RadView Software Ltd. (RDVWF)

[midastouch017]

Overview

We develop, market and support software that enables companies to assure the scalability, performance, efficiency and reliability of web applications.

We derive the majority of our software license revenues from perpetual licenses of our load testing products and, to a lesser extent, our functional testing and root-cause analysis products. We derive the majority of our services revenues from support and maintenance arrangements and, to a lesser extent, from training and consulting services. Substantially all of our revenues are denominated in U.S. dollars.

A portion of our revenues was derived from royalty fees, license fees and engineering service fees from technology license transactions. Revenues recognized under such arrangements totaled $362,000 in the three months ending March 31, 2005 and $501,000 for the same period in 2006. We expect that the impact of future technology license transactions, if any, will not represent a material portion of our total revenues. In March 2006, we implemented a series of measures to reduce operating expenses, including staff reductions, renegotiation of certain vendor contracts, and reduced spending on professional fees. As a result of increased revenues and lower operating expenses, we reported net income of $171,000 for the quarter ended March 31, 2006. However, we expect that we will not be able to sustain profitable operations in the immediate future due to an expected decline in revenues resulting from the substantial completion of recognition of revenues during the first quarter of 2006 arising from previously signed technology transactions.

On April 4, 2006, we signed definitive agreements for a financing led by Fortissimo Capital Funds, or Fortissimo, along with several co-investors including one of our directors and two existing shareholders, to provide for a minimum initial investment of $1.5 million and up to $2.25 million of additional investments, at the election of the investors, over 18 months. The completion of the proposed financing is subject to approval by a majority of our shareholders. Prior to signing the definitive agreements for the financing, in January 2006, we executed a bridge loan agreement with Fortissimo to provide us with interim funding for up to $500,000, subject to approval by Fortissimo and compliance by us with an approved budget, of which we have borrowed $330,000 as of April 30, 2006. Borrowings under the bridge loan will become part of the minimum initial investment at closing.

Our cash balance was $130,000 as of March 31, 2006 compared to $166,000 as of December 31, 2005.

We believe that our existing cash and cash equivalents, along with the proceeds available under the bridge loan and the expected proceeds from the initial investment from the financing, assuming the approval by a majority our shareholders and completion of the financing, will be sufficient to meet our anticipated needs for working capital and capital expenditures for at least the next 12 months.

Application of Critical Accounting Policies and Estimates

General

We prepare our consolidated financial statements in conformity with U.S. generally accepted accounting principles. As such, we are required to make certain estimates, judgments and assumptions that we believe are reasonable based upon the information available. These estimates and assumptions affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the periods presented. To fully understand and evaluate our reported financial results, we believe it is important to understand the significant estimates and judgments applied as they relate to our policies for revenue recognition, software development costs, restructuring costs and accounting for stock options. More detailed descriptions of these policies are provided in Note 2 to the consolidated financial statements.

Revenue Recognition

Our revenue recognition approach requires that four basic criteria must be met before revenue can be recognized: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred or services rendered; (3) the fee is fixed and determinable; and (4) collectibility is reasonably assured. Determination of criteria (3) and (4) is based on management's judgments regarding the fixed nature of the fee charged for services rendered and products delivered, and the collectibility of those fees. Should changes in conditions cause management to determine these criteria are not met for certain future transactions, revenue recognized for any reporting period could be adversely affected.

Software Development Costs

Software development costs incurred from the point of reaching technological feasibility until the time of general product release should be capitalized. We define technological feasibility as the completion of a working model. The determination of technological feasibility requires the exercise of judgment by our management. Because we sell our products in a market that is subject to rapid technological change, new product development and changing customer needs, we have concluded that technological feasibility is not established until the development stage of the product is nearly complete. For us, the period in which we can capitalize software development costs is very short, so the amounts that could be capitalized are not material to our financial statements. Therefore, we have charged all such costs to research and development expense in the period incurred.

Accounting for Stock Options

Effective January 1, 2005, we have accounted for stock options issued to employees in accordance with SFAS No. 123R (Revised 2004) ("SFAS 123(R)"), Share-Based Payment. Under this approach all share based payments to employees, including grants of employee stock options, are required to be recognized in the financial statements based on their fair values, instead of providing the information in a pro forma disclosure in the notes to the financial statements. We have elected to use the modified prospective method of adoption as permitted under SFAS 123 (R), which requires that compensation expense be recorded for all unvested stock options and restricted stock at the beginning of the first quarter of adoption of SFAS 123(R). We have determined the fair value of share based-payments issued after January 1, 2005 using the Black-Scholes option valuation model.

For reporting periods before January 1, 2005, we accounted for stock options using the intrinsic method in accordance with Accounting Principles Board, or APB, Opinion No. 25, Accounting for Stock Issued to Employees. Under this approach we did not record any expense at the time the options were granted unless the exercise price of a granted option is below the fair market price of our ordinary shares on the date of grant. For reporting periods before January 1, 2005, we have provided disclosures of impact to our reported net loss and net loss per share if we had applied the fair value method.

The determination of fair value of stock options, whether for actual expense reporting under SFAS 123(R) or for pro forma disclosures, requires the application of estimates, such as estimated expected life of the options and


estimated market volatility for our ordinary shares. These estimates are based on management's review of historical option lives and computations of market volatility for our ordinary shares.


Results of Operations



The following table sets forth, as a percentage of total revenues, consolidated
statement of operations data for the periods indicated:



Three Months Ended
March 31,
2006 2005
Revenues:
Software licenses 47.8 % 62.4 %
Services 52.2 % 37.6 %
Total revenues 100.0 % 100.0 %

Cost of revenues:
Software licenses 3.0 % 2.4 %
Services 4.6 % 3.8 %
Total cost of revenues 7.6 % 6.2 %

Gross profit 92.4 % 93.8 %

Operating expenses:
Sales and marketing 39.5 % 63.8 %
Research and development 20.5 % 47.1 %
General and administrative 21.5 % 31.6 %
Total operating expenses 81.5 % 142.5 %

Income (loss) from operations 10.9 % (48.7 )%

Other income:
Interest expense, net (1.0 )% (0.1 )%
Other income (expense), net 0.2 % (0.5 )%

Net income (loss) 10.1 % (49.3 )%




Three Months Ended March 31, 2006 and 2005

Revenues

Total Revenues. Total revenues were $1.7 million for the three months ended March 31, 2006 and $1.5 million for the same period in 2005. This increase was due to an increase in services revenues partially offset by a decrease in software license revenues.

Software Licenses. Software license revenues consist primarily of revenues from the sale of licenses to our end-user customers and revenues from the sale of technology licenses. Software license revenues were $807,000 for the three months ended March 31, 2006 and $940,000 for the same period in 2005, which represents a decrease of $133,000, or 14.1%. The decrease in software license revenues resulted from a $162,000 decrease in license revenues from technology license transactions, partially offset by a $29,000 increase in license revenues from end-users. The decrease attributable to technology licenses resulted from the recognition of $362,000 of revenues from Ixia in the first quarter of 2005 compared to $200,000 from OPNET in the first quarter of 2006. As a result of the completion of the OPNET technology transaction during the first quarter of 2006, we expect that software licenses revenues will be lower in the second quarter of 2006 than in the first quarter of 2006.


Services. Services revenues consist primarily of revenue from annual support and maintenance contracts and, to a lesser extent, training and consulting services. Services revenues were $883,000 for the three months ended March 31, 2006 compared to $567,000 for the same period in 2005, which represents an increase of $316,000, or 55.7%. The increase resulted primarily from $301,000 of services revenues attributable to services provided to OPNET in the first quarter of 2006. No similar revenues were recognized in the same period in 2005. There was also $15,000 of incremental revenues from maintenance services and other training services in the first quarter of 2006. As a result of the completion of the OPNET technology transaction during the first quarter of 2006, we expect that services revenues will be lower in the second quarter of 2006 than in the first quarter of 2006.

Cost of Revenues

Cost of Software Licenses. Cost of software licenses consists principally of direct product costs, such as product media and packaging, as well as royalties due to third parties. Cost of software licenses was $50,000, or 6.2% of software license revenues, for the three months ended March 31, 2006 compared to $36,000, or 3.8% of software license revenues, for the same period in 2005. The cost of revenues increased due to higher third-party royalties in respect of increased revenues from our WebLOAD Analyzer product, which bear such third-party royalties.

Cost of Services. Cost of services consists of personnel-related costs associated with customer support and training in additions to costs associated with providing engineering services to OPNET. Cost of services was $77,000, or 8.7% of service revenues, for the three months ended March 31, 2006 compared to $57,000, or 10.1% of services revenues, for the same period in 2005. The increase in absolute dollars was due to $38,000 of incremental labor and travel costs incurred in relation to the engineering services to OPNET, partially offset by an $18,000 decrease in customer support labor costs due to cost reductions made in July 2005. As a result of the completion of the OPNET engineering services in the first quarter of 2006, we expect that cost of services will decline in the second quarter of 2006.

Operating Expenses

Sales and Marketing. Sales and marketing expenses consist principally of salaries and commissions earned by sales personnel, travel and marketing program costs such as lead generation, trade shows, advertising and product promotion. Sales and marketing expenses were $668,000, or 39.5% of total revenues, for the three months ended March 31, 2006, compared to $961,000, or 63.8% of total revenues, for the same period in 2005. The decrease resulted primarily as a result of cost reductions in July 2005 achieved through reductions in personnel and salary-related costs and reduced marketing program spending. We expect sales and marketing expenses for the remainder of 2006 to remain at relatively the same level as the first quarter of 2006.

Research and Development. Research and development expenses consist principally of salaries and related expenses required to develop and enhance our products. Research and development expenses were $346,000, or 20.5% of total revenues, for the three months ended March 31, 2006, compared to $710,000, or 47.1% of total revenues, for the same period in 2005. These decreases resulted primarily as a result of cost reductions in July 2005 and March 2006 achieved through reductions in personnel and salary-related costs. We expect research and development expenses for the remainder of 2006 to remain at relatively the same level as the first quarter of 2006.

General and Administrative. General and administrative expenses consist principally of finance, executive and administrative salaries and related expenses, professional fees and other costs associated with being a public company. General and administrative expenses were $364,000, or 21.5% of total revenues, for the three months ended March 31, 2006, compared to $476,000, or 31.6% of total revenues, for the same period in 2005. The decrease resulted from a decrease in professional fees and reduced salary related costs due to staffing reductions in the latter half of 2005. As a result of cost reduction measures taken in March 2006, including the future impact of renegotiation of certain vendor contracts, some of which may have delayed effect, we expect that our general and administrative expenses in the second quarter of 2006 will remain consistent with the first quarter of 2006, but are expected to decline in the second half of 2006.


Interest Expense, Net. Interest expense, net consists principally of interest expenses and amortization of warrant discount and deferred financing costs arising from outstanding borrowings under the revolving line of credit facility and under the bridge loan, offset by interest earned on cash investments. Interest expense, net was $17,000 for the three months ended March 31, 2006, compared to $2,000 for the same period in 2005. The change in interest expense, net, resulted from increased interest expenses arising from borrowings under our revolving line of credit facility and amortization of warrant discount and deferred financing costs. We expect that interest expense in will increase upon completion of the proposed financing transaction in respect to the portion attributable to bridge loan and convertible debt.

Other Income (Expense), Net. Other expense, net consists principally of currency translation gains and losses. Other income, net was $3,000 for the three months ended March 31, 2006, compared to Other expense, net of $8,000 for the same period in 2005. The change in other expense, net was due to exchange rate fluctuations.

Income Taxes. We have estimated net operating loss carryforwards for Israeli tax purposes totaling approximately $16.4 million through March 31, 2006, that would reduce future Israeli income taxes, if any. These net operating losses may be carried forward indefinitely and offset against future taxable business income. We expect that during the period these losses are utilized, our income would be substantially tax exempt. Accordingly, there will be no tax benefit available from these losses and no deferred income taxes have been included in our consolidated financial statements.
Our U.S. subsidiary has estimated net operating loss carryforwards for U.S. federal and state tax purposes totaling approximately $35.2 million through March 31, 2006. These losses are available to offset any future U.S. taxable income of the U.S. subsidiary and will expire between 2012 and 2026. The Company has recorded a full valuation allowance against its deferred tax asset due to the uncertainty surrounding the ability and the timing of the realization of these tax benefits.

Liquidity and Capital Resources

Cash and cash equivalents totaled $130,000 as of March 31, 2006 and $166,000 as of December 31, 2005.

Cash used in operating activities was $206,000 for the three months ended March 31, 2006 and $1.2 million for the same period in 2005. Cash used in operating activities for the three months ended March 31, 2006 was due primarily to decreases of $277,000 in deferred revenues, $186,000 in accounts payable, and $92,000 in accrued severance, and an increase of $34,000 in accounts receivable, partially offset by net income of $171,000, a decrease of $74,000 in prepaid expenses and an increase of $94,000 in accrued expenses. Deferred revenues decreased as a result of the completion in March 2006 of recognition of previously deferred revenues from a technology license transaction, partially offset by increased deferred maintenance service contracts from new customers and renewal orders. Accounts payable decreased as a result of settlement of delayed vendor payments. Accrued severance decreased as a result of payments in accordance with Israel employment practices to terminated Israeli employees in 2006. Accounts receivable increased as a result of longer collection cycles on several international accounts. Prepaid expenses decreased primarily as a result of decrease in insurance, taxes and VAT prepayments. Accrued expenses increased primarily as a result of an increase in accrued salary.

Cash provided by investing activities was $55,000 for the three months ended March 31, 2006 and $103,000 for the same period in 2005. Cash provided by investing activities in 2006 resulted from a decrease of $55,000 in other assets as a result of the release of severance fund deposits to certain terminated employees in accordance with Israel employment practices.

Cash provided by financing activities was $115,000 for the three months ended March 31, 2006. There was no cash provided by financing activities for the same period in 2005. The cash provided by financing activities in 2006 consisted of $185,000 of borrowings under a bridge loan, net, partially offset by the final repayment of $70,000 under our prior revolving line of credit facility.

Comerica Line of Credit

In May 2005, we obtained a one-year revolving line of credit facility with Comerica Bank for borrowings of up to $2.0 million. Advances under the facility were limited to the lesser of $2.0 million or the sum of 75% of eligible accounts receivables plus $1.0 million. In December 2005, our borrowings under the credit facility exceeded the collateral base and, as a result, we triggered an event of default. We agreed upon a repayment plan with Comerica Bank to repay the outstanding borrowings under the facility in installments through January 2006. In January 2006, all outstanding borrowings under the credit facility were fully repaid and the revolving line of credit facility was terminated.

Fortissimo Financing

On April 4, 2006, we signed definitive agreements for a financing with Fortissimo Capital Fund GP LP on behalf of several limited partnerships in which it serves as general partner and other potential co-investors including one of our directors and two existing shareholders, or the Investors. The initial investment of the financing would be for a minimum of $1.5 million consisting of $750,000 to purchase 25,000,000 of convertible preferred shares, or Preferred Shares, at a price of $0.03 per share and $750,000 as a convertible loan. The closing of the initial investment is required to occur within 14 days of approval by a majority of our shareholders. The financing also provides for an additional investment, at the option of the Investors, to purchase up to an additional $2.25 million of Preferred Shares at a price of $0.03 per share for a period of 18 months after the closing of the initial investment. Each Preferred Share would be convertible into one of our ordinary shares, subject to adjustment for anti-dilution events. Each Preferred Share would receive the same voting rights as ordinary shares, except Preferred Shares would be entitled to elect the majority of our board of directors and have approval rights over specified actions. Each Preferred Share would be entitled to a preference in liquidation over our ordinary shares. The Investors would also receive warrants to purchase 18,750,000 Preferred Shares with respect to the initial investment and up to 56,250,000 Preferred Shares with respect to the additional investment, each at an exercise price of $0.04 per share for a period of five years from date of issuance.

The financing also provides for the issuance of a convertible loan payable at the closing of the initial investment in the principal amount of $250,000 plus the balance of any borrowings still available under the Bridge Loan at the time of closing. The principal balance of bridge loans previously borrowed also will become part of the convertible loan at the closing of the Investment. The convertible loan will bear interest at 8.0% per annum. The convertible loan plus, at the election of the Investors, any accrued interest thereon, would be convertible into Preferred Shares at a conversion price of $0.03 per share. The convertible loan would mature three years from the closing date and, if not converted by such date, would become due and payable 30 days thereafter.

Prior to the signing of definitive agreements, on January 26, 2006, we entered into a bridge loan agreement, or the Bridge Loan, with the Investors. Under the Bridge Loan, the Investors agreed to provide us with up to $500,000 of loans, subject to the terms of the loan. As of April 30, 2006, we have borrowed $330,000 and the remaining $170,000 remains available for future borrowing on an as-needed basis until the closing, subject to approval of the Investors and compliance by us with an approved budget. The Bridge Loan bears interest at 8.0% per annum and is secured by a fixed charge on our accounts receivables and intellectual property and a floating charge on all of our assets. The Bridge Loan would be subject to the terms and conditions of the convertible loan portion of the financing when the financing closes. If the financing is not closed due to failure to secure shareholder approval or termination by either party, the Bridge Loan will become due and payable within 60 days of notice by either party of an intention to terminate negotiations with respect to the financing.

The financing remains subject to, among other things, filing of amended articles of association establishing the rights and preferences of the Preferred Shares and approval by a majority of our shareholders. Several of our significant shareholders, representing 39.3% of our outstanding ordinary shares, have represented to us that they intend to vote in favor of the financing. If a majority of our shareholders does not approve the financing, the Investors will be entitled to receive a termination fee of $250,000.

The financing also provides for an us to enter into an management services agreement with Fortissimo, under which Fortissimo will provide management and board services in consideration a minimum fee of $50,000 per year


payable quarterly plus an additional amount of up to $70,000 payable at the end of each year that we are profitable, provided that such additional amount may not to exceed the available profits.

Working Capital Needs

We expect that operating expenses will constitute a material use of our cash resources. We believe that our existing cash and cash equivalents, along with amounts available under the existing bridge loan agreement and potential investment by the Investors, assuming the execution of definitive agreements related to the proposed investment and approval by a majority of our shareholders, will be sufficient to meet our anticipated needs for working capital for at least the next 12 months. In the event that we are unable to complete the proposed investment with the Investors, our ability to conduct our business will be materially adversely affected.


Contractual Obligations



We lease all of our office facilities under noncancellable operating leases that
expire over varying terms through 2009. As of March 31, 2006, our contractual
obligations were as follows:



Payments due by Period
Less than More than
Contractual Obligations Total 1 year 1-3 years 3-5 years 5 years
(In Thousands)

Operating leases $ 335 $ 130 $ 205 $ - $ -
Severance pay (1) 447 66 - - 381
Total $ 782 $ 196 $ 205 $ - $ 381


(1) Severance pay relates to accrued severance obligations to our Israeli employees as required under Israeli labor laws. These obligations are payable only upon the termination of the respective employee and may be reduced if the employee's termination is voluntary.


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