, 2017, the Company
and each of the individual defendants filed their answer and affirmative defenses raising numerous substantive and legal defenses
to the alleged claims set forth in the second amended complaint. On August 7, 2017, plaintiff’s counsel filed a motion for
class certification and incorporated memorandum of law. The Company and defendants filed papers in opposition to such motion, and
on March 13, 2018, the Court entered an order denying plaintiff’s motion for class certification and providing that the plaintiff
may attempt to file a further amended complaint within 30 days after the order denying the request for class certification.
Ability Inc.
Notes to the Consolidated Financial Statements
NOTE
8 - commitments and contingencies (CONT.):
a.
|
Legal proceedings
(Cont.):
|
Plaintiff
has now filed a verified third amended class action and derivative complaint attempting to assert the same type of claims raised
in the defective second amended complaint. The Company intends to vigorously defend against such claims, and to continue to explore
potential opportunities to settle and resolve the litigation. If the case does not settle, it is impossible to predict the probable
outcome of these legal proceedings at this time in light of the relatively early stage of the proceedings.
|
4)
|
Pottash
Litigation
|
|
|
|
|
|
On December 13, 2016, a complaint, captioned Pottash v. Benjamin Gordon et. al., Case No. 50-2016-CA-013823, was filed in the 15th Circuit, Palm Beach County, Florida in the United States, against the Company, its former director, Benjamin Gordon, BG Strategic Advisors, LLC, Cambridge Capital, LLC and Jonathan Morris, in his capacity as trustee of the Gordon Family 2007 Trust. On January 23, 2017, the plaintiff filed an amended complaint. On March 2, 2017, the Company filed a motion to dismiss all of the claims asserted against it in the amended complaint. On the same day, Mr. Gordon and BG Strategic Advisors also filed motions seeking the dismissal of the amended complaint in its entirety. On November 27, 2017, the plaintiff filed a second amended complaint against the Company, Benjamin Gordon and Jonathan Morris. The complaint alleges violations of Florida State securities laws, common law fraud, negligent misrepresentation and conspiracy. On January 17, 2018, the Company filed a motion to dismiss seeking the dismissal of all claims asserted against it on various legal grounds. The co-defendants also filed motions seeking dismissal of the second amended complaint. The Court will be scheduling a special set hearing on the pending motions to dismiss. The Company intends to continue vigorously defend against this action. It is impossible to predict the probable outcome of these legal proceedings at this time in light of the relatively early stage of the proceedings.
|
|
5)
|
Hammel
Litigation
|
|
|
|
|
|
On January 19, 2018, a complaint, captioned Hammel v. Benjamin Gordon et. al (Case No. 50-2018-CA-000762-MB-AG), was filed in the 15th Circuit, Palm Beach County, Florida in the United States, against the Company, Benjamin Gordon and Jonathan Morris. The complaint alleges that the defendants, through a series of misrepresentations and omissions, induced the plaintiff, Robert Hammel, to invest in the stock of Cambridge. Plaintiff alleges to have lost more than $1.6 million due to the defendants’ conduct. In a summons issued in February 26, 2018, the Company was also named as one of the defendants. The Company has received a service copy of the complaint, and will be filing a motion to dismiss the claims asserted in the complaint on or before May 1, 2018. The Company intends to vigorously defend against this action. Given that these proceedings are in the preliminary stage, the timing or outcome of this matter cannot be predicted at this time.
|
Ability Inc.
Notes to the Consolidated Financial Statements
NOTE
8 - commitments and contingencies (CONT.):
a.
|
Legal proceedings (Cont.):
|
|
6)
|
Patent
Infringement Litigation
|
|
|
|
|
|
On October 27, 2015, ACSI received a notice alleging that its GSM interception and decryption systems allegedly fall within the claims of an Israeli patent owned by the claimant. The notice demands an accounting of all such products manufactured, exported, sold or otherwise commercialized by ACSI and/or any entity on its behalf. On November 12, 2015, a lawsuit, captioned Dr. Elad Barkan et al. v. Ability Computer & Software Industries Ltd. et al. C.C. 29551-11-15, alleging patent infringement, violation of a non-disclosure agreement, trade secret misappropriation and unjust enrichment, was filed with the Central District Court in Israel by a company and an individual against ACSI and its controlling shareholders. The amount sought in the lawsuit for registration fee purposes is NIS 5.0 million (approximately $1.4 million), however the plaintiffs have not yet quantified the amount of the compensation demanded. Furthermore, the plaintiffs demanded that ACSI and/or its controlling shareholders immediately cease any infringement of the patent as well as any further use of the claimed technology, including the further manufacture, export, sale or marketing of the alleged infringing products. On April 5, 2016, ACSI and its controlling shareholders filed a statement of defense, and on April 13, 2016 a preliminary hearing was held. On May 23, 2016, the plaintiffs filed a petition to add the Company, Ability Limited, a company wholly-owned by Anatoly Hurgin, and ASM as defendants and to amend the statement of claim. The parties then agreed to appoint a mediator in an attempt to settle the dispute out of court, and agreed, with the approval of the court, on a stay of proceedings until September 2016. However, the parties did not reach an agreement by that time. On October 9, 2016, upon the Company’s application and with the plaintiffs’ consent, the court decided to stay the proceedings until a decision is handed down on a related pending application to the Israeli Patent Registrar to revoke the patent in dispute. On August 23, 2017, the Deputy Patent Registrar decided to reject the revocation application, and on August 28, 2017 the plaintiffs informed the court of the deputy registrar’s decision, and requested to resume the proceedings and instruct the defendants (the Company and its controlling shareholders) to file their response to the petition to join the Company, Ability Limited and ASM as defendants (a response was filed on September 25, 2017, and a rejoinder was filed by the plaintiffs on October 22, 2017). On December 25, 2017, the defendants filed a petition to order the plaintiffs to deposit a guarantee for costs of the trial (a response was filed on January 14, 2018, and a rejoinder was filed on January 17, 2018). A second preliminary hearing was held on January 17, 2018, in which the court decided that the plaintiffs were allowed to amend the statement of claim without having the consent either of the defendants or of the Company, Ability Limited and ASM to the content of the amended statement of claim, and without waiving the right to request dismissal of the amended suit (partially or completely). The court also decided that the petition to order the plaintiffs to deposit a guarantee will be adjudicated after the statement of case is amended. On March 15, 2018 the plaintiffs filed an amended statement of claims against the original defendants, as well as against the Company, Ability Limited and ASM.
|
Ability Inc.
Notes to the Consolidated Financial Statements
NOTE
8 - commitments and contingencies (CONT.):
a.
|
Legal proceedings (Cont.):
|
The
defendants are required to file an amended statement of defense by May 15, 2018. A third preliminary hearing was set to June 13,
2018. The Company intends to continue vigorously defend against this action. The Group believes that the suit’s probability
of success, as filed, is less than even, and we intend to vigorously defend against it.
In addition,
after the Deputy Patent Registrar decided to reject the revocation application on August 23, 2017, the patentee, Dr. Barkan, filed
an amended version of certain claims on September 28, 2017. The amendment was subject to opposition by third parties until December
28, 2017. On December 27, 2017, the Company filed with the Patent Registrar an opposition to the request to have the specification
of the patent amended. On March 15, 2018, the Company filed its statement of claims, arguing that the request should be dismissed
for various reasons. Dr. Barkan is required to file his statement of claims by June 15, 2018.
|
7)
|
Ladragor
Litigation
|
|
|
|
|
|
On May 4, 2016, the Company was served with a
lawsuit and a motion for the certification of the lawsuit as class action, captioned Ladragror v. Ability Inc. et al. C.A.
8482-05-16, in the Tel Aviv District Court in Israel, filed, against the Company, Anatoly Hurgin, Alexander Aurovsky, and
Benjamin Gordon and Mitchell Gordon. The claim alleges, among other things, that the Company misled the public in our public
filings with regard to its financial condition and included misleading information (or omitted to include relevant
information) in its financial statements published in connection with the January 12, 2016 listing of shares for trading on
the Tel Aviv Stock Exchange. In addition, the claim alleges that the defendant directors breached their fiduciary duty under
Israeli law towards the Company and its public shareholders. The claim alleges that the plaintiff suffered personal damages
of NIS 137.7 (approximately $39.7), and estimates that its shareholders suffered damages of approximately NIS 23.3 million
(approximately $6.72 million). On September 15, 2016, the Company filed a motion for a stay of proceedings, due to other
pending class action lawsuits in the United States that also relate (among other things) to the stated causes of action and
based on similar claims. The Court required the parties to update the Court on the status of the United States class actions
by March 15, 2017. On March 15, 2017, the plaintiff filed an update and requested that proceedings be stayed until the
completion of the internal investigation of the audit committee. On the same day, the Company filed a separate update with
respect to the United States class actions, together with a motion for a stay of proceedings pending resolution of the
consolidated United States class actions. On March 16, 2017, the Court held that the plaintiff must respond to the motion to
stay proceedings pending resolution of the consolidated United States class actions. On March 26, 2017, the plaintiff filed
a partial response, requesting an extension until May 15, 2017 to file a full response, alleging that the publication of
the Company’s annual financial statements, together with the findings of the internal investigation, would affect
its position on its motion to stay proceedings. On May 23, 2017, the Court granted the plaintiff the requested extension.
On May 15, 2017, the plaintiff filed a motion asking for an additional three month extension to file a full response,
among other things, as the Company had not filed its annual financial statements or published the findings of the
internal investigation. On August 14, 2017, the Company and Messrs. Hurgin and Aurovsky filed a notice regarding their
counsel substitution. In light of this, the judge decided on August 27, 2017 to recuse herself from the case. On August
21, 2017, the plaintiff filed a motion and an updated notice in which he claimed that the Company had not yet published
the report of the internal investigation, and hence the reasons for granting him a continuance to file his response to
the motion to stay of proceedings are still relevant. The plaintiff also informed the Court that in the U.S. proceedings,
the parties agreed to mediation, and the mediation meeting was scheduled in October 2017. The plaintiff asked the Court
to file an update notice in 90 days. On August 28, 2017, the Court ordered the parties to file an update notice on
September 28, 2017. On September 28, 2017 and November 7, 2017 the plaintiff, the Company, and Messrs. Hurgin and
Aurovsky updated the Court that the mediation process in the U.S. was still pending. On November 8, 2017, the Court
ordered the parties to file an update notice in 90 days. On February 7, March 7 and April 12, 2018, the parties updated
the Court that they are holding negotiations in order to settle the case, and requested extensions for filing the update
notice. The parties are required to file the abovementioned notice on May 8, 2018. The Company intends to attempt to
settle and resolve the litigation. If the case does not settle, the Company intends to continue vigorously defend against
this action. Given that the proceeding is currently suspended, the timing or outcome of this matter cannot be predicted
at this time. As referenced above in Note 8.a.2, the
Ladragor Litigation is not subject to the Discharge Agreement.
|
Ability Inc.
Notes to the Consolidated Financial Statements
NOTE
8 - commitments and contingencies (CONT.):
a.
|
Legal proceedings (Cont.):
|
|
|
In January 2015, ACSI, Messrs. Anatoly Hurgin and Alexander Aurovsky, and a third party plaintiff entered into an arbitration process, following a claim filed with the Tel Aviv Magistrates Court in October 2014 by the plaintiff against ACSI and its former shareholders, claiming a right to review ACSI’s accounts and reserving the right to file a monetary claim. On September 14, 2016, the plaintiff presented the defendants with a settlement proposal for the resolution of all claims against the defendants and any entity affiliated with them in exchange of the full and final payment of an amount of NIS 8,450,000 (approximately $2,437,265), which was subsequently approved by the Company’s Board of Directors. On or about the time of the Board of Director's meeting at which (among things) the settlement proposal was approved, the plaintiff made claims that the proposal did not include VAT and that a settlement agreement has not been entered into between the parties. This dispute was referred to a new arbitration process, at the conclusion of which, a settlement was reached, according to which the parties agreed that the plaintiff would receive a total of NIS 8,142,000 (approximately $2,348,428), plus VAT. Thereafter, on February 20, 2017, such settlement was approved by the arbitrator and was made an arbitral award. Following the arbitral award and according to the determination of the Company’s Board of Directors, ACSI appointed an independent legal expert acting as an arbitrator to make a final determination as to the allocation of the settlement amount between the Company and Messrs. Hurgin and Aurovsky. On March 30, 2017, and as clarified on April 13, 2017, the legal expert determined that the Company shall be required to pay 70% of the settlement amount and the VAT and the remaining 30% of the settlement amount shall be paid by Messrs. Hurgin and Aurovsky. During the year ended December 31, 2017, the Company paid the entire settlement amount which was recorded during the year ended December 31, 2016 and in connection therewith, on April 19, 2017, each of Messrs. Hurgin and Aurovsky paid to the Company NIS 376,410 (approximately $98,000), or a total of NIS 752,820 (approximately $196,000) constituting their portion of the settlement amount.
|
The Group has the following lease agreements:
|
1)
|
A 5 year lease agreement, with respect to an office space, expiring on November 30, 2017, with an option to extend for an additional five years. The monthly rent is NIS 25 thousand ($7 thousand) linked to the Israeli consumer products index.
|
A
2.5 year lease agreement with respect to an office space, expiring on November 30, 2017, with an option to extend for an additional
five years. The monthly rent is NIS 16 thousand ($4 thousand) linked to the Israeli consumer products index.
Both
options were exercised for additional five years up to November 30, 2022 based on an aggregate monthly rent of NIS 44 (approximately
$13 thousand).
|
2)
|
A lease for an installation and quality assurance facility with an initial term from August 15, 2015 through August 15,
2016 which was extended until August 15, 2018. The Group has an option to extend the lease until August 15, 2019. The monthly
rent for the facility for the initial term and the option period is NIS 5 thousand (approximately $1 thousand).
|
In the years ended December
31, 2017, 2016 and 2015, the rent expenses amounted to $130 thousand, $152 thousand and $128 thousand, respectively.
Ability Inc.
Notes to the Consolidated Financial Statements
NOTE
8 - commitments and contingencies (CONT.):
|
c.
|
Agreement with a Provider:
|
On October 20, 2015 (the “Effective
Date”), ACSI entered into an agreement with an unrelated company which is a service provider and an owner and licensor of
telecommunications solutions (the “Provider”). The Provider granted ACSI an exclusive and non-transferable right and
license for three years to market, promote, advertise, sell and distribute the Provider’s products directly to customers
worldwide, in consideration for 50% of ACSI’s net income relating to those sales. The agreement sets minimum annual sales
at $10 million. In case ACSI does not satisfy this minimum commitment at the end of any contract year, ACSI is required to pay
the Provider a 15% penalty against the shortfall amount (maximum $1.5 million per year). In order to secure minimum sales and penalty,
it was also agreed that ACSI pay the Provider monthly payments of $125 thousand. During the year ended December 31, 2015, ACSI
paid the Provider $375 thousand. Those payments were recorded as prepayments in other receivables in the consolidated balance sheet
as of December 31, 2015, as ACSI believed it will satisfy those sales. During the year ended December 31, 2016, ACSI continued
to pay the monthly payments and paid the Provider an aggregated amount of $1,500 thousand. Those payments (along with the $375
thousand that were paid during the year ended December 31, 2015 and recorded initially as part of the balance sheet) were recorded
as part of the selling and marketing expenses since ACSI succeeded to sell only one of the Provider products during the year ended
December 31, 2016. The Provider waived its rights to the 50% net income share in connection with that sole 2016 sale in order to
support his product marketing efforts in the relevant region.
During the year ended December 31, 2016, ACSI and the Provider agreed that ACSI will be able to utilize
the monthly payments through the entire agreement period and not only on an annual basis.
|
d.
|
Resignation and appointment
of independent directors:
|
On April 9, 2017, the Company
received letters from each of Amnon Dick, Efraim Halevy, Amos Malka, Meir Moshe and Shalom Singer, representing all of the Company’s
independent directors, tendering their resignation as a member of the Company’s Board of Directors and committees thereof,
effective immediately (each, a “Resignation Letter” and collectively, the “Resignation Letters”).
Ability Inc.
Notes to the Consolidated Financial Statements
NOTE
8 - commitments and contingencies (CONT.):
|
d.
|
Resignation and appointment
of independent directors (cont.):
|
At the time of their resignations,
Mr. Dick was the Chairman of the Board of Directors and a member of the Company’s audit committee and compensation committee;
Mr. Halevy was a member of the Company’s nominating committee; Mr. Malka was a member of the Company’s compensation
committee; Mr. Moshe was the Chairman of the Company’s audit committee and Chairman of its nominating committee; and Mr.
Singer was the Chairman of the Company’s compensation committee and a member of its audit committee and nominating committee.
Each of Messrs. Dick, Malka,
Moshe and Singer stated in his respective Resignation Letter that his resignation was due to his approach to risk assessment and
management of the Company’s affairs not being aligned with that of the Controlling Shareholders, which made him unable to
contribute to the Company in a productive way. Each noted that, in view of the various challenges that the Company is currently
facing, a shared vision and broad cooperation among the Company’s Controlling Shareholders and directors is required and
that in view of the foregoing, and especially as he served as a director for only a few months, he does not believe it would be
appropriate to continue to serve as a director of the Company Mr. Halevy did not state any reason for his resignation in his Resignation
Letter.
Following the resignation
of the former independent directors, on May 15, 2017 the Company appointed Levi Ilsar, Brigadier General (Ret.) Eli Polak and
Nimrod Schwartz to serve as independent directors on the Company’s Board of Directors and the audit, compensation and
nominating committees thereof, in each case effective as of May 17, 2017. However, on June 29, 2017, Levi Ilsar, Eli Polak
and Nimrod Schwartz, representing all of the Company’s independent directors, tendered their written resignations with
immediate effect. Each of Messrs. Ilsar, Polak and Schwartz stated in his respective resignation notice that his resignation was due, among
other things, to the lack of cooperation by management which prevented him from fulfilling his duties as an independent director.
On July 5, 2017, the Company’s
Board of Directors appointed three new independent directors, Avraham Dan, Naftali Granot and Limor Beladev, effective immediately.
On July 24, 2017 and October 15, 2017, the Company’s Board of Directors appointed additional independent directors, Brigadier
General (Ret.) Yair Cohen and Joseph Tenne, respectively, effective immediately.
During the first quarter of
2015, through an internal investigation conducted by ACSI, it was discovered that ACSI was a victim of fraud from an outside, unrelated
third party. The fraud resulted in an unauthorized outgoing transfer to the third party by ACSI in the amount of $462 thousand.
While ACSI reported the fraud to the police and to its bank, there can be no assurance that the funds will be recovered. Accordingly,
the wire transfer amount has been recorded within general and administrative expenses in the statement of operations and comprehensive
income for the year ended December 31, 2015.
Ability Inc.
Notes to the Consolidated Financial Statements
NOTE
9 - rEVENUE CLASSIFIED BY GEOGRAPHICAL AREA:
|
|
Year Ended December 31,
|
|
|
|
2017
|
|
|
2016
|
|
|
2015
|
|
|
|
(U.S. dollars in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
Asia
|
|
$
|
555
|
|
|
$
|
9,230
|
|
|
$
|
8,373
|
|
Latin America
|
|
|
754
|
|
|
|
5,320
|
|
|
|
34,603
|
|
Europe
|
|
|
210
|
|
|
|
1,750
|
|
|
|
495
|
|
Israel*
|
|
|
1,325
|
|
|
|
-
|
|
|
|
8,365
|
|
Other
|
|
|
128
|
|
|
|
208
|
|
|
|
315
|
|
|
|
$
|
2,972
|
|
|
$
|
16,508
|
|
|
$
|
52,151
|
|
*
|
Sales in Israel during the years ended December 31, 2017, 2016 and 2015 include sales to Israeli integrators that have been sold to end users in Asia and Africa, which represented 45%, 0% and 16% of revenues during such periods, respectively.
|
Ability Inc.
Notes to the Consolidated Financial Statements
NOTE
10 – GENERAL and administrative expenses:
|
|
Year Ended December 31,
|
|
|
|
2017
|
|
|
2016
|
|
|
2015
|
|
|
|
(U.S. dollars in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
Legal fees*
|
|
$
|
2,741
|
|
|
$
|
3,849
|
|
|
$
|
36
|
|
Professional services fees
|
|
|
2,126
|
|
|
|
2,821
|
|
|
|
339
|
|
Settlement in connection in one of the legal proceedings (see Note 8.a.8.)
|
|
|
-
|
|
|
|
1,664
|
|
|
|
-
|
|
Salaries and related
|
|
|
620
|
|
|
|
681
|
|
|
|
224
|
|
Fraud from an unrelated third party (see Note 8e)
|
|
|
-
|
|
|
|
-
|
|
|
|
462
|
|
Impairment of fixed assets
|
|
|
-
|
|
|
|
114
|
|
|
|
-
|
|
Office maintenance (including rent)
|
|
|
76
|
|
|
|
98
|
|
|
|
59
|
|
Others
|
|
|
453
|
|
|
|
435
|
|
|
|
197
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
6,016
|
|
|
$
|
9,662
|
|
|
$
|
1,317
|
|
|
*
|
The 2017 legal fees includes a deduction of $2 million legal fees refund in connection with the 2016 directors and officers insurance policy based on a settlement agreement. Such amount was received on February 23, 2018 and presented within the other receivables as of December 31, 2017.
|
NOTE
11 - income taxes:
The Israeli corporate tax rates
applicable to ACSI and ASM:
2015 - 26.5%
2016 – 25%
2017 – 24%
2018 and thereafter –
23%
|
b.
|
“Approved Enterprise”
status
:
|
ACSI was granted an ‘approved
enterprise’ status for the 10 years ended December 31, 2014, under the Israeli Law for the Encouragement of Capital Investments,
1959 (the “Encouragement Law”). The tax benefit is a reduced corporate income tax rate on non-distributed income generated
in approved areas (“Approved Income”). Distributed Approved Income is subject to 25% corporate income tax at the company
level and 15% withholding income tax at the shareholder level.
Ability Inc.
Notes to the Consolidated Financial Statements
NOTE
11 - income taxES (CONT.):
|
b.
|
“Approved Enterprise”
status (Cont.):
|
As of December 31, 2011, upon
a tax assessment by the Israel Tax Authority, all of the accumulated Approved Income was distributed as dividends to the Controlling
Shareholders and the applicable income tax was applied. As ACSI distributes its Approved Income to its Controlling Shareholders,
a deferred tax liability was recorded on the non-distributed Approved Income as generated, on the difference of the reduced corporate
income tax rate applied and the regular corporate tax rates, as well as related deferred income tax expenses.
On May 30, 2016, ACSI and the
Israel Tax Authority signed a tax assessment agreement for the three years ended December 31, 2014 according to which all of the
accumulated Approved Income was distributed as dividends to the Controlling Shareholders and the applicable income tax were applied.
As part of that tax assessment ACSI was also required to pay $1.1 million in excess accrued tax provision for that period; such
additional tax was recorded as part of the 2016 income tax.
ACSI has final tax assessments
for the years up to 2014 inclusive.
|
c.
|
“Preferred Enterprise”
status:
|
Commencing January 1, 2015,
ACSI has elected the “Preferred Enterprise” program under the amendment of the Encouragement Law, whereby ACSI is subject
to corporate income tax rate on non-Preferred Income and 16% reduced income tax rate on its Preferred Income generated in all areas
other than Development Area A. As part of the tax assessment for the three years ended December 31, 2014 as mentioned above, it
was agreed that ACSI will be subject to a 14.6% (based on blended tax rates) for the tax years 2015 and 2016 and a reduced tax
rate, not yet determined (but up to 16%) in the tax year 2017 and thereafter.
|
|
Year Ended December 31,
|
|
|
|
2017
|
|
|
2016
|
|
|
2015
|
|
|
|
(U.S. dollars in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
Current
|
|
$
|
-
|
|
|
$
|
32
|
|
|
$
|
3,446
|
|
Previous year
|
|
|
-
|
|
|
|
1,054
|
|
|
|
-
|
|
Deferred
|
|
|
-
|
|
|
|
-
|
|
|
|
(423
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income tax expenses
|
|
$
|
-
|
|
|
$
|
1,086
|
|
|
$
|
3,023
|
|
Ability Inc.
Notes to the Consolidated Financial Statements
NOTE
11 - income taxES (CONT.):
e.
|
Deferred
income taxes:
|
In
assessing the realization of deferred tax assets, the Group considers whether it is more likely than not that all or some
portion of the deferred tax assets will not be realized. As described in Note 1. regarding the substantial doubt about the
Group’s ability to continue as a going concern, the Group applied a full valuation allowance for its deferred tax
assets.
Composition:
|
|
December 31,
|
|
|
|
2017
|
|
|
2016
|
|
|
|
(U.S. dollars in thousands)
|
|
|
|
|
|
|
|
|
Net and comprehensive loss
|
|
$
|
3,271
|
|
|
$
|
1,338
|
|
Temporary difference of expense in connection with the working capital received as part of the reverse merger
|
|
|
-
|
|
|
|
271
|
|
Temporary differences of expense in connection with employees benefits
|
|
|
41
|
|
|
|
42
|
|
Deferred tax assets before valuation allowance
|
|
|
3,312
|
|
|
|
1,651
|
|
Valuation allowance
|
|
|
(3,312
|
)
|
|
|
(1,651
|
)
|
|
|
$
|
-
|
|
|
$
|
-
|
|
Ability Inc.
Notes to the Consolidated Financial Statements
NOTE
11 - income taxES (CONT.):
|
f.
|
Reconciliation of income
tax expenses:
|
As the Company and ASM stand-alone
net results during the years ended December 31, 2017 and 2016 are relatively immaterial and zero during the year ended December
31, 2015, the Group’s overall effective tax rate is attributable to Israeli income tax and therefore a reconciliation between
the theoretical income tax, assuming corporate tax rates and the actual income tax expenses (benefit) as reported in the consolidated
statements of comprehensive income (loss) is calculated based on the Israeli corporate tax rates and is as follows:
|
|
Year ended December 31,
|
|
|
|
2017
|
|
|
2016
|
|
|
2015
|
|
|
|
(U.S. dollars in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) before income tax
|
|
$
|
(9,111
|
)
|
|
$
|
(6,967
|
)
|
|
$
|
17,776
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Israeli corporate income tax rate
|
|
|
25
|
%
|
|
|
25
|
%
|
|
|
26.5
|
%
|
Theoretical income tax expenses (benefit)
|
|
|
(2,278
|
)
|
|
|
(1,742
|
)
|
|
|
4,711
|
|
Valuation allowance for deferred tax
|
|
|
2,278
|
|
|
|
1,109
|
|
|
|
-
|
|
Tax rates differences
|
|
|
-
|
|
|
|
725
|
|
|
|
(1,659
|
)
|
Previous year
|
|
|
-
|
|
|
|
1,054
|
|
|
|
-
|
|
Other, net
|
|
|
-
|
|
|
|
(60
|
)
|
|
|
(29
|
)
|
Income tax expenses
|
|
$
|
-
|
|
|
$
|
1,086
|
|
|
$
|
3,023
|
|
g.
|
Uncertain tax positions:
|
The
following is a roll-forward of the total amounts of the Group’s unrecognized tax benefits at the beginning and at the end
of the years ended December 31, 2017, 2016 and 2015:
|
|
Year ended December 31,
|
|
|
|
2017
|
|
|
2016
|
|
|
2015
|
|
|
|
(U.S. dollars in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
Balance at beginning of year
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
Increase as a result of tax position taken in prior period
|
|
|
-
|
|
|
|
1054
|
|
|
|
-
|
|
Decrease due to settlement with the Israeli tax authorities
|
|
|
-
|
|
|
|
(1054
|
)
|
|
|
-
|
|
Balance at end of year
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
Ability Inc.
Notes to the Consolidated Financial Statements
NOTE
12 - CONCENTRATION Risk:
Major customers and vendors
are defined as those from whom the Group derives at least 10% of its revenues and cost of revenues, respectively.
During the years ended December
31, 2017, 2016 and 2015, revenues from the major customers reflected 89% (three customers), 79% (two customers) and 91% (three
customers) of the total consolidated revenues, respectively.
During the years ended December
31, 2017, 2016 and 2015, the cost of revenues from major vendors reflected 17% (one vendor), 72% (three vendors) and 70% (three
vendors) of the total consolidated cost of revenues, respectively.
As of December 31, 2017, accounts
receivables from one of the Group’s customers represented 99% of total accounts receivables.
NOTE
13 - Subsequent events:
On February 21, 2018, the Controlling
Shareholders executed an Undertaking for the benefit of the Group. According to the Undertaking, the Controlling Shareholders agreed
to make available to ACSI from, March 1, 2018, a $3.0 million line of credit or loan in favor of the Group. On April 11, 2018,
the Group obtained a six-month line of credit from an Israeli commercial bank in the amount of NIS 11 million (approximately $3.1
million). For additional information, see Note 1.f.
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