As filed with the Securities and Exchange Commission on July 10, 2007

Registration No. 333-      

 

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

 

 

Form F-1

REGISTRATION STATEMENT

UNDER THE

SECURITIES ACT OF 1933

 

 

 

 

 

 

 

 

Voltaire Ltd.

9 Hamenofim Street Building A

Herzeliya 46725

Israel

+972 (9) 971-7666

(Address, Including Zip Code, and Telephone Number,

Including Area Code, of Registrant’s Principal Executive Offices)

 

Voltaire, Inc.

6 Fortune Drive

Billerica, Massachusetts 01821

(978) 439-5400

(Name, Address, Including Zip Code, and Telephone Number,

Including Area Code, of Agent for Service)

 

 

Approximate date of commencement of proposed sale to the public:

 

As soon as practicable after effectiveness of this registration statement.

 

If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, as amended (the “Securities Act”), check the following box.   o

 

If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.   o

 

If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.   o

 

If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earliest effective registration statement for the same offering.   o

 

If delivery of the prospectus is expected to be made pursuant to Rule 434 under the Securities Act, check the following box.   o

 

 

 

 

 

 

TABLE OF CONTENTS

 

 

You should rely only on the information contained in this prospectus. We have not authorized anyone to provide you with information different from that contained in this prospectus. This prospectus is not an offer to sell or a solicitation of an offer to buy our ordinary shares in any jurisdiction where it is unlawful. The information contained in this prospectus is accurate only as of the date of this prospectus, regardless of the time of delivery of this prospectus or of any sale of ordinary shares.

 

PROSPECTUS SUMMARY

	•	Lower latency for acceleration of information delivery.   Based on published product specifications, our InfiniBand-based solutions provide significantly lower end-to-end latency than existing Ethernet- and Fibre Channel-based solutions. Through our relationships with independent software vendors, or ISVs, in our targeted vertical markets, we are able to further reduce end-to-end latency and deliver greater application acceleration benefits to our end customers.
	•	Higher bandwidth for improved resource utilization.   In high-performance computing environments, customers require optimal bandwidth to address and eliminate performance bottlenecks. Based on published product specifications, our InfiniBand-based solutions provide significantly higher bandwidth than existing Ethernet- and Fibre Channel-based solutions.
	•	Greater scalability to grow with customers’ demands.   Our server and storage switching solutions enable linear scalability by off-loading communication processing to allow servers to run applications more efficiently.
	•	Simplified data center infrastructure.   Our solutions eliminate the need for multiple adapters and related cables for each grid computing interconnect architecture. Because we are able to reduce the number of required adapters and cables to multiple networks, our solutions reduce the complexity of the data center.
	•	Improved grid performance, manageability and provisioning through enhanced software.   Our software solutions are designed to maximize grid performance and efficiency.

	•	Continue to develop high-performance grid computing interconnect solutions.   We intend to continue to extend our market position, technical expertise and customer relationships to further develop high-performance grid computing interconnect solutions built upon unified fabric architectures. To broaden our market opportunity, we will continue to promote grid adoption and develop products that are compatible with other grid computing interconnect architectures, while further expanding our InfiniBand-based solutions.
	•	Extend our software offerings.   We intend to expand our portfolio of grid infrastructure software. We are primarily focused on enhancing our existing software offerings in the areas of performance monitoring and management, as well as fabric virtualization.
	•	Leverage our OEM relationships to expand market position.   We intend to continue to expand our relationships with our existing server OEMs, while establishing similar relationships with other server,

		storage and communication OEMs. We believe these relationships will help to accelerate the adoption of our high-performance grid computing interconnect solutions.

	•	Expand existing and new vertical and geographic markets.   We intend to further penetrate existing vertical markets and enter new vertical markets. We believe that our relationships with ISVs allow us to bring the benefits of our grid solutions to end customers across a broad range of vertical markets. We also plan to expand our sales and marketing efforts in new geographic markets to meet the needs of end customers in our various vertical markets.

	•	We have a history of losses, may incur future losses and may not achieve profitability.
	•	Our revenues and prospects may be harmed if the InfiniBand-based architecture is not widely adopted in the grid computing interconnect market.
	•	Enterprises may not adopt our technology and may continue to use Ethernet-based solutions, which could harm our future growth.
	•	A small number of OEM customers currently account for the majority of our revenues, and the loss of one or more of these OEM customers, or a significant decrease or delay in sales to any of these OEM customers, could reduce our revenues significantly.
	•	We may be unable to compete effectively with other companies in our market which offer, or may in the future offer, competing products.
	•	Our reliance on Mellanox Technologies Ltd. and other limited-source suppliers could harm our ability to meet demand for our products in a timely manner or within budget.

THE OFFERING

 

Ordinary shares offered:
By Voltaire		5,770,000 shares.
By the selling shareholders		1,923,000 shares.
Shares to be outstanding after this offering		20,480,554 shares.
Use of proceeds		We intend to use the net proceeds of this offering to fund our research and development activities, business development and marketing activities, and for general corporate purposes and working capital. We also intend to use a portion of the net proceeds to repay in full a loan with an outstanding principal amount of $5.0 million. We also may use a portion of the net proceeds to acquire or invest in complementary companies, products or technologies although we currently do not have any acquisition or investment planned. We will not receive any proceeds from the sale of shares by the selling shareholders.
Risk Factors		See “Risk Factors” and other information included in this prospectus for a discussion of factors you should carefully consider before deciding to invest in our ordinary shares.
Proposed Nasdaq Global Market symbol		“VOLT”.

	•	3,768,508 ordinary shares reserved for issuance under our share option plans, of which options to purchase 3,469,007 ordinary shares at a weighted average exercise price of $2.41 per share and options to purchase 2,931 ordinary shares at an exercise price of $320.00 per share have been granted; and
	•	140,625 ordinary shares issuable upon the exercise of warrants to purchase Series E preferred shares granted to an entity that made a loan to us at an exercise price of $4.00 per share and 59 ordinary shares issuable upon the exercise of warrants to purchase ordinary shares granted to an Israeli non-profit organization at an exercise price of $1,270 per share.

	•	reflects the conversion upon the closing of this offering of all of our issued and outstanding preferred shares into 13,946,624 ordinary shares on a one-for-one basis;
	•	assumes an initial public offering price of $13.00 per ordinary share, the midpoint of the estimated initial public offering price range;
	•	assumes no exercise of the underwriters’ option to purchase up to an additional 865,462 ordinary shares from us and 288,488 ordinary shares from the selling shareholders to cover overallotments; and
	•	reflects a 1-for-100 reverse share split effected on March 7, 2004 and a 1-for-4 reverse share split effected on July 5, 2007.

		Year Ended December 31,												Three Months Ended March 31,
		2004				2005				2006				2006				2007
														(unaudited)
		(in thousands, except share and per share data)
Consolidated statements of operations data:
Revenues		$	4,916			$	15,366			$	30,427			$	4,389			$	8,580
Cost of revenues			3,565				10,830				19,223				2,846				5,391
Gross profit			1,351				4,536				11,204				1,543				3,189
Operating expenses:
Research and development, gross(1)			6,658				6,538				7,694				2,003				2,714
Less royalty-bearing participation			700				621				—				—				—
Research and development, net			5,958				5,917				7,694				2,003				2,714
Sales and marketing(1)			4,327				6,045				8,281				1,604				2,106
General and administrative(1)			2,271				2,681				3,534				711				979
Total operating expenses			12,556				14,643				19,509				4,318				5,799
Loss from operations			(11,205	)			(10,107	)			(8,305	)			(2,775	)			(2,610	)
Financial income (expenses), net			144				191				(460	)			102				(355	)
Loss before income tax expenses			(11,061	)			(9,916	)			(8,765	)			(2,673	)			(2,965	)
Income tax expenses			—				(111	)			(84	)			—				(35	)
Net loss			(11,061	)			(10,027	)			(8,849	)			(2,673	)			(3,000	)
Accretion of redeemable convertible preferred shares(2)			(2,144	)			(2,959	)			(3,573	)			(893	)			(1,054	)
Benefit to Series A, B and B1 shareholders(3)			(1,800	)			—				—				—				—
Charge for beneficial conversion feature of Series D and D2 redeemable convertible preferred shares			(362	)			(482	)			(535	)			(134	)			(149	)
Net loss attributable to ordinary shareholders		$	(15,367	)		$	(13,468	)		$	(12,957	)		$	(3,700	)		$	(4,203	)
Net loss per share attributable to ordinary shareholders — basic and diluted		$	(29.67	)		$	(21.16	)		$	(19.92	)		$	(5.73	)		$	(6.30	)
Weighted average number of ordinary shares used in computing net loss per share attributable to ordinary shareholders — basic and diluted			517,926				636,536				650,476				645,419				667,631
Pro forma net loss per share attributable to ordinary
shareholders — basic and diluted (unaudited)(4)										$	(0.69	)						$	(0.22	)
Weighted average number of ordinary shares used in computing pro forma net loss per share attributable to ordinary shareholders — basic and diluted (unaudited)(4)											12,794,446								13,776,282

(1)		Includes share-based compensation expense related to options granted to employees and others as follows:

		Year Ended December 31,												Three Months Ended March 31,
		2004				2005				2006				2006				2007
														(unaudited)
		(in thousands)
Research and development, net		$	—			$	9			$	59			$	14			$	18
Sales and marketing			—				—				90				21				26
General and administrative			382				65				161				33				73
Total		$	382			$	74			$	310			$	68			$	117

(2)		Accretion of redeemable convertible preferred shares represents the original purchase price plus accrued dividends calculated using the interest method. Certain holders of our preferred shares have the option, after March 7, 2009, to require us to redeem all of the preferred shares for an amount equal to the greater of (i) the original purchase price plus accrued dividends (and, with respect to the Series D preferred shares, plus certain interest payments) and (ii) the then current fair market value of such shares. The redemption option and the related accretion of the preferred shares will terminate upon conversion of the preferred shares into ordinary shares upon the closing of this offering.
(3)		In connection with the sale of our Series E preferred shares in 2004, our Series A, Series B and Series B1 preferred shares were converted into ordinary shares. At the time of this conversion, we issued junior liquidation securities to the holders of such shares, which entitle the holders to an aggregate payment of $1.8 million, following payment of certain required amounts to the holders of our Series C, D, E and E2 preferred shares, if we complete a merger transaction or are acquired or liquidated. The junior liquidation securities do not have voting rights and will be cancelled upon the closing of this offering for no consideration.
(4)		Pro forma basic and diluted loss per ordinary share gives effect to the conversion upon the closing of this offering, assuming such closing occurred on March 31, 2007, of all of our issued and outstanding preferred shares into ordinary shares on a one-for-one basis. See Note 2w to our consolidated financial statements for an explanation of the number of shares used in computing per share data.

		As of March 31, 2007
						Pro Forma As
		Actual				Adjusted
		(unaudited)
		(in thousands)
Consolidated balance sheet data:
Cash and cash equivalents		$	17,221			$	79,721
Restricted deposit			269				269
Working capital			19,733				82,233
Total assets			41,789				104,289
Long-term loan			5,000				—
Total liabilities			27,694				21,773
Redeemable convertible preferred shares			76,167				—
Accumulated deficit			(66,285	)			66,285
Total shareholders’ equity (capital deficiency)			(62,072	)			82,516

 

This offering and an investment in our ordinary shares involve a high degree of risk. You should consider carefully the risks described below, together with the financial and other information contained in this prospectus, before you decide to buy our ordinary shares. If any of the following risks actually occurs, our business, financial condition and results of operations would suffer. In this case, the trading price of our ordinary shares would likely decline and you might lose all or part of your investment.

 

Risks Relating to Our Business

 

We have a history of losses, may incur future losses and may not achieve profitability.

 

We have incurred net losses in each fiscal year since we commenced operations in 1997. We incurred net losses of $3.0 million in the three months ended March 31, 2007, $8.8 million in 2006, $10.0 million in 2005 and $11.1 million in 2004. As of March 31, 2007, our accumulated deficit was $66.3 million. Our losses could continue for the next several years as we expand our sales and marketing activities, continue to invest in research and development, expand our general and administrative operations and incur additional costs related to being a public company. We made our first sales of products in the grid computing market in 2003 and accordingly, we have a limited operating history. We may not generate sufficient revenues in the future to achieve or maintain profitability.

 

Our revenues and prospects may be harmed if the InfiniBand-based architecture is not widely adopted in the grid computing interconnect market.

 

Our solutions leverage the performance and latency benefits of the InfiniBand grid computing interconnect architecture and provide interconnect functionality for data center environments that rely on industry-standard server and storage units. The InfiniBand architecture was first introduced in October 2000 and has a relatively short history and limited adoption in the grid computing interconnect market. End customers that purchase information technology, or IT, products and services from server vendors, such as our original equipment manufacturer, or OEM, customers, must find InfiniBand to be a compelling solution to meet their grid computing needs. We cannot control third-party adoption of InfiniBand over competing grid computing interconnect architectures such as Ethernet, Fibre Channel and other proprietary technologies. InfiniBand may fail to compete effectively with these architectures, some of which are well established. If other architectures continue to remain the market standard or if a superior alternative architecture to InfiniBand is developed, our revenues and prospects may be harmed. Furthermore, we may be required to incur substantial costs to modify our existing products to remain competitive with new or existing architectures and we can provide no assurance that we will succeed in doing so.

 

Enterprises may not adopt our technology and may continue to use Ethernet-based solutions, which could harm our future growth.

 

More than half of our revenues to date have been derived from end customers that are governmental, research or educational institutions, such as government-funded research laboratories and post-secondary educational institutions. An important element of our strategy is to accelerate the adoption of our InfiniBand-based solutions by enterprises, which have traditionally used products based on the Ethernet architecture. In order to compete effectively against providers of solutions that utilize Ethernet, we must convince current Ethernet users to move to a new technology, and incur the related marketing, education and maintenance costs associated with such a move. Potential enterprise customers may also elect to rely on internally-developed solutions or proprietary solutions developed by other companies instead of implementing our InfiniBand-based solutions. In addition, even if potential enterprise customers adopt InfiniBand, we may have to compete with other suppliers of InfiniBand-based products in the enterprise market. If a leading company or several companies in the enterprise market incorporates our InfiniBand-based products, but fails to achieve desired performance and reliability, our reputation and revenues could be adversely affected.

A small number of our OEM customers currently account for the majority of our revenues, and the loss of one or more of these OEM customers, or a significant decrease or delay in sales to any of these OEM customers, could reduce our revenues significantly.

 

We market and sell our products to end customers primarily through our OEM customers who integrate our solutions into their product offerings. To date, we have derived a substantial portion of our revenues from a small number of OEM customers. Sales to our top three OEM customers accounted for 58% of our revenues in 2005, 63% of our revenues in 2006 and 67% of our revenues in the three months ended March 31, 2007, as follows:

 

 

We anticipate that a large portion of our revenues will continue to be derived from sales to a small number of OEM customers in the future. Our sales to our OEM customers are made on the basis of purchase orders rather than long-term purchase commitments. Our relationships with our OEM customers are generally governed by non-exclusive agreements that typically have an initial term of one to three years and automatically renew for successive one year terms, have no minimum sales commitments and do not prohibit our OEM customers from offering products and services that compete with our products. In addition, our agreements typically require us to deliver our products to our OEM customers within 30 to 90 days from the time we receive the order, however, in many cases they may request faster delivery. A failure by us to meet product delivery deadlines may damage our relationship with our OEM customers and harm our market position. The size of purchases by our OEM customers typically fluctuates from quarter-to-quarter and year-to-year, and may continue to fluctuate in the future, which may affect our quarterly and annual results of operations.

 

In addition, our competitors may provide incentives to our existing and potential OEM customers to use or purchase their products and services or to prevent or reduce sales of our solutions. Some of our OEM customers also possess significant resources and advanced technical capabilities and may, either independently or jointly with our competitors, develop and market products and related services that compete with our solutions. If either of these were to occur, our OEM customers may discontinue marketing and distributing our solutions. Therefore, if any of our OEM customers reduces or cancels its purchases from us, or terminates its agreement with us for any reason, and we are unable to replace the lost revenues with sales to an alternate OEM customer, it would have an adverse effect on our revenues and results of operations.

 

We may be unable to compete effectively with other companies in our market which offer, or may in the future offer, competing products.

 

We compete in a rapidly evolving and highly competitive market. Our InfiniBand-based solutions currently address the high performance computing, or HPC, interconnect, the 10 Gigabit Ethernet switching, and the storage switching end-markets. These markets are characterized by continuous technological change and customer demand for high performance products. Our current principal competitor is Cisco Systems, Inc., which is a significant supplier of InfiniBand, Ethernet and Fibre Channel-based solutions, and has traditionally been the most recognized and dominant supplier for enterprises. We also compete with QLogic Corporation, a provider of Fibre Channel-based and InfiniBand-based solutions. These companies are substantially larger than we are and have significantly greater brand recognition and resources, which may allow them to respond more quickly to changes in customer requirements or to new or emerging technologies. We also compete to a lesser degree with providers of 10 Gigabit Ethernet and proprietary high-performance grid computing interconnect solutions. The entry of new competitors into our market and acquisitions of our existing competitors by companies with significant resources, better brand recognition and established relationships with our end

customers could result in increased competition and harm our business. Increased competition may cause us to make competitive price reductions thereby reducing our gross margins and market share, any of which could have a material adverse effect on our business, financial condition or result of operations.

 

We depend significantly on our OEM customers to market, sell, install and provide initial and escalation level technical support for our products, and if any of these OEMs fails to adequately perform, then our sales may suffer.

 

Our OEM customers are responsible for integrating our solutions into their products and providing first call and second escalation service and support for products incorporating our solutions. As a result, we depend on the ability of our OEM customers to market, sell and service our solutions successfully to end customers and to provide adequate customer support. Any failure by our OEM customers to provide adequate support to end customers could result in customer dissatisfaction with us or our solutions, which could result in a loss of an end customer, harm our reputation and delay or limit market acceptance of our solutions. In addition, if any significant OEM customer should fail, individually or in the aggregate, to perform as an end customer expects, our sales may suffer. We cannot provide any assurance that our OEM customers will market our solutions effectively, receive and fulfill end-customer orders of our solutions on a timely basis or continue to devote adequate resources to support the sales, marketing and technical support of our products.

 

We do not expect to sustain our recent revenue growth rate, which may reduce our share price.

 

Our revenues have grown rapidly over the last four years. Our revenues were $1.2 million in 2003, $4.9 million in 2004, $15.4 million in 2005, $30.4 million in 2006 and $8.6 million in the three months ended March 31, 2007. We do not expect to sustain our recent growth rate in future periods. You should not rely on our revenue growth in any prior quarterly or annual period as an indication of our future revenue growth. If we are unable to maintain adequate revenue growth, we may not have sufficient resources to execute our business objectives and our share price may decline. You must consider our business and prospects in light of the risks and difficulties we encounter as a rapidly growing technology company.

 

Our gross margins and results of operations may be adversely affected if we do not continue to achieve economies of scale and maintain or increase sales of higher margin products.

 

Our gross margins have increased from 27% in 2004 to 30% in 2005 and to 37% in 2006 and in the three months ended March 31, 2007. Our historical gross margins improved primarily due to reductions in costs of materials and manufacturing overhead due to higher production volumes. Our gross margins are also impacted by the mix of products that we sell. Our strategy is to increase our gross margins in the future by increasing sales of our Grid Director ISR 9288 and ISR 9096 director-class switches and Grid Switch edge switches as a percentage of revenues, while reducing sales of lower-margin host adapter cards as a percentage of revenues. We may not succeed in this strategy because customers may seek complete solutions that require us to sell host adapter cards to them and we may not succeed in our efforts to sell host adapter cards at premium prices. In addition, we may incur additional costs as a result of our efforts to increase sales of our higher-margin products and may not be successful in doing so. As a result, our financial position may be adversely affected. If we are unable to continue to achieve economies of scale and maintain or increase sales of higher margin products, we may not achieve our expected gross margin rate, resulting in lower than expected profitability.

 

Our reliance on Mellanox Technologies Ltd. and other limited-source suppliers could harm our ability to meet demand for our products in a timely manner or within budget.

 

We obtain the application-specific integrated circuit, or ASIC, the main component used in our Grid Director ^tm director-class switches and Grid Switch ^tm edge switches, from Mellanox Technologies Ltd., which is currently the only manufacturer of this chip. Our switch products accounted for approximately 54% of our revenues in 2006. We entered into a non-exclusive agreement with Mellanox dated as of October 7, 2005, for an initial period of two years, which automatically renews for successive one-year periods unless one party notifies the other party within 90 days prior to each annual termination date that it does not wish to renew the agreement. Standard lead-times under the agreement may be changed at Mellanox’s sole discretion upon

30-days prior written notice. In addition, Mellanox may increase the ASIC purchase price upon 30-days prior notice and has the right to alter the ASIC upon 120-days prior notice, and to discontinue production of the ASIC upon six-months prior notice. During a period of six months after our receipt of a notice of discontinuance from Mellanox, we may purchase from Mellanox such commercially reasonable quantity of the discontinued product as we deem reasonably necessary for our future requirements. Mellanox is obligated to continue to provide us the discontinued product and to facilitate our transition to new products for a period not to exceed nine months following our receipt of the notice of discontinuance.

 

In the event that Mellanox is unable to supply the ASIC on a timely basis or in the quantities that we require, we would be unable to manufacture our switch products without incurring significant development and design costs. There is currently no alternative supplier for the ASIC produced by Mellanox. If an alternative supplier of the ASIC were to develop in the future, we would likely be forced to make changes to our switching products to ensure interoperability with the new ASIC. There can be no assurance that we will be able to successfully modify our switches to accommodate any alternate technology or any change in Mellanox’s product. As a result, a failure by Mellanox to supply the ASIC would materially adversely affect our business.

 

In addition, we have designed our products to incorporate several specific components, such as our InfiniBand connectors and backplanes, printed circuit boards, chassis and mechanical parts, power supplies and processor boards. We purchase these components from major industry suppliers, but do not have long-term supply contracts with these suppliers. We believe that substitute components are available from alternate sources, however, any change in these components would require us to qualify a new supplier’s components for inclusion in our products which would likely require significant engineering changes, which could take a number of months to complete.

 

We currently depend on two outside contract manufacturers, Sanmina-SCI Corporation and Zicon Ltd., to manufacture and warehouse our products and if they experience delays, disruptions, quality control problems or a loss in capacity, it could materially adversely affect our operating results.

 

We subcontract the manufacture, assembly and testing for our products to two contract manufacturers. These functions are performed by Sanmina-SCI Corporation and Zicon Ltd. These contract manufacturers provide us with full turn-key manufacturing and testing services. Sanmina-SCI is responsible for the manufacture of our Grid Switch InfiniBand Switch Router, or ISR, 9024. Zicon manufacturers all modules and mechanics related to our director class switches and their gateway modules for connecting to Ethernet and Fibre Channel. Our contract manufacturers also store our inventory of key components, as well as finished products after manufacturing and before shipping to customers. If any of these contract manufacturers experience delays, disruptions or quality control problems in manufacturing our products, including insufficient inventory or supply of components, or if we fail to effectively manage the relationship with any of these subcontractors, shipments of products to our customers may be delayed, which could have a material adverse effect on our relationships with our customers and end customers.

 

We currently have only a letter agreement with Sanmina-SCI and no long-term supply contract with Zicon. We are in the process of negotiating a long-term supply contract with Zicon and currently rely on committed purchase orders to meet our manufacturing requirements. Unless we enter into a long-term supply contract with each of these manufacturers, they will not be obligated to perform services or supply products to us for any specific period, in any specific quantities or at any specific price, except as may be provided in a particular purchase order. Neither of our contract manufacturers has provided contractual assurances to us that adequate capacity will be available to us to meet future demands for our products.

 

Sanmina-SCI’s facilities are located in Ma’alot, Israel and Zicon’s facilities are located in Petach Tikva, Israel. Ma’alot is located in northern Israel and is in range of rockets that were fired into Israel during the mid-2006 war with Hezbollah in Lebanon. In the event that the facilities of either contract manufacturer are damaged for any reason, including as a result of hostile action, our ability to deliver products to customers could be materially adversely affected. See also “—Risks Relating to Our Location in Israel—Conditions in Israel could adversely affect our business.”

Our solutions are highly technical and any undetected software or hardware errors in our products could have a material adverse effect on our operating results.

 

Due to the complexity of our solutions and variations among customers’ computing environments and data centers, we may not detect product defects until our products are fully deployed in our customers’ high performance computing environments and data centers. Regardless of whether warranty coverage exists for a product, we may be required to dedicate significant technical resources to resolving any defects. If we encounter significant product problems, we could experience, among other things, loss of customers, cancellation of product orders, increased costs, delays in recognizing revenue and damage to our reputation. Some of our customers traditionally demand early delivery of products containing our most advanced technology prior to completion of our rollout. For example, during the third quarter of 2006, we provided early product delivery of a high-end switch based on the newly released double data rate, or DDR, chipset to a limited number of OEM and end customers desiring the newest technology available. Because the system did not perform as expected in the field under certain high stress environments, we had to defer recognition of $7.3 million of revenue, which we expect to recognize during the second and third quarters of 2007. We are currently in the process of finalizing our testing of the redesigned version of the DDR-based system required for general release to the market.

 

In addition, we could face claims for product liability, tort or breach of warranty. Defending a lawsuit, regardless of its merit, is costly and may divert management’s attention from normal business operations. If our business liability insurance is inadequate or future coverage is unavailable on acceptable terms or at all, our financial condition could be harmed.

 

We have limited visibility into end customer demand for our solutions, which introduces uncertainty into our manufacturing forecasts and business planning, and could negatively impact our financial results.

 

Our business is subject to uncertainty because of our limited visibility into end customers’ future buying patterns and demands, which poses a challenge for us in predicting the amount and timing of our revenue. Sales of our solutions are made on the basis of purchase orders rather than long-term purchase commitments. In addition, we place orders with our suppliers and contract manufacturers based on forecasts of our OEM customers’ demand, which are based on numerous assumptions, each of which may introduce variability and error into our estimates. This process requires us to make multiple demand forecast assumptions with respect to both our OEM customers’ and end customers’ demands. Because the lead time for fulfilling an order from an OEM customer is typically one to two months, while the lead-time to order certain of the components and assemble our products can be three to four months, forecasts of demand for our products must be made in advance of customer orders. In addition, we base business decisions regarding our growth on our forecasts of end customer demand. As we grow, anticipating end customer demand may become increasingly challenging. If we overestimate end customer demand, we may order more inventory of components and allocate more resources to manufacturing products than is necessary. In the event that we are unable to sell our finished product or in the event that our inventory of components becomes obsolete, we may be required to incur significant charges and write-offs related to our inventory. This could have an adverse affect on our balance sheet and results of operations. Conversely, if we underestimate end customer demand, we could forego revenue opportunities, lose market share and damage our end customer relationships.

 

If we fail to develop new products or enhance the performance of our existing solutions with improved technologies to meet rapid technological change and market demands in a timely and cost-effective manner, our business will suffer.

 

We invest heavily in advancing our technology and developing new solutions to keep pace with rapid changes in customer demand and with our competitors’ efforts to advance their technology. In particular, we must satisfy demand for improved computing performance. We are currently engaged in the development process for next generation solutions in order to meet these demands. The development process for these advancements is lengthy and requires us to accurately anticipate technological innovations and market trends.

Developing and enhancing these products can be time-consuming, costly and complex. Successful product design, development and introduction on a timely basis require that we:

 

 

We may be unable to successfully develop additional next-generation products or product enhancements. In addition, we cannot provide any assurance that new products or enhancements, such as our next generation DDR optimized director class products and supporting software, will be completed in a timely manner. Delays in completing the development and introduction of products that address new applications or markets could cause our sales to decline and our operating loss to increase. Furthermore, we may make substantial investments in the research and development of new products that are then not accepted by the market. If we fail to address effectively the changing demands of customers and to develop the required enhancements to our products in order to keep pace with advances in technology, our business and revenues will be adversely affected. In addition, we cannot provide any assurance that we will be able to obtain certification, as required, for our existing or newly developed products by national regulators.

 

If we fail to manage our future growth effectively, we may not be able to market and sell our products and services successfully.

 

We have expanded our operations significantly since we began offering grid computing solutions in 2003 and anticipate that further expansion will be required. Our future operating results depend to a large extent on our management’s ability to plan and direct our expansion and growth successfully, including training our sales personnel to become productive and generate revenue, forecasting revenue, controlling expenses, implementing and enhancing infrastructure, addressing new markets and expanding international operations in addition to maintaining and expanding our research and development efforts. A failure to manage our growth effectively could materially and adversely affect our ability to market and sell our products and services.

 

In addition, in order to accommodate our growth, our contract manufacturers may need to increase their manufacturing capacity. If our contract manufacturers are unable to maintain the required manufacturing capacity to meet our requirements, the demand for our products may exceed their capacity, which could result in a backlog of orders and harm our ability to meet our customers’ timing demands.

 

Fluctuations in our revenues and operating results on a quarterly and annual basis could cause the market price of our ordinary shares to decline.

 

Our quarterly and annual revenues and operating results are difficult to predict and have fluctuated in the past, and may fluctuate in the future, from quarter-to-quarter and year-to-year. It is possible that our operating results in some quarters and years will be below market expectations. This may cause the market price of our ordinary shares to decline. Our quarterly and annual operating results are affected by a number of factors, many of which are outside of our control. In particular, we have limited exposure to end customer demand upon which we predict future sales of our solutions. Our OEM customers derive a substantial portion of their revenues from sales to a small number of end customers. If a small number of end customers defer delivery or installation of our products for even a short period of time, recognition of a significant amount of revenues may be delayed. In limited circumstances, we do not recognize revenue upon a sale to an OEM customer because the sale by the OEM customer to the end customer is subject to performance of an acceptance test by the end customer. As a result, we may experience quarterly fluctuations in revenues if OEM products incorporating our solutions do not meet the technical specifications required by the end customers.

Additional factors that may affect our quarterly and annual operating results include:

 

 

The international nature of our business exposes us to financial and regulatory risks and we may have difficulty protecting our intellectual property in some foreign countries.

 

To date, we have derived a significant portion of our revenues from OEM customers located outside the United States, principally in Europe, which accounted for 23.6% of our revenues in 2006 and 31.0% of our revenues in the three months ended March 31, 2007, and the Asia-Pacific region and Japan, which accounted for 13.0% of our revenues in 2006 and 24.1% of our revenues in the three months ended March 31, 2007. The international nature of our business subjects us to a number of risks, including the following:

 

 

As we expand our business globally, our success will depend, in large part, on our ability to anticipate and effectively manage these risks. Our failure to manage any of these risks successfully could harm our international operations and reduce our international sales, adversely affecting our business, operating results and financial condition.

 

If we are unable to successfully protect our technology through the issuance and enforcement of patents and other means of protection, our business could be harmed significantly.

 

Our ability to prevent competitors from gaining access to our technology is essential to our success. If we fail to protect our intellectual property rights adequately, we may lose an important advantage in the markets in which we compete. Trademark, patent, copyright and trade secret laws in the United States and other jurisdictions, as well as our internal confidentiality procedures and contractual provisions, are at the core of

our efforts to protect our proprietary technology and our brand. As of June 30, 2007, we had one issued U.S. patent and five pending U.S. patent applications. We also have four pending counterpart applications outside of the United States, filed pursuant to the Patent Cooperation Treaty. While we plan to protect our intellectual property with, among other things, patent protection, there can be no assurance that:

 

 

In addition, our intellectual property is also used in a large number of foreign countries. Effective intellectual property enforcement may be unavailable or limited in some foreign countries, such as China and the Russian Federation. As a result, it may be difficult for us to protect our intellectual property from misuses or infringement by other companies in these countries. We expect this to become a greater problem for us as our OEM customers increase their manufacturing presence in countries that provide less protection for intellectual property.

 

Litigation and administrative proceedings are inherently uncertain and divert resources that could be directed towards other business priorities. We may not be able to obtain positive results and may spend considerable resources in our efforts to defend and protect our intellectual property. Furthermore, legal standards relating to the validity, enforceability, and scope of protection of intellectual property rights are uncertain. Effective patent, trademark, copyright and trade secret protection vary from one jurisdiction to another and may not be attainable in every country in which our products are available. Our failure to obtain patents, including with claims of a scope necessary to cover our technology, or the invalidation of our patents, may weaken our competitive position and may adversely affect our revenues and profitability.

 

In addition to patent protection, we customarily require our employees and subcontractors to execute confidentiality agreements or agree to confidentiality undertakings when their relationship with us begins. Typically, our employment contracts also include assignment of intellectual property rights for inventions developed by employees, and non-disclosure of confidential information and non-compete clauses for twelve months following termination of an employee’s employment with us. We cannot provide any assurance that the terms of these agreements are being observed and will be observed in the future. Because our product designs and software are stored electronically and thus are highly portable, we attempt to reduce the portability of our designs and software by physically protecting our servers through the use of closed networks, which prevent external access to our servers. We cannot be certain, however, that such protection will adequately deter individuals or groups from wrongful access to our technology. We cannot be certain that the steps we have taken to protect our proprietary information will be sufficient. In addition, to protect our intellectual property, we may become involved in litigation, which could result in substantial expenses, divert the attention of management, cause significant delays, materially disrupt the conduct of our business or adversely affect our revenue, financial condition and results of operations.

 

Our use of open source and third-party software could impose unanticipated conditions or restrictions on our ability to commercialize our solutions.

 

We incorporate open source software into our switch chassis, GridVision Enterprise software, IP Router, Fibre Channel Gateway, ISER initiator, GridStack software and GridBoot software. Open source software is accessible, usable and modifiable by anyone, provided that users and modifiers abide by certain licensing requirements. The original developers of the open source code provide no warranties on such code. For

example, our products incorporate open source code such as an embedded Linux-based operating system. The Linux-based operating system has been developed under a license (known as a General Public License), which permits it to be liberally copied, modified and distributed.

 

Under certain conditions, the use of some open source code to create derivative code may obligate us to make the resulting derivative code available to others at no cost. The circumstances under which our use of open source code would compel us to offer derivative code at no cost are subject to varying interpretations. While we monitor our use of open source code in an effort to avoid situations that would require us to make parts of our core proprietary technology freely available as open source code, we cannot guarantee that such circumstances will not occur or that a court would not conclude that, under a different interpretation of an open source license, certain of our core technology must be made available as open source code. The use of such open source code may also ultimately require us to take remedial action, such as replacing certain code used in our products, paying a royalty to use some open source code, making certain proprietary source code available to others or discontinuing certain products, that may divert resources away from our development efforts.

 

The license under which we licensed the embedded Linux-based operating system is currently the subject of litigation in the case of The SCO Group, Inc. v. International Business Machines Corp. , pending in the United States District Court for the District of Utah. SCO filed its complaint in 2003. According to the current trial schedule, the parties are briefing certain issues for summary judgment and other issues are already being argued. The trial date was postponed indefinitely. SCO has alleged that certain versions of the Linux operating system contributed by IBM contain unauthorized UNIX code or derivative works of UNIX code, which SCO claims it owns. If the court were to rule in SCO’s favor and find, for example, that Linux-based products, or significant portions of them, may not be liberally copied, modified or distributed, we may have to modify our products and/or seek a license to use the code in question, which may or may not be available on commercially reasonable terms, and this could materially adversely affect our business. Regardless of the merit of SCO’s allegations, uncertainty concerning SCO’s allegations could adversely affect our products and customer relationships.

 

We may also find that we need to incorporate certain proprietary third-party technologies, including software programs, into our products in the future. Licenses to relevant third-party technology may not be available to us on commercially reasonable terms, or at all. Therefore, we could face delays in product releases until equivalent technology can be identified, licensed or developed and integrated into our current products. Such delays could materially adversely affect our business, operating results and financial conditions.

 

We may be subject to claims of intellectual property infringement by third parties that, regardless of merit, could result in litigation and our business, operating results or financial condition could be materially adversely affected.

 

There can be no assurance that third parties will not assert that our products and other intellectual property infringe, or may infringe their proprietary rights. For example, Crossroads Systems, Inc., a U.S. developer of storage routing devices, has contacted us regarding a potential license for some of its patents consisting of the following as of November 2006: U.S. Patent Nos. 5,941,972; 6,425,035; 6,421,753; 6,763,419; 6,738,854; 6,789,152 and 7,051,147. We are currently in discussions with Crossroads to determine whether a license is necessary or appropriate. We believe that the only potentially relevant product is our Fibre Channel Router. Between 2004 and 2006, our total sales of Fibre Channel Routers were approximately $232,000. Some of these patents have been the subject of prior and ongoing litigation. See Crossroads Systems (Texas), Inc. v. Chaparral Network Storage, Inc. , Case No. A-00-CA-217-SS (W.D. Tex.); Crossroads Systems (Texas), Inc. v. Pathlight Technology, Inc. , Case No. A-00-CA-248-SS (W.D. Tex.); and Crossroads Systems (Texas), Inc. v. Dot Hill Systems Corporation , Case No. A-03-CA-754-SS (W.D. Tex.); EqualLogic, Inc. v. Crossroads Systems, Inc. et al ., Case No. 06 CA 11478 EFH (D. Mass.) Some of these patents have also successfully passed reexamination proceedings before the U.S. Patent and Trademark Office.

 

We are not currently subject to any proceedings for infringement of patents or other intellectual property rights and are not aware of any parties that intend to pursue such claims against us. Any such claims,

regardless of merit, could result in litigation, which could result in substantial expenses, divert the attention of management, cause significant delays and materially disrupt the conduct of our business and have a material adverse effect on our financial condition and results of operations. As a consequence of such claims, we could be required to pay a substantial damage award, develop non-infringing technology, enter into royalty-bearing licensing agreements, stop selling our products or re-brand our products. If it appears necessary, we may seek to license intellectual property that we are alleged to infringe. Such licensing agreements may not be available on terms acceptable to us or at all. Litigation is inherently uncertain and any adverse decision could result in a loss of our proprietary rights, subject us to significant liabilities, require us to seek licenses from others and otherwise negatively affect our business. In the event of a successful claim of infringement against us and our failure or inability to develop non-infringing technology or license the infringed or similar technology, our business, operating results or financial condition could be materially adversely affected.

 

If we fail to retain our executive officers and attract and retain other skilled employees, we may not be able to timely develop, sell or support our products.

 

Our success depends in large part on the continued contribution of our research and development and sales and marketing teams, as well as our management. In particular, we depend on the continued service of Miron (Ronnie) Kenneth, our Chief Executive Officer and Chairman, for whom we carry key man life insurance in an amount in shekels that currently represents approximately $2.0 million. We have entered into employment agreements with all of our executive officers, including Mr. Kenneth. Our employment agreements do not specify a minimum employment term, nor do they guarantee the continued service of our executive officers with us. In addition, the enforceability of covenants not to compete in Israel and the United States is subject to limitations and may not be enforceable at all.

 

If our business continues to grow, we will need to add to our research and development and sales and marketing teams, as well as to members of management in order to manage our growth. The process of hiring, training and successfully integrating qualified personnel into our operation is a lengthy and expensive one. The market for qualified personnel is very competitive because of the limited number of people available with the necessary technical skills, sales skills and understanding of our products and technology. This is particularly true in Israel where competition for qualified personnel is intense due to the density of technology companies. Our failure to hire and retain qualified personnel could cause our revenues to decline and impair our ability to meet our research and development and sales objectives.

 

Our business is subject to increasingly complex environmental legislation that may increase our costs and the risk of noncompliance.

 

We face increasing complexity in our product design and procurement operations as we adjust to new and upcoming requirements relating to the material composition of many of our products. For instance, the European Union has adopted certain directives to facilitate the recycling of electrical and electronic equipment sold in the European Union, including the Restriction of the Use of Certain Hazardous Substances in Electrical and Electronic Equipment that restricts the use of lead, mercury and certain other substances in electrical and electronic products placed on the market in the European Union after July 1, 2006. The European Union has also approved a directive on Waste Electrical and Electronic Equipment, which requires that all electrical and electronic equipment placed for sale in the European Union be appropriately labeled regarding waste disposal and contains other obligations regarding the collection and recycling of waste electrical and electronic equipment. In connection with our compliance with these and other environmental laws and regulations, we could incur substantial costs, including research and development costs and costs associated with assuring the supply of compliant components from our suppliers. Similar laws and regulations have been proposed or may be enacted in other regions in which we do business. Other environmental regulation may require us to reengineer our solutions to utilize components that are compatible with these regulations. Such reengineering and component substitution may result in additional costs to us or disrupt our operations or logistics.

Our international operations expose us to the risk of fluctuation in currency exchange rates.

 

In 2006, we derived the majority of our revenues in U.S. dollars. Although almost all of our revenues were denominated in U.S. dollars, a significant portion of our expenses were denominated in Israeli shekels and to a significantly lesser extent in euros. Our shekel-denominated expenses consist principally of salaries, building leases and related personnel expenses. We anticipate that a material portion of our expenses will continue to be denominated in shekels. If the U.S. dollar weakens against the shekel, there will be a negative impact on our profit margins. We currently do not hedge our currency exposure through financial instruments. In addition, if we wish to maintain the dollar-denominated value of our products in non-U.S. markets, devaluation in the local currencies of our customers relative to the U.S. dollar could cause our customers to cancel or decrease orders or default on payment.

 

We may engage in future acquisitions that could disrupt our business, cause dilution to our shareholders, reduce our financial resources and result in increased expenditures.

 

In the future, we may acquire other businesses, products or technologies. We have not made any acquisitions to date and our ability to make acquisitions is therefore unproven. We may not be able to find suitable acquisition candidates, and we may not be able to complete acquisitions on favorable terms, if at all. If we do complete acquisitions, we may not strengthen our competitive position or achieve our goals, or these acquisitions may be viewed negatively by customers, financial markets or investors. In addition, any acquisitions that we make could pose challenges in integrating personnel, technologies and operations from the acquired businesses and in retaining and motivating key personnel from such businesses. Acquisitions may also disrupt our ongoing operations, divert management from day-to-day responsibilities, increase our expense and adversely impact our business.

 

Under current U.S. and Israeli law, we may not be able to enforce employees’ covenants not to compete and therefore may be unable to prevent our competitors from benefiting from the expertise of some of our former employees.

 

It is our practice to have our employees and subcontractors sign non-compete agreements. These agreements prohibit our employees, if they cease working for us, from competing directly with us or working for our competitors for a period, typically limited to twelve months following the end of employment. Under current U.S. and Israeli law, we may be unable to enforce these agreements and it may be difficult for us to restrict our competitors from acquiring the expertise our former employees acquired while working for us. If we cannot enforce our employees’ non-compete agreements, we may be unable to prevent our competitors from benefiting from the expertise of our former employees.

 

We have not yet evaluated our internal controls over financial reporting in compliance with Section 404 of the Sarbanes-Oxley Act.

 

We are required to comply with the internal control evaluation and certification requirements of Section 404 of the Sarbanes-Oxley Act in our annual report on Form 20-F for the year ending December 31, 2008. We are in the process of determining whether our existing internal controls over financial reporting systems are compliant with Section 404. This process may divert internal resources and will take a significant amount of time and effort to complete. In particular, we have experienced rapid growth during the last three years and may continue to do so in the future. As a result, certain elements of our internal controls have been strained and may need to be enhanced and additional controls and functions implemented. Irrespective of compliance with Section 404, any failure of our internal controls could have a material adverse effect on our stated results of operations and harm our reputation. As a result, we may experience higher than anticipated operating expenses, as well as higher independent auditor fees during the implementation of these changes and thereafter. Further, we may need to hire additional qualified personnel in order for us to comply with Section 404. If we are unable to implement these changes effectively or efficiently, it could harm our operations, financial reporting or financial results and could result in an adverse opinion on internal controls from our independent auditors.

Risks Related to this Offering

 

There has been no prior market for our ordinary shares and our share price may be volatile.

 

Prior to this offering there has been no public market for our ordinary shares. We cannot predict the extent to which investor interest will lead to the development of an active trading market in our ordinary shares or whether such a market will be sustained. The market price of our ordinary shares may be volatile and could fluctuate substantially due to many factors, including:

 

 

Share price fluctuations may be exaggerated if the trading volume of our ordinary shares is too low. The lack of a trading market may result in the loss of research coverage by securities analysts. Moreover, we cannot assure you that any securities analysts will initiate or maintain research coverage of our company and our ordinary shares. If our future quarterly operating results are below the expectations of securities analysts or investors, the price of our ordinary shares may decline. Securities class action litigation has often been brought against companies following periods of volatility. Any securities litigation claims brought against us could result in substantial expense and divert management’s attention from our business.

 

A total of 12,648,167 or 61.8% of our outstanding ordinary shares following this offering are restricted from immediate resale, but may be sold into the market in the near future. This could cause the market price of our ordinary shares to drop significantly, even if our business is profitable.

 

After this offering, we will have 20,480,554 ordinary shares outstanding. This includes the 7,693,000 ordinary shares we and certain of our shareholders are selling in this offering, which may be resold in the public market immediately after this offering. We expect that the remaining 12,787,554 ordinary shares, representing 62.4% of our total outstanding ordinary shares following this offering, will become available for resale in the public market as shown in the chart below. Our directors and officers, and substantially all of our shareholders, have signed lock-up agreements for a period of 180 days following the date of this prospectus, subject to extension in the case of an earnings release or material news or a material event relating to us. J.P. Morgan Securities Inc. and Merrill Lynch, Pierce, Fenner & Smith Incorporated may, in their sole discretion and without notice, release all or any portion of the ordinary shares subject to lock-up agreements. As restrictions on resale end, the market price of our ordinary shares could drop significantly if the holders of these restricted shares sell them or are perceived by the market as intending to sell them. These factors could also make it more difficult for us to raise additional funds through future offerings of our ordinary shares or other securities.

 

After 180 days following this offering, subject to the lock-up agreements described above, holders of 8,334,640 of our ordinary shares will be entitled to request that we register their shares for resale and certain other shareholders have the right to include their shares in any such registration statement or in a registration statement for any public offering we undertake in the future. After this offering we also intend to register on Form S-8 all of the ordinary shares that we may issue under our stock option plans. Once the Form S-8 becomes effective, these may be freely sold in the public market, subject to the lock-up agreements described above. The registration or sale of any of these shares could cause the market price of our ordinary shares to drop significantly. See “Certain Relationships and Related Party Transactions—Registration Rights.”

 

The ownership of our ordinary shares will continue to be highly concentrated, and your interests may conflict with the interests of our existing shareholders.

 

Our executive officers and directors and their affiliates, together with our current significant shareholders, will beneficially own approximately 49.0% of our outstanding ordinary shares upon completion of this offering. Moreover, three of our shareholders, BCF II Belgium Holding SPRL, Pitango Venture Capital and Vertex Venture Capital will beneficially own approximately 40.2% of our outstanding ordinary shares upon completion of this offering. In addition, individual partners of these shareholders serve on our board of directors. Accordingly, these shareholders, acting as a group, could exercise a controlling influence on us and, even if they do not act as a group, will continue to have significant influence over the outcome of corporate actions requiring shareholder approval, including the election of directors, amending our articles of association, raising future capital, any merger, consolidation or sale of all or substantially all of our assets or any other significant corporate transaction. These shareholders could delay or prevent a change of control of our company, even if such a change of control would benefit our other shareholders. The significant concentration of share ownership may adversely affect the trading price of our ordinary shares due to investors’ perception that conflicts of interest may exist or arise.

 

Our U.S. shareholders may suffer adverse tax consequences if we are characterized as a Passive Foreign Investment Company.

 

Generally, if for any taxable year 75% or more of our gross income is passive income, or at least 50% of our assets are held for the production of, or produce, passive income, we would be characterized as a passive foreign investment company for U.S. federal income tax purposes. To determine if at least 50% of our assets are held for the production of, or produce, passive income we may use the market capitalization method for certain periods. Under the market capitalization method, the total asset value of a company would be considered to equal the fair market value of its outstanding shares plus outstanding indebtedness on a relevant testing date. Because the market price of our ordinary shares is likely to fluctuate after this offering, the market price of the shares of technology companies has been especially volatile, and the market price may affect the determination of whether we will be considered a passive foreign investment company, there can be no assurance that we will not be considered a passive foreign investment company for any taxable year. If we are characterized as a passive foreign investment company, our U.S. shareholders may suffer adverse tax consequences, including having gains realized on the sale of our ordinary shares treated as ordinary income, rather than capital gain, the loss of the preferential rate applicable to dividends received on our ordinary shares by individuals who are U.S. holders, and having potentially punitive interest charges apply to the proceeds of share sales. See “Taxation and Government Programs—United States Federal Income Taxation—Passive Foreign Investment Company Considerations.”

 

You will experience immediate and substantial dilution in the net tangible book value of the ordinary shares you purchase in this offering.

 

The initial public offering price of our ordinary shares is expected to exceed substantially the net tangible book value per share of our ordinary shares immediately after this offering. Therefore, based on an assumed initial public offering price of $13.00 per share, if you purchase our ordinary shares in this offering, you will suffer, as of March 31, 2007, immediate dilution of $8.97 per share or $8.64 if the underwriters exercise their option to purchase additional ordinary shares. As a result of this dilution, as of March 31, 2007, investors

purchasing ordinary shares from us in this offering will have contributed 50.0% of the total amount of our total gross funding to date but will only own 28.3% of our equity. If outstanding options and warrants to purchase our ordinary shares are exercised in the future, you will experience additional dilution.

 

Our management will have broad discretion over the use of proceeds from this offering and may not obtain a favorable return on the use of these proceeds.

 

Our management will have broad discretion in determining how to spend the net proceeds from this offering and may spend the proceeds in a manner that our shareholders may not deem desirable. We currently intend to use the net proceeds from this offering to fund our research and development activities, expand our business development and marketing activities, repay existing debt, and other general corporate purposes and working capital. We may also use a portion of the net proceeds to acquire or invest in complementary companies, products or technologies. We cannot assure you that these uses or any other use of the net proceeds of this offering will yield favorable returns or results.

 

If you hold 10.0% or more of our shares, you may be subject to adverse United States federal income tax consequences if we are classified as a Controlled Foreign Corporation.

 

Each “Ten Percent Shareholder” in a non-U.S. corporation that is classified as a “controlled foreign corporation,” or a CFC, for United States federal income tax purposes in any taxable year is required to include in income for U.S. federal tax purposes such “Ten Percent Shareholder’s” pro rata share of the CFC’s “Subpart F income” and investment of earnings in U.S. property, even if the CFC has made no distributions to its shareholders. A non-U.S. corporation will be classified as a CFC for United States federal income tax purposes in any taxable year in which “Ten Percent Shareholders” own, directly or indirectly, more than 50.0% of either the total combined voting power of all classes of stock of such corporation entitled to vote or of the total value of the stock entitled to vote of such corporation. A “Ten Percent Shareholder” is a United States person (as defined by the U.S. Internal Revenue Code of 1986, as amended (the “Code”)) who owns or is considered to own, on any day during such taxable year, 10.0% or more of the total combined voting power of all classes of stock entitled to vote of such corporation.

 

Although we may have been a CFC in the beginning of the 2007 tax year, we expect that, because of the anticipated dispersion of our share ownership as a result of this offering, we will not be classified as a CFC after the offering. It is possible, however, that a shareholder treated as a United States person for United States federal income tax purposes will acquire, directly or indirectly, enough shares to be treated as a Ten Percent Shareholder after application of the constructive ownership rules and, together with any other Ten Percent Shareholders of the Company, cause the Company to be treated as a CFC for United States federal income tax purposes. Holders should consult their own tax advisors with respect to the potential adverse U.S. tax consequences of becoming a Ten Percent Shareholder in a CFC.

 

We may need to raise additional capital in the future and may be unable to do so on acceptable terms.

 

We believe that the net proceeds from this offering, together with our existing cash balances and cash generated from operations, will be sufficient to meet our anticipated cash needs for working capital and capital expenditures for at least the next twelve months. If our estimates of revenues, expenses or capital or liquidity requirements change or are inaccurate or if cash generated from operations is insufficient to satisfy our liquidity requirements, we may seek to sell additional equity or arrange additional debt financing. We cannot be certain that we will be able to sell additional equity or arrange additional debt financing on commercially reasonable terms or at all, which could limit our ability to grow and carry out our business plan, or that any such additional financing, if raised through the issuance of equity securities, will not be dilutive to our existing shareholders.

Risks Relating to our Location in Israel

 

Conditions in Israel could adversely affect our business.

 

We are incorporated under Israeli law and our principal offices, and research and development facilities are located in Israel. Accordingly, political, economic and military conditions in Israel directly affect our business. Since the State of Israel was established in 1948, a number of armed conflicts have occurred between Israel and its Arab neighbors. Although Israel has entered into various agreements with Egypt, Jordan and the Palestinian Authority, there has been an increase in unrest and terrorist activity, which began in September 2000 and has continued with varying levels of severity into 2007. In mid-2006, a war took place between Israel and Hezbollah in Lebanon, resulting in thousands of rockets being fired from Lebanon up to approximately 50 miles into Israel. Furthermore, several countries, principally in the Middle East, still restrict doing business with Israel and Israeli companies, and additional countries may impose restrictions on doing business with Israel and Israeli companies if hostilities in Israel continue or increase. These restrictions may limit materially our ability to sell our solutions to companies in these countries. Any hostilities involving Israel or the interruption or curtailment of trade between Israel and its present trading partners, or a significant downturn in the economic or financial condition of Israel, could adversely affect our operations and product development, cause our revenues to decrease and adversely affect the share price of publicly traded companies having operations in Israel, such as us. Additionally, any hostilities involving Israel may have a material adverse effect on our facilities or on the facilities of our local suppliers and manufacturers in which event, all or a portion of our inventory may be damaged, and our ability to deliver products to customers may be materially adversely affected.

 

Our operations may be disrupted by the obligations of personnel to perform military service.

 

As of March 31, 2007, we had 150 employees of whom 125 were based in Israel. Our employees in Israel, including executive officers, may be called upon to perform up to 31 days (in some cases more) of annual military reserve duty until they reach age 49 and, in emergency circumstances, could be called to active duty. In response to increased tension and hostilities, there have been since September 2000 occasional call-ups of military reservists, including in connection with the mid-2006 war in Lebanon, and it is possible that there will be additional call-ups in the future. Our operations could be disrupted by the absence of a significant number of our employees related to military service or the absence for extended periods of one or more of our key employees for military service. Such disruption could materially adversely affect our business and results of operations. Additionally, the absence of a significant number of the employees of our suppliers and contract manufacturers related to military service or the absence for extended periods of one or more of their key employees for military service may disrupt their operations in which event our ability to deliver products to customers may be materially adversely affected.

 

Our operations may be affected by negative economic conditions or labor unrest in Israel.

 

General strikes or work stoppages, occasionally carried out or threatened by Israeli trade unions due to labor disputes may have an adverse effect on the Israeli economy and on our business, including our ability to deliver products to our customers and to receive raw materials from our suppliers in a timely manner. These general strikes or work stoppages may prevent us from shipping our assembled products from Israel to our OEM customers, which could have a material adverse affect on our results of operations.

 

The tax benefits that are available to us require us to meet several conditions and may be terminated or reduced in the future, which would increase our costs and taxes.

 

Our investment program in equipment at our facility in Herzeliya Pituach, Israel has been granted approved enterprise status and we are therefore eligible for tax benefits under the Israeli Law for the Encouragement of Capital Investments, 1959, referred to as the Investment Law. We expect to utilize these tax benefits after we utilize our net operating loss carry forwards. As of December 31, 2006, the end of our last fiscal year, our net operating loss carry forwards for Israeli tax purposes amounted to approximately $43 million. To remain eligible for these tax benefits, we must continue to meet certain conditions stipulated

in the Investment Law and its regulations and the criteria set forth in the specific certificate of approval. If we do not meet these requirements, the tax benefits would be canceled and we could be required to refund any tax benefits that we have received. These tax benefits may not be continued in the future at their current levels or at any level.

 

Effective April 1, 2005, the Israeli Law for the Encouragement of Capital Investments was amended. As a result, the criteria for new investments qualified to receive tax benefits were revised. No assurance can be given that we will, in the future, be eligible to receive additional tax benefits under this law. The termination or reduction of these tax benefits would increase our tax liability in the future, which would reduce our profits or increase our losses. Additionally, if we increase our activities outside of Israel, for example, by future acquisitions, our increased activities might not be eligible for inclusion in Israeli tax benefit programs.

 

See “Taxation and Government Programs—Israeli Tax Considerations and Government Programs—Law for the Encouragement of Capital Investments, 1959.”

 

The government grants we have received for research and development expenditures restrict our ability to manufacture products and transfer technologies outside of Israel and require us to satisfy specified conditions. If we fail to comply with such restrictions or these conditions, we may be required to refund grants previously received together with interest and penalties, and may be subject to criminal charges.

 

We have received grants from the government of Israel through the Office of the Chief Scientist of the Ministry of Industry, Trade and Labor, for the financing of a portion of our research and development expenditures in Israel, pursuant to the provisions of The Encouragement of Industrial Research and Development Law, 1984, referred to as the Research and Development Law. Under Israeli law and the approved plans, royalties on the revenues derived from sales of all of our products are payable to the Israeli government, generally at the rate of 3.5%, up to the amount of the received grants as adjusted for fluctuation in the U.S. dollar/shekel exchange rate. The amounts received after January 1, 1999, bear interest equal to the 12-month London Interbank Offered Rate applicable to dollar deposits that is published on the first business day of each calendar year. Royalties are paid on our consolidated revenues. We did not apply for or receive grants in 2006, although we did receive grants totaling $5.6 million through December 31, 2005. As of March 31, 2007, the royalty amount payable to the Office of the Chief Scientist was approximately $4.4 million, including accrued interest.

 

The terms of the grants prohibit us from manufacturing products outside of Israel or transferring intellectual property rights in technologies developed using these grants inside or outside of Israel without special approvals. Even if we receive approval to manufacture our products outside of Israel, we may be required to pay an increased total amount of royalties, which may be up to 300% of the grant amount plus interest, depending on the manufacturing volume that is performed outside of Israel. This restriction may impair our ability to outsource manufacturing or engage in similar arrangements for those products or technologies. Know-how developed under an approved research and development program may not be transferred to any third parties, except in certain circumstances and subject to prior approval. In addition, if we fail to comply with any of the conditions and restrictions imposed by the Research and Development Law or by the specific terms under which we received the grants, we may be required to refund any grants previously received together with interest and penalties, and may be subject to criminal charges. In recent years, the government of Israel has accelerated the rate of repayment of the Office of Chief Scientist grants and may further accelerate them in the future.

 

It may be difficult to enforce a U.S. judgment against us, our officers and directors and the Israeli experts named in this prospectus in Israel or the United States, or to assert U.S. securities laws claims in Israel or serve process on our officers and directors and these experts.

 

We are incorporated in Israel. The majority of our executive officers and directors and the Israeli experts named in this prospectus are not residents of the United States, and the majority of our assets and the assets of these persons are located outside the United States. Therefore, it may be difficult for an investor, or any other person or entity, to enforce a U.S. court judgment based upon the civil liability provisions of the U.S. federal

securities laws against us or any of these persons in a U.S. or Israeli court, or to effect service of process upon these persons in the United States. Additionally, it may be difficult for an investor, or any other person or entity, to assert U.S. securities law claims in original actions instituted in Israel. Israeli courts may refuse to hear a claim based on a violation of U.S. securities laws on the grounds that Israel is not the most appropriate forum in which to bring such a claim. Even if an Israeli court agrees to hear a claim, it may determine that Israeli law and not U.S. law is applicable to the claim. If U.S. law is found to be applicable, the content of applicable U.S. law must be proved as a fact which can be a time-consuming and costly process. Certain matters of procedure will also be governed by Israeli law. There is little binding case law in Israel addressing the matters described above. See “Enforceability of Civil Liabilities.”

 

Your rights and responsibilities as a shareholder will be governed by Israeli law and differ in some respects from those under Delaware law.

 

Since we are an Israeli company, the rights and responsibilities of our shareholders are governed by our articles of association and by Israeli law. These rights and responsibilities differ in some respects from the rights and responsibilities of shareholders in a Delaware corporation. In particular, a shareholder of an Israeli company has a duty to act in good faith towards the company and other shareholders and to refrain from abusing his, her or its power in the company, including, among other things, in voting at the general meeting of shareholders on certain matters. In addition, a shareholder who knows that it possesses the power to determine the outcome of a shareholders’ vote or to appoint or prevent the appointment of a director or executive officer in the company has a duty of fairness towards the company. However, Israeli law does not define the substance of this duty of fairness. Because Israeli corporate law has undergone extensive revisions in recent years, there is little case law available to assist in understanding the implications of these provisions that govern shareholder behavior.

 

Provisions of Israeli law and our articles of association may delay, prevent or make undesirable an acquisition of all or a significant portion of our shares or assets.

 

Our articles of association contain certain provisions that may delay or prevent a change of control. These provisions include a classified board of directors and supermajority provisions to amend certain provisions of our articles of association. In addition, Israeli corporate law regulates acquisitions of shares through tender offers and mergers, requires special approvals for transactions involving significant shareholders and regulates other matters that may be relevant to these types of transactions. These provisions of Israeli law could have the effect of delaying or preventing a change in control and may make it more difficult for a third party to acquire us, even if doing so would be beneficial to our shareholders, and may limit the price that investors may be willing to pay in the future for our ordinary shares. Furthermore, Israeli tax considerations may make potential transactions undesirable to us or to some of our shareholders. See “Description of Share Capital—Anti-Takeover Measures” and “Acquisitions under Israeli Law.”

 

This prospectus contains forward-looking statements. We have based these forward-looking statements on our current expectations and projections about future events. These statements include but are not limited to:

 

 

These statements may be found in the sections of this prospectus entitled “Prospectus Summary,” “Risk Factors,” “Use of Proceeds,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Business” and in this prospectus generally, including the section of this prospectus entitled “Business—Overview” and “Business—Industry Background,” which contains information obtained from independent industry sources. Actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including all the risks discussed in “Risk Factors” and elsewhere in this prospectus.

 

In addition, statements that use the terms “believe,” “expect,” “plan,” “intend,” “estimate,” “anticipate” and similar expressions are intended to identify forward-looking statements. All forward-looking statements in this prospectus reflect our current views about future events and are based on assumptions and are subject to risks and uncertainties that could cause our actual results to differ materially from future results expressed or implied by the forward-looking statements. Many of these factors are beyond our ability to control or predict. You should not put undue reliance on any forward-looking statements. Unless we are required to do so under U.S. federal securities laws or other applicable laws, we do not intend to update or revise any forward-looking statements.

 

The forward looking statements contained in this prospectus are excluded from the safe harbor protection provided by the Private Securities Litigation Reform Act of 1995 and Section 27A of the Securities Act of 1933, as amended.

USE OF PROCEEDS

 

Assuming an initial public offering price of $13.00 per share, the midpoint of the estimated initial public offering price range, we estimate that we will receive total net proceeds from this offering of $67.5 million, after deducting the underwriting discount and estimated offering expenses payable by us. A $1.00 increase (decrease) in the assumed initial public offering price of $13.00 per share would increase (decrease) the net proceeds from this offering by $5.4 million, assuming the number of shares offered, as set forth on the cover page of this prospectus, remains the same and after deducting the estimated underwriting discount and estimated offering expenses payable by us.

 

We intend to use the net proceeds of this offering for research and development activities, expand our business development and marketing activities, and for general corporate purposes and working capital. We also intend to use a portion of the net proceeds to repay in full a loan with an outstanding principal amount of $5.0 million, which is required to be repaid in 24 equal monthly installments of principal and accrued interest commencing January 1, 2008. The loan bears interest at the Wall Street Journal prime-lending rate plus 4.00%, which totaled 12.25% as of March 31, 2007. We may also use a portion of the net proceeds to acquire or invest in complementary companies, products or technologies, although we currently do not have any acquisitions or investments planned.

 

We will have broad discretion in the way that we use the net proceeds of this offering. The amounts that we actually spend for the purposes described above may vary significantly and will depend, in part, on the timing and amount of our future revenues.

 

Pending use of the net proceeds as described above, we intend to invest the net proceeds in interest-bearing, investment-grade instruments with maturities of less than one year or deposit the net proceeds in bank accounts in Israel or outside of Israel.

 

We will not receive any of the proceeds from the sale of shares by the selling shareholders.

DIVIDEND POLICY

 

We have never declared or paid any cash dividends on our ordinary shares and we do not anticipate paying any cash dividends on our ordinary shares in the future. We currently intend to retain all future earnings to finance our operations and to expand our business. Any future determination relating to our dividend policy will be made at the discretion of our board of directors and will depend on a number of factors, including future earnings, capital requirements, the provisions of applicable Israeli law, financial condition and future prospects and other factors our board of directors may deem relevant.

 

The following table presents our capitalization as of March 31, 2007:

 

 

You should read this table in conjunction with “Selected Consolidated Financial Data,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and related notes included elsewhere in this prospectus.

 

 

A $1.00 increase (decrease) in the assumed initial public offering price of $13.00 would increase (decrease) each of additional paid-in capital and total stockholders’ equity by $5.4 million, assuming the number of ordinary shares offered by us, as set forth on the cover of this prospectus, remains the same and after deducting the estimated underwriting discount and offering expenses payable by us.

 

The preceding table excludes as of March 31, 2007:

 

 

Our pro forma consolidated net tangible book value as of March 31, 2007 was $14.7 million, or $1.01 per ordinary share. Pro forma consolidated net tangible book value per share represents consolidated tangible assets less consolidated liabilities divided by the number of ordinary shares outstanding on a pro forma basis after giving effect to the conversion of all our issued and outstanding preferred shares into ordinary shares. Our pro forma as adjusted consolidated net tangible book value as of March 31, 2007 would have been $82.2 million or $4.03 per ordinary share after giving effect to:

 

 

This represents an immediate increase in pro forma consolidated net tangible book value of $3.02 per ordinary share to existing shareholders and an immediate dilution of $8.97 per ordinary share to new investors purchasing ordinary shares in this offering. Dilution per share represents the difference between the price per share to be paid by new investors for the ordinary shares sold in this offering and the pro forma consolidated net tangible book value per share immediately after this offering. The following table illustrates this per share dilution:

 

 

A $1.00 increase (decrease) in the assumed initial public offering price of $13.00 per share would increase (decrease) the net tangible book value by $5.4 million, the net tangible book value per share after this offering by $0.26 per share and the dilution in net tangible book value per share to investors in this offering by $0.74 per share, assuming that the number of ordinary shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting the estimated underwriting discount and offering expenses payable by us.

 

The following table presents the differences between the total consideration paid to us and the average price per share paid by existing shareholders and by new investors purchasing ordinary shares in this offering, before deducting the underwriting discount and estimated offering expenses payable by us:

 

 

The preceding table excludes as of March 31, 2007:

 

 

You should read the following selected consolidated financial data in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and the related notes included elsewhere in this prospectus. The consolidated statements of operations data for the years ended December 31, 2004, 2005 and 2006 and the consolidated balance sheet data as of December 31, 2005 and 2006 are derived from our audited consolidated financial statements included elsewhere in this prospectus, which have been prepared in accordance with generally accepted accounting principles in the United States. The consolidated statements of operations for the years ended December 31, 2002 and 2003 and the consolidated balance sheet data as of December 31, 2002, 2003 and 2004 have been derived from our audited consolidated financial statements which are not included in this prospectus. The consolidated statements of operations data for the three months ended March 31, 2006 and 2007 and the consolidated balance sheet data as of March 31, 2007 are derived from our unaudited consolidated financial statements that are included elsewhere in this prospectus. In the opinion of management, these unaudited interim consolidated financial statements include all adjustments, consisting of normal recurring adjustments, necessary for a fair presentation of our financial position and operating results for these periods. Results for interim periods are not necessarily indicative of the results that may be expected for the entire year.

 

 

 

 

 

 

 

 

 

The following management’s discussion and analysis of financial condition and results of operations contains forward-looking statements which involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including those set forth under “Risk Factors” and elsewhere in this prospectus. We assume no obligation to update forward-looking statements or the risk factors. You should read the following discussion in conjunction with our consolidated financial statements and related notes included elsewhere in this prospectus.

 

Overview

 

We design and develop server and storage switching and software solutions that enable high-performance grid computing within the data center. Our solutions allow one or more discrete computing clusters to be linked together as a single unified computing resource, or fabric. We create this unified fabric by integrating high-performance switching with dynamic management and provisioning software. We refer to our server and storage switching and software solutions as the Voltaire Grid Backbone ^tm .

 

We were incorporated and commenced operations in 1997. Between 1997 and 2001, we developed, manufactured and sold data security products. In 2001, we shifted our business plan to focus on developing grid computing switches and software for the data center, primarily based on the InfiniBand grid computing interconnect architecture. Between 2001 and 2003, we continued to develop our technology and in 2003 we made our first commercial shipments of our Internet Protocol routers and first generation InfiniBand Switch Router, or ISR, 6000 and ISR 9600 switches, host channel adapters and GridStack ^tm software. In 2004, we introduced our Grid Director ^tm director-class switches, in 2005 we introduced our Grid Switch ^tm edge switches, and in 2006 we began developing solutions for 20 Gigabit server switching, 10 Gigabit Ethernet routing and enterprise software for grid infrastructure management. Throughout our history, we have been funded through a combination of issuances of preferred shares, redeemable preferred shares, venture loans and cash flow from operations.

 

Our solutions are based on the InfiniBand grid computing interconnect architecture, which competes with other grid computing architectures, such as Ethernet, Fibre Channel and other proprietary technologies. Historically, more than half of our end customers have been governmental, educational and research institutions. More recently, we have expanded into enterprise markets, including oil and gas, manufacturing, life sciences, entertainment and financial services. Enterprise customers have traditionally used products based on the Ethernet architecture and must therefore switch to an InfiniBand-based architecture to adopt our server and storage switching and software solutions. A key component of our growth strategy is to collaborate with independent software vendors, or ISVs, that have expertise in key vertical markets, such as financial services and manufacturing, and work together to design solutions that meet the needs of end customers in these vertical markets. We seek to leverage our relationships with our OEM customers and ISVs to achieve greater penetration across certain key vertical markets.

 

We sell our products primarily through server original equipment manufacturers, or OEMs, which incorporate our products into their solutions, as well as through value-added resellers and systems integrators. Sales to our OEM customers are made on the basis of purchase orders that are issued pursuant to product purchase agreements or statements of work. Due to the nature of our OEM strategy, we derive the majority of our revenues from sales to a limited number of large customers. Sales to three OEM customers accounted for 58% of our revenues in 2005, 63% of our revenues in 2006 and 67% of our revenues in the three months ended March 31, 2007. We believe that our revenues will continue to be highly concentrated among a relatively small number of OEM customers for the foreseeable future.

 

Our OEM customers generally do not carry any, or any significant, inventory of our products. We have experienced significant changes in the percentage of total annual sales represented by each of our OEM customers. These fluctuations were due to significant sales by one OEM customer to a particular end customer during a particular year. As a result, in addition to the impact on our results of operations of seasonal fluctuations in revenues, our quarterly results of operations also are impacted by the sales cycles of our OEM

customers with respect to their end customers. In particular, large purchases by a small number of end customers are a significant contributor to our revenues from our OEM customers. For example, based on our internal tracking data we believe that approximately 35% of our revenues were derived from sales by our OEM customers to two end customers in 2006. If a significant order by an end customer of one of our OEM customers is deferred until a subsequent quarter, we may experience significant fluctuations in our quarterly results of operations. We expect this concentration of our sales among end customers to decrease in the future, although we expect to continue to have significant revenue concentration among our OEM customers.

 

Our current statement of work with IBM expires on November 19, 2007. The initial term of our agreement with Hewlett-Packard Company, or HP, expired on October 8, 2006 upon which it automatically renewed for successive one year periods. The agreement can be terminated at will by us upon 60 days’ notice and by HP upon 90 days’ notice. Additionally, in the event of a breach, the non-breaching party may terminate this agreement if the other party fails to cure such breach within 45 days after receiving notice of such breach by the non-breaching party. To date, we have made all of our sales to Sun Microsystems pursuant to purchase orders that are not governed by the terms of a master supply agreement. In November 2006, we signed a master supply agreement with Sun Microsystems which, at Sun Microsystems’ election, may govern any purchase orders issued by it. The initial term of the agreement expires in 2009 after which it will automatically renew for successive one-year terms unless terminated by either party upon 180 days notice. We cannot predict with certainty what impact, if any, an expiration or termination of any of these agreements would have on our results of operations since none of our OEM agreements contain minimum purchase requirements and because we cannot predict which OEM will receive a design win from an end-customer. Nevertheless, the termination or expiration of an agreement with a large OEM customer could have a material adverse impact on our revenues and operating results.

 

We currently rely on Mellanox Technologies Ltd. as our sole-source supplier for the InfiniBand switching application-specific integrated circuit, or ASIC, the main component used in our Grid Director director-class switches and Grid Switch edge switches. The ASICs constitute a significant portion of our cost of revenues. If Mellanox is unable to supply the switch chip on a timely basis or in the quantities that we require, we would likely be unable to manufacture our switching products without adopting a different industry standard solution in place of InfiniBand. This would require significant changes to our products that would take time to complete if we are able to do so successfully. In addition, our cost of revenues may be impacted negatively by any disruption in the supply of this component, including as a result of higher-priced alternative components we may be forced to purchase in connection with product reconfigurations.

 

We subcontract the manufacturing, assembly and testing for our products to two contract manufacturers, Sanmina-SCI Corporation and Zicon Ltd. As a result, our business has relatively low capital requirements. We currently have offices in North America, Europe, the Middle East and Asia-Pacific. We will seek to extend our geographic reach by adding to our sales and marketing and support and services teams in order to expand sales of our Grid Backbone.

 

Gross margins.   A key component of our growth objectives is to maintain and improve our gross margins. Our gross margins have increased from 27% in 2004 to 30% in 2005 and 37% in 2006 and in the three months ended March 31, 2007. We analyze the following two metrics which impact our gross margins:

 

 

Our cost of revenues includes an expense equal to 3.5% of revenues on account of royalty payments to the Government of Israel for repayment of grants received by the Office of the Chief Scientist.

 

Net income.   We monitor our operating expenses closely as we grow our business and are working towards generating positive net income. To date, we have incurred net losses in each fiscal year since we commenced operations in 1997. Upon generating positive net income, we believe that net income would become a more important metric for us to track as an indication of our performance.

 

Results of Operations

 

Revenues

 

Our revenues have grown rapidly since we began commercial shipment of our solutions in late 2003. We generate the majority of our revenues from sales of our Grid Director director-class and Grid Switch edge switches and sales of our host channel adapters and cables. We grant a one-year hardware warranty and a three-month software warranty on our products. Based on our historical experience, we record a reserve on account of possible warranty claims, which increases our cost of revenues. In addition, we provide a variety of fee-based support and extended warranty packages.

 

We recognize revenues from product sales in accordance with Statement of Position 97-2, “Software Revenue Recognition,” and EITF Issue No. 03-5, “Applicability of AICPA Statement of Position 97-2 to Non-Software Deliverables in an Arrangement Containing More than Incidental Software.” We recognize revenues from the sale of our products when persuasive evidence of an agreement exists, delivery of the product has occurred, the fee is fixed or determinable and collection is probable. We typically defer recognition of revenue until each of these standards has been satisfied. Delivery occurs when title is transferred under the applicable international commerce terms, or IncoTerms, to our customer, including an OEM customer, value added reseller or systems integrator. We do not provide rights of return and generally do not provide for acceptance tests by end-customers. In a limited number of circumstances, however, we have deviated from our standard policy by agreeing to arrangements with OEM, value added reseller or system integrator customers which provide for acceptance tests. These arrangements have clear milestones and acceptance tests before the purchase price is considered non-cancelable. In these instances, we do not recognize revenue until all obligations, milestones and acceptance tests have been satisfied. Until such time, we account for this as deferred revenue.

We recognize revenues from warranty and support services on a straight-line basis over the term of the warranty and support agreement. See “Critical Accounting Policies and Estimates — Revenue Recognition.”

 

Geographical breakdown

 

We classify our revenue geographically based on the location of our customer, regardless of the location of the end customer. The following table sets forth the geographic breakdown of our total revenues for the periods indicated:

 

 

Cost of revenues

 

Our cost of revenues consists primarily of cost of product components and materials, fees paid to our contract manufacturers and personnel cost associated with production management. In addition, to a lesser extent our cost of revenues includes expenses for inventory obsolescence, costs for providing customer service and support, warranty obligations, general overhead and royalties paid to the Office of the Chief Scientist of the Israeli Ministry of Industry, Trade and Labor, or the Office of the Chief Scientist. Generally, our cost of revenues as a percentage of sales revenues has decreased over time, primarily due to unit manufacturing cost reductions given economies of scale from higher manufacturing volumes. In the future, we expect overall cost of revenues to increase in absolute terms as product sales increase, but to decrease as a percentage of revenues due to continued economies of scale, expected increased sales of higher-margin products and absorption of fixed operating costs as a gross percentage of sales.

 

Operating expenses

 

Operating expenses consist of research and development, sales and marketing and general and administrative expenses. We have invested significant resources to develop our OEM relationships. Operating costs associated with the development of our OEM relationships involve a significant initial investment by us in order to satisfy OEM performance requirements, develop professional relationships within the OEM organization, and provide education and training to each OEM customer. These initial costs typically decrease once our OEM customers have approved our solutions for inclusion in their products and begun generating sales. The largest component of our operating expenses is personnel costs. Personnel costs consist of salaries and benefits for our employees, including commissions for sales personnel and share-based compensation for all employees. We grew from 93 employees as of December 31, 2004 to 117 employees as of December 31, 2005 and to 141 employees as of December 31, 2006 and 150 employees as of March 31, 2007. We expect to continue to hire additional employees to support our growth. The timing of these additional hires could materially affect our operating expenses in any particular period, both in absolute terms and as a percentage of revenues.

 

Research and development.   Our research and development expenses consist primarily of salaries and related personnel costs, as well as costs for subcontractor services and costs of materials consumed in connection with the design and development of our products. We expense all of our research and development costs as incurred. Through 2005, our research and development expenses were partially offset by financing through royalty-bearing grants from the Office of the Chief Scientist. We recognized such participation grants at the time at which we were entitled to such grants on the basis of the costs incurred and included these grants as a deduction from research and development expenses (see “—Government Grants”). We do not anticipate receiving additional grants in the future. We intend to continue to invest significantly in our research and development efforts and believe these areas are essential to maintaining our competitive position. We

expect that in future periods our research and development expenses will increase in absolute terms and decrease as a percentage of revenues.

 

Sales and marketing.   Our sales and marketing expenses consist primarily of salaries and related personnel costs, sales commissions, travel expenses, marketing programs and facilities costs. We intend to continue to invest heavily in sales and marketing, including further developing our relationships with our OEM customers, hiring additional sales and marketing personnel, extending brand awareness and sponsoring marketing events. We expect that our sales and marketing expenses will increase in absolute terms and decrease as a percentage of revenues.

 

General and administrative.   Our general and administrative expenses consist primarily of salaries and related personnel costs, travel, and facilities expenses related to our executive, finance, human resource and information technology teams and other fees for professional services provided by subcontractors. In addition, in accordance with EITF Issue No. 00-10 “Accounting for Shipping and Handling Fees and Costs,” we account for our product shipping costs as general and administrative expense. Professional services consist of outside legal, audit and tax services and information technology consulting costs. We expect these expenses to increase on an absolute basis following this offering as we incur additional costs related to the growth of our business, including accounting and legal expenses related to compliance with the Sarbanes-Oxley Act of 2002 and the rules and regulations implemented by the U.S. Securities and Exchange Commission, as well as additional insurance, investor relations and other costs associated with being a public company.

 

Amortization of deferred share-based compensation.   We have granted options to purchase our ordinary shares to our employees and consultants at prices below the fair market value of the underlying ordinary shares on the grant date. These options were considered compensatory because the deemed fair market value of the underlying ordinary shares was greater than the exercise prices determined by our board of directors on the option grant date. The determination of the fair market value of the underlying ordinary shares prior to this offering involved subjective judgment, third-party valuations and the consideration by our board of directors of various factors. Because there has been no public market for our ordinary shares prior to this offering, the amount of the compensation charge was not based on an objective measure, such as the trading price of our ordinary shares. We discuss in detail the factors affecting our determination of the deemed fair value of the underlying ordinary shares below in “Critical Accounting Policies and Estimates — Accounting for Share-Based Compensation.” As of January 1, 2006, we adopted Statement of Financial Accounting Standards No. 123(R) “Share Based Payment”, or SFAS No. 123(R), which requires us to expense the fair value of employee share options. We adopted the fair value recognition provisions of SFAS No. 123(R), using the modified prospective method for grants that were measured using the fair value method for either recognition or pro forma disclosures and adopted SFAS No. 123(R) using the prospective-transition method. The fair value of share-based awards granted after January 1, 2006, was estimated using the Black-Scholes valuation model. As a result of adopting SFAS No. 123(R) on January 1, 2006, our net loss increased by $0.3 million in 2006 and $0.1 million in the three months ended March 31, 2007.

 

In connection with the grant of options, we recorded total share-based compensation expenses of $0.4 million in 2004, $74,000 in 2005, $0.3 million in 2006 and $0.1 million for the three months ended March 31, 2007. In the future, stock-based compensation expense may increase as we issue additional equity-based awards to continue to attract and retain key employees. As of March 31, 2007, we had an aggregate of $1.5 million of deferred unrecognized share-based compensation remaining to be recognized. We estimate that this deferred unrecognized share-based compensation balance will be amortized as follows: approximately $0.5 million in 2007, approximately $0.5 million in 2008 and approximately $0.5 million in 2009 and thereafter.

 

Financial income (expenses), net

 

Financial income consists primarily of interest earned on our cash balances and other financial investments and foreign currency exchange gains. Financing expenses consist primarily of outstanding interest to be paid on a $5.0 million loan from Lighthouse Capital Partners V (Israel), LLC, bank fees, foreign currency exchange losses, as well as charges to record outstanding preferred share warrants at fair value.

Corporate tax

 

Israeli companies are generally subject to corporate tax at the rate of 29% of their taxable income in 2007. The rate is scheduled to decline to 27% in 2008, 26% in 2009 and 25% in 2010 and thereafter. However, the effective tax rate payable by a company that derives income from an “Approved Enterprise” designated as set forth under the Law for the Encouragement of Capital Investments, 1959, or the Investment Law, may be considerably less. Our investment programs in equipment at our facilities in Herzeliya, Israel have been granted “Approved Enterprise” status under the Investment Law and enjoy certain tax benefits. We expect to utilize these tax benefits after we utilize our net operating loss carry forwards. As of December 31, 2006, the end of our last fiscal year, our net operating loss carry forwards for Israeli tax purposes amounted to approximately $43.0 million. Income derived from other sources, other than the “Approved Enterprise,” during the benefit period will be subject to tax at the regular corporate tax rate. For more information about the tax benefits available to us as an Approved Enterprise see “Taxation and Government Programs—Law for the Encouragement of Capital Investments, 1959.”

 

Government Grants

 

Our research and development efforts have been financed, in part, through grants from the Office of the Chief Scientist under our approved plans in accordance with the Israeli Law for Encouragement of Research and Development in the Industry, 1984, or the R&D Law. Through December 31, 2005, we had applied and received approval for grants totaling $5.6 million from the Office of the Chief Scientist. We did not apply for or receive any grants in 2006 or in the three months ended March 31, 2007. Under Israeli law and the approved plans, royalties on the revenues derived from sales of all of our products are payable to the Israeli government, generally at the rate of 3.5%, up to the amount of the received grants as adjusted for fluctuation in the U.S. dollar/shekel exchange rate. The amounts received after January 1, 1999, bear interest equal to the 12-month London Interbank Offered Rate applicable to dollar deposits that is published on the first business day of each calendar year. Royalties are paid on our consolidated revenues.

 

The government of Israel does not own proprietary rights in know-how developed using its funding and there is no restriction related to such funding on the export of products manufactured using the know-how. The know-how is, however, subject to other legal restrictions, including the obligation to manufacture the product based on the know-how in Israel and to obtain the Office of the Chief Scientist’s consent to transfer the know-how to a third party, whether in or outside Israel. These restrictions may impair our ability to outsource manufacturing or enter into similar arrangements for those products or technologies and they continue to apply even after we have paid the full amount of royalties payable for the grants.

 

If the Office of the Chief Scientist consents to the manufacture of the products outside Israel, the regulations allow the Office of the Chief Scientist to require the payment of increased royalties, ranging from 120% to 300% of the amount of the grant plus interest, depending on the percentage of foreign manufacture. If the manufacturing is performed outside of Israel by us, the rate of royalties payable by us on revenues from the sale of products manufactured outside of Israel will increase by 1% over the regular rates. If the manufacturing is performed outside of Israel by a third party, the rate of royalties payable by us on those revenues will be a percentage equal to the percentage of our total investment in our products that was funded by grants. The R&D Law further permits the Office of the Chief Scientist, among other things, to approve the transfer of manufacturing or manufacturing rights outside Israel in exchange for an import of certain manufacturing or manufacturing rights into Israel as a substitute, in lieu of the increased royalties.

 

The R&D Law provides that the consent of the Office of the Chief Scientist for the transfer outside of Israel of know-how derived out of an approved plan may only be granted under special circumstances and subject to fulfillment of certain conditions specified in the R&D Law as follows: (1) the grant recipient pays to the Office of the Chief Scientist a portion of the sale price paid in consideration for such Office of the Chief Scientist-funded know-how (according to certain formulas), except if the grantee receives from the transferee of the know-how an exclusive, irrevocable, perpetual unlimited license to fully utilize the know-how and all related rights; (2) the grant recipient receives know-how from a third party in exchange for its Office

of the Chief Scientist-funded know-how; or (3) such transfer of Office of the Chief Scientist-funded know-how arises in connection with certain types of cooperation in research and development activities.

 

As of March 31, 2007, the royalty amount payable to the Office of the Chief Scientist was approximately $4.4 million, including accrued interest.