Company Quick10K Filing
Magal Security Systems
20-F 2020-12-31 Filed 2021-04-26
20-F 2019-12-31 Filed 2020-04-23
20-F 2018-12-31 Filed 2019-04-15
20-F 2017-12-31 Filed 2018-03-28
20-F 2016-12-31 Filed 2017-03-29
20-F 2015-12-31 Filed 2016-03-29
20-F 2013-12-31 Filed 2014-03-27
20-F 2012-12-31 Filed 2013-03-21
20-F 2011-12-31 Filed 2012-04-04
20-F 2010-12-31 Filed 2011-04-11
20-F 2009-12-31 Filed 2010-05-03

MAGS 20F Annual Report

Item 17 O Item 18 O
Part I
Item 1. Identity of Directors, Senior Management and Advisers
Item 2. Offer Statistics and Expected Timetable
Item 3. Key Information
Item 4. Information on The Company
Item 4A. Unresolved Staff Comments
Item 5. Operating and Financial Review and Prospects
Item 6. Directors, Senior Management and Employees
Item 7. Major Shareholders and Related Party Transactions
Item 8. Financial Information
Item 9. The Offer and Listing
Item 10. Additional Information
Item 11. Quantitative and Qualitative Disclosures About Market Risk
Item 12. Description of Securities Other Than Equity Securities
Part II
Item 13. Defaults, Dividend Arrearages and Delinquencies
Item 14. Material Modifications To The Rights of Security Holders and Use of Proceeds
Item 15. Controls and Procedures
Item 16. [Reserved]
Item 16A. Audit Committee Financial Expert
Item 16B. Code of Ethics
Item 16C. Principal Accountant Fees and Services
Item 16D. Exemptions From The Listing Standards for Audit Committees
Item 16E. Purchase of Equity Securities By The Issuer and Affiliated Purchasers
Item 16F. Changes in Registrant's Certifying Accountant
Item 16G. Corporate Governance
Item 16H. Mine Safety Disclosure
Part III
Item 17. Financial Statements
Item 18. Financial Statements
Item 19. Exhibits
Note 1:- General
Note 2:- Significant Accounting Policies
Note 3:- Other Accounts Receivable and Prepaid Expenses
Note 4:- Inventories
Note 5:- Property and Equipment, Net
Note 6:- Other Intangible Assets, Net
Note 7:- Goodwill
Note 8:- Short-Term Bank Credit and Credit Lines
Note 9:- Other Accounts Payable and Accrued Expenses
Note 10:- Long-Term Bank Debt
Note 11:- Commitments and Contingent Liabilities
Note 12:- Shareholders' Equity
Note 13:- Basic and Diluted Net Earnings per Share
Note 14:- Taxes on Income
Note 15:- Balances and Transactions with Related Parties
Note 16:- Segment Information
Note 17:- Selected Statements of Income Data
Note 18:- Subsequent Events - Unaudited
EX-2.4 exhibit_2-4.htm
EX-8.1 exhibit_8-1.htm
EX-12.1 exhibit_12-1.htm
EX-12.2 exhibit_12-2.htm
EX-13.1 exhibit_13-1.htm
EX-13.2 exhibit_13-2.htm
EX-15.1 exhibit_15-1.htm

Magal Security Systems Earnings 2013-12-31

Balance SheetIncome StatementCash Flow

20-F 1 zk1414647.htm 20-F zk1414647.htm


SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549

FORM 20-F
 
o
REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES EXCHANGE ACT OF 1934
 
OR
 
x
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the fiscal year ended December 31, 2013
 
OR
 
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from __________ to __________
 
o
SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
Date of event requiring this shell company report .................
 
Commission file number: 0-21388
 
MAGAL SECURITY SYSTEMS LTD.
(Exact Name of Registrant as specified in its charter
and translation of Registrant’s name into English)
 
Israel
(Jurisdiction of incorporation or organization)

P.O. Box 70, Industrial Zone, Yehud 56100, Israel
(Address of principal executive offices)

Ilan Ovadia, Chief Financial Officer
Magal Security Systems Ltd.
P.O. Box 70, Industrial Zone
 Yehud 56100, Israel
+972-3-5391444 (phone), +972-3-5366245 (fax)
(Name, Telephone, E-mail and/or Facsimile number of Company Contact Person)
 
Securities registered or to be registered pursuant to Section 12(b) of the Act:

Title of each class
Name of each exchange on which registered
Ordinary Shares, NIS 1.0 Par Value
NASDAQ Global Market
 
Securities registered or to be registered pursuant to Section 12(g) of the Act: None
 
Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act: None
 
Indicate the number of outstanding shares of each of the issuer's classes of capital or common stock as of the close of the period covered by the annual report:
Ordinary Shares, par value NIS 1.0 per share …….…16,147,522
(as of December 31, 2013)
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
 
Yes o    No x
 
 
 

 

 
If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.

Yes o    No x
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
 
Yes x    No o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).   
 
Yes x    No  o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act. (Check one):
     
Large accelerated filer o
Accelerated filer o
Non-accelerated filer x
 
Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements included in this filing:
     
U.S. GAAP x
International Financial Reporting Standards as issued by the International Accounting Standards Board o
Other o
 
If “Other” has been checked in response to the previous question, indicate by check mark which financial statement item the registrant has elected to follow:
 
Item 17 o    Item 18 o
 
If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
 
Yes o    No x
 
This Annual Report on Form 20-F is incorporated by reference into the Registrant’s Registration Statements on Form S-8, File Nos. 333-127340, 333-164696, 333-174127 and 333-190469.
 
 
 

 
 
TABLE OF CONTENTS

     
Page No.
 
1
 
1
 
1
 
1
 
A.
Selected Consolidated Financial Data.
1
 
B.
Capitalization and Indebtedness.
2
 
C.
Reasons for the Offer and Use of Proceeds.
3
 
D.
Risk Factors.
3
 
14
 
A.
History and Development of the Company.
14
 
B.
Business Overview.
14
 
C.
Organizational Structure.
26
 
D.
Property, Plants and Equipment.
26
 
27
 
27
 
A.
Operating Results.
27
 
B.
Liquidity and Capital Resources
40
 
C.
Research and Development, Patents and Licenses.
43
 
D.
Trend Information.
43
 
E.
Off-Balance Sheet Arrangements.
44
 
F.
Tabular Disclosure of Contractual Obligations.
44
 
44
 
A.
Directors and Senior Management.
44
 
B.
Compensation
47
 
C.
Board Practices
48
 
D.
Employees
58
 
E.
Share Ownership.
59
 
61
 
A.  
Major Shareholders.
61
 
B.
Related Party Transactions.
62
 
C.
Interests of Experts and Counsel.
62
 
62
 
A.
Consolidated Statements and Other Financial Information.
62
 
B.
Significant Changes.
63
 
64
 
A.
Offer and Listing Details.
64
 
B.
Plan of Distribution.
65
 
C.
Markets.
65
 
D.
Selling Shareholders.
65
 
E.
Dilution.
65
 
F.
Expenses of the Issue.
65
 
65
 
A.
Share Capital.
65
 
B.
Memorandum and Articles of Association.
65
 
C.
Material Contracts.
68
 
D.
Exchange Controls.
69
 
E.
Taxation.
69
 
F.
Dividends and Paying Agents.
80
 
G.
Statements by Experts.
80
 
 
- i -

 
 
 
H.
Documents on Display.
80
 
I.
Subsidiary Information.
81
 
81
 
82
 
82
 
82
 
82
 
82
 
83
 
83
 
83
 
84
 
84
 
84
 
84
  Mine Safety Disclosure
85
 
85
 
85
 
85
 
86
 
 
- ii -

 
 
INTRODUCTION

Magal Security Systems Ltd. is a leading international solutions provider of safety, security, site management and intelligence gathering and compilation solutions and products.  Based on more than 35 years of experience and interaction with customers, we have developed a unique set of solutions and products, optimized for perimeter, outdoor and general security applications.  Our turnkey solutions are typically integrated and managed by sophisticated modular command and control software, supported by expert systems for real-time decision support.  Our broad portfolio of critical infrastructure protection and site protection technologies includes a variety of smart barriers and fences, fence mounted detectors, virtual gates, buried and concealed detection systems and a sophisticated protection package for sub-surface intrusion.  As a world class innovator in the development of closed circuit television, intelligence video analysis and motion detection technology for outdoor operation, we have successfully installed customized solutions and products in more than 75 countries worldwide.  Our ordinary shares are traded on the NASDAQ Global Market under the symbol “MAGS”.  Our website is www.magal-s3.com.  The information on our website is not incorporated by reference into this annual report.  As used in this annual report, the terms “we,” “us,” “our,” and “Magal S3” mean Magal Security Systems Ltd. and its subsidiaries, unless otherwise indicated.
 
ULTRAWAVE, E-FIELD, FLARE, FLEXPI, FLEXPS, GUIDAR, INTELLI-FIELD, LOGO DESIGN (old Senstar), MISCELLANEOUS DESIGN (Stellar logo), OMNITRAX, PANTHER, PERIMITRAX, PINPOINTER, REPELS, S DESIGN, SENNET, SENSTAR, SENSTAR & DESIGN, SENSTAR-STELLAR, SENSTAR-STELLAR & DESIGN, SENTIENT, XFIELD, MAGAL, DTR, FORTIS, DREAMBOX, PIPEGUARD AND MAESTRO DB are registered trademarks and INTELLI-FLEX, INTELLIFIBER, STARLED, STARNET, ARMOURFLEX, FLASH, FLEXZONE, ROBOGUARD, FENSOR, CYBERSEAL, the Magal logo and all other marks used to identify particular products and services associated with our businesses are unregistered trademarks.  Any other trademarks and trade names appearing in this annual report are owned by their respective holders.
 
Our consolidated financial statements appearing in this annual report are prepared in U.S. dollars and in accordance with generally accepted accounting principles in the United States, or U.S. GAAP.  All references in this annual report to “dollars” or “$” are to U.S. dollars and all references in this annual report to “NIS” are to New Israeli Shekels.  The representative exchange rate between the NIS and the dollar as published by the Bank of Israel and effective on December 31, 2013 was NIS 3.471 per $1.00.
 
Statements made in this annual report concerning the contents of any contract, agreement or other document are summaries of such contracts, agreements or documents and are not complete descriptions of all of their terms.  If we filed any of these documents as an exhibit to this annual report or to any registration statement or annual report that we previously filed, you may read the document itself for a complete description of its terms.
 
This Annual Report on Form 20-F contains various “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, and within the Private Securities Litigation Reform Act of 1995, as amended.  Such forward-looking statements reflect our current view with respect to future events and financial results.  Forward-looking statements usually include the verbs, “anticipates,” “believes,” “estimates,” “expects,” “intends,” “plans,” “projects,” “understands" and other verbs suggesting uncertainty.  We remind readers that forward-looking statements are merely predictions and therefore inherently subject to uncertainties and other factors and involve known and unknown risks that could cause the actual results, performance, levels of activity, or our achievements, or industry results, to be materially different from any future results, performance, levels of activity, or our achievements expressed or implied by such forward-looking statements.  Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof.  We undertake no obligation to publicly release any revisions to these forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.  We have attempted to identify additional significant uncertainties and other factors affecting forward-looking statements in the Risk Factors section which appears in Item 3.D “Key Information -Risk Factors.”
 
 
- iii -

 
 
 
IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS
 
Not applicable.
 
OFFER STATISTICS AND EXPECTED TIMETABLE
 
Not applicable.
 
KEY INFORMATION
 
A.            Selected Consolidated Financial Data.
 
The following selected consolidated financial data for and as of the five years ended December 31, 2013 are derived from our audited consolidated financial statements which have been prepared in accordance with U.S. GAAP.  We have derived the following selected consolidated financial data as of December 31, 2012 and 2013 and for each of the years ended December 31, 2011, 2012 and 2013 from our consolidated financial statements set forth elsewhere in this annual report that have been prepared in accordance with U.S. GAAP.  We have derived the following selected consolidated financial data as of December 31, 2009, 2010 and 2011 and for each of the years ended December 31, 2009 and 2010 from our audited consolidated financial statements not included in this annual report.  The selected consolidated financial data set forth below should be read in conjunction with and are qualified entirely by reference to Item 5.  “Operating and Financial Review and Prospects” and our audited consolidated financial statements and notes thereto included elsewhere in this annual report.

   
2009(1)
   
2010
   
2011
   
2012
   
2013
 
                               
Revenues                                                             
  $ 54,518     $ 49,699     $ 88,591     $ 77,697     $ 51,517  
Cost of revenues                                                             
    33,404       31,400       49,089       44,163       31,059  
Gross profit                                                             
    21,114       18,299       39,502       33,534       20,458  
Operating expenses:
                                       
Research and development, net                                                           
    5,059       4,105       3,898       4,041       4,409  
Selling and marketing                                                           
    10,820       11,261       19,415       16,528       12,781  
General and administrative                                                           
    8,100       7,593       8,682       7,408       7,787  
   Other income
    -       -       (2,304 )     -       -  
Total operating expenses                                                             
    23,979       22,959       29,691       27,977       24,977  
Operating income (loss)                                                             
    (2,865 )     (4,660 )     9,811       5,557       (4,519 )
Financial expenses (income), net                                                             
    1,568       967       (756 )     472       (59 )
Income (loss) before income taxes                                                             
    (4,433 )     (5,627 )     10,567       5,085       (4,460 )
Income taxes                                                             
    864       602       723       991       69  
Income (loss) from continuing operations 
    (5,297 )     (6,229 )     9,844       4,094       (4,529 )
Income (loss) from discontinued operations, net
    4,216       -       -       -       -  
Net income (loss)
  $ (1,081 )   $ (6,229 )   $ 9,844     $ 4,094     $ (4,529 )
Less: net income (loss) attributable to non-controlling interest
    54       (24 )     -       -       (66 )
Net income (loss) attributable to Magal’s shareholders
  $ (1,135 )   $ (6,205 )   $ 9,844     $ 4,094     $ (4,463 )
Basic and diluted net earnings (loss) per share from
continuing operations
  $ (0.52 )   $ (0.60 )   $ 0.78     $ 0.26     $ (0.28 )
Basic and diluted net earnings (loss) per share from discontinued operations
    0.41       -       -       -       -  
Basic and diluted net earnings (loss) per share
  $ (0.11 )   $ (0.60 )   $ 0.78     $ 0.26     $ (0.28 )
                                         
Weighted average number of ordinary shares used in computing basic net earnings per share
    10,396,548       10,396,548       12,645,283       16,003,482       16,138,944  
Weighted average number of ordinary shares used in computing diluted net earnings per share
    10,398,624       10,396,548       12,645,283       16,030,816       16,138,944  
 
(1)
In September 2009, our Board of Directors resolved to discontinue the operations of the European integration subsidiary that we acquired in September 2007.  The subsidiary was sold in December 2009.  Accordingly, operating results and cash flows for the year ended December 31 2009, as well as the capital gain resulting from the sale, were reclassified to disclose the results of that subsidiary as discontinued operations.
 
 
- 1 -

 
 
   
2009
   
2010
   
2011
   
2012
   
2013
 
                         
Consolidated statements of Comprehensive Income:
                       
Net income (loss)
  $ (1,135 )   $ (6,205 )   $ 9,844     $ 4,094     $ (4,529 )
Realized foreign currency translation adjustments from subsidiary
    (789 )     -       -       (421 )     -  
Foreign currency translation adjustments
    2,166       1,226       (589 )     684       2,365  
Total comprehensive income (loss)
  $ 242     $ (4,979 )   $ 9,225     $ 4,357     $ (2,164 )
Less - comprehensive income (loss) attributable to non-controlling interests
    54       (24 )     -       -       (66 )
Comprehensive income (loss) attributable to Magal shareholders'
  $ 296     $ (5,003 )   $ 9,225     $ 4,357     $ (2,098 )
                   
      2009       2010       2011       2012       2013  
                   
Consolidated Balance Sheets Data:
                                       
Cash and cash equivalents
  $ 11,869     $ 16,596     $ 30,005     $ 36,784     $ 32,235  
Short and long-term bank deposits and restricted deposits
    2,019       4,888       10,123       9,607       12,255  
Working capital
    20,646       26,612       40,493       49,202       46,958  
Total assets
    60,650       65,710       85,987       91,036       87,787  
Short-term bank credit (including current maturities of long-term loans)
    10,058       9,830       5,390       5,391       6,270  
Long-term bank loans
    548       50       38       6       1,912  
Loan from related party
    -       9,907       -       -       -  
Total shareholders’ equity
    32,309       28,016       51,011       58,326       57,540  
Ordinary shares issued and outstanding
    10,396,548       10,396,548       15,819,822       16,098,022       16,147,522  
 
B.            Capitalization and Indebtedness.
 
Not applicable.
 
 
- 2 -

 
 
C. 
Reasons for the Offer and Use of Proceeds.
 
Not applicable.

D.            Risk Factors.

Investing in our ordinary shares involves a high degree of risk and uncertainty.  You should carefully consider the risks and uncertainties described below before investing in our ordinary shares.  If any of the following risks actually occurs, our business, prospects, financial condition and results of operations could be harmed.  In that case, the value of our ordinary shares could decline, and you could lose all or part of your investment.
 
Risks Related to Our Business
 
We have a history of operating losses and may not be able to achieve and sustain profitable operations.  We may not have sufficient resources to fund our operations in the future.
 
After two years of profitable operations, we incurred an operating loss in 2013 and may not be able to achieve and sustain profitable operations in the future.  If we do not generate sufficient cash from operations, we will be required to obtain additional financing or reduce our level of expenditure or cash balance.  Such financing may not be available in the future, or, if available, may not be on terms favorable to us.  If adequate funds are not available to us, our business, and results of operations and financial condition will be materially and adversely affected.
 
We depend on large orders from a relatively small number of customers for a substantial portion of our revenues.  The loss of one or more of our key customers could result in a loss of a significant amount of our revenues.
 
A relatively small number of customers account for a large percentage of our revenues.   Revenues from the provision of the perimeter security solution to the port of Mombasa, Kenya accounted for 19.3% and 14.2% of our revenues in 2012 and 2013, respectively and revenues from the provision of the perimeter security and command and control solutions for the 2012 Africa Cup of Nations in the Gabonese Republic, or the Gabonese Republic Project, accounted for 34.8% and 6.7% of our revenues in 2011 and 2012, respectively.  Historically, the Israeli Ministry of Defense, or the MOD, and the Israeli Defense Forces, or the IDF, have accounted for a significant amount of our revenues. For the years ended December 31, 2011, 2012 and 2013, they accounted for 7.8%, 9% and 15% of our revenues, respectively.
 
The MOD, the IDF or any of our other major continuing customers may not maintain their volume of business with us or, if such volume is reduced, other customers generating similar revenues may not replace the lost business. For example, in 2012, we completed the Gabonese Republic Project, and we do not expect to receive any future revenues from this project.  Our inability to replace business from large contracts will adversely affect our financial results.  Any unanticipated delays in a large project, changes in customer requirements or priorities during the project implementation period, or a customer’s decision to cancel a project, may adversely impact our operating results and financial performance.
 
Because our sales tend to be concentrated among a small number of customers during any period, our operating results may be subject to substantial fluctuations. Accordingly, our revenues and operating results for any particular quarter may not be indicative of our performance in future quarters, making it difficult for investors to evaluate our future prospects based solely on the results of any one quarter.
 
Given the nature of our customers and products, we receive relatively large orders for products from a relatively small number of customers. Consequently, a single order from one customer may represent a substantial portion of our sales in any one period and significant orders by any customer during one period may not be followed by further orders from the same customer in subsequent periods. Our sales and operating results are subject to very substantial periodic variations. Since quarterly performance is likely to vary significantly, our results of operations for any quarter or calendar year are not necessarily indicative of the results that we might achieve for any subsequent period. Accordingly, quarter-to-quarter and year-to-year comparisons of our operating results may not be meaningful. In addition, we have a limited order backlog that is generally composed of orders that are mostly fulfilled within a period of three to twelve months after receipt, which makes revenues in any quarter substantially dependent upon orders received in prior quarters.
 
 
- 3 -

 
 
We may not be able to complete the implementation of our 2013 growth strategy plan and may not be able to successfully expand our business activity and increase our sales.
 
In last quarter of 2013 we adopted a growth strategy beyond the core of our PIDS activity. Pursuant to this growth strategy, we will seek to acquire a security products or cyber company that will expand our portfolio in the security business (HLS) both in the physical and logical field. In addition, we determined to focus our business on our sensor activity, expand our sales channels and close certain technology gaps in response to new demands in the market place.  We intend to implement the plan though organic growth or the acquisition of, or investment in, businesses, products and technologies that complement our security business within the PIDS or Cyber fields.
 
We may not be able to implement our growth strategy plan and may not be able to successfully expand our business activity and increase our sales.  If we are successful in the implementation of our strategic plan, we may be required to hire additional employees in order to meet customer demands, and if we are unable to attract or retain qualified employees, our business could be adversely affected.
 
We may not be able to consummate any acquisitions or investments in the future or realize the benefits of such acquisitions and investments, if consummated.
 
Our failure to successfully integrate the operations of an acquired business or to retain key employees of acquired businesses and integrate and manage our growth may have a material adverse effect on our business, financial condition, results of operation or prospects.  We may not be able to realize the anticipated benefits of any acquisition.  Moreover, future acquisitions by us could result in potentially dilutive issuances of our equity securities, the incurrence of debt and contingent liabilities and amortization expenses related to identifiable intangible assets, any of which could materially adversely affect our operating results and financial position.  Acquisitions also involve other risks, including risks inherent in entering markets in which we have no or limited prior experience.
 
Our revenues depend on government procurement procedures and practices.  A substantial decrease in our customers’ budgets would adversely affect our results of operations.
 
Our products are primarily sold to governmental agencies, governmental authorities and government-owned companies, many of which have complex and time consuming procurement procedures.  A substantial period of time often elapses from the time we begin marketing a product until we actually sell that product to a particular customer.  In addition, our sales to governmental agencies, authorities and companies are directly affected by these customers’ budgetary constraints and the priority given in their budgets to the procurement of our products.  A decrease in governmental funding for our customers’ budgets would adversely affect our results of operations.  This risk is heightened during periods of global economic slowdown.
 
Accordingly, governmental purchases of our systems, products and services may decline in the future as the governmental purchasing agencies may terminate, reduce or modify contracts or subcontracts if:
 
 
·
their requirements or budgetary constraints change;
 
 
·
they cancel multi-year contracts and related orders if funds become unavailable;
 
 
·
they shift spending priorities into other areas or for other products; or
 
 
·
they adjust contract costs and fees on the basis of audits.
 
Any such event may have a material adverse effect on us.
 
 
- 4 -

 
 
Because competition in our industry is intense, our business, operating results and financial condition may be adversely affected.
 
The global market for safety, security, site management solutions and products is highly fragmented and intensely competitive.  It is characterized by rapidly changing technology, frequent new product introductions and rapidly changing customer requirements.  We compete principally in the market for perimeter intrusion detection systems, or PIDS, and turnkey projects and solutions.  Some of our competitors and potential competitors have greater research, development, financial and personnel resources, including governmental support.  We cannot assure you that we will be able to maintain the quality of our products relative to those of our competitors or continue to develop and market new products effectively. Continued competitive pressures could cause us to lose significant market share.
 
Increased competition and bid protests in a budget-constrained environment may make it more difficult to maintain our financial performance.
 
A substantial portion of our business is awarded through competitive bidding. Governments increasingly have relied upon competitive contract award types and multi-award contracts, which has the potential to create pricing pressure and increase our cost by requiring that we submit multiple bids and proposals. The competitive bidding process entails substantial costs and managerial time to prepare bids and proposals for contracts that may not be awarded to us or may be split among competitors. Following award, we may encounter significant expenses, delays, contract modifications, or even loss of the contract if our competitors protest or challenge contracts that are awarded to us. Multi-award contracts require that we make sustained efforts to obtain task orders under the contract.
 
As an example, in October 2012, we participated in a MOD experimental program with respect to the Israeli border security fence.   During 2013, our technology was tested and we were eventually chosen to install 15 km of border sensors. Two other Israeli contractors were also awarded contracts. However, follow-up orders may be split between the three competing parties pending the customer’s determination of the performance of the different technologies. As a result, the amount of revenues to be generated from this project is uncertain.
 
Unfavorable global economic conditions may adversely affect our customers, which directly impact our business and results of operations.
 
Our business and financial condition is affected by global economic conditions. For example, starting in late 2008 and lasting through much of 2009, a steep downturn in the global economy sparked by uncertainty in credit markets and deteriorating consumer confidence, reduced technology spending by many organizations. More recently, credit and sovereign debt issues destabilized certain European economies as well and thereby increased global macroeconomic uncertainties. Uncertainty about current global economic conditions continues to pose a risk as customers may postpone or reduce spending in response to restraints on credit. Should the economic slowdown increase and/or companies in our target markets reduce capital expenditures, it may cause our customers to reduce or postpone their capital spending significantly, potentially resulting in reductions in sales of our products, longer sales cycles, collectability delays, non-payment for product, slower adoption of new technologies and increased price competition, each of which could have a material adverse effect on our business, operating results and financial condition.

We may also be required in the future to record impairment charges relating to the carrying value of our intangible assets and goodwill, increase our reserves for doubtful accounts and further write-down our tax assets.  In addition, the fair value of some of our assets may decrease as a result of an uncertain economy and as a result, we may be required to record impairment charges in the future.  If global economic and market conditions or economic conditions in key markets remain uncertain or weaken further, our financial condition and operating results may be materially adversely affected.
 
We may be adversely affected by our long sales cycles.
 
We have in the past and expect in the future to experience long time periods between initial sales contacts and the execution of formal contracts for our products and completion of product installations.  The cycle from first contact to revenue generation in our business involves, among other things, selling the concept of our technology and products, developing and implementing a pilot program to demonstrate the capabilities and accuracy of our products, negotiating prices and other contract terms, and, finally, installing and implementing our products on a full-scale basis.  This cycle entails a substantial period of time, sometimes as much as one or more years, and the lack of revenues during this cycle and the expenses involved in bringing new sales to the point of revenue generation may put a substantial strain on our resources. Our business involves significant risks and uncertainties that may not be covered by indemnity or insurance.
 
 
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Our business involves significant risks and uncertainties that may not be covered by indemnity or insurance.
 
A significant portion of our business relates to designing, developing, and manufacturing advanced security, site management and intelligence gathering systems and products.  New technologies may be untested or unproven. Failure of some of these products and services could result in extensive loss of life or property damage. Accordingly, we also may incur liabilities that are unique to our products and services. In some, but not all circumstances, we may be entitled to certain legal protections or indemnifications from our customers, either through regulatory protections, contractual provisions or otherwise. The amount of insurance coverage that we maintain may not be adequate to cover all claims or liabilities, and it is not possible to obtain insurance to protect against all operational risks and liabilities.
 
Substantial claims resulting from an accident, failure of our products or services, or other incident, or liability arising from our products and services in excess of any indemnity and our insurance coverage (or for which indemnity or insurance is not available or not obtained) could adversely impact our financial condition, cash flows, or operating results. Any accident, even if fully indemnified or insured, could negatively affect our reputation among our customers and the public, and make it more difficult for us to compete effectively. It also could affect the cost and availability of adequate insurance in the future.
 
The market for our products is characterized by changing technology, requirements, standards and products, and we may be adversely affected if we do not respond promptly and effectively to these changes.
 
The market for our products is characterized by evolving technologies, changing industry standards, changing regulatory environments, frequent new product introductions and rapid changes in customer requirements.  The introduction of products embodying new technologies and the emergence of new industry standards and practices can render existing products obsolete and unmarketable.  Our future success will depend on our ability to enhance our existing products and to develop and introduce, on a timely and cost-effective basis, new products and product features that keep pace with technological developments and emerging industry standards and address the increasingly sophisticated needs of our customers.
 
In the future:
 
 
·
we may not be successful in developing and marketing new products or product features that respond to technological change or evolving industry standards;
 
 
·
we may experience difficulties that could delay or prevent the successful development, introduction and marketing of these new products and features; or
 
 
·
our new products and product features may not adequately meet the requirements of the marketplace and achieve market acceptance.
 
If we are unable to respond promptly and effectively to changing technologies and market requirements, we will be unable to compete effectively in the future.
 
Our failure to retain and attract personnel could harm our business, operations and product development efforts.
 
Our products require sophisticated research and development, marketing and sales and technical customer support.  Our success depends on our ability to attract, train and retain qualified research and development, marketing and sales and technical customer support personnel.  Competition for personnel in all of these areas is intense and we may not be able to hire sufficient personnel to achieve our goals or support the anticipated growth in our business.  If we fail to attract and retain qualified personnel, our business, operations and product development efforts would suffer.
 
 
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Our financial results may be significantly affected by currency fluctuations.
 
Most of our sales are made in North America, Europe, Africa and Israel.  Our revenues are primarily denominated in dollars, Euros and NIS, while a portion of our expenses, primarily labor expenses, is incurred in NIS and Canadian Dollars.  Additionally, certain assets, especially trade receivables, as well as part of our liabilities are denominated in NIS.  As a result, fluctuations in rates of exchange between the dollar and non-dollar currencies may affect our operating results and financial condition.  The dollar cost of our operations in Israel may be adversely affected by the appreciation of the NIS against the dollar.  In addition, the value of our non-dollar revenues could be adversely affected by the depreciation of the dollar against such currencies. During the years ended December 31, 2012 foreign currency fluctuations had an adverse impact on our results of operations and we recorded foreign exchange losses, net of $530,000.  In 2011 and 2013, foreign currency fluctuations had a positive impact on our results of operations and we recorded foreign exchange income, net of $1,394,000 and $89,000, respectively.  Our results of operations may continue to be materially affected by currency fluctuations in the future.
 
If we do not receive Israeli MOD approvals necessary for us to export the products we produce in Israel, our revenues may significantly decrease.
 
Israel’s defense export policy regulates the sale of a number of our systems and products. Current Israeli policy encourages export to approved customers of defense systems and products, such as ours, as long as the export is consistent with Israeli government policy.  A license is required to initiate marketing activities.  We are also required to obtain a specific export license for any products, services and knowledge exported from Israel.  We    may not be able to receive all the required licenses for which we may apply in the future.  If we do not receive the required licenses for which we apply, our revenues may decrease.
 
We are subject to laws regulating export of “dual use” items (items that are typically sold in the commercial market, but that also may be used in the defense market) and defense export control legislation.  Additionally, our participation in governmental procurement processes in Israel and other countries is subject to specific regulations governing the conduct of the process of procuring defense contracts.  Furthermore, solicitations for procurements by governmental purchasing agencies in Israel and other countries are governed by laws, regulations and procedures relating to procurement integrity, including avoiding conflicts of interest and corruption in the procurement process.  We may not be able to respond quickly and effectively to changing laws and regulations and any failure to comply with such laws and regulations may subject us to significant liability and penalties.
 
Our international operations require us to comply with anti-corruption laws and regulations of various governments and different international jurisdictions, and our failure to comply with these laws and regulations could adversely affect our reputation, business, financial condition and results of operations.
 
Doing business on a worldwide basis requires us and our subsidiaries to comply with the laws and regulations of various governments and different international jurisdictions, and our failure to successfully comply with these rules and regulations may expose us to liabilities. These laws and regulations apply to companies, individual directors, officers, employees and agents, and may restrict our operations, trade practices, investment decisions and partnering activities. In particular, as a company registered with the Securities and Exchange Commission, or the SEC, we are subject to the regulations imposed by the Foreign Corrupt Practices Act, or FCPA. The FCPA prohibits us from providing anything of value to foreign officials for the purposes of influencing official decisions or obtaining or retaining business or otherwise obtaining favorable treatment, and requires companies to maintain adequate record-keeping and internal accounting practices to accurately reflect the transactions of the company. As part of our business, we deal with state-owned business enterprises, the employees and representatives of which may be considered foreign officials for purposes of the FCPA. If our efforts to screen third-party agents and detect cases of potential misconduct fail, we could be held responsible for the noncompliance of these third parties under applicable laws and regulations, which may have a material adverse effect on our reputation and our business, financial condition and results of operations. In addition, some of the international locations in which we operate lack a developed legal system and have elevated levels of corruption. As a result of the above activities, we are exposed to the risk of violating anti-corruption laws. We have established policies and procedures designed to assist us and our personnel to comply with applicable U.S. and international laws and regulations. However, there can be no assurance that our policies and procedures will effectively prevent us from violating these regulations in every transaction in which we may engage, and such a violation could adversely affect our reputation, business, financial condition and results of operations.
 
 
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Reduction in Israeli government spending or changes in priorities for homeland security products may adversely affect our financial condition, operating results and prospects.
 
Historically, a significant portion of our revenues were from sales to the MOD and IDF and our financial condition, operating results and prospects would be adversely affected by Israeli government budget cutbacks or spending reductions.  The award of additional contracts from the Israeli government could be adversely affected by spending reductions or budget cutbacks at government agencies that currently use or are likely to use our products.  Our programs may be affected in the future if there is a reduction in Israeli government defense spending for our programs or a change in priorities to products other than ours.  Accordingly, changes in government contracting policies, budgetary constraints and delays or changes in the appropriations process could have an adverse effect on our business, financial condition and results of operations.
 
We face risks associated with doing business in international markets.
 
A large portion of our sales is to markets outside of Israel.  For the years ended December 31, 2011, 2012 and 2013 approximately 88.6%, 86.9% and 77.6%, respectively, of our revenues were derived from sales to markets outside of Israel.  A key component of our strategy is to continue to expand in such international markets.  Our international sales efforts are affected by costs associated with the shipping of our products and risks inherent in doing business in international markets, including:
 
 
·
different and changing regulatory requirements in the jurisdictions in which we currently operate or may operate in the future;
 
 
·
fluctuations in foreign currency exchange rates;
 
 
·
export restrictions, tariffs and other trade barriers;
 
 
·
difficulties in staffing, managing and supporting foreign operations;
 
 
·
longer payment cycles;
 
 
·
difficulties in collecting accounts receivable;
 
 
·
political and economic changes, hostilities and other disruptions in regions where we currently sell or products or may sell our products in the future; and
 
 
·
seasonal reductions in business activities.
 
Negative developments in any of these areas in one or more countries could result in a reduction in demand for our products, the cancellation or delay of orders already placed, difficulty in collecting receivables, and a higher cost of doing business, any of which could adversely affect our business, results of operations or financial condition.
 
We have significant operations in countries that may be adversely affected by political or economic instability, regime replacement, major hostilities or acts of terrorism.
 
We are a global security company with worldwide operations. Although approximately 63% of our sales are generated in Israel, North America and Western Europe, we expect to derive an increasing portion of our sales and future growth from other regions or regime replacements which freeze the activity, budget allocation and execution decisions in these markets until the new regime is setting up, such as Africa or regime replacements which freeze the activity, budget allocation and execution decisions in these markets until the new regime is setting up, India, Latin America and Central and Eastern Europe, which may be susceptible to political or economic instability.
 
Significant portions of our operations are conducted outside the markets in which our products and solutions are manufactured or generally sold, and accordingly, we often export a substantial number of products into such markets. We may, therefore, be denied access to potential customers or suppliers or denied the ability to ship products from any of our subsidiaries into the countries in which we currently operate or wish to operate, as a result of economic, legislative, political and military conditions, including hostilities and acts of terrorism, in such countries.

 
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Breaches of network or information technology security, natural disasters or terrorist attacks could have an adverse effect on our business.
 
Cyber attacks or other breaches of network or information technology (IT) security, natural disasters, terrorist acts or acts of war may cause equipment failures or disrupt our systems and operations. We may be subject to attempts to breach the security of our networks and IT infrastructure through cyber attack, malware, computer viruses and other means of unauthorized access.  While we maintain insurance coverage for some of these events, the potential liabilities associated with these events could exceed the insurance coverage we maintain.  A failure to protect the privacy of customer and employee confidential data against breaches of network or IT security could result in damage to our reputation.  To date, we have not been subject to cyber attacks or other cyber incidents which, individually or in the aggregate, resulted in a material impact to our operations or financial condition.
 
We may not be able to protect our proprietary technology and unauthorized use of our proprietary technology by third parties may impair our ability to compete effectively.
 
Our success and ability to compete depend in large part upon protecting our proprietary technology.  We have 14 patents and have 5 patent applications pending.  We also rely on a combination of trade secret and copyright law and confidentiality, non-disclosure and assignment-of-inventions agreements to protect our proprietary technology.  It is our policy to protect our proprietary rights in our products and operations through contractual obligations, including confidentiality and non-disclosure agreements with certain employees, distributors and agents, suppliers and subcontractors.  These measures may not be adequate to protect our technology from third-party infringement, and our competitors may independently develop technologies that are substantially equivalent or superior to ours.  Additionally, our products may be sold in foreign countries that provide less protection to intellectual property than that provided under U.S. or Israeli laws.
 
Claims that our products infringe upon the intellectual property of third parties may require us to incur significant costs, enter into licensing agreements or license substitute technology.
 
Third parties may in the future assert infringement claims against us or claims asserting that we have violated a patent or infringed upon a copyright, trademark or other proprietary right belonging to them.  Any infringement claim, even one without merit, could result in the expenditure of significant financial and managerial resources to defend against the claim.  In addition, we purchase components for our turnkey products from independent suppliers.  Certain of these components contain proprietary intellectual property of these independent suppliers.  Third parties may in the future assert claims against our suppliers that such suppliers have violated a patent or infringed upon a copyright, trademark or other proprietary right belonging to them.  If such infringement by our suppliers or us were found to exist, a party could seek an injunction preventing the use of their intellectual property.  Moreover, a successful claim of product infringement against us or a settlement could require us to pay substantial amounts or obtain a license to continue to use such technology or intellectual property.  Infringement claims asserted against us could have a material adverse effect on our business, operating results and financial condition.
 
Undetected defects in our products may increase our costs and impair the market acceptance of our products.
 
The development, enhancement and implementation of our complex systems entail substantial risks of product defects or failures.  Despite testing by us and our customers, errors may be found in existing or new products, resulting in delays, loss of revenues, warranty expense, loss of market share, failure to achieve market acceptance, adverse publicity, product returns, loss of competitive position or claims against us by customers. Any such problems could be costly to remedy and could cause interruptions, delays, or cessation of our product sales, which could cause us to lose existing or prospective customers and could negatively affect our results of operations.  Moreover, the complexities involved in implementing our systems entail additional risks of performance failures.  We may encounter substantial difficulties due to such complexities which could have a material adverse effect upon our business, financial condition and results of operations.
 
 
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If subcontractors and suppliers terminate our arrangements with them, or amend them in a manner detrimental to us, we may experience delays in production and implementation of our products and our business may be adversely affected.
 
We acquire most of the components utilized in our products, including our turnkey solutions, from a limited number of suppliers.  We may not be able to obtain such items from these suppliers in the future or we may not be able to obtain them on satisfactory terms.  Temporary disruptions of our manufacturing operations would result if we were required to obtain materials from alternative sources, which may have an adverse effect on our financial results.  In addition, the installation of our fence mounted vibration detection systems in Israel is outsourced primarily to two subcontractors.  If either or both of such subcontractors were to be unable or unwilling to continue to perform such services, we would have to identify and qualify one or more substitute subcontractors to perform such services.  This could cause delays in the implementation of our fence mounted vibration detection systems in Israel, the costs associated with installing such systems may increase and our business may be adversely affected.
 
We currently benefit from government programs and tax benefits that may be discontinued or reduced in the future, which would increase our future tax expenses.
 
We currently benefit from grants and tax benefits under Israeli government programs, which require us to meet specified conditions, including, but not limited to, making specified investments from our equity in fixed assets and paying royalties with respect to grants received.  In addition, some of these programs restrict our ability to manufacture particular products or transfer particular technology outside of Israel.  We also benefit from tax credits pursuant to the Scientific Research and Experimental Development Tax incentive Program in Canada.
 
If we fail to comply with the conditions imposed by the Israeli law or the Canadian tax program in the future, the benefits we receive could be cancelled and we could be required to refund any payments previously received under these programs, including any accrued interest, or pay increased taxes or royalties.  Such a result would adversely affect our results of operations and financial condition.
 
The Israeli government has reduced the benefits available under these programs in recent years and these programs and benefits may be discontinued or curtailed in the future.  If the Israeli or Canadian governments resolve to end these programs and benefits, our business, financial condition, results of operations and net income could be materially adversely affected.
 
We may fail to maintain effective internal control over financial reporting, which could result in material misstatements in our financial statements.
 
The Sarbanes-Oxley Act of 2002 imposes certain duties on us and our executives and directors.  Our efforts to comply with the requirements of Section 404 of the Sarbanes-Oxley Act of 2002 governing internal controls and procedures for financial reporting have resulted in increased general and administrative expense and a diversion of management time and attention, and we expect these efforts to require the continued commitment of significant resources.  Section 404 of the Sarbanes-Oxley Act requires management’s annual review and evaluation of our internal control over financial reporting in connection with the filing of the annual report on Form 20-F for each fiscal year.  We may identify material weaknesses or significant deficiencies in our internal control over financial reporting.  Failure to maintain effective internal control over financial reporting could result in material misstatements in our financial statements.  Any such failure could also adversely affect the results of our management’s evaluations and annual auditor reports regarding the effectiveness of our internal control over financial reporting.  Failure to maintain effective internal control over financial reporting could result in investigation or sanctions by regulatory authorities and could have a material adverse effect on our operating results, investor confidence in our reported financial information and the market price of our ordinary shares.
 
Regulations that impose disclosure requirements regarding the use of “conflict” minerals mined from the Democratic Republic of Congo and adjoining countries in our products will result in additional cost and expense and could result in other significant adverse effects.
 
Rules adopted by the SEC implementing the Dodd-Frank Wall Street Reform and Consumer Protection Act impose diligence and disclosure requirements regarding the use of “conflict” minerals mined from the Democratic Republic of Congo and adjoining countries in our products. Compliance with these rules may result in additional cost and expense, including for due diligence to determine and verify the sources of any conflict minerals used in our products, in addition to the cost of remediation and other changes to products, processes, or sources of supply as a consequence of such verification activities. These rules may also affect the sourcing and availability of minerals used in the manufacture of our products to the extent that there may be only a limited number of suppliers offering “conflict free” metals that can be used in our products. There can be no assurance that we will be able to obtain such metals in sufficient quantities or at competitive prices. Also, since our supply chain is complex, we may face reputational challenges with our customers, stockholders and other stakeholders if we are unable to sufficiently verify the origins of the metals used in our products. We may also encounter customers who require that all of the components of our products be certified as conflict free. If we are not able to meet customer requirements, such customers may choose to disqualify us as a supplier, which could impact our sales and the value of portions of our inventory.

 
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Risks Relating to Our Ordinary Shares
 
Volatility of the market price of our ordinary shares could adversely affect our shareholders and us.
 
The market price of our ordinary shares has been, and is likely to be, highly volatile and could be subject to wide fluctuations in response to numerous factors, including the following:
 
 
·
actual or anticipated variations in our quarterly operating results or those of our competitors;
 
 
·
announcements by us or our competitors of technological innovations or new and enhanced products;
 
 
·
developments or disputes concerning proprietary rights;
 
 
·
introduction and adoption of new industry standards;
 
 
·
changes in financial estimates by securities analysts;
 
 
·
market conditions or trends in our industry;
 
 
·
changes in the market valuations of our competitors;
 
 
·
announcements by us or our competitors of significant acquisitions;
 
 
·
entry into strategic partnerships or joint ventures by us or our competitors;
 
 
·
additions or departures of key personnel;
 
 
·
political and economic conditions, such as a recession or interest rate or currency rate fluctuations or political events; and
 
 
·
other events or factors in any of the countries in which we do business, including those resulting from war, incidents of terrorism, natural disasters or responses to such events.
 
In addition, the stock market in general, and the market for Israeli companies and home security companies in particular, has been highly volatile.  Many of these factors are beyond our control and may materially adversely affect the market price of our ordinary shares, regardless of our performance.  In the past, following periods of market volatility, shareholders have often instituted securities class action litigation relating to the stock trading and price volatility of the company in question.  If we were involved in any securities litigation, it could result in substantial cost to us to defend and divert resources and the attention of management from our business.
 
We do not expect to distribute dividends in the foreseeable future.
 
We currently intend to retain our existing and future earnings to finance operations and expand our business and, therefore, do not expect to pay any dividends in the foreseeable future.  According to the Israeli Companies Law, a company may distribute dividends out of its profits (as defined by the Israeli Companies Law), provided that there is no reasonable concern that such dividend distribution will prevent the company from paying all its current and foreseeable obligations, as they become due, or otherwise upon the permission of the court.  The declaration of dividends is subject to the discretion of our board of directors and would depend on various factors, including our operating results, financial condition, future prospects and any other factors deemed relevant by our board of directors.  You should not rely on an investment in our company if you require dividend income from your investment.
 
 
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As a foreign private issuer whose shares are listed on the NASDAQ Global Market, we may follow certain home country corporate governance practices instead of certain NASDAQ requirements.  We follow Israeli law and practice instead of NASDAQ rules regarding the director nomination process, compensation of executive officers and the requirement that our independent directors have regularly scheduled meetings at which only independent directors are present.
 
As a foreign private issuer whose shares are listed on the NASDAQ Global Market, we are permitted to follow certain home country corporate governance practices instead of certain requirements of The NASDAQ Stock Market Rules.  We follow Israeli law and practice instead of NASDAQ rules regarding the director nomination process, compensation of executive officers and the requirement that our independent directors have regularly scheduled meetings at which only independent directors are present.  As a foreign private issuer listed on the NASDAQ Global Market, we may also follow home country practice with regard to, among other things, the composition of the board of directors and quorum at shareholders’ meetings.  In addition, we may follow home country practice instead of the NASDAQ requirement to obtain shareholder approval for certain dilutive events (such as for the establishment or amendment of certain equity-based compensation plans, an issuance that will result in a change of control of the company, certain transactions other than a public offering involving issuances of a 20% or more interest in the company and certain acquisitions of the stock or assets of another company).  A foreign private issuer that elects to follow a home country practice instead of NASDAQ requirements must submit to NASDAQ in advance a written statement from an independent counsel in such issuer’s home country certifying that the issuer’s practices are not prohibited by the home country’s laws.  In addition, a foreign private issuer must disclose in its annual reports filed with the SEC, each such requirement that it does not follow and describe the home country practice followed by the issuer instead of any such requirement.  Accordingly, our shareholders may not be afforded the same protection as provided under NASDAQ’s corporate governance rules.
 
Risks Relating to Our Location in Israel
 
Political, economic and military instability in Israel may disrupt our operations and negatively affect our business condition, harm our results of operations and adversely affect our share price.
 
We are incorporated under the laws of, and our principal executive offices and manufacturing and research and development facilities are located in, the State of Israel.  As a result, political, economic and military conditions affecting Israel directly influence us.  Any major hostilities involving Israel, a full or partial mobilization of the reserve forces of the Israeli army, the interruption or curtailment of trade between Israel and its present trading partners, or a significant downturn in the economic or financial condition of Israel could adversely affect our business, financial condition and results of operations.
 
Since its establishment in 1948, Israel has been involved in a number of armed conflicts with its Arab neighbors and a state of hostility, varying from time to time in intensity and degree, has continued into 2013. Also, since 2011, riots and uprisings in several countries in the Middle East and neighboring regions have led to severe political instability in several neighboring states and to a decline in the regional security situation. Such instability may affect the local and global economy, could negatively affect business conditions and, therefore, could adversely affect our operations.  In addition, Iran has threatened to attack Israel and is widely believed to be developing nuclear weapons. Iran is also believed to have a strong influence among extremist groups in areas that neighbor Israel, such as Hamas in Gaza, Hezbollah in Lebanon and Syria and El-Qaida in Egypt.  To date, these matters have not had any material effect on our business and results of operations; however, the regional security situation and worldwide perceptions of it are outside our control and there can be no assurance that these matters will not negatively affect us in the future.
 
Furthermore, we could be adversely affected by the interruption or reduction of trade between Israel and its trading partners.  Some countries, companies and organizations continue to participate in a boycott of Israeli companies and others doing business with Israel or with Israeli companies.  As a result, we are precluded from marketing our products to these countries, companies and organizations.  Foreign government defense export policies towards Israel could also make it more difficult for us to obtain the export authorizations necessary for our activities.  Also, over the past several years there have been calls in Europe and elsewhere to reduce trade with Israel.  Restrictive laws, policies or practices directed towards Israel or Israeli businesses may have an adverse impact on our operations, our financial results or the expansion of our business.
 
 
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Our results of operations may be negatively affected by the obligation of our personnel to perform reserve military service.
 
Many of our employees and some of our directors and officers in Israel are obligated to perform annual reserve duty in the Israeli Defense Forces and may be called for active duty under emergency circumstances at any time.  If a military conflict or war arises, these individuals could be required to serve in the military for extended periods of time.  Our operations could be disrupted by the absence for a significant period of one or more of our executive officers or key employees or a significant number of other employees due to military service.  Any disruption in our operations could adversely affect our business.
 
The rights and responsibilities of the shareholders are governed by Israeli law and differ in some respects from the rights and responsibilities of shareholders under U.S. law.
 
We are incorporated under Israeli law.  The rights and responsibilities of holders of our ordinary shares are governed by our memorandum of association and articles of association and by Israeli law.  These rights and responsibilities differ in some respects from the rights and responsibilities of shareholders in typical U.S. corporations.  In particular, a shareholder of an Israeli company has a duty to act in good faith in exercising his or her rights and fulfilling his or her obligations toward the company and other shareholders and to refrain from abusing his power in the company, including, among other things, in voting at the general meeting of shareholders on certain matters.  Israeli law provides that these duties are applicable in shareholder votes on, among other things, amendments to a company's articles of association, increases in a company’s authorized share capital, mergers and interested party transactions requiring shareholder approval.  In addition, a controlling shareholder of an Israeli company or a shareholder who knows that it possesses the power to determine the outcome of a shareholder vote or who has the power to appoint or prevent the appointment of a director or executive officer in the company has a duty of fairness toward the company.  However, Israeli law does not define the substance of this duty of fairness.  Because Israeli corporate law has undergone extensive revision in recent years, there is little case law available to assist in understanding the implications of these provisions that govern shareholder behavior.
 
Our shareholders generally may have difficulties enforcing a U.S. judgment against us, our executive officers and directors and some of the experts named in this annual report, or asserting U.S. securities law claims in Israel.
 
We are incorporated in Israel and all of our executive officers and directors named in this annual report reside outside the United States. Service of process upon them may be difficult to effect within the United States. Furthermore, since substantially all of our assets and all of our directors and officers are located outside the United States, any judgment obtained in the United States against us or these individuals may not be collectible within the United States and may not be enforced by an Israeli court. It also may be difficult for you to assert U.S. securities law claims in original actions instituted in Israel.
 
There is doubt as to the enforceability of civil liabilities under the Securities Act and the Securities Exchange Act in original actions instituted in Israel.  However, subject to certain time limitations and other conditions, Israeli courts may enforce final judgments of U.S. courts for liquidated amounts in civil matters, including judgments based upon the civil liability provisions of those and similar acts.
 
 
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Information on the Company
 
A.            History and Development of the Company.
 
We were incorporated under the laws of the State of Israel on March 27, 1984 under the name Magal Security Systems Ltd.  We are a public limited liability company under the Israeli Companies Law, 5739-1999, and operate under this law and associated legislation.  Our principal executive offices and primary manufacturing and research and development facilities are located near Tel Aviv, Israel, in the Yehud Industrial Zone.  Our mailing address is P.O. Box 70, Industrial Zone, Yehud 56100, Israel and our telephone number is +972-3-539-1444.  Our agent for service of process in the United States is Senstar Inc., 13800 Coppermine Road, Second Floor, Herndon, Virginia 20171.  Our website address is www.magal-S3.com.  The information on our website is not incorporated by reference into this annual report.
 
We are a leading international provider of products and solutions for physical and cyber security, safety and site management. Over the past 42 years, we have delivered products and tailor-made solutions and turnkey projects to hundreds of satisfied customers in over 80 countries in some of the world’s most demanding locations.
 
We offer comprehensive integrated solutions for critical sites, managed by Fortis4G – our 4th generation cutting edge Physical Security Information Management system (PSIM). The solutions leverage our broad portfolio of homegrown Perimeter Intrusion Detection Systems (PIDS), advanced outdoors Close Circuit Television (CCTV)/ Intelligent Video Analysis (IVA), technology and cyber security solutions.
 
We will implement our 2013 growth strategy plan to acquire a security products or Cyber company that will broaden our portfolio in the security business (HLS) both in the physical and logical field. 
 
We intend to increase our revenues in the perimeter products segment and Cyber segment by (i) locating new channels to promote and market our products; (ii) maintaining technology leadership; (iii) investing in research and development; (iv) entering into additional OEM agreements; (v) acquiring new technologies independently or through mergers and acquisitions; and (vi) acquiring a new products or cyber company.
 
In June 2012, our Canadian subsidiary signed an OEM agreement to supply an advanced long range fiber based detection system, which complements our product offerings for sites with long perimeters.  We established a new joint venture in India in 2012 and intend to continue to focus on and enhance our presence in emerging markets such as Russia, India and China, in order to increase our exposure to small and medium size business opportunities for both our perimeter products and solutions and turnkey projects segments.  In January 2013, we purchased WebSilicon Ltd., an Israeli cyber security company, which later changed its name to CyberSeal Ltd. CyberSeal products and services complement our physical security products and services Our capital expenditures for the years ended December 31, 2011, 2012 and 2013 were approximately $1.2 million, $1.7 million and $1.2 million, respectively.  These expenditures were principally for the purchase of vacant land in Cuernavaca, Mexico, on which we are building facilities for our Mexican subsidiary and the purchase of vehicles, computers software, demo and promotional equipment. In addition, part of the acquisition of CyberSeal was paid in cash of approximately $2.6 million.
 
B.            Business Overview.
 
Overview and Strategy
 
We develop, manufacture, market and sell comprehensive computerized physical and cyber security, products and systems to high profile customers.  Our systems are used in more than 80 countries to protect sensitive facilities, including national borders, military bases, power plants, airports, seaports, prisons, industrial sites, oil and gas facilities, Olympic villages and stadiums and municipalities from intrusion, crime, sabotage or vandalism to infrastructure, assets and personnel.
 
Based on more than 40 years of experience and interaction with customers, we have developed a comprehensive set of solutions and products, optimized for perimeter, outdoor and general security applications.  Our portfolio of mission critical infrastructure and site protection technologies includes a variety of smart fences and barriers, fence mounted sensors, virtual (volumetric) fences and gates, buried and concealed detection systems and a sophisticated protection package for sub-surface intrusion.  As a world class innovator in outdoor video motion detection, or VMD, and IVA applications, we deliver comprehensive IP technology and traditional CCTV solutions.
 
 
- 14 -

 
 
With the addition of CyberSeal's products and expertise, we are now able to expand our solutions to include cyber security. Our initial focus is to provide cyber security for physical security networks; these networks are extremely exposed due to several reasons:
 
 
·
Lack of awareness –Security solutions have migrated, along the last ten years, to become fully networked. Yet unlike the IT world, where network security is an integral element, customers, integrators and product suppliers have no awareness of the new cyber threats to these networks.
 
 
·
The proliferation of internet, WiFi and mobile devices into the security market expose these networks to new, easy to access threats.
 
 
·
Lack of knowhow – Security integrators have very limited knowhow regarding network security and thus fail to implement even basic measurements against cyber threats.
 
However these security networks have some inherent characteristics that differentiate them from regular IT networks:
 
 
·
Security networks are relatively static (compared to IT networks). As an example Camera A is always transmitting video through a specific path; Point B is always seeing the same protocol from device C.
 
 
·
The frequency of changes in the networks is very low (unlike IT networks).
 
We therefore believe that these networks should be protected by dedicated solutions, rather than trying to implement some very expensive standard cyber security solutions (IT). We currently offer 3 families of products:
 
 
·
Network security – Hardware and software products which are built into the security network, and monitor abnormal behavior.
 
 
·
Cellular security – Transceivers with a variety of features enabling secure cellular and RF environments around and within critical sites.
 
 
·
Cyber management tolls which collect cyber events and support quick reaction and risk mitigation.
 
Our integrated solutions are based on a broad in-house product portfolio, complemented by OEM and third party products.  A typical turnkey solution is integrated and managed by our Fortis - a sophisticated, geographical information system, or GIS, based command and control system. Fortis can also manage the cyber solutions we provide.
 
A typical turnkey project consists of the following phases:
 
 
·
Studying and understanding customers’ requirements and conducting an environmental and site analysis;
 
 
·
Conducting a terrain survey;
 
 
·
Detailed planning that is focused and tailored around the users – first responders and operators in the command and control center(s);
 
 
·
Implementation - manufacturing, purchasing, integrating, testing and installing the project;
 
 
·
Commissioning and training; and
 
 
·
Post-sales support, including upgrades, especially for the cyber portion of our solutions.
 
 
- 15 -

 
 
Our revenues are principally derived from:
 
 
·
Sales of security products;
 
 
·
Installation of comprehensive security solutions and / or turnkey projects derived from process bids leading to fixed-price contracts; and
 
 
·
Services and maintenance based on post-sale maintenance contracts.
 
Our primary objective is to become a leading international solution provider of safety, security and site management solutions and products.  To achieve this objective, we are implementing a business strategy incorporating the following key elements:
 
 
·
Leverage existing customer relationships.  We believe that we have the capability to offer certain of our customers a comprehensive security package.  As part of our product development process, we seek to maintain close relationships with our customers to identify market needs and to define appropriate product specifications.  We intend to expand the depth and breadth of our existing customer relationships while initiating similar new relationships. Our new cyber offering is an excellent opportunity to revisit our existing customers.
 
 
·
Refine and broaden our product portfolio.  We have identified the security needs of our customers and intend to enhance our current products’ capabilities, develop new products, acquire complementary technologies and products and enter into OEM agreements with third parties in order to meet those needs.
 
 
·
Refine and broaden our integration and turnkey delivery capabilities.  As a solution provider we depend on our capability to tailor specific solutions for each customer.  Our integration building blocks and our execution skills are key factors in achieving our growth and profitability.
 
 
·
Enter new markets and strengthen presence in existing markets.  We intend to continue to penetrate new geographic markets by various means, including the establishment of alliances with local distributors and international integrators of security systems.  We also intend to increase our marketing efforts in our existing markets and to acquire or invest in complementary businesses and joint ventures.
 
Emerging Opportunities
 
 
·
The rapid introduction of digital communication and information technology into the security market provides us with the opportunity to consolidate safety and site management with security applications.  Cities and municipalities, air and sea ports, chemical factories, Olympic villages and stadiums and critical infrastructure sites are currently utilizing the benefits of this approach to security management.  This integration allows users to share dispersed sensors (such as cameras and emergency buttons), IT systems, traffic management tools, Cyber solutions and other resources and feed them into a single command and control platform.  Users from different departments within organizations can now share the same information, allowing for improved communication and coordination, whether it is a routine operation or crisis situation.  We believe that we are well positioned and are in the forefront of this emerging market opportunity. We can also address the new cyber threats that massive digitization and networking impose on the sites we traditionally protect with physical security.  We believe that these new threats create additional opportunities for us to expand our offerings with products, solutions and services.
 
 
·
The urgent need to treat cyber and physical security together in a holistic manner is gaining momentum. We believe that following the acquisition of CyberSeal, we are well positioned to capitalize on this trend.
 
 
- 16 -

 
 
Products and Services
 
General
 
Our products are categorized into five families of systems:
 
 
·
Perimeter security systems, consisting of a mix of PIDS technologies with physical barrier solutions;
 
 
·
Perimeter security Robot;
 
 
·
CCTV systems;
 
 
·
Cyber security systems;
 
 
·
Command and control systems; and
 
 
·
Miscellaneous systems tailored for specific vertical market needs.
 
The following table shows the breakdown of our consolidated revenues for the calendar years 2011, 2012 and 2013 by operating segment:
 
   
Years ended December 31,
 
   
2011
   
2012
   
2013
 
    (In thousands)  
Perimeter products                                                                      
  $ 30,012     $ 33,941     $ 30,551  
Turnkey projects                                                                      
    59,707       45,038       20,137  
Cyber                                                                      
    -       -       1,638  
Eliminations                                                                      
    (1,128 )     (1,282 )     (809 )
Total                                                                      
  $ 88,591     $ 77,697     $ 51,517  
 
Perimeter Security Systems
 
Perimeter security systems enable customers to monitor, limit and control access by unauthorized personnel to specific regions or areas.  High-end perimeter systems are sophisticated in nature and are used for correctional facilities, borders, nuclear and conventional power plants, air and sea ports, military installations and other high security installations.  In early 2010, two independent research organizations, Frost & Sullivan and IMS Research, recognized our company as the number one provider of PIDS technology.
 
Our line of perimeter security systems utilizes sophisticated sensor devices to detect and locate intruders and identify the nature of intrusions.  Our perimeter security systems have been installed along thousands of kilometers of borders and facility boundaries throughout the world, including more than 600 correctional institutions and prisons in the United States and in several other countries.  In addition, we have installed several hundred kilometers of high security smart perimeter systems along Israel’s borders.
 
Our line of outdoor perimeter security systems consists of the following:
 
 
·
Taut wire – hybrid perimeter intrusion detection systems with physical barrier;
 
 
·
Fence mounted vibration detection systems – mechanical, copper “microphonic” wire sensors, fiber optic sensors or electronic ranging  sensors;
 
 
·
Smart barriers – a variety of robust detection grids, gates and innocent looking fences, designed to protect water passages, VIP residences and other outdoor applications;
 
 
·
Buried cable sensors - traditional volumetric buried cable sensors, seismic sensors to protect pipelines and critical assets against digging and fiber sensors to protect buried pipelines (an OEM product);
 
 
- 17 -

 
 
 
·
Electrical field disturbance sensors (volumetric); and
 
 
·
Microwave sensors.
 
Taut Wire Perimeter Intrusion Detection Systems
 
Our taut wire perimeter systems consist of wire strung at high tension between anchor posts.  Sensor posts are located at the middle between anchor posts.  These sensor posts contain one or more devices that detect changes in the tension being exerted on and by the taut wires.  Any force applied against these wires or released from them (such as by cutting) that is not within the parameters designed into the sensors themselves or programmed into the central control units, automatically triggers an alarm.  Taut wire technology provides three critical elements of protection against unauthorized intruders: deterrence, detection and delaying (until first responders may react and intercept the intruder).
 
Our sealed sensors are not affected by radio frequency interference, climatic or atmospheric conditions, or electrical transients from power lines or passing vehicles.  The sensors self-adjust to, or remain unaffected by, extreme temperature variation, minor soil movements and other similar environmental changes that might trigger false alarms in less sophisticated systems.  Our taut wire perimeter systems are designed to distinguish automatically between fence tension changes typically caused by small animals or violent weather and forces more typically exerted by a human intruder.
 
Our taut wire perimeter systems offer customers a wide range of installation options.  Sensor posts can be as far as 200 feet apart, with relatively inexpensive ordinary fence anchor posts between them.  These systems may stand alone, be mounted on a variety of fence posts or added to an existing wall or other structure, or mounted on short posts, with or without outriggers.
 
Taut wire perimeter systems have been approved by various Israeli and U.S. security and military authorities.  We have installed several hundred kilometers of these perimeter systems along Israel’s borders to assist in preventing unauthorized entry and infiltration.  Our taut wire perimeter systems are typically sold to the end-user for between $50 to $200 per meter (depending, among other things, on the model, height, density, and corrosion protection level of the system).
 
Fence Mounted Vibration Detection Systems
 
We offer various types of vibration detection systems.  While less sensitive than taut wire installations, the adaptability of these systems to a wide range of pre-existing barrier structures makes these products viable alternatives for cost-conscious customers.  Our vibration detection devices are most effective when installed on common metal fabric perimeter systems, such as chain link or welded mesh.  In our BARRICADE system, electro-mechanical sensors are attached to fence panels approximately three meters apart on any of several common types of fence structures.  Once attached to the fence, each sensor detects vibrations in the underlying structures.  The sensor system’s built-in electro-mechanical filtering combines with system input from a weather sensor to minimize the rate of false alarms from wind, hail or other sources of nuisance vibrations.  Our BARRICADE II system leverages the same configuration of the first generation and adds a ranging feature, which provides the capability to locate the exact vibrated sensor (rather than causing an alarm of a full physical segment of approximately 100 meters). The last development is the Fensor – an electronic, fence mounted, vibration detection system that is capable of locating the exact location of an intrusion within 3 meters. Each sensor can be tuned separately according to the local environment.
 
Intelli-FLEX, FLEX PS, Intelli-FIBER and fence protection systems, or FPS, microprocessor-based triboelectric and electric cable fence sensors are vibration sensitive transducers.  These systems detect any attempt to cut, climb or penetrate the fence and have microphonic properties.  The microphonic feature permits audio to be used for low-cost alarm assessment, providing users with an additional tool for determining the nature of an attempted intrusion.  Our vibration detection system is typically sold to the end-user for between $15 to $60 per meter.
 
We recently began to sell the Pinpointer, a fence-mounted vibration sensor that is capable of defining the exact location of an intrusion to within 2 to 3 meters (6.5 to 10 ft.).  While maintaining the legacy features of the original sensor, Pinpointer has the ability to identify the exact disturbed sensor along a long chain of sensors, which are typically 2 to 3 meters (6.5 to 10 ft.) apart.
 
 
- 18 -

 
 
During 2012, we added the FiberLR as an OEM product that is optimized to protect sites with long perimeters (more than 7km or 4.35 miles).
 
 In 2013, we developed two advanced technologies which are expected to be incorporated in new products that are scheduled to be introduced in the second part of 2014.  While our goal is that these new technologies will position us as technology leaders, we believe that these new products will not account for significant revenues in 2014 because of the nature of the market, which is often slow in adopting new technologies.
 
Buried Sensors
 
Omnitrax is a fifth generation, covert outdoor perimeter security intrusion detection sensor that generates an invisible radar detection field around buried sensor cables.  An alarm is emitted and the exact location identified within one meter if an intruder disturbs the field.  Targets are detected by their conductivity, size and movement and the digital processor is able to filter out common alarms caused by environmental conditions and small animals.  The Omnitrax system is sold for between $40 to $80 per meter.
 
 PipeGuard and TunnelGuard are products developed around commercial off-the-shelf seismic) sensors in order to detect digging around critical assets. TunnelGuard is installed mainly in Latin America to protect bank vaults and prisons. TunnelGuard is also being used to protect archeological sites in China.
 
A PipeGuard solution will include an array of standalone sensors, all communicating within a meshed network that senses any attempt to dig close to the protected assets.  It can be integrated into a full turnkey solution, including perimeter intrusion protection, ground or air patrols and alarm monitoring and control.  PipeGuard combines geophones with advanced technology recognition algorithm capabilities based on the analysis of seismic signals to effectively filter out false alarms.  This intelligent signal processing provides a high probability of detection and low false and nuisance alarm rates.
 
We believe that the target markets for PipeGuard are in the western and developed countries where environmental issues are, or will become, regulated.  PipeGuard is an ideal solution for alerting utility operators early enough before digging causes catastrophic damage to existing oil and gas pipes.
 
FiberLR, our new OEM product is also offered to protect pipelines against sabotage, leakage and siphoning.
 
Electrical Field Disturbance Sensors
 
Terrain following volumetric sensors can detect intrusions before the intruder touches the sensor.  They can be installed on buildings, free-standing posts, existing fences, walls or rooftops, and will sense changes in the electrostatic field when events, such as intruders penetrating through the wires, take place.  The system’s tall, narrow, well contained detection zone allows the sensor to be installed in almost any application and minimizes nuisance alarms caused by nearby moving objects.  Our flagship product is X-Field; it consists of a set of four and/or eight parallel field sensing wires and is sold for between $100 and $190 per meter.  We also offer a deployable volumetric sensor, used to protect military forces deployed on short notice that need fast reaction with minimal effort.
 
Microwave Products
 
We also offer a range of bi-static microwave products that are designed for stable, reliable operation in extreme outdoor environments.  Coverage distances range from 180 meters to 450 meters.  In 2011, we launched a new version of our microwave product, which has a K band improved sensor, is fully digital and has extended processing and communication features.
 
 
- 19 -

 
 
Perimeter security Robot;
 
In 2013, we added new product for perimeter security, called RoboGuard. RoboGuard is a revolutionary innovation in perimeter security: a robot that runs on an elevated rail along the perimeter of protected sites or border lines, carrying an assortment of sensors. The robot can respond promptly and rush to the exact zone or location where intrusions is suspected; or automatically patrol and inspect the fence integrity, looking for holes or suspicious nearby objects, by using sophisticated IVA (Intelligent Video Analytics) algorithms.
 
A typical RoboGuard configuration would include:
 
 
·
Two fixed cameras with IR illuminators for stereoscopic fence investigation
 
 
·
One PTZ camera
 
 
·
Two-way intercom in order to communicate with intercepted would-be intruders
 
CCTV Systems
 
We have a proven track record in delivering CCTV and IVA solutions that are designed for use in outdoor applications. In the past Magal offered a dedicated Video Management System (VMS). These capabilities are now fully embedded as part of Magal’s PSIM system – the Fortis4GMTC-1500I.
 
MTC-1500I is a high-end yet affordable, dual technology (thermal and charge-coupled device) outdoor surveillance system.  A high-quality image rendered by the thermal sensor provides long distance detection and recognition of humans in day, night and under poor visibility conditions.  The two cameras are mounted on a single pedestal and controlled through an agile and accurate pan-tilt-zoom-focus engine.
 
The MTC-1500I is suitable for the protection of any critical object or site.  Markets for the system include airports, seaports, critical border crossings, utilities (such as oil, gas, refineries and water dams).
 
MSS-1500I
 
MSS-1500I is a dual camera (day and night) system designed for outdoor rapid deployment operations.  The system is tailored for law enforcement, security and special operations forces.  It enables camera installation close to the required observation area and communicates data to a remote center.  The deployable element has a low footprint for concealed operation and can be put into operation within less than five minutes.
 
Command and Control Systems
 
The development of communication and IT technology has significantly affected the security market.  Multiple security systems and technologies, sometimes supplied by different vendors, can now be integrated into a unified command and control system.  We offer three types of command and control systems:
 
 
·
Fortis4G – a fourth generation high-end comprehensive command and control system;
 
 
·
StarNet 1000 - a basic security management system, or SMS; and
 
 
·
Network Manager – a middleware (software) package.
 
Fortis 4G
 
FORTIS4G, is our latest Physical Security Information Management system (PSIM).  It is a comprehensive, wide area and real time command and control solution, designed for entities requiring management of security, safety and dispatching.  It is designed to manage daily routines and site activities, security, regular and irregular events as well as crisis situations.
 
 
- 20 -

 
 
FORTIS4G architecture integrates with legacy systems and sensors from the physical and logical (cyber) levels through a configuration and business logic layer and up to the situational awareness and management levels.  It is based on a strong GIS engine, which creates a common layer for inputs, outputs and presentation.  The GIS engine enables the display of synchronized information in time and space across all screens such as location of mobile forces, located alarms from stationary sensors, video of related cameras, pop-ups of associated radar screens and managed voice communication related to the managed area.  Real-time information enables security personnel to respond immediately, while maintaining a full two-way communication and situational awareness between the command and control center(s) and the first responders. The target markets for Fortis4G are municipalities, city protection applications and, as part of other integrated solutions supplied by us, for use in airport, border and homeland security applications. Fortis4G incorporate the advanced video management capacities with full IVA features:
 
 
·
Our investments in IVA tools help eliminate dependency on constant human monitoring.  Automatic tools and algorithms extract abnormalities and only irregular events are transferred and analyzed for verification.  This approach saves bandwidth and storage and more importantly requires human intervention only when needed.
 
 
·
Our unique to the industry IVA / VMD has been developed to meet the challenge of the outdoor environment (such as weather effects, moving objects like trees, glare and flashing lights).
 
 
·
Our video solutions have a proven track record in high-end vertical markets that require outdoor security such as military bases, government organizations, airports, seaports, mass transportation, correctional facilities, utilities and industrial sites.
 
StarNet 1000
 
StarNet 1000, an SMS, is suitable to manage basic sites, consisting of a PIDS with a few other devices.
 
StarNet2
 
StarNet2 is –a new version of the basic StarNet system. It is derived from the Fortis4G and thus will significantly improve its ancestor (StarNet 1000).
 
Network Manager
 
Network Manager is a middleware (software) package that is as an interface between our family of PIDS sensors and any command and control solution, be it our own system or an external third party application. It is provided to integrators with a full software development kit to enable fast integration of our PIDS into any other SMS and physical security information system.
 
Miscellaneous Systems
 
Life Safety / Duress Alarm Products
 
Our products include high reliability, personal, portable duress alarm systems to protect personnel in prisons.  These products identify individuals in distress and can pinpoint the location of the distress signal with an indoor-to-outdoor and floor-to-floor accuracy unmatched by any other product.
 
Flash and flare personal emergency locating systems use radio frequency technology to provide a one touch emergency system that is so small it can be worn on a belt.  The systems, sold to prisons, consist of transmitters that send distress signals to receivers mounted throughout the building.  Receivers relay the signal to a central location, indicating that someone requires assistance and their location in the building.  The systems employ automated testing procedures that help to reduce maintenance costs.  The hardware and software was developed and researched in the United States and competes against infrared and other similar technologies.
 
 
- 21 -

 
 
PAS is another personal alarm system that uses an ultrasonic based emergency notification system.  The system, sold mainly to prisons in the United States, allows individuals moving throughout a facility to quickly indicate their exact location in a crisis situation.
 
Cyber Protection Solutions
 
In January 2013, we acquired CyberSeal and started to initiate our strategy to expand our product offerings to include cyber protection solutions.  These new solutions will monitor, detect and protect against abnormal network activity, both landline and wireless, within and close to protected sites.  Following the acquisition of CyberSeal, we have developed the following new products:
 
 
·
Tungsten – A hardened managed switch with built in security capabilities to monitor unauthorized traffic which is optimized for outdoors security networks;
 
 
·
Cobalt – A Ruggedized Unidirectional Ethernet Data Diode, designed to control the flow of information between distinct networks and protect against cyber attacks;
 
 
·
Yttrium - IMSI (International Mobile Subscriber  Identity) Catcher Appliance that is capable of enforcing  a cellular usage policy at a site by using a configurable set of rules;

 
·
Vanadium - IMSI Catcher Detector designed to protect cellular subscribers within a secured site against diversion of their mobile devices (calls and data) through unauthorized pseudo operators;
 
 
·
Rubidium – An easily operated SIEM (Security Information & Event Management) application, designed to manage CyberSeal’s products as well as third party network and cyber monitoring devices.
 
During 2014, we intend to launch these products into our existing channels as well as through new channels, and to integrate them together for end users.
 
Marketing, Sales and Distribution
 
We believe that our reputation as a vendor of high-security products in one of the world’s most security conscious countries often provides us and our sales representatives with direct access to senior government and corporate officials in charge of security matters elsewhere.
 
Our sales efforts focus on:
 
 
·
Products (mainly PIDS and cyber).  Products are sold indirectly through system integrators and distribution channels.  Due to the sophistication of our products, we often need to approach end-users directly and be in contact with system integrators, however the sale is directed through a third party; and
 
 
·
Solutions.  This part of the business deals with end-customers or high-end system integrators.  We offer a full comprehensive solution, which includes our in-house portfolio of products and products manufactured by third parties.  Solutions are focused around our core competency (outdoor and cyber security, safety and site management).  In many cases we take responsibility for the full turnkey solution and we integrate and deliver a full solution, including civil works, installation, training, warranty and after sale support. Cyber security is now offered as an integrated part of our comprehensive solutions.
 
In addition to our two main sales offices in Israel and Canada, we have sales offices in the United States, the United Kingdom, Germany, Mexico, China, Romania, Colombia and Spain. In India we have a joint venture covering this emerging market.
 
 
- 22 -

 
 
Customers
 
The following table shows the geographical breakdown of our consolidated revenues for the three years ended December 31, 2013:
 
   
Year Ended December 31,
 
   
2011
   
2012
   
2013
 
   
(In thousands)
 
Israel                                                                      
  $ 10,091     $ 10,152     $ 11,517  
North America                                                                      
    13,373       10,732       13,614  
Europe                                                                      
    10,913       12,809       7,311  
South and Latin America                                                                      
    12,145       15,159       3,118  
Africa                                                                      
    35,499       21,642       8,182  
Others                                                                      
    6,570       7,203       7,775  
Total                                                                
  $ 88,591     $ 77,697     $ 51,517  
 
For the years ended December 31, 2011, 2012 and 2013, revenues generated from sales to the MOD and IDF accounted for 7.8%, 9% and 15% respectively, of our revenues. The Mexican Federal Prisons Authority, or CNS, a client in Mexico, accounted for 10.7%, 7.7% of our revenues in the years ended December 31, 2011 and 2012, respectively.  In addition, our Gabonese Republic Project accounted for 34.8% of our revenues in 2011 and 6.7% of our revenues in 2012. The revenues from the provision of the perimeter security solution to the port of Mombasa, Kenya accounted for 2%, 19.3% and 14.2% of our revenues in the years ended December 31, 2011, 2012 and 2013, respectively.  We cannot assure you that any of our major customers will maintain their level of business with us or that, if such business is reduced, other customers generating similar revenues will replace the lost business. For example, we completed the Gabonese Republic Project and do not expect to receive any future revenues from this project.  The failure to replace these customers with one or more customers generating similar revenues will have a material adverse effect on our financial results.
 
Installation, Support and Maintenance
 
Our systems are installed by us or by the customer after appropriate training, depending on the size of the specific project and the location of the customer’s facilities, as well as on the customer’s prior experience with our systems.  We generally provide our customers with training on the use and maintenance of our systems, that we conduct either on-site or at our facilities.  In addition, some of our local perimeter security systems customers have signed maintenance contracts with us.  For systems installed outside of Israel, maintenance is provided by an independent third party, by distributors or by the end-user.  We also provide services, maintenance and support on an “as needed” basis.
 
The life expectancy of a high-security perimeter system is approximately ten years.  Consequently, many miles of perimeter systems need to be replaced each year.
 
During the years ended December 31, 2011, 2012 and 2013, we derived approximately 6.6%, 8.9% and 16.7% of our total revenues, respectively, from maintenance and services.
 
Research and Development; Royalties
 
We place considerable emphasis on research and development to improve our existing products and technology and to develop new products and technology.  We believe that our future success will depend upon our ability to enhance our existing products and technology and to introduce on a timely basis new commercially viable products and technology addressing the needs of our customers.  We intend to continue to devote a significant portion of our personnel and financial resources to research and development.  As part of our product development process, we seek to maintain close relationships with our customers to identify market needs and to define appropriate product specifications.  Our development activities are a direct result of the input and guidance we receive from our marketing personnel during our annual meetings with such personnel.  In addition, the heads of research and development for each of our development centers discussed below meet annually to identify market needs for new products.
 
 
- 23 -

 
 
Our research and development expenses during 2011, 2011 and 2013 were $3.9 million, $4 million and $4.4 million, respectively.  In addition to our own research and development activities, we also acquire know-how from external sources.  We cannot assure you that any of our research and development projects will yield profitable results.
 
We have the following two development centers, each of which develops products and technologies based on its area of expertise:
 
 
·
In Israel - we develop a wide range of perimeter products including our taut wire, mechanical vibration, electronically vibration, video, perimeter security Robot and high-end SMS, command and control systems and PipeGuard, as well as the Cyber products.
 
 
·
In Canada - we develop our buried cable sensors, fence mounted vibration detection systems, mechanical, copper and fiber-optic fence sensors, electrostatic volumetric detection, medium to high-end control systems, microwave detection, personal alarm systems and small to medium control systems.
 
Manufacturing and Supply
 
Our manufacturing operations consist of designing and developing our products, fabricating and assembling components and finished products, quality control and final testing.  Substantially all of our perimeter manufacturing operations are currently performed at our facilities in Yehud, Israel and Ottawa, Canada.  See Item 4D. “Information on the Company - Property, Plants and Equipment.” Our cyber manufacturing operations are currently performed at our facilities in Tel Aviv, Israel.
 
We acquire most of the components utilized in our products, including our turnkey products, and certain services from a limited number of suppliers and subcontractors.  We cannot assure you that we will continue to be able to obtain such items from these suppliers on satisfactory terms.  Alternative sources of supply are available, and therefore we are not dependent upon these suppliers and subcontractors.  We also maintain an inventory of systems and spare parts in order to enable us to overcome potential temporary supply shortages until an alternate source of supply is available.  Nevertheless, temporary disruptions of our manufacturing operations would result if we were required to obtain materials from alternative sources, which may have an adverse effect on our financial results.
 
Competition
 
PIDS Sensors.  The principal factors affecting competition in the market for security systems are a system’s high probability for detection and low probability of false and nuisance alarms.  We believe that a manufacturer’s reputation for reliable equipment is a major competitive advantage, and that such a reputation will usually be based on the performance of the manufacturer’s installed systems.  Additional competitive factors include quality of customer support, maintenance and price.
 
The PIDS market is very fragmented. According to Frost & Sullivan and IMS Research reports which were published in the first half of 2012, we rank first based on market share with 10.2% - 15% of the market (the difference results from inclusion or exclusion of different technologies, such as radar and CCTV). Our competition includes Elfar Ltd. and RB-Tec Ltd. in Israel, and South West Microwave Inc., Future Fiber Technologies, Detection Security Systems Inc., Fiber Sensys Inc. Geoquip Ltd., GPS Standard SpA and Cias Elettronica Srl outside of Israel.
 
We don't see any competition for the RoboGuard right now.
 
We believe that our principal competitors for the PipeGuard system are Future Fibre Technologies Pty. Ltd., Optellios inc., Quinetic and FOTech and that our principal competitors for personal emergency location systems are Actall Corp. and Visonic Networks.
 
The cyber market is still in its embryonic phase. We believe that this market will mature during the next three years at which time we will be in a better position to analyze it.
 
 
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Turn Key Projects and Solutions.   Thousands of solution providers offer security products and services.  Most of the integrators focus on indoor applications, but some also offer outdoor solutions.  Most of the market players are local to their countries; however some are global, such as ADT, Honeywell and Siemens.  In some cases we may cooperate with global integrators or may supply equipment to them.  We believe that our principal competitors in Israel for security solutions are Elbit Systems Ltd., C. Mer Industries Ltd., Afcon Industries Ltd. and Orad Ltd.
 
Some of our competitors and potential competitors have greater research, development, financial and personnel resources, including governmental support, or more extensive business experience than we do.  We cannot assure you that we will be able to maintain the quality of our products relative to those of our competitors or continue to develop and market new products effectively.
 
Intellectual Property Rights
 
We have 14 patents issued and have 5 patent applications pending in the U.S. and in several other countries and have obtained licenses to use proprietary technologies developed by third parties.  We cannot assure you:
 
 
·
that patents will be issued from any pending applications, or that the claims allowed under any patents will be sufficiently broad to protect our technology;
 
 
·
that any patents issued or licensed to us will not be challenged, invalidated or circumvented; or
 
 
·
as to the degree or adequacy of protection any patents or patent applications may or will afford.
 
In addition, we claim proprietary rights in various technologies, know-how, trade secrets and trademarks relating to our principal products and operations.  We cannot assure you as to the degree of protection these claims may or will afford.  It is our policy to protect our proprietary rights in our products and operations through contractual obligations, including confidentiality and non-disclosure agreements with certain employees and distributors.  We cannot assure you as to the degree of protection these contractual measures may or will afford.  Although we are not aware that we are infringing upon the intellectual property rights of others, we cannot assure you that an infringement claim will not be asserted against us in the future.  We believe that our success is less dependent on the legal protection that our patents and other proprietary rights may or will afford than on the knowledge, ability, experience and technological expertise of our employees.  We cannot provide any assurance that we will be able to protect our proprietary technology.  The unauthorized use of our proprietary technology by third parties may impair our ability to compete effectively.  We could become subject to litigation regarding intellectual property rights, which could seriously harm our business.
 
We have registered trademarks for ULTRAWAVE, E-FIELD, FLARE, FLEXPI, FLEXPS, GUIDAR, INTELLI-FIELD, LOGO DESIGN (old Senstar), MISCELLANEOUS DESIGN (Stellar logo), OMNITRAX, PANTHER, PERIMITRAX, PINPOINTER, REPELS, S DESIGN, SENNET, SENSTAR, SENSTAR & DESIGN, SENSTAR-STELLAR, SENSTAR-STELLAR & DESIGN, SENTIENT, XFIELD, MAGAL, DTR, FORTIS, DREAMBOX, PIPEGUARD AND MAESTRO DB.
 
INTELLI-FLEX, INTELLIFIBER, STARLED, STARNET, ARMOURFLEX, FLASH, FLEXZONE, ROBOGUARD, FENSOR, CYBERSEAL, the Magal logo and all other marks used to identify particular products and services associated with our businesses are unregistered trademarks.  Any other trademarks and trade names appearing in this annual report are owned by their respective holders.
 
Government Regulations
 
Current Israeli governmental policy encourages the export of security related products to approved customers, as long as the export is consistent with Israeli government policy.  We are also subject to regulations related to the export of “dual use” items (items that are typically sold in the commercial market, but which may also be used for military use).  Israel enhanced enforcement of export control legislation under the Defense Export Control Law, 2007, under which a license is required to initiate marketing activities and a specific export license is required for any hardware exported from Israel.  The law provides for certain exemptions from the licensing requirement and broadens certain areas of licensing, particularly with respect to transfer of technology.  We cannot assure that we will receive all the required permits and licenses for which we may apply in the future.
 
 
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In addition, our participation in governmental procurement processes in Israel and other countries is subject to specific regulations governing the conduct of the process of procuring defense contracts.  Furthermore, solicitations for procurements by governmental purchasing agencies in Israel and other countries are governed by laws, regulations and procedures relating to procurement integrity, including avoiding conflicts of interest and corruption in the procurement process.
 
In addition, antitrust laws and regulations in Israel and other countries often require governmental approvals for transactions that are considered to limit competition.  Such transactions may include cooperative agreements for specific programs or areas, as well as mergers and acquisitions.
 
C.            Organizational Structure.
 
We have wholly owned subsidiaries that operate in Israel (CyberSeal), Canada, the United States, Colombia, Brazil, Germany, Mexico, the United Kingdom, Romania and Spain. We also own 51% of the outstanding capital stock of our Indian subsidiary.   Set forth below are our significant subsidiaries.
 
Subsidiary Name
 
Country of Incorporation/Organization
 
Ownership Percentage
Senstar Corp
 
Canada
 
100%
Senstar Inc.
 
United States
 
100%
 
D.            Property, Plants and Equipment.
 
We own a two-story 2,533 square meter facility located on a 4,352 square meter parcel in the Yehud Industrial Zone, Israel, which is used as our principal facility.  Approximately 600 square meters are devoted to administrative, marketing and management functions and approximately 700 square meters are used for engineering, system integration and customer service.  We use the remaining area of approximately 1,200 square meters for production management and production operations, including manufacturing, assembly, testing, warehousing, shipping and receiving.  We also lease a one-story 810 square meter facility located on a 1,820 square meter parcel in the Yehud Industrial Zone for $96,000 per year for use in production and operations.  The lease terminates in 2029.  The products that we manufacture at our facilities in the Yehud Industrial Zone include our taut-wire intrusion detection systems, our vibration detection systems, our video-motion detection systems, Fortis4G, Maestro DB, PipeGuard, MTC-1500, MSS-1500 and other perimeter systems.
 
We own a 33,000 square foot facility in Carp, Ontario, Canada.  Approximately 9,000 square feet are devoted to administrative, marketing and management functions, and approximately 8,000 square feet are used for engineering, system integration and customer service.  We use the remaining area of approximately 16,000 square feet for production operations, including cable manufacturing, assembly, testing, warehousing, shipping and receiving.  We own an additional 182,516 square feet of vacant land adjacent to this property, which is being held for future expansion.  We also rent 358,560 square feet of land near this facility for use as an outdoor sensor test and demonstration site for our products including the Omnitrex buried cable intrusion detection system, the X-Field volumetric system, the Intelli-FLEX and FlexPS microphonic fence detection system, Flash and Flare, and various perimeter monitoring and control systems.  The rent for this site is approximately $3,500 per year plus taxes under a lease that expires in November 2014.  In addition, we lease a 1,900 square feet facility adjacent to our Carp, Ontario property for use as additional storage and system integration space under a month to month tenancy costing approximately $1,500 per month.
 
In June 2012, we purchased 1,408 square meter of vacant land in Cuernavaca, Mexico, on which we established a facility for our Mexican subsidiary. This facility was officially opened on August, 2013. Since the beginning of 2013 till we have entered our new facility, we have paid approximately $28,000 for the previous offices in Mexico.
 
We also lease small office spaces in China, Colombia, Germany, Romania, Spain, the United Kingdom, India, Israel and Virginia and California in the United States, for our remaining entities.  The aggregate annual rent for such offices was approximately $ 350,000 in 2013.
 
 
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We believe that our facilities are suitable and adequate for our current operations and the foreseeable future.
 
ITEM 4A.               Unresolved Staff Comments
 
Not applicable.
 
Operating and Financial Review and Prospects
 
The following discussion of our results of operations and financial condition should be read in conjunction with our consolidated financial statements and the related notes thereto included elsewhere in this annual report.  This discussion contains forward-looking statements that involve risks and uncertainties.  Our actual results may differ materially from those anticipated in these forward-looking statements as a result of certain factors, including, but not limited to, those set forth in Item 3.D. “Key Information–Risk Factors.”
 
A.            Operating Results.
 
Overview
 
We develop, manufacture, market and sell complex computerized security systems.  Our systems are used in more than 80 countries to protect aircraft, national borders and sensitive facilities, including military bases, power plant installations, airports, postal facilities, prisons, Olympic villages and stadiums and industrial locations from terrorism, theft and other security threats.
 
Our revenues are derived from our three operating segments:
 
 
·
Perimeter Products segment - sales of perimeter products, including services and maintenance that are performed either on a fixed-price basis or pursuant to time-and-materials based contracts, and
 
 
·
Turnkey Projects segment - installation of comprehensive turnkey solutions for which revenues are generated from long-term fixed price contracts.
 
 
·
Cyber segment - provides hardware and software products, in the field of Cyber Security, for monitoring, securing, and the active management of wired, wireless, and fiber optic communication networks.
 
Perimeter Products Segment
 
The Perimeter Products segment sells its products worldwide and this segment includes the operations of Senstar Canada, Senstar Germany, Senstar UK and Senstar Inc. as one reporting unit within the Perimeter Products segment.  The Israeli operations of the Perimeter Products segment as well as the Spanish operations are considered as two separate reporting units within that segment.
 
Turnkey Projects Segment
 
The Turnkey Projects segment has operations worldwide and the segment includes a number of reporting units operating in Israel, Mexico, Romania, Colombia and a division of Senstar Canada.
 
Cyber Segment
 
The Cyber segment has operation mainly in the US and in Israel. As of December 31, 2013, this segment includes the operations of CyberSeal Ltd.
 
Business Challenges/Areas of Focus
 
Our primary business challenges and areas of focus include:
 
 
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·
continuing the growth of revenues and profitability of our perimeter security system line of products;
 
 
·
enhancing the introduction and recognition of our new products into the markets;
 
 
·
penetrating new markets and strengthening our presence in existing markets; and
 
 
·
succeeding in selling our comprehensive turnkey solutions.
 
Our business is subject to the effects of general global economic conditions.  If general economic conditions or economic conditions in key markets remain uncertain or weaken further, demand for our products could be adversely affected.
 
Key Performance Indicators and Sources of Revenues
 
Our management believes that our revenues and operating income are the two key performance indicators for our business.
 
Our revenues from our perimeter products and turnkey projects segments for the three years ended December 31, 2013 and our revenues from our Cyber segment for the year ended December 31, 2013 were as follows:
 
   
Year Ended December 31,
 
   
2011
   
2012
   
2013
 
   
(in thousands)
 
Perimeter products                                                                      
  $ 30,012     $ 33,941     $ 30,551  
Turnkey projects                                                                      
    59,707       45,038       20,137  
Cyber                                                                      
    -       -       1,638  
Eliminations                                                                      
    (1,128 )     (1,282 )     (809 )
Total                                                                
  $ 88,591     $ 77,697     $ 51,517  
 
The decrease in revenues from turnkey projects was primarily due to the early 2012 completion of the Gabonese Republic Project, which we received in 2011 with respect to the 2012 Africa Cup of Nations.
 
Our operating income (loss) from our perimeter products and turnkey projects segments for the three years ended December 31, 2013 and our operating income (loss) from our Cyber segment for the year ended December 31, 2013 were as follows:
 
   
2011
   
2012
   
2013
 
   
(In thousands)
 
Perimeter products                                                                      
  $ 2,665     $ 4,409     $ 542  
Turnkey projects                                                                      
    5,224       1,634       (3,571 )
Cyber                                                                      
    -       -       (1,184 )
Other income                                                                      
    2,304       -       -  
Eliminations                                                                      
    (382 )     (486 )     (306 )
Total                                                                
  $ 9,811     $ 5,557     $ (4,519 )
 
The profit in 2011 and 2012 is mainly attributable to increased government spending in certain territories which led to new projects in 2011 and 2012, while in 2013 the market was depressed due to the European economic slowdown and the reduction in government spending in certain territories.
 
Key Factors Affecting our Business
 
Our operations and the operating metrics discussed below have been, and will likely continue to be affected by certain key factors as well as certain historical events and actions. The key factors affecting our business and results of operations include among others, reliance on large orders from a small number of customers, the 2013 growth strategy plan, reliance on government contracts and competition. For further discussion of the factors affecting our results of operations, see “Risk factors.”
 
 
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Reliance on large orders from a small number of customers
 
We receive relatively large orders for products from a relatively small number of customers. Consequently, a single order from one customer may represent a substantial portion of our sales in any one period and significant orders by any customer during one period may not be followed by further orders from the same customer in subsequent periods. Our sales and operating results are subject to very substantial periodic variations. Since quarterly performance is likely to vary significantly, our results of operations for any quarter or calendar year are not necessarily indicative of the results that we might achieve for any subsequent period. Accordingly, quarter-to-quarter and year-to-year comparisons of our operating results may not be meaningful. In addition, we have a limited order backlog that is generally composed of orders that are fulfilled within a period of three to twelve months after receipt, which makes revenues in any quarter substantially dependent upon orders received in prior quarters.
 
Growth Strategy Plan
 
In last quarter of 2013 we adopted a growth strategy beyond the core of our PIDS activity. Pursuant to this growth strategy, we will seek to acquire a security products or cyber company that will expand our portfolio in the security business (HLS) both in the physical and logical field. In addition, we determined to focus our business on our sensor activity, expand our sales channels and close certain technology gaps in response to new demands in the market place.  We intend to implement the plan though organic growth or the acquisition of, or investment in, businesses, products and technologies that complement our security business within the PIDS or Cyber fields.
 
We may not be able to implement our growth strategy plan and may not be able to successfully expand our business activity and increase our sales.  If we are successful in the implementation of our strategic plan, we may be required to hire additional employees in order to meet customer demands, and if we are unable to attract or retain qualified employees, our business could be adversely affected.
 
We may not be able to consummate any acquisitions or investments in the future or realize the benefits of such acquisitions and investments, if consummated.
 
Our failure to successfully integrate the operations of an acquired business or to retain key employees of acquired businesses and integrate and manage our growth may have a material adverse effect on our business, financial condition, results of operation or prospects.  We may not be able to realize the anticipated benefits of any acquisition.  Moreover, future acquisitions by us could result in potentially dilutive issuances of our equity securities, the incurrence of debt and contingent liabilities and amortization expenses related to identifiable intangible assets, any of which could materially adversely affect our operating results and financial position.  Acquisitions also involve other risks, including risks inherent in entering markets in which we have no or limited prior experience.
 
Reliance on government contracts
 
Our products are primarily sold to governmental agencies, governmental authorities and government-owned companies, many of which have complex and time consuming procurement procedures.  A substantial period of time often elapses from the time we begin marketing a product until we actually sell that product to a particular customer.  In addition, our sales to governmental agencies, authorities and companies are directly affected by these customers’ budgetary constraints and the priority given in their budgets to the procurement of our products.  A decrease in governmental funding for our customers’ budgets would adversely affect our results of operations.  This risk is heightened during periods of global economic slowdown. Accordingly, governmental purchases of our systems, products and services may decline in the future if governmental purchasing agencies terminate, reduce or modify contracts.
 
 
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Competition
 
The global market for safety, security, site management solutions and products is highly fragmented and intensely competitive.  It is characterized by rapidly changing technology, frequent new product introductions and rapidly changing customer requirements.  We compete principally in the market for perimeter intrusion detection systems, or PIDS, and turnkey projects and solutions.  Some of our competitors and potential competitors have greater research, development, financial and personnel resources, including governmental support.  We cannot assure you that we will be able to maintain the quality of our products relative to those of our competitors or continue to develop and market new products effectively. Continued competitive pressures could cause us to lose significant market share.
 
Explanation of Key Income Statement Items
 
Cost of revenues.  Our cost of revenues for perimeter products consists of component and material costs, direct labor costs, subcontractor costs, shipping expenses, overhead related to manufacturing and depreciation.  Our cost of revenues for turnkey projects consists primarily of component and material costs, subcontractor costs, direct labor costs and overhead related to the turnkey projects. Our cost of revenues for Cyber sales consists primarily of direct labor costs, some component, material and subcontractor costs and overhead related to those sales.
 
Our gross margin is affected by the proportion of our revenues generated from perimeter products, turnkey projects.  Our revenues from perimeter products generally have higher gross margins than our other segment.
 
Research and development expenses, net.  Research and development expenses, net consists primarily of expenses for on-going research and development activities and other related costs.
 
Selling and marketing expenses.  Selling and marketing expenses consist primarily of commission payments, compensation and related expenses of our sales teams, attendance at trade shows and advertising expenses and related costs for facilities and equipment.
 
General and administrative expenses.  Our general and administrative expenses consist primarily of salary and related costs associated with our executive and administrative functions, legal and accounting expenses, allowances for doubtful accounts and bad debts and other miscellaneous expenses.  Staff costs include direct salary costs and related costs, such as severance pay, social security and retirement fund contributions, vacation and other pay.
 
Depreciation and Amortization. The amount of depreciation and amortization attributable to our business segments for the three years ended December 31, 2013 are as follows:
 
   
Years Ended December 31,
   
2011
   
2012
   
2013
   
(in thousands)
Perimeter products                                                                      
  $ 722     $ 624     $ 606  
Turnkey projects                                                                      
    497       554       629  
Cyber                                                                      
    -       -       484  
Total                                                                      
  $ 1,219     $ 1,178     $ 1,719  
 
Financial Expenses, Net. Financial expenses, net include exchange rate differences arising from changes in the value of monetary assets and monetary liabilities stated in currencies other than the functional currency of each entity, currency and hedge transactions, interest charged on loans from banks as well as interest income on our cash and cash equivalents and short term investments.
 
Tax expense.  Tax expense consists of federal, state and local taxes on the income of our business.  We paid income taxes in Germany, Colombia and Mexico in each of the years ended December 31, 2011 and 2012.In 2013 we did not pay income taxes on those territories due to losses.  In addition, we paid income taxes in Canada and the United States in 2012 and 2013. We did not pay taxes elsewhere because of our operating loss carry forwards.
 
 
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Discussion of Critical Accounting Policies
 
The preparation of financial statements in conformity with U.S. GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  Actual results could differ from those estimates and the use of different assumptions would likely result in materially different results of operations.  Critical accounting policies are those that are both most important to the portrayal of our financial position and results of operations and require management’s most difficult, subjective or complex judgments.  Although not all of our significant accounting policies require management to make difficult, subjective or complex judgments or estimates, the following policies and estimates are those that we deem most critical.
 
Revenue Recognition
 
We generate our revenues mainly from (i) long-term fixed price contracts for installation of comprehensive turnkey systems; (ii) sales of perimeter products, including services and maintenance that are performed either on a fixed-price basis or as time-and-materials based contracts; and (iii) services and maintenance, which are performed either on a fixed-price basis or as time-and-materials based contracts.
 
Revenues from installation of comprehensive turnkey systems are generated from fixed-price contracts according to which the time between the signing of the contract and the final customer acceptance is usually over one year.  Such contracts require significant customization for each customer’s specific needs and, as such, revenues from this type of contract are recognized in accordance with ASC, 605-35 “Revenue Recognition -Construction-Type and Production-Type Projects,” using contract accounting on a percentage of completion method.  Accounting for long-term contracts using the percentage-of-completion method stipulates that revenue and expense are recognized throughout the life of the contract, even though the project is not completed and the purchaser does not have possession of the project.  Percentage of completion is calculated based on the “Input Method.”
 
Turnkey projects costs include materials purchased to produce the solutions, related labor and overhead expenses and subcontractor’s costs.  The percentage to completion is measured by monitoring costs and efforts devoted using records of actual costs incurred to date in the project compared to the total estimated project requirement, which corresponds to the costs related to earned revenues.  The amounts of revenues recognized are based on the total fees under the agreements and the percentage of completion achieved.  Provisions for estimated losses on uncompleted contracts are made in the period in which such losses are first determined, in the amount of the estimated loss on the entire contract.
 
Estimated gross profit or loss from long-term contracts may change due to changes in estimates resulting from differences between actual performance and original forecasts.  Such changes in estimated gross profit are recorded in results of operations when they are reasonably determinable by management, on a cumulative catch-up basis.
 
We believe that the use of the percentage of completion method is generally appropriate as we have the ability to make reasonably dependable estimates of the extent of progress towards completion, contract revenues and contract costs.  In addition, executed contracts include provisions that clearly specify the enforceable rights regarding services to be provided and received by the parties to the contracts, the consideration to be exchanged and the manner and the terms of settlement, including in cases of termination for convenience.  In most cases we expect to perform our contractual obligations and our customers are expected to satisfy their obligations under the contract.
 
Fees are payable upon completion of agreed upon milestones and subject to customer acceptance. Revenues recognized in advance of contractual billing are recorded as unbilled accounts receivable.  The period between most instances of advanced recognition of revenues and the billing of the customers generally ranges between one to six months.  As of December 31, 2013, we had recorded $2.4 million of such unbilled receivables.
 
We also sell security products to customers according to customer orders without performing any installation work. Revenues from security product sales are recognized in accordance with Staff Accounting Bulletin No. 104, "Revenue Recognition in Financial Statements," or SAB No. 104, when delivery has occurred, persuasive evidence of an agreement exists, the vendor's fee is fixed or determinable, no further obligation exists and collectability is probable. Customers do not have a right to return the products.
 
 
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Services and maintenance are performed under either fixed-price based or time-and-materials based contracts.  Under fixed-price contracts, we agree to perform certain work for a fixed price.  Under time-and-materials contracts, we are reimbursed for labor hours at negotiated hourly billing rates and for materials.  Such service contracts are not in the scope of  ASC 605-35, and accordingly, related revenues are recognized in accordance with SAB No. 104, as those services are performed or over the term of the related agreements provided that, an evidence of an arrangement has been obtained, fees are fixed and determinable and collectability is reasonably assured.
 
Deferred revenue includes unearned amounts under installation service contracts, service contracts and maintenance agreements.
 
Inventories
 
Inventories are stated at the lower of cost or market value.  We periodically evaluate the quantities on hand relative to historical and projected sales volumes, current and historical selling prices and contractual obligations to maintain certain levels of parts.  Based on these evaluations, inventory write-offs are provided to cover risks arising from slow-moving items, discontinued products, excess inventories, market prices lower than cost and adjusted revenue forecasts.  Cost is determined as follows:
 
 
·
Raw materials, parts and supplies - using the “first-in, first-out” method.
 
 
·
Work-in-progress and finished products - on the basis of direct manufacturing costs with the addition of allocable indirect manufacturing costs.
 
During 2011, 2012 and 2013 we recorded inventory write-offs from continuing operations in the amounts of $1.0 million, $0.6 million and $0.6 million, respectively.  Such write-offs were included in cost of revenues.
 
Income taxes
 
We account for income taxes in accordance with ASC 740 “Income Taxes.”  This statement prescribes the use of the liability method whereby deferred tax asset and liability account balances are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse.  We provide a valuation allowance, if necessary, to reduce deferred tax assets to their estimated realizable value.
 
As part of the process of preparing our consolidated financial statements, we are required to estimate our income taxes in each of the jurisdictions in which we operate.  This process involves estimating our actual current tax exposure together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes.  These differences result in deferred tax assets and liabilities, which are included within our consolidated balance sheet.  We must then assess the likelihood that our deferred tax assets will be recovered from future taxable income and we must establish a valuation allowance to reduce our deferred tax assets to the amount that is more likely than not to be realized.  Increases in the valuation allowance result in additional expense to be reflected within the tax provision in the consolidated statement of income.
 
As of December 31, 2013, we had a net deferred tax asset of $0.3 million attributable to our subsidiaries.  We had total estimated available tax loss carryforwards of $13 million with respect to our operations in Israel and our subsidiaries, outside Israel, had estimated total available tax loss carryforwards of $11.9 million, of which $7.4 million was attributable to our U.S. subsidiary, which may be used as an offset against future taxable income for periods ranging between 6 and 18 years.  As of December 31, 2013, we recorded a full valuation allowance on these carryforward tax losses due to the uncertainty of their future realization.  Utilization of U.S. net operating losses may be subject to a substantial annual limitation due to the “change in ownership” provisions of the Internal Revenue Code of 1986 and similar state provisions.  The annual limitation may result in the expiration of net operating losses before utilization.
 
Goodwill
 
We have recorded goodwill as a result of acquisitions, which represents the excess of the cost over the net fair value of the assets of the businesses acquired.  We follow ASC 350, “Intangibles – Goodwill and Other,” which requires goodwill to be tested for impairment, at the reporting unit level, at least annually or between annual tests in certain circumstances, and written down when impaired, rather than being amortized.  We perform our annual goodwill impairment test at December 31 of each year, or more often if indicators of impairment are present.
 
 
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ASC 350 prescribes a two phase process for impairment testing of goodwill.  The first phase screens for impairment, while the second phase (if necessary) measures impairment.  In the first phase of impairment testing, goodwill attributable to each of the reporting units is tested for impairment by comparing the fair value of each reporting unit with its carrying value.  If the carrying value of the reporting unit exceeds its fair value, the second phase is then performed.  The second phase of the goodwill impairment test compares the implied fair value of the reporting unit's goodwill with the carrying amount of that goodwill. If the carrying amount of the reporting unit's goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized in an amount equal to that excess.  Fair value is determined using discounted cash flows, based on the income approach, as we believe that this approach best approximates the reporting unit’s fair value at this time.  Significant estimates used in the methodologies include estimates of future cash flows, future short-term and long-term growth rates and weighted average cost of capital for each of the reportable units.
 
The goodwill on our balance sheet as of December 31, 2013 relates to certain of our subsidiaries within the Perimeter Products segment and to our last acquisition of CyberSeal.  During 2011, 2012 and 2013 no impairment losses were identified.
 
The material assumptions used for the goodwill annual impairment test for the Perimeter Products segment, according to the income approach for 2013 were five years of projected net cash flows, a weighted average cost of capital rate of 14.3% and a long-term growth rate of 1%. The Company considered historical rates and current market conditions when determining the discount and growth rates to use in its analyses. If these estimates or their related assumptions change in the future, the Company may be required to record impairment charges for its goodwill.

The material assumptions used for the goodwill annual impairment test for the Cyber segment (which comprises a one reporting unit), according to the income approach for 2013 were five years of projected net cash flows, a weighted average cost of capital rate of 15% and a long-term growth rate of 2%. The Company considered current market conditions when determining the discount and growth rates to use in its analyses. If these estimates or their related assumptions change in the future, the Company may be required to record impairment charges for its goodwill.
 
Impairment of long lived assets
 
Our long-lived assets and certain identifiable intangibles are reviewed for impairment in accordance with ASC 360 “Property, Plant, and Equipment” whenever events or changes in circumstances indicate that the carrying amount of a group of assets may not be recoverable.  Recoverability of a group of assets to be held and used is measured by a comparison of the carrying amount of the group to the future undiscounted cash flows expected to be generated by the group. If such group of assets is considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds their fair value. During 2011, 2012 and 2013, no impairment losses were identified.
 
Functional Currency and Financial Statements in U.S. Dollars
 
While our functional currency in Israel is the NIS, our reporting currency is the U.S. dollar.  Translation adjustments resulting from translating our financial statements from NIS to the U.S. dollar are reported as a separate component in shareholders’ equity.  As of December 31, 2011, 2012 and 2013, our foreign currency translations totaled $0.6 million $2.2 million and $1.3 million, respectively.
 
During the years ended December 31, 2012 and 2013, we recorded accumulated foreign currency translation income of approximately $0.3 million and $2.4 million, respectively.  During the year ended December 31, 2011 we recorded accumulated foreign currency translation expense of approximately $0.6 million, included in our balance sheets as part of “accumulated other comprehensive income.” As of December 31, 2011, 2012 and 2013, foreign currency translation adjustments, net of $4.5 million, $4.7 million and $7.1 million, respectively, were included under “accumulated other comprehensive income.”
 
 
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The first step in the translation process is to identify the functional currency for each entity included in the financial statements.  The accounts of each entity are then “re-measured” in its functional currency.  All transaction gains and losses from the re-measurement of monetary balance sheet items are reflected in the statement of operations as financial income or expenses, as appropriate.
 
After the re-measurement process is complete the financial statements are translated into our reporting currency, which is the U.S. dollar, using the current rate method.  Equity accounts are translated using historical exchange rates.  All other balance sheet accounts are translated using the exchange rates in effect at the balance sheet date.  Statement of operations amounts have been translated using the average exchange rate for the year.  The resulting translation adjustments are reported as a component of shareholders’ equity in accumulated other comprehensive income (loss).
 
Concentrations of credit risk
 
Financial instruments that are potentially subject to concentrations of credit risk consist principally of cash and cash equivalents, short and long-term bank deposits, unbilled accounts receivable, trade receivables, long-term trade receivables and long-term loans.
 
Of our cash and cash equivalents and short-term, restricted and long-term bank deposits at December 31, 2013, $35.2 million was deposited with major Israeli banks.  An additional $9.3 million was deposited mainly with the Deutsche Bank, Royal Bank of Canada, BBVA Bankcomer, Helm Bank and Westpac Bank of Canada.  Cash and cash equivalents deposited with U.S. banks or other banks may be in excess of insured limits and are not insured in other jurisdictions.  Generally these deposits maybe redeemed upon demand and therefore bear low risk.
 
The short-term and long-term trade receivables and the unbilled accounts receivable of our company and our subsidiaries are derived from sales to large and solid organizations located mainly in Israel, the United States, Canada, Africa, Mexico and Europe.  We perform ongoing credit evaluations of our customers and to date have not experienced any material losses.  An allowance for doubtful accounts is determined with respect to those amounts that we have determined to be doubtful of collection and in accordance with an aging policy.  In certain circumstances, we may require letters of credit, other collateral or additional guarantees.  During the years ended December 31, 2011, 2012 and 2013 we recorded $411,000, $413,000 and $165,000 of expenses related to doubtful accounts, respectively.  As of December 31, 2013, our allowance for doubtful accounts amounted to $809,000.
 
We have no significant off-balance sheet concentration of credit risks, such as foreign exchange contracts or foreign hedging arrangements, except derivative instruments, which are detailed below.
 
Results of Operations
 
In 2013, we continued to suffer from the decrease in governmental spending in certain territories. We believe that this trend is continuing and that government spending in certain territories will stay low compare to previous levels.
 
Due to the nature of our customers and products, our revenues are often generated from a relatively small number of large orders.  Consequently, individual orders from individual customers can represent a substantial portion of our revenues in any one period and significant revenues from a customer during one period may not be followed by additional significant revenues from the same customer in subsequent periods.  Accordingly, our revenues and operating results may vary substantially from period to period.  Consequently, we do not believe that our revenues and operating results should necessarily be judged on a quarter-to-quarter comparative basis.
 
The following table presents certain financial data expressed as a percentage of revenues for the periods indicated:
 
   
Year Ended December 31,
 
   
2011
   
2012
   
2013
 
Revenues                                                               
    100 %     100 %     100 %
Cost of revenues                                                               
    55.4       56.8       60.3  
Gross profit                                                               
    44.6       43.2       39.7  
Operating expenses:
                       
Research and development, net                                                            
    4.4       5.2       8.6  
Selling and marketing, net                                                            
    21.9       21.3       24.8  
General and administrative                                                            
    9.8       9.5       15.1  
   Other income
    (2.6 )     -       -  
Operating income (loss)                                                               
    11.1       7.2       (8.8 )
Financial income (expenses), net                                                               
    0.9       (0.6 )     0.1  
Income (loss) before income taxes                                                               
    12.0       6.5       (8.7 )
Income taxes                                                               
    0.9       1.3       0.1  
Net income (loss)                                                               
    11.1       5.3       (8.8 )

 
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Year Ended December 31, 2013 Compared with Year Ended December 31, 2012
 
Revenues.  Revenues decreased by 33.7% to $51.5 million for the year ended December 31, 2013 from $77.7 million for the year ended December 31, 2012.  Revenues from sales of perimeter systems decreased by 10% to $30.6 million in 2013 from $33.9 million in 2012, primarily due to economy slowdown in Europe and governmental spending cutbacks.  Revenues from security turnkey projects decreased by 55.3% to $20.1 million in 2013 from $45 million in 2012, primarily due to government budgets that were frozen.  We anticipate that our revenues will increase in 2014, as a result of anticipated improvements in economic conditions in certain territories and increases in governmental spending.
 
Cost of revenues. Cost of revenues decreased by 29.7% to $31.1 million for the year ended December 31, 2013 from $44.2 million for the year ended December 31, 2012.  This decrease was primarily due to the decrease in revenues.  Cost of revenues as a percentage of revenues increased to 60.3% in 2013 from 56.8% in 2012, primarily due to the decreased sales without a matching decrease in fixed costs and due to a mix of projects. Our cost of revenues as a percentage of revenues was negatively impacted by the appreciation of the NIS against the U.S. dollar in 2013.
 
Research and development expenses, net.  Research and development expenses, net increased by 9.1% to $4.4 million for the year ended December 31, 2013 from $4 million for the year ended December 31, 2012. The increase in research and development expenses in 2013 was primarily due to the CyberSeal acquisition.
 
Selling and marketing expenses, net.  Selling and marketing expenses, net decreased by 22.7% to $12.8 million for the year ended December 31, 2013 from $16.5 million for the year ended December 31, 2012.  The decrease in selling and marketing expenses in 2013 was primarily due to decreased sales commissions in 2013 compared with 2012, as well as lower associated expenses such as royalties. The decrease is offset by an increase in expenses attributable to the average exchange rate of the NIS against the U.S. dollar in 2013. Selling and marketing expenses amounted to 24.8% and 21.3% of revenues in 2013 and 2012, respectively.
 
General and administrative expenses.  General and administrative expenses increased by 5.1% to $7.8 million for the year ended December 31, 2013 from $7.4 million for the year ended December 31, 2012.  The increase in general and administrative expenses in 2013 was primarily due to the CyberSeal acquisition, as well as the impact of the average exchange rate appreciation of the NIS against the U.S. dollar in 2013.  General and administrative expenses amounted to 15.1% of revenues in 2013 compared to 9.5% in 2012.
 
Other income.   In 2011, we collected an arbitration award of approximately $2.5 million and recorded income of $2.3 million from the arbitration, net of legal expenses.  We did not record any other income in 2012 and 2013.
 
 
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Operating profit.  We had an operating loss of $4.5 million for the year ended December 31, 2013 compared to an operating profit of $5.6 million for the year ended December 31, 2012.  The operating profit (loss) of our business segments for the years ended December 31, 2013 and 2012 were as follows:
 
   
Year Ended December 31,
 
   
2012
   
2013
 
   
(In thousands)
 
Perimeter products                                                                      
  $ 4,409     $ 542  
Turnkey projects                                                                      
    1,634       (3,571 )
Cyber                                                                      
    -       (1,184 )
Eliminations                                                                      
    (486 )     (306 )
Total                                                                      
  $ 5,557     $ (4,519 )
 
Our perimeter products segment recorded operating income of $0.5 million for the year ended December 31, 2013 compared to operating income of $4.4 million for the year ended December 31, 2012, primarily as a result of decreased sales of perimeter products due to continued economy slowdown in Europe and governmental spending cutbacks. In addition, the decrease results from the combination of low sales in 2013 and fixed operating costs. Our turnkey project segment recorded operating loss of $3.6 million in the year ended December 31, 2013 compared to operating income of $1.6 million for the year ended December 31, 2012 primarily as a result of decreased sales of turnkey projects due to government budgets that were frozen. Our Cyber segment recorded operating loss of $1.2 million in the year ended December 31, 2013.
 
Financial expenses (income), net.  Our financial income, net, for the year ended December 31, 2013 was $0.1 million compared to financial expenses, net of $0.5 million for the year ended December 31, 2012.  The change was primarily attributable to foreign exchange gain, net of $0.1 million in the year ended December 31, 2013 compared to foreign exchange loss, net of $0.5 million in the year ended December 31, 2012.
 
Income taxes. We recorded income tax expense of $0.1 million for the year ended December 31, 2013 compared to income tax expense of $1 million for the year ended December 31, 2012. Tax expenses primarily relate to the tax expenses of our foreign subsidiaries.
 
Year Ended December 31, 2012 Compared with Year Ended December 31, 2011
 
Revenues.  Revenues decreased by 12.3% to $77.7 million for the year ended December 31, 2012 from $88.6 million for the year ended December 31, 2011.  Revenues from sales of perimeter systems increased by 13.1% to $33.9 million in 2012 from $30 million in 2011, primarily due to continued governmental spending,  Revenues from security turnkey projects decreased by 24.6% to $45 million in 2012 from $59.7 million in 2011, primarily due to the early 2012 completion of the Gabonese Republic Project.  We anticipate that our revenues will increase in 2013, as a result of anticipated improvements in economic conditions in certain territories and increases in governmental spending.
 
Cost of revenues. Cost of revenues decreased by 10% to $44.2 million for the year ended December 31, 2012 from $49.1 million for the year ended December 31, 2011.  This decrease was primarily due to the decrease in revenues.  Cost of revenues as a percentage of revenues increased to 56.8% in 2012 from 55.4% in 2011, primarily due to the decreased sales without a matching decrease in fixed costs and due to a mix of projects. Our cost of revenues as a percentage of revenues was positively impacted by the appreciation of the NIS against the U.S. dollar in 2012.
 
Research and development expenses, net.  Research and development expenses, net increased by 3.7% to $4 million for the year ended December 31, 2012 from $3.9 million for the year ended December 31, 2011.
 
Selling and marketing expenses, net.  Selling and marketing expenses, net decreased by 14.9% to $16.5 million for the year ended December 31, 2012 from $19.4 million for the year ended December 31, 2011.  The decrease in selling and marketing expenses in 2012 was primarily due to decreased sales commissions in 2012 compared with 2011, as well as lower associated expenses such as royalties. The decrease is also attributable to the average exchange rate appreciation of the NIS and the Mexican Peso against the U.S. dollar in 2012, which decreased the U.S. dollar value of our NIS and Mexican Peso denominated expenses.  Selling and marketing expenses, net amounted to 21.3% and 21.9% of revenues in 2012 and 2011, respectively.
 
 
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General and administrative expenses.  General and administrative expenses decreased by 14.7% to $7.4 million for the year ended December 31, 2012 from $8.7 million for the year ended December 31, 2011.  The decrease in general and administrative expenses in 2012 was primarily due to the decreased compensation paid to our management, as well as the impact of the average exchange rate appreciation of the NIS against the U.S. dollar in 2012, which increased the U.S. dollar value of our NIS and Canadian dollar denominated general and administrative expenses.  General and administrative expenses amounted to 9.5% of revenues in 2012 compared to 9.8% in 2011.
 
Other income.   In 2011, we collected an arbitration award of approximately $2.5 million and recorded income of $2.3 million from the arbitration, net of legal expenses.  We did not record any other income in 2012.
 
Operating profit.  We had an operating profit of $5.6 million for the year ended December 31, 2012 compared to an operating profit of $9.8 million for the year ended December 31, 2011.  The operating profit of our business segments for the years ended December 31, 2012 and 2011 were as follows:
 
   
Year Ended December 31,
 
   
2011
   
2012
 
   
(In thousands)
 
Perimeter products                                                                      
  $ 2,665     $ 4,409  
Turnkey projects                                                                      
    5,224       1,634  
Other income                                                                      
    2,304       -  
Eliminations                                                                      
    (382 )     (486 )
Total                                                                      
  $ 9,811     $ 5,557  
 
Our perimeter products segment recorded operating income of $4.4 million for the year ended December 31, 2012 compared to operating income of $2.7 million for the year ended December 31, 2011, primarily as a result of increased sales of perimeter products due to continued governmental spending. Our turnkey project segment recorded operating income of $1.4 million in the year ended December 31, 2012 compared to operating income of $5.2 million for the year ended December 31, 2011.  We experienced extraordinary results in 2011 mainly due to the revenues generated by the African Cup of Nations Football Championship project.
 
Financial expenses (income), net.  Our financial expenses, net, for the year ended December 31, 2012 were $0.5 million compared to financial income, net of $0.8 million for the year ended December 31, 2011.  The change was primarily attributable to foreign exchange losses, net of $0.5 million in the year ended December 31, 2012 compared to foreign exchange gains, net of $1.4 million in the year ended December 31, 2011, which was partially set off by $0.4 million of income attributable to forward transaction.
 
Income taxes. We recorded income tax expense of $1 million for the year ended December 31, 2012 compared to income tax expense of $0.7 million for the year ended December 31, 2011. Tax expenses primarily relate to the tax expenses of our foreign subsidiaries in Mexico and Germany, uncertain tax provisions and a valuation allowance recorded with respect to tax withheld by our clients in 2012.
 
Seasonality
 
Our operating results are characterized by a seasonal pattern, with a higher volume of revenues towards the end of the year and lower revenues in the first part of the year.  This pattern, which is expected to continue, is mainly due to two factors:
 
 
·
our customers are mainly budget-oriented organizations with lengthy decision processes, which tend to mature late in the year; and
 
 
·
due to harsh weather conditions in certain areas in which we operate during the first quarter of the calendar year, certain projects and services are put on hold and consequently payments are delayed.
 
 
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Our revenues are dependent on government procurement procedures and practices, and because we receive large product orders from a relatively small number of customers, our revenues and operating results are subject to substantial periodic variations.
 
Impact of Inflation and Currency Fluctuations on Results of Operations, Liabilities and Assets
 
We sell most of our products in Africa, Latin America, North America, Europe and Israel.  Our financial results, which are reported in U.S. dollars, are affected by changes in foreign currency.  Our revenues are primarily denominated in U.S. dollars, Euros and NIS, while a portion of our expenses, primarily labor expenses, is incurred in NIS and Canadian dollars.  Additionally, certain assets, especially trade receivables, as well as part of our liabilities are denominated in NIS.  As a result, fluctuations in rates of exchange between the U.S. dollar and non-U.S. dollar currencies may affect our operating results and financial condition.  The dollar cost of our operations in Israel and Canada may be adversely affected by the appreciation of the NIS and the Canadian dollar against the U.S. dollar.  In addition, the value of our non-U.S. dollar revenues could be adversely affected by the depreciation of the U.S. dollar against such currencies.
 
The appreciation of the NIS, the Mexican Pesos and the Canadian dollar in relation to the U.S. dollar has the effect of increasing the U.S. dollar value of any unlinked assets and the U.S. dollar amounts of any unlinked liabilities and increasing the U.S. dollar value of revenues and expenses denominated in other currencies.  Conversely, the depreciation of the NIS, the Mexican Peso and the Canadian dollar in relation to the U.S. dollar has the effect of reducing the U.S. dollar value of any of our liabilities which are payable in NIS, Mexican Pesos or in Canadian dollars (unless such costs or payables are linked to the U.S. dollar).  Such depreciation also has the effect of decreasing the U.S. dollar value of any asset that is denominated in NIS, Mexican Pesos and Canadian dollars or receivables payable in NIS, Mexican Pesos or Canadian dollars (unless such receivables are linked to the U.S. dollar).  In addition, the U.S. dollar value of revenues and expenses denominated in NIS, Mexican Pesos or Canadian dollars would increase.  Because foreign currency exchange rates fluctuate continuously, exchange rate fluctuations may have an impact on our profitability and period-to-period comparisons of our results.  The effects of foreign currency re-measurements are reported in our consolidated financial statements in current operations.
 
The following table presents information about the rate of inflation in Israel, the rate of devaluation or appreciation of the NIS against the dollar, and the rate of inflation in Israel adjusted for the devaluation:
 
Year ended
December 31,
 
Israeli inflation
rate %
   
NIS devaluation (appreciation)
rate %
   
Israeli inflation adjusted for devaluation (appreciation) %
 
2009
    3.9       (0.7 )     4.6  
2010
    2.7       (6.0 )     8.7  
2011
    2.2       7.7       (5.5 )
2012
    1.6       (2.3 )     3.9  
2013
    1.8       (7.0 )     8.8  

In addition, the U.S. dollar cost of our operations in Canada is influenced by the exchange rate between the U.S. dollar and the Canadian dollar.  In 2012, the Canadian dollar depreciated against the U.S. dollar by 2.6% and in 2013 the Canadian dollar appreciated against the U.S. dollar by 6.8%.
 
In 2013, foreign currency fluctuations had a small positive impact on our results of operations as we recorded foreign exchange income, net of $0.1 million, compared to $0.5 million of foreign exchange losses, net in 2012.  We expect that our results of operations will continue to be affected by currency fluctuations in the future.
 
To manage this risk, from time to time, we have entered into forward exchange contracts to hedge some of our foreign currency exposure relating to bank deposits and unbilled accounts receivable denominated in foreign currencies.  During 2012 and 2013, we recorded $410,000 and $39,000, respectively, in financial income. During 2011, these forward transactions had no impact on our results.
 
 
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Conditions in Israel
 
We are incorporated under the laws of, and our principal executive offices and manufacturing and research and development facilities are located in, the State of Israel.  See Item 3D “Key Information – Risk Factors – Risks Relating to Our Location in Israel” for a description of governmental, economic, fiscal, monetary and political policies or factors that have materially affected or could materially affect our operations.
 
Effective Corporate Tax Rate
 
The Israeli corporate tax rate was 24% in 2011 and 25% in 2012 and 2013.

On December 5, 2011, the "Knesset" (Israeli parliament) passed the Law for Tax Burden Reform (Legislative Amendments), 2011 ("the Law") which, among others, cancels effective from 2012, the scheduled reduction in the corporate tax rate. The Law also increases the corporate tax rate to 25% in 2012. In view of this increase in the corporate tax rate to 25%, as above, the real capital gain tax rate and the real betterment tax rate were also increased accordingly.

On August 5, 2013, the "Knesset" issued the Law for Changing National Priorities (Legislative Amendments for Achieving Budget Targets for 2013 and 2014), 2013 ("the Budget Law"), which consists, among others, of fiscal changes whose main aim is to enhance the collection of taxes in those years.
 
These changes include, among others, increasing the corporate tax rate from 25% to 26.5%, cancelling the reduction in the tax rates applicable to privileged enterprises (9% in development area A and 16% elsewhere) and, in certain cases, increasing the rate of dividend withholding tax within the scope of the Law for the Encouragement of Capital Investments to 20% effective from January 1, 2014. There are also other changes such as taxation of revaluation gains effective from August 1, 2013. The provisions regarding revaluation gains will become effective only after the publication of regulations defining what should be considered as "retained earnings not subject to corporate tax" and regulations that set forth provisions for avoiding double taxation of overseas assets. As of the date of approval of these financial statements, these regulations have not been issued.
 
Our effective corporate tax rate may substantially exceed the Israeli tax rate since our U.S.-based subsidiaries will generally be subject to applicable federal, state, local and foreign taxation, and we may also be subject to taxation in the other foreign jurisdictions in which we own assets, have employees or conduct activities.  Because of the complexity of these local tax provisions, it is not possible to anticipate the actual combined effective corporate tax rate, which will apply to us.
 
As of December 31, 2013, we had net deferred tax assets of $0.3 million attributable to our subsidiaries.  We had total estimated available carryforward tax losses of $12 million with respect to our operations in Israel to offset against future taxable income.  We have recorded a full valuation allowance for such carryforward tax losses due to the uncertainty of their future realization. As of December 31, 2013, our subsidiaries had estimated total available carryforward tax losses of $12.9 million, which may be used as an offset against future taxable income for periods ranging between 1 and 19 years.  Utilization of U.S. net operating losses may be subject to a substantial annual limitation due to the “change in ownership” provisions of the Internal Revenue Code of 1986 and similar state tax law provisions.  The annual limitation may result in the expiration of net operating losses before utilization.
 
Trade Relations
 
Israel is a member of the United Nations, the International Monetary Fund, the International Bank for Reconstruction and Development and the International Finance Corporation.  Israel is a member of the World Trade Organization and is a signatory to the General Agreement on Tariffs and Trade.  Israel is also a member of the Organization for Economic Co-operation and Development, or the OECD, an international organization whose members are governments of mostly developed economies.  The OECD’s main goal is to promote policies that will improve the economic and social well-being of people around the world.  In addition, Israel has been granted preferences under the Generalized System of Preferences from the United States, Australia, Canada and Japan.  These preferences allow Israel to export products covered under such programs either duty-free or at reduced tariffs.
 
 
- 39 -

 
 
Israel and the European Union Community, known as the “European Union,” concluded a Free Trade Agreement in July 1975 that confers some advantages with respect to Israeli exports to most European countries and obligates Israel to lower its tariffs with respect to imports from these countries over a number of years.  In 1985, Israel and the United States entered into an agreement to establish a Free Trade Area.  The Free Trade Area has eliminated all tariff and some non-tariff barriers on most trade between the two countries.  On January 1, 1993, an agreement between Israel and the European Free Trade Association, known as the “EFTA,” established a free-trade zone between Israel and the EFTA nations.  In November 1995, Israel entered into a new agreement with the European Union, which includes a redefinition of rules of origin and other improvements, such as allowing Israel to become a member of the Research and Technology programs of the European Union.  In recent years, Israel has established commercial and trade relations with a number of other nations, including Russia, China, India, Turkey and other nations in Eastern Europe and the Asia-Pacific region.  In addition, Israel has entered into a free trade agreement with the MercoSur countries (Brazil, Paraguay, Argentina and Uruguay) which became fully effective in September 2011.  Generally, the purpose of this agreement is to reduce the custom rates between Israel and these countries and to abolish them completely in certain cases.  Israel is the first country outside of Latin America to enter into such an agreement with the MercoSur countries.
 
B.            Liquidity and Capital Resources
 
Our working capital at December 31, 2012 and 2013 was $49.2 million and $47 million, respectively.  Cash and cash equivalents amounted to $36.8 million at December 31, 2012 compared to $32.2 million at December 31, 2013.  Short-term and long-term bank deposits, restricted bank deposits and escrow deposits amounted to $9.6 million at December 31, 2012 compared to $12.2 million at December 31, 2013.  Our cash and cash equivalents, short and long-term bank deposits are held in various banks, mainly in U.S. dollars, Euros, NIS and Canadian dollars.
 
From our inception until our initial public offering in March 1993, we financed our activities mainly through cash flow from operations and bank loans.  In March 1993, we received proceeds of $9.8 million from our initial public offering of 1,380,000 ordinary shares.  Subsequently, we made follow-on public offerings, in February 1997 (of 2,085,000 ordinary shares) and in April 2005 (of 1,700,000 ordinary shares), in which we raised $9.4 million and $14.9 million, respectively.  To allow us to begin to implement our 2010 strategic plan, on September 8, 2010, Ki Corporation Limited, or Ki Corporation, a company affiliated with Mr. Nathan Kirsh, our principal shareholder, provided us with a bridge loan of $10.0 million.  To repay the loan and to raise permanent capital for general working capital purposes including facilitating the implementation of our new business strategy, in July and August 2011 we raised $16.2 million from a rights offering of 5,273,274 ordinary shares and a private placement of 150,000 of our ordinary shares.
 
On August 7, 2013 we took a bank loan in the amount of $2.5 million bearing annual interest of Libor + 3.4%. The loan is being repaid by 20 equal quarterly installments until August 7, 2018. The proceeds of such exercise, if any, will be used for working capital purposes.
 
We expect that our total research and development expenses in 2014 will be approximately $4.4 million. Our research and development plan for 2014 covers the following main areas:
 
 
·
Sensor development - We intend to continue the development of new and innovative sensors and Cyber products based on existing, new and hybrid technologies.  Most of the development will be based on in-house competencies; however, we may acquire some know-how externally.
 
 
·
Sensor improvements – We are conducting an ongoing program of improvement of our existing sensors in order to enhance performance, reliability and capability to source and produce and reduce cost. Security Management Systems – We intend to continue to develop our two levels of security management systems:
 
 
o
High-end systems – PSIM systems, mainly used as part of a turnkey solution, is a comprehensive command and control solution, designed for entities requiring management of security, safety, site management and dispatching.  These systems are designed to manage both daily routines and crisis situations. Cyber security management is being developed as part of our PSIM system with the concept of integrated logical and physical security solutions.
 
 
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o
Low-end systems – Basic SMS typically used for managing and controlling the PIDS of a site.
 
 
o
We are also developing an interface package to facilitate integration of our sensors into a third party SMS/command and control system.
 
 
o
Video systems – We will continue to develop our video management software to improve the IVA and cope with advanced video protocols such as regular IP streaming, megapixel and high definition video cameras.
 
We believe that our cash and cash equivalents, bank facilities, bank deposits and our expected cash flows from operations in 2014 will be sufficient to meet our ongoing cash requirements through 2015.  However, our liquidity could be negatively affected by a decrease in demand for our products, including the impact of potential reductions in customer purchases that may result from the current general economic climate.
 
Cash Flows
 
The following table summarizes our cash flows for the periods presented:
 
   
Year ended December 31,
 
   
2011
   
2012
   
2013
 
   
(in thousands)
 
Net cash provided by (used in) operating activities                                                                                    
    20,418       5,706       (2,590 )
Net cash used in investing activities                                                                                    
    (6,406     (1,048 )     (5,760 )
Net cash provided by financing activities                                                                                    
    1,833       961       2,583  
Effect of exchange rate changes on cash and cash equivalents
    (2,436 )     1,160       1,218  
Increase (decrease) in cash and cash equivalents                                                                                    
    13,409       6,779       (4,549 )
Cash and cash equivalents at the beginning of the year
    16,596       30,005       36,784  
Cash and cash equivalents at the end of the year                                                                                    
  $ 30,005     $ 36,784     $ 32,235  
 
Net cash used in operating activities was approximately $2.6 million in the year ended December 31, 2013 compared to net cash provided by operating activities of $5.7 million in the year ended December 31, 2012 and net cash provided by operating activities of $20.4 million in the year ended December 31, 2011.  Net cash used in operating activities in the year ended December 31, 2013 was primarily attributable to 2013 loss as well as to the decrease of $3.1 million in customer advances, decrease of $3 million in trade payables and decrease of $1.5 million in other accounts payable and accrued expenses. This was offset in part by a decrease of $6.2 million in short and long term trade receivables, net, $1.7 million of depreciation and amortization expenses and $0.5 million of stock based compensation.
 
Net cash provided by operating activities in the year ended December 31, 2012 was primarily attributable to 2012 income as well as to the $1.2 million of depreciation and amortization expenses, $0.2 million of stock based compensation, a decrease in other accounts receivable and prepaid expenses of $2.9 million, unbilled accounts receivables of $2.6 million, inventory of $1.4 million, long term trade receivables of $0.4 million and an increase of $0.8 million in customer advances. This was offset in part by an increase of $4.1 million in trade receivables, a decrease in other accounts payable and accrued expenses of $3.3 million and a decrease of $0.4 million in accrued severance pay.
 
Net cash provided by operating activities in the year ended December 31, 2011 was primarily attributable to 2011 income as well as to the $1.2 million of depreciation and amortization expense, $0.4 million of stock based compensation, a decrease in trade accounts receivables and inventories of $1.2 million and $0.2 million, respectively, an increase of $6.1 million in other accounts payable and accrued expenses, an increase of $3.2 million in trade payables, an increase of $3.9 million in customer advances and an increase of $0.3 million in accrued severance pay.  This was offset in part by an increase of $2.4 million in unbilled accounts receivables, an increase of $3.3 million in other accounts receivable and prepaid expenses, an increase of $0.2 million in accrued interest and exchange differences on short term and long term deposits and long term loans and an increase in deferred income taxes of $0.1 million. The significant increase in net cash provided by operating activities was due in part to the special terms and timing of the receipts and payments of projects performed in 2011 and may not be indicative of future operating performance.
 
 
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Net cash used in investing activities was approximately $5.8 million for the year ended December 31, 2013 compared to net cash used in investing activities of approximately $1 million for the year ended December 31, 2012 and net cash used in investing activities of approximately $6.4 million for the year ended December 31, 2011. In the year ended December 31, 2013, our net cash used in investing activities was primarily attributable to short-term deposits net of sale of short-term bank deposits for $4.4 million, payments for business acquisitions of CyberSeal for $2.6 million and a purchase of property and equipment for $1.2 million. These amounts were offset in part by the release of long-term bank deposits and restricted deposit of $2.3 million.
 
In the year ended December 31, 2012, our investments in restricted long term and short term bank deposits were $0.2 million and $1.5 million, respectively, and we purchased $1.7 million of property and equipment. These amounts were offset in part by the sale of short term bank deposits of $0.2 million and the realization of $2.1 million from the release of funds from a restricted deposit.
 
In the year ended December 31, 2011, our investments in restricted long term and short term bank deposits were $7.6 million and $0.4 million, respectively and we purchased $1.2 million and $28,000, respectively, of property and equipment and know-how and patents.  These amounts were offset in part by the sale of short term bank deposits of $31,000, the realization of $2.8 million from the release of funds from a restricted deposit and proceeds of $50,000 from sale of property and equipment.
 
In the year ended December 31, 2013, net cash provided by financing activities was $2.6 million, primarily attributable to $2.5 million proceeds from long-term bank debt.
 
In the year ended December 31, 2012, net cash provided by financing activities was $1 million, primarily attributable to the $1.1 million proceeds from issuance of shares upon exercise of options and employee stock purchase plan.
 
In the year ended December 31, 2011, net cash provided by financing activities was $1.8 million, primarily attributable to the $16.2 million derived from the previously mentioned rights offering and private placement.  This was offset by the repayment of the $10.4 million bridge loan received from Ki Corporation (including accrued interest) and the repayment of short term and long term bank credit of $3.5 million and $0.5 million, respectively.
 
We had capital expenditures of approximately $1.2 million, $1.7 and 1.2 million in the years ended December 31, 2011, 2012 and 2013, respectively.  These capital expenditures were principally for computers, other machinery, land and building construction for one of our subsidiaries' offices and equipment and for expanding and renovating our facilities.  We estimate that our capital expenditures for 2014 will total approximately $1.1 million.  We expect to finance these expenditures primarily from our cash and cash equivalents and our operating cash flows.  However, the actual amount of our capital expenditures will depend on a variety of factors, including general economic conditions and changes in the demand for our products. In addition, part of CyberSeal acquisition was paid in cash of approximately $2.6M.
 
Credit Lines and Other Debt
 
Short-term and long-term bank credit at December 31, 2012 and 2013 was $5.4 million and $8.2 million, respectively.  Our highest level of short-term and long-term bank borrowings in the years ended December 31, 2012 and 2013 was $5.4 million and $8.3 million, respectively.
 
As of December 31, 2013, we had credit lines with Bank Leumi Le-Israel B.M., or Bank Leumi, Union Bank of Israel Ltd., or Union Bank, and Bank Hapoalim B.M., or Bank Hapoalim, totaling $28.4 million in the aggregate (of which $7.2 million is reserved exclusively for guarantees out of which $3.3 million was available as of December 31, 2013).  Our credit lines at Bank Leumi and Union Bank have no restrictions as to our use of the credit, while our credit line at Bank Hapoalim is restricted to projects execution.  Some of the loans under these credit lines are denominated in NIS and one is denominated in US dollar.  We are not under any obligation to maintain financial ratios or other terms in respect of our credit lines. In addition, as of December 31, 2013, our subsidiaries had credit lines with the Royal Bank of Canada, Deutsche Bank and Helm Bank of $3.1 million in the aggregate, of which $2.3 million was available at December 31, 2013.
 
 
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Our Canadian subsidiary, which is primarily engaged in sale of perimeter products and turnkey projects, has undertaken to maintain general covenants and the following financial ratios and terms in respect of its outstanding credit lines: a quick ratio of not less than 1.25:1; a ratio of total liabilities to tangible net worth of not greater than 0.75:1; and tangible net worth of at least $10.0 million.  As of December 31, 2013, our Canadian subsidiary was in compliance with these ratios and terms.
 
As of December 31, 2013, our outstanding balances under our credit lines in Israel consisted of:
 
 
·
Short-term NIS-denominated loans of approximately $5.8 million, bearing interest at an average rate of 1.5%;
 
 
·
Several bank performance, advance payment and bid guarantees totaling approximately $3.9 million, at an annual cost of 1%-1.5%; and
 
 
·
An immaterial amount of long-term NIS-denominated loans.
 
 
·
Long term USD dominated loan of approximately $ 2.5 million bearing interest at an average rate of Libor + 3.4%;
 
As of December 31, 2013, the outstanding balances under the credit lines of our subsidiaries consisted of several bank performance, advance payment and bid guarantees totaling approximately $0.8 million, at an annual cost of 1.5% -1.8%.
 
C.            Research and Development, Patents and Licenses.
 
Government Grants
 
We participate in programs sponsored by the Israeli Government for the support of research and development activities.  In the past we have received royalty-bearing grants from the OCS for certain of our research and development projects for perimeter security products.  We did not obtain any grants from the OCS in the past three years. We are obligated to pay royalties to the OCS amounting to 3.5%  of revenues derived from sales of the products funded with these grants and ancillary services, up to 100% of the grants received, linked to the U.S. dollar.  All grants received after January 1, 1999 also bear interest equal to the 12 month LIBOR rate.  The obligation to pay these royalties is contingent on actual sales of the products, and in the absence of such sales no payment is required.
 
For the three years ended December 31, 2013, we paid the OCS royalties in the amount of $68,000, $178,000 and $123,000, respectively.  These royalties related to sales of perimeter security products and management security systems and to some of the sales of our Israeli Subsidiary. As of December 31, 2013, we had a contingent obligation to pay royalties to the OCS in the amount of approximately $1.8 million upon the successful sale of perimeter security products developed under research and development programs sponsored by the OCS.
 
Investment Tax Credit
 
Our Canadian subsidiary is eligible for investment tax credits for its research and development activities and for certain current and capital expenditures.  For the years ended December 31, 2013, 2012 and 2011, our Canadian subsidiary recognized $270,000, $280,000 and $268,000, respectively, of investment tax credits.
 
In addition, as of December 31, 2013, our Canadian and U.S. subsidiaries had available investment tax credits of approximately $1.4 million in Canada and $0.1 million in the U.S. to reduce future federal and provincial income taxes payable.  These credits will expire in 2027 through 2032 in Canada and 2019 through 2023 in the U.S. As of December 31, 2013, our subsidiaries made a full valuation allowance in respect of such investment tax credits.
 
D.            Trend Information.
 
We recorded a loss in 2013 compare with a profit in 2011 and 2012.  The shift to loss in 2013 from profits in 2011 and 2012 is mainly attributable to held back in governmental spending in certain territories which led to delay in new projects in 2013, while in 2011 and 2012 the market was less influenced by the global economic slowdown and the reduction in governmental spending.
 
 
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To the extent this trend will be change in 2014, we believe that we will face increased revenues which will result in continued profitable operations.
 
E.            Off-Balance Sheet Arrangements.
 
We are not a party to any material off-balance sheet arrangements.  In addition, we have no unconsolidated special purpose financing or partnership entities that are likely to create material contingent obligations.
 
F.             Tabular Disclosure of Contractual Obligations.
 
The following table summarizes our minimum contractual obligations and commercial commitments as of December 31, 2013 and the effect we expect them to have on our liquidity and cash flow in future periods.
 
   
Payments due by period
 
Contractual Obligations
 
Total
   
Less than 1 year
   
1-2 years
   
3-5 years
   
More than 5 years
 
   
(in thousands)
 
Long-term bank debt obligations
  $ 2,381     $ 506     $ 1,000     $ 875       -  
Operating lease obligations
  $ 3,468     $ 817     $ 744     $ 753     $ 1,154  
Other long-term liabilities reflected on our balance sheet under U.S. GAAP
  $ 3,813       -       -       -     $ 3,813  
Total
  $ 9,662     $ 1,323