SILICOM LTD. [SILC] Filings

Not Applicable.

 

Not Applicable.

 

This annual report and statements that we may make from time to time may contain forward-looking information. There can be no assurance that actual results will not differ materially from our expectations, statements or projections. Factors that could cause actual results to differ from our expectations, statements or projections include the risks and uncertainties relating to our business described below.

 

Summary of Risk Factors

 

An investment in our ordinary shares is subject to a number of risks. The following summarizes some, but not all, of these risks. Please carefully consider all of the information discussed in “Item 3. Key Information—D. Risk Factors” in this annual report for a more thorough description of these and other risks.

 

Risks Related to Our Business and Industry

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

General Risk Factors

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

We may not be able to capitalize, as planned, on our Design Wins.

 

Once we secure a Design Win, we may not be able to properly capitalize on such Design Win. For example, we may not receive revenues from a Design Win due to the customer deciding to hold back the introduction of its product or service, of which our Design Win product is a component, to the market. Alternatively, we may experience delays in receiving revenues from a Design Win due to circumstances unrelated to us, such delays may stem from delays in the deployment of the customer's product/service in the market. Delays may also lead to a request by the customer to change the specifications of our product due to changes in industry standards and/or market requirements. There is no assurance that we will be able to secure a Design Win for the product with the new specifications. A customer may also experience a lower demand than forecasted by the customer at the time of securing the Design Win for its product/service, which will accordingly affect its demand for our Design Win product. Additionally, the Design Win client may decide to abandon the use of our product and use an alternate source. The adoption of new restrictions relating to the spread of Covid-19, which may occur in various geographies globally, as well as other factors which may affect our supply chain, such as the war in Ukraine and related business disruptions and sanctions, as well as U.S. restrictions on certain trade with China, may result in us experiencing extended delays in materialization of revenue from Design Wins, as mentioned above.

 

The market for Cloud-based and Cloud-focused solutions is rapidly developing, and if it develops in ways that are different from what we anticipate or expect, our business could be harmed.

 

In recent years, the Cloud-based market has rapidly developed, and the demand for Cloud-based data centers utilizing virtualization and SDN has increased. We expect that this increase in demand will lead to increased demand for our CPE/EDGE products as well as for our networking, offloading and acceleration related Field Programmable Gate Arrays, or FPGAs. We also expect the Cloud-based data centers to be increasingly based on generic server platforms. These platforms will require offload capabilities in order to address the performance challenges resulting from enormous volume of traffic, the high volume of data, the need to encrypt such data, the need to run in virtualized environment, which by itself is a challenge for the server CPU, and the need to include switching within the server for high efficiency SDN. We anticipate the demand for add-on adapters which address these challenges will grow. Power, heat and space limitations in such environments increase the need for hardware accelerators. Such systems will require essential building blocks in their own generic severs, which can be served by our products.

 

While we believe that we address the above needs with a comprehensive suite of products, many factors may affect the market acceptance of cloud-based and cloud-focused solutions, the achievement of Design Wins relating to such solutions, the consummation of Design Wins achieved by us and/or the acceptance of products incorporated into such solutions. Some of these factors include the possibility of seeing a reduction in the number of physical servers and appliances required by the providers of cloud based or virtualized solutions, or the evolving of different architecture designs which provide for functionality which our products offer without the need for our products. These factors may also affect our ability to accurately predict the anticipated revenues which may be generated under any such Design Win, our growth potential in the Cloud, our operations, including our inventory levels, and our financial results.

 

In addition, we believe that market's demand for our products and solutions in the Cloud demonstrates that the ongoing industry transition to the Cloud continues to represent a fast-growing opportunity for us. Nonetheless, if significant organizations providing Cloud based solutions or other virtualized networks do not perceive the benefits of our cloud-focused and/or virtualized network based solutions, or if our competitors or new market entrants are able to develop solutions for this market that do not require products such as ours, or offer features that are, or are perceived to be, more effective than our solutions, this would have a material adverse effect on our ability to achieve and/or consummate Design Wins, on our business, and on our results of operations and financial condition.

 

The market for Edge Networking Devices to Telcos and service providers for NFV or SD-WAN deployments is rapidly developing, and if it develops in ways that are different from what we anticipate or expect, our business could be harmed.

 

Recently, with the evolution of the NFV and SD-WAN, most Telcos and service providers have begun seeking for solutions which utilize CPEs for the deployment of SD-WAN or other applications within an NFV architecture. We believe that our CPE products address the requirements of such Telcos and service providers' needs and requirements, and in recent years we secured several Design Wins for such products.

 

While we believe that we address the above needs with a comprehensive suite of products, many factors may affect the market acceptance of such solutions and our ability to secure Design Wins and/or awards in this market. Some of these factors include our relatively limited experience in transacting with such Telcos and service providers, the possible offering of a wider selection of products by some of our competitors, or the possible offering by our competitors of products which include wider, better suited or more advanced features than the ones included in our products, development of technologies with which our current products may not be compatible, and the price expectations of such Telcos and service providers which may require us to offer our products for lower prices in order to better position ourselves in the market, or remain competitive, thus leading to lower gross profit, which in turn may have an adverse effect on our financial results.

 

We believe that the market's demand for our products and solutions in the NFV and SD-WAN era demonstrate that the Telcos' and service providers' related industry is transitioning into CPEs which represent a fast growing opportunity for us. Nonetheless, if such Telcos and service providers do not perceive the benefits of our Edge Networking CPEs, or if our competitors or new market entrants are able to develop solutions for this market that are better suited to the market demand, offer their solutions at lower prices, or offer features that are, or are perceived to be, more effective than ours, this would have a material adverse effect on our business, results of operations and financial condition.

 

The market for Infrastructure Deployment of 4G/5G Distributed Units and UPF acceleration with the Telcos and Mobile operators is rapidly developing, and if it develops in ways that are different from what we anticipate or expect, our business could be harmed.

 

Recently, with the evolution of O-RAN, most Telcos have begun seeking solutions that are compliant with the Disaggregation and Decoupling trends, especially in the Distributed Units market and with respect to UPF acceleration, where, in both cases, solutions are required which are stand alone and not a part of a comprehensive solution.

 

While we believe that we address the above needs with a comprehensive suite of products, many factors may affect the market acceptance of such solutions and our ability to secure Design Wins and/or awards in this market. Some of these factors include our limited experience in transacting with such mobile operators, the possible offering of a wider selection of products by some of our competitors, or the possible offering by our competitors of products which include wider, better suited or more advanced features than those included in our products, development of technologies with which our current products may not be compatible, and the price expectations of such Telcos and Mobile operators which may require us to offer our products at lower prices in order to better position ourselves in the market, or remain competitive, thus leading to lower gross profit, which in turn may have an adverse effect on our financial results.

 

We believe that the market's demand for our products and solutions in the infrastructure deployment for 4G/5G Distributed Units and UPF acceleration demonstrates a transition by the Telcos and related industry into O-RAN, which represents a fast-growing opportunity for us. Nonetheless, if such Telcos do not perceive the benefits of our offering to the market, or if our competitors or new market entrants are able to develop solutions for this market that are better suited to the market demand, offer their solutions at lower prices, or offer features that are, or are perceived to be, more effective than ours, this would have a material adverse effect on our business, including the results of operations and our financial condition.

 

Rapid development of our business in the Cloud-based, Telco and service providers' markets may require us to offer our potential customers with longer payment terms in order to better position ourselves in these markets, to hold higher inventory levels and to increase our need for working capital significantly.

 

Rapid development of our business in the Cloud-based, Telco, and service providers' markets, which we consider major sources of growth in the future, may require us to offer longer payment terms to our targeted customers in the Cloud, Telco and service providers markets as customary in these markets, in order to establish and maintain relationships with such targeted customers and strengthen our competitive position in such markets. In addition, we may be required by such customers to hold higher inventory levels in order to meet their expectations for on-demand deliveries, making the higher available inventory pivotal to our ability to position ourselves and compete in such markets. These factors may significantly increase our need for working capital in order to support our activities in these markets.

 

Our networking and data infrastructure solution products which are targeted by us mainly to customers in the OEM, Cloud, Telco, Mobile and related service providers' markets, are characterized by long sales cycles.

 

We target and sell our networking and data infrastructure solution products to customers mainly in the original equipment manufacturing ("OEMs"), Cloud, Telco, Mobile and related service providers' markets. We usually sell our products to such customers after achieving Design Wins, which are secured after a process which ends with the implementation of our products in our customers' systems or their deployment within the relevant customer's network. Securing Design Wins is a lengthy, time-consuming process, which involves the decision making process of our customers, which usually includes several time consuming processes as well, resulting from the critical importance of our products in our customers' systems or networks. Our customers usually need to define the required configuration of their server system, appliance or network, define the needed solution and the type of products that will address their need, evaluate our products, test and qualify our products for their use and then (or in parallel) negotiate the terms for a purchase. This process is lengthy and may result in investing twelve months or more from the time we first contact a prospective customer before such customer implements our products in its system, appliance or network, constituting what is known as a Design Win. Additionally, once a Design Win for one of our products is secured, our sales of these products typically involve significant capital investment decisions by the customer or its prospective end customers, as well as a significant amount of time to educate such end customers as to the benefits of systems and appliances that include our products. As a result, before initiating the deployment of our products within their infrastructure, and before purchasing systems and appliances, which include our products (and consequently facilitating sales of our products), our potential customers usually invest a substantial amount of time performing internal reviews and obtaining capital expenditure approvals, thereby lengthening the period of time required for a Design Win to mature into consistent sales. These long sale cycles make it difficult to predict when and to what extent, discussions with potential customers will materialize into sales and could cause our revenue and operating results to fluctuate widely from period to period. These long sale cycles may be especially exacerbated due to the spread of Covid-19, as detailed above. In addition, once a Design Win has been secured, the ramp-up of sales under the Design Win is dependent on various factors which are not under our control. This introduces uncertainty as to our ability to accurately predict the ramp-up of sales of our products, may result in significant quarterly, or even annual, fluctuations in the sale rates of our products and may have an adverse effect on our backlog, actual sales and results of operation.

 

Furthermore, we are required to allocate significant resources in order to compete for the achievement of Design Wins. Since there is no guarantee that we will be successful in achieving such Design Wins or that secured Design Wins will materialize into consistent sales in the competitive and rapidly evolving market in which we operate, unsuccessful efforts to secure or materialize Design Wins may lead to substantial increases in our expenditures, divert the attention of our sales force and management from other business opportunities, and could ultimately have a material adverse effect on our business, results of operations and financial condition.

 

The loss of Design Wins from customers in the Cloud, Telco, Mobile and related service providers' markets may result in significant quarterly and even annual fluctuations in our revenues.

 

The Cloud, Telco, Mobile and related service providers' markets constitute major sources of growth. We anticipate that Design Wins secured from customers in these markets would be significantly larger in size than our Design Wins from other customers. In light of the risk factors related to our operations in the Cloud, Telco, Mobile and related service providers' markets as detailed elsewhere in this Annual Report, we may experience losses of Design Wins in such markets, for which we may not be able to compensate in a timely manner. The losses of such Design Wins may result in significant quarterly or even annual fluctuations in our revenues and results of operations.

 

Rapid development of our business in the Cloud, Telco, Mobile and related service providers' markets may lead to a decrease in our gross margins which may result in a decrease in our profitability.

 

Rapid development of our business in the Cloud, Telco, Mobile and related service providers' markets, and our increasing operations and efforts in these markets, require us to adopt a lower gross margin strategy relative to our gross margins in past years, in order to take advantage of increased revenue potential and opportunities in these markets. While in the past we were able to increase our profitability while operating under such lower gross margins, there can be no assurance that we will be able to maintain or increase our profitability and/or earnings per share in the future and we may not be successful in maintaining or increasing our profitability and/or earnings per share while operating under such lower gross margins in the future.

 

 

The rapid development of the Cloud, Telco, Mobile and related service providers' markets may lead some of the players in these markets to explore different technologies in the course of their internal development process. Even if we secure Design Wins with some of these players, there is no guarantee that such players will ultimately decide to develop or commercialize their products for which our solutions were selected, for reasons which are not related to us and which are not under our control. If such players decide to pursue other paths than the ones for which we secured Design Wins, we may be unable to consummate such Design Wins, which may lead to excess inventory levels and write-offs, that may increase our costs. These factors may increase our operational efforts and expenses. We may also be required to find alternative use for any unused inventory relating to such Design Wins, and if we are unable to find such alternative use or sell such inventory to other customers, we may experience write-offs. All of these factors may have a material adverse effect on our financial condition and results of operation. While we focus our efforts on securing Design Wins in these markets, our share price may decline as a result of cancellation of such Design Wins in these markets, if they occur.

 

A loss of a material Design Win may lead to a decrease in the volume of orders placed in relation to such Design Win by a few of our customers, which would be harmful for our business and impair our financial results.

 

In some cases, one of our Design Wins may lead to the placement of purchase orders for our products by several of our customers for the purpose of integrating our products into other systems, as part of the assembly process relating to the said Design Win. The loss of such material Design Win may lead to a decrease in the purchase orders placed by such customers, impair our revenues generated from such customers and have a material adverse effect on our business and financial results.

 

Difficulties in the fulfillment of financial obligations of one or more of our customers may have an adverse effect on our ability to consummate the collection of consideration payable under purchase orders placed by, or invoiced to, such customers under one or more Design Wins in relation to which such customers operate.

 

Certain customers may become significant to us. In some cases, a customer will place orders for our products under several Design Wins for the purpose of integrating our products into other systems. In other cases, a customer, especially, but not limited to, those active in the Cloud, Telco, Mobile and related markets, will place very significant orders for a single Design Win with us. Difficulties in the fulfillment of such customers' financial obligations towards us may expose us to credit risks, may have a material adverse effect on our business, including on our ability to consummate the collection of consideration payable by, or invoiced to, such customer in connection with the Design Wins under which such customer placed orders, may lead to financial losses, may increase our collection expenses, may lead to excess inventory levels, may lead to significant write-offs, may cause legal disputes, may delay the consummation of the relevant Design Win and may ultimately lead to the reduction in the volume of orders placed under such Design Win, or even lead to the cancellation thereof. This may have a material adverse effect on our business, financial condition, and results.

 

We may not be successful in achieving and consummating Design Wins for our products for the Cloud, Telco, Mobile and the service providers markets, which constitute a main source of growth.

 

Our ability to achieve Design Wins for our products for the Cloud, Telco, Mobile and related service providers' markets, and to consummate the sales of our products under Design Wins achieved, is dependent on a large number of factors, many of which are out of our control. These factors include the highly competitive nature of the markets in which we operate, including the Cloud, Telco, Mobile and service providers' markets, the long sale cycles of our products to our OEMs, Cloud, Telco and Mobile customers, as well as other factors detailed in this Item 3.D. In addition, the loss, ineffectiveness or inability to maintain our customer relationships or our inability to develop new customer relationships, especially due to limitations on travel and meetings, which are still imposed from time to time, and the general disruption of our business by external factors such as the Covid virus, may have an adverse effect on our ability to achieve, secure or consummate Design Wins for our Cloud, Telco, Mobile and service providers' related products.

 

Significant growth in markets demanding functionality similar to the functionality offered by certain of our products may cause manufacturers to integrate such characteristics into server motherboards or increase the market share of servers and appliances that already have such functionality in-built, eliminating the need for our products.

 

A significant portion of our products are add-on adapters that are added to existing servers in order to improve their functionality. If demand for improved functionality similar to that of our add-on adapters increases significantly, server manufacturers may begin incorporating such functionality as a part of the basic design of their servers, thereby eliminating the need to achieve such functionality through add-on adapters. Furthermore, the market-share of special purpose servers and appliances that already have such functionality built-in may increase, consequently reducing the market share of solutions based on servers with add-on adapters. We cannot provide assurance that such a trend will not occur in connection with our add-on adapters or any of our other products. Such a trend would have a material adverse effect on our business, results of operations and financial condition.

 

Our customers may replace the servers and appliances they currently use, use or sell servers and appliances that do not require our cards, and/or incorporate cards other than ours.

 

Many of our customers that use and/or sell servers and appliances which include our cards do so for a few years, and then consider migration to a newer generation. We cannot guarantee that our cards will be needed or selected for such new generation or compatible with it. A decision by a current customer to select a new server and/or appliance without including our cards in such new server and/or appliance may have a significant adverse effect on our results of operations and financial condition.

 

We may experience difficulty in developing solutions for servers and appliances with proprietary interfaces, which may be used by some of our potential customers.

 

The market for networking and data infrastructure includes servers and appliances that make use of proprietary interfaces. These servers and appliances are offered to our potential customers in addition to the customary servers and appliances which use standard interfaces. Our potential customers may decide to use servers and appliances with such proprietary interfaces instead of the customary standard interfaces for which several manufacturers may provide add-on cards. There can be no assurance that we would be able to develop non-standard add-on cards for servers and appliances with proprietary interfaces or, if we are successful in developing such cards, that manufacturers of the proprietary interfaces or the customers electing to use these interfaces will make use of our cards in such non-standard environments.

 

The short lead time of customer orders combined with the long lead time of our suppliers when ordering certain components for our products could result in either a surplus or lack of sufficient supplies and may negatively impact on our financial results.

 

While we are generally required to fill orders for our products within one or two weeks following the receipt of a firm purchase order, we are usually required to place orders of certain components for our products within sixteen to twenty weeks prior to delivery, and more recently, in many cases, even earlier, where the global supply chains are affected by the external disruptions detailed above. As a result, we must have a significant amount of components in our inventory to be able to meet our best forecasts of projected purchase orders as opposed to on the basis of firm purchase orders. In the event that firm purchase orders are significantly lower than such forecasts, a significant part of our inventory will not be used and we may be unable to adjust costs in a timely manner to compensate for revenue shortfalls and in the event that firm purchase orders exceed such forecasts, we will not be able to fulfill such purchase orders which may lead to the loss of business from a customer.

 

Risks Related to Operations in Israel and Internationally

 

 

Our production facilities have been granted "Approved Enterprise" or "Benefited Enterprise" or "Preferred Enterprise" status in past years and we currently report as a "Preferred Technological Enterprise", under the Encouragement of Capital Investments Law, and as such, we are entitled to certain tax benefits. In order to be eligible for these tax benefits, we must meet certain conditions. If we fail to meet these conditions in the future, the tax benefits could be reduced or canceled. These tax benefits may not be continued in the future at their current levels, or at any level. The termination or reduction of these benefits may increase our income tax expense in the future. To the best of our knowledge, to date we have met the conditions for benefits under our "Preferred Technological Enterprise" status in all material respects. There can be no assurance, however, that we will continue to meet such conditions in the future. If these tax benefits are reduced, cancelled, or discontinued, our Israeli taxable income would be subject to "regular" Israeli corporate tax rate. In December 2016, the regular tax rate in Israel was reduced to 24% in 2017 and to 23% as from 2018 and thereafter. See "Item 10 – Additional Information – Taxation – the Encouragement of Capital Investments Law, 1959" for more information about our "Preferred Technological Enterprise" status.

 

The government programs and benefits, which we previously received, require us to meet several conditions in order to transfer intellectual property and know-how developed using government funding abroad, or in order to consummate a change of control.

 

We received grants from the Government of Israel through programs with the Office of the Chief Scientist of the Israeli Ministry of Economy and Industry (known as the Israel Innovation Authority, or the "IIA")to the Israeli Law for the Encouragement of Industrial Research, Development and Technological Innovation, 1984, and related regulations (the "R&D Law").

 

The R&D Law and the IIA impose certain limitations with respect to transfer of manufacturing rights and know-how, as well as to change of control in companies which receive government funding from the IIA. Under the IIA rules, the IIA needs to be notified of any offering and the IIA grants and attendant restrictions need to be disclosed in any applicable prospectus. Companies which received governmental funding from the IIA are also subject to increased payment obligations with respect to outsourcing or transferring development or manufacturing activities with respect to any product or technology developed using IIA funding outside of Israel, which may impair our ability to sell such technology assets outside of Israel or to outsource, transfer development, or manufacturing activities with respect to any such product or technology outside of Israel, or impose difficulties in consummation of a change of control in the Company.

 

The political environment and hostilities in Israel could harm our business.

 

Since the establishment of the State of Israel in 1948, a state of hostility has existed between Israel and the Arab countries in the region. This state of hostility has varied in degree and intensity over time. There has also been conflict and unrest between Israel, the Palestinian Authority and certain terrorist groups operating within the Palestinian Authority and Lebanon.

 

Also, Israel has been engaged, from time to time, in armed conflicts with Hamas. These conflicts involve missile strikes against civilian targets in the southern and northern parts of Israel and have also involved such missile strikes against central parts of Israel, most recently in April 2023. All of the above raise a concern as to the stability in the region, which may affect the political and security situation in Israel and therefore could adversely affect our business, financial condition and results of operations.

 

Civil unrest and political turbulence have occurred in many other countries in the region, including those which share a common border with Israel, and is affecting the political stability of those countries. This instability and any intervention may lead to deterioration of the political and economic relationships that exist between the State of Israel and some of these countries, and may have the potential for additional conflicts in the region. 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 the region, such as Hamas in Gaza, and Hezbollah in Lebanon. Iran is known to support the government of Syria in its battles against various rebel militia groups in Syria.

 

Any future armed conflict, political instability, continued violence in the region or restrictions could have a material adverse effect on our business, operating results and financial condition. While such hostilities did not in the past have a material adverse impact on our business, we cannot guarantee that hostilities will not be renewed and have such an effect in the future. The political and security situation in Israel may result in parties with whom we have contracts claiming that they are not obligated to perform their commitments under those agreements pursuant to force majeure provisions.

 

Any hostilities involving Israel or the interruption or curtailment of trade between Israel and its present trading partners could adversely affect our operations and could make it more difficult for us to raise capital or obtain components used in our products. Since many of our facilities are located in Israel, we could experience serious disruptions if acts associated with this conflict result in any serious damage to our facilities. Any insurance coverage we may have may not adequately compensate us for losses that may occur and any losses or damages incurred by us could have a material adverse effect on our business. Any future armed conflict or political instability in the region could negatively affect business conditions and harm our results of operations.

 

 Furthermore, several countries still restrict trade with Israeli companies and additional countries may impose such restrictions as a result of changes in the military and/or political conditions in Israel and/or the surrounding countries, which may limit our ability to make sales in, or purchase components from, those countries. In addition, such boycott, restrictive laws, policies, or practices may change over time in unpredictable ways, and could, individually or in the aggregate, have a material adverse effect on our business in the future. Should the BDS Movement, the movement for boycotting, divesting and sanctioning Israel and Israeli institutions (including universities) and products become increasingly influential in the United States, Europe and around the world, this may also adversely affect our business and financial condition.

 

Since early 2023, the current Israeli government has pursued radical reform to Israel’s judicial system. In response to such developments, Israel has seen mass civilian protests and individuals, organizations, and financial institutions, both within and outside of Israel, have voiced concerns that the proposed changes may negatively impact the business environment in Israel. Such proposed changes may also adversely affect the labor market in Israel or lead to political instability, or civil unrest. To the extent that any of these negative developments do occur, they may have an adverse effect on our business, our results of operations and our ability to raise additional funds, if deemed necessary by our management and board of directors, and to attract or retain qualified and skilled “talents” and personnel. We can give no assurance that the political, economic and security situation in Israel will not have a material adverse impact on our business in the future.

 

All non-exempt male adult citizens and permanent residents of Israel under the age of 40, or older for reserves officers or citizens with certain occupations, as well as certain female adult citizens and permanent residents of Israel, are obligated to perform military reserve duty and may be called to active duty under emergency circumstances. In recent years, there have been significant call-ups of military reservists, and it is possible that there will be additional call-ups in the future. While we have operated effectively despite these conditions in the past, we cannot assess what impact these conditions may have in the future, particularly if emergency circumstances arise. 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 our other employees due to military service. Any disruption in our operations would harm our business.

 

Exchange rate fluctuations and international risks could increase the cost of our operations.

 

Israeli courts might not enforce judgments rendered outside of Israel.

 

We are incorporated in Israel. All of our executive officers and directors are non-residents of the United States, and a substantial portion of our assets and the assets of these persons are located outside the United States. Therefore, it may be difficult to enforce a judgment obtained in the United States against us or any such persons. It may also be difficult to enforce civil liabilities under U.S. federal securities laws in original actions instituted in Israel. However, subject to certain time limitations, Israeli courts may enforce U.S. final executory judgments for liquidated amounts in civil matters obtained after due trial before a court of competent jurisdiction (according to the rules of private international law currently prevailing in Israel) which enforces similar Israeli judgments, provided that the requisite procedural and legal requirements are adhered to.

 

If a foreign judgment is enforced by an Israeli court, it generally will be payable in NIS, which can then be converted into foreign currency at the rate of exchange of such foreign currency on the date of payment. Pending collection, the amount of the judgment of an Israeli court stated in NIS (without any linkage to a foreign currency) ordinarily will be linked to the Israeli consumer price index plus interest at the annual statutory rate prevailing at such time. Judgment creditors bear the risk of unfavorable exchange rates.

We may experience a decline in our share price, including during periods of uncertainty in global economic conditions, and there is no guarantee that our share price will remain stable or not decline.

 

In the past, our share price has declined, including during periods of uncertainty in global economic conditions, and we may be affected by, among others, the current downturn in economic conditions. We cannot assure you that our share price will remain stable or not decline in the future.

 

We may not be able to distribute dividends in the future.

 

On January 14, 2013, we announced a dividend policy for distributing up to 50% of our annual distributable profits as a dividend. As part of the stated dividend policy the Company's Board of Directors reserved the right to declare additional dividend distributions, to change the rate of dividend distributions (either as a policy or on a one-time basis), to cancel a specific distribution or to cancel the policy as a whole at any time, at its sole discretion. On March 15, 2018, our Board of Directors adopted a resolution to suspend until further notice the said dividend policy.

 

Our ability to distribute dividends in the future may be adversely affected by the risk factors described in this report. Any dividend will depend on our earnings, capital requirements, financial condition and other business and economic factors affecting us at the time as our board of directors may consider relevant. Our ability to pay cash dividends may be restricted by instruments governing any of our obligations. We are restricted by Israeli law to pay dividends in any fiscal year only out of "profits", as defined by the Companies Law, unless otherwise authorized by an Israeli court, and provided that the distribution is not reasonably expected to impair our ability to fulfill our outstanding and expected obligations. There is no assurance that we will be able to pay dividends or increase our payment of dividends in the future, nor is there any assurance that our Board of Directors will not further change or cancel our dividend policy in the future. If we are unable to pay dividends at levels anticipated by investors in our shares, the market price of our shares may be negatively affected and the value of our shareholders' investment may be reduced. See "Item 8.A. – Consolidated Statements and Other Financial Information", under the caption "A8. – Dividend Policy" for additional information regarding the payment of dividends.

 

The trading volume of our shares has been low in the past and may be low in the future, resulting in lower than expected market prices for our shares.

 

Our shares have been traded at low volumes in the past and may be traded at low volumes in the future for reasons related or unrelated to our performance. This low trading volume may result in lower than expected market prices for our ordinary shares and our shareholders may not be able to resell their shares for prices equal to or higher than the price for which they were purchased.

 

If we are characterized as a passive foreign investment company for U.S. federal income tax purposes, our U.S. shareholders may suffer adverse tax consequences.

 

We will be a passive foreign investment company, or PFIC, if 75% or more of our gross income in a taxable year, including our pro-rata share of the gross income of any company, U.S. or foreign, in which we are considered to own, directly or indirectly, 25% or more of the shares by value, is passive income. Alternatively, we will be considered a PFIC if at least 50% of our assets in a taxable year, averaged over the year and ordinarily determined based on fair market value and including our pro-rata share of the assets of any company in which we are considered to own, directly or indirectly, 25% or more of the shares by value, are held for the production of, or produce, passive income. If we were to be a PFIC, and a U.S. Holder does not make an election to treat us as a "qualified electing fund", or QEF, or a "mark-to-market" election, "excess distributions" to a U.S. Holder, and any gain recognized by a U.S. Holder on a disposition or our ordinary shares, would be taxed in an unfavorable way. Among other consequences, our dividends, to the extent that they constitute "excess distributions", would be taxed at the regular rates applicable to ordinary income, rather than the 20% maximum rate applicable to certain dividends received by an individual from a "qualified foreign corporation", and certain "interest" charges may apply. In addition, gains on the sale of our shares would be treated in the same way as excess distributions. The tests for determining PFIC status are applied annually and it is difficult to make accurate predictions of future income and assets, which are relevant to the determination of PFIC status. In addition, under the applicable statutory and regulatory provisions, it is unclear whether we would be permitted to use a gross loss from sales (sales less cost of goods sold) to offset our passive income in the calculation of gross income.

 

As a result of our substantial cash position, if the value of our shares declines, there is a substantial risk that we will be classified as a PFIC under the asset test described above. There can be no assurance that we will not be classified as a PFIC by the U.S. Internal Revenue Service. In light of the uncertainties described above, no assurance can be given that we will not be a PFIC in any year. A U.S. Holder who makes a QEF election is taxed currently on such holder's proportionate share of our earnings, including both ordinary income and net capital gain. If the IRS determines that we are a PFIC for a year with respect to which we have determined that we were not a PFIC, however, it might be too late for a U.S. Holder to make a timely QEF election, unless the U.S. Holder qualifies under the applicable Treasury regulations to make a retroactive (late) election. U.S. Holders who hold ordinary shares during a period when we are a PFIC will be subject to the foregoing rules, even if we cease to be a PFIC, subject to exceptions for U.S. Holders who made a timely QEF or mark-to-market election, or certain other elections. We do not currently intend to prepare or provide the information that would enable you to make a Qualified Electing Fund election. Accordingly, our shareholders are urged to consult their tax advisors regarding the application of PFIC rules.

 

Our business may be adversely impacted by risks arising from a widespread outbreak of an illness or any other communicable disease, or any public perception of the risks, related to a pandemic or other health crisis, similar to the COVID-19 pandemic.

 

Over three years after the World Health Organization declared COVID-19 a pandemic, COVID-19 and its variants have caused and may continue to cause waves of increased infections which may adversely impact economic activity. The extent to which a pandemic may ultimately impact our business will depend on future developments, which are highly uncertain and cannot be predicted, such as the geographical spread, duration of the outbreak, and the effectiveness of actions taken in Israel, the United States and other countries, to contain and treat the disease and address its impact. We, our suppliers and other business partners may experience significant impairment of business activities due to operational shutdowns or suspensions that may be requested or mandated by national or local governmental authorities or self-imposed by us, our suppliers or other business partners. We cannot predict whether, for how long, or the extent to which a pandemic and pandemic containment efforts may disrupt our supply chain and/or operations. 

 

We may be affected by global economic trends such as recession, rising inflation, rising interest rates, economic slowdown, etc.

 

       Recent inflation, geopolitical issues, increase in energy costs, increases in interest rates, unstable global conditions and changes in currency exchange rates have led to global economic instability. Such changes, and their impact on the global macro-economic environment, may adversely affect our business, operating results, and financial condition.

Customers and potential customers are increasingly using ESG screening criteria in making their business decisions, to provide information relating to our environmental, social and governance, or ESG, practices. Our failure, or perceived failure, to pursue or fulfill ESG goals, targets and objectives, or to satisfy various ESG reporting standards, may harm our reputation, impact our relationships with our customers and could adversely affect our business.

 

Additionally, as ESG best practices, reporting standards and disclosure requirements continue to develop, we may incur increasing costs related to ESG monitoring and reporting.

 

Loss of our sources for certain key components could harm our operations.

 

Although we generally use standard parts and components for our products, certain key components used in our products are currently available from only one source, and others are available from a limited number of sources, on which we depend. Nevertheless, we believe that we maintain a sufficient inventory of these components to protect against delays in deliveries. However, we cannot guarantee that we will not experience delays in the supply of critical components in the future or that we will have a sufficient inventory of critical components at such time to produce products at full capacity, especially due to disruptions to global supply chains, including those related to certain critical components relating to the production of our products, as detailed above. For example, a key component in many of our cards is manufactured by Intel. While we have not encountered difficulties in purchasing such components from Intel's distributors, we cannot guarantee that we will continue to be able to purchase such components without delays or at reasonable prices. In the event that we are not able to purchase key components from our limited sources, or can only purchase these key components under unreasonable terms, we may need to redesign certain products. We cannot guarantee that we will have adequate resources for such a redesign or that such a redesign will be successful. Such inability to obtain alternative resources or to successfully redesign our products could have a material adverse effect on our business, results of operations, and financial condition.

 

The markets for our products change rapidly and demand for new products is difficult to predict and may affect our ability to commercialize our solutions.

 

The markets for our products are characterized by rapidly changing technology and evolving industry standards. For example, the migration to higher line rate Ethernet solutions, the adaptation of new bus interfaces and increased use of emerging technologies such as Cloud, Virtualization, NFV, SD-WAN, 5G and O-RAN, cause some of our customers to demand such new products and technologies. In the event that such customers decide to begin using new technologies, we may not be able to develop products for the new technologies in a timely manner. Such customers may also select competing products despite our ability to develop products incorporating new technologies. For example, with the shift towards running applications in the Cloud we anticipate that the demand will grow for add-on adapters and products which address the challenges presented by the Cloud, such as a switch in every server, hardware acceleration, power, heat and space limitations in such environments, which increase the need for essential building blocks in generic servers, which can potentially be served by our products. Another example is related to the NFV, SD-WAN, O-RAN and 5G market sectors, in which our CPE/EDGE (as defined below), as well as our networking, offloading and acceleration related FPGA solutions may have significant demand. While we have announced the securing of several Design Wins relating to such aforementioned solutions, there is no assurance that our customers will continue to buy such solutions from us or that we will be able to generate significant sales in these areas in the long run. If we do not generate significant sales in these areas we may accumulate unusable inventory which can be used only with older technologies. We intend to continue investing in product and technology development. Although we expect growing sales in our new market segments, there can be no assurance that we will continue to be successful in the marketing of our current products and in developing, manufacturing and marketing enhanced and new products in a timely manner. Any decrease in the price of, or demand for, any of our products or solutions could have a material adverse effect on our business, results of operations and financial condition.

 

The market for our products is highly competitive and some of our competitors may be better positioned than us.

 

The market for our products is highly competitive. We face competition from numerous companies, some of whom are more established, benefit from greater market recognition and have greater financial, production and marketing resources than we do. For example, as further detailed in "Item 4.B – Business Overview – Competition", with respect to Server Adapters, our main competitors are Nvidia, Intel, and Broadcom. However, we believe these companies are targeting mostly major accounts and we believe rarely offer customized solutions, while we target accounts of all sizes, with a broader product offering and with various interfaces and form factors. Consequently, we believe that we only overlap with these companies' offerings in a small part of our target markets.

 

In the Smart Cards products sector, our competition is fragmented and differs with respect to the specific solution being offered by us. In this sector, Marvel, Nvidia, Netronome, Napatech, Molex, Lanner and Caswell compete with certain of our Smart Cards. In some cases of FPGA based cards, Intel and AMD also compete with our Smart Cards, however, similarly to the Server Adapters space, they target mostly the biggest accounts and only with mainstream products, while for other accounts they cooperate with us.

 

In the Smart Platforms products sector, our main competitors are Caswell, Lanner, Advantech and Nexcom.

 

There may be other solutions which might also compete with our other products. We cannot guarantee that our present or contemplated products will continue to be distinguishable from those of our competitors or that the marketplace will find our products preferable to those of our competitors. Furthermore, there can be no assurance that competitive pressures will not result in price reductions that could materially adversely affect our business, results of our operations and financial condition.

 

We may need to invest significantly in research and development and business development in order to diversify our product offering and enter new markets.

 

Most of our revenues are generated from the sale of our networking and data infrastructure solution products. The technology industry in which we operate is characterized by rapid technological changes, frequent new product introductions, changes in customer requirements and evolving industry standards. While these changes could lead to a reduction in the demand for our existing products, they could also create an opportunity for us to expand our product offering to our existing customers and to new customers. Accordingly, our future success may depend on our ability to diversify our product offering and enter new markets, which could involve numerous risks, including:

 

 

 

 

There can be no assurance that we will be able to successfully complete the development and market introduction of new products and no assurance that we will be able to successfully enter new markets. This could have a material adverse effect on our business, results of operations and financial condition.

 

We may experience difficulty in developing new and commercially successful products at acceptable release times.

 

We conduct extensive research, development and engineering activities. Our efforts emphasize our view of the importance of and the need for the development of new products, cost reduction of current products, and enhancement of existing products in response to rapidly changing customer preferences, technologies, and industry standards. We cannot guarantee the continued success of our efforts, or that our products will continue to be widely accepted by the marketplace or that any of our ongoing development efforts will result in other commercially successful products, that such products will be released in a timely manner or at a competitive price, or that we will be able to respond effectively to technological changes or new product announcements by others. Additionally, this may be exacerbated due to the spread of Covid-19, as detailed above, due to some of our employees being infected or quarantined along with any periodically imposed lockdowns and travel limitations. Such difficulties along with a material delay in our ability to release new products, may have a material adverse effect on our business, results of operations and financial condition.

 

Our short lead time of customer orders introduces uncertainty into our revenues and severely limits our ability to accurately forecast future sales.

 

Our sales are made on the basis of purchase orders, which may be placed pursuant to Design Wins, rather than long-term purchase commitments. In addition, our customers may defer purchase orders. The short lead time for firm purchase orders introduces uncertainty into our revenue and production forecasts and business planning, and leads to our inability to accurately forecast future revenues from product sales. As a result, even dramatic fluctuation in revenue (whether an increase or decrease) might not be detected until the very end of a financial quarter, which may not enable us to monitor and mitigate costs in a timely manner in order to compensate for such fluctuation.

 

The fluctuations in components' lead time and price may adversely affect our business.

 

In recent years, the market for electronic components, which we typically use in our products, has been demonstrating fluctuations in lead time and prices. Such fluctuations are led by some of the world’s leading vendors for such components and there is a risk that such fluctuations will impact our ability to deliver products to our customers or to maintain our margins on such products, should they affect components for which we cannot find a replacement in a timely manner or at a competitive price, and this may have an adverse effect on our business. Delays in lead time and fluctuations in price, may be further exacerbated by the periodic effects of the Covid virus or other pandemics.

 

The decrease in demand for basic/standard server adapters may adversely affect our business.

 

Over the past few years, we have seen a gradual decrease in demand for our basic server adapters. There is a risk that the actual decrease in demand would be faster than that projected by us. In addition, in the case of a decrease in sales, we may accumulate unusable inventory. Any such decrease in the demand for our basic server adapters could have a material adverse effect on our business, results of operations and financial condition.

 

The possible cancellation and write-off of capitalized development projects may adversely affect our business.

 

Capitalized development projects may be cancelled and written-off due to a change in our strategy (such as that which occurred in 2020 where we aborted some efforts which did not match our focus strategy), or due to our being unsuccessful in the market, or to other related triggers. Such cancellations may result in a significant one-time adverse effect on our results of operation.

 

The loss of a significant customer may have a material adverse effect on us.

 

We depend on a small number of customers for our products. Our top 4 ultimate customers in 2022 accounted for approximately 33% of our revenues in 2022 (out of which our top ultimate customer accounted for approximately 15% of our revenues in 2022). We expect that a small number of customers will continue to account for a significant portion of our revenues for the foreseeable future. Loss or cancellation of business from, significant changes in deliveries to, or decreases in the prices of products sold to, one or more of our key customers has, in the past, significantly reduced our revenues for a reporting period and could, in the future, harm our business, margins, results of operations, and financial condition.

 

The loss or ineffectiveness of any of our key customer relationships or a reduction of purchase orders by such customers may have a material adverse effect on our operations and financial results.

 

Our sales and marketing strategy includes development and maintenance of strategic relationships with leading OEMs in the servers industry and server-based systems industry, as well as with leading Cloud, Telco and service provider customers, which integrate our products into their own systems, or deploy our products in their network. These customers are not within our control, are not obligated to purchase our products, and may select other products that may compete with our lines of products. A reduction in sales efforts or discontinuance of sales of our products by our OEM customers, and/or the reduction in or discontinuance of deployments by our Cloud, Telco, or service provider customers, could lead to reduced sales and could materially adversely affect our operating results. In addition, there is the risk that our customers would build up inventories in anticipation of a growth in sales or deployments. If such growth does not occur as anticipated, such customers may substantially decrease the number of products ordered in subsequent quarters or discontinue product orders. The termination or loss of either one or more of our key customer relationships at approximately the same time, without being able to compensate this loss with sales to other customers, may have a material adverse effect on our operations and financial results.

 

We are dependent on key personnel.

 

Our success has been, and will continue to be, dependent to a large degree on our ability to retain the services of key personnel and to attract additional qualified personnel in the future. Competition for such personnel is intense. There can be no assurance that we will be able to attract, assimilate, or retain key personnel in the future and our failure to do so would have a material adverse effect on our business, financial condition and results of operations.

 

We may not be able to prevent others from claiming that we have infringed their proprietary rights.

 

We cannot guarantee that one or more parties will not assert infringement claims against us. The cost of responding to claims could be significant, regardless of whether the claims have merit. Significant and protracted litigation may be necessary to determine the scope of the proprietary rights of others or to defend against claims of infringement, regardless of whether the claims have merit. Although we believe that all our products use only our intellectual property, or intellectual property which is properly licensed to us, and we are working to ensure that all our employees are properly assigning or licensing to us all rights to the intellectual property we use in our products on a regular basis, in the event that any infringement claim is brought against us and infringement is proven, we could be required to discontinue the use of the relevant technology, to cease the manufacture, use and sale of infringing products, to incur significant litigation damages, costs and expenses, to develop non-infringing technology or to obtain licenses to the alleged infringing technology and to pay royalties to use such licenses. There can be no assurance that we would be able to develop any such alternative technologies or obtain any such licenses on terms commercially acceptable to us.

 

Although in the past we have resolved a claim of infringement through a license agreement, the terms of which did not have a material effect on our business, any infringement claim or other litigation against us could seriously harm our business, operating results and financial condition. While there are no other lawsuits or other claims currently pending against us or our subsidiaries regarding the infringement of patents or intellectual property rights of others, we have been a party to such claims in the past and may be party to such claims in the future.

 

We may not be able to protect our intellectual proprietary rights.

 

Our success, ability to compete, and future revenue growth are dependent and will depend, in part, on our ability to protect our intellectual property. It is possible that competitors or other unauthorized third parties may obtain, copy, use, or disclose our technologies and processes. Any of our existing, acquired, or future patents or other rights to our intellectual property may be challenged, invalidated, or circumvented. If our intellectual property rights do not adequately protect our technology, our competitors may be able to offer products similar to ours.

 

In order to establish and protect the technology we use in our products, we primarily rely on a combination of non-disclosure agreements and technical measures, and to a lesser degree on patents. We enter into confidentiality arrangements with our employees, key consultants and other third parties with whom we conduct business. In addition, our employees and key consultants involved in the development of our technologies are required to sign non-compete and invention assignment agreements. We also control access to and distribution of our technologies, documentation and other proprietary information. Despite these efforts, internal or external parties may attempt to copy, disclose, obtain, or use our products, services, or technology without our authorization.

 

Despite perceived exclusive access to any intellectual property rights obtained via acquisition, and our best efforts during any such acquisition process to secure such rights, internal or external parties may attempt to copy, disclose, obtain, or use our products, services, or technology without our authorization, or others may assert infringement claims against us with respect to a product of ours which utilizes such acquired intellectual property rights.

 

We believe that the measures we take afford only limited protection, and accordingly, there can be no assurance that the steps we take will be adequate to prevent the challenging of our rights in our technology, or misappropriation of our technology or the independent development of similar technologies by others.

 

In addition, the process of seeking patent protection to our technology may take a long time and be expensive. We cannot assure that pending or future patent applications will result in the issuance of patents or that, if patents are issued, they will not be challenged, invalidated, or circumvented or that the rights granted under the patents will provide us with meaningful protection or any commercial advantage.

 

In addition, we cannot assure you that other countries in which we market our services and products will protect our intellectual property rights to the same extent as the United States. Effective intellectual property enforcement may be unavailable or limited in some countries. It may be difficult for us to protect our intellectual property from misuse or infringement by other companies in these countries. Our inability to enforce our intellectual property rights in some countries may harm our business and results of operations. Litigation, which could result in substantial costs to us and diversion of our resources, may also be necessary to enforce our patents or other intellectual property rights.

 

Further, we cannot assure you that we will at all times enforce our patents or other intellectual property rights or that courts will uphold our intellectual property rights, or enforce the contractual arrangements that we have entered into to protect our proprietary technology, which could reduce our opportunities to generate revenues. Our intellectual property assignment, confidentiality and non-competition agreements may not be enforceable and our proprietary technology may not remain a secret. Others may develop similar technology and use it to compete with us. Despite our efforts to protect our proprietary rights, former employees and other unauthorized parties may attempt to copy aspects of our products or obtain and use information that we regard as proprietary.

 

Inability to cooperate with and receive information from our key component manufacturers could affect our ability to develop new products required by our customers and by the industry in which we operate.

 

Our products are based on silicon which is mostly manufactured by Intel and a few other leading components manufacturers. In order to design our products, we need to receive information that enables us to design products with the use of such silicon. There can be no assurance that we will continue to receive all the information required for designing products with the use of new silicons continuously released by such manufacturers. The reduction in the level of cooperation with our manufacturers, including as a result of such manufacturers' decision to compete with our products, or our inability to obtain information from our manufacturers relating to their products used by us, may adversely affect our ability to develop new products required by customers and by the industry in which we operate.

 

Our investment portfolio may be impaired by disruptions in the financial and credit markets.

 

Our investment portfolio currently consists of corporate debt securities which the Company classified on December 31, 2022, as "held-to-maturity." As of December 31, 2022, we hold approximately US$ 19.2 million in corporate debt securities and government debt securities.

 

Due to possible significant disruptions in the financial and credit markets, the corporate debt securities in our portfolio are subject to a possible increased risk of default due to bankruptcy, lack of liquidity, operational failure, or other factors affecting the issuers of those securities. In addition, securities in our portfolio are subject to other risks, such as credit, liquidity, market and interest rate risks, which may be exacerbated by market disruptions, and which may impair the assets. We may be required to adjust the carrying value of our investment securities due to a default, lack of liquidity or other event. For that matter we are required to use of forward-looking information to calculate credit loss estimates

 

As of December 31, 2022, we were not required to adjust the carrying value of our investment securities. If we will experience such a loss, it will be recorded in our consolidated statement of operations which could materially adversely impact our consolidated results of operations and financial condition.

 

We may make acquisitions or pursue mergers that could disrupt our business and harm our financial condition.

 

As part of our business strategy, we have sought and may continue to seek to invest in or acquire other businesses, technologies, or assets, and we may enter into joint ventures or other strategic relationships with third parties.

 

We may assume liabilities, incur amortization expenses related to intangible assets, or realize large and immediate write-offs in connection with future acquisitions. In addition, the future valuation of these acquisitions may decrease from the market price paid by us, which may result in the writing-off or impairing, of the relevant assets. In addition, our operation of any acquired or merged businesses, technologies, or assets could involve numerous risks, including:

 

 

 

 

 

We cannot assure you that any acquisition or merger will be successful. If the operation of the business of any acquisition or merger disrupts our operations, our business may suffer. In addition, even if we successfully integrate the acquired business with our own, we may not receive the intended benefits of the acquisition.

 

We may be subject to risks associated with laws, regulations, economic sanctions and customer initiatives, including such that relate to the environment, conflict minerals, privacy or other issues, which may force us to incur additional expenses, may make our supply chain and operations more complex and may result in damage to our reputation with customers.

 

Our business, results of operations and financial condition could be adversely affected if new laws, regulations, or standards relating to our business and products, us or our employees (including labor laws and regulations) are implemented or existing laws, regulations or standards changed. Such laws and regulations include requirements in the United States, Europe, Israel and other territories, in relation to data privacy and protection, anti-bribery and anti-corruption, import and export, labor, tax and environmental and social issues. From time to time, we may also operate pursuant to specific authorizations of, and commitments towards, U.S., Israeli, E.U., or other governmental authorities and agencies. While we make every effort to comply with such requirements, we cannot assure you that we will be fully successful in our efforts, and that our business will not be harmed. Failure to comply with such laws, regulations, authorizations and commitments could result in fines, damages, civil liability and criminal sanctions against us, our officers and our employees, prohibitions on the conduct of our business and damage to our reputation.

 

The impact of the current war in Ukraine and sanctions on Russia and Belarus is unknown at this time. However, we may incur additional expenses, adverse effects on sales, or experience delays in our supply chain and operations as a result.

 

Such laws and regulations include the EU's General Data Protection Regulation ("GDPR") and the Dodd-Frank Wall Street Reform and Consumer Protection Act.

 

The GDPR provides that companies must comply with certain standards regarding the protection of the personal data or risk significant financial penalties. Regulations or interpretive positions may be enforced specifically with respect to the use of outsourced services, such as SaaS, hosting and cloud-based services. Compliance with such legislation and regulations may require that we invest in the modification of our operations to comply with such legislation and regulations, or subject ourselves to liability resulting from a breach of such regulations. Failure to comply with privacy legislation or procedures may cause us to incur civil liability to government agencies, customers, shareholders and individuals whose privacy may have been compromised.

 

The Dodd-Frank Wall Street Reform and Consumer Protection Act includes disclosure requirements regarding the use of "conflict" minerals mined from the Democratic Republic of Congo and adjoining countries ("DRC") and procedures regarding a manufacturer's efforts to prevent the sourcing of such "conflict" minerals. These requirements require companies to undertake due diligence, disclose and report whether or not such "conflict" minerals originate from the DRC. Because our supply chain is complex, we may face reputational challenges with our customers, shareholders and other stakeholders if we are unable to sufficiently verify the origins for the minerals used in our products. In such event, we may also face difficulties in satisfying customers who require that all of the components of our products are certified as conflict mineral free. For additional information see "Item 4 – Information on the Company – Business Overview."

 

We depend on governmental licenses for our exports.

 

Our international sales depend largely on export licenses from the government of Israel in relation to products which contain encryption capabilities, which we are currently required to hold. As of the date of this annual report, we have obtained all such licenses necessary to carry out our international sales. If we fail to obtain a material license in the future, or if a material license previously obtained is revoked or expires and is not renewed, our ability to sell our products to overseas customers could be interrupted, resulting in a material adverse effect on our business, results of operations and financial condition.

 

Significant disruptions of our information technology systems or breaches of our data security could adversely affect our business.

 

Although we have not, to date, been the victim of any cybersecurity incidents, a significant invasion, interruption, destruction, or breakdown of our information technology systems and/or infrastructure by persons with authorized or unauthorized access could negatively impact our business and operations. We are subject to laws and regulations governing the collection, use and transmission of personal information. As the legislative and regulatory landscape for data privacy and protection continues to evolve around the world, there has been an increasing focus on privacy and data protection issues that may affect our business, including the GDPR, and other laws and regulations governing the collection, use, disclosure and transmission of data. We could also experience business interruption, information theft, legal claims and liability, regulatory penalties and/or reputational damage from cyber-attacks, which may compromise our systems and lead to data leakage either internally or at our third party providers. Our systems may be the target of malware and other cyber-attacks. Although we have invested in measures to reduce these risks, we cannot assure you that these measures will be successful in preventing the compromise and/or disruption of our information technology systems and related data. Additionally, this may be exacerbated due to any new waves of Covid-19, where our employees are required to work from home and remotely access our IT networks.

 

We are affected by worldwide downturns in industries based on technology.

 

The volatility in the securities markets and its effect on high-technology companies may have a ripple effect on our performance. For example, we were affected by the downturn in the economic markets which began in 2008, posing a risk to industries based on technology as well as the overall economy. There can be no assurance that our results will not be affected on a going forward basis by any economic downturns, including the current downturn to the global economy relating to the spread of Covid-19.

 

General economic conditions may adversely affect the Company's results.

 

Uncertainty in global economic conditions, including any disruption in financial and credit markets, such as the current disruption to the global economy relating to the spread of Covid-19, pose a risk to the overall economy that could impact demand for our and our customers' products, as well as our ability to manage commercial relationships with our customers and suppliers. If the global economic situation worsens, our business could be negatively impacted, including such areas as reduced demand for our products and services, or supplier or customer disruptions, which could reduce our revenues or our ability to collect our accounts receivable and could have a material adverse effect on our financial condition and results of operations.

 

Principal capital expenditures and divestitures

 

On April 24, 2023, we issued a press release on form 6-K announcing that we secured two NIC Design Wins, one for an advanced encryption offload acceleration card, and the other for an FPGA-based SmartNIC, from a Tier 1, US-based cybersecurity vendor. Both Design Wins will be ramping up during the second half of 2023, and mass deployment will begin in 2024.

 

The loss of some of our customers, or any single key customer, may have a material adverse effect on our operations and financial results and we cannot assure you that we will be able to enter into strategic relationships with any such customer in the future. Payment terms of our customers are, on average, approximately 70 days net. Approximately 95% of our international sales are denominated in U.S. Dollars and may be subject to government controls and other risks, including, in some cases, export licenses, federal restrictions on export, currency fluctuations, political instability, trade restrictions and changes in tariffs and freight rates. We have experienced no material difficulties to date as a result of these factors.

 

General

 

Recent Accounting Pronouncements

 

Impact of Inflation and Currency Fluctuations on Results of Operations, Liabilities and Assets

 

 

In accordance with the Companies Law, the following table presents information regarding compensation actually received by our five most highly paid office holders during the year ended December 31, 2022. All amounts are in USD, based on the following components:

 

“Salary and Benefits” include annual salary or service fees paid, payments to the National Insurance Institute, manager’s insurance and pension funds, severance, advanced education funds, basic health insurance, vacation pay, recuperation pay, tax gross-up payments, automobile-related expenses, telephone expenses and benefits and perquisites as mandated by Israeli or applicable law.

 

“Cash Bonus” includes bonus payments as recorded in our financial statements for the year ended December 31, 2022.

 

“Equity-based Compensation” includes the expense recorded in our financial statements for the year ended December 31, 2022, with respect to equity-based compensation granted to the executive officers detailed above.

 

 

 

Liron Eizenman – President and CEO (*). Salary and Benefits $322,932; Cash Bonus $174,775; Equity-based Compensation $287,699.

 

 

David Castiel – VP Engineering. Salary and Benefits $270,020; Cash Bonus $35,123; Equity-based Compensation $103,360.

 

Compensation Package for Liron Eizenman, the Company's President and Chief Executive Officer

 

In June 2022, following the approval of the Company's Compensation Committee and Board of Directors, the Company's shareholders approved a compensation package for Liron Eizenman. The approved Compensation Package consists of (i) an amendment to Liron Eizenman's compensation structure and (ii) a severance agreement, identical to the previous CEO severance agreement. The principal terms of the compensation package, which commenced on July 1, 2022, are as follows:

 

In addition, at the June 2022 General Meeting, our shareholders approved a grant to Liron Eizenman of 50,000 Plan Options to purchase Ordinary Shares of the Company, pursuant to the Plan.

 

Item 8.

FINANCIAL INFORMATION

 

A.          Consolidated Statements and Other Financial Information

 

A1.         See Item 18 for our consolidated financial statements.

 

A2.         See Item 18 for our consolidated financial statements, which cover the last three financial years.

 

A3.         See page F-3 for the audit report of our accountants, entitled "Report of Independent Registered Public Accounting Firm."

 

A4.         Not applicable.

 

A5.         Not applicable.

 

A6.         See Note 13A to our audited consolidated financial statements included in Item 18 of this annual report for the geographic distribution of our sales based on the location of the customer.

 

A7.         Litigation

 

A8.         Dividend Policy

 

 B.          Significant Changes

 

On December 27, 2005, our shares commenced trading on the TASE in Israel under the symbol "SILC." On October 26, 2015, our Board of Directors resolved to act to delist the Company's shares from trading on the TASE. The last trading day in our shares on the TASE was January 26, 2016, and on January 28, 2016, our shares were delisted from trading on the TASE.

 

Item 10.

ADDITIONAL INFORMATION

 

A.           Share Capital

 

Not applicable.

 

B.           Memorandum and Articles of Association

 

Articles of Association

In general, a simple majority is required to amend our Articles of Association.

 

Pursuant to the Companies Law, resolutions regarding the following matters must be passed at a general meeting of shareholders:

 

An extraordinary general meeting may be convened by demand of two directors or by written request of one or more shareholders holding at least 5% of our issued share capital and 1% of the voting rights or one or more shareholders holding at least 5% of the voting rights. Shareholders requesting a special meeting must include in their request all relevant information, including the reason that such subject is proposed to be brought before the special meeting.

 

Our ordinary shares may generally be freely transferred under our amended and restated Articles of Association, unless the transfer is restricted or prohibited by applicable law or the rules of the stock exchange on which the shares are traded. The ownership or voting of our ordinary shares by non-residents of Israel is not restricted in any way by our amended and restated Articles of Association or the laws of the State of Israel, except under certain circumstances for ownership by nationals of certain countries that are, or have been, in a state of war with Israel.

 

The Companies Law

 

We are subject to the provisions of the Companies Law. The Companies Law codifies the fiduciary duties that "office holders", including directors and executive office holders, owe to a company. An office holder, as defined in the Companies Law, is a general manager (also referred to as the "chief executive officer"), chief business manager, deputy general manager, vice general manager, executive Vice-President, Vice-President, any other person assuming the responsibilities of any of the foregoing positions without regard to such person's title, as well as a director, or another manager directly subordinate to the general manager. Each person listed in the table in "Item 6 – Directors, Senior Management and Employees" above is an office holder of Silicom.

 

The Companies Law requires that an office holder of a company promptly disclose, no later than the first board meeting in which such transaction is discussed, any personal interest that he or she may have and all related material information known to him or her, in connection with any existing or proposed transaction by the company. In addition, if the transaction is an extraordinary transaction, the office holder must also disclose any personal interest held by the office holder's relative (which includes for these purposes any members of his/her (or his/her spouse's) immediate family or the spouses of any such members of his or her (or his/her spouse's) immediate family), or by any corporation in which the office holder or the office holder's relative is a 5% or greater shareholder, holder of 5% or more of the voting power, director or general manager or in which he or she has the right to appoint at least one director or the general manager. An extraordinary transaction is defined as a transaction not in the ordinary course of business, not on market terms, or that is likely to have a material impact on the company's profitability, assets or liabilities.

 

In the case of a transaction in which an office holder of the company has a personal interest and which is not an extraordinary transaction, after the office holder complies with the above disclosure requirement, board approval is required unless the articles of association of the company provide otherwise. The transaction must be for the benefit of the company. If the transaction is an extraordinary transaction, then, in addition to any approval required by the articles of association, it must also be approved by the audit committee and by the board of directors, and, under specified circumstances, by a meeting of the shareholders, as well.

 

Subject to certain exceptions provided for in the regulations to the Companies Law, agreements regarding directors' terms of compensation require the approval of the compensation committee, board of directors and the shareholders of the company. The transaction must be for the benefit of the company.

 

In matters concerning an extraordinary transaction in which a person has a personal interest, as well as matters concerning his or her terms of compensation, he or she shall not be permitted to vote on the matter or be present in the audit committee or board of directors meeting in which the matter is considered, however, with respect to an office holder, he/she may be present at the meeting discussions if the chairman determines that the presence of the office holder is necessary in order to present the matter. However, if a majority of the audit committee or of the board of directors has a personal interest in the matter then:

 

According to the Companies Law, the personal interest disclosure requirements discussed above also apply to a "controlling shareholder" of a public company. Such requirements also apply to certain shareholders of a public company who have a personal interest in the adoption by the shareholders of certain proposals with respect to (i) certain private placements that will increase their relative holdings in the company, (ii) certain special tender offers or forced bring along share purchase transactions, (iii) election of external directors, (iv) approval of a compensation policy governing the terms of employment and compensation of office holders, (v) approval of the terms of employment and compensation of the general manager, (vi) approval of the terms of employment and compensation of office holders of the company when such terms deviate from the compensation policy previously approved by the company's shareholders, and (vii) approving the appointment of either (1) the chairman of the board or his/her relative as the chief executive officer of the company, or (2) the chief executive officer or his/her relative as the chairman of the board of directors of the company. If any shareholder casting a vote at a shareholders meeting in connection with such proposals as aforesaid does not notify the company if he, she or it has a personal interest with respect to such proposal, his, her or its vote with respect to the proposal will be disqualified.

 

The term "controlling shareholder" is defined as a shareholder who has the ability to direct the activities of a company, other than if this power derives solely from the shareholder's position on the board of directors or any other position with the company, and the definition of "controlling shareholder" in connection with matters governing: (i) extraordinary transactions with a "controlling shareholder" or in which a "controlling shareholder" has a personal interest, (ii) certain private placements in which the "controlling shareholder" has a personal interest, (iii) certain transactions with a "controlling shareholder" or relative with respect to services provided to or employment by the company, (iv) the terms of employment and compensation of the general manager, and (v) the terms of employment and compensation of office holders of the company when such terms deviate from the compensation policy previously approved by the company's shareholders, also includes shareholders that hold 25% or more of the voting rights if no other shareholder owns more than 50% of the voting rights in the company (and the holdings of two or more shareholders which each have a personal interest in such matter will be aggregated for the purposes of determining such threshold).

 

In general, extraordinary transactions with a "controlling shareholder" or in which a "controlling shareholder" has a personal interest, and agreements relating to non-office holder employment and compensation terms of a "controlling shareholder" (or a relative of such) or to the provision of services to the company by such "controlling shareholder" (or relative of such), require the approval of the audit committee, the board of directors and the shareholders of the company. Agreements relating to the terms of office and employment of a "controlling shareholder" (or relative of such) as an office holder in the company require the approval of the compensation committee, the board of directors and the shareholders of the company.

 

The shareholder approval for such matters requiring shareholder disclosure of a personal interest as noted above, generally must either include at least a majority of the shares held by non-controlling and disinterested shareholders who actively participate in the voting process (without taking abstaining votes into account), or, alternatively, the total shareholdings of the non-controlling and disinterested shareholders who vote against the transaction must not represent more than two percent of the voting rights in the company. The shareholder approval for approving the appointment of either (1) the chairman of the board or his/her relative as the chief executive officer of the company, or (2) the chief executive officer or his/her relative as the chairman of the board of directors of the company, must either include at least two-thirds of the shares held by non-controlling and disinterested shareholders who actively participate in the voting process (without taking abstaining votes into account), or, alternatively, the total shareholdings of the non-controlling and disinterested shareholders who vote against the transaction must not represent more than two percent of the voting rights in the company. Agreements and extraordinary transactions with a "controlling shareholder" or in which a "controlling shareholder" has a personal interest, or agreements relating to any employment terms of a "controlling shareholder" (or relative if such) or to the provision of services to the company by such "controlling shareholder" (or relative if such), as aforesaid, with duration exceeding three years, are subject to re-approval once every three years by the audit committee (or compensation committee, as applicable), the board of directors and the shareholders of the company. Extraordinary transactions with a "controlling shareholder" or in which a "controlling shareholder" has a personal interest may be approved in advance for a period exceeding three years if the audit committee determines such approval reasonable under the circumstances. In addition, agreements and extraordinary transactions with duration exceeding three years which were approved prior to Amendment 16 to the Companies Law, which was passed by the Israeli legislature, the Knesset, in March 2011, and which came into effect gradually during the year 2011 ("Amendment 16"), will need to be re-approved by the proper corporate actions at the later of (i) the first general meeting held after May 14, 2011, (ii) November 14, 2011, or (iii) the expiration of three years from the date on which they were originally approved, even though they were properly approved prior to the passing of the Amendment 16.

 

The board of directors of an Israeli company whose shares or debentures are publicly traded is obligated to adopt a compensation policy governing the terms of office and employment of office holders, after considering the recommendations of the compensation committee. The final adoption of the compensation policy is subject to the approval of the shareholders of the company. Such shareholder approval is subject to certain special majority requirements, as set forth in the Companies Law, pursuant to which the shareholder majority approval must also either include at least a majority of the shares held by non-controlling and disinterested shareholders who actively participate in the voting process (without taking abstaining votes into account), or, alternatively, the total shareholdings of the non-controlling and disinterested shareholders who voted against the transaction must not represent more than two percent of the voting rights in the company.

 

Nonetheless, even if the shareholders of the company do not approve the proposed compensation policy, the board of directors of a company may approve the proposed compensation policy, provided that the compensation committee and, thereafter, the board of directors resolved, based on detailed, documented, reasons and after a second review of the compensation policy, that the approval of such compensation policy is for the benefit of the company.

 

Pursuant to the Companies Law, the terms of office and employment of an office holder in a public company should be in accordance with the company's compensation policy. Nonetheless, provisions were established in the Companies Law that allow a company, under special circumstances, to approve terms of office and employment that are not in line with the approved compensation policy.

 

Terms of office and employment of office holders who are neither directors nor the general manager and which comply with the company's compensation policy require approval by the (i) compensation committee; and (ii) the board of directors. Approval of terms of office and employment for such office holders which do not comply with the compensation policy may nonetheless be approved subject to two cumulative conditions: (i) the compensation committee and thereafter the board of directors, approved the terms after having taken into account the various policy considerations and mandatory requirements set forth in the Companies Law with respect to office holder compensation, and (ii) the shareholders of the company approved the terms of office and employment for such office holders by means of the special majority required for approving the compensation policy (as detailed above). Following the Amendment to the Affiliation Regulations, non-material changes to the terms of compensation of office holders who are subordinated to the company general manager will require only general manager approval, provided that the company's compensation policy includes a reasonable range for such non-material changes.

 

Terms of office and employment of the general manager which comply with the company's compensation policy require approval by the (i) compensation committee; (ii) the board of directors; and (iii) the shareholders of the company by means of the special majority required for approving the compensation policy (as detailed above). Approval of terms of office and employment for the general manager which do not comply with the compensation policy may nonetheless be approved subject to two cumulative conditions: (i) the compensation committee and thereafter the board of directors, approved the terms after having taken into account the various policy considerations and mandatory requirements set forth in the Companies Law with respect to office holder compensation, and (ii) the shareholders of the company approved the terms of office and employment for the general manager which deviate from the compensation policy by means of the special majority required for approving the compensation policy (as detailed above). Notwithstanding the foregoing, a company may be exempted from receiving shareholder approval with respect to the terms of office and employment of a proposed candidate for general manager if such candidate meets certain independence criteria, the terms of office and employment are in line with the compensation policy, and the compensation committee has determined for specified reasons that presenting the matter for shareholder approval would thwart the proposed engagement. In addition, following the Amendment to the Affiliation Regulations, the terms of compensation of the general manager will not require shareholders' approval when extending or re-approving the company's engagement with its general manager, provided that such terms are not more beneficial compared to his previous compensation terms approved by the shareholders pursuant to the Companies Law and provided that such terms comply with the company's compensation policy.

 

Terms of office and employment of office holders (including the general manager) that are not directors may nonetheless be approved by the company despite shareholder rejection, provided that a company's compensation committee and thereafter the board of directors have determined to approve such terms of office and employment based on detailed reasoning, after having re-examined the proposed terms of office and employment, and having taken the shareholder rejection into consideration.

 

Terms of office and employment of directors which comply with the company's compensation policy require approval by the (i) compensation committee; (ii) the board of directors and (iii) the shareholders of the company. Approval of terms of office and employment for directors of a company which do not comply with the compensation policy may nonetheless be approved subject to two cumulative conditions: (i) the compensation committee and thereafter the board of directors, approved the terms after having taken into account the various policy considerations and mandatory requirements set forth in the Companies Law with respect to office holder compensation, and (ii) the shareholders of the company have approved the terms by means of the special majority required for approving the compensation policy (as detailed above).

 

Private placements in a public company require approval by a company's board of directors and shareholders in the following cases:

 

 

 

 

 

 

In addition, under the Companies Law, certain transactions or a series of transactions are considered to be one private placement. A private placement that meets all of the above conditions, and which must be approved by the shareholders, must also be for the benefit of the company.

 

Any placement of securities that does not fit the above description may be issued at the discretion of the board of directors.

 

Under the Companies Law, a shareholder has a duty to act in good faith towards the company and other shareholders when exercising his or her rights and refrain from abusing his power in the company, including, among other things, voting in the general meeting of shareholders on the following matters:

 

Furthermore, the Companies Law requires that a shareholder refrain from acting in a discriminatory manner towards other shareholders.

 

The Companies Law does not describe the substance of the aforementioned duties of shareholders, but provides that laws applicable to a breach of contract, adjusted according to the circumstances shall apply to a breach of such duties. With respect to the obligation to refrain from acting discriminatorily, a shareholder that is discriminated against can petition the court to instruct the company to remove or prevent the discrimination, as well as provide instructions with respect to future actions.

 

In addition, any "controlling shareholder", any shareholder who knows that it possesses power to determine the outcome of a shareholder vote and any shareholder who, pursuant to the provisions of a company's articles of association, has the power to appoint or prevent the appointment of an office holder in the company is under a duty to act with fairness towards the company. The breach of such duty is governed by Israeli contract laws. The Companies Law does not describe the substance of this duty to act with fairness, but provides that laws applicable to a breach of contract, adjusted according to the circumstances, and taking into account the status within the company of such shareholder, shall apply to a breach of such duty.

 

The Companies Law requires that specified types of transactions, actions and arrangements be approved as provided for in a company's articles of association and in some circumstances by the audit committee or compensation committee, by the board of directors and by the general meeting of the shareholders.

 

In addition, the Companies Law includes a code of recommended corporate governance practices, which was added to the Companies Law following the enactment of Amendment 16. In the explanatory notes to Amendment 16, the Knesset noted that an "adopt or disclose non-adoption" regulation would be issued by the ISA with respect to such code. As of the date of this Annual Report, the ISA has issued reporting instructions with respect to this code which are applicable only to publicly traded companies whose securities are traded solely on the Tel Aviv Stock Exchange and which report solely to the ISA.

 

The ISA is authorized to impose fines on any person or company performing a violation, in connection with a publicly traded company which reports to the ISA, and specifically designated as a violation under Amendment 16.

 

Although we expect to be in compliance with the Companies Law, there is no assurance that we will not be required to adjust our current corporate governance practices, as discussed in this annual report, pursuant to the provisions of the Companies Law.

 

The Israeli Securities Law

 

The Israeli Securities Law includes provisions relating to administrative enforcement procedure which are applicable to Israeli public companies, including companies which are listed for trading on the NASDAQ Global Market, which are designated to enable the ISA to enhance the efficacy of enforcement in the securities market in Israel. The administrative enforcement procedure may be applied to any company or person (including director, office holder or shareholder of a company) performing any of the actions specifically designated as breaches of law under the Securities Law.

 

Furthermore, the Securities Law requires that the chief executive officer of a company supervise and take all reasonable measures to prevent the company or any of its employees from breaching the Securities Law.

 

Under the Securities Law, a company cannot obtain insurance against or indemnify a third party (including its office holders and/or employees) for any administrative procedure and/or monetary fine (other than for certain legal expenses and payments of damages to an injured party). The Securities Law permits insurance and/or indemnification for expenses related to an administrative procedure, such as reasonable legal fees, provided that it is permitted under the company's articles of association. In January 2012, each of our audit committee and Board of Directors approved a new form of Indemnification Agreement with our directors and office holders serving in such positions from time to time so as to reflect this amendment, subject to approval of our shareholders to the relevant changes required to our Articles. Our shareholders approved these amendments to the Articles of Association and a revised form of Indemnification Agreement for directors serving in such capacity from time to time, at the Annual General Meeting of the Shareholders held on April 11, 2012. As per Amendment 20, it was decided on July 31, 2013, at the Extraordinary General Meeting of the Shareholders to adopt the Executive Compensation Policy of the Company, which had been recommended by our Compensation Committee and approved by our Board of Directors. The Policy was re-approved by our shareholders at the Annual General Meeting which took place on June 8, 2016. Our approved Executive Compensation Policy includes the above referenced form of Indemnification Agreement to be entered into by the Company with our directors and office holders serving in such capacities from time to time.

 

We periodically review all of our internal policies and procedures in order to ensure compliance with all the securities laws to which we are subject. There is no assurance that we will not be required to take certain actions in order to enhance our compliance with the securities laws to which we are subject, such as adopting and implementing an internal enforcement plan as well as additional internal policies and procedures in order to reduce our exposure to potential breaches of the Securities Law.

 

NASDAQ Listing Rules and Home Country Practices

 

Below is a concise summary of the significant ways in which our corporate practices, which are in accordance with Israeli law and practice, including the provisions of the Companies Law, differ from the requirements which may be applicable to domestic U.S. listed companies:

 

C.            Material Contracts

 

All of our commercial contracts over the past two years have been entered into in the ordinary course of business.

 

Information regarding our real property leases is provided in "Item 4.D. – Information on the Company – Property, Plant and Equipment" and "Item 19 – Exhibits."

 

For information on the engagement terms of our new President and CEO, see Item 7B “Related Party Transactions.”

 

D.            Exchange Controls

 

Under current Israeli laws and regulations, any dividends or other distributions paid in respect of our ordinary shares purchased by nonresidents of Israel with certain non-Israeli currencies (including U.S. Dollars) and any amounts payable upon the dissolution, liquidation or winding up of our affairs, as well as the proceeds of any sale in Israel of our securities to an Israeli resident, will be freely repatriable in such non-Israeli currencies, provided that Israeli income tax has been paid on (or withheld from) such payments.

 

There are currently no Israeli currency control restrictions on remittances of dividends on our ordinary shares, proceeds from the sale of the shares or interest or other payments to non-residents of Israel, except under certain circumstances, for shareholders who are subjects of countries that are, or have been, in a state of war with Israel.

 

E.           Taxation

 

The following is a summary of some of the current tax law applicable to companies in Israel, with special reference to its effect on us. The following also contains a discussion of specified Israeli tax consequences to our shareholders and government programs from which we benefit. To the extent that the discussion is based on tax legislation (including the legislation passed as part of the recent tax reform in Israel) that has not been subject to judicial or administrative interpretation, there can be no assurance that the views expressed in the discussion will be accepted by the tax authorities or courts. 

 

The discussion is not intended, and should not be construed, as legal or professional tax advice and is not exhaustive of all possible tax considerations.

 

General Corporate Tax

 

Israeli companies are subject to corporate tax at the rate of 25% as of 2016, 24% as of 2017, and 23% as from 2018. However, the effective tax rate payable by a company which derives income from a "Benefited Enterprise", or from a "Preferred Enterprise" or from "Preferred Technological Enterprise" (as further discussed below) may be considerably less.

 

In 2006, transfer pricing regulations came into force, following the introduction of Section 85A of the Israeli Income Tax Ordinance (New Version), 5721-1961, referred to herein as the Israeli Tax Ordinance, under Amendment 132. In principal, the transfer pricing rules require that cross-border transactions between related parties be carried out implementing an arms' length principle and reported and taxed accordingly.

 

In 2008, an amendment to the Income Tax Law (Inflationary Adjustments), 1985 was enacted which limits the scope of the law starting in 2008 and thereafter. Starting in 2008, the revenues for tax purposes are measured in nominal values, excluding certain adjustments for changes in the Israeli Consumer Price Index carried out in the period up to December 31, 2007. The amended law includes, among other provisions, the elimination of the inflationary additions and deductions and the additional deduction for depreciation for the period starting in 2008.

 

The Encouragement of Capital Investments Law, 1959 (the "Investment Law")

 

Pursuant to the Investment Law, a "Preferred Enterprise" is entitled to a reduced corporate flat tax rate of 16% with respect to income that qualifies as “Preferred Technological Income” as defined in the Investment Law, unless the "Preferred Enterprise" is located in a certain development zone, in which case the rate will be 7.5%. Such corporate tax rates are 12% and 7.5% with respect to Preferred Technological Income. Income derived by a "Special Preferred Enterprise" (as such term is defined in the Investment Law) are entitled, during a benefits period of 10 years, to further reduced tax rates of 8%, or to 5% if the "Special Preferred Enterprise" is located in a certain development zone. Under the Investment Law, most of the tax incentives offered are not dependent on minimum qualified investments or on foreign ownership. Companies may be able to enjoy both government grants and tax benefits concurrently.

 

"Preferred Enterprise" is defined as an Industrial Enterprise (including, inter alia, an enterprise which develops software, an enterprise which provides approved R&D services to foreign residents and an enterprise which the IIA confirmed is carrying out R&D in the field of alternative energy), which inter-alia, generally more than 25% of its business income is from export to market consisting more than 14 million residents.

 

Chapter B2 of the Investment Law determines the conditions and limitations applying to the tax benefits offered to a "Special Preferred Enterprise." Chapter B2 determines that a "Special Preferred Enterprise" is entitled to benefited corporate income tax rate: of 5% if located in a preferred zone and 8% if not.

 

"Special Preferred Enterprise" is defined as a "Preferred Enterprise" which meets all of the following conditions: (a) its Preferred Income is equal to or exceeds NIS 1 billion; (b) the total income of the company which owns the "Preferred Enterprise" or which operates in the same field of the "Preferred Enterprise" and which consolidates in its financial reports the company that owns the "Preferred Enterprise" equals or exceeds NIS 10 billion; and (c) its business plan was approved by the authorities as significantly benefitting the Israeli economy, either by an investment of at least NIS 400 - 800 million in assets; Annual growth of 100 - 150 million NIS in R&D (or half of this amount if the average annual R&D is above NIS 500 million) compared to the average R&D in the three tax years prior to the year of approval; or the employment of at least 250 to 500 new employees, for preferred zones and regular zones, respectively.

 

Dividends paid out of income attributed to a "Preferred Enterprise" are generally subject to withholding tax at source at a rate of 20% (15% until 2014) or such lower rate as may be provided in an applicable tax treaty, subject to the submission and approval of a request submitted on behalf of the recipient of such dividends to the Israel Tax Authority. However, if such dividends are paid to an Israeli company no tax will be withheld.

 

The Company elected in 2014 to be taxed as a "Preferred Enterprise" under the Investment Law, commencing with the 2014 fiscal year.

 

There can be no assurance that we will comply with the conditions of the Investment Law in the future or that we will be entitled to any additional benefits under the Investment Law and whether the influence of any changes to the Investment Law will be beneficial to the Company or not.

 

On January 6, 2011 the Israeli Parliament (the "Knesset") enacted the Economic Policy Law for 2011 and 2012 (legislative amendments), 2011 in which the Investment Law was also amended (the “2011 Amendment”). The 2011 Amendment introduced new benefits for income generated by a “Preferred Company” through its “Preferred Enterprise” (as such terms are defined in the Investment Law) as of January 1, 2011. 

 

The definition of a “Preferred Company” includes a company incorporated in Israel that is not fully owned by a governmental entity, and that has, among other things, a “Preferred Enterprise” and is controlled and managed from Israel. Pursuant to the 2011 Amendment, beginning in 2014 and in each year thereafter until 2016, a Preferred Company may only be entitled to a reduced corporate tax rate of 16% with respect to its preferred income derived by its Preferred Enterprise, unless the Preferred Enterprise is located in a specified development zone, in which case the rate will be 9%.

 

On December 29, 2016 the Knesset enacted the "Economic Efficiency Law (Legislative Amendments for Achieving Budget Objectives in the Years 2017 and 2018) – 2016" in which the Investment Law was amended again (hereinafter: “the 2017 Amendment”). The 2017 Amendment added new tax benefit tracks for a “preferred technological enterprise” and a “special preferred technological enterprise” which award reduced tax rates to a technological industrial enterprise for the purpose of encouraging activity relating to the development of qualifying intangible assets. In addition, the corporate tax rate for Preferred Enterprise which is located in a specified development zone will be 7.5%.

 

The benefits will be awarded to a “preferred company” that has a “preferred technological enterprise” or a “special preferred technological enterprise” with respect to taxable “preferred technological income” per its definition in the Investment Law.

 

Preferred technological income that meets the conditions required in the law, will be subject to a reduced corporate tax rate of 12%, and if the preferred technological enterprise is located in "Development Area A" in Israel - to a reduced tax rate of 7.5%. A company that owns a special preferred technological enterprise will be subject to a reduced corporate tax rate of 6% regardless of the development area in which the enterprise is located. The 2017 Amendment is effective as from January 1, 2017.

 

Income derived by a Preferred Company from a “Special Preferred Enterprise” (as such term is defined in the Investment Law) would be entitled, during a benefit period of ten years, to further reduced tax rates of 8%, or 5% if the Special Preferred Enterprise is located in a certain development zone. 

 

On June 14, 2017 the Knesset Finance Committee approved "Encouragement of Capital Investment Regulations (Preferred Technological Income and Capital Gain of Technological Enterprise) – 2017" (hereinafter: “the Regulations”), which provides rules for applying the “preferred technological enterprise” and “special preferred technological enterprise” tax benefit tracks, including the Nexus formula that provides the mechanism for allocating the technological income eligible for the benefits.

 

Should the Company derive income from sources other than the “preferred technological enterprise”, such income will be taxable at the "Preferred Company" tax rate (for manufacturing activity in Israel) or regular corporate tax rates for the applicable year.

 

On November 15, 2021, the Knesset Finance approved Economic Efficiency Law (Legislative Amendments for Achieving Budget Objectives in the Years 2021 and 2022) – 2021 (“the 2021 Amendment”). The 2021 Amendment stipulated rules with respect to “Accumulated income” which was generated by a company until December 31, 2020.

 

“Accumulated Income” is defined as an income including capitalized income that was exempt from corporation tax on the year in which it was generated, according to the Investment Law provisions, and the company did not pay any corporation tax except for tax payments made regarding a distribution made to a subsidiary or which was attributed to the subsidiary directly or indirectly.

 

The tax rate that will be imposed on the Selected Accumulated Income shall be at the corporation tax rate which would have applied to that income under section 47 provisions, in the year it was generated, multiplied by the tax coefficient (according to the definition of this term under the Investment Law provisions), and not less than 6%. The company shall pay the tax within 30 days and will not be able to regret it. The rest of the Accumulated Income which is not the Selected Accumulated Income will be taxed according to the provisions of the Investment Law.

 

The company shall be entitled to pay tax regarding its Accumulated Income, in whole or in part, in accordance with its choice by written notice to the ITA (“Selected Accumulated Income” and “Selection Date” respectively). After paying the corporate tax, the Investment Law provisions stipulate that the company shall invest in its Industrial Enterprise, during the 5 years starting on the Selection Date for at least one of the following: (1) purchase of productive assets according to the definition of this term and excluding buildings; (2) investment in research and development in Israel; or (3) payment of salaries to new employees in the company compared to the employees employed by the company at the end of the tax year 2020, and excluding salaries to company’s officers (as defined under the Investment Law). The investment amount will be calculated according to the Investment Law Provisions. Subject to additional conditions stipulated by the Investment Law provisions, the company will be able to distribute Its Selected Accumulated income as a dividend, after withholding 15% tax from the distributed amount. The 2021 Amendment is effective as from January 1, 2022.

 

As a result of the aforesaid legislation, starting 2021 the Company has implemented the “preferred technological enterprise” tax benefit track.

 

Law for the Encouragement of Research, Development and Technological Innovation in Industry, 1984

 

Programs approved by the Research Committee of the IIA are eligible for grants or loans if they meet certain criteria, generally in return for the payment of royalties from the sale of the product or services developed in accordance with the program and subject to other restrictions. Once a project is approved, the IIA award grants generally of up to 50% of the project's expenditures in return for royalties, usually at the rate of 3% of sales of products developed with such grants. For projects approved after January 1, 1999, the amount of royalties payable is up to a dollar-linked amount equal to 100% of such grants plus interest at LIBOR or other applicable interest rate.

 

The terms of these grants prohibited the manufacture outside of Israel of the product developed in accordance with the program without the prior consent of the Research Committee of the IIA. Such approval, if granted, was generally subject to an increase in royalty rates, as well as in the total amount to be repaid to the IIA to between 120% and 300% of the amount granted, depending on the extent of the manufacturing to be conducted outside of Israel.

 

The R&D Law also provides that know-how from the research and development, which is used to develop or produce produce the product, may not be transferred to Israeli third parties without the approval of the Research Committee. The R&D Law stresses that it is not just transfer of know-how that is prohibited, but also transfer of any rights in such know-how. Such restriction does not apply to exports from Israel of final products developed with such technologies. It is possible to receive approval of the transfer only if the transferee undertakes to abide by all of the provisions of the R&D Law and regulations promulgated thereunder, including the restrictions on the transfer of know-how and the obligation to pay royalties. Generally, royalty payments by the transferor are required in connection with the transfer to an Israeli third party. There is no assurance that such consent, if requested, would be granted. For additional information regarding the R&D Law, see "Item 4.B. – Information on the Company – Business Overview – Governmental Regulation Affecting the Company."

 

Tax Benefits for Research and Development

 

Israeli tax law allows, under certain conditions, a tax deduction in the year incurred for expenditures (including capital expenditures) in scientific research and development projects, if the expenditures are approved by the relevant Israeli Government Ministry (determined by the field of research) and the research and development is for the promotion of the enterprise and is carried out by or on behalf of the company seeking such deduction. Such expenditures not so approved are required to be deducted over a three-year period.

 

Law for the Encouragement of Industry (Taxes), 1969

 

Under the Law for the Encouragement of Industry (Taxes), 1969 (the "Industry Encouragement Law"), Industrial Companies (as defined below) are entitled to the following tax benefits:

 

 

 

Eligibility for benefits under the Industry Encouragement Law is not subject to receipt of prior approval from any governmental authority. Under the Industry Encouragement Law, an "Industrial Company" is defined as a company which is an Israeli resident and incorporated in Israel, at least 90% of the income of which, in any tax year, determined in Israeli currency, exclusive of income from government loans, is derived from an "Industrial Enterprise" owned by it and located in Israel or in the “Area” as defined in the Israeli Tax Ordinance. An "Industrial Enterprise" is defined as an enterprise whose major activity in a given tax year is industrial production activity.

 

We believe that we currently qualify as an "Industrial Company" within the definition of the Industry Encouragement Law. No assurance can be given that we will continue to qualify as an "Industrial Company" or that the benefits described above will be available in the future.

 

Calculation of Results for Tax Purposes

 

The Israeli Income Tax Regulations (Rules for Maintaining Accounting Records of Foreign Investors' Companies and Certain Partnerships and Determining Their Taxable Income), 1986, provide that as a "Foreign Investors' Company" (as defined in the Investment Law described above) is eligible to calculate its taxable income in accordance with these regulations, and therefore, if we elect to follow such regulations, our taxable income or loss is to be calculated in US Dollars. We have elected to apply these regulations and accordingly our taxable income or loss is calculated in US Dollars in the manner set forth in such regulations.

 

Capital Gains Taxes Applicable to Israeli Resident Shareholders.

 

In general, an individual is subject to a 25% tax rate on real capital gains derived from the sale of shares, as long as the individual is not a "substantial shareholder" in the company issuing the shares. A "substantial shareholder" is generally a person who alone, or together with his relative or another person who collaborates with him on a permanent basis, holds, directly or indirectly, at least 10% of any of the "Means of control" of the corporation. "Means of control" generally include the right to vote, receive profits, nominate a director or an office holder, receive assets upon liquidation, or order someone who holds any of the aforesaid rights how to act, and all regardless of the source of such right.

 

A "substantial shareholder" will be subject to a withholding tax rate of 30% in respect of real capital gains derived from the sale of shares issued by a company in which he or she is a "substantial shareholder." The determination of whether the individual is a "substantial shareholder" will be made on the date on which the securities are sold. In addition, the individual will be deemed to be a "substantial shareholder" if at any time during the 12 months preceding the date of sale, he or she was a "substantial shareholder."

 

Shareholders that are not Israeli residents are generally exempt from Israeli capital gains tax on any gains derived from the sale, exchange or disposition of our shares, provided that such share is not traded on the TASE on the day of the sale and such gains were not derived from a permanent establishment or business activity of such shareholders in Israel. However, non-Israeli corporations will not be entitled to the foregoing exemptions if an Israeli resident(s) (i) have a controlling interest of more than 25% in such non-Israeli corporation; or (ii) are the beneficiaries of or are entitled to 25% or more of the revenues or profits of such non-Israeli corporation, whether directly or indirectly.

 

In addition, under the U.S.-Israel Income Tax Treaty, 1995, or the U.S.-Israel Tax Treaty, the sale, exchange or disposition of our shares by a shareholder who is a U.S. resident (for purposes of the U.S.-Israel Tax Treaty) holding the shares as a capital asset is exempt from Israeli capital gains tax unless either (i) the shareholder holds, directly or indirectly, shares representing 10% or more of our voting capital during any part of the 12-month period preceding such sale, exchange or disposition; or (ii) the capital gains arising from such sale are attributable to a permanent establishment of the shareholder located in Israel; or (iii) the shareholder, being an individual, was present in Israel for a period of time or several periods of time, which aggregate to a total of 183 days or more, during a single taxable year. In either case, the sale, exchange, or disposition of the shares would be subject to Israeli tax, to the extent applicable; however, under the U.S.-Israel Tax Treaty, the U.S. resident would be permitted to claim a credit for the tax against the U.S. federal income tax imposed with respect to the sale, exchange or disposition, subject to the limitations in U.S. laws applicable to foreign tax credits. The U.S.-Israel Tax Treaty does not relate to U.S. state or local taxes.

 

Shareholders may be required to demonstrate that they are exempt from tax on their capital gains in order to avoid withholding of tax at source at the time of sale.

 

Residents of Israel who are individuals are generally subject to Israeli income tax on the receipt of dividends paid on our shares at the rate of 25%, which tax will be withheld at the source. With respect to a person who is a "substantial shareholder" at the time of receiving the dividend or on any date within the 12 months preceding such date, the applicable tax rate is 30%.

 

Israeli resident corporations are generally exempt from Israeli tax for dividends paid on our shares.

 

In case of dividends paid out of the profits of a "Preferred Enterprise" or "Preferred Technological Enterprise", the applicable tax rate is 20% for an individual and 0% for an Israeli corporation.

 

Non-residents of Israel are generally subject to Israeli income tax on the receipt of dividends paid on our shares at the rate of 25% or 30%, if such person (including a non-Israeli corporation) is a "substantial shareholder" at the time of recipient of the dividend or on any date in the 12 months preceding such date, which tax will be withheld at the source, unless a different rate is provided in a tax treaty between Israel and the shareholder's country of residence. Under the U.S.-Israel Tax Treaty, the maximum rate of tax withheld in Israel on dividends paid to a holder of our ordinary shares who is a U.S. resident (for purposes of the U.S.-Israel Tax Treaty) is 25% or 15% for a US corporation in the case of dividends paid out of the profits of an "Approved Enterprise" (as such term is defined in the Investment Law), subject to certain conditions. However, generally, the maximum rate of withholding tax on dividends that are paid to a U.S. corporation holding 10% or more of our outstanding voting capital throughout the tax year in which the dividend is distributed as well as the previous tax year and the dividend is not paid from the profits of an "Approved Enterprise", the Israeli tax withheld may not exceed 12.5%, subject to certain conditions. A non-resident of Israel who receives dividends from which tax was withheld is generally exempt from the duty to file returns in Israel in respect of such income, provided such income was not derived from a business conducted in Israel by the taxpayer, and the taxpayer has no other taxable sources of income in Israel.

 

In case of dividends paid out of the profits of a "Preferred Enterprise" or "Preferred Technological Enterprise", the applicable tax rate is 20% for individuals and 15% for a US corporations holding 10% or more of our outstanding voting capital throughout the tax year in which the dividend is distributed as well as the previous tax year, subject to certain conditions.

 

Residents of the United States will generally have taxes in Israel withheld at source.

 

Excess Tax.

 

Individuals who are subject to tax in Israel are also subject to an additional tax at a rate of 3% on annual income exceeding NIS 698,281, including, but not limited to, dividends, interest and capital gains.

 

Passive Foreign Investment Company Status under U.S. Federal Income Tax Law

 

In general, a non-U.S. corporation will be classified for U.S. tax purposes as a passive foreign investment company (hereafter also referred to as a "PFIC") in any taxable year in which either (i) 75% or more of its gross income (including the pro-rata gross income of any company (U.S. or foreign) in which it is considered to own 25% or more of the ordinary shares by value) for the taxable year is passive income, or (ii) at least 50% of the average value of all of its gross assets (including the pro-rata fair market value of the assets of any company in which it is considered to own 25% or more of the ordinary shares by value) during the taxable year, calculated quarterly by value, produce, or are held for the production of, passive income. Passive income for these purposes includes items such as dividends, interest, royalties, rents and gains from commodities and securities transactions.

 

If we are classified as a passive foreign investment company, highly complex rules will apply to our U.S. shareholders. Accordingly, U.S. shareholders are urged to consult their tax advisors regarding the application of such rules.

 

If a corporation is a passive foreign investment company, a U.S. shareholder will be subject to one of three alternative taxing regimes:

 

"QEF" regime -  If the shareholder elects to treat the PFIC as a QEF, then each year the shareholder includes in its gross income a proportionate share of the PFIC's ordinary income and net capital gain. We do not currently intend to prepare or provide the information that would enable you to make a Qualified Election Fund election. A second regime may be elected if the PFIC stock is "marketable." The U.S. shareholder may elect to "mark the stock to market" each year. At the end of each taxable year, the shareholder recognizes gain equal to the excess of the fair market value of the PFIC stock over the shareholder's tax basis in the stock. Losses may also be recognized to the extent of previously recognized gains.

 

A U.S. shareholder making neither of these elections is subject to the "excess distribution" regime. The tax is triggered when the shareholder receives an "excess distribution" from the PFIC. An "excess distribution" is either (1) a distribution with respect to stock that is greater than 125% of the average of such distributions over the preceding three years, or (2) 100% of the gain from the disposition of shares in the PFIC.

 

An "excess distribution" is subject to special tax rules. In most cases, only a portion of it is included in the gross income of the U.S. shareholder and taxed at normal rates. The remainder is never so included, but is used as the basis for calculating a "deferred tax amount", which is simply added to the shareholder's tax liability.

 

The deferred tax amount is computed as follows. The "excess distribution" is first ratably allocated, share by share, to each day of the shareholder's holding period. Portions allocated to the current year, and to any pre-PFIC years (that is, years before 1987, when there were no PFICs, or years before the first year in which the company was a PFIC with respect to that shareholder), are included in ordinary income for the current year. Portions allocated to prior PFIC years are hypothetically taxed at the highest marginal rate in effect for those years (without regard to the shareholder's actual rate or to any deductions or credits for those years). To this hypothetical tax is added the interest that the shareholder would have paid if it were simply paying that tax late for that year. The sum of the tax and the interest charge is the deferred tax amount, which cannot be offset or otherwise affected by current net operating losses or other deductions.

 

A U.S. person who inherits shares in a foreign corporation that was a PFIC in the hands of the decedent (other than a decedent who was a nonresident alien at all times during his holding period in the shares) who did not make either of the elections described above, is denied the otherwise available step-up in the tax basis of such shares to fair market value at the date of death. The U.S. person steps into the shoes of the decedent and will be subject to the rules described above.

 

Although a determination as to a corporation's PFIC status is made annually, an initial determination that a corporation is a PFIC for any taxable year generally will cause the above-described consequences to apply for all future years as to U.S. shareholders who held shares in the corporation at any time during the PFIC taxable year and who made neither a valid QEF election with respect to such shares nor a valid election to mark such shares to market. This will be true even if the corporation loses its PFIC status in later years. However, with respect to a PFIC that does not make any distributions or deemed distributions, the above tax treatment would apply only to gains realized on the disposition of such shares by a U.S. shareholder.

 

If we are classified as a PFIC, complicated rules will apply to our U.S. shareholders. Our status in future years will depend on our assets and activities in those years, although shareholders will be treated as continuing to own an interest in a passive foreign investment company if we are a passive foreign investment company in any year in which a shareholder owns our shares, unless certain elections are made.

 

This discussion does not address all aspects of U.S. federal income taxation that may be relevant to a U.S. shareholder in light of his or her particular circumstances or to a U.S. shareholder subject to special treatment under U.S. federal income tax law. We do not currently intend to prepare or provide the information that would enable you to make a Qualified Election Fund election. U.S. shareholders are urged to consult their tax advisors about the U.S. federal income taxation rules to which they will be subject, as well as the PFIC rules, including the advisability, procedure and timing of making a mark-to-market election, in connection with their holding of our shares, including warrants or rights to acquire our shares.

 

Certain Reporting Requirements

 

Certain U.S. investors are required to file IRS Form 926, Return by U.S. Transferor of Property to a Foreign Corporation, and certain U.S. Investors may be required to file IRS Form 5471, Information Return of U.S. Persons with Respect to Certain Foreign Corporations, reporting transfers of cash or other property to us and information relating to the U.S. investor and us. Substantial penalties may be imposed upon a U.S. investor that fails to comply. Each U.S. investor should consult its own tax advisor regarding these requirements.

 

In addition, legislation imposes reporting requirements for the holder of certain foreign financial assets, including equity of foreign entities, if the aggregate value of all of these assets exceeds certain thresholds. Our shares are expected to be subject to these new reporting requirements unless the shares are held in an account at a domestic financial institution. Penalties may apply to any failure to comply with such reporting requirements. U.S. investors should consult their own tax advisors regarding the application of this legislation.

 

Backup Withholding Tax and Information Reporting Requirements

 

Generally, information reporting requirements will apply to distributions with respect to our shares or proceeds on the disposition of our shares paid within the United States (and, in certain cases, outside the United States) to U.S. investors other than certain exempt recipients, such as corporations. Furthermore, backup withholding (currently at 24%) may apply to such amounts if the U.S. investor fails to (i) provide a correct taxpayer identification number, (ii) report interest and dividends required to be shown on its U.S. federal income tax return, or (iii) make other appropriate certifications in the required manner. U.S. investors who are required to establish their exempt status generally must provide such certification on IRS Form W-9.

 

Backup withholding is not an additional tax. Amounts withheld as backup withholding from a payment may be credited against a U.S. investor's U.S. federal income tax liability and such U.S. investor may obtain a refund of any excess amounts withheld by filing the appropriate claim for refund with the IRS and furnishing any required information in a timely manner.

 

Tax Assessment

 

The company and its subsidiaries file income tax returns in Israel, U.S.A and Denmark.

 

The Israeli tax returns of the Company are open for examination by the Israeli Tax Authority for tax years beginning in 2018.

 

The Federal tax returns of our U.S. subsidiary are open for examination by the Federal Tax Authorities for tax years beginning in 2019. The New Jersey state tax returns of the U.S. subsidiary are open for examination by the New Jersey State Tax Authority for the tax years beginning in 2018. The California State Tax returns of the U.S. subsidiary are open for examination by the California State Tax Authority for tax years beginning in 2018. The Virginia State Tax returns of the U.S. subsidiary are open for examination by the Virginia State Tax Authority for tax periods beginning in 2020. The Tennessee, New Mexico and New York State Tax returns of the U.S. subsidiary are open for examination by the respective jurisdiction tax authorities for tax years beginning in 2020. The Texas State Tax returns of the U.S. subsidiary are open for examination by the Texas State tax authorities for tax years beginning in 2018. The Illinois State Tax returns of the U.S. subsidiary are open for examination by the by the Illinois State tax authorities for tax years beginning in 2020.

 

The Danish tax returns of our Danish subsidiary are open for examination by the Danish Tax Authority for tax years beginning on January 1, 2017.

 

Not applicable.

 

G.           Statement by experts

 

Not applicable.

 

H.           Documents on Display

 

We are required to file reports and other information with the SEC under the Securities Exchange Act of 1934 (the "Exchange Act") and the regulations thereunder applicable to foreign private issuers. Although as a foreign private issuer we are not required to file periodic information as frequently or as promptly as United States companies, we generally do publicly announce our quarterly and year-end results promptly and file periodic information with the SEC under cover of Form 6-K. We are also exempt from the rules under the Exchange Act prescribing the furnishing and content of proxy statements and our office holders, directors and principal shareholders are exempt from the reporting and other provisions in Section 16 of the Exchange Act.

 

You may review a copy of our filings with the SEC, including any exhibits and schedules, at the SEC's public reference room at 100 F Street N.E., Washington, D.C. 20549. You may call the SEC at 1-800-SEC-0330 for further information on the public reference room. As a foreign private issuer, all documents which were filed after November 4, 2002 on the SEC's EDGAR system will be available for retrieval on the SEC's website at www.sec.gov. The documents referred to in this document may be inspected at the Company's offices, located at 14 Atir Yeda Street, Kfar Sava, Israel 4464323.

 

Any statement in this annual report about any of our contracts or other documents is not necessarily complete. If the contract or document is filed as an exhibit to the annual report the contract or document is deemed to modify the description contained in this annual report. We urge you to review the exhibits themselves for a complete description of the contract or document.

 

Our website is http://www.silicom.co.il. We do not intend for any information contained on our internet website to be considered part of this annual report, and we have included our website address in this annual report solely as an inactive textual reference. We will post on our website any materials required to be posted on such website under applicable corporate or securities laws and regulations, including posting any XBRL interactive financial data required to be filed with the SEC, and any notices of general meetings of our shareholders.

 

I.           Subsidiary information

Not applicable.

 

Market risk is the risk of loss related to changes in market prices, including interest rates and foreign exchange rates, of financial instruments that may adversely impact our consolidated financial position, results of operations or cash flows. Our primary market risk exposures relate to our investment portfolio and fluctuation of the exchange rate of the US Dollar, which is the primary currency in which we conduct our operations, against the NIS with respect to the Company's Israeli operations, and against the DKK and Euro with respect to Danish operations.

 

As of December 31, 2022, our investment portfolio consisted of approximately US$ 19.2 million invested in corporate and government debt securities. These securities are classified as "held to maturity." All of the Company's investments are in fixed-rate instruments.

 

We may be required to adjust the carrying value of our investment securities due to a default, lack of liquidity or other event. For that matter we are required to use of forward-looking information to calculate credit loss estimates

 

 As of December 31, 2022, we were not required to adjust the carrying value of our investment securities.

 

For quantitative information on the Company's marketable securities, please see Note 4 to our consolidated financial statements included elsewhere in this annual report.

 

As of December 31, 2022, we did not have any short or long term interest bearing loans or debts, hence with respect to the Company's business operations, we do not have any exposure to interest rate risk.

Most of our revenues are generated in U.S. Dollars. In addition, most of our costs are denominated and determined in U.S. Dollars and NIS. According to the salient economic factors indicated in ASC 830 "Foreign Currency Matters" (formerly SFAS No. 52), "Foreign Currency Translation", our cash flow, sale price, sales market, expense, financing and inter-company transactions, and arrangement indicators, are predominantly denominated in U.S. Dollars, and so, the U.S. dollar is the primary currency of the economic environment in which we operate. Thus, the U.S. dollar is our functional and reporting currency. In our balance sheet, we re-measure into U.S. Dollars all monetary accounts (principally cash and cash equivalents and liabilities) that are maintained in other currencies. For this re-measurement, we use the relevant foreign exchange rate at the balance sheet date. Any gain or loss that results from this re-measurement is reflected in the statement of operations as appropriate. We measure and record non-monetary accounts in our balance sheet in U.S. Dollars. For this measurement, we use the U.S. dollar value in effect at the date that the asset or liability was initially recorded in our balance sheet (the date of the transaction).

 

As of December 31, 2022, we had accounts receivable in NIS or in funds linked thereto in the amount of US$ 6,047 thousand. Market risk was estimated as the potential decrease in balance resulting from a hypothetical 10% increase in the year-end Dollar exchange rate. Assuming such increase in the Dollar exchange rate, the balance of our accounts receivable would decrease by US$550 thousand. As of December 31, 2022, we had accounts payable in NIS or linked thereto in the amount of US$ 13,885 thousand. Market risk was estimated as the potential increase in balance resulting from a hypothetical 10% decrease in the year-end Dollar exchange rate. Assuming such decrease in the Dollar exchange rate, the balance of our accounts payable would increase by US$ 1,543 thousand.

 

In 2022, there was an increase of 13.15% in the Dollar exchange rate to the NIS which resulted in an aggregate decrease in the fair value of our assets of US$ 1,671 thousand and an aggregate decrease in the fair value of our liabilities of US$ 2,320 thousand.

 

Inflation in Israel and the Israeli currency as well as U.S. Dollar exchange rate fluctuations may have only a limited effect on our accounts payable as well as on our accounts receivable, as described above.

 

Inflation in Denmark and the Danish currency as well as U.S. Dollar exchange rate fluctuations do not have a significant effect on our accounts receivable as well as on our accounts payable.

 

Our operating expenses may be affected by fluctuations in the value of the U.S. dollar as it relates to the NIS. By way of example, a hypothetical 10% weakening in the value of the U.S. Dollar relative to the NIS in 2022 would have resulted in an increase in operating expenses of approximately US$ 2,166 thousand for the year ended December 31, 2022. In addition, our operating expenses may be affected by fluctuations in the value of the U.S. Dollar as it relates to the DKK. By way of example, a hypothetical 10% weakening in the value of the U.S. dollar relative to the DKK in 2022, would have resulted in an increase in operating expenses of approximately US$ 589 thousand for the year ended December 31, 2022.

 

As of December 31, 2022, all of our investments, other than a portion of our cash and cash equivalents comprising a small portion of our overall investment portfolio, consisted of investments denominated in U.S. Dollars, and our portfolio is therefore not subject to significant exposure to foreign currency exchange risk.

 

As of December 31, 2022, we were not engaged in any hedging or other transactions intended to manage the risks relating to foreign currency exchange rate or interest rate fluctuations.

 

Our investment portfolio includes "held to maturity" marketable securities. These securities include investments issued by highly rated corporations. As of December 31, 2022, the rating of the securities in our portfolio was at least A-. Nonetheless, these investments are subject to general credit and counterparty risks (such as that the counterparty to a financial instrument fails to meet its contractual obligations), which were exacerbated by the recent turmoil that has affected the financial markets and the global economy and caused credit issues for a number of reputable financial institutions. Any changes in fair value of our investment securities due to credit risk do not affect our profit or loss unless there is other than temporary impairment (see Note 2X to our financial statements for the year ended December 31, 2022). For additional information see "Item 3.D. Key Information – Risk Factors."

 

As of December 31, 2022, we were not required to adjust the carrying value of our investment securities.

 

Our top four ultimate customers accounted for approximately 33% of our revenues in 2022. We expect that a small number of customers will continue to account for a significant portion of our revenues for the foreseeable future. Difficulties in the fulfillment of the financial obligations of one or more of such customers may expose us to credit risk and may have a material adverse effect on our business and our financial condition and results. For additional information see "Item 3.D. Key Information – Risk Factors". Difficulties in the fulfillment of financial obligations of one or more of our customers may have an adverse effect on our ability to consummate the collection of consideration payable under purchase orders placed by, or invoiced to, such customers under one or more Design Wins in relation to which such customers operate. See Note 2.X (2) of our consolidated financial statements.

 

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in its Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms, and that such information is accumulated and communicated to our Chief Executive Officer and Chief Financial Officer to allow timely decisions regarding required disclosure. Our management, including our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of our disclosure controls and procedures, as defined under Exchange Act Rule 13a-15(e) and Rule 15d-15(e), as of the end of the period covered by this Annual Report on Form 20-F. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of such date, our disclosure controls and procedures were effective.

 

Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles.

 

Management assessed our internal control over financial reporting as of December 31, 2022, the end of our fiscal year. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in "Internal Control — Integrated Framework (2013)."

 

Based on our assessment, management has concluded that our internal control over financial reporting was effective as of December 31, 2022, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external reporting purposes in accordance with U.S. generally accepted accounting principles. We reviewed the results of management's assessment with the audit committee of our Board of Directors.

 

This annual report includes, on page F-4 of this form 20-F, an attestation report of the Company's registered public accounting firm on management's assessment of the Company's internal control over financial reporting.

 

Internal control over financial reporting has inherent limitations. Internal control over financial reporting is a process that involves human diligence and compliance and is subject to lapses in judgment and breakdowns resulting from human failures. Internal control over financial reporting also can be circumvented by collusion or improper management override. Because of such limitation, there is a risk that material misstatements will not be prevented or detected on a timely basis by internal control over financial reporting. However, these inherent limitations are known features of the financial reporting process. Therefore, it is possible to design into the process safeguards to reduce, though not eliminate, this risk.

 

There was no change in our internal controls over financial reporting that occurred during the period covered by this annual report that has materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting.

Not Applicable.

 

Our board of directors had determined that both Ms. Ayelet Aya Hayak and Mr. Ilan Erez were our audit committee financial experts.

 

Our company has adopted a code of ethics, which applies to all our employees, office holders and directors, including our Chief Executive Officer, our Chief Financial Officer, our VP Finance, Director of Finance and our Corporate Controller.

The following table presents fees for professional services for the audit of the Company's consolidated annual financial statements for the years ended December 31, 2022 and 2021, audit-related services and tax services rendered by Somekh Chaikin, a member firm of KPMG International, and Kesselman & Kesselman Certified Public Accountants (Isr.) PwC Israel.

 

We are required to obtain the approval of our audit committee (and subsequently the consent of the Board of Directors and shareholders) before engaging our independent auditors, Kesselman & Kesselman Certified Public Accountants (Isr.) PwC Israel, to audit our consolidated financial statements, as well as to provide other audit or permitted non-audit services to us. This policy, which is designed to assure that such engagements do not impair the independence of our auditors, requires pre-approval from the audit committee on an annual basis for the various audit and non-audit services that may be performed by our auditors. Our audit committee is not permitted to approve the engagement of our auditors for any services that would be inconsistent with maintaining the auditor's independence or that are not permitted by applicable law.

 

Following a resolution of our Board of Directors on March 15, 2021, Somekh Chaikin, Certified Public Accountants (Israel), a member of KPMG International (“KPMG”), declined to be reelected as our independent accountant.

 

KPMG audited our financial statements as of and for the fiscal years ended December 31, 2020 and 2019. The reports of KPMG on the financial statements of the Company for the fiscal years ended December 31, 2020 and 2019, did not contain any adverse opinion or disclaimer of opinion and were not qualified or modified as to uncertainty, audit scope or accounting principles

 

During the period between January 1, 2020 and the cessation of their engagement on March 15, 2021, there were no disagreements between us and KPMG on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure, which disagreements, if not resolved to the satisfaction of KPMG, would have caused KPMG to make reference to the subject matter of the disagreements in connection with its audit reports on our financial statements.

 

During the period between January 1, 2020 to March 15, 2021, KPMG did not advise the Company of any reportable events specified in Item 304(a)(1)(v) of Regulation S-K with respect to us.

 

Kesselman & Kesselman Certified Public Accountants (Isr.) PwC Israel (“PwC”) was initially appointed as our independent registered public accounting firm following the Company’s Annual General Meeting on June 3, 2021, and were reappointed at the Company’s Annual General Meeting on June 7, 2022.

 

Through the period prior to the engagement of PwC, we did not consult KPMG regarding (i) the application of accounting principles to any specified transaction, either completed or proposed; (ii) the type of audit opinion that might be rendered on our financial statements, and either a written report was provided to the registrant or oral advice was provided that the new accountant concluded was an important factor considered by the registrant in reaching a decision as to the accounting, auditing or financial reporting issue; or (iii) any matter that was either the subject of a disagreement (as defined in Item 16F(a)(1)(iv) and the related instructions to this Item) or a reportable event (as defined in Item 16F(a)(1)(v)).

 

Our corporate governance practices differ from those followed by domestic companies as required under the listing standards of the NASDAQ Global Market, due to an exemption that we obtained from NASDAQ as foreign private issuer which enables us to comply with our home country laws of the State of Israel, including the provisions of the Companies Law, in lieu of NASDAQ Listing Rules. Below is a concise summary of the significant ways in which our corporate governance practices differ from the corporate governance requirements of NASDAQ applicable to domestic U.S. listed companies:

 

 

4.9	Lease agreement between Silicom Denmark A/S and Svanestraede ApS, for space in Søborg, Denmark, dated November 1, 2020. As this lease agreement is written in Danish, a summary is included in the Exhibit. (*)

April 27, 2023