** **

**SECURITIES AND EXCHANGE COMMISSION**

WASHINGTON, D.C. 20549

 

**FORM 20-F**

 

******ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF**

**THE SECURITIES EXCHANGEACT OF 1934**

 

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002      COMMISSION FILE NO. 005-60609

_______________________________________________

**Compugen Ltd.**

(Exact name of registrant asspecified in its charter and translation of registrant's name into English)

________________________________________________________________________________

 

**Israel**

(Jurisdiction ofincorporation or organization)

 

**72 Pinchas Rosen Street****, Tel Aviv, 69512****Israel**

(Address of principalexecutive offices)

________________________________________________

 

**Securities registered orto be registered pursuant to Section 12(b) of the Act****:**

 

None

 

**Securities registered orto be registered pursuant to Section 12(g) of the Act:**

 

        OrdinaryShares, par value New Israeli Shekels 0.01 per share      

(Title of Class)

 

**Securities for which there is a reporting obligationpursuant to Section 15(d) of the Act:**

 

None

 

Indicate the number of outstanding shares of eachof the issuer's classes of capital or common stock as of the close of theperiod covered by the annual report: 

 

                                                                                                                                                                                                                               26,243,446Ordinary Shares

 

Indicate by check mark whether the registrant (1)has filed all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file such reports), and (2)has been subject to such filing requirements for the past 90 days: 

                                                                                                                                                                                                                                                   Yes[x]      No [  ]

 

 

Indicate by check mark which financial statementitem the registrant has elected to follow:

                                                                                                                                                                                                                                                               Item17 [  ]   Item 18 [x]      
**____(1)____ 

This annual report on Form 20-F includes"forward-looking" statements within the meaning of Section 21E of theSecurities Exchange Act of 1934. We have based these forward-looking statementson information available to us on the date hereof, our current intentions, ourbeliefs, and expectations or projections about future events. We assume noobligation to update any such forward-looking statements. These statementsinvolve risks and uncertainties and actual results could differ materially fromour expectations or projections. Factors that could cause our actual results todiffer materially from those projected in the forward-looking statementsinclude the risk factors set forth in this annual report at "Item 3. RiskFactors."

‐‐‐‐‐‐‐‐‐‐‐‐

 

We have prepared our consolidated financialstatements in United States dollars and in accordance with accountingprinciples generally accepted in the United States. All references herein to"dollars" or "$" are to United States dollars, and all references to "Shekels"or "NIS" are to New Israeli Shekels.  

‐‐‐‐‐‐‐‐‐‐‐‐

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****____(2)____ 

 

**PART I.**

** **

**ITEM 1.                   IDENTITY OF DIRECTORS, SENIORMANAGEMENT AND ADVISORS**

 

                       Not applicable.

 

**ITEM 2.                   OFFER STATISTICS AND EXPECTEDTIMETABLE**

 

                       Not applicable.

 

**ITEM 3.                   KEY INFORMATION**

 

**Selected Financial Data**

** **

                       The selected financial data is incorporated byreference to Item 5 of this annual report.

 

**Risk Factors**

*** ***

           This annual report includes forward-lookingstatements. We have based these forward-looking statements on our currentintentions, beliefs, expectations or projections about the future. Theseforward-looking statements are not guarantees of future performance and aresubject to risks, uncertainties and assumptions that could cause our actualresults to differ materially from those projected in the forward-lookingstatements. 

* *

***Risks Related to Our Business***

** **

**Our approach of incorporating ideas and methods frommathematics, computer science and physics into the disciplines of biology,organic chemistry and medicine is novel and may not be accepted by ourpotential customers and/or collaborators.**

** **

Compugen is a drug and diagnostic discovery companyand a leader in incorporating ideas and methods from mathematics, computerscience and physics into the disciplines of biology, organic chemistry andmedicine. Our objective is to significantly increase the probability of successof drug discovery and diagnostic development. Notwithstanding that we havealready made discoveries by using this approach, our approach and the productsand technologies derived from our approach are novel. As a result, they mayprove to be ineffective or not as effective as other methods, or they may notbe accepted by our potential customers or collaborators. Our products andtechnologies may prove to be ineffective if, for instance, they fail to accountfor the complexity of the life processes that we are now attempting to model.If our customers or collaborators do not accept our products or technologiesand/or if our technologies prove to be ineffective our business may fail or wemay never become profitable. 

 

**We have a history of losses, we expect to incur futurelosses and we may never achieve or sustain profitability***.*

 

We incurred net losses of approximately $13.4million in 2000, $15.1 million in 2001, and $12.2 million in 2002. As of December 31, 2002, we had an accumulated deficit of approximately $55.7 million (notincluding approximately $24.9 million in accumulated deficit attributable tothe conversion of preferred shares upon the closing of our initial publicoffering). We expect to continue to incur net losses and negative cash flows inthe future due in part to high research and development expenses, includingenhancements to our technologies and investments in new technologies. As aresult, we will need to generate significantly higher revenues to achieveprofitability. We cannot assure you that we will ever achieve profitability.Even if we do achieve profitability, we may not be able to sustain or increaseprofitability.
**____(3)____ 

**Even if our computational technologies are effective asresearch tools, we or our customers may be unable to develop or commercializenew drugs, therapies or other products based on them.**

** **

Even if our computationaltechnologies perform their intended functions as research tools, we or ourcustomers may be unable to use the discoveries resulting from them to producenew drugs, therapies, diagnostic products or other life science products.Despite recent scientific advances in the life sciences and our improvedunderstanding of biology, the roles of genes and proteins and their involvementin diseases and in other life processes is not well understood. Only a fewtherapeutic products based on the study of and discoveries relating to genes orproteins have been developed and commercialized. If we and our customers areunable to use our discoveries to make new drugs or other life science products,our business may fail or we may never become profitable.

 

**There are many risks of failure in the development ofdrugs, therapies, diagnostic products and other life science products. Theserisks are inherent to the development and commercialization of these type ofproducts**.

 

A number of risks of failureare an inseparable from the process of developing and commercializing drugs,therapies, diagnostic products and other life science products. These risksinclude the possibility that any of these products will:
- be found to be toxic or ineffective; 
- fail to receive necessary regulatory     approvals; 
- be difficult or impossible to manufacture on a     large scale; 
- be uneconomical to market; 
- fail to be developed prior to the successful     marketing of similar products by competitors; or
- be impossible to market because they infringe on the     proprietary rights of third parties or compete with superior products     marketed by third parties.

 

Any of these risks could materially harm ourbusiness and financial results.

 

**The industries in which we are active are evolvingrapidly, and we may be unable to keep pace with changes in technology.**

** **

The pharmaceutical and biotechnology industries arecharacterized by rapid technological change. This is especially true of thedata-intensive areas of such technologies. Our future success will largelydepend on maintaining a competitive position in the field of drug, therapeuticsand diagnostic products discovery. If we fail to keep pace with changes intechnology, our business will be materially harmed. Rapid technologicaldevelopment may result in our products or technologies becoming obsolete. Thismay occur even before we recover the expenses that we incurred in connectionwith developing those products and technologies. Products or services offeredby us could become obsolete due to the development of less expensive or moreeffective drug or diagnostics discovery technologies. We may not be able tomake the necessary enhancements to our technologies to compete successfullywith newly emerging technologies. In addition, human genomic sequence data andsoftware is available to the public as a result of the federally funded HumanGenome Project and other projects which are engaged in the study of genes andtheir behavior in normal and diseased conditions. These publications, includingthe publication of the human genome, may make some of our products and technologiesless valuable or obsolete. 

** **

**We face intense competition, and if we are unable tocompete successfully, we could experience a loss of market share and reducedgross margins for our platforms, services and technologies.**

** **

The markets for our products and services are verycompetitive, and we expect the competition to increase in the future. Wecompete with entities in the United States and elsewhere that provide productsand services for the analysis of genomic information and information relating tothe study of proteins (proteomic information) or that commercialize novel genesand proteins. These include genomics, pharmaceutical and biotechnologycompanies, academic and research institutions and government and otherpublicly-funded agencies. We may not be able to successfully compete withcurrent and future competitors. Many of our competitors have substantiallygreater capital resources, research and development staffs, facilities,manufacturing and marketing experience, distribution channels and humanresources than we do. This may allow these competitors to discover and todevelop products or to obtain regulatory approval for products based on thesediscoveries, in advance of us or of our customers. 
**____(4)____ 

Greater resources may also allow these competitorsto develop products that are more effective than ours or than those of ourcustomers. Some of our competitors, especially academic and researchinstitutions and government and other publicly funded agencies, may provide forfree services or data similar to the services and data that we provide for afee. Moreover, our competitors may obtain patent and other intellectualproperty protection that would limit our rights or our customers' and partners`ability to use or commercialize our discoveries, products and services. If weare unable to compete successfully against existing or potential competitors,our market share, revenues and margins may decline.

** **

**We have allocated limited resources to our discoveryactivities, and we may never be able to commercialize products resulting fromthese activities or achieve profitability.**

** **

Our discovery team has limited research anddevelopment personnel and limited marketing capabilities. We currently have notherapeutics or diagnostic products manufacturing capabilities. Our discoveryactivities have generated only negligible revenues to date, have no clearsource of revenues and may never achieve profitability. Although we intend toallocate additional cash resources to our discovery activities, we do notanticipate that this funding will enable us to achieve profitability in thenear future. As a result, our discovery activities may require substantialadditional funds in the future. If we are unable to obtain the requiredadditional funds for our discovery activities, whether internally or from thirdparties on commercially reasonable terms, we may have to curtail or cease ourdiscovery activities. 

 

To date, our discovery team identified a number ofpotential diagnostic markers and therapeutic proteins. Once developed, productcandidates must undergo extensive testing, including animal and human clinicaltrials, to obtain regulatory approvals needed for commercialization. Even if weare able to develop and commercialize our potential product candidates, wecannot assure you that these products, or any of them, would be commerciallymarketable or successful.  

 

**We may not be able to find business partners to developand commercialize product candidates deriving from our discovery activities.**

 

Our strategy for the development andcommercialization of diagnostic markers and therapeutic proteins depends on theformation of collaborations or licensing relationships with third parties thathave complementary capabilities in relevant fields. Potential third partiesinclude pharmaceutical and biotechnology companies, diagnostic companies,academic institutions and other entities. 

 

We have granted two licenses for the developmentand commercialization of diagnostic markers or therapeutic proteins, which arein their initial stages. We cannot assure you that these collaborations andlicenses will be successful.  We cannot assure you that we will enterinto any other collaboration in the future.  If we are not able toestablish successful collaborations or licenses, we may be required toundertake product development and commercialization at our own expense. Such anundertaking may:

 
- limit the number of product candidates that we will     be able to develop and commercialize;
- reduce the likelihood of successful product     introduction; 
- delay the time by which our product candidates may be     developed and commercialized; 
- significantly increase our capital requirements; and
- disrupt our business, distract our management and     employees and increase our expenses.

 

As a result of the above, if we fail to enter intosuccessful collaborations and licenses, our discovery activities and financialcondition and results of operations may be materially harmed. 

** **

**Our dependence on licensing and other collaborationagreements with third parties subjects us to a number of risks.**

** **

We may not be able to enter into licensing or othercollaboration agreements on terms favorable to us. Collaborators may typicallybe afforded significant discretion in electing whether to pursue any of theplanned activities. In most cases, our collaborators or licensees will haveresponsibility for formulating and implementing key strategic or operationalplans. Decisions by our collaborators or licensees on these key plans, whichmay include development, clinical, regulatory, marketing (including pricing),inventory management and other issues, may prevent successful commercializationof the product or otherwise affect our profitability.  
**____(5)____ 

In addition, we may not be able to control theamount and timing of resources our collaborators devote to the productcandidates, and collaborators may not perform their obligations as expected.Additionally, business combinations or changes in a collaborator's or alicensee`s business strategy may negatively affect its willingness or ability tocomplete its obligations under the arrangement with us. Furthermore, our rightsin any intellectual property or products that may result from ourcollaborations may depend on additional investment of money that we may not beable or willing to make. 

** **

Potential or future collaborators may pursuealternative technologies, including those of our competitors. Disputes mayarise with respect to the ownership of rights to any technology or productdeveloped with any future collaborator. Lengthy negotiations with potentialcollaborators or disagreements between us and our collaborators may lead todelays or termination in the research, development or commercialization ofproduct candidates or result in time-consuming and expensive litigation orarbitration. If our collaborators pursue alternative technologies or fail todevelop or commercialize successfully any product candidate to which they haveobtained rights from us, our business, financial condition and results ofoperations may be significantly harmed. 

** **

**Our business of providing access to our platforms,tools and data to our customers and the activities of our discovery team mayconflict with each other.  **

** **

Our discovery activities depend, in large part, onour computational platforms and tools and proprietary data to make inventionsand establish intellectual property rights in genes and proteins. We believethat the access to our platforms, tools and proprietary information providesour discovery team with a competitive advantage over biotechnology companiesthat are pursuing technologies that may compete with us and that seek patentprotection to gene and protein sequences in which we have an interest. When wemake these platforms, tools and information available to our customers,primarily biotechnology and pharmaceutical companies, our discovery team`scompetitive advantage over these customers may be diminished or eliminated. Ifour customers, many of which have greater financial and other resources than wehave, research genes or proteins that we are also researching, they mayestablish intellectual property rights in such genes or proteins before ourdiscovery team does. As a result, our business, financial condition and resultsof operations may be significantly harmed. In addition, our discovery team maypursue opportunities in fields that could conflict with those of our customersor discourage potential customers from working with us, thereby reducing ourpotential revenues.    

 

**The trend towards consolidation in the****pharmaceutical and biotechnology industriesmay adversely affect us.**

 

The trend towards consolidation in thepharmaceutical and biotechnology industries may negatively affect us in severalways. These consolidations usually involve larger companies acquiring smallercompanies, which results in the remaining companies having greater financialresources and technological capabilities, thus strengthening competition in theindustry. In addition, continued consolidation may result in fewer customersfor our products and services. Also, if one of the consolidating companiesalready uses the products or services of our competitors, we may lose existingcustomers as a result of such consolidation.

** **

**We rely on a small number of customers for a largeportion of our revenues from products and services.**

** **

A small number of our customers account for asubstantial amount of our revenues. Warner-Lambert Company, a subsidiary ofPfizer, Inc., accounted for approximately 35% of our revenues in 2000,approximately 30% of our revenues in 2001 and approximately 14% of our revenuesin 2002. The U.S. Patent and Trademark Office accounted for approximately 24%of our revenues in 2000, approximately 17% of our revenues in 2001, and lessthan 10% of our revenues in 2002. Novartis Pharma A.G. accounted for approximately17% of our revenues in 2001 and approximately 18% of our revenues in 2002; anddiaDexus Inc. accounted for approximately 12% of our revenues in 2002. Some ofthese agreements have expired or will expire, unless renewed, in the nearfuture. A loss of our significant customers, or a reduction in orders fromthese customers, could harm our business and financial results. 
****____(6)____ 

** **

**If we are unable to hire or retain key personnel orsufficient qualified employees, we may be unable to successfully operate ourbusiness.**

** **

Our business is highly dependent upon the continuedservices of our senior management and key technical personnel. While members ofour senior management are parties to employment or consulting agreements andnon-competition and non-disclosure agreements, we cannot assure you that thesekey personnel and others will not leave us or compete with us, which couldmaterially harm our financial results and our ability to compete. We do notcarry key person life insurance on any member of our senior management.Furthermore, competition for highly qualified personnel in our industry andgeographic locations is intense. Our business would be seriously harmed if wewere unable to retain our key employees, or to attract, integrate or retainother highly qualified personnel in the future.

 

**If we are unable to raise additional capital in thefuture, we may have to curtail or cease operations.**

** **

Based on our current projections, we anticipatethat our existing cash and cash equivalents will be sufficient to support ouroperations for at least the next two years. We cannot assure you, however, thatwe will not need to raise additional capital prior to that time or that wewould be able to raise sufficient additional capital on favorable terms, if atall. If we fail to raise sufficient funds, we may have to curtail or ceaseoperations, which would materially harm our business and financial results. Ifwe raise additional capital by issuing equity securities, our shareholders mayexperience dilution. If we raise additional funds through collaboration andlicensing arrangements, we may be required to relinquish some rights to ourtechnologies or product candidates, or grant licenses on terms that are notfavorable to us.  

 

**Our operating results are likely to fluctuate and mayfail to meet the expectations of the investment community, which may cause ourshare price to decline.**

** **

Our quarterly operatingresults have fluctuated in the past and are likely to do so in the future.These fluctuations could cause our share price to fluctuate significantly. Ifour operating results fail to meet the expectations of the investmentcommunity, this could also cause our share price to fluctuate. Consequentlythese results should not be relied upon as indications of future performance andcomparisons quarterly results of operations may not be meaningful. Ouroperating results may fluctuate as a result of:
- the timing of our receipt of payments under     arrangements with our current and future customers and collaborators;
- our rate of success and timing of new     collaborations and sales of our products, services and discoveries;
- changes in demand for our existing products     and services;
- a drop in the financial resources available to     our customers; 
- changes to our fee structure imposed by market     constraints, or to our operating expenses; 
- product quality problems; 
- increased competition and the timing of the     release of products and data by our competitors and academic and other     non-profit organizations; 
- inflation in Israel or changes in the conversion     rate of Israeli currency (New Israeli Shekel);
- fluctuations in the sales activities of our     distributors; and
- the outcome of conflicts in the Middle East. 

** **

**We may acquire or make strategic investments in otherbusinesses and technologies in the future, and these could prove difficult tointegrate, disrupt our business, dilute stockholder value and adversely affectour operating results.**

** **

We have not made acquisitions of other companies orbusinesses in the past and currently have no commitments or agreements withrespect to future acquisitions. However, if opportunities arise, we mayconsider making future acquisitions of businesses, technologies, services orproducts.***  ***Moreover, even if we acquire complementarybusinesses or technologies, we may be unable to successfully integrate anyadditional personnel, operations or acquired technologies into our business.Difficulties in integrating an acquired business could disrupt our business,distract our management and employees and increase our expenses. In addition,if we make acquisitions using convertible debt or equity securities, existingstockholders may be diluted, which could affect the market price of our stock.
**____(7)____ 

 

**If our access to tissue samples or to genomic data orother information is restricted, or if this data is faulty, our business maysuffer.**

** **

To continue to build our technologies and relatedproducts and services, we need access to third parties` scientific and otherdata and information. We also need access to normal and diseased human and othertissue samples and other biological materials. We may not be able to obtain ormaintain such access on commercially acceptable terms. Some of our supplierscould become our competitors and discontinue selling supplies to us.Information and data from these suppliers could also contain errors or defectsthat could corrupt our databases or the results of our analysis of theinformation and data. In addition, government regulation in the United Statesand other countries could result in restricted access to, or use of, human andother tissue samples. Although currently we do not face significant problems inobtaining access to tissues, if we lose access to sufficient numbers or sourcesof tissue samples, or if tighter restrictions are imposed on our use of theinformation generated from tissue samples, our business may suffer.

** **

**Our business and the products developed by ourcollaborators and licensees may be subject to governmental regulation.**

** **

Any new therapy or diagnostic product that may bedeveloped by us, by our collaborators, or by our licensees will have to undergoa lengthy and expensive regulatory review process in the United States andother countries before it can be marketed. It may be several years, or longer,before any therapy or diagnostic product that we develop by using ourtechnologies, will be sold or will provide us with any revenues. This may delayor prevent us from becoming profitable. Changes in policies of regulatorybodies in the United States and in other countries could increase the delay foreach new therapy and diagnostic product. Even if regulatory approval isobtained, a product on the market and its manufacturer are subject tocontinuing review. Discovery of previously unknown problems with a product mayresult in withdrawal of the product from the market.

 

We have not yet applied for or received regulatoryapproval for any therapeutic, diagnostic or other product resulting from theuse of our products or services or from our discovery activities. Although weintend to become involved in the clinical phases in the future, we still expectto rely mainly on collaborators or licensees of our discovery activities tofile these applications and generally direct the regulatory review process. Wecannot be certain whether our collaborators or licensees will be able to obtainmarketing clearance for any product that may be developed on a timely basis, ifat all. If our collaborators or licensees fail to obtain required governmentalclearances, it will prevent them from marketing therapeutic or diagnosticproducts until clearance can be obtained, if at all. This will in turn reduceour chances of receiving various forms of payments, including those relating tosales of marketed therapeutic or diagnostic products by our collaborators orlicensees.

** **

**If ethical and other concerns surrounding the use ofgenetic information become widespread, there may be less demand for ourproducts and services.**

** **

Genetic testing has raised ethical issues regardingconfidentiality and the appropriate uses of the resulting information. Forthese reasons, governmental authorities may call for limits on or regulation ofthe use of genetic testing or prohibit testing for genetic predisposition tovarious conditions, particularly for those that have no known cure. Any ofthese scenarios could reduce the potential markets for our technologies in thefield of predictive drug response, which could materially harm our business andfinancial results.

** **

**The sales cycle for some of our products and servicesis lengthy. We expend substantial funds and management effort with no assuranceof successfully selling our products or services**.

** **

Our ability to obtain customers for our platforms,tools and services depends in large upon the perception that our technologiescan help accelerate their efforts in drug and diagnostics discovery. Ourability to obtain customers for our therapeutic or diagnostic productcandidates significantly depends on our ability to validate and prove that eachsuch product candidate is suitable for our claimed therapeutic or diagnosticpurposes. Our ability to obtain customers will also depend on our ability tosuccessfully negotiate terms and conditions for such arrangements. The salescycle for our therapeutic and diagnostic product candidates is typically lengthyand may take more than 12 months.
**____(8)____ 

The sales cycle for some of our platforms, toolsand services may also take 12 months or longer. Our sales effort may requirethe effective demonstration of the benefits of our products and services to,and significant training of, many different departments within a potentialcustomer. These departments may include key management personnel. In addition,we are often required to negotiate agreements containing terms unique to eachcustomer. Therefore, we expend and will need to continue expending substantialfunds and management effort with no assurance that we will be successful inreaching agreements with potential customers.

 

**We may be subject to product liability claims if ourproducts, or products derived from our products or services, harm people.**

** **

We may be held liable if any product we develop, orany product that is made with the use, or incorporation of, any of ourtechnologies or data causes harm or is found otherwise unsuitable. These risksare inherent in the development of genomics, functional genomics andpharmaceutical products. If we are sued for any harm or injury caused byproducts derived from our services or products, our liability could exceed ourtotal assets.  In addition, such claims could cause us to incursubstantial costs and subject us to negative publicity even if we prevail inour defense of such claims. 

**Our business is dependent on the continuous, reliableand secure operation of our computational tools and platforms. If we are unableto safeguard the integrity, security and privacy of our data or our customers'data, our revenue may decline, our business could be disrupted, and we may besued.**

** **

We have implemented and maintain physical andsoftware security measures to preserve and protect our computer andcommunications hardware and software as well as our data and our customers'data. These measures are intended to protect against loss, corruption andmisappropriation caused by system failures or unauthorized access. However,these methods cannot protect us against fire, storm, flood, power loss,earthquakes, telecommunications failures, physical or software break-ins andsimilar events. In addition, our database products are complex andsophisticated and could contain erroneous data, design defects or softwareerrors that could be difficult to detect and correct. Software errors andviruses may be found in current products or any future products that wedevelop. If we fail to maintain and further develop the necessary data tosupport our customers' data discovery efforts, it could result in a loss of ordelay in our revenues and market acceptance and exposure. 

 

We have also taken security measures to protect ourproprietary databases and have entered into confidentiality agreements withemployees, customers and collaborators who have access to our confidential orproprietary information. However, these measures may not be sufficient toprevent unauthorized access, use or publication of our proprietary data. Aparty who is able to circumvent our security measures could misappropriate ordestroy proprietary information or cause interruptions in our operations. Inaddition, a party who obtains unauthorized access to our proprietary data orbreaches a confidentiality agreement with us could publish large portions orall of our proprietary data.  Such publication of our proprietarydata could make some of our products less valuable or obsolete, therebyseriously harming our financial condition.  We also could be subjectto liability claims by customers or our collaborators who have submitted theirdata to us for analysis.  

 

We may be required to bear significant expenditureson an on-going basis to protect against system failures or security breaches orto alleviate problems caused by any failures or breaches. Any failure thatcauses the loss or corruption of, or unauthorized access to, our or ourcustomers` data could reduce customer satisfaction, expose us to liability and,if significant, could cause our revenue to decline or our entire business tocease.

 

**Any inability to protect our proprietary data,technologies or products could harm our competitive position.**

** **

If we do not adequately protect the intellectualproperty underlying our products and services, competitors may be able todevelop and market the same or similar products and services. This would erodeour competitive advantage. The laws of some countries do not protect or enablethe enforcement of intellectual property to the same extent as the laws of the U.S.
**____(9)____ 

We use contractual obligations to protect asignificant portion of our confidential and proprietary information andknow-how. This includes a substantial portion of the knowledge base from whichwe develop a large portion of our proprietary products and services. However, thesemeasures may not provide adequate protection for our trade secrets or otherproprietary information and know-how. Customers, employees, scientificadvisors, collaborators or consultants may still disclose our proprietaryinformation in violation of their agreements with us, and we may not be able tomeaningfully protect our trade secrets against this disclosure. 

 

In addition, we have applied for patents coveringsome aspects of some of our technologies and predicted genes and proteins wehave discovered using these technologies. To date, we have been granted onepatent for one of our discoveries. We plan to continue to apply for patentscovering parts of our technologies and discoveries as we deem appropriate, butcannot assure you that we will be able to obtain any patents. The patentpositions of biotechnology companies, including Compugen, are generallyuncertain and involve complex legal and factual questions. Legislative changesand/or changes in the examination guidelines of governmental patents officesmay negatively affect our ability to obtain patent protection for certainaspects of our intellectual property, especially with respect to geneticdiscoveries. 

 

**Our success depends in large part on our ability topatent our discoveries.**

 

The success of our discovery activities depends, inlarge part, on our ability to obtain patents on genes and proteins that we havediscovered and are attempting to commercialize. We face intense competitionfrom other biotechnology and pharmaceutical companies. These include customerswho use our products and technologies and are pursuing patent protection fordiscoveries, which may be similar or identical to our discoveries. We cannotassure you that other parties have not sought patent protection relating to thegenes and proteins that we discovered or may discover in the future. Our patentapplications may conflict with prior applications of third parties or withprior publications. They may not result in issued patents and, even if issued,our patents could be invalidated or may not be sufficiently broad to provide uswith any competitive advantages. U.S. and other patent applications ordinarilyremain confidential for 18 months from the date of filing. As a result, patentapplications that we file which we believe are novel at the time of filing, maybe determined at a later stage to be inconsistent with earlier applications.  Anyof these events could materially harm our business or financial results.

** **

**Litigation or other proceedings or third party claimsof intellectual property infringement could prevent us, or our customers orcollaborators, from using our discoveries or require us to spend time and moneyor modify our operations.**

** **

If we infringe patents or proprietary rights ofthird parties, or breach licenses that we have entered into with regard to ourtechnologies and products, we could experience serious harm. If litigation iscommenced against us for intellectual property rights infringement, we mayincur significant costs in litigating, whether or not we prevail in suchlitigation. These costs would also include diversion of management andtechnical personnel to defend ourselves against third parties or to enforce ourpatents (once issued) or other rights against others. In addition, partiesmaking claims against us may be able to obtain injunctive or other equitablerelief that could prevent us from being able to further develop orcommercialize. This could also result in the award of substantial damagesagainst us. In the event of a successful claim of infringement against us, wemay be required to pay damages and obtain one or more licenses from thirdparties. If we are not able to obtain these licenses at a reasonable cost, ifat all, we could encounter delays in product introductions while we attempt to developalternative methods or products. Defense of any lawsuit or failure to obtainany of these licenses could prevent us from commercializing available products.  

 

**Any claims related to the hazardous chemicals andradioactive and biological materials we use in our business could be timeconsuming and costly.**

 

Our research and development processes involve thecontrolled use of hazardous materials, including chemicals, radioactive andbiological materials. To our knowledge, our work is performed in accordancewith applicable environmental regulations. However, we cannot eliminate therisk of accidental contamination or discharge and any harm from thesematerials. We could be subject to civil damages and criminal penalties in theevent of improper or unauthorized release of, or exposure of individuals to,hazardous materials. In addition, claimants may sue us for harm orcontamination that results from our use or the use by third parties (includingour collaborators) of these materials, and our liability may exceed ourinsurance coverage or even our total assets. We could be held responsible forany injury caused to persons or property by exposure to, or release of, thesehazardous materials.   
**____(10)____ 

**Our chemistry operation is in its early research anddevelopment stage. We may never be able to validate the technology that we aredeveloping, and even if validated, we may never be able to commercialize it.**

 

Our chemistry operation is in its early researchand development stage. We consider it a high-risk operation in that it consumessignificant resources and funds but is uncertain of success. Althoughsubstantial progress has been made since the initiation of this activityapproximately three years ago, the underlying scientific rationale has not yetbeen fully validated. We do not know whether the underlying technology willever be validated and, if validated, whether we will be able to commercializethis technology.

** **

***Risks Related to our Ordinary Shares***

*** ***

**Holders of our ordinary shares who are****United  States****residents face income tax risks.**

 

There is a significant risk that we will beclassified as a passive foreign investment company, or PFIC. Our treatment as aPFIC could result in a reduction in the after-tax return to the holders of ourordinary shares and may cause a reduction in the value of these shares. ForU.S. Federal income tax purposes, we will be classified as a PFIC for anytaxable year in which either (i) 75% or more of our gross income is passiveincome, or (ii) at least 50% of the average value of all of our assets for thetaxable year produce or are held for the production of passive income. For thispurpose, passive income includes dividends, interest, royalties, rents,annuities and the excess of gains over losses from the disposition of assets thatproduce passive income. If we were determined to be a PFIC for U.S. federalincome tax purposes, highly complex rules would apply to U.S. taxpayers owningour ordinary shares. Accordingly, you are urged to consult your tax advisorsregarding the application of these rules.

 

As a result of our substantial cash position andthe decline in the value of our stock in 2002, there is a significant risk thatwe will be classified as a PFIC under the asset test described in the precedingparagraph.  In addition, there can be no assurance that we will notbe classified as a PFIC in the future, because the determination of whether weare a PFIC is based upon the composition of our income and assets from time totime, and such determination cannot be made with certainty until the end of acalendar year. 

 

United States residents should carefully read"Taxation, United States Federal Income Tax Consequences" under "Item 10.Additional Information" for a more complete discussion of the U.S. federalincome tax risks related to owning and disposing of our ordinary shares. 

 

**Our business is difficult to evaluate because we have alimited history of operations.**

 

Since our incorporation in 1993, our researchfocus, the products we developed and our business model have been continuallyevolving. In addition, since 1998, part of our business has involved theresearch and development of therapeutic products and diagnostic markers. Theseproducts are typically developed over a period of approximately 12 years and 5years respectively. For these reasons, we have a history of operations in whichthere is insufficient information to identify any historical pattern. Even ifwe could discern such a pattern, the rapidly evolving nature of thebiotechnology and pharmaceutical industries would make it very difficult toidentify any meaningful information in such a history. Therefore, it is also bedifficult to make any projections about the future of our operations.  Thisdifficulty may result in our ordinary shares trading below their value.

 

**Our share price has been volatile and is likely to bevolatile in the future.**

** **

The market price of ourordinary shares has been highly volatile and is likely to continue to be highlyvolatile. This is due to the risks and uncertainties described in this annualreport, as well as other factors, including:  

.  conditions in the economy or in life science-related industries;

.  actual or anticipated fluctuations in our operating results; 

.  changes in expectations as to our future financial performance orchanges in financial estimates by the investment community;

.  technological innovations by us or our competitors; 

.  investors' perceptions or changes in market valuation of lifescience companies generally; and

.  the operating and share price performance of other comparablecompanies.
**____(11)____ 

In addition, due to the downturn in the worldeconomy over the past few years and geo-political events, the equity markets ingeneral have experienced a down turn and increased volatility. This hasparticularly affected the share market prices of many publicly listedhigh-technology and biotechnology companies. The market prices of equitysecurities of companies that have a significant presence in Israel may also beaffected by the security situation in the Middle East and particularly in Israel.As a result these companies may experience difficulties in raising additionalfinancing required to effectively operate and grow their businesses. Suchfailure and the volatility of the securities market in general, and our shareprice in particular, may affect our ability to raise additional financing inthe future. Market and industry fluctuations may adversely affect the tradingprice of our ordinary shares, regardless of our actual operating performance.In the past, following periods of volatility in the market price of somecompanies' securities, securities class action litigation has been broughtagainst them. We do not know of any reason why such litigation would be broughtagainst us. Nevertheless, we could become involved in this type of litigationin the future. Litigation of this type is often very expensive and divertsmanagement attention and resources. 

 

**Future sales of our ordinary shares may depress ourshare price.**

** **

A substantial number of our ordinary shares couldbe sold in the public market. The occurrence of these sales, or the perceptionthat these sales could occur, could materially and adversely affect our shareprice or could impair our ability to obtain capital through future offerings ofequity securities. As of April 30, 2003, we had outstanding 26,182,260 ordinaryshares.  In addition, as of April 30, 2003, options to purchase4,688,167 of our ordinary shares were outstanding, of which 2,880,804 wereexercisable. In addition, as of April 30, 2003, there were 35,000 ordinaryshares issuable upon the exercise of outstanding warrants, all of which areexercisable.

** **

**The trading volume of our shares has been low in thepast and may be low in the future, resulting in lower than expected marketprices for our shares.**

** **

Our shares have been traded at low volumes in thepast and may be traded at low volumes in the future for reasons related orunrelated to our performance. This low trading volume may result in marketprice for our ordinary shares that are below their value.

** **

**Our cash reserves have exceeded our quoted marketvalue.  If this occurs again we may become an attractive target fortakeover attempts by third parties that are interested in those cash reserves.**

** **

Our cash reserves have been greater than our quotedmarket value. If this situation reoccurs, we may become an attractive targetfor third parties that wish to take control over our cash reserves. Thissituation would make us more likely to become a target for hostile takeoverattempts. However, we believe that the limitations and requirements imposed bythe Israeli law on takeovers, will make it very difficult for third parties tosucceed in a hostile take over.

** **

**Provisions of Israeli law may delay, prevent or affecta potential acquisition of all or a significant portion of our shares or assetsand therefore depress the price of our stock.**

** **

Israeli corporate law regulates acquisitions ofshares through tender offers. It requires special approvals for transactionsinvolving significant shareholders and regulates other matters that may berelevant to these types of transactions. The provisions of Israeli law maydelay or prevent an acquisition, or make it less desirable to a potentialacquirer and therefore depress the price of our shares. For information aboutthese limitations, see "Anti-Takeover Provisions under Israeli Law" Under "Item10. Additional Information".  Furthermore, Israeli tax considerationsmay make potential transactions undesirable to us or to some of ourshareholders.

** **

**Some of our existing shareholders can exert controlover us and may not make decisions that are in the best interests of allshareholders.**

** **

As of April 30, 2003, officers, directors andshareholders holding more than 5% of our outstanding shares collectivelycontrolled approximately 23% of our outstanding ordinary shares. As a result,these shareholders, if they act together, would be able to exert a significantdegree of influence over our management and affairs and over matters requiringshareholder approval, including the election of directors and approval ofsignificant corporate transactions. Accordingly, this concentration ofownership may harm the market price of our ordinary shares by delaying orpreventing a change in control of us, even if a change is in the best interestsof our other shareholders. 
**____(12)____ 

In addition, the interests of this concentration ofownership may not always coincide with our interests or the interests of othershareholders, and accordingly, they could cause us to enter into transactionsor agreements that we would not otherwise consider.

 

**Our ordinary shares are traded on more than one marketand this may result in price variations.**

 

Our ordinary shares are traded primarily on theNasdaq National Market and on the Tel Aviv Stock Exchange. Trading in ourordinary shares on these markets is made in different currencies (U.S. dollarson the Nasdaq National Market, and New Israeli Shekels on the Tel Aviv StockExchange), and at different times (resulting from different time zones,different trading days and different public holidays in the United States andIsrael). Consequently, the trading prices of our ordinary shares on these twomarkets often differ. Any decrease in the trading price of our ordinary shareson one of these markets could cause a decrease in the trading price of ourordinary shares on the other market.

*** ***

***Risks Relating to Operations in******Israel***

** **

**Conditions in the****Middle East****and in****Israel****may harm our ability to produce and sell our products and services.**

* *

Our principal offices andresearch and development facilities and many of our suppliers are located in Israel.Political, economic and military conditions in Israel directly affect ouroperations. Since the establishment of the State of Israel in 1948, a number ofarmed conflicts have taken place between Israel and its Arab neighbors, as wellas incidents of civil unrest, military and terrorist actions. A state ofhostility, varying in degree and intensity, has led to security and economicproblems for Israel. There has been a significant increase in violence sinceSeptember 2000, which has continued with varying levels of severity through tothe present. While certain parties with whom we do business have declined tovisit our facilities in Israel during periods of heightened unrest or tension,we have made alternative arrangements when required and we do not believe thatthe political and security situation has had any material adverse impact on ourbusiness. The political and security situation in Israel may result in certainIsraeli parties with whom we have contracts claiming that they are notobligated to perform their commitments under those agreements pursuant to"force majeure" provisions. Any hostilities involving Israel or theinterruption or curtailment of trade between Israel and its present tradingpartners could adversely affect our operations and could make it more difficultfor us to raise capital. Furthermore, since we do not have a detailed disasterrecovery plan that would allow us to quickly resume business activity in theevent of a major interruption, we could experience serious disruptions as aresult of events associated with the Israeli-Palestinian conflict or any war inthe Middle East, resulting in any serious damage to our facilities. Ourbusiness interruption insurance may not adequately compensate us for lossesthat may occur. Any losses or damages incurred by us could have a materialadverse effect on our business. Any future armed conflicts or politicalinstability in the region would likely negatively affect business conditions andcould harm our results of operations.  

 

In addition, in the past Israel and companies doingbusiness with Israel have been subjected to an economic boycott. Severalcountries still restrict business with Israel and Israeli companies. Theserestrictive laws and policies may have an adverse impact on our operatingresults, financial condition or the expansion of our business.

* *

**Our results of operations may be negatively affected bythe obligation of key personnel to perform military service.**

** **

Some of our executive officers and employees areobligated to perform military reserve duty and are subject to being called toactive duty for extended periods of time under emergency conditions. To date,any calls to active duty have not affected us materially. However, it ispossible that there will be additional call-ups in the future which may have amore material effect on us. The absence of one or more of our executiveofficers or key employees due to military service could disrupt our operations.Any disruption in our operations may have an adverse impact on our business.
**____(13)____ 

 

**Because a substantial portion of our revenues aregenerated in U.S. dollars, while a significant portion of our expenses areincurred in New Israeli Shekels, our results of operations may be adverselyaffected by inflation and currency fluctuations.**

** **

We generate a substantial portion of our revenuesin U.S. dollars but incur a significant portion of our expenses, principallysalaries and related personnel expenses, in New Israeli Shekels, commonlyreferred to as NIS. As a result, we are exposed to the risk that the rate ofinflation in Israel will exceed the rate of devaluation of the NIS in relationto the dollar or that the timing of any devaluation may lag behind inflation in  Israel. While in recent years the rate of devaluation of the NIS against thedollar has exceeded the rate of inflation, we cannot be sure that this trendwill continue. If the dollar cost of our operations in Israel increases, ourdollar-measured results of operations will be adversely affected. Ouroperations also could be adversely affected if we are unable to guard againstcurrency fluctuations in the future. Accordingly, we may enter into currencyhedging transactions to decrease the risk of financial exposure from fluctuationsin the exchange rate of the dollar against the NIS. These measures, however,may not adequately protect us from material adverse effects due to the impactof inflation in Israel.

** **

**The government programs from which we currentlyreceive benefits require us to meet various conditions. The termination orreduction of these programs in the future would negatively impact our revenuesfrom grants or increase our costs or taxes.**

 

We currently receive research and developmentgrants and are entitled to certain grants and tax benefits under Israeligovernment programs, particularly as a result of the "approved enterprise"status of our existing facilities in Israel and research and developmentprograms funded by Office of Chief Scientist of the Israeli Ministry ofIndustry and Trade. To maintain our eligibility for some of these programs andtax benefits, we must continue to meet conditions, including making specifiedinvestments in fixed assets and financing a percentage of investments withshare capital. In addition, we must continue to file periodic reports and payroyalties with respect to some of the grants received. If we fail to meet suchconditions, we will become ineligible for such grants and tax benefits andcould be required to return all or part of the benefits received. We cannotassure you that we will continue to receive grants at the same rate, if at all.In addition, some of these programs restrict our ability to manufactureparticular products or transfer particular technologies outside of Israel. See"Item 5.****Operating and Financial Review and Prospects-Government of  Israel Support Programs." From time to time, we submit requests foradditional research and development grants and expansions of our approvedenterprise programs or for new programs. These requests might not be approved.The termination or reduction of these programs and tax benefits could have amaterial adverse effect on our business, financial condition and results ofoperations.******If these programs or tax benefits are terminated orreduced, we could lose a significant source of income or be required to payincreased taxes in the future, which could decrease our profits.

 

Israeli law and regulations prescribe an expirydate for the grant of new benefits. The expiry date has been extended severaltimes in the past. The last expiry date that was in effect was in May 2003, andno new benefits will be granted after that date unless the expiry date is againextended. A government committee is reviewing the benefits program under the law.There can be no assurance that new benefits will be available after May 2003,however benefits already granted will stay in effect throughout the planperiod. 

 

**Terrorist attacks that occurred in New York andWashington on September 11, 2001, the war in Iraq and other acts of violence orwar may materially affect the markets on which our securities trade, themarkets in which we operate, our operations and profitability.  **

 

In the aftermath of the September 11, 2001terrorist attacks on the United States, the United States-led coalition ofnations commenced a series of retaliatory military strikes in Afghanistan uponstrategic installations of the Taliban regime, and governmental intelligenceauthorities issue from time to time warnings of the imminent threat of furtherattacks against civilian and military installations. In addition, the U.S. andthe United Kingdom together with certain coalition nations, lead a militarycampaign to topple the regime of Saddam Hussein in Iraq. These attacks andarmed conflicts, as well as the uncertainty surrounding these issues, have had,and we expect will continue for the unforeseeable future to have, an adverseeffect on the global economy generally, and the biotechnology industry inparticular. 
**____(14)____ 

**It may be difficult to enforce a****U.S.****judgment against us, or our officers and directors to assert****U.S.****securities law claims in****Israel****.**

** **

Service of process upon Compugen, which isincorporated in Israel, and upon our directors and officers and our Israeliauditors, almost all of whom reside outside the United States, may be difficultto obtain within the United States. In addition, because substantially all ofour assets and almost all of our directors and officers are located outside the  United States, any judgment obtained in the United States against us or anyof our directors and officers may not be collectible within the United States.
****____(15)____ 

**ITEM 4.                 INFORMATION ON THE COMPANY**

 

**History and Development of the Company**

** **

Our legal and commercial name is Compugen Ltd. Wewere established under the laws of the State of Israel in 1993.  Ourprincipal office premises are located at 72 Pinchas Rosen Street, Tel Aviv69512, Israel, and our telephone number is +972-3-765-8585. The principaloffice premises of Compugen, Inc., our U.S. subsidiary, are located at 7 Centre  Drive, Jamesburg, New Jersey 08831, and its telephone number is (609)655-5105. Our primary Internet address is www.cgen.com. None of the informationon our websites is incorporated by reference into this annual report.

 

Our mission is to increase the probability ofsuccess of drug and diagnostic product development by incorporating ideas andmethods from mathematics, computer science and physics into the disciplines ofbiology, organic chemistry and medicine. To accomplish our mission, we areactive in the three scientific fields underlying the drug development process.These fields are biology, chemistry and medicine. This unique capability is thebasis for both in-house discovery of potential therapeutic and diagnostic products,and for the development of high value platforms, tools and services for ourcustomers. 

 

We initially directed ourtechnologies towards developing computer hardware systems and softwareapplications to accelerate searches for:

(a)           similarity in genetic structure between different organisms, and/orgenes -(such similarity is also known as "homology");

(b)           sequences of nucleotides, which are components both of thegenetic material, DNA, and of RNA (which is a molecule related to and derivingfrom the transcription of DNA); and

(c)           protein sequence databases. 

This system and thoseapplications are commercialized under the name "Bioccelerators".

 

Since 1997, a significant portion of our activitieshave been directed to the development of technologies that allow molecularbiologists to obtain significantly more information and more valuableinformation from genomic databases and from databases of nucleotide sequencesthat encode for the expression of protein sequences (referred to as "expressedsequences", "expressed sequence tags" or "EST"s) through the analysis andmodeling of the underlying biological phenomena and processes and by accountingfor errors inherently generated during the process of constructing suchdatabases. An important aspect of these technologies is the analysis andrearrangement (also known as clustering and assembly) of genomic and expressedsequence data in order to provide information that can lead to the discovery ofnew genes and proteins and the annotation of genes and proteins. This clusteringand assembly technology, when applied to publicly available databaseinformation, can lead and has led to our discovery of novel genes and novelproteins. Some of these discoveries have been discoveries of "splice variants".Splice variants are formed from the alternative splicing of a section of mRNA,before the latter expresses a protein. Such splicing accounts for theexpression of more than one protein from the same gene.

 

We have also developed solutions for challenges inthe fields of functional genomics and proteomics. In the field of functionalgenomics, we are active in improving the design of probes. Probes are shortnucleotide sequences that are designed to be unique and, representative of muchlarger corresponding genes. Probes which we design can be used for geneexpression experiments - experiments that identify the RNA (and, thereby,corresponding genes) that express proteins in certain tissues and/orphysiological conditions. While important advances have been made in geneexpression technologies, we believe that the current usefulness of some of thedevices used for gene expression analysis can be significantly enhanced bybetter probe design. We are applying our clustering and assembly technologiesto develop more efficient probe design and data analysis for gene expression. 

 

Additionally, we have applied our technologies inthe area of proteomics. A common problem for scientists in this area is theneed to separate individual proteins from the thousands included in a testsample and then to identify the known and unknown proteins. Our scientists havecreated advanced computational techniques to analyze pattern recognition andimage processing to seek to overcome these difficult problems.
**____(16)____ 

Since 1997, our multi-disciplinary team of mathematicians,computer scientists, physicists, chemists, physicians and molecular biologistshas developed and continues to develop technologies for:
- analyzing and modeling molecular biology     phenomena;
- accelerating the analysis of data relating to     the genetic material of organisms (genomic data), the functions of genes     and their behavior in normal and diseased conditions (functional     genomics), and proteins (proteomic data);
- creating user-friendly applications that allow     scientists in the field of genomics, functional genomics and proteomics to     quickly obtain results from their queries using our modeling and     analytical tools; 
- discovering potential therapeutic proteins and     diagnostic markers; 
- designing  small molecules for the     discovery of drug candidates; 
- analyzing medical and clinical data for the     purpose of developing predictive drug response models; and
- providing value added information (including     annotations) to already existing information.

 

We apply the above technologies in the areas ofbiology, chemistry and medicine, which are the three scientific areasunderlying the drug development process.

In the area of biology, we develop andcommercialize platforms and tools that enable and enhance the discovery andfunctional analysis of genes, proteins and cell processes. Our platforms andtools include: LEADS, Genecarta, Oligo design (being the design of shortnucleotide sequences, also known as "oligonucleotides"), OligoLibraries, Z3 andZ4000. 

 

During the past two years we have expanded ouractivities in the field of protein discovery by using our proprietary tools andby focusing on therapeutic proteins (drugs which are actually proteins) anddiagnostic markers (tools which indicate the presence or absence of aphysiological condition, such as a disease). We discover and seek tocommercialize potential therapeutic proteins and diagnostic markers, bypursuing commercial relationships with leading biotechnology, diagnostic andpharmaceutical companies. 

 

In the area of chemistry we are developing a uniquetechnology for discovering small molecule drugs. 

 

In the area of medicine we are developingpredictive models for drug response, in an effort to improve the effectivenessof drugs, to enhance safety in drug usage and to improve the design of clinicaltrials.

 

**Business Overview**

 

As stated above, our mission is to increase theprobability of success of drug and diagnostic product development, byincorporating ideas and methods from mathematics, computer science and physicsinto the disciplines of biology, organic chemistry and medicine. This uniquecapability is the basis for both in-house discovery of potential therapeuticand diagnostic products, and for the development of high value platforms, toolsand services for our customers. In order to understand the importance of thismission, it is helpful to understand how drugs are discovered.

 

***Current Challenges in Pharmaceutical Researchand Development***

 

*Background*

 

*Gene-Based Drug Discovery* - The process ofgene-based drug discovery is very complex. The first step may involveidentifying a gene that codes for a specific protein. Proteins play a range ofbiological roles. For instance, by increasing or decreasing the amount of aprotein or by activating or inhibiting its activity, a disease may beprevented, treated or cured. In such circumstances, the protein may be a targetfor a drug, and is known as a "drug target". Scientists try to find a drug thatbinds to the protein and intervenes and/or alters its function and/or activity(known as a "drug candidate"), thereby possibly preventing, treating or curinga disease. Drug candidates may be identified by testing, or"screening", hundreds of thousands of chemical compounds against aselected drug target. 
**____(17)____ 

This is a trial and error method for discovering adrug (also known as "high throughput screening"). Such trial anderror methods typically involve very large amounts of chemical compounds. Whenone or more of these compounds is found to interact with the drug target and toproduce a desired effect, similar compounds may be synthesized in an attempt toidentify a compound with an increased desired effect.  This processis known as "lead optimization" and results in a "drug candidate". Ifand once a drug candidate is identified, drug candidate undergoes safety and suitabilitytests relevant for human use.

 

In some cases, the protein itself may be a drug. Afamiliar example of such a drug is insulin. This category of proteins isreferred to as "therapeutic proteins", because use or administrationof the protein itself may have the desired effect of preventing, treating orcuring a disease. In the case of therapeutic proteins, it is not necessary toperform screening against a drug target because the protein in suchcircumstances is the drug rather than the drug target.  However,therapeutic proteins must undergo tests for safety and efficacy, includingclinical trials.

 

*Diagnostic Markers* - Another aspect of thepharmaceutical (and biotechnological) research and development is theidentification of diseases and a range of other physiological conditions. Thepresence or absence of proteins or other molecules or changing quantities ofproteins or other molecules, may give information about the presence or absencea disease or of the particular stage of a disease or other physiologicalcondition of the body. A molecule that provides this information is known as adiagnostic marker. For example, the presence or unusually increased presence ofa certain protein in blood may indicate the presence of a cancerous condition.In order to develop a diagnostic marker it is first necessary to identify acorrelation between, on the one hand the presence or absence or the quantity ofa marker or its increased or decreased presence and, on the other hand, adisease or other physiological condition. Once such a correlation isidentified, it is then necessary to develop a means of recognizing thecorrelation. The task of developing a method of recognition which is easy toperform, safe and inexpensive is a challenge faced by the pharmaceutical andbiotechnological industry.

 

*Challenges*

 

One of the critical challenges currently facing thepharmaceutical industry is the length of time and expense of the drug discoveryand development process. Typically, ten to twelve years elapse from the time researchbegins to the time a drug can reach the market. This process is expensive, onaverage costing about $800 million per drug (which accounts for the developmentof drugs that do not reach the market), and involves a very high degree of riskdue to the unpredictable nature of the drug discovering and developmentprocess. Only one to four percent of the projects initiated by pharmaceuticalcompanies actually result in marketed medicines. Many problems may arise duringthe discovery and development process. For instance, a potential drug may befound to be toxic or otherwise unsafe, and/or it may not have the intendedeffect. Since the biology of many diseases is still unknown, the pharmaceuticalindustry encounters many difficulties in finding drugs. Many if not most drugsare discovered by trial and error.  

 

A range of diseases may be triggered by orassociated with changes in the concentration or level of activity of certainproteins. Therefore, treatments for such diseases may involve drugs that interactwith the relevant proteins. Such drugs are often discovered by trial and error.By identifying the proteins associated with a disease and/or the genes thatcode for such proteins and by understanding their respective functions, it maybe possible to understand the biological process involved in the correspondingdisease and to scientifically discover a therapeutic drug in a focused andmethodical manner, rather than by trial and error.  

 

*Our Approach to Addressing the Challenges*

 

There is more and more pressure in thepharmaceutical industry to discover and develop effective and cost effectivedrugs and diagnostic products, even though the process is long, risky andexpensive and often relies on trial and error. Our mission is to increase theprobability of success of drug and diagnostic products development byincorporating ideas and methods from mathematics, computer science and physicsinto the disciplines of biology, organic chemistry and medicine. By using ourexpertise in a range of disciplines, which were previously generally notcombined, we have begun to gain an insight into the underlying biology ofdiseases and have been able to identify genes and proteins and other moleculeswithin the body that may play a crucial part in diseases, their prevention,treatment and/or cure. Our strategy and our core competence involve the use ofthe exact and computational sciences to do this in combination with traditional"wet" experimentation done in a laboratory. 
**____(18)____ 

 

We methodically analyze the very large amounts ofgenomic information discovered through public research, such as the HumanGenome Project, as well as privately-generated information. We use mathematicalmodels to analyze and predict structures and processes within the human cellsand tissues. We believe that our increasing understanding of the workings ofsome biological processes within the body will make drug discovery anddevelopment a shorter and more efficient process, less prone to failure andless expensive.

 

We believe that understanding the functions ofgenes and their behavior in normal and diseased conditions, a science called"functional genomics", and the role played by proteins, a sciencecalled "proteomics", will lead to an improved understanding of thebiology of diseases. We believe that this will lead to better researchcapabilities and to more efficient and effective development of drugs anddiagnostic products. In order to do this, it is necessary to find a way toanalyze the very large amounts of complex genomic and functional genomic datathat have become publicly available in recent years, and to extract the data,which is vital to understanding specific diseases.

 

A key part of our mission is to make this researchand development easier through the use of our technologies. These technologiescan assist life science researchers in understanding and harnessing genomic andproteomic data. In addition, our technologies may assist researchers indeveloping more systematic methods to discover and predict drug responses byconverting genomic information into knowledge about a particular gene, diseaseor drug. Our mission, in other words, is to take some of the "trial anderror" out of the drug discovery process. 

 

***Explanation of the Biological Processes***

 

The characteristics of all living organisms aredetermined by DNA, a molecule found in most living cells. DNA is comprised ofpairs of four types of small chemical units, each called a nucleotide. DNAcontains genes, which in general are comprised of thousands of nucleotides. TheHuman Genome Project, an international research program designed to constructdetailed genetic maps of the human genome (that is, all of the geneticinformation contained in the human genes), demonstrated that the human genomeconsists of a total of approximately three and a half billion nucleotides andcontains at least 30,000 genes.

 

Cells carry out most of their biological functionsby means of genetic instructions encoded in DNA. These codes govern theproduction of proteins through a process known as gene expression. During geneexpression, the nucleotides in a gene are first copied into a related moleculecalled messenger RNA, or mRNA. This mRNA then instructs the cell to produce aprotein. Proteins are the molecules that regulate or perform most of the physiologicalfunctions of the body. The sequence of nucleotides determines which protein outof a very large number of possible proteins is produced. Because the sequenceof nucleotides in each gene is different, each gene directs the production of adifferent protein or proteins. Identifying these proteins is made even moredifficult because of a phenomenon called alternative splicing. This is anatural process by which a single gene may, under different circumstances or atthe same time, express a number of different proteins.

 

Many human diseases are associated with theinadequate or inappropriate presence, production or performance of proteins.For this reason, genomics, functional genomics and proteomics can assistpharmaceutical and biotechnology companies in developing diagnostic products,****therapies and drugs that will interact with a targeted protein involved indisease. Drug therapies currently on the market address several hundredspecific protein targets. However, we believe that as the functions of additionalproteins are better understood, hundreds or thousands of additional potentialdrug targets will be identified. As additional progress is achieved ingenomics, functional genomics and proteomics research, new drugs, diagnosticmarkers and therapies may be developed to diagnose, and ultimately to curedisease, rather than just treat the symptoms.

** **

**Challenges in Converting DNA Sequence Data intoUseful Information**

** **

In recent years, public and private endeavors,including the Human Genome Project, have created vast amounts of raw genomicand related data at an increasing rate. These efforts led to the publication ofthe final draft of the human genome in April of 2003 and to the publication ofthe genome of mouse, rat and other organisms during 2002. Although these setsof data contain information that provides scientists with important insightsand knowledge about molecular biological processes, the data are very difficultto analyze. This difficulty is due to many factors, including the complexity ofunderlying biological processes, the limitations of existing laboratorydevices, and the enormous quantity of raw data with a high rate of errors andinaccuracies.
**____(19)____ 

Although new data are constantly being created atan increasing rate, we believe that a substantial amount of the usefulinformation contained in the data that already exists, has yet to be extracted.

 

The primary tool used to understand this data stillconsist of experimental techniques performed in the laboratory. However,scientists are now applying to life sciences more and more techniques from theexact and computational sciences. In these techniques, progress is achievedthrough the quantitative analysis of vast amounts of data and the use ofmathematical models to predict structures and processes in the fields ofbiology, chemistry and medicine. We believe that the use of techniques from theexact sciences has the potential to significantly improve the research anddevelopment processes in the pharmaceutical industry. 

 

The following are some of the most important challenges inmaking use of this new biological data:

 

*Computational Challenge: Vast Amounts of Data:*Publicdatabases today contain millions of randomly arranged short genomic segments,each representing a short fragment of a gene, that code for sections ofproteins (ESTs). In order to find the full coding sequence of the gene,scientists must be able to effectively cluster and assemble these millions ofESTs, a process which poses significant computational challenges.

 

*Experimental Challenge: Errors and Anomalies:*Experimental errors and anomalies, including sequencing errors, the fusion oftwo nucleotide sequences from different loci (chimeric events), vectorcontaminations and genomic contaminations introduce errors into data andcomplicate the analysis of such data.

 

*Biological Challenge: Alternative Splicing*:Alternative splicing is the expression of more than one protein from the samegenomic location (also known as "locus") that results from the alternativesplicing of mRNA segments. It is now generally accepted by the scientificcommunity that alternative splicing occurs in somewhere between 40% and 60% ofthe human genes. Alternatively spliced proteins often perform differentfunctions, may be produced in different organs and in different physiologicalconditions. We believe that, in general, effective analysis of genomic datamust take this phenomenon into account.

 

*Biological Challenge: Antisense:*Naturallyoccurring antisense refers to the occurrence of genes that are located onopposite strands of DNA of the same genomic locus. The nucleic acid sequence ofthese are complementary to each other and of opposite orientation. We havefound that naturally occurring antisense occurs in thousands of loci in thegenome. Failure to identify the occurrence of antisense, may lead the erroneousprediction of mRNA (transcripts).

*** ***

***Challenges in Research Tools, FunctionalGenomics and Proteomics***

*** ***

The following are some of the most importantchallenges in creating research tools which will effectively analyze thebiological data described above.

 

*Challenges in DevelopingEfficient Gene Expression Experimental Devices*: The use of gene expressionexperimental devices enable scientists to perform thousands of measurements ofmRNA expression levels in a tissue sample in a single experiment. Whileimportant advances have been made in gene expression technology, we believethat such technology can be further improved by developing better probe designcapabilities. The main challenges in the selection of probes for geneexpression experiments are:
- selecting error-free probes that accurately     reflect the exact genes (or corresponding mRNA) of interest;
- selecting probes that are unique to the genes     (or corresponding mRNA) of interest; 
- ensuring that the probes account for the     different alternative splice variants of the genes; and
- ensuring that the probes are constituted by a     sequence capable of effectively binding to corresponding portions of genes     that such probes represent (this is known as "hybridizing").

 

Scientists need a reasonably complete picture ofall of the possible mRNA, including alternative splice variants, of a testedorganism. 
****____(20)____ 

*Challenges in Getting Better Information FromProtein Separation Using 2-D Gels:*****Proteomics research aims at characterizingthe many thousands of proteins found in organisms and identifying the specifictissues where they are located, including normal as contrasted with diseasedstates. Although still facing technological challenges, typical of an earlyphase science, the field of proteomics is believed to be indispensable inunderstanding disease mechanisms and identifying therapeutic targets. One ofthe main challenges associated with analyzing proteomic data is separating outindividual proteins from a mixture of proteins. This is done using a widelyused technique known as 2-D Gel PAGE (or polyAcrylamide Gel Electrophoresis).Proteins comprising a protein mixture can be separated through the use of gelsbased on their molecular weight and the proteins electric. After the separationprocess is completed, two or more gels are compared for differences betweenthem. The technology of separating proteins by using 2D gels has been availablefor over 20 years and, although widely used, it has significant limitations. Forexample, often biologists performing the same experiment in seemingly the sameconditions obtain completely different results. This has led many researchersto search for other protein separation techniques.

* *

**Our Technologies, Tools and Services**

 

Our core technology and expertise is the modelingof biological phenomena in the field of molecular biology and applying thismodeling to the analysis of biological data. This technology, which includesour clustering and assembly technology, has enabled us to efficiently andeffectively extract valuable information from genomic, functional genomics andproteomic databases. We have applied our technology and expertise in the fieldsof functional genomics, to improve the design of probes for gene expressionexperiments and also in proteomics. We have also created user-friendlyapplications that allow scientists in the field of genomics, functionalgenomics and proteomics to quickly obtain results using our modeling andanalytical tools. 

*** ***

***Core Technology - LEADS and Related Productand Service Offerings***

* *

Our clustering and assembly software technology isprimarily used in analyzing DNA and EST sequence data.***  ***Thistechnology involves seven major steps:
- First, it examines     the expressed input data, which is EST or mRNA sequences, and cleans it by     eliminating erroneous sequence fragments and marking for identification     repetitive and low complexity sequence fragments.
- Second, it compares     the cleaned expressed data to the available genomic data, and finds the     best possible genomic location.
- Third, based upon the     location of the expressed data on the genomic data, it forms groups of EST     and mRNA sequences that are located in the same genomic area, and have     overlapping regions (clusters), along with the relevant genomic sequence.
- Fourth, it assembles     sequences in most of the genomic clusters, taking into account alternative     splicing, and derives a consensus genomic sequence, putative genomic     segments from the same gene that are not spliced out and therefore are     parts of mature mRNA (exons) and putative segments located between     expressed segments of a single gene, that are spliced out. A consensus     sequence is a predicted combination of all putative exons in a cluster     inferred from the data available about these segments. The consensus may     or may not exist in nature. This consensus accounts for alternative     splicing by re-inserting exons that are left out of each different     alternative spliced sample. Introns are considered part of a gene,     although they are not part of the mature mRNA. 
- Fifth, a transcript     is inferred from the combination of some or all contig segments in the     order suggested by the biological data. In cases of alternative splicing,     a contig has multiple transcripts, each with a different and usually     overlapping set of segments.
- Sixth, it takes all     the cleaned expressed data that cannot be located on the genomic data, and     taking into account alternative splicing, forms expressed contigs.
- Seventh, it     automatically annotates the thousands of predicted genes and presents     concise analytical findings for each gene to be used for further     evaluation by biologists and other life scientists. This annotation     includes predicted SNPs, predicted coding regions, and homology     information relating to these coding regions.
**____(21)____ 

 

*LEADS  forGenomic and Expressed Data*

 

Our LEADS software platform for computationalbiology analyzes genomic and expressed sequence data to enable rapid discoveryof genes, splice variants and gene function. LEADS solves quantitative andqualitative problems inherent in the analysis of EST data and allows molecularbiologists to quickly identify genes from gene fragments. Most LEADS customershave in-house access to the product, which gives them the capability to analyzetheir own databases in conjunction with public data.

 

LEADS improves the quality ofavailable genomic and expressed sequence data by, among other things:
- eliminating overlapping regions of sequences     belonging to the same gene, thus reducing the size of the databases and     the amount of required analysis;
- improving gene coverage by creating a fuller     picture of gene structure from EST fragments;
- detecting and correcting sequencing errors; 
- detecting and accounting for instances of     alternative splicing, antisense and changes in single nucleotides (also known     as "single nucleotide polymorphisms" or "SNPs") and distinguishing these     occurrences from sequencing errors;
- detecting other experimental anomalies,     including chimeric sequences, and contaminations; and
- automatically annotating the resulting sequences. 

 

*Genecarta*

 

Genecarta is an annotated database representing thegenome, transcriptome (which is comprised of RNA molecules) and proteome. It iscomprised of the data obtained from the periodic application of our LEADSsoftware platform to various public databases. Genecarta includes threecomponents: the database, a graphical user interface, and query tools. Thecurrent version of Genecarta includes a gene index, with predicted splicevariants, genomic alignments, the location of a gene on one of the DNA-containinglinear bodies of a cell nucleus (chromosomal location), alignment of ESTs andknown mRNAs to their genes, predicted SNPs (based upon the multiple alignmentsof the DNA, mRNAs and ESTs) and a prediction of the expression distribution ofthe gene in the body tissues (based on SAGE tag prediction and libraries). Eachpredicted transcript is further analyzed and annotated, resulting in predictedproteins (where identified), annotation of the predicted functionality andprocess in which the proteins are involved (using GO descriptions) andhomologies to known and predicted proteins and protein domains. The browserinterface provides an intuitive graphic presentation of database elements andtheir inter-relationships, which enables users to browse the genes efficiently.The query tools are suitable for various types of experimental approaches, andenable users to perform searches from multiple entry points. The currentversion of Genecarta, Version 3.2, includes human, mouse, rat, zebrafish andarabidopsis (a species of grass used as a model for botanical studies) data.

 

To date, we have found full or partial sequenceinformation for thousands of predicted human proteins that we believe have notbeen discovered by others. This information exists in our Genecarta annotateddatabase. 

 

We commenced marketing Genecarta in the firstquarter of 2001 and offer it as a complete package including the hardware,software and database, which we install at customers` sites and updateregularly. We also offer Genecarta in the form of a license to access and querythe Genecarta database over the Web, without providing any hardware and withoutinstalling software on the customer`s computer.

* *

*Oligo Design Service and OligoLibraries*

* *

We apply our LEADS software platform technologiesto develop more efficient probe design for gene expression experiments. Withour technology, we are able to improve the efficiency and accuracy of probedesign, thereby enabling more informative and accurate analysis of geneexpression experiments and a significant improvement in the quality of theresults. We believe that the main challenge in effective oligo design is toselect sensitive and specific probes that will represent their correspondinggenes and all their splice variants, or alternatively, will ensure accuratedifferentiation between the different expressed forms, or alternative splicevariants, of these genes.
**____(22)____ 

 

*Oligo Design Service -*Ourprobe design service offers the following advantages: 
- it reduces the number of redundant clusters,     allowing representation of a larger number of genes on any given gene     expression device by more accurately clustering large amounts of EST and     genomic data;
- it identifies sequencing errors, SNPs and     introns in ESTs and selects probes from the most error-free and     intron-free regions it identifies, making our probes high quality     representatives of the desired transcripts;
- it can select probes in a manner designed to     either maximize the differentiation between different splice variants or     maximize the chance that alternatively spliced variants of a gene will be     identified, depending on the customer`s needs; and
- it designs probes to be as specific as possible to     genes of interest, by comparing the probes to other transcripts in the     transcriptome.

 

*OligoLibraries* - OligoLibraries areoligonucleotide collections, representing genes, or sub-sets of genes, ofvarious organisms. They are designed to provide scientists with a more accuratesolution for the rapidly growing area of high-throughput analysis of gene function.Our OligoLibraries are based on probe selection using our LEADS technologyplatform and our proprietary design tools. These technologies enable us toaddress redundancy, account for alternative splicing, choose oligos of highsequence quality, and consider specificity and cross-homology while designingoptimum oligos for gene expression, drug discovery or functional assays.  

 

**Other Product Offerings**

 

**Bioccelerators**

* *

Our Bioccelerator line of products consists ofdedicated computers designed to accelerate similarity, or homology, searches innucleotide and protein sequence databases. Some of the rigorous algorithms usedfor these types of searches are computationally intensive, forcing researchersto use possibly less sensitive but faster algorithms. By performing rigoroussearches significantly faster than a typical high-end single-processorworkstation, the Bioccelerator makes the use of more sensitive algorithms moreattractive. 

 

Since 1994, we have sold Bioccelerator products toover 40 customers worldwide, including many of the leading companies andresearch institutions in the field of genomic research. 

 

*Our Proteomics Products.*

* *

*Z3 2D-PAGE Gel Analysis*- our Z3 2D-PAGE gelanalysis uses advanced computational technologies and novel algorithms forimage registration, spot detection and differential expression calculation, inorder to automatically analyze 2D gel images. Z3`s raw master gel module,designed to maximize the amount and quality of information derived from repeatruns, and the multiple gel analysis mode enable high throughput analyses inmultiple gel studies. The product`s color coding enables users toinstantaneously detect differential expressions.

 

*Z4000 2D-PAGE GEL Analysis* - our Z4000 isbased on the Z3 technology and is designed to enable analysis of a large numberof gels. Z4000 allows the user to organize the experiment in a hierarchialmanner according to the different dimensions tested and control the study'sprogress. The Z4000`s workflow is designed to extract the most significant dataout of the images while enabling the user, at any point, to view the entireexpression level  of a certain protein across the experiment. Z4000also includes important query possibilities that allow the user to extractmeaningful information from the data accumulated in the study.
*****____(23)____ 

***Selected Customers and Collaborators***

 

**Company**

**Agreement**

**Commencement Date**

LEADS

 

Pfizer Inc. 

We granted Warner Lambert Company (now Pfizer) a  non-exclusive license to use LEADS for analyzing genomic and expressed data  for all of Pfizer`s internal research and development activities. This  agreement accounted for approximately 35% of our revenues from products and  services in 2000, approximately 30% of our revenues from products and  services in 2001 and approximately 14% of our revenues from products and  services in 2002. The LEADS component of the Agreement expired in September  2002.

 

October 1998 

Novartis Pharma A.G. 

We granted Novartis a non-exclusive license to use LEADS  for analyzing genomic and expressed data for Novartis and its affiliates`  internal research and development activities in exchange for an annual  license fee. In July, 2002 we amended our agreement with Novartis, under  which the parties engage in joint research and collaboration to design molecules  for RNA interference. Compugen`s role was to create software for the design  of oligonucleotide interference molecule sequences. Our agreement with  Novartis accounted for approximately 17% of our revenues from products and  services in 2001 and for approximately 18% of our revenues from products and  services in 2002. Our agreement with Novartis is for a term of three years.

 

July 2001 

diaDexus Inc.

We entered into a Service Agreement under which we used  LEADS to perform an analysis of both proprietary and public genomic and  proteomic data for the development of human diagnostic and therapeutic  products. This agreement accounted for approximately 12% of our revenues from  products and services in 2002. Our agreement with diaDexus expired in  February 2003.

December 2001

Abbott Laboratories

We granted Abbott a non-exclusive license to our LEADS  computational biology platform for the analysis of human genomic data,  creating a comprehensive transcriptome database  that represents the repertoire of human mRNA  molecules.

December 2002

GENECARTA

 

GeneLogic Inc.

We entered into a Collaboration Agreement pursuant to  which we customized and integrated our human Genecarta database with the gene  expression information in Gene Logic's GeneExpress® Suite. 

Gene Logic is marketing this customized human Genecarta  database as an add-on component available to its existing and prospective  GeneExpress® Suite customers.****

January 2002

OLIGOLIBRARIES

 

Sigma Genosys, Inc., a wholly-owned subsidiary of Sigma  Aldrich, Inc. 

We entered into a Joint License and Marketing Agreement  for the production of OligoLibraries and their marketing as co-branded  products. Compugen provides the designs for these products, Sigma  manufactures them and both parties market and sell them. The OligoLibraries  product line includes collections representing the human, mouse, rat,  zebrafish and bacillus subtilis genome substances.

May 2001

** **
****____(24)____ 

** **

**Our Discovery Activities**

** **

We use the capabilities of ourpioneering platforms to identify genomic sequences and putative proteins thatthose sequences encode. We seek to discover novel proteins and mRNAs that havepotential pharmaceutical therapeutic or diagnostic uses.  Ourin-house molecular biology laboratories validate the predictions generated byour platforms. The validation may also be performed in our molecular biologylaboratory or in one of our collaborator`s molecular biology laboratory, suchas a university or  another academic institution. We havesuccessfully verified the existence of a large proportion of our predictedpotential therapeutic proteins and diagnostic markers.

During the past two years weexpanded our discovery activities. We discover and seek to commercializepotential therapeutic proteins and diagnostic markers, for which we pursue commercialrelationships with leading biotechnology, diagnostic and pharmaceuticalcompanies. During 2002, we also launched a protein development team, whichfocuses on protein expression and purification.  

 

Using our proprietary analysis and predictive models,our discovery team has identified full or partial sequence information forthousands of predicted mRNAs. We believe these mRNAs are novel and were notpreviously identified in any public databases, published scientific literatureor patents. In about 90% of the approximately 300 cases we have tested in ourlaboratory, we verified the existence of the genes predicted by our analysis.

 

***Our Discoveries***

 

*General Biological Phenomena:*
- Significance of general biological     phenomena  - We believe that the understanding of one scientific     phenomenon that is derived from an understanding of other scientific     phenomena is made possible as science transforms and matures from largely     observational to more predictive. We believe that pharmaceutical research     and development is now undergoing this process. As the language of     mathematics is increasingly being used to create predictive models for     important aspects of life science, we believe that there will be radical     changes in the process of pharmaceutical research and development. Through     our unique multidisciplinary approach and proven capabilities, we intend     to establish ourselves as a worldwide leader in this ongoing revolution.     The creation of predictive models presents numerous important commercial     opportunities for us. Three examples are our discovery new proteins     PSA-LM, K-LM and VEGF114. 
- Alternative Splicing  - alternative     splicing is a biological phenomenon whereby one gene may express more than     one protein. Since 1997, by applying our proprietary LEADS platform to the     analysis of publicly available genomic information, we discovered that the     phenomenon of alternative splicing occurs in at least 30% of human genes.     Previously, alternative splicing was believed to occur in only a very     small number of genes. By having identified the wide-spread nature of the     alternative splicing phenomenon and having developed the computational     tools to identify it, we are able to discover unknown proteins that are     encoded by known genes.
- Antisense  - antisense is a biological     phenomenon of the existence of two genes that are located on opposite     strands of DNA and, therefore, have complementary nucleic acid sequences.     In 2002, by applying our proprietary LEADS platform to the analysis of     publicly available genomic information, we discovered that the phenomenon     of antisense, in the human genome, was significantly more common that     previously believed.  We identified hundreds of antisense pairs     of genes and published our findings in the April 2003 issue of Nature     Biotechnology, Volume 21, No 4. 

* *

*Specific Proteins:*
- Potential Diagnostic Markers PSA-LM and     K-LM -  In February 2002 we announced the discovery of two novel     prostate-specific proteins. This discovery was published in the May 17, 2002 issue of The Journal of Biological Chemistry. These proteins are encoded by     alternative mRNA splice variants of the genes for prostate specific     antigen (PSA) and its related protein, human kallikrein 2 (hK2). The novel     transcripts were predicted using our LEADS platform and then verified in     our molecular biology laboratory. These novel proteins may have important     applications in developing additional diagnostic tools for prostate cancer     and for understanding the disease. Prostate specific antigen (PSA) is the     premier tumor marker for screening, diagnosis, monitoring and prognosis of     prostate cancer. Despite the substantial experimental research of the PSA     field, the variant molecules that we discovered had not been discovered     previously. 
- Potential Therapeutic Proteins - VEGF114 -  In     April 2003 we announced the discovery of VEGF114, a variant protein     expressed from the vascular endothelial growth factor (the "VEGF") gene.     We have been granted a United States patent covering the protein sequence     of this novel VEGF splice variant, vectors and host cells containing     VEGF114 sequences, and pharmaceutical drugs and detection methods     developed using VEGF114 sequences. Modulation of VEGF activity may have     clinical applications in cancer, cardiovascular and related diseases, and     in fertility control. Although the VEGF gene has been the subject of     extensive worldwide research the existence of our splice variant was     unknown. Our discovery was made possible through the predictive capability     of our LEADS platform, coupled with additional proprietary discovery     technologies and experimental validation in our molecular biology     laboratory. 

 

***Our Commercial Collaborations***

*** ***

We intend to continuecommercializing the most promising discoveries through collaborations andlicensing arrangements with third parties, primarily pharmaceutical andbiotechnology companies. Currently, we intend to market some of our therapeuticproduct candidates at the preliminary stage of pre-clinical trials. Inaddition, we intend to pursue collaborations with pharmaceutical andbiotechnology companies and research and academic organizations for the jointdiscovery, development and commercialization of therapeutic proteins anddiagnostic markers. We believe that by combining our computational andexperimental capabilities with proprietary technologies of potentialcollaboration partners, we can substantially increase both our chances and ourpotential collaborators` chances of successfully discovering, developing andcommercializing therapeutic and diagnostic products. At the same time, we arerecruiting experienced personnel for the purpose of building our internalcapabilities in order to further develop products ourselves should we decide todo so.

To date, we have entered intotwo licensing agreements.   
- In December 2002, we granted a license     Diagnostic Products Corporation ("DPC"), on an exclusive basis, to develop     and commercialize  in-vitro  diagnostic assays based on our two novel     prostate-specific proteins (PSA-LM and K-LM proteins), for the use in the     field of cancer immuno-diagnostics. In consideration we will receive     milestone payments and royalties based on the commercialization of our     intellectual property.
- In April 2003, we granted a license MultiGene     Vascular Systems Ltd. ("MGVS"), on a non-exclusive basis to develop and     commercialize gene and cell therapy products incorporating our VEGF114     splice variant for use in the treatment of cardiovascular diseases. Under     the terms of the agreement, we will receive an equity stake in MGVS and     royalties on any future product sales. 

 

In addition, to date, we have entered into a numberof academic collaborations, with academic institutions for certain aspects ofour research. 

 

**Other Activities**

 

***Chemistry Activities***

 

To date, there exists no systematic method forguaranteed discovery lead compounds for protein targets. Existing techniquesare largely based on trial and error methodology. 

 

Our mission in the field of chemistry is to developa unique technology for systematically discovering lead compounds for proteintargets. Our technology is based on incorporating ideas and methods frommathematics, computer science and physics into the discipline of organicchemistry. If we are successful, the resulting technology will provide for therapid creation of lead compounds, without there being a need for high throughputscreening of large "drug like" compound libraries. We have made substantialprogress since initiating our activities in this field, approximately threeyears ago. Since the underlying scientific basis of our project has not yetbeen fully validated, we cannot give any assurance that this technology willindeed be validated and, even if validated, that we will be able or willing tocommercialize it. 

 

Although we are currently funding all of ourresearch and development in the field of chemistry, these activities areadvancing towards a stage where, for its continued progress, additionalresources will be required. The Company is currently initiating discussionswith potential partners. 
**____(25)____ 

 

***Medicine Activities***

* *

One of the mainchallenges faced by the pharmaceutical and medical communities is the existenceof large variations in the response of different patients to the same drug.This variation adds to the complexity of developing therapeutic products. Ourobjective in the field of medicine is to develop a unique technology forsystematically discovering correlations between the administration of a drug(or other treatments) and the response caused by that drug. Our technology isbased on incorporating ideas and methods from mathematics and computer science,as well as biology, into the discipline of medicine.  Our goalsinclude to increase the benefit from and safety of drug use and to improve thedesign of clinical trials. To accomplish this goal, we are attempting todevelop an advanced drug response analysis platform, based on an analysis ofmultiple types of information that may include patient medical history filesfrom health care providers, information from clinical trials and environmental,genomic and phenotypic information. Our first pilot project is currentlyundergoing development and validation. We cannot assure you that our approachwill ever be validated and, if validated, we cannot assure you that we willever be able or willing to commercialize this platform or technologies.

 

We already have in place research collaborationsand we are seeking further research collaborations with pharmaceuticalcompanies and/or health care organizations. However, we do not anticipatecommercializing this platform in the near future.

 

**Our Strategy**

 

We strive to substantially increase the probabilityof success of drug and diagnostic product discovery and development. The keyelements of our business strategy are:

 

*Discovery-Based Revenues.* We commercializeand intend to continue to commercialize potential therapeutic proteins,diagnostic markers and other intellectual property that we continue to discoverin our research and development efforts. We intend to commercialize ourintellectual property portfolio with an emphasis on royalty bearing and otherrevenue-sharing arrangements with diagnostics, pharmaceutical and biotechnologycompanies. We have currently identified a number of proteins that we believeare the basis for the potential development of therapeutic or diagnosticproducts and are candidates for further development and licensing. To date wehave implemented this strategy by granting a license to DPC on an exclusivebasis to develop and commercialize *in-vitro*diagnostic assays based onour two novel prostate-specific proteins, for the use in the field of cancerimmuno-diagnostics. We also granted a license on a non-exclusive basis toMultiGene Vascular Systems Ltd. ("MGVS"), to develop and commercialize gene andcell therapy products incorporating VEGF114 splice variant for use in thetreatment of cardiovascular diseases.

* *

*Technology-Based Revenues.*We plan tocontinue to pursue collaborations and other agreements with leadingbiopharmaceutical companies for the commercialization of our LEADS softwareplatform and our other existing and future tools and services.

 

*Expand our Technological Leadership.* Ourcurrent technologies address an immediate need of the pharmaceutical andbiotechnology industries to improve the probability of success of the drugdevelopment processes. We intend to continue to use our multidisciplinaryapproach to molecular biology in order to discover and commercialize potentialnovel therapeutic proteins and diagnostic markers, as well as solutions to theindustry's future biological challenges. In addition, our Chemistry division iscurrently applying our unique approach to creating novel technologies fordiscovering lead compounds for protein targets. Finally, in the area ofmedicine, we focus on improving the efficiency of drug use, using advanced drugresponse analysis through patient stratification based on multiple informationtypes. 
**____(26)____ 

**Agricultural Biotechnology Company in which CompugenHas Equity Interest**

 

In October 1999, we formed a division focusing onagricultural biotechnology and plant genomics. On January 1, 2002, we spun-off the business of this division into a majority-owned subsidiary, Evogene Ltd.,in which Compugen holds 1,640,000 ordinary shares, representing 82% of theoutstanding shares. On January 6, 2003, Evogene entered a Convertible LoanAgreement with a group of new lenders for the aggregate amount of two milliondollars. Compugen did not participate in this financing round. As part of thisconvertible loan, Compugen agreed to (1) forgo the entire loan that it extendedto Evogene upon Evogene`s incorporation, in the amount of $900,000 plus allaccrued interest, and (2) extend the term of the license to use certain ofCompugen`s computational tools free of charge, that was granted to Evogene uponEvogene`s incorporation, until December 31, 2005. (See Item 7. MajorShareholders and Related Party Transactions. Related Party Transactions.Evogene Ltd.).

 

**Sales and Marketing and Business Development**

 

Since our founding in 1993, we have devoted most ofour capital and human resources to research and development of ourtechnologies, products and services. Between 1999 and 2001 we significantlyexpanded our sales and marketing capabilities. 

*** ***

In the United States, we have marketing, sales andbusiness development presence in Sunnyvale, California, Jamesburg, New Jersey,and Rockville, Maryland. We also perform some of our research and developmentin our New Jersey premises. We also conduct marketing, sales and businessdevelopment from our Tel Aviv offices, and sales activities from the United  Kingdom.  

 

The approximate geographic breakdown of our totalsales from products and services for the year ended December 31, 2002 was 68% in North America, 20% in Europe, 7% in the Far East and 5% in othercountries. The approximate geographic breakdown of our total sales from productsand services for the year ended December 31, 2001 was 68% in North America, 22%in Europe, 8% in the Far East and 2% in other countries. The approximategeographic breakdown of our total sales for the year ended December 31, 2000 was 94% in North America, 3% in Europe, 2% in the Far East and 1% in othercountries.  

 

As of December 31, 2002, our sales, marketing andbusiness development staff consisted of 18 employees, with 10 based in the United  States, 6 based in Tel Aviv and 2 based in England. 

 

We plan to continue toaggressively market our technologies, products and services to pharmaceuticaland biotechnology companies. To accomplish this we intend to:
- recruit additional business development     personnel in the United States;  
- continue to enter into commercial arrangements     with third parties with respect to some of our products and services. In     the past, these arrangements included worldwide marketing arrangements     such as our agreement with Sigma-Genosys relating to our OligoLibraries     and our arrangement with Gene Logic relating to Genecarta. In the future,     our commercial arrangements may be of a different nature;  
- continue to exhibit and speak at industry and     scientific conferences; and
- continue to increase the awareness to our     technologies and products through publications in scientific journals and     coverage in trade and general media.  

** **

**Intellectual Property Rights  **

** **

We seek patent protection for certain components ofour technology platform, including analysis techniques, and for certain of ourdiscoveries relating to genomic and protein sequences. We also rely heavily onconfidentiality obligations to protect our trade secrets and confidential andproprietary information. We use license agreements both to access third partytechnologies and to grant licenses to third parties to use our intellectualproperty rights. Our commercial success will be dependent in part on ourability to obtain commercially valuable patent positions, maintain theconfidentiality of our trade secrets and otherwise protect our intellectualproperty portfolio. 
**____(27)____ 

 

Our strategy to apply for patents relates primarilyto certain aspects of our computational technologies, certain databases andindividual nucleic acid and amino acid sequences. The latter comprisesapproximately 35 patent applications (not including foreign counterparts). 

 

The patent positions ofbiotechnology companies, including ours, are generally uncertain and involvecomplex legal and factual questions that are still evolving. Our business couldbe harmed by any of the following:
- our pending patent applications may not be     accepted by United States Patent and Trademarks Office and, where     relevant, corresponding patents jurisdictions and, therefore, may not     result in issued patents;
- the claims of any patents that may be issued     from an application may not provide meaningful protection;
- we may not be successful in developing     additional proprietary technologies that can be effectively protected;
- patents that we may ultimately obtain may not     provide a basis for commercially viable products or any competitive     advantages;
- patents that we obtain may be successfully     challenged by third parties; and
- third parties may have patents that claim the     inventions or technology that we use.

 

The degree of future protection for ourintellectual property is therefore uncertain. Furthermore, others mayindependently develop similar or alternative technologies, duplicate any of ourtechnologies or, if patents are licensed or issued to us, design around thepatented technologies licensed to or owned by us. Other third partytechnologies may also provide third parties with competitive advantages over usand may harm our business. In addition, we could incur substantial costs inlitigation if we are required to initiate suits to prevent infringement of ourpatents, once issued, or to defend ourselves in patent suits brought by thirdparties.  

 

These costs could significantly increase ourexpenses and our losses. Furthermore, in circumstances where claims relating toproprietary technology or information are asserted against us, we may seeklicenses to this intellectual property. However, any required licenses may notbe made available on commercially viable terms, if at all. Failure to obtainany required license could prevent us from using or commercializing one or moreof our technologies or discoveries.

 

We have applied, and intend to make additionalapplications, for patent protection for inventions relating to novel genes andsplice variants and to novel uses for known genes or splice variants identifiedthrough our research discovery programs. To date we have one patent issued inour name. We may not be able to continue to obtain patent protection for ourinventions.

 

Several companies and other organizations areattempting to obtain patents relating to novel genes and gene fragments anduses for known genetic sequences, whose functions have not been characterized,as well as for fully characterized genetic sequences. To the extent any patentsare issued to other parties on these partial or full-length genes, we may beprevented from commercializing such genes or products or processes, which arebased on such genes. Others may have filed, and in the future are likely tofile, patent applications covering genes or gene products that are similar oridentical to those for which we may seek patent protection. These patentapplications may have priority over patent applications filed by us. Any legalaction against us or our customers claiming damages and seeking to enjoincommercial activities relating to the affected products and/or processes could,in addition to subjecting us to potential liability for damages, require us,our consultants and/or our customers to obtain a license in order to continueto manufacture or market the affected products and processes. We, ourconsultants or our customers may not prevail in any action, and any licenserequired under any patent may not be available on commercially acceptableterms, if at all. In light of the nature of our industry, we believe that thereis likely to be litigation in the industry regarding patent and otherintellectual property rights. If we become involved in litigation, it couldconsume a substantial portion of our managerial and financial resources andnegatively affect our financial results.

 

With respect to proprietary know-how that is notpatentable or that we choose not to patent, we rely on trade secret protectionand confidentiality agreements to protect our interests. We believe thatseveral elements of our computational genomics, functional genomics andproteomics capabilities involve proprietary know-how, technology or data thatare not covered by patents or patent applications. In addition, we havedeveloped a proprietary database of genes, alternative splice variants, genefragment sequences, and methods for discovering novel biological phenomena,which we update on an ongoing basis. Some of these data is the subject topatent applications. 
**____(28)____ 

We have implemented security measures to protectour proprietary know-how and technologies and confidential data, including arange of confidentiality agreements with out employees, consultants andcustomers. While we require employees, consultants and customers to enter intoconfidentiality agreements, we cannot be sure that proprietary information willnot be disclosed in violation of these agreements, that others will notindependently develop substantially equivalent proprietary information andtechniques or that we can otherwise meaningfully protect our trade secrets. Inthe case of arrangements with our customers that require the sharing ofinformation, our policy is to make available to our customers only informationthat is relevant to our agreements with these customers, under controlledcircumstances, and only during the contractual term of those agreements, andsubject to a duty of confidentiality on the part of our customer. However,these measures may not adequately protect our information. Any material leak ofconfidential information into the public domain or to third parties may causeour business, financial condition and results of operations to be harmed.

 

We are a party to various license agreements thatgive us rights to use technologies and biological materials in our research anddevelopment processes. We may not be able to maintain these rights oncommercially reasonable terms, if at all. Our failure to maintain these rightscould harm our business.

 

**Competition**

** **

The biotechnology andpharmaceutical industries are highly competitive. We face tough competitionfrom numerous companies, some of which are more established, may benefit fromgreater market recognition and have greater financial, production and marketingresources than we do. Our principal competitors include:

 
- Celera Genomics Group, which provides genomic     data that may compete with our LEADS platform, Genecarta and our genomic     services;
- Incyte Genomics, Inc., which provides genomic     data that may compete with our LEADS platform and Genecarta;
- Lion Bioscience AG, which provides genomic     research and infrastructure tools and services that may compete with our     genomic services;
- Amersham Pharmacia Biotech, Nonlinear Dynamics     Ltd., Biorad, Inc., Geneva Bioinformatics S.A. and Definiens AG, which     provide 2D-gel analysis systems that compete with our Z3 product; 
- Nonlinear Dynamics Ltd., which provides 2D-gel     analysis systems that compete with our Z4000 product; 
- MWG-Biotech AG, Operon Technologies, Inc. and     Clonetech Laboratories, Inc., which provide products that compete with our     OligoLibraries; and
- Millenium Pharmaceuticals Inc., which have a platform     for clustering and arranging ESTs.

 

Competition among entities attempting to identifythe genes and proteins associated with specific diseases and to developproducts based on these discoveries is intense. We face, and expect to continueto face, competition from pharmaceutical, biotechnology and diagnosticcompanies, academic and research institutions, and government agencies, in theUnited States and elsewhere, including many of our customers. We are aware thatseveral of our competitors use a variety of gene expression analysismethodologies, including the use of gene expression systems, functionalinformation, cell based assays, animal modules and proprietary ESTs, to attemptto identify disease-related genes.

 

In addition, our discovery activities depend, inlarge part, on our computational platforms and tools and proprietary data tomake inventions and establish intellectual property rights in genes andproteins. We believe that access to our tools and proprietary informationprovides our discovery team with a competitive advantage over biotechnologycompanies that are pursuing patent protection that may compete with our own,including patents relating to gene and protein sequences. We may lose thatadvantage when we provide our customer, primarily biotechnology companies,pharmaceutical companies and diagnostic companies, access to our platforms,tools and proprietary data. If our customers, many of which have greaterfinancial and other resources than we do, research genes or proteins that weare also researching, they may establish intellectual property rights in suchgenes or proteins which have priority over the protection that we are seeking.In addition, our discovery team may pursue opportunities in fields that couldconflict with those of our customers or discourage potential customers fromworking with us. As a result, our business, financial condition and results ofoperations may be significantly harmed.
**____(29)____ 

 

Our chemistry activities face fierce competitionfrom all fully integrated pharmaceutical companies and from companies engagedin drug discovery, such as Infinity pharmaceuticals, Pharmacopia Inc., VertexPharmaceuticals Incorporated, Structural GenomiX Inc., Albany MolecularResearch inc. and Celera Genomics Group.

*** ***

Our medicine activities compete withpharmacogenomics companies, such as Genaissance, that are engaged in theprediction of drug response based on genetic information, and withorganizations providing clinical trial analysis capabilities, such as Entelos,Inc., Physiome Sciences, Inc., Gene Network Sciences (GNS) and Optimata.

 

Many of our competitors have substantially greatercapital resources, research and development staffs, manufacturing and marketingexperience, distribution channels and human resources than we do. Owing totheir greater resources, these competitors may discover, characterize ordevelop important genes, drug targets, lead compounds, drug discoverytechnologies or drugs before we, our customers or collaborators do so. These competitorsmay also discover, characterize or develop drug targets, lead compounds, drugdiscovery technologies or drugs that are more effective than those developed byus, our customers or collaborators, or they may obtain regulatory approvals fortheir drugs more rapidly than we or our customers do. Any of these events couldhave a material adverse effect on any of our similar programs. Moreover, ourcompetitors may obtain patent protection or other intellectual property rightsthat could limit our rights or our customers' ability to use our technologiesor commercialize drug, therapeutics, diagnostics or agricultural products. 

 

**Government Regulation**

** **

As a company which performs life science researchwe use hazardous materials and tissue samples. We are subject to governmentalregulations concerning this use. These regulations impose certain restrictionson our access to and use of human tissue samples. In addition, we receiveresearch and development grants from the Government of Israel. As a result, theproducts of this research and development are subject to certain restrictions.

** **

***Environmental Regulation***

* *

Our research and development activities in somecases involve the controlled use of biological and hazardous materials, such aschemicals and radioactive materials. We are subject to Israeli laws andregulations governing the use, storage, handling and disposal of thesematerials and resulting waste products. We comply with these laws andregulations. However, the risk of accidental contamination or injury from thesematerials cannot be entirely eliminated. In the event of an accident, we couldbe held liable for any resulting damages, and any liability could exceed ourresources. 

 

***Regulation of Use of Human Tissue***

* *

Our access to and use of human or other organisms`tissue samples in the expansion of our proprietary database or our productdevelopment may become subject to further government regulation, in the UnitedStates, Israel and elsewhere. U.S. and foreign governmental agencies may alsoimpose restrictions on the use of data derived from human or other tissuesamples. If our access to or use of human tissue samples, or our customers' useof data derived from these samples, is restricted, our business may suffer.

 

***Regulation of Products Developed with GovernmentalSupport***

**

For a discussion of regulations governing productsdeveloped with research and development grants from the Government of Israel,see "Item 5. Operating and Financial Review and Prospects, Government of IsraelSupport Programs, Research and Development Grants."
**____(30)____ 

 

***Regulation of the Internet***

 

There is an increasing body of law and regulationpertaining to the Internet. In addition, a number of legislative and regulatoryproposals regarding regulation of the Internet are under consideration byIsraeli and foreign governments and agencies. Laws or regulations may beadopted with respect to the Internet relating to liability for informationretrieved from or transmitted over the Internet, on-line content regulation,user privacy, taxation and quality of products and services. Moreover, it maytake years to determine whether and how existing laws, including thosegoverning intellectual property ownership and infringement, privacy, copyright,trademark, trade secret, taxation and the regulation of the sale of otherspecified goods and services, apply to the Internet. The requirement that wecomply with any new legislation or regulation, or any unanticipated applicationor interpretation of existing laws, may decrease the growth in the use of theInternet, which could in turn decrease the demand for our Internet-basedproducts, increase our cost of doing business or otherwise harm our business,results of operations and financial condition.

 

Due to the global reach of the Internet, it ispossible that governments of nations to which we transmit data over theInternet might attempt to regulate Internet activity and our transmissions ortake action against us for violations of their laws. Violations of these lawsmay be alleged or charged by state or foreign governments. In addition, theselaws may be modified, or new laws enacted, in the future. Any regulation ofthis type could materially harm our business, results of operations andfinancial condition. 

** **

**Organizational Structure**

 

Compugen is the parent of one wholly-ownedsubsidiary, Compugen, Inc., which is incorporated in Delaware and which has itsprincipal place of business in New Jersey.  Compugen owns 82% of theoutstanding shares of Evogene Ltd., which was formed under the laws of theState of Israel and which has its principal place of business in Rehovot, Israel(See Item 7. Major Shareholders and Related Party Transactions. Related PartyTransactions. Evogene Ltd.).

  

**Property, Plant and Equipment**

** **

We lease an aggregate of approximately 2,300 squaremeters of office and laboratory facilities in Tel Aviv, Israel, andapproximately 720 square meters of office and laboratory facilities in Ashqelon, Israel. The leases in Tel Aviv expire on December 31, 2006 and the lease in Ashqelon expires on September 2006. 

 

In addition, Compugen, Inc. leases approximately4,490 square feet of office space in Jamesburg, New Jersey, approximately 233square feet of office space in Sunnyvale, California, and approximately 450square feet of office space in Rockville, Maryland. The lease in New Jerseyexpires in December 2005, the lease in Sunnyvale expires on November 2003, andthe lease in Maryland expires on December 2004.  

 

Evogene Ltd. leases approximately 289 square metersof offices and laboratory facilities in Rehovot, Israel. The lease expires inMarch 2004.

 

We believe that the facilities we currently leaseare sufficient for approximately the next 12******months. 
**____(31)____ 

**ITEM 5.                   OPERATING AND FINANCIAL REVIEW ANDPROSPECTS**

*** ***

**Selected Financial Data**

 

The following discussion and analysis is based onand should be read in connection with the Company`s audited consolidatedfinancial statements, including the related notes, contained in "Item 18 -Financial Statements" and the other financial information appearing elsewherein this annual report. 

*** ***

****

****

**Year ended December 31,**

** **

****

****

**1998***

****

**1999***

****

**2000***

****

**2001***

****

**2002        **

 

**(U.S. $ in thousands, except share and per  share data)**

**Consolidated Statements of**

**Operations Data**

Revenues:

  Products

$4,020

$783

                       $2,268

                       $5,883

                       $5,014

  Services

511

   2,454

                       4,623

                       4,483

                       4,248

  Research and development grants

          333

                       507

                       466

                       994

                       1,835

    Total revenues

4,864

3,744

                       7,357

11,360

                       11,097

 

 

 

 

 

 

Cost of revenues:

 

  Products

1,399

                       611

                       477

                       1,853

                       1,411

  Services

100

                       480

                       1,243

                       1,602

                       1,408

Research and development expenses

3,900

   7,183

                       12,635

15,976

                       14,170

Sales and marketing expenses

924

1,166

                       3,781

                       6,565

                       5,538

General and administrative

    Expenses

 

      1,815

 

   3,152

 

                       5,397

 

                       4,383

 

                       3,614

        Total  operating expenses **

      8,138

   12,592

                       23,533

30,379

                       26,141

        Operating  (loss) profit

(3,274)

(8,848)

(16,176)

(19,019)

(15,044)

Financial and other income, net

        192

                     719

                       2,772

                       3,875

                       2,840

Net loss

$ (3,082)

$ (8,129)

$ (13,404)

$ (15,144)

$  (12,204)

Dividends  related to convertible   preferred shares

882

 

1,886

 

                       24,923

 

                       -

                       -

Net loss available to ordinary shares

   (3,964)

   (10,015)

(38,327)

(15,144)

(12,204)

Basic and diluted net loss per

  ordinary share ***

 

$   (0.67)

 

$  (1.70)

 

$  (2.75)

 

$  (0.58)

 

$   (0.47)

Weighted average number of ordinary

  shares used in computing basic and  diluted  net loss per share

 

 

5,886,208

 

 

   5,896,780

 

 

13,914,485

 

 

26,005,784

 

 

26,103,343

Pro forma basic and diluted net loss

  Per share (unaudited) ****

 

$    (0.29)

 

$    (0.58)

 

$    (0.69)

 

                               -

 

                               -

Pro forma weighted average number of

  shares outstanding (unaudited) ****

 

  10,749,861

 

14,102,899

 

19,305,553

 

                               -

 

                               -

 
**____(32)____ 

 

 

**As of December 31,**

** **

** **

** **

** **

** **

** **

** **

**1998**

**1999**

**2000**

**2001**

**2002**

 

**(****U.S.****$  in thousands)**

**Consolidated Balance Sheet  Data:**

Cash and cash equivalents,  short-term cash deposits and marketable securities

    $  19,941

   $  11,436

   $  90,675

   $ 32,347

  $  48,402

Long-term investments in  marketable securities and cash deposits

 

                       -

 

                       -

 

                       -

 

46,148

 

18,940

Receivables, net

                       905

                       710

                       2,720

3,159

4,581

Inventory

                       530

                       380

                       347

                       134

111

Total assets

                       23,279

                       15,518

                       97,872

87,289

77,257

Accumulated deficit

(6,788)

(14,917)

(53,244)

(68,388)

(80,592)

Total shareholders' equity

                       18,780

                       12,787

                       92,510

80,062

68,881

 

(*)   Reclassified 

*** ***

(**) Includes deferredstock compensation - see Note 12 to the consolidated financial statements.

 

(***) Basic and dilutednet loss and pro-forma basic and diluted net loss, for the year ended December31, 2000 exclude the non-cash dividend recorded in the amount of $24.9 millionrelated to the beneficial conversion feature of the issuance of 5,538,462Series C preferred shares (at a price of $6.50 per share). As per their terms,all preferred shares were converted to ordinary shares upon the closing ofCompugen`s initial public offering (IPO) in August 2000.

 

(****) Pro-forma basicand diluted net loss per share and pro-forma weighted average number of sharesoutstanding for the year ended December 31, 2000 give effect to the automaticconversion of the preferred shares which occurred in August 2000 upon theclosing of the IPO (using the "as-if converted" method from original date ofissuance).

 

**Overview  **

** **

The following discussion should be read inconjunction with the selected financial data included above and ourconsolidated financial statements and the related notes thereto includedelsewhere in this annual report.

** **

We are a leader in increasing the probability ofsuccess of drug and diagnostic development through the incorporation of ideasand methods from mathematics, computer science and physics into the disciplinesof biology, organic chemistry and medicine. Our unique capability is the basisfor both in-house discovery of potential therapeutic and diagnostic products,and the development of high value platforms, tools and services. To accomplishthis goal, we have operations in the three scientific areas underlying the drugdevelopment process: biology, organic chemistry and medicine. 

 

In the area of biology, we develop platforms andtools that enable and enhance the discovery and functional analysis of genes,proteins and cell processes. In addition, we discover and seek tocommercialize, therapeutic proteins and diagnostic markers, for which we pursuecommercial relationships with leading biotechnology, diagnostic andpharmaceutical companies. 

 

Since our inception, we have incurred significantlosses and, as of December 31, 2002, we had an accumulated deficit of $55.7million (not including approximately $24.9 million in accumulated deficitattributable to the conversion of preferred shares upon the closing of ourinitial public offering). Through 2002, our revenues were primarily generatedby the licensing of, and provision of services related to, our LEADS platform;sales and maintenance of Bioccelerator systems; licenses of Genecarta; licensesof Z3 and Z4000; sales of OligoLibraries; and both royalty-bearing and non-royaltybearing government grants.
**____(33)____ 

 

We recorded compensationexpenses of approximately $5.7 million in 2000, approximately $2.6 million in2001 and approximately $900,000 in 2002 in connection with the grant of shareoptions. These amounts are being amortized over the vesting periods of theindividual share options. Based on options granted through December 31, 2002, future amortization of compensation expenses are expected to amount toapproximately $506,000 in 2003 and $74,000 in 2004. Our current policy is togrant options at the fair market value of the underlying shares on the date ofgrant.  

 

In July 2000, we raised an aggregate ofapproximately $35.5 million in a private placement through the issuance of5,538,462 Series C preferred shares at a price of $6.50 per share. As a resultof this transaction, we recorded a preferred share dividend for the thirdquarter of 2000 of approximately $24.9 million, representing the value of thebeneficial conversion feature of this issuance, based on the difference betweenthe conversion price of $6.50 per share and $11.00 per share, the range of theoffering price in our initial public offering. 

 

In August 2000, we sold 5,000,000 of our ordinaryshares in the initial public offering of our shares on the Nasdaq NationalMarket at $10.00 per share, and in September 2000, we sold an additional750,000 ordinary shares upon the exercise by our underwriters of theirover-allotment option. Our aggregate net proceeds from these sales were $51.1million. All outstanding preferred shares were converted into Ordinary Sharesupon the closing of the public offering.

*** ***

Commencing January 1, 2001, we record researchgrants as part of revenues. Prior to January 1, 2001, research grants wereaccounted for as a reduction in research and development expenses. Ourfinancial statements for previous years have been changed to conform to thischange in 2001. 

** **

In January 2002, we listed our shares for tradingin the Tel Aviv Stock Exchange (TASE). 

** **

**Critical Accounting Policies**

** **

Our consolidated financial statements are preparedin accordance with accounting principles generally accepted in the United  States ("GAAP"). These accounting principles require management to makecertain estimates, judgments and assumptions based upon information availableat the time that they are made, historical experience and various other factorsthat are believed to be reasonable under the circumstances. These estimates,judgments and assumptions can affect the reported amounts of assets andliabilities as of the date of the financial statements, as well as the reportedamounts of revenues and expenses during the periods presented. 

** **

In many cases, the accounting treatment of aparticular transaction is specifically dictated by GAAP and does not require management`sjudgment in its application. There are also areas in which management`sjudgment in selecting among available alternatives would not produce amaterially different result. Our management has reviewed these criticalaccounting policies and related disclosures with the Audit Committee. See Note2 to the Consolidated Financial Statements, which contain additionalinformation regarding the Company`s accounting policies and other disclosuresrequired by GAAP. 

** **

Management believes that the accounting policywhich most affects its judgments and the estimates used in the preparation ofour consolidated financial statements and which is the most critical to aid infully understanding and evaluating our reported financial results are ourRevenue Recognition policy and Allowance for Doubtful Debts.

 

***Revenue Recognition Policy***

 

We generate most of our revenues fromcollaborations and license fees of software products. We also generate revenuesfrom sales of services including maintenance, support, customization, trainingand installation as well as sale of products (OligoLibraries). In addition, werecognized revenues from research and development grants (as described below).We sell our products primarily through our direct sales force and resellers,both of whom are considered end users. 
**____(34)____ 

We recognize software license revenue in accordancewith Statement of Position 97-2, "Software Revenue Recognition" ("SOP 97-2"),as amended. SOP 97-2 generally requires revenue earned on software arrangementsinvolving multiple elements to be allocated to each element based on therelative fair value of the elements. We have also adopted SOP 98-9,"Modification of SOP 97-2, Software Revenue Recognition with Respect to CertainTransactions" ("SOP 98-9"), for all transactions entered into after January 1, 2000. SOP 98-9 requires that revenue be recognized under the "Residual Method"when vendor specific objective evidence (VSOE) of fair value exists for allundelivered elements and no VSOE exists for the delivered elements. 

 

Revenue from license fees is recognized whenpersuasive evidence of an agreement exists, delivery of the product hasoccurred, no significant obligations with regard to implementation remain, thefee is fixed or determinable, and collectibility is probable. At the time ofthe transaction we assess whether the fee is fixed or determinable. If the feeis not fixed or determinable, revenue is recognized as payments become due fromthe customer provided that all other revenue recognition criteria have been met.We assess the likelihood of collection based on a number of factors, includingpast transaction history, the credit worthiness of the customer and, in someinstances, a review of the customer`s financial statements.

 

When contracts contain multiple elements whereinVSOE of fair value exists for all undelivered elements, we account for thedelivered elements in accordance with the "Residual Method" prescribed by SOP98-9. Maintenance and support revenue included in these arrangements isdeferred and recognized on a straight-line basis over the term of themaintenance and support agreement. The VSOE of fair value of the undeliveredelements (maintenance, support and professional services) is determined basedon the price charged for the undelivered element when sold separately.

 

We license products on a perpetual and on a termbasis. License revenue arising from the sale of perpetual licenses and termlicenses for a period longer than one year is recognized in the accountingperiod that the sale takes place. License revenue arising from term license fora period of less than one year is recognized over the contractual term of thelicense.

 

Revenues from software licenses that requiresignificant customization, integration and installation are recognized in accordancewith Statement of Position 81-1 "Accounting for Performance ofConstruction - Type and Certain Production - Type Contracts" ("SOP 81-1"),using contract accounting on a percentage of completion method, based on therelationship of actual costs incurred to total costs estimated to be incurredover the duration of the contract. Milestone payments are recognized only whenperformance is reasonably assured.

 

Provisions for estimated losses on uncompletedcontracts are made in the period in which such losses are first determined, inthe amount of the estimated loss on the entire contract. As of December 31, 2002, no such estimated losses were identified.

 

Arrangements that include consulting services areevaluated to determine whether those services are essential to thefunctionality of other elements of the arrangement. When services areconsidered essential, revenue under the arrangement is recognized usingcontract accounting. When services are not considered essential, the revenueallocable to the software services is recognized as the services are performed.

 

Revenue from sales of hardware systems (includingassociated software) is recognized in accordance with SOP 97-2, upon delivery,or at the end of the evaluation period provided all other revenue recognitioncriteria have been met. 

 

Revenues from sales of products (OligoLibraries)are recognized in accordance with Staff Accounting Bulletin No. 101 "RevenueRecognition in Financial Statements" ("SAB No. 101") when the product has beendelivered, persuasive evidence of an arrangement exists, the vendor`s fee isfixed or determinable and collectibility probable.

 

Revenues from web-based services are recognized inaccordance with SAB No. 101 when the service has been rendered, persuasiveevidence of an agreement exists, the vendor`s fee is fixed or determinable andcollectibility probable.
**____(35)____ 

We account for equity instruments received inaccordance with Emerging Issues Task Force ("EITF") No.0-08 "Accounting by aGrantee for Equity Instruments to be Received in Conjunction with ProvidingGoods or Services". We deem the fair value of the equity instruments receivedto date to be minimal and as a result no revenues were recognized.

 

Revenue from maintenance contracts is recognizedratably over the term of the maintenance contract. Revenues related to otherservices are recognized as the services are rendered.

 

Royalty and non royalty bearing grants from theGovernment of Israel through the Ministry of Industry and Trade - the Office ofthe Chief Scientist of Israel ("OCS") for funding approved research anddevelopment projects, are recognized as revenues as the related research anddevelopment expenses are incurred. We are not obligated to repay any amountsreceived from the OCS if the research effort is unsuccessful.

 

Deferred revenue includes amounts received fromcustomers for which revenue has not been recognized.

** **

***Allowance for Doubtful Debts***

** **

Management continually reviews the collectibilityof trade accounts receivable and the adequacy of the allowance for doubtfuldebts against the trade accounts receivable. Management specifically analyzescustomer accounts, account receivable aging reports, history of bad debts andthe business or industry sector to which they belong, customer concentrations,customer credit worthiness, current economic trends and any other pertinentfactors. Management is able to make reasonably objective judgments on theadequacy of other provisions relating to trade accruals. We have not made anyprovision for contingent liabilities, which has involved significant managementjudgment that either we will prevail in the case of material litigation or thatwe have sufficient insurance to cover any adverse outcome.

** **

**Results of Operations**

*** ***

***Years Ended******December 31, 2002******and 2001***

* *

*Revenues.* Total revenues decreased 2% toapproximately $11.1 million for 2002 from approximately $11.4 million for 2001.Products revenues decreased 15% to approximately $5.0 million for 2002 fromapproximately $5.9 million for 2001. The decrease in products revenues wasprimarily due to decreased sales of Bioccelerator systems, decreased sales ofLEADS and decreased sales of Genecarta, which were partially offset byincreased sales of OligoLibraries(TM). Services revenues decreased 5% toapproximately $4.2 million for 2002 from approximately $4.5 million for 2001.Revenues from research and development grants increased 85% to approximately$1.8 million for 2002 from approximately $994,000 for 2001. This increase wasdue to an increase in grants received from the Office of the Chief Scientist ofthe Ministry of Industry and Trade of the State of Israel (OCS). Revenues fromPfizer, Novartis and diaDexus represented 44% of our products and servicesrevenues in 2002.

 

*Cost of Revenues.*Cost of revenues decreased18% to approximately $2.8 million for 2002 from approximately $3.5 million for2001. Cost of products revenues decreased 24% to approximately $1.4 million for2002 from approximately $1.9 million for 2001. This decrease was primarily dueto decreased costs related to the sale of Bioccelerator systems and Genecarta,which were partially offset by the cost of sales related to our OligoLibraries.Cost of services revenues decreased 12% to approximately $1.4 million for 2002from approximately $1.6 million for 2001. This decrease was primarily due tocosts related to support services provided to Novartis and Pfizer. 

* *

*Research and Development Expenses.*Researchand development expenses decreased 11% to approximately $14.2 million for 2002from approximately $16.0 million for 2001. The decrease in research anddevelopment expenses was primarily due to the devaluation of the Israeli shekelagainst the US dollar and a decrease in amortization of deferred compensationto approximately $621,000 for 2002 from approximately $1.6 million for 2001.Research and development expenses as a percentage of total revenues decreasedfrom 141% in 2001 to 128% in 2002.   

* *

*Sales and Marketing Expenses*. Sales andmarketing expenses decreased 16% to approximately $5.5 million for 2002 fromapproximately $6.6 million for 2001. This decrease was due to the devaluationof the Israeli shekel against the US dollar, a decrease in amortization ofstock based compensation expenses to approximately $197,000 for 2002 fromapproximately $510,000 for 2001, and a decrease in promotional costs andmarketing expenses. Sales and marketing expenses as a percentage of totalrevenues decreased from 58% in 2001 to 50% in 2002.
***____(36)____ 

* *

*General and Administrative Expenses.*Generaland administrative expenses decreased 18% to approximately $3.6 million for2002 from approximately $4.4 million for 2001. This decrease was primarily dueto a decrease of approximately $384,000 in stock based compensation expensesrecorded in connection with options issued to employees and consultants.Without taking into account the stock based compensation expenses, general andadministrative expenses decreased 10% to approximately $3.5 million for 2002from approximately $3.9 million for 2001. This decrease was primarily due tothe devaluation of the Israeli shekel against the US dollar. General andadministrative expenses as a percentage of total revenues decreased from 39%for 2001 to 33% for 2002. 

* *

*Financial and Other Income, Net.*Financialand other income, net decreased 27% to approximately $2.8 million for 2002 fromapproximately $3.9 million for 2001. This decrease was attributable to lowerlevels of cash and cash related accounts, and lower interest rates we receivedon short and long-term cash deposits and marketable securities. Financial andother income, net as a percentage of total revenues decreased from 34% for 2001to 26% for 2002.

 

***Years Ended******December 31, 2001******and 2000***

* *

*Revenues.*Total revenues increased 54% toapproximately $11.4 million for 2001 from approximately $7.4 million for 2000.Products revenues increased 159% to approximately $5.9 million for 2001 fromapproximately $2.3 million for 2000. This increase was due to increased salesof LEADS, sales of Genecarta, which was introduced in the second quarter of2001, sales of OligoLibraries(TM), which were introduced on an early access basisin the second quarter, and commercially launched in October, of 2001, and salesof Z3. Services revenues decreased 3% to approximately $4.5 million for 2001from approximately $4.6 million for 2000. Revenues from research anddevelopment grants increased 113% to approximately $994,000 for 2001 fromapproximately $466,000 for 2000. This increase was due to an increase inapplications for grants submitted to, and grants received from, the Office of ChiefScientist of the Ministry of Industry and Trade of State of Israel (OCS).Revenues from Pfizer, the United State Patent and Trademark Office and Novartisrepresented 64% of our products and services revenues in 2001.

* *

*Cost of Revenues.*Cost of revenues increased101% to approximately $3.5 million for 2001 from approximately $1.7 million for2000. Cost of product revenues increased 288% to approximately $1.9 million for2001 from approximately $477,000 in 2000. This increase was primarily due toincreased costs related to the introduction of new products to the market andmanufacturing costs related to our OligoLibraries, which were introduced in2001. Cost of services revenues increased 29% to approximately $1.6 million for2001 from approximately $1.2 million for 2000. This increase was primarily dueto costs related to support services provided to Novartis and an increase inthe support services provided to Pfizer. 

* *

*Research and Development Expenses.*Researchand development expenses increased 26% to approximately $16.0 million for 2001from approximately $12.6 million for 2000. The increase in research anddevelopment expenses was primarily due to an increase in the number of researchand development personnel to support existing as well as new research anddevelopment projects and increased salaries. This increase was partially setoff by a decrease in compensation expenses to approximately $1.6 million for2001 from approximately $2.4 million for 2000. Research and developmentexpenses as a percentage of total revenues decreased from 172% in 2000 to 141%in 2001.*  *

 

*Sales and Marketing Expenses.*Sales andmarketing expenses increased 74% to approximately $6.6 million for 2001 fromapproximately $3.8 million for 2000. This increase was primarily due to anincrease in the number and variety of products we market and sell, an increasein sales and marketing personnel, costs related to the launch of new products,and increased promotional costs and marketing expenses to accommodate thegrowth of our business. Sales and marketing expenses as a percentage of totalrevenues increased from 51% in 2000 to 58% in 2001.
***____(37)____ 

* *

*General and Administrative Expenses.* Generaland administrative expenses decreased 19% to approximately $4.4 million for2001 from approximately $5.4 million for 2000. This decrease was primarily dueto a decrease of approximately $2.2 million in amortization of deferredcompensation recorded in connection with options issued to employees andconsultants. Without taking into account the amortization of deferredcompensation, general and administrative expenses increased 42% toapproximately $3.9 million for 2001 from approximately $2.8 million for 2000.This increase was primarily due to an increase in personnel to support thegrowth of our business, the leasing of additional office space and humanresource activities. General and administrative expenses as a percentage oftotal revenues decreased from 73% for 2000 to 39% for 2001. Excluding expensesrelated to the amortization of deferred compensation, general andadministrative expenses as a percentage of total revenues decreased from 37%for 2000 to 35% for 2001. 

 

*Financial and Other Income, Net.* Financialand other income, net increased 40% to approximately $3.9 million for 2001 fromapproximately $2.8 million for 2000. This increase was attributable to higherlevels of cash and cash equivalents available from the aggregate proceeds ofapproximately $35.5 million from the sale of our Series C preferred shares inJuly 2000, net of issuance expenses of $487,000, and approximately $51.1million from the initial public offering of our shares on the Nasdaq NationalMarket, net of issuance expenses of approximately $6.4 million, in August 2000.Financial and other income, net as a percentage of total revenues decreasedfrom 38% for 2000 to 34% for 2001.

*** ***

**Impact of Inflation and Currency Fluctuations**

** **

We generate substantially all of our revenues inU.S. dollars but incur a significant portion of our expenses, principallysalaries and related personnel expenses, in New Israeli Shekels, or NIS. As aresult, we are exposed to the risk that the rate of inflation in Israel willexceed the rate of devaluation of the NIS in relation to the U.S. dollar orthat the timing of this devaluation lags behind inflation in Israel. Inaddition, we are exposed to the risk that the U.S. dollar will be devaluedagainst the NIS. We try to protect ourselves against this possibility byinvesting a portion of our cash in NIS deposits. While in recent years the rateof devaluation of the NIS against the dollar has exceeded the rate ofinflation, which is a reversal from prior years, we cannot be sure that thisreversal will continue. To date, we have not been materially affected bychanges in the Israeli rate of inflation or the exchange rates of the NIScompared to the U.S. dollar. We do not currently use financial instruments fortrading purposes and do not currently hold any derivative financial instrumentsthat could expose us to significant market risk.

 

**Liquidity and Capital Resources**

** **

From our inception until the initial publicoffering of our Ordinary Shares in August 2000, we obtained financing primarilythrough private placements of equity securities, and, to a lesser extent,government grants and loans. Financing activities from private placements ofpreferred and ordinary shares, net of issuance costs, provided cash ofapproximately $14.8 million in 1998, approximately $19,000 in 1999 andapproximately $35.5 million in 2000.

 

In August 2000, we sold 5,000,000 of our ordinaryshares in the initial public offering of our shares on the Nasdaq NationalMarket, and in September 2000, we sold an additional 750,000 ordinary sharesupon the exercise by our underwriters of their over-allotment option. Ouraggregate consideration from these sales was $57.5 million ($51.1 million netof issuance expenses). All outstanding preferred shares were converted intoOrdinary Shares upon the closing of the public offering. 

 

Net cash used in operating activities wasapproximately $6.1 million in 2000, approximately $9.0 million in 2001, andapproximately $9.1 million in 2002. These amounts were used to fund our netlosses for these periods, adjusted for non-cash expenses and changes inoperating assets and liabilities.

 

Net cash used in investing activities consists ofpurchase of marketable securities, purchases of short-term and long-termdeposits, purchases of property and equipment, and proceeds from redemption ofmarketable securities. Net cash provided by (used in) investing activities wasapproximately $(12.1) million in 2000, $(63.4) million in 2001, and $5.8million in 2002. The increase in net cash provided by investing activities in2002 is mainly related to the proceeds of approximately $9.2 million receivedfrom short-term and long-term deposits. the investment of approximately $15.9million in marketable securities, and the proceeds from sale of marketablesecurities, of approximately $13.9 million.
**____(38)____ 

 

Our net cash provided by financing activities wasapproximately $87.4 million in 2000, approximately $104,000 in 2001, andapproximately $161,000 in 2002. The principal sources of cash in 2000 werederived from the private placement of our preferred shares and issuance ofOrdinary Shares in our initial public offering, and in 2001 and 2002, proceedsfrom issuance of Ordinary Shares related to employee option exercises.  

 

As of December 31, 2002, we had cash and cashequivalents, short-term cash deposits and marketable securities ofapproximately $48.4 million, and long-term marketable securities ofapproximately $18.9 million. We believe that our existing cash and cashequivalents, short-term cash deposits and short-term and long-term marketablesecurities will be sufficient to fund our operations for at least the next twoyears. However, we may need additional equity or debt financing in the futureto fund our operations or to finance potential acquisitions of otherbusinesses, products or technologies.

** **

**Off-Balance SheetArrangements**

 

We do not have any off-balance-sheet arrangements. 

 

**Corporate Tax Rate**

** **

Israeli companies are generally subject to incometax at the corporate tax rate of 36%. However, several investment programs atour manufacturing facility in Tel Aviv have been granted approved enterprisestatus and we are, therefore, eligible for the reduced tax benefits under theLaw for the Encouragement of Capital Investments, 1959. We have derived, andexpect to continue to derive, a substantial portion of our income from theapproved enterprise programs at our manufacturing facility. Subject tocompliance with applicable requirements, the portion of our income derived fromthe approved enterprise programs will be tax-exempt for a period of two yearscommencing in the first year in which it generates taxable income and will besubject, for a period of five to eight years, to a reduced corporate tax of upto 25%, depending on the percentage of non-Israeli investors who acquire ourordinary shares. The period of tax benefits with respect to our approvedenterprise programs has not yet commenced, because we have yet to realizetaxable income. These benefits should result in income recognized by us beingtax exempt or taxed at a lower rate for a specified period after we begin toreport taxable income and exhaust any net operating loss carry-forwards.However, these benefits may not be applied to reduce the tax rate for anyincome derived by our U.S. subsidiary.  The law prescribing thebenefits was terminated in May 2003. There can be no assurance that such taxbenefits will continue in the future at their current levels or otherwise.

 

As of December 31, 2002, our net operating losscarry-forwards for Israeli tax purposes, including Evogene Ltd., amounted toapproximately $34 million. Under Israeli law, these net-operating losses may becarried forward indefinitely and offset against certain future taxable income.

 

As of December 31, 2002, the net operating losscarry-forwards of our U.S. subsidiary for U.S. tax purposes amounted toapproximately $15.0 million. These losses are available to offset any future U.S.taxable income of our U.S. subsidiary and will expire between the years 2012and 2022.

 

On January 1, 2003 a comprehensive tax reform tookeffect in Israel, that could adversely affect the Company`s effective tax rate.See "Israeli Tax Considerations" under "Item 10 - Additional Information."

 

**Research and Development, Patents and Licenses**

** **

We invest heavily in research and development, bothwith respect to our core activities in human health, and in the broadening of ourtechnological base. We believe that our future success will depend upon ourability to maintain technological leadership, to enhance existing technologiesand products, and to introduce new technologies addressing our own needs andthose of our customers. Therefore, research and development expenses continueto be the major expenditure of the company, and represented more than 50% ofthe total operating expenses for each of 2000, 2001 and 2002. As of December 31, 2002, 102 of our employees were engaged in research and development on afull-time basis. Our research and development expenses were $14.2 million in2002 compared to $16.0 million in 2001, and $12.6 million in 2000. 
**____(39)____ 

*Israeli Government Research and Development*

 

We participate in programs offered by the Office ofthe Chief Scientist of Israel ("OCS") that support research and developmentactivities. We received or accrued participations from the OCS ofapproximately, $466,000 in 2000, approximately $994,000******in 2001,and approximately $1.8 million in 2002. 

 

We have received grants from the OCS for severalprojects. Under the terms of these grants, a royalty of 3% to 5% of the netsales of products developed from a project funded by the OCS must be paid,beginning with the commencement of sales of products developed with grant fundsand ending when 100% of the dollar value of the grant is repaid (100% plusLIBOR interest for grants received from January 1, 1999 and afterwards). As of December 31, 2002, we were subject to the payment of approximately $1.9 million******inroyalties to the OCS out of future net sales of products developed under OCSfunded projects. The terms of Israeli government participation also requirethat the manufacture of products developed with government grants be performedin Israel, unless a special approval has been granted by the OCS. Thisapproval, if granted, is generally subject to an increase in the total amountto be repaid to the OCS to between 120% and 300% of the amount granted,depending on the extent of the manufacturing to be conducted outside of Israel.A recent amendment to applicable law has provided that the restriction onmanufacturing outside of Israel shall not apply to the extent that plans to somanufacture were disclosed when applying for funding. Separate Israeli governmentconsent is required to transfer to third parties technologies developed throughprojects in which the government participates. Transfer to non-Israeli thirdparties is prohibited. A recent amendment to applicable law has specified thatit is not just transfer of know-how that is prohibited, but also transfer ofany rights in such know-how. These restrictions do not apply to exports from Israelof products developed with these technologies.

 

In addition to the OCS programs described above, weare a party to several consortia of Israeli research institutions and hightechnology companies devoted to the development of various generic technologiesin the fields of biotechnology, agricultural biotechnology and pharmaceuticals.The OCS MAGNET program sponsors these consortia. Under the terms of the MAGNETprogram, the OCS contributes 66% of the approved budget of the consortium andthe members of the consortium contribute the remaining 34%. No royalties arepayable to the OCS with respect to this funding. Expenses in excess of theapproved budget are borne by the consortium members. 

 

In general, any member of the consortium thatdevelops technology in the framework of the consortium retains the intellectualproperty rights to this technology and all other members of the consortium havethe right to use and implement this technology without having to pay royaltiesto the developing consortium member, provided that the technology will not betransferred under any circumstances to any entity outside of the consortium.None of the other members of these consortia is currently a direct competitorof ours. The terms of the program prohibit the manufacture of products usingtechnology developed in the context of the program outside of Israel and thetransfer of technology developed under the program to any person, without theprior written consent of the OCS. These restrictions do not apply to the saleor export from Israel of products developed based on this know-how.  

 

**Trend Information**

** **

There is a trend towards consolidation in thepharmaceutical and biotechnology industries. This trend may negatively affectus in several ways. These consolidations usually involve larger companiesacquiring smaller companies, which results in the remaining large companieshaving greater financial resources and technological capabilities, thus makingcompetition in the industry more intense. Continued consolidation within thepharmaceutical and biotechnology industries may result in fewer customers forour products and services. In addition, if one of the parties to aconsolidation uses the products or services of our competitors, we may loseexisting customers as a result of such consolidation. 

** **

Another trend in our industries involves the largeamount of data which is becoming available to the general public. To date, mostof the public efforts relating to genomics involved producing data under theHuman Genome Project. Following the publication of the first draft of the humangenome, there has been an increase in public efforts to develop analysis toolsfor understanding genomic, functional genomic and proteomic data. These effortsmay result in the development of tools which are competitive to ours andavailable for free. Such developments could require us to lower our prices orcause some of our products to be less commercially viable or to be obsolete.
**____(40)____ 

 

Due to the downturn in the securities marketsworldwide during the past three years, including in the stock of biotechnologycompanies, biotechnology companies, including current and potential customersof ours, may experience difficulties in raising additional financing requiredto effectively operate and grow their businesses. If some of our current orpotential customers are unable to raise such financing, they may be unable or lesswilling to expend the amounts required to purchase our products and services.As a result, we may lose potential sales or may be forced to lower our prices.This could negatively impact our business, financial condition and results ofoperations.

 
**____(41)____ 

 

**ITEM 6.                   DIRECTORS, SENIOR MANAGEMENT ANDEMPLOYEES**

** **

**Directors and Senior Management**

** **

The following sets forth information with respectto our directors and executive officers as of April 30, 2003.

** **

**Name                              **

**Age**

**Positions**

Martin S. Gerstel

61

Chairman of the Board of Directors

Mor Amitai, Ph.D

37

Chief Executive Officer, President and Director

David Haselkorn, Ph.D

58

Director

Rimon Ben  Shaul

58

Director

Orna Berry, Ph.D

53

Director

David Schlachet

57

Director

Nurit Benjamini

36

Chief Financial Officer

Erez Chimovits 

39

Executive Vice President, Marketing & Sales  and President, BioApplications 

Michal Preminger, Ph.D.

39

Vice President, New Research Directions

Kinneret Savitsky, Ph.D.

36

Vice President, Experimental Biology

Dror Ofer, Ph.D.

40

Chief Technology Officer, Computational  Chemistry and Drug Design

Dorit Bitter

35

Vice President, Research and Development,  BioApplications

** **

**Martin S. Gerstel** has served as our Chairmansince August 1997. From September 1993 until August 1997, Mr. Gerstel was anindependent consultant and lecturer and served on various boards of directors.From July 1987 until August 1993, he was Co-Chairman and Chief ExecutiveOfficer of Alza Corporation in Palo Alto, California. Mr. Gerstel is co-chairmanof Itamar Medical Ltd. and serves on the board of directors of SymyxCorporation.  He also serves on the Board of Governors and Executivecommittee of the Weizmann Institute of Science, and he is an advisor to theU.S.-Israel Binational Industrial Research and Development Foundation. Mr.Gerstel is obligated to devote at least 50% of his time to our affairs. Mr.Gerstel holds a B.S. in Engineering from Yale University and an M.B.A. from Stanford University. 

 

**Mor Amitai, Ph.D.** joined Compugen in November1994 as Chief Scientist, was promoted to Head of Research at the end of 1995,has served as our Chief Executive Officer and a director since January 1998 andreceived the title of President in 2000. Prior to joining us, Mr. Amitai hadserved as an engineer at Comverse Technologies since August 1991. Mr. Amitaiholds a B.Sc. in Mathematics and Physics, and a M.Sc. and a Ph.D. inMathematics, each from Hebrew University.

 

**David Haselkorn, Ph.D.** has served as adirector since December 1998. Since 1998, Dr. Haselkorn has been the ChiefExecutive Officer of Clal Biotechnology Industries Ltd. From 1987 to 1998, Dr.Haselkorn served as a Managing Director and Chief Operating Officer ofBio-Technology General Corp. Dr. Haselkorn is also on the board of directors ofseveral privately-held companies. Dr. Haselkorn holds a B.Sc. in Chemistry andan M.Sc. in Biochemistry from Hebrew University, and a Ph.D. in ChemicalImmunology from the Weizmann Institute of Science.

 

**Rimon Ben Shaul** has been Co-Chairman,President and Chief Executive Officer of Koonras Technologies Ltd., aninvestment company controlled by Poalim Investments Ltd. since February 2001.  FromJune 1997 to February 2001, he was President and Chief Executive Officer ofClal Industries and Investments Ltd., one of Israel`s largest holdingcompanies. During that period, Mr. Ben-Shaul also served on the Boards ofDirectors of Clal (Israel) Ltd. and several of its subsidiaries.  From1985 to June 1997, Mr. Ben-Shaul was President and Chief Executive Officer ofClal Insurance Company Ltd. and a member of its Board of Directors, andChairman or member of the Board of Directors of various subsidiaries of ClalInsurance Company Ltd. He holds a B.A. in economics and an MBA from Tel Aviv University.
**____(42)____ 

**Orna Berry, Ph.D**joined our Board as anoutside director in June 2001. She is a Venture Partner at Gemini Israel Funds,and the Chairperson at Lambda Crossing, Ltd. and at Riverhead Inc. From 1997 to2000, she was the Chief Scientist of the Ministry of Industry and Trade of theGovernment of Israel. Dr. Berry was the co-founder of ORNET Data CommunicationTechnologies Ltd.. She served as the Chief Scientist of Fibronics and as asenior research engineer in several companies, including IBM and UNISYS.  Dr.  Berry received her Ph.D. in computer science from the University of Southern  California and her M.A. and B.A. degrees in statistics and mathematics fromTel Aviv and Haifa Universities, respectively. Dr. Berry serves as an outsidedirector on our Board for a fixed term, which expires in June 2004. 

** **

**David Schlachet** joined our Board as anoutside director in June 2001.  He is a managing partner of BioComManagement and Investment (2002) Ltd, which serves as the managing company ofBiocom venture capital fund, focused on life sciences.  He alsoserves on the Boards of Directors of the following companies: Poalim CapitalMarkets & Investments Ltd., Harel Capital Markets Ltd (as Chairman), TayaInvestment Company Ltd., United Studios Ltd., Pharmos Ltd., Taldor Ltd.,ProSeed Venture Capital Fund Ltd and Israel DiscountBank Limited.  From 1997 to July 2000, he was Chairman of theBoard of Directors of Elite Industries Ltd.  From 1996 to January2000, Mr. Schlachet served as Vice President of the Strauss Group of companies.  From1990 to 1996, he was Vice President, Finance and Administration at the WeizmannInstitute of Science. From 1989 to 1990, Mr. Schlachet was Chief ExecutiveOfficer of Yeda Research and Development Ltd. of the Weizmann Institute ofScience.  From 1974 to 1988, he was a senior manager at theInvestment Company of Bank Hapoalim Ltd. Mr. Schlachet holds a B.Sc. degree inchemical engineering from the Technion, Israel Institute of Technology and anMBA degree from Tel Aviv University.

 

**Nurit Benjamini**joined Compugen as VicePresident Finance and Investor Relations in April 2000, and was promoted toChief Financial Officer in December 2000.  Prior to joining Compugen,she served as the Chief Financial Officer of Phone-Or Ltd., from 1998 to 2000,and of Aladdin Knowledge Systems Ltd. (NASDAQ: ALDN) from 1993 and 1998.Previously, Ms. Benjamini served as Chief Financial Analyst and Economist withCubital Ltd, and as an economist on the Tel Aviv Stock Exchange. Ms. Benjaminiholds a BA in Economics and Business and an MBA in Finance from Bar Ilan  University, Israel.

 

**Erez Chimovits**joined Compugen as Directorof Marketing & Sales in 1999, was promoted to Vice President Marketing& Sales Compugen Inc. in June 2001, and was promoted to Executive VicePresident, Marketing & Sales and President, BioApplications Division inAugust******2001. Prior to joining Compugen, Mr. Chimovits heldvarious positions in business development, marketing and sales at Saifan Ltd.Mr. Chimovits holds a B.Sc. in Molecular Biology, an M.Sc. in Human Geneticsand an MBA, all from Tel Aviv University, Israel.  

** **

**Michal Preminger, Ph.D.**joined Compugen asDirector of Business Development in 1998 and was promoted to Vice President ofBusiness Development in 2000 and since August 2001 has served as Compugen`sVice President of New Research Directions. Prior to joining Compugen, Dr.Preminger served as Director of Marketing and Business Development at LucentTechnologies. Prior to her position at Lucent, she served in a senior marketingmanagement position at the LANNET division of Madge Networks. Dr. Premingerholds a Ph.D. in Biological Sciences from the Weizmann Institute of Science,Department of Membrane Research and Biophysics in Israel, and an MBA fromINSEAD in France. She holds a Bachelor of Medicine from the Hadassah Medical School,  Hebrew University in Jerusalem, and an M.Sc., Biological Sciences, from theWeizmann Institute of Science. 

 

**Kinneret Savitsky, Ph.D.**joined Compugen in1997 as a senior scientist in the Company`s newly founded laboratory. In 2000,she assumed her current position of Vice President, Experimental Biology withinthe Company. Dr. Savitsky completed her Ph.D. with distinction in theDepartment of Human Genetics at Tel Aviv University on the subject ofidentification of genes related to genetic diseases. Dr. Savitsky also holds aB.Sc. in Life Sciences with Honors from The Hebrew University, and an M.Sc.from the Department of Human Genetics at Tel Aviv University.

 

**Dror Ofer, Ph.D.** joined Compugen in 1998 asa research scientist and, in 2001, assumed his current position as ChiefTechnology Officer, Computational Chemistry and Drug Design within the Company.Prior to joining Compugen, Dr. Ofer served as a senior research physicist at anational laboratory. Dr. Ofer holds a B.Sc. in physics from The HebrewUniversity, an M.Sc. in physics from Ben-Gurion University and a Ph.D. inphysics from The Weizmann Institute of Science.
**____(43)____ 

 

**Dorit Bitter** joined Compugen in 2001,holding several senior positions in research and development before assumingher current position of Vice President, Research and Development,BioApplications in 2002. Prior to joining Compugen, Ms. Bitter worked atCimatron, where she held various R&D management positions during herseven-year tenure at the company.  Ms. Bitter earned a B.Sc. inmathematics and computer science and an M.Sc. in mathematics, both from TheHebrew University.

 

Mr. Amos Goren,  Mr. Philip Young and Mr.Eli Mintz ceased to serve on our Board of Directors during 2002. Mr. Lior D.Ma`ayan`s employment with Compugen terminated in March 2003.

 

**Compensation**

** **

***Compensation***

**

The aggregate compensation paid by us and oursubsidiaries to all persons who served as directors or senior management forthe year 2002 (12 persons) was $1,537,790. This amount includes $357,277 setaside or accrued to provide pension, severance, retirement or similar benefits.This amount also includes sums paid to Shomar Corporation under the consultingagreements which have been modified and that are further described under "Item7. Major Shareholders and Related Party Transactions; Related PartyTransactions and Consulting Agreement with Shomar Corporation". 

* *

During 2002, we granted a total of 370,000 optionsto purchase ordinary shares to our directors and senior management, as a group.These options are exercisable at a range of between $1.38 and $4.49 per share,and each expires ten years after their applicable date of grant. As of December 31, 2002, there were a total of 1,799,250 outstanding options to purchaseordinary shares that were granted to our directors and senior management, and75,000 outstanding options that were granted to the members of our scientificadvisory board.

* *

All members of our board of directors who are notemployees or consultants of the company are reimbursed for their expenses foreach meeting attended and are eligible to receive share options under our shareoption plans. The aggregate amount paid to all of our non-employee directorsfor the year ended December 31, 2002 was approximately $186,738. These fees areadjusted semi-annually to reflect changes prescribed by regulations under theCompanies Law, for payment to outside directors. Members of our scientificadvisory board receive cash compensation have been granted and may be grantedfurther share options for their services.  

* *

**Board practices**

* *

***Election of Directors andTerms of Office***

 

Our board of directors currently consists of sixmembers, including our chairman and chief executive officer. Other than our twooutside directors, our directors are elected by an ordinary resolution at theannual general meeting of our shareholders. Unless they resign before the endof their term or are removed in accordance with our Articles of Association,all our directors other than our outside directors will serve as directorsuntil our next annual general meeting of shareholders.  

 

Dr. Orna Berry and Mr. David Schlachet serve asoutside directors pursuant to the provisions of the Israeli Companies Law,5759-1999 (the "Companies Law") for a three-year term ending in June 2004.After this date, their term of service may be renewed for one additionalthree-year term. None of our directors or officers has any family relationshipswith any other director or officer.

 

None of our directors is entitled to receive anyseverance or similar benefits upon termination of his or her service, exceptDr. Mor Amitai who is entitled to severance as an employee, pursuant to theterms of his employment agreement.  

 

Our Articles of Association permit us to holdofficers' liability insurance and to indemnify our officers for actionsperformed on our behalf, subject to specified limitations.  
**____(44)____ 

 

***Alternate Directors***

** **

Our Articles of Association provide that a directormay appoint, by written notice to us, any individual to serve as an alternatedirector, provided that the director is not currently serving as a director oras an alternate director. An alternate director will have the right to be paid,as well as all of the rights and obligations of the director appointing him or her,except the power to appoint an alternate, unless the instrument appointing himor her provides otherwise. The alternate director may not act at any meeting atwhich the director appointing him or her is present. Unless the time period orscope of any appointment is limited by the appointing director, the appointmentis effective for all purposes, but will expire upon the expiration of theappointing director's term.

 

***Outside and Independent Directors***

** **

The Israeli Companies Lawrequires Israeli companies with shares that have been offered to the public inor outside of Israel to appoint two outside directors. No person may beappointed as an outside director if the person or the person's relative,partner, employer or any entity under the person's control, has or had, on orwithin the two years preceding the date of the person's appointment to serve asoutside director, any affiliation with the company or any entity controlling,controlled by or under common control with the company. The term affiliation includes:
- an employment relationship; 
- a business or professional relationship     maintained on a regular basis;
- control; and 
- service as an office holder. 

 

No person may serve as an outside director if theperson's position or business activities create, or may create, a conflict ofinterest with that person's responsibilities as an outside director or mayotherwise interfere with his/her ability to serve as an outside director. If,at the time outside directors are to be appointed, all current members of the boardof directors are of the same gender, then at least one outside director must beof the other gender.

 

Outside directors are to beelected by a majority vote at a shareholders' meeting, provided that either:
- the majority of shares voted at the meeting,     including at least one-third of the shares held by non-controlling     shareholders voted at the meeting, vote in favor of election of the     director; abstaining votes shall not be counted in this vote, or
- the total number of shares held by non-controlling     shareholders voted against the election of the director does not exceed     one percent of the aggregate voting rights in the company.

 

The initial term of an outside director is threeyears and may be extended for an additional three years term. Outside directorsmay be removed only by the same percentage of shareholders as is required fortheir election, or by a court, and then only if the outside directors cease tomeet the statutory qualifications for their appointment or if they violatetheir duty of loyalty to the company. Each committee of a company's board ofdirectors must include at least one outside director.

 

An outside director is entitled to compensation asprovided in regulations adopted under the Israeli Companies Law and isotherwise prohibited from receiving any other compensation, directly orindirectly, in connection with service provided as an outside director.

 

In addition, the Nasdaq National Market requires usto have at least two independent directors on our board of directors and toestablish an audit committee, at least a majority of whose members areindependent of management. 

 

Dr. Orna Berry and David Schlachet currently serveas our outside directors under Israeli law and as our independent directorsunder Nasdaq requirements.  They both serve on our audit committee.
*****____(45)____ 

*** ***

***Audit Committee***

** **

The Companies Law requires public companies toappoint an audit committee. The responsibilities of the audit committee includeidentifying irregularities in the management of the company's business and approvingrelated party transactions as required by law. An audit committee must consistof at least three directors, including all of its outside directors. Thechairman of the board of directors, any director employed by or otherwiseproviding services to the company, and a controlling shareholder or anyrelative of a controlling shareholder, may not be a member of the auditcommittee. An audit committee may not approve an action or a transaction with acontrolling shareholder, or with an office holder, unless at the time ofapproval two outside directors are serving as members of the audit committeeand at least one of the outside directors was present at the meeting in whichan approval was granted.

 

Our audit committee is currently comprised of Dr.Orna Berry, David Schlachet and Rimon Ben-Shaul.  Rimon Ben-Shaulserves as the Chairman of our Audit Committee.

** **

***Internal Auditor***

** **

Under the Companies Law, the board of directorsmust appoint an internal auditor, nominated by the audit committee. The role ofthe internal auditor is to examine, among other matters, whether the company'sactions comply with the law and orderly business procedure. Under the CompaniesLaw, the internal auditor may be an employee of the company but not an officeholder (as defined above), or an affiliate, or a relative of an office holderor affiliate, and he or she may not be the company's independent accountant orits representative.  

 

***Scientific Advisory Board***

** **

Our scientific advisory board meets once or twiceannually, and we consult with its individual members regularly. At itsmeetings, we review our primary ongoing and planned projects, and the advisoryboard recommends which projects to pursue and in what priority. Our scientificadvisory board currently includes: 

*** ***

**Name**

**Affiliation**

Richard Durbin, Ph.D.

Head of Informatics, Deputy Director of the  Wellcome Trust Sanger Institute, UK

 

 

C. Ronald Kahn, M.D.

President and Director, Joslin Diabetes Center; 

Mary K. Iacocca Professor, Harvard Medical School, Boston,  MA, USA  

 

 

 

Joseph Schlessinger, Ph.D.

William H. Prusoff Professor and Chairman of the  Department of Pharmacology of the Yale University School of Medicine; Member,  National Academy of Sciences, USA

 

 

 

Arthur Weiss, M.D., Ph.D.   

Ephraim P. Engleman Distinguished Professor of  Rheumatology; Investigator, Howard Hughes Medical Institute, University of California,  San Francisco, CA, USA

 

 

 
**____(46)____ 

 

**Employees**

** **

The following table sets forth for the last threefiscal years, the number of our employees engaged in the specified activities,by geographic location. 

 

**Year Ended December 31,**

**2002**

**2001**

**2000**

Research and Development and  Engineering

  Israel

  U.S.

  United Kingdom

 

109

15

1

 

108

17

-

  105    15

-

Administration, Accounting and Operations

  Israel

  U.S.

 

23

3

 

22

4

 

21

2

Sales, Marketing, Business Development and Support 

  Israel

  U.S.

  United Kingdom

 

 

8

9

2

 

 

12

13

-

 

 

17

8

-

 

Total 

 

170

 

176

 

168

** **

We and our Israeli employees are subject toprovisions of the collective bargaining agreements between the Histadrut, theGeneral Federation of Labor in Israel and the Coordination Bureau of EconomicOrganizations, including the Industrialists Associations, by order of theIsraeli Ministry of Labor and Welfare. These provisions principally concerncost of living increases, recreation pay and other conditions of employment. Weprovide our employees with benefits and working conditions equal to or abovethe required minimum. Our employees are not represented by a labor union. Wehave written employment contracts with our employees and we believe that ourrelations with our employees are good. 

 

**Share Ownership**

 

***Share Ownership by Directors and Senior Management***

*** ***

All of the persons listed above under the caption"Directors and Senior Management" own ordinary shares and/or options topurchase ordinary shares. Except as set forth below, none of the directors orexecutive officers owns shares and/or options amounting to 1% or more of theoutstanding ordinary shares. 

 

The following table sets forth certain informationas of April 30, 2003, regarding the beneficial ownership by our directors andexecutive officers.  

*** ***

**Beneficial Owner**

**Amount Owned (**)**

**Percent of Class**

Martin S. Gerstel(1)

1,669,888

6.4%

Mor Amitai, Ph.D.(2)

700,778

2.7%

David Haselkorn, Ph.D. (3)

3,064,754

11.7%

Rimon Ben  Shaul (4)

799,226

3.1%

Orna Berry,  Ph.D*

 

 

David  Schlachet*

 

 

Erez  Chimovits*

 

 

Nurit  Benjamini*

 

 

Michal  Preminger, Ph.D.*

 

 

Kinneret  Savitsky, Ph.D.*

 

 

Dror Ofer,  Ph.D.*

 

 

Dorit Bitter*

 

 

Directors and senior management as a group 

6,681,728

25.5%

*** ***

(1)         Includes 550,000shares held by Shomar Corporation, an affiliate of Mr. Gerstel, and 1,119,888shares held by Merrill Lynch IRA for Martin Gerstel, of which Martin Gerstel isthe beneficiary.  Based on information provided by Mr. Martin Gerstelon March 17, 2003.******
*****____(47)____ 

*** ***

(2)         Includes optionsto purchase 690,078 shares that are exercisable within 60 days of April 30, 2003. 

 

(3)         Ownership consistsof options to purchase 15,915 that are exercisable within 60 days of April 30, 2003, 4,091 shares held by Clal Industries & Investments Ltd., and 3,041,748shares held by Clal Biotechnology Industries, both affiliates of Dr. Haselkorn.Dr. Haselkorn`s address is c/o Clal Biotechnology Industries Ltd., 3 Azrieli Center,Tel Aviv 67023, Israel.

 

(4)         Ownership consistsof options to purchase 10,641 shares that are exercisable within 60 days of April 30, 2003 and 788,585 shares held by Koonras Technologies Ltd., an affiliate of Mr.Ben Shaul. Mr. Ben Shaul`s address is 21 Ha`arba`ah Street, Tel Aviv 64739, Israel.

 

(*)         Beneficially ownsless than 1% of the Company`s share capital.

 

(**)     All numbers quotedin the table above are inclusive of options to purchase shares, that areexercisable within 60 days of April 30, 2003.

 

***Share Option Plans***

** **

We maintain the following share option plans forour and our subsidiaries' employees, directors and consultants. In addition tothe discussion below, see Note 12 to our Consolidated Financial Statements.

*** ***

Our board of directors administers our share optionplans and has the authority to designate all terms of the options granted underour plans including the grantees, exercise prices, grant dates, vestingschedules and expiration dates, which may be no more than ten years after thegrant date. Options may not be granted with an exercise price of less than thefair market value of our ordinary shares on the date of grant, unless otherwisedetermined by our board of directors.

 

*Compugen Ltd. Employee Share Option Plan (1996)*

* *

We have granted options to purchase up to 559,750ordinary shares to our employees and consultants under the Compugen Ltd.Employee Share Option Plan (1996). As of April 30, 2003, options to purchase 398,500 ordinary shares, granted at a weighted average exercise price ofapproximately $1.87 per share, remained outstanding under the plan. Of theseoptions, 344,250 were held by the directors and officers listed under"Directors and Senior Management" above. These options expire tenyears after the date of grant or four weeks after termination of a grantee`semployment or other relationship with us without cause. If we terminate thegrantee for cause, the options expire immediately. We do not intend to grantadditional options under this plan.

 

*Compugen Share Option Plan (1998)*

* *

Under the Compugen Share Option Plan (1998), wehave granted options to purchase up to 2,289,250 ordinary shares to employees,directors and consultants of Compugen and its subsidiaries. As of April 30, 2003, options to purchase 1, 235,273 ordinary shares were outstanding under theplan at a weighted average exercise price of approximately $2.05 per share.Options to purchase 637,758 ordinary shares under the plan have previously beenexercised at an exercise price of approximately $1.40, and options to purchase626,969 ordinary shares remain available for future grant. If a grantee leaveshis or her employment or other relationship with us, his or her unexercisedvested options expire 90 days later. 

 

*Compugen Share Option Plan (2000)*

* *

Under the Compugen Share Option Plan (2000), we maygrant options for up to an aggregate of 4,727,688 ordinary shares to our andour subsidiaries' employees, directors and consultants. This total numberautomatically increases every January 1 by the lesser of 1,500,000 shares or 4%of the total number of our then-outstanding shares, or such lower amount asshall be determined by the board of directors. If a grantee leaves his or heremployment or other relationship with us, or if his or her relationship with usis terminated without cause, his or her unexercised options will expire 90 dayslater. As of April 30, 2003, options to purchase 2,993,654 ordinary shares wereoutstanding under the plan at a weighted average exercise price ofapproximately $4.48 per share. 
**____(48)____ 

Options to purchase 5,592 ordinary shares under theplan have previously been exercised at an exercise price of approximately$3.51, and options to purchase 1,728,442 ordinary shares remain available forfuture grant. In 2003, the terms of this plan have been modified slightly toallow for changes in the Israeli tax law.

 

Pursuant to the Tax Reform (See Item 10. AdditionalInformation. Taxation. Israeli Tax Considerations. Tax Reform) and in order tocomply with the provisions of Section 102 of the Income Tax Ordinance (AmendmentNo. 132), 5762-2002 (the "Ordinance"), on February 4, 2003 our board ofdirectors adopted an addendum to our share option plan with respect to optionsgranted as of January 1, 2003 to grantees who are residents of Israel (the"Addendum"). The Addendum does not add to nor modify our share option plan inrespect of grantees that are not residents of Israel.

 

On February 4, 2003the board of directors further resolved to elect the "Capital Gains Route" (as defined in Section 102(b)(2) of theOrdinance) for the grant of options to Israeli grantees. Generally, subject tothe fulfillment of the provisions of Section 102 of the Ordinance, under the Capital Gains Route gains realized from the sale of sharesissued upon exercise of options shall be taxed at a rate of 25% and not at themarginal income tax rate applicable to the grantee. The company will not beentitled to a tax deduction in an amount equal to the capital gain realized bythe grantee. Neither the company, not the grantee will be liable for any socialtaxes upon the sale of such shares.

 

*Non-Plan Options*

* *

In 1996, we granted options to purchase a total of249,250 ordinary shares to three of our employees. 133,847 of these optionswere forfeited without being exercised in November 1999. In addition, 54,663 ofthese options have been exercised to date. The terms of these options are thesame as those granted under the Compugen Share Option Plan (1998). 

 

*Directors` Options*

* *

Prior to our initial public offering, we adopted aplan to grant options to our directors, effective as of the closing of ourinitial public offering. Pursuant to such plan, effective as of the closing ofour initial public offering, we granted options to purchase 20,000 ordinaryshares at an exercise price of $10.00 per share to each of our directors(serving on our board on the date of the closing of our initial publicoffering) who were not employees or consultants. Of these options, options topurchase 1,250 ordinary shares vest at the end of every three-month periodfollowing the date of grant. Pursuant to this plan, we also grant each newnon-employee director options to purchase 20,000 ordinary shares at the time heor she becomes a director. Of these options, options to purchase 5,000 ordinaryshares vest on the first anniversary of the grant date, and options to purchase1,250 ordinary shares vest at the end of every three-month period afterwards.In addition, pursuant to the plan, we grant each director options to purchasean additional 5,000 ordinary shares on each anniversary of the initial date ofgrant of options to such director. Of these options, options to purchase 1,250ordinary shares vest at the end of every three-month period during the fourthyear after the date of grant. All of the options described above have been andwill be granted under, and subject to, the terms of share option plans ofCompugen in effect on the date of the grant of the option. 

 

On September 3, 2002 our shareholders approved thefollowing grants to Dr. David Haselkorn: (i) the grant of options to purchase2,000 ordinary shares, and (ii) upon each anniversary of said grant, the grantof additional options to purchase 2,000 ordinary shares, subject to Dr.Haselkorn`s continued provision of service to Compugen. The options shall vestover a four-year period. The exercise price of the first 2,000 options is $1.38per share. The exercise price for the other options shall be equal to the fairmarket value of Compugen`s shares on the date of each grant.

 

On September 3, 2002 our shareholders approved thefollowing grants to our Board members: (i) each audit committee member shall beentitled to an annual grant of options to purchase 2,000 ordinary shares, (ii)each executive committee member shall be entitled to an annual grant of optionsto purchase 2,000 ordinary shares, and (iii) in addition to the previousgrants, the chairmen of the Audit Committee and the Executive Committeerespectively, shall each be granted additional options to purchase 2,000ordinary shares, each year. All of these options shall vest over a four-yearperiod. As of April 30, 2003, 8,000 of these options have been granted to ourdirectors, at an exercise price of $1.38 per share. The rest of these optionsshall be granted at the exercise price equal to the fair market value of Compugen`sshares, at the time of grant.
**____(49)____ 

 

**ITEM 7.   MAJOR SHAREHOLDERS AND RELATED PARTYTRANSACTIONS**

** **

**Major Shareholders**

** **

The following table sets forth certain informationregarding beneficial ownership of our ordinary shares as of April 30, 2003 by each person who is known by us to own beneficially more than 5% of our outstandingordinary shares. The voting rights of our major shareholders do not differ fromthe voting rights of other holders of our ordinary shares. 

** **

** **

**Beneficial Owner**

**Number of Ordinary Shares**

**Beneficially Owned**

**Percent of Ownership**

Martin Gerstel (1)

1,669,888

6.4%

David Haselkorn Ph.D.(2)

3,064,754

11.7%

Clal Biotechnology Industries Ltd.(3)

3,041,748

11.6%

Apax (OCS) Nominees Limited

1,384,615

5.3%

 

  (1)       Includes 550,000shares held by Shomar Corporation, an affiliate of Mr. Gerstel, and 1,119,888shares held by Merrill Lynch IRA for Martin Gerstel, of which Martin Gerstel isthe beneficiary. Based on information provided by Mr. Martin Gerstel on March 17, 2003.******

(2)         Ownership consistsof options to purchase 15,915 that are exercisable within 60 days of April 30, 2003, 4,091 shares held by Clal Industries & Investments Ltd. and 3,041,748shares held by Clal Biotechnology Industries, both affiliates of Dr. Haselkorn.Dr. Haselkorn's address is c/o Clal Biotechnology Industries Ltd., 3 Azrieli Center,Tel Aviv 67023, Israel. 

 

(3)         The address ofClal Biotechnology Industries Ltd. is 3 Azrieli Center, Tel Aviv 67023, Israel.David Haselkorn, Ph.D. the member of our board of directors who is affiliatedwith Clal Biotechnologies Industries Ltd., may be deemed to be the naturalperson with voting or investment control over the shares held by this entity.

 

As of April 30, 2003, there were a total of 156holders of record of our ordinary shares, of which 84 were registered withaddresses in the United States. Such United States holders were, as of suchdate, the holders of record of approximately 75.326% of the outstandingordinary shares.  ****

** **

**Related Party Transactions**

** **

It is our policy to enter into transactions withrelated parties on terms that, on the whole, are no less favorable than thosethat would be available from unaffiliated parties. Based on our experience inthe business segments in which we operate and the terms of our transactionswith unaffiliated third parties, we believe that all of the transactionsdescribed below met our policy standards at the time they occurred.

*** ***

***Evogene Ltd.***

 

In October 1999, we formed a division focusing onagricultural biotechnology and plant genomics. On January 1, 2002, we spun-off the business of this division into a majority-owned subsidiary, Evogene Ltd. inwhich Compugen holds 1,640,000 ordinary shares, representing 82% of Evogene`soutstanding share capital. On January 6, 2003, a group of investors, led byMartin Gerstel, the Chairman of our board of directors, extended to EvogeneLtd. a loan, convertible into equity, in the amount of $2,000,000.******Compugendid not participate in this financing round. In connection with thisconvertible loan, Compugen agreed to (1) forgo the entire loan that it extendedto Evogene upon Evogene`s incorporation, in the amount of $900,000 plus allaccrued interest, and (2) extend until December 31, 2005 the term of thelicense to use Compugen`s computational tools free of charge, that was grantedto Evogene upon Evogene`s incorporation. Additionally, in connection with theconvertible loan, Compugen (and the founders of Evogene) agreed to grant to thelenders a proxy to vote fifty percent (50%) of their shares in Evogene.Compugen also waived, in connection with the convertible loan, its right toappoint the majority of the directors in Evogene, and it now has the right toappoint only two out of the six directors in Evogene. The convertible loan wasextended by new lenders after Compugen determined that it does not wish toinvest additional capital or resources in Evogene, as Evogene`s business isoutside the scope of Compugen`s strategic focus of developing technologies inthe field of human health. 
**____(50)____ 

 

***Private Placement of Series C Preferred Shares***

* *

We issued 5,538,462 Series C preferred shares onJuly 17, 2000 at a purchase price of $6.50 per share, to Apax Partners &Co., Pequot Private Equity Fund II, L.P., Clal Biotechnology Industries Ltd.,Evergreen Canada - Israel Management and certain of its affiliates, and IsraelGrowth Fund L.P. and certain of its affiliates, some of which were shareholdersof Compugen at the time of issuance. Upon the closing of the initial publicoffering of our ordinary shares, each Series C preferred share was convertedinto one ordinary share and all preferred rights granted to the series Cpreferred share holders expired, except the registration rights describedbelow. 

** **

***Registration Rights***

* *

Under the terms of the Investor Rights Agreement,the holders of registration rights are entitled to request that we effect theregistration of their Compugen ordinary shares under the Securities Act.  Atthe request of any holder of demand registration rights, we must use our bestefforts to register at least 20% of the shares held by that holder if they arenot freely tradable under the Securities Act. These demand rights may beexercised at least six months following any other registration of our shares.Certain groups of shareholders may only make one demand for us to registershares. Other of our shareholders and a warrant holder will have the right toinclude their shares in these registrations, subject to specified limitations.  

 

At any time when we are eligible to registersecurities on Form F-3, subject to specified exceptions, the holders ofregistration rights will have the right to request that we register theirordinary shares that are not freely tradable under the Securities Act. Theminimum aggregate offering price of the securities to be registered is at least$500,000.

 

The holders of registration rights will also havethe right to include their shares in any registration statements filed by usfor purposes of a public offering, subject to specified limitations. Anunderwriter participating in an offering may limit the number of shares offeredfor marketing reasons, in which case the number of shares to be registeredwould be reduced pro rata among the holders requesting registration of theirshares.

 

We will pay all expenses in connection with anyregistration, other than underwriting fees or discounts. These registrationrights are transferable under specified circumstances and may be amended orwaived only with our written consent and a specified number of the affectedholders. 

 

***Consulting Agreement with Shomar Corporation***

* *

In October 1998, we entered into a two-yearconsulting agreement with Shomar Corporation, a company controlled by Martin S.Gerstel, our active Chairman of the Board of Directors. The agreement renewsautomatically each year unless terminated by either party. Under the agreement,as amended, Mr. Gerstel provides consulting services to us and is required todevote at least 50% of his business time to us. As compensation for hisservices under this agreement, we pay Shomar Corporation an annual consultingfee of $150,000, plus reimbursement of Mr. Gerstel's reasonable out-of-pocketexpenses. The agreement includes non-disclosure and non-competition obligationsin our favor. In February 1999, our shareholders ratified our board's decisionsto grant Shomar options to purchase an aggregate of 500,000 of our ordinaryshares at a price of $1.35 per share. All of these options have been exercised.In August 2001, our shareholders ratified our board`s decision to pay ShomarCorporation a year-end bonus of $15,000 for the year ended December 31, 2000. On  April 29, 2003 our Board of Directors adopted a proposal, under which Shomarwill waive the annual consulting fees of $150,000 for the years 2003 - 2006,and Compugen will grant to Shomar Corporation options to purchase 250,000ordinary shares of the Company, under the terms of our 2000 Option Plan. Thisproposal must be approved by our shareholders. Except for the aforesaidremuneration and for remuneration that all of our non-employee directorsreceive (which is the maximum amount payable to external directors inaccordance with the Companies Law), Mr. Gerstel does not receive any othercompensation for his services to us.
**____(51)____ 

**ITEM 8.                   FINANCIAL INFORMATION**

 

**Consolidated Statements and Other Financial Information**

** **

Our consolidated financial statements areincorporated herein by reference to pages F-1 through F-28.  

 

***Legal Proceedings***

*** ***

Currently, we are not a party to any materialpending legal proceedings. Except for the three sets of correspondence notedbelow, there are no legal proceedings pending or, to our knowledge threatenedagainst us or our subsidiaries and we are not involved in any legal proceedingsthat our management believes, individually or in the aggregate, would have a materialadverse effect on our business, financial conditions or operating results. 

** **

On March 10, 2002, we received a letter on behalfof Microsoft Corporation in which Microsoft claimed that our use of thetrademark "Gencarta" infringes its rights in the trademark "Encarta". We agreedwith Microsoft to resolve its claim by phasing out use of references to"Gencarta" and replacing these with references to "Genecarta".

** **

On December 26, 2002, we received a letter fromOxford Gene Technology IP Ltd. ("OGT"), a company which has represented that itowns a number of patents in the microarray field. OGT enquired whether ouractivities in making and selling our OligoLibraries product infringes any ofthe OGT patents.  We are not in the business of making or sellingmicroarrays. Our OligoLibraries may be used for the purpose of makingmicroarrays, amongst a range of other things. By a letter dated March 12, 2003 from OGT to us, OGT acknowledged that we are not in the business ofmanufacturing microarrays, and queried whether we offer products or servicesthat could comprise components of OGT`s patented inventions. Compugen continuesto assess the merits of OGT`s claims. The parties are now corresponding for thepurpose of identifying whether the Company manufactures or sells any productswhich is of concern to OGT.   

** **

On February 24, 2003, we received a letter onbehalf of the Carnegie Institution of Washington, ("Carnegie"), which claims toown a patent regarding certain RNAi technology. Carnegie is enquiring whetherthe Company may require a license from it  in relation thereto. 

** **

If Microsoft and/or OGT and/or Carnegie were toinstitute litigation against us, the cost of such litigation, if instituted,could be substantial whether or not the Company prevails.

 

***Dividend Distributions***

*** ***

We have never paid any cash dividends on ourordinary shares and we do not intend to pay cash dividends on our ordinaryshares in the foreseeable future. Our current policy is to retain earnings foruse in our business.

 

In the event that we decide to pay a cash dividendfrom income that is tax exempt under our approved enterprise status, we wouldbe liable for corporate tax on the amount distributed at the rate of up to 25%.See Note 15 to our Consolidated Financial Statements and "Item 10.Taxation". Cash dividends may be paid by an Israeli company only out ofretained earnings as calculated under Israeli law.

 

**Significant Changes**

 

No significant changes have occurred since the dateof the consolidated financial statements included in this annual report 
**____(52)____ 

** **

**ITEM 9.                   THE OFFER AND LISTING**

 

*Markets and Share Price History*

 

The primary trading market for our ordinary sharesis the Nasdaq National Market, where our shares have been listed and traded onthe under the symbol "CGEN" since our initial public offering in August, 2000.Our shares have also been traded on the Tel Aviv Stock Market under the symbol"CGEN" since January 7, 2002.  The following table setsforth, for the periods indicated, the high and low reported sales prices of theordinary shares on the Nasdaq National Market and on the Tel Aviv StockExchange: 

 

** **

**Nasdaq**

**TASE**

**Last Six Calendar Months**

**High**

**Low**

**High**

**Low**

May 2003

$4.620

$2.450

$4.539

$2.452

April 2003

$2.660

$1.750

$2.702

$1.866

March 2003

$2.100

$1.500

$1.894

$1.506

February 2003

$2.060

$1.550

$2.258

$1.790

January 2003

$2.490

$1.690

$2.629

$1.632

December 2002

$2.250

$1.340

$2.197

$1.341

 

 

 

 

 

**Financial Quarters During the Past Two Years**

 

 

 

 

First Quarter 2003

$2.490

$1.500

$2.629

$1.506

Fourth Quarter 2002

$2.250

$0.910

$2.197

$0.894

Third Quarter 2002

$2.260

$1.000

$2.268

$1.129

Second Quarter 2002

$3.730

$1.810

$4.160

$1.947

First Quarter 2002

$5.240

$3.130

$6.335

$3.212

Fourth Quarter 2001

$4.950

$2.600

--

--

Third Quarter 2001

$4.700

$2.760

--

--

 

 

 

 

 

**Full Financial Years During the Past Five Years**

 

 

 

 

2002

$5.240

$0.910

$6.335

$0.894

2001

$8.625

$2.600

--

--

2000 commencing August 11, 2000

$19.500

$5.063

--

--

 
**____(53)____ 

 

**ITEM 10.               ADDITIONAL INFORMATION**

 

**Memorandum and Articles of Association**

** **

***Objects and Purposes of the Company***

** **

We are registered under the Israel Companies Law asa public company with the name Compugen Ltd. and registration number51-177-963-9. The objective stated in our articles of association is to engagein any lawful activity. 

** **

***Powers of the Directors***

** **

Pursuant to the Companies Law and our articles ofassociation, a director is not permitted to vote on a proposal, arrangement orcontract in which he or she has a personal interest. Also, the directors maynot vote compensation to themselves or any members of their body without theapproval of our audit committee and our shareholders at a general meeting.  Therequirements for approval of certain transactions are set forth above in "Item6. Directors, Senior Management and Employees; Directors and Senior Management;Approval of Certain Transactions". The powers of our directors to enter intoborrowing arrangements on our behalf is limited to the same extent as any othertransaction by us. 

** **

***Approval of Certain Transactions***

 

The Companies Law codifies the fiduciary dutiesthat office holders, including directors and executive officers, owe to acompany. An office holder, as defined in the Companies Law, is a director,general manager, chief business manager, deputy general manager, vice generalmanager, executive vice president, vice president, other manager directlysubordinate to the managing director or any other person assuming theresponsibilities of any of the foregoing positions without regard to suchperson's title. An office holder's fiduciary duties consist of a duty of careand a duty of loyalty. The duty of loyalty includes avoiding any conflict ofinterest between the office holder's position in the company and his personalaffairs, avoiding any competition with the company, avoiding exploiting anybusiness opportunity of the company in order to receive personal advantage forhimself or others, and revealing to the company any information or documentsrelating to the company's affairs which the office holder has received due to hisposition as an office holder. Each person listed in the table under"Directors and Senior Management" above is an office holder ofCompugen. Under the Companies Law, all arrangements as to compensation ofoffice holders who are not directors require approval of the board ofdirectors, or a committee thereof. Arrangements regarding the compensation ofdirectors also require audit committee and shareholders approval, with theexception of compensation to outside directors in the amounts specified in the regulationsdiscussed above.

 

The Companies Law requires that an office holderpromptly discloses any personal interest that he or she may have and allrelated material information known to him or her, in connection with anyexisting or proposed transaction by the company. The disclosure must be made toour board of directors or shareholders prior to the meeting at which thetransaction is to be discussed. In addition, if the transaction is anextraordinary transaction, as defined under the Companies law, the officeholder must also disclose any personal interest held by the office holder'sspouse, siblings, parents, grandparents, descendants, spouse's descendants andthe spouses of any of the foregoing, or by any corporation in which the officeholder is a five percent (5%) or greater shareholder, or holder of 5% or moreof the voting power, director or general manager or in which he or she has theright to appoint at least one director or the general manager. An extraordinarytransaction is defined as a transaction not in the ordinary course of business,not on market terms, or that is likely to have a material impact on thecompany's profitability, assets or liabilities.

 

In the case of a transaction which is not anextraordinary transaction, after the office holder complies with the abovedisclosure requirement, only board approval is required unless the Articles ofAssociation of the company provides otherwise. The transaction must not beadverse to the company's interest. If the transaction is an extraordinarytransaction, then, in addition to any approval required by the Articles ofAssociation, the transaction must also be approved by the audit committee andby the board of directors, and under specified circumstances, by a meeting ofthe shareholders. An office holder who has a personal interest in a matter thatis considered at a meeting of the board of directors or the audit committee maynot be present at this meeting or vote on this matter.
**____(54)____ 

 

The Companies Law applies the same disclosurerequirements to a controlling shareholder of a public company, which is definedas a shareholder who has the ability to direct the activities of a company,other than in circumstances where this power derives solely from theshareholder`s position on the Board or any other position with the company, andincludes a shareholder that holds 25% or more of the voting rights if no othershareholder owns more than 50% of the voting rights in the company.Extraordinary transactions with a controlling shareholder or in which a controllingshareholder has a personal interest, and the terms of compensation of acontrolling shareholder who is an office holder, require the approval of theaudit committee, the board of directors and the shareholders of the company.

 

The shareholder approval must either include atleast one-third of the disinterested shareholders who are present, in person orby proxy, at the meeting, or, alternatively, the total shareholdings of thedisinterested shareholders who vote against the transaction must not representmore than one percent of the voting rights in the company.

 

In addition, a private placement of securities thatwill increase the relative holdings of a shareholder that holds five percent ormore of the company`s outstanding share capital, assuming the exercise by suchperson of all of the convertible securities into shares held by that person, orthat will cause any person to become a holder of more than five percent of thecompany`s outstanding share capital, requires approval by the board of directorsand the shareholders of the company.  However, subject to certainexceptions, shareholder approval will not be required if the aggregate numberof shares issued pursuant to such private placement, assuming the exercise ofall of the convertible securities into shares being sold in such a privateplacement, comprises less than twenty percent of the voting rights in a companyprior to the consummation of the private placement.

 

Under the Companies Law, ashareholder has a duty to act in good faith towards the company and othershareholders and refrain from abusing his power in the company, including,among other things, voting in the general meeting of shareholders on thefollowing matters:

.  any amendment to the Articles of Association; 

.  an increase of the company's authorized share capital; 

.  a merger; or 

.   approval ofinterested party transactions that require shareholder approval.

 

In addition, any controlling shareholder, anyshareholder who knows it can determine the outcome of a shareholder vote and anyshareholder who, under a company's Articles of Association, can appoint orprevent the appointment of an office holder, is under a duty to act withfairness towards the company. The Companies Law does not describe the substanceof this duty. The Companies Law requires that specified types of transactions,actions and arrangements be approved as provided for in a company`s articles ofassociation and in some circumstances by the audit committee, by the board ofdirectors and by the shareholders. In general, the vote required by the auditcommittee and the board of directors for approval of these matters, in eachcase, is a majority of the disinterested directors participating in a dulyconvened meeting. 

 

For information concerning the direct and indirect personalinterests of some of our office holders and principal shareholders intransactions with us, see "Item 7. Major Shareholders and Related PartyTransactions."

** **

***Rights Attached to Ordinary Shares***

** **

Our authorized share capital consists of 50,000,000ordinary shares, par value NIS 0.01 per share.  Holders of ordinaryshares have one vote per share, and are entitled to participate equally in thepayment of dividends and share distributions and, in the event of ourliquidation, in the distribution of assets after satisfaction of liabilities tocreditors. No preferred shares are currently authorized. All outstandingordinary shares are validly issued and fully paid.

** **

***Transfer of Shares and Notices***

** **

Fully paid ordinary shares are issued in registeredform and may be freely transferred under our Articles of Association unless thetransfer is restricted or prohibited by another instrument. Our Articles ofAssociation provide that each shareholder of record is entitled to receive atleast 21 days' prior notice of any shareholders' meeting.
****____(55)____ 

** **

***Dividend and Liquidation Rights***

** **

We may declare a dividend to be paid to the holdersof ordinary shares according to their rights and interests in our profits. Inthe event of our liquidation, after satisfaction of liabilities to creditors,our assets will be distributed to the holders of ordinary shares in proportionto the nominal value of their holdings. This right may be affected by the grantof preferential dividend or distribution rights to the holders of a class of shareswith preferential rights that may be authorized in the future. Pursuant to Israel'ssecurities laws, a company registering its shares for trade on the TASE may nothave more than one class of shares for a period of one year followingregistration, after which it is permitted to issue preference shares. Under theCompanies Law, the declaration of a dividend does not require the approval ofthe shareholders of the company, unless the company's Articles of Associationrequire otherwise. Our Articles of Association provide that the board ofdirectors may declare and distribute dividends without the approval of theshareholders.

** **

***Annual and Extraordinary General Meetings***

*** ***

We must hold our annual general meeting ofshareholders each year no later than 15 months from the last annual meeting, ata time and place determined by the board of directors, upon at least 21 days`prior notice to our shareholders. A special meeting may be convened by requestof two directors or by written request of one or more shareholders holding atleast 5% of our issued share capital and 1% of the voting rights or one or moreshareholders holding at least 5% of the voting rights. Shareholders requestinga special meeting must submit their proposed resolution with their request.  Within21 days of receipt of the request, the Board must convene a special meeting andsend out notices setting forth the date, time and place of the meeting.  Suchnotice must be given at least 21 days but not more than 35 days prior to thespecial meeting.

*** ***

The quorum required for a meeting of shareholdersconsists of at least two shareholders present in person or by proxy who hold orrepresent between them at least 33.3% of the issued share capital. A meetingadjourned for lack of a quorum generally is adjourned to the same day in thefollowing week at the same time and place or any time and place as thedirectors designate in a notice to the shareholders. At the reconvened meeting,the required quorum consists of any two members present in person or by proxy.  

 

***Voting Rights***

* *

Our ordinary shares do not have cumulative votingrights in the election of directors. As a result, the holders of ordinaryshares that represent more than 50% of the voting power represented at ashareholders meeting have the power to elect all of our directors, except theoutside directors whose election requires a special majority as described underthe section entitled "Item 6. Directors, Senior Management and Employees;Board Practices; Outside and Independent Directors."

* *

Holders of ordinary shares have one vote for eachordinary share held on all matters submitted to a vote of shareholders.Shareholders may vote in person or by proxy. These voting rights may beaffected by the grant of any special voting rights to the holders of a class ofshares with preferential rights that may be authorized in the future. 

 

Under the Companies Law, unless otherwise providedin the Articles of Association or by applicable law, all resolutions of theshareholders require a simple majority and all shareholders' meetings requireprior notice of at least 21 days. Our Articles of Association provide that alldecisions may be made by a simple majority. See "Item 6. Directors, SeniorManagement and Employees; Directors and Senior Management; Approval of CertainTransactions" above for certain duties of shareholders towards the company.

 

***Limitations on the Rights to Own Securities***

** **

The ownership or voting of ordinary shares bynon-residents of Israel is not restricted in any way by our articles ofassociation or the laws of the State of Israel, except that nationals ofcountries which are, or have been, in a state of war with Israel may not berecognized as owners of ordinary shares.
**____(56)____ 

 

***Anti-Takeover Provisions under Israeli Law***

** **

The Companies Law providesthat an acquisition of shares in a public company must be made by means of atender offer if as a result of the acquisition the purchaser would becomeshareholder with over 25% of the voting rights in the company. This rule doesnot apply if there is already another shareholder of the company with 25% ormore of the voting rights. Similarly, the Companies Law provides that anacquisition of shares in a public company must be made by means of a tenderoffer if as a result of the acquisition the purchaser`s shareholdings wouldentitle the purchaser to over 45% of the voting rights in the company, unlessthere is a shareholder with 50% or more of the voting rights in the company.These rules do not apply if the acquisition is made by way of a merger.Regulations promulgated under the Companies Law provide that these tender offerrequirements do not apply to companies whose shares are listed for tradingoutside of Israel if, according to the law in the country in which the sharesare traded, including the rules and regulations of the stock exchange or whichthe shares are traded, either:
- there is a limitation on acquisition of any     level of control of the company; or
- the acquisition of any level of control requires the     purchaser to do so by means of a tender offer to the public.

 

****Finally, ingeneral, Israeli tax law treats specified acquisitions less favorably than does  U.S. tax law. However, Israeli tax law has recently been amended to providefor tax deferral in specified acquisitions, including transactions where theconsideration for the sale of shares is the receipt of shares of the acquiringcompany, making Israeli tax consequences more favorable than they had been inthe past for shareholders who exchange their ordinary shares for shares in aforeign corporation under certain circumstances.

 

**Material Contracts**

** **

***Convertible Loan Agreement in Evogene Ltd.***

 

In December 2002 Evogene Ltd., our majority-ownedsubsidiary, entered into a Convertible Loan Agreement with a group of lenders,pursuant to which these lenders lent US $2,000,000 to Evogene, at a pre-moneyvaluation of the company of US $2,000,000. For more information on thistransaction see Item 7. Major Shareholders and Related Party Transactions.Related Party Transactions. Evogene Ltd.

**Exchange Controls**

 

Under Israeli Law, Israeli non-residents whopurchase ordinary shares with certain non-Israeli currencies (includingdollars) may freely repatriate in such non-Israeli currencies all amountsreceived in Israeli currency in respect of the ordinary shares, whether as adividend, as a liquidating distribution, or as proceeds from any sale in Israelof the ordinary shares, provided in each case that any applicable Israeliincome tax is paid or withheld on such amounts. The conversion into thenon-Israeli currency must be made at the rate of exchange prevailing at thetime of conversion.  

 

**Taxation**

 

The following discussion of Israeli and United  States tax consequences material to our shareholders is not intended andshould not be construed as legal or professional tax advice and does notexhaust all possible tax considerations. To the extent that the discussion isbased on new tax legislation, which has not been subject to judicial oradministrative interpretation, the views expressed in the discussion might notbe accepted by the tax authorities in question.  

 

**We urge shareholders and prospective purchasersof our ordinary shares to consult their own tax advisors as to the U.S.,Israeli, or other tax consequences of the purchase, ownership and dispositionof ordinary shares, including, in particular, the effect of any foreign, stateor local taxes.**
***____(57)____ 

* *

***Israeli Tax Considerations***

 

The following discussion refers to the current taxlaw applicable to companies in Israel, with special reference to its effect onus. This discussion also includes specified Israeli tax consequences to holdersof our ordinary shares and Israeli Government programs benefiting us. To theextent that the discussion is based on new tax legislation that has not beensubject to judicial or administrative interpretation, we cannot assure you thatthe views expressed in the discussion will be accepted by the tax authoritiesin question.  The following discussion of Israeli tax considerationsis not intended and should not be construed as legal or professional tax adviceand does not exhaust all possible tax considerations.

*** ***

*Tax Reform*

 

On January 1, 2003 a comprehensive tax reform tookeffect in Israel. Pursuant to the reform, resident companies are subject toIsraeli tax on income accrued or derived in Israel or abroad. In addition, theconcept of controlled foreign corporation was introduced according to which anIsraeli company may become subject to Israeli taxes on certain income of anon-Israeli subsidiary if the subsidiaries primary source of income is passiveincome (such as interest, dividends, royalties, rental income or capitalgains). The tax reform also substantially changed the system of taxation ofcapital gains.

* *

*General Corporate Tax Structure*

* *

Israeli companies are generally subject to companytax at the rate of 36% of taxable income. However, the effective tax ratepayable by a company which derives income from an approved enterprise may beconsiderably less, as discussed further below.

 

*Tax Benefits Under the Law for the Encouragementof Capital Investments, 1959*

* *

The Law for the Encouragement of CapitalInvestment, 1959, as amended, commonly referred to as the Investment Law,provides that a proposed capital investment in eligible facilities may, uponapplication to the Investment Center of the Ministry of Industry and Trade ofthe State of Israel, be designated as an approved enterprise. Each certificateof approval for an approved enterprise relates to a specific investment programdelineated both by its financial scope, including its capital sources, and byits physical characteristics, for example, the equipment to be purchased andutilized under the program. The tax benefits derived from any certificate ofapproval relate only to taxable income attributable to the specific approved enterprise.If a company has more than one approval or only a portion of its capitalinvestments is approved, its effective tax rate is the result of a weightedaverage of the applicable rates.

 

Taxable income of a company derived from anapproved enterprise is subject to company tax at the maximum rate of 25%,rather than 36%, for the benefit period. This period is ordinarily seven years,or ten years if the company qualifies as a foreign investors' company asdescribed below, commencing with the year in which the approved enterprisefirst generates taxable income. However, this period is limited to 12 yearsfrom commencement of production or 14 years from the date of approval,whichever is earlier.

 

A company owning an approved enterprise may electto forego entitlement to grants otherwise available as a result of an approvedenterprise in return for an alternative package of benefits. Under thealternative package of benefits, a company's undistributed income derived froman approved enterprise will be exempt from company tax for a period of betweentwo and ten years from the first year of taxable income, depending on thegeographic location of the approved enterprise within Israel, and the companywill be eligible for a reduced tax rate for the remainder of the benefitsperiod.  

 

A company that has elected the alternative packageof benefits and that subsequently pays a dividend out of income derived fromthe approved enterprise during the tax exemption period will be subject to taxon the amount distributed, including any Company tax on these amounts, at therate which would have been applicable had it not elected the alternativepackage of benefits, generally 10%-25%, depending on the percentage of thecompany's shares held by foreign shareholders. The dividend recipient is taxedat the reduced rate applicable to dividends from approved enterprises, which is15%, if the dividend is distributed during the tax exemption period or within12 years after this period, or in the case of a foreign investors' company,without time limitation. The company must withhold this tax at source,regardless of whether the dividend is converted into or paid in foreigncurrency.
**____(58)____ 

 

A company that has an approved enterprise programis eligible for further tax benefits if it qualifies as a foreign investors'company. A foreign investors' company is a company more than 25% of whose sharecapital and combined share and loan capital is owned by non-Israeli residents.A company which qualifies as a foreign investors' company and has an approvedenterprise program is eligible for tax benefits for a ten-year benefit period.The company tax rate applicable to income earned from approved enterpriseprograms in the benefit period by a company meeting these qualifications is asfollows:

 

** **

**For a company with foreign investment of**

****

**Company Tax Rate**

Over 25% but less than 49%.................... 

25%

49% or more but less than 74%............... 

20%

74% or more but less than 90%............... 

15%

90% or more................................................ 

10%

 

Subject to applicable provisions concerning incomeunder the alternative package of benefits, all dividends are considered to beattributable to the entire enterprise and their effective tax rate is theresult of a weighted average of the various applicable tax rates. Under theInvestment Law, a company that has elected the alternative package of benefitsis not obliged to distribute exempt retained profits, and may generally decidefrom which year's profits to declare dividends. We currently intend to reinvestany income derived from our approved enterprise programs and not to distributethe income as a dividend.

 

The Investment Center bases its decision whether ornot to approve an application on the criteria set forth in the Investment Lawand regulations, the then prevailing policy of the Investment Center, and thespecific objectives and financial criteria of the applicant. Therefore, wecannot assure you that any applications we may make in the future will beapproved. In addition, the benefits available to an approved enterprise areconditioned upon the fulfillment of conditions stipulated in the Investment Lawand its regulations and in the criteria in the specific certificate ofapproval, as described above. If a company does not meet these conditions, itwould be required to refund the amount of tax benefits, together with consumerprice index linkage adjustment and interest.

 

The Investment Center has granted approvedenterprise status to three of our investment programs. Taxable income derivedfrom these programs will be tax exempt for a period of two years beginning withthe year in which we first generate taxable income, and thereafter will besubject to a reduced tax rate of 25% or less, if we qualify as a foreigninvestors' company, for a period of between five and eight years, depending onthe percentage of our capital held by non-Israeli shareholders. We havederived, and expect to continue to derive, a substantial portion of ourrevenues from our approved enterprise programs. To date, we have not generatedtaxable revenues, from our approved enterprise programs or otherwise.

 

Although the Law for the Encouragement of CapitalInvestment, 1959 provides that no new benefits may be granted after May 2003,we expect that this date could be extended, as has been the case in the past.There can be no assurances that new benefits will be available after May 2003.Since we have already been granted approved enterprise status under this Law,the deadline does not have any affect on such status or on the benefits wereceive.

 

*Tax Benefits for Research and Development*

* *

Israeli tax law allows,under specific conditions, a tax deduction in the year incurred forexpenditures, including capital expenditures, relating to scientific researchand development projects, if the expenditures are approved by the relevantIsraeli government ministry, determined by the field of research, and theresearch and development is for the promotion of the company and is carried outby or on behalf of the company seeking the deduction. Expenditures not soapproved are deductible over a three-year period. However, expenditures madeout of proceeds made available to us through government grants are notdeductible. 
**____(59)____ 

 

*Tax Benefits Under the Law for the Encouragementof Industry (Taxes), 1969*

* *

The Law for the Encouragement of Industry (Taxes),1969, generally referred to as the Industry Encouragement Law, provides severaltax benefits for industrial companies. An industrial company is defined as acompany resident in Israel, at least 90% of the income of which in a given taxyear exclusive of income from specified government loans, capital gains,interest and dividends, is derived from an industrial enterprise owned by it.An industrial enterprise is defined as an enterprise whose major activity in agiven tax year is industrial production activity.

 

Under the IndustryEncouragement Law, industrial companies are entitled to a number of corporatetax benefits, including:
- deduction of purchase of know-how and patents     over an eight-year period; 
- deduction of certain share issuance expenses     over a three-year period; and
- the right to elect, under specified conditions, to     file a consolidated tax return with additional related Israeli industrial     companies and an industrial holding company.

 

Under some tax laws and regulations, an industrialenterprise may be eligible for special depreciation rates for machinery,equipment and buildings. These rates differ based on various factors, includingthe date the operations begin and the number of work shifts. An industrialcompany owning an approved enterprise may choose between these specialdepreciation rates and the depreciation rates available to the approvedenterprise.

 

Eligibility for benefits under the IndustryEncouragement Law is not subject to receipt of prior approval from anygovernmental authority.

 

We believe that we currently qualify as anindustrial company within the definition of the Industry Encouragement Law. Wecannot assure you that we will qualify or, if we qualify, that we will continueto qualify as an industrial company or that the benefits described above willbe available to us in the future.

 

*Special Provisions Relating to Taxation underInflationary Conditions*

* *

The Income Tax Law(Inflationary Adjustments), 1985, generally referred to as the InflationaryAdjustments Law, represents an attempt to overcome the problems presented to atraditional tax system by an economy undergoing rapid inflation. TheInflationary Adjustments Law is highly complex. Its features which are materialto us can be described as follows:
- there is a special tax adjustment for the     preservation of equity which classifies corporate assets into fixed assets     and non-fixed assets. Where a company's equity, as defined in the law,     exceeds the depreciated cost of fixed assets, a deduction from taxable     income that takes into account the effect of the applicable annual rate of     inflation on the excess is allowed up to a ceiling of 70% of taxable     income in any single tax year, with the unused portion permitted to be     carried forward on a linked basis. If the depreciated cost of fixed assets     exceeds a company's equity, then the excess multiplied by the applicable     annual rate of inflation is added to taxable income.
- subject to specified limitations, depreciation     deductions on fixed assets and losses carried forward are adjusted for     inflation based on the increase in the consumer price index.
- in specified circumstances, gains on traded     securities, which might otherwise be eligible for reduced rates of tax,     will be liable to company tax at the rate of 36%. 

** **

*Capital Gains Tax on**Sale**of ourOrdinary Shares*

** **

Israeli law generally imposes a capital gains taxon the sale of capital assets located in Israel, including shares in Israeliresident companies, by both residents and non-residents of Israel, unless aspecific exemption is available or unless a treaty between Israel and thecountry of the non-resident provides otherwise. Regulations promulgated underthe Israeli Income Tax Ordinance provided for an exemption from Israeli capitalgains tax for gains accrued before January 1, 2003 and derived from the sale ofshares of an "Industrial Company", as defined by the Industry EncouragementLaw, that are traded on specified non-Israeli markets, including The NASDAQNational Market, provided that the sellers purchased their shares either in thecompany`s initial public offering or in public market transactions thereafter.
**____(60)____ 

This exemption does not apply to shareholders whoare in the business of trading securities, or to shareholders that are Israeliresident companies subject to the Income Tax (Adjustments for Inflation) Law-1985. The Company believes that it is currently an Industrial Company, asdefined by the Industry Encouragement Law. The status of a company as anIndustrial Company may be reviewed by the tax authorities from time to time.There can be no assurance that the Israeli tax authorities will not deny theCompany`s status as an Industrial Company, possibly with retroactive effect. 

 

On January 1, 2003, the Law for Amendment of theIncome Tax Ordinance (Amendment No.132), 5762-2002, known as the tax reform,came into effect thus imposing capital gains tax at a rate of 15% on gainsderived on or after January 1, 2003 from the sale of shares in Israelicompanies publicly traded on a recognized stock exchange outside of Israel.This tax rate does not apply to: (1) dealers in securities; (2) shareholdersthat report in accordance with the Income Tax Law (Inflationary Adjustment) -1985; or (3) shareholders who acquired their shares prior to an initial publicoffering. The tax basis of shares acquired prior to January 1, 2003 will be determined in accordance with the average closing share price in the three tradingdays preceding January 1, 2003. Non-Israeli residents shall be exempt fromIsraeli capital gains tax on any gains derived from the sale of shares publiclytraded on a stock exchange recognized by the Israeli Ministry of Finance,provided such shareholders did not acquire their shares prior to an initialpublic offering. In any event, the provisions of the tax reform shall notaffect the exemption from capital gains tax for gains accrued before January 1,2003, as described in the previous paragraph and capital gains in respect ofassets purchased prior to that date will be subject to a blended tax ratecalculated based on the relative time periods before and after January 1, 2003.This is not true with respect to traded securities, where post-2002 gains aremeasured based on the closing prices at the end of 2002.

 

In addition, pursuant to the Convention Between theGovernment of the United States of America and the Government of Israel withRespect to Taxes on Income, as amended (the "United States- Israel TaxTreaty"), the sale, exchange or disposition of ordinary shares by a person whoqualifies as a resident of the United States within the meaning of the UnitedStates-Israel Tax Treaty and who is entitled to claim the benefits afforded tosuch person by the United States- Israel Tax Treaty (a "Treaty United StatesResident") generally will not be subject to the Israeli capital gains tax unlesssuch "Treaty United States Resident" holds, directly or indirectly, sharesrepresenting 10% or more of the Company`s voting power during any part of thetwelve- month period preceding such sale, exchange or disposition, subject tocertain conditions. However, under the United States-Israel Tax Treaty, such"Treaty United States Resident" would be permitted to claim a credit for suchtaxes against the United States federal income tax imposed with respect to suchsale, exchange or disposition, subject to the limitations in United States lawsapplicable to foreign tax credits. The United States-Israel Tax Treaty does notrelate to United States state or local taxes. 

 

*Taxation of Non-Resident Holders of Shares*

* *

Non-residents of Israel are subject to income taxon income accrued or derived from sources in Israel. These sources of incomeinclude passive income, including dividends, royalties and interest, as well asnon-passive income from services rendered in Israel. On distribution ofdividends other than bonus shares or stock dividends, income tax is withheld atsource, at the rate of 25%, or 12.5% for dividends not generated by an approvedenterprise if the non-resident is a U.S. corporation and holds at least 10% ofour voting power, and 15% for dividends generated by an approved enterprise,unless in each case a different rate is provided in a treaty between Israel andshareholder's country of residence. Under the U.S.-Israel tax treaty, themaximum tax on dividends paid to a holder of ordinary shares who is a U.S.resident will be 25%. However, under the Investment Law, dividends generated byan approved enterprise are taxed at the rate of 15%.

*** ***

***United States******Federal Income TaxConsiderations***

** **

The following discusses thematerial United States federal income tax consequences to a holder of ourordinary shares and qualifies as a U.S. Holder, which is defined as:
- a citizen or resident of the United States; 
- a corporation created or organized under the     laws of the United States, the District of Columbia, or any state; or
- a trust or estate, treated, for United States federal     income tax purposes, as a domestic trust or estate.
**____(61)____ 

 

This opinion is based on current provisions of theInternal Revenue Code of 1986 (the "Code"), as amended, current and proposedTreasury regulations promulgated under the Code, and administrative andjudicial decisions as of the date of this prospectus, all of which are subjectto change, possibly on a retroactive basis. This opinion does not address anyaspect of state, local or non-United States tax laws.

 

Further, this opinion doesnot purport to be a comprehensive description of all of the tax considerationsthat may be relevant to U.S. Holders entitled to special treatment under UnitedStates federal income tax laws, for example, financial institutions, insurancecompanies, tax-exempt organizations and broker-dealers, and it does not addressall aspects of United States federal income taxation that may be relevant toany particular shareholder based on the shareholder's individual circumstances.In particular, this opinion does not address the potential application of thealternative minimum tax, nor the special United States federal income tax rulesapplicable in special circumstances, including to U.S. Holders who:
- have elected mark-to-market accounting; 
- hold our ordinary shares as part of a     straddle, hedge or conversion transaction with other investments;
- own directly, indirectly or by attribution at     least 10% of our voting power; and
- have a functional currency that is not the U.S. dollar.     

 

Additionally, this opinion does not consider thetax treatment of partnerships or persons who hold ordinary shares through apartnership or other pass-through entity or the possible application of United  States federal gift or estate taxes. Material aspects of United Statesfederal income tax relevant to a holder other than a U.S. Holder are alsodescribed below.

** **

***Taxation of Dividends Paid On Ordinary Shares***

* *

A U.S. Holder will be required to include in grossincome as ordinary income the amount of any distribution paid on ordinaryshares, including any Israeli taxes withheld from the amount paid, to theextent the distribution is paid out of our current or accumulated earnings andprofits as determined for United States federal income tax purposes. Distributionsin excess of these earnings and profits will be applied against and will reducethe U.S. Holder's basis in the ordinary shares and, to the extent in excess ofthis basis, will be treated as gain from the sale or exchange of ordinaryshares.

 

Recently enacted amendments to the Code, asamended, provide that dividend income may be eligible for a reduced rate oftaxation. Dividend income will be taxed at the applicable long-term capitalgains rate if the dividend is received from a "qualified foreigncorporation," and the shareholder of such foreign corporation holds suchstock for more than 60 days during the 120 day period that begins on the datethat is 60 days before the ex-dividend date for the stock. The holding periodis tolled for any days on which the shareholder has reduced his risk of loss. A"qualified foreign corporation" is one that is eligible for thebenefits of a comprehensive income tax treaty with the United States. A foreigncorporation will be treated as qualified with respect to any dividend paid, ifits stock is readily tradable on an established securities market. 

 

Distributions of current or accumulated earningsand profits paid in foreign currency to a U.S. Holder will be includible in theincome of a U.S. Holder in a U.S. dollar amount calculated by reference to theexchange rate on the day the distribution is received. A U.S. Holder thatreceives a foreign currency distribution and converts the foreign currency intoU.S. dollars subsequent to receipt will have foreign exchange gain or lossbased on any appreciation or depreciation in the value of the foreign currencyagainst the U.S. dollar, which will generally be U.S. source ordinary income orloss.

 

As described above, we willgenerally be required to withhold Israeli income tax from any dividends paid toholders who are not resident in Israel. See "Israeli Tax Considerations -Taxation of Non-Resident Holders of Shares." If a U.S. Holder receives adividend from Compugen that is subject to Israeli withholding, the followingwould apply:
- You must include the gross amount of the     dividend, not reduced by the amount of Israeli tax withheld, in your U.S.     taxable income.
- You may be able to claim the Israeli tax     withheld as a foreign tax credit against your U.S. income tax liability.
- The foreign tax credit is subject to     significant and complex limitations. Generally, the credit can offset only     the part of your U.S. tax attributable to your net foreign source passive     income. Additional special rules apply to taxpayers predominantly engaged     in the active conduct of a banking, insurance, financing or similar     business. Additionally, if we pay dividends at a time when 50% or more of     our stock is owned by U.S. persons, you may be required to treat the part     of the dividend attributable to U.S. source earnings and profits as U.S.     source income, possibly reducing the allowable credit, unless you elect to     calculate your foreign tax credit separately with respect to Compugen     dividends.
- A U.S. Holder will be denied a foreign tax     credit with respect to Israeli income tax withheld from dividends received     on the ordinary shares to the extent the U.S. Holder has not held the     ordinary shares for at least 16 days of the 30-day period beginning on the     date which is 15 days before the ex-dividend date or to the extent the     U.S. Holder is under an obligation to make related payments with respect     to substantially similar or related property. Any days during which a U.S.     Holder has substantially diminished its risk of loss on the ordinary     shares are not counted toward meeting the 16-day holding period required     by the statute.
- If you do not elect to claim foreign taxes as     a credit, you will be entitled to deduct the Israeli income tax withheld     from your Compugen dividends in determining your taxable income. Individuals     who do not claim itemized deductions, but instead utilize the standard     deduction, may not claim a deduction for the amount of the Israeli income     taxes withheld.
- If you are a U.S. corporation holding our stock, you     cannot claim the dividends-received deduction with respect to our     dividends.

 

Special rules, described below, apply if Compugenis a passive foreign investment company.

 

***Taxation of the Disposition of Ordinary Shares***

* *

Subject to the description of the passive foreigninvestment company rules below, upon the sale, exchange or other disposition ofour ordinary shares, a U.S. Holder will recognize capital gain or loss in anamount equal to the difference between the U.S. Holder's basis in the ordinaryshares, which is usually the cost of these shares, and the amount realized onthe disposition. If, as anticipated, the ordinary shares are publicly traded, adisposition of shares will be considered to occur on the trade date, regardlessof the holder's method of accounting. Capital gain from the sale, exchange orother disposition of ordinary shares held more than one year is long-termcapital gain and is eligible for a reduced rate of taxation for non-corporateholders. Gain or loss recognized by a U.S. Holder on a sale, exchange or otherdisposition of ordinary shares generally will be treated as United Statessource income or loss for United States foreign tax credit purposes. Thedeductibility of capital losses is subject to limitations for both corporateand individual shareholders.

 

A U.S. Holder that uses the cash method ofaccounting calculates the U.S. dollar value of the proceeds received from asale of ordinary shares as of the date that the sale settles, and willgenerally have no additional foreign currency gain or loss on the sale, while aU.S. Holder that uses the accrual method of accounting is required to calculatethe value of the proceeds of the sale as of the trade date and may thereforerealize foreign currency gain or loss, unless the U.S. Holder has elected touse the settlement date to determine its proceeds of sale for purposes ofcalculating this foreign currency gain or loss. In addition, a U.S. Holder thatreceives foreign currency upon disposition of our ordinary shares and convertsthe foreign currency into U.S. dollars subsequent to receipt will have foreignexchange gain or loss based on any appreciation or depreciation in the value ofthe foreign currency against the U.S. dollar, which will generally be U.S.source ordinary income or loss.

 

***Tax Consequences If We Are a Passive ForeignInvestment Company***

* *

Generally, a foreign corporation is treated as apassive foreign investment company ("PFIC") for United States federal incometax purposes for any tax year if, in such tax year, either (i) 75% or more ofits gross income is passive in nature (the "Income Test"), or (ii) the averagepercentage of its assets during such tax year that produce, or are held for theproduction of, passive income (determined by averaging the percentage of thefair market value of its total assets which are passive assets as of the end ofeach quarter of such year) is 50% or more (the "Asset Test").

* *

Because less than 75% of our gross income in 2002and in prior years constituted passive income, as defined for purposes of theIncome Test, we do not believe that application of the Income Test would haveresulted in our classification as a PFIC for any of such years. In addition, wedo not believe that application of the Asset Test would have resulted in ourclassification as a PFIC for any tax year prior to 2001. 
**____(62)____ 

For 2001 and 2002, however, it is possible that wecould be classified as a PFIC under the Asset Test principally because asignificant portion of our assets continued to consist of the cash raised inconnection with both a public offering and a private offering of our ordinaryshares in2000, coupled with the decline in the public market value of ourordinary shares during 2001 and 2002 and the timing of the required valuations,although there is no definitive method prescribed in the Code, United StatesTreasury Regulations or administrative or judicial interpretations thereof fordetermining the value of a foreign corporation`s assets for purposes of theAsset Test. While the legislative history of the United States Taxpayer ReliefAct of 1997 indicates that "the total value of a publicly-traded foreigncorporation`s assets generally will be treated as equal to the sum of theaggregate value of its outstanding stock plus its liabilities", there remainssubstantial uncertainty regarding the valuation of a publicly-traded foreigncorporation`s assets for purposes of the Asset Test, and it is arguable thatunder alternative valuation methodologies, the value of our total assets as ofthe relevant valuation dates in 2001 and/or 2002 would not result in ourclassification as a PFIC during either or both of such years.

 

In view of the uncertainty regarding the valuationof our assets for purposes of the Asset Test and the complexity of the issuesregarding our treatment as a PFIC for 2001, 2002 and, quite possibly,subsequent years, U.S. Shareholders are urged to consult their own tax advisorsfor guidance as to our status as a PFIC. For those U.S. Shareholders whodetermine that we were a PFIC for 2001, 2002 and/or any subsequent years and notifyus in writing of their request for the information required in order toeffectuate the QEF Election described below, we will promptly make suchinformation available to them.

 

If we are treated as a PFIC for United Statesfederal income tax purposes for any year during a U.S. Shareholder`s holdingperiod of ordinary shares and the U.S. Shareholder does not make a QEF Electionor a "mark-to-market" election (both as described below), any gain recognizedby the U.S. Shareholder upon the sale of ordinary shares (or the receipt ofcertain distributions) would be treated as ordinary income. This income wouldbe allocated over the U.S. Shareholder`s holding period with respect to hisordinary shares and an interest charge would be imposed on the amount of deferredtax on the income allocated to prior taxable years.

 

Although we generally will be treated as a PFIC asto any U.S. Shareholder if we are a PFIC for any year during the U.S.Shareholder`s holding period, if we cease to satisfy the requirements for PFICclassification, then under such circumstances, the U.S. Shareholder may avoidthe consequences of PFIC classification for subsequent years if he elects torecognize gain based on the unrealized appreciation in the ordinary sharesthrough the close of the tax year in which we cease to be a PFIC. Additionally,if we are treated as a PFIC, a U.S. Shareholder who acquires ordinary sharesfrom a decedent would be denied the normally available step-up in tax basis forthese ordinary shares to fair market value at the date of death and insteadwould have a tax basis equal to the decedent`s tax basis in these ordinaryshares.

 

For any tax year in which we are treated as a PFIC,a U.S. Shareholder may elect to treat his ordinary shares as an interest in aqualified electing fund (a "QEF Election"), in which case, the U.S. Shareholderwould be required to include in income currently his proportionate share of ourearnings and profits in years in which we are a PFIC regardless of whetherdistributions of our earnings and profits are actually distributed to the U.S.Shareholder. Any gain subsequently recognized upon the sale by the U.S.Shareholder of his ordinary shares, however, generally would be taxed ascapital gain.

 

As an alternative to a QEF Election, a U.S. Shareholdermay elect to mark his ordinary shares to market annually, recognizing ordinaryincome or loss (subject to certain limitations) equal to the difference betweenthe fair market value of his ordinary shares and the adjusted tax basis of hisordinary shares. Losses would be allowed only to the extent of netmark-to-market gain accrued under the election.

 

We cannot assure you that we will avoid becoming aPFIC. U.S. holders who hold ordinary shares during a period when we are a PFICwill be subject to the foregoing rules, even if we cease to be a PFIC. U.S.Holders are urged to consult their tax advisors about the PFIC rules, includingQEF elections.

*** ***

***United States******Federal Income TaxConsequences for Non-U.S. Holders of Ordinary Shares***

 

Except as described in "Information Reportingand Back-up Withholding" below, a Non-U.S. Holder of ordinary shares willnot be subject to U.S. federal income or withholding tax on the payment ofdividends on, and the proceeds from the disposition of, ordinary shares, unless:
**____(63)____ 

 
- the item is effectively connected with the conduct by     the Non-U.S. Holder of a trade or business in the United States and, in     the case of a resident of a country which has a tax treaty with the United     States, the item is attributable to a permanent establishment or, in the     case of an individual, a fixed place of business, in the United States;
- the Non-U.S. Holder is an individual who holds the     ordinary shares as a capital asset and is present in the United States for     183 days or more in the taxable year of the disposition and does not     qualify for an exemption; or
- the Non-U.S. Holder is subject to tax under the     provisions of United States tax law applicable to U.S. expatriates.

 

***Information Reporting and Back-up Withholding***

 

U.S. Holders generally are subject to informationreporting requirements with respect to dividends paid in the United States onordinary shares. Under existing regulations, these dividends are not subject toback-up withholding. U.S. Holders are subject to information reporting and back-upwithholding at a rate of 30% on proceeds paid from the disposition of ordinaryshares unless the U.S. Holder provides IRS Form W-9 or otherwise establishes anexemption.

 

Non-U.S. Holders generally are not subject toinformation reporting or back-up withholding with respect to dividends paid on,or upon the disposition of, ordinary shares, provided that the non-U.S. Holderprovides a taxpayer identification number, certifies to its foreign status, orotherwise establishes an exemption.

 

Treasury regulations effective January 1, 2001 may alter the rules regarding information reporting and back-up withholding. Inparticular, those regulations would impose back-up withholding on dividendspaid in the United States on ordinary shares unless the U.S. Holder providesIRS Form W-9 or otherwise establishes an exemption. Prospective investorsshould consult their tax advisors concerning the effect, if any, of theseTreasury regulations on an investment in ordinary shares. The amount of anyback-up withholding will be allowed as a credit against a U.S. or Non-U.S.Holder's United States federal income tax liability and may entitle the Holderto a refund, provided that specified required information is furnished to theIRS.

** **

**Documents on Display**

** **

We are required to file reports and otherinformation with the SEC under the Securities Exchange Act of 1934 and theregulations thereunder applicable to foreign private issuers. You may inspectand copy reports and other information filed by us with the SEC at the SEC`s publicreference facilities described below.  Although as a foreign privateissuer we are not required to file periodic information as frequently or aspromptly as United States companies, we generally announce publicly ourquarterly and year-end results promptly and file periodic information with theSEC under cover of Form 6-K. As a foreign private issuer, we are also exemptfrom the rules under the Exchange Act prescribing the furnishing and content ofproxy statements and our officers, directors and principal shareholders areexempt from the reporting and other provisions in Section 16 of the ExchangeAct.

 

You may review a copy of our filings with the SEC,including any exhibits and schedules, at the SEC`s public reference facilitiesin Room 1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549and at the regional office of the SEC located at the Northwestern Atrium Center,  500 West Madison Street, Suite 1400, Chicago, Illinois 60661. You may alsoobtain copies of such materials from the Public Reference Section of the SEC,Room 1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549, atprescribed rates. You may call the SEC at 1-800-SEC-0330 for furtherinformation on the public reference rooms. As a foreign private issuer we wereonly required to file through the SEC`s EDGAR system as of November 2002. Ourperiodic filings are therefore available on the SEC`s Web site from that date.You may read and copy any reports, statements or other information that we filewith the SEC, through the SEC`s EDGAR system available on the SEC`s website andat the SEC facilities listed above. These SEC filings are also available to thepublic from commercial document retrieval services.  

 

Any statement in this annual report about any ofour contracts or other documents is not necessarily complete. If the contractor document is filed as an exhibit to this annual report, the contract ordocument is deemed to modify the description contained in this annual report.We urge you to review the exhibits themselves for a complete description of thecontract or document.
**____(64)____ 

**ITEM 11.               QUANTITATIVE AND QUALITATIVEDISCLOSURES ABOUT MARKET RISK**

** **

**Market Risks**

 

  We are exposed to a variety of risks, includingchanges in interest rates and foreign currency exchange risk and inflation. At December 31, 2002 and December 31, 2001 we did not own any market risk sensitiveinstruments. However, we may in the future undertake hedging or other similartransactions or invest in market risk sensitive instruments if managementdetermines that it is necessary to offset these risks.

 

**Interest Rate Risk**

 

As of December 31, 2002, we had $67.3 million incash, cash equivalents, cash deposits and marketable securities. We invest ourcash surplus in time deposits, cash deposits, and corporate bonds. Since theseinvestments typically carry fixed interest rate and since our policy andpractice is to hold these investments to maturity, financial income over theholding period is not sensitive to changes in rates interest.

 

**Foreign Currency Exchange Risk and Inflation**

** **

Since the majority of our revenues are paid in U.S.dollars, we believe that inflation and fluctuations in the NIS/U.S. dollarexchange rate have no material effect on our revenues. We incur a significantportion of our expenses, principally salaries and related personnel expenses,in New Israeli Shekels, or NIS. As a result, we are exposed to the risk thatthe rate of inflation in Israel will exceed the rate of devaluation of the NISin relation to the U.S. dollar or that the timing of this devaluation lagsbehind inflation in Israel. In addition, we are exposed to the risk that theU.S. dollar will be devalued against the NIS. We try to protect ourselvesagainst this possibility by investing a portion of our cash in NIS deposits. Todate, we have not been materially affected by changes in the Israeli rate ofinflation or the exchange rates of the NIS compared to the U.S. dollar. 

 

** **

**ITEM 12.                             DESCRIPTIONOF SECURITIES OTHER THAN EQUITY SECURITIES**

 

                       Not applicable.
**____(65)____ 

**PART II**

 

**ITEM 13.             DEFAULTS, DIVIDEND ARREARAGESAND DELINQUENCIES**

 

                       None.

 

**ITEM 14.                             MATERIALMODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS**

 

**Material Modifications to the Rights of SecurityHolders**

** **

****None.

 

**Use of Proceeds**

** **

                       None.

** **

**ITEM 15.               CONTROLS AND PROCEDURES**

 

Compugen has established and maintains disclosurecontrols and procedures that are designed to ensure that material informationrelating to Compugen and its subsidiary required to be disclosed in the reportsthat it files or submits under the Securities Exchange Act of 1934 is recorded,processed, summarized, and reported within the time periods specified in theSecurities and Exchange Commission`s rules and forms, and that such informationis accumulated and communicated to the company`s management, including itsChief Executive Officer and Chief Financial Officer, as appropriate to allowtimely decisions regarding required disclosure. 

 

Within the 90 days prior to the filing date of thisannual report, the company carried out an evaluation, under the supervision andwith the participation of management, including the Chief Executive Officer andChief Financial Officer, of the effectiveness of the design and operation ofdisclosure controls and procedures. Based on that evaluation of thesedisclosure controls and procedures, the Chief Executive Officer and ChiefFinancial Officer concluded that Compugen`s disclosure controls and procedureswere effective as of the date of such evaluation. 

 

The Chief Executive Officer and Chief FinancialOfficer have also concluded that there were no significant changes in theCompany`s internal controls or in other factors that could significantly affectthe internal controls subsequent to the date that Compugen completed itsevaluation, including any corrective actions with regard to significantdeficiencies and material weaknesses.

 

 

**ITEM 16.               RESERVED**

 
****____(66)____ 

**PART III**

*** ***

**ITEM 17.               FINANCIAL STATEMENTS**

 

                       We have elected to furnish financialstatements and related information specified in Item 18.

 

**ITEM 18.               FINANCIAL STATEMENTS**

 

                       See pages F-1 to F-28.

 

**ITEM 19.               EXHIBITS**

*** ***

**Index to Exhibits**

*** ***

**Exhibit Number**

Description     

*1.1

Form of Articles of Association of Registrant

 

 

10.1

Auditors Consent dated June 9, 2003.

 

 

 

  *  Incorporatedby reference to our registration statement on Form F-1, registration number333-12316, as amended, filed with the Securities and Exchange Commission.

 

 

** **
**____(67)____ 

**SIGNATURES**

 

Pursuant to the requirements of Section 12 of theSecurities Exchange Act of 1934, the registrant hereby certifies that it meetsall the requirements for filing on Form 20-F and has duly caused this AnnualReport to be signed on its behalf by the undersigned, thereunto duly authorizedon this 4th day of June 2003.

 

 

**COMPUGENLTD.**

 

 

 

 

Signature:                 \s\ Mor Amitai

 

Name:                               Mor Amitai, Ph.D.

Title:                                   President, Chief Executive 

                                                     Officer and Director

 

Date:                                   June 9, 2003

 
**____(68)____ 

**CERTIFICATION**

I, Dr. Mor Amitai, certify that:

1. I have reviewed this annualreport on Form 20-F of Compugen Ltd.; 

2. Based on my knowledge, this annualreport does not contain any untrue statement of a material fact or omit tostate a material fact necessary to make the statements made, in light of thecircumstances under which such statements were made, not misleading withrespect to the period covered by this annual report; 

3. Based on my knowledge, thefinancial statements, and other financial information included in this annualreport, fairly present in all material respects the financial condition,results of operations and cash flows of the registrant as of, and for, theperiods presented in this annual report; 

4. The Registrant's othercertifying officer and I are responsible for establishing and maintainingdisclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and15d-14) for the registrant and have: 

a.                   designed such disclosure controls and procedures to ensure that materialinformation relating to the registrant, including its consolidatedsubsidiaries, is made known to us by others within those entities, particularlyduring the period in which this annual report is being prepared; 

b.                  evaluated the effectiveness of the registrant's disclosure controls andprocedures as of a date within 90 days prior to the filing date of this annualreport (the "Evaluation Date"); and 

c.                   presented in this annual report our conclusions about the effectivenessof the disclosure controls and procedures based on our evaluation as of theEvaluation Date; 

5. The Registrant's othercertifying officer and I have disclosed, based on our most recent evaluation,to the Registrant's auditors and the audit committee of Registrant's board ofdirectors (or persons performing the equivalent function): 

a.                   all significant deficiencies in the design or operation of internalcontrols which could adversely affect the Registrant's ability to record,process, summarize and report financial data and have identified for theregistrant's auditors any material weaknesses in internal controls; and 

b.                  any fraud, whether or not material, that involves management or otheremployees who have a significant role in the registrant's internal controls;and 

6. The Registrant's othercertifying officer and I have indicated in this annual report whether or notthere were significant changes in internal controls or in other factors that couldsignificantly affect internal controls subsequent to the date of our mostrecent evaluation, including any corrective actions with regard to significantdeficiencies and material weaknesses. 

 

 

 

Signature:                 \s\ Mor Amitai

 

Name:                               Mor Amitai, Ph.D.

Title:                                   President, Chief Executive 

                                                     Officer and Director

 

Date:                                   June 9, 2003

 
**____(69)____ 

 

**CERTIFICATION**

 

I, Nurit Benjamini, certify that:

 

1. I have reviewed this annualreport on Form 20-F of Compugen Ltd.; 

2. Based on my knowledge, thisannual report does not contain any untrue statement of a material fact or omitto state a material fact necessary to make the statements made, in light of thecircumstances under which such statements were made, not misleading withrespect to the period covered by this annual report; 

3. Based on my knowledge, thefinancial statements, and other financial information included in this annualreport, fairly present in all material respects the financial condition,results of operations and cash flows of the registrant as of, and for, theperiods presented in this annual report; 

4. The Registrant's othercertifying officer and I are responsible for establishing and maintainingdisclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and15d-14) for the registrant and have: 

a.                   designed such disclosure controls and procedures to ensure that materialinformation relating to the registrant, including its consolidatedsubsidiaries, is made known to us by others within those entities, particularlyduring the period in which this annual report is being prepared; 

b.                  evaluated the effectiveness of the registrant's disclosure controls andprocedures as of a date within 90 days prior to the filing date of this annualreport (the "Evaluation Date"); and 

c.                   presented in this annual report our conclusions about the effectivenessof the disclosure controls and procedures based on our evaluation as of theEvaluation Date; 

5. The Registrant's othercertifying officer and I have disclosed, based on our most recent evaluation,to the Registrant's auditors and the audit committee of Registrant's board ofdirectors (or persons performing the equivalent function): 

a.                   all significant deficiencies in the design or operation of internalcontrols which could adversely affect the Registrant's ability to record,process, summarize and report financial data and have identified for theregistrant's auditors any material weaknesses in internal controls; and 

b.                  any fraud, whether or not material, that involves management or otheremployees who have a significant role in the registrant's internal controls;and 

6. The Registrant's othercertifying officer and I have indicated in this annual report whether or notthere were significant changes in internal controls or in other factors thatcould significantly affect internal controls subsequent to the date of our mostrecent evaluation, including any corrective actions with regard to significantdeficiencies and material weaknesses. 

 

 

** **

Signature:               \s\ Nurit Benjamini

 

Name:                                                                     NuritBenjamini

Title:                                                                         ChiefFinancial Officer 

Date:                                                                         June 9, 2003

 
**____(70)____ 

 

**Certification Pursuant to 18.U.S.C. Section 1350,**

**As adopted Pursuant to Section 906 of the Sarbanes-OxleyAct of 2002**

 

Inconnection with the annual report of Compugen Ltd. (the "Company") on Form 20-Ffor the periods ending December 31, 2002 as filed with the Securities andExchange Commission on the date hereof (the "Report"), I the undersigned, beingthe President and Chief Executive Officer of the Company, certify, pursuant to18 U.S.C. Section 1350, as adopted pursuant to Section 906 of theSarbanes-Oxley Act of 2002, that to my knowledge:****

 

1)

 

The Report fully complies with  the requirements of sections 13(a) or 15(d) of the Securities Exchange Act of  1934; and 

 

2)

 

The information contained in  the Report fairly presents, in all material respects, the financial condition  and results of operations of the Company. 

 

 

 

 

Signature:               \s\ Mor Amitai

 

Name:                                                                     Mor Amitai,Ph.D.

Title:                                                                         President,Chief Executive 

                                                                                           Officerand Director

 

Date:                                                                         June 9, 2003

 

 
**____(71)____ 

 

**Certification Pursuant to 18.U.S.C. Section 1350,**

**As adopted Pursuant to Section 906 of the Sarbanes-OxleyAct of 2002**

 

Inconnection with the annual report of Compugen Ltd. (the "Company") on Form 20-Ffor the periods ending December 31, 2002 as filed with the Securities andExchange Commission on the date hereof (the "Report"), I the undersigned, beingthe Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C.Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of2002, that to my knowledge:****

 

1)

 

The Report fully complies with  the requirements of sections 13(a) or 15(d) of the Securities Exchange Act of  1934; and 

 

2)

 

The information contained in  the Report fairly presents, in all material respects, the financial condition  and results of operations of the Company. 

 

 

 

** **

Signature:               \s\ Nurit Benjamini

 

Name:                                                                     NuritBenjamini

Title:                                                                         ChiefFinancial Officer 

Date:                                                                         June 9, 2003

 
**____(72)____ 

 

** **

**Exhibit 10.1**

****

** **

** **

** **

**CONSENT OF INDEPENDENT AUDITORS**

 

 

 

We consent to the incorporation by reference in theRegistration Statement on Form S-8 File No. 333-13144 of Compugen Ltd. of ourreport dated, February 5, 2003, with respect to the consolidated financialstatements of Compugen Ltd., included in the Annual Report (Form 20-F) for theyear ended December 31, 2002.

 

 

 

 

 

 

 

 

 

Tel-Aviv, Israel

 

KOST, FORER & GABBAY

June 9, 2003

 

A member of Ernst & Young  Global
**____(73)____ 

 

 

 

**COMPUGENLTD. AND ITS SUBSIDIARIES**

 

 

**CONSOLIDATEDFINANCIAL STATEMENTS**

** **

** **

**ASOF****DECEMBER 31, 2002**

 

 

**U.S. DOLLARSIN THOUSANDS**

 

 

 

 

 

**INDEX**

 

 

** **

**Page**

** **

** **

** **

** **

**Report of  Independent Auditors and Independent Public Accountants**

**F-2 - F-3**

** **

** **

**Consolidated  Balance Sheets**

**F-4**

** **

** **

**Consolidated  Statements of Operations**

**F-5**

** **

** **

**Statements of  Changes in Shareholders' Equity**

**F-6**

** **

** **

**Consolidated  Statements of Cash Flows**

**F-7**

** **

** **

**Notes to  Consolidated Financial Statements**

**F-8 - F-28**

 

 

 

- - - - - - - - - - - - -

 
**____(74)____ 

 

 

 

**REPORTOF INDEPENDENT AUDITORS**

 

 

 

To the Shareholders' of

Compugen Ltd.

 

 

 

We have audited theaccompanying consolidated balance sheets of Compugen Ltd. (the"Company") and its subsidiaries as of December 31, 2002, and therelated consolidated statements of operations, changes in shareholders' equityand cash flows for the year then ended December 31, 2002.These financial statements are the responsibility of the Company's management.Our responsibility is to express an opinion on these financial statements basedon our audits.

 

We conducted our audit inaccordance with auditing standards generally accepted in the United States.Those standards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. An audit includes examining, on a test basis, evidence supportingthe amounts and disclosures in the financial statements. An audit also includesassessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall financial statement presentation.We believe that our audit provides a reasonable basis for our opinion.

 

In our opinion, theconsolidated financial statements referred to above present fairly, in allmaterial respects, the consolidated financial position of Compugen Ltd. and itssubsidiaries as of December 31, 2002, and the consolidated results of their operations andcash flows for the year then ended, in conformity with accounting principlesgenerally accepted in the United States.

 

 

 

Tel-Aviv, Israel

**KOST FORER  & GABBAY**

February 5, 2003

A Member of Ernst  & Young Global

 

 

 
**____(75)____ 

 

**Thisis a copy of the previously issued Independent Public Accountants` report of****Arthur********Andersen****.**

** **

**Thereport has not been reissued by****Arthur********Andersen****.**

** **

**REPORTOF INDEPENDENT PUBLIC ACCOUNTANTS**

 

 

 

 

To the Shareholders' of

Compugen Ltd.

 

 

 

We have audited the accompanying consolidated balance sheets ofCompugen Ltd. (an Israeli corporation) and its subsidiaries (the "Company") asof December 31, 2000 and 2001, and the related consolidated statements ofoperations, changes in shareholders' equity and cash flows for each of the threeyears in the period ended December 31, 2001. These financial statements are theresponsibility of the Company's management. Our responsibility is to express anopinion on these financial statements based on our audits. 

 

 

We conducted ouraudit in accordance with generally accepted auditing standards in the UnitedStates and in Israel, including those prescribed under the Auditors` Regulatios(Auditor`s Mode of Performance), 1973. Those standards require that we plan andperform the audit to obtain reasonable assurance about whether the financialstatements are free of material misstatement. An audit includes examining, on atest basis, evidence supporting the amounts and disclosures in the financialstatements. An audit also includes assessing the accounting principles used andsignificant estimates made by management, as well as evaluating the overallfinancial statement presentation. We believe that our audits provide areasonable basis for our opinion.

 

 

In our opinion, theconsolidated financial statements referred to above present fairly, in allmaterial respects, the consolidated financial position of Compugen Ltd. and itssubsidiaries as of December 31, 2000, 2001 and the results of their operations,changes in shareholders` equity and cash flows for each of the three years inthe period ended December 31, 2001, in conformity with accounting principlesgenerally accepted in the United States.

 

 

 

Tel-Aviv, Israel

**Luboshits  Kasierer**

February 12, 2002

Arthur Andersen

 

 

 
**____(76)____ 

 

** **

** **

** **

** **

 

** **

** **

** **

December 31,

 

** **

** **

** **

 

 

** **

Note

** **

2002

 

2001

ASSETS

 

 

 

 

 

 

CURRENT ASSETS:

 

 

 

 

 

 

Cash and cash equivalents

 

4

 

$                 5,289

 

$                 8,438

Short-term cash deposits

 

5

 

30,195

 

9,241

Marketable securities

 

6

 

12,918

 

14,668

Trade receivables (net of  allowance for doubtful accounts of $ 0and $ 22 at December 31, 2002 and 2001, respectively)

 

 

 

1,451

 

1,122

Other accounts receivable  and prepaid expenses

 

7

 

3,130

 

2,037

Inventory

 

 

 

111

 

134

 

 

 

 

 

 

 

Total current assets

 

 

 

53,094

 

35,640

 

 

 

 

 

 

 

LONG-TERM INVESTMENTS:

 

 

 

 

 

 

Marketable securities

 

6

 

18,940

 

15,953

Long-term cash deposits

 

8

 

-

 

30,195

Long-term lease deposits

 

 

 

156

 

137

Severance pay fund

 

 

 

1,266

 

1,092

 

 

 

 

 

 

 

 

 

 

 

20,362

 

47,377

 

 

 

 

 

 

 

PROPERTY AND EQUIPMENT, NET

 

9

 

3,801

 

4,272

 

 

 

 

 

 

 

Total assets

 

 

 

$                 77,257

 

$                 87,289

 

 

 

 

 

 

 

LIABILITIES AND SHAREHOLDERS` EQUITY

** **

** **

** **

 

 

 

CURRENT LIABILITIES:

 

 

 

 

 

 

Accounts payable and accrued expenses

 

10

 

$                 4,949

 

$                 4,887

Deferred revenue

 

 

 

1,595

 

960

 

 

 

 

 

 

 

Total current liabilities

 

 

 

6,544

 

5,847

 

 

 

 

 

 

 

LONG-TERM LIABILITIES:

 

 

 

 

 

 

Accrued severance pay

 

 

 

1,832

 

1,380

 

 

 

 

 

 

 

COMMITMENTS AND CONTINGENCIES

 

11

 

 

 

 

 

 

 

 

 

 

 

SHAREHOLDERS` EQUITY:

 

12

 

 

 

 

Share capital:

 

 

 

 

 

 

Ordinary shares of NIS  0.01 par value;  50,000,000 shares authorized at December 31, 2002 and 2001; 26,162,405 and 26,048,384 shares issued and outstanding at December 31, 2002 and 2001, respectively

 

 

 

71

 

71

Additional paid-in capital

 

 

 

149,982

 

150,418

Deferred stock  compensation

 

 

 

(580)

 

(2,039)

Accumulated deficit

 

 

 

(80,592)

 

(68,388)

 

 

 

 

 

 

 

Total shareholders` equity 

 

 

 

68,881

 

80,062

 

 

 

 

 

 

 

Total liabilities and shareholders` equity

 

 

 

$                 77,257

 

$                 87,289

 

The accompanying notes are an integral part of theconsolidated financial statements.

 
**____(77)____ 

 

 

 

** **

** **

** **

**Year  ended**

 

** **

 

** **

December 31,

 

** **

Note

** **

2002

 

2001

 

2000

 

 

 

 

 

 

 

 

 

Revenues:

 

13

 

 

 

 

 

 

Products

 

 

 

$                 5,014

 

$                 5,883

 

$                 2,268

Services

 

 

 

4,248

 

4,483

 

4,623

Research and  development grants

 

 

 

1,835

 

994

 

466

 

 

 

 

 

 

 

 

 

Total revenues

 

 

 

11,097

 

11,360

 

7,357

 

 

 

 

 

 

 

 

 

Cost of revenues:

 

 

 

 

 

 

 

 

Products

 

 

 

1,411

 

1,853

 

477

Services

 

 

 

1,408

 

1,602

 

1,243

Research and  development expenses 

 

 

 

14,170

 

15,976

 

12,635

Sales and  marketing expenses 

 

 

 

5,538

 

6,565

 

3,781

General and  administrative expenses 

 

 

 

3,614

 

4,383

 

5,397

 

 

 

 

 

 

 

 

 

Total operating  expenses (*)

 

 

 

26,141

 

30,379

 

23,533

 

 

 

 

 

 

 

 

 

Operating loss

 

 

 

(15,044)

 

(19,019)

 

(16,176)

Financial and  other income, net

 

14

 

2,840

 

3,875

 

2,772

 

 

 

 

 

 

 

 

 

Net loss

 

 

 

$                   (12,204)

 

$                   (15,144)

 

$                   (13,404)

Dividends related to  Convertible Preferred shares

 

 

 

-

 

-

 

(24,923)

 

 

 

 

 

 

 

 

 

Net loss available  to Ordinary shares 

 

 

 

$                 (12,204)

 

$                 (15,144)

 

$                 (38,327)

 

 

 

 

 

 

 

 

 

Basic and diluted  net loss per Ordinary share 

 

 

 

$                 (0.47)

 

$                 (0.58)

 

$                 (2.75)

 

 

 

 

 

 

 

 

 

Weighted average number of Ordinaryshares used in computing basic and diluted net loss  per share

 

 

 

26,103,343

 

26,005,784

 

13,914,485

 

 

(*)         Includes deferred stock compensation - see Note 12.

 

 

The accompanying notes are an integral part of theconsolidated financial statements.

 
**____(78)____ 

 

** **

Ordinary shares

 

Preferred shares

 

**Additional  paid-in**

 

**Deferred**

**stock**

 

**Accumulated**

 

**Total  shareholders'**

 

 

Number

 

Amount

 

Number

 

Amount

 

capital

 

compensation

 

deficit

 

equity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance as of January 1, 2000

 

5,981,000

 

$                 18

 

8,206,119

 

$                 24

 

$   31,430

 

$   (3,768)

 

$    (14,917)

 

$                 12,787

Employee options  exercised

 

505,835

 

1

 

-

 

-

 

784

 

-

 

-

 

785

Issuance of Series C Convertible Preferred shares

 

  -

 

-

 

  5,538,462

 

14

 

**)    35,499

 

  -

 

  -

 

  35,513

Issuance of Ordinary  shares in an initial public offering

 

  5,750,000

 

14

 

  -

 

-

 

***) 51,134

 

  -

 

  -

 

  51,148

Conversion of  Convertible Preferred shares

 

13,744,581

 

38

 

(13,744,581)

 

(38)

 

-

 

-

 

-

 

-

Dividend related to Convertible Preferred shares

 

  -

 

-

 

  -

 

-

 

  24,923

 

  -

 

  (24,923)

 

  -

Deferred stock  compensation

 

-

 

-

 

-

 

-

 

4,680

 

(4,680)

 

-

 

-

Amortization of  deferred stock compensation

 

  -

 

-

 

  -

 

-

 

  -

 

  3,751

 

  -

 

  3,751

Compensation relating to options and warrants issued  to scientific advisory board members, consultants and others

 

   -

 

-

 

   -

 

-

 

   1,930

 

   -

 

-

 

1,930

   Net loss

 

-

 

-

 

-

 

-

 

-

 

-

 

(13,404)

 

(13,404)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance as of December 31, 2000

 

25,981,416

 

71

 

-

 

-

 

150,380

 

(4,697)

 

(53,244)

 

92,510

Employee options  exercised

 

66,968

 

*)

 

-

 

-

 

104

 

-

 

-

 

104

Amortization of deferred stock compensation

 

  -

 

-

 

  -

 

-

 

  -

 

  2,593

 

  -

 

  2,593

Compensation relating to options and warrants issued to scientific  advisory board members, consultants and others

 

   -

 

-

 

   -

 

-

 

   (1)

 

   -

 

   -

 

   (1)

Forfeited options

 

-

 

-

 

-

 

-

 

(65)

 

65

 

-

 

-

Net loss

 

-

 

-

 

-

 

-

 

-

 

-

 

(15,144)

 

(15,144)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance as of December 31, 2001

 

26,048,384

 

71

 

-

 

-

 

150,418

 

(2,039)

 

(68,388)

 

80,062

Employee options  exercised

 

114,021

 

*)

 

-

 

-

 

161

 

-

 

-

 

161

Amortization of deferred stock compensation

 

-

 

-

 

-

 

-

 

-

 

1,001

 

-

 

1,001

Compensation relating to options and warrants issued to scientific  advisory board members, consultants and others

 

-

 

-

 

-

 

-

 

(139)

 

-

 

-

 

(139)

Forfeited options

 

-

 

-

 

-

 

-

 

(458)

 

458

 

-

 

-

Net loss

 

-

 

-

 

-

 

-

 

-

 

-

 

(12,204)

 

(12,204)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance as of December 31, 2002

 

26,162,405

 

$                 71

 

                                          -

 

$                 -

 

$149,982

 

$                 (580)

 

$   (80,592)

 

$                 68,881

 

 

*)             Represents anamount lower than $ 1

**)         Net of issuanceexpenses of approximately $ 487

***)   Net of issuanceexpenses of approximately $ 6,352

 

The accompanying notes are an integral part of theconsolidated financial statements.
**____(79)____ 

 

 

 

** **

Year ended December 31

 

** **

2002

 

2001

 

2000

Cash flows from  operating activities:

 

 

 

 

 

 

Net loss

 

$                   (12,204)

 

$                   (15,144)

 

$                   (13,404)

Adjustments to reconcile net loss to net cash used in operating  activities -

 

 

 

 

 

 

Amortization of deferred stock compensation

 

1,001

 

2,593

 

3,751

Compensation relating to options and warrants issued to 

     scientific advisory board members, consultants and others

 

(139)

 

(1)

 

1,930

Depreciation

 

1,897

 

1,682

 

1,242

Accrued severance pay, net

 

278

 

55

 

120

Interest and  amortization of premium on marketable securities

 

793

 

547

 

-

Decrease  (increase) in trade receivables

 

(329)

 

81

 

(1,033)

Increase in other accounts receivable and prepaid expenses

 

(1,093)

 

(349)

 

(939)

Decrease  (increase) in inventory

 

23

 

42

 

(5)

Increase in other  accounts payable and accrued expenses

 

62

 

  1,769

 

1,481

Increase (decrease) in deferred revenue

 

635

 

(225)

 

716

 

 

 

 

 

 

 

Net cash used in  operating activities

 

(9,076)

 

(8,950)

 

(6,141)

 

 

 

 

 

 

 

Cash flows from  investing activities:

 

 

 

 

 

 

Purchase of marketable securities

 

(15,934)

 

(35,547)

 

-

Proceeds from redemption of marketable securities

 

13,904

 

4,379

 

-

Proceeds from (purchase of) short-term and long-term deposits

 

9,241

 

(29,436)

 

(10,000)

Purchase of  property and equipment

 

(1,426)

 

(2,765)

 

(2,034)

Increase in lease  deposits

 

(19)

 

(22)

 

(32)

 

 

 

 

 

 

 

Net cash provided by (used in) investing activities

 

5,766

 

(63,391)

 

(12,066)

 

 

 

 

 

 

 

Cash flows from  financing activities:

 

 

 

 

 

 

Proceeds from issuance of Ordinary shares

 

161

 

104

 

51,933

Proceeds from  issuance of Preferred shares

 

-

 

-

 

35,513

 

 

 

 

 

 

 

Net cash provided  by financing activities

 

161

 

104

 

87,446

  

 

 

 

 

 

 

Increase (decrease) in cash and cash equivalents

 

(3,149)

 

  (72,237)

 

  69,239

Cash and cash equivalents at beginning of year

 

8,438

 

  80,675

 

  11,436

 

 

 

 

 

 

 

Cash and cash  equivalents at end of year

 

$                 5,289

 

$                 8,438

 

$                 80,675

 

 

 

 

 

 

 

Non-cash  financing activities:

 

 

 

 

 

 

Dividend related  to convertible preferred shares

 

$                 -

 

$                 -

 

$                 24,923

 

 

The accompanying notes are an integral part of theconsolidated financial statements.

 
**____(80)____ 

 

** **

**NOTE 1:-             GENERAL**

 

a.         Compugen Ltd.("Compugen" or the "Company") was incorporated in Israel in1993. The Company is engaged in the merging of computational technologies withbiology, chemistry and medicine to enhance drug discovery and development. Thiscapability is used for in house discovery and for providing high value productsand services to leading biotechnology and pharmaceutical companies (see Note 13for information regarding major customers). The Company`s headquarters andresearch facilities are located in Israel, with U.S. operations, through a wholly-owned subsidiary,(Compugen Inc.) in Jamesburg, New Jersey and Sunnyvale, California.

 

b.         On January 1, 2002, the Companyestablished a majority-owned subsidiary, Evogene Ltd. ("Evogene"),which focuses on agricultural biotechnology and plant genomics (See Note 3).

 

 

c.         On January 7, 2002, the Company duallisted its Ordinary shares for trading on the Tel Aviv Stock Exchange, inaddition to Nasdaq.

 

 

**NOTE 2:-             SIGNIFICANT ACCOUNTING POLICIES**

 

The consolidatedfinancial statements have been prepared in conformity with accountingprinciples generally accepted in the United  States ("U.S. GAAP"). The significantaccounting policies followed in the preparation of the consolidated financialstatements, applied on a consistent basis, are:

 

a.          Use of estimates:

 

The preparation offinancial statements in conformity with generally accepted accountingprinciples requires management to make estimates and assumptions that affectthe amounts reported in the financial statements and accompanying notes. Actualresults could differ from those estimates.

 

b.          Financial statements in U.S.dollars:

 

The functionalcurrency of the Company and its subsidiaries is the U.S. dollar, as theCompany`s management believes that the U.S. dollar is the primary currency ofthe economic environment in which the Company and its subsidiaries haveoperated and expect to continue to operate in the foreseeable future. Amajority of the Company`s sales are made outside Israel in U.S. dollars. Themajority of the Company and its subsidiaries' operations are currentlyconducted in Israel and most Israeli expenses are currently paid in newIsraeli shekels ("NIS"); however most of the expenses are denominated anddetermined in U.S. dollars.

 

Accordingly,transactions and balances originally denominated in U.S. dollars are presentedat their original amounts. Transactions and balances in currencies other thanthe U.S. dollar are remeasured into U.S. dollars in accordance with StatementNo. 52 of the Financial Accounting Standards Board ("SFAS") No. 52"Foreign Currency Translations". All transaction gains and lossesfrom the remeasurement of monetary balance sheet items are reflected in thestatements of operations as financial income or expenses, as appropriate.
**____(81)____ 

 

**NOTE 2:-             SIGNIFICANT ACCOUNTING POLICIES (Cont.)**

 

c.          Basis of consolidation:

 

The consolidatedfinancial statements include the accounts of the Company, its wholly-ownedsubsidiary, Compugen, Inc., and its majority-owned subsidiary, Evogene Ltd.Intercompany transactions and balances have been eliminated upon consolidation.

 

d.          Cash and cash equivalents:

 

The Companyconsiders all highly liquid investments with an original maturity of threemonths or less as cash equivalents.

 

e.          Short-term cash deposits:

 

                 Bankdeposits with maturities of more than three months but less than one year areincluded in short-term cash deposits. The short-term cash deposits arepresented at their cost.

 

f.           Marketable securities:

 

The Company accountsfor its investments in marketable securities using SFAS No. 115,"Accounting for Certain Investments in Debt and Equity Securities".

 

Managementdetermines the appropriate classification of its investments in marketable debtand equity securities at the time of purchase and reevaluates suchdeterminations at each balance sheet date. To date, all debt securities havebeen classified as held-to-maturity as the Company has the positive intent andability to hold the securities to maturity.

 

These investmentsare stated at amortized cost, including accrued interest. Amortization ofpremium and accretion of discounts, interest and declines in value consideredto be other than temporary, are included in financial and other income, net.The Company`s investment holdings have been classified in the consolidatedbalance sheet according to the maturity date.

 

g.          Inventory:

 

Inventories arestated at the lower of cost or market value. Inventory write-offs are providedto cover risks arising from slow-moving items, technological obsolescence,discontinued products, and for market prices lower than cost. To date, theCompany`s write-offs have not been material.

 

Cost is determinedas follows:

 

Raw materials, partsand supplies - using the "first-in, first-out" method.

Work-in-progress -represents the cost of manufacturing with the addition of allocable indirectcosts.

 

Finished products -on the basis of direct manufacturing costs with the addition of allocableindirect manufacturing costs.
**____(82)____ 

 

**NOTE 2:-             SIGNIFICANT ACCOUNTING POLICIES (Cont.)**

 

h.          Long-term lease deposits:

 

Long-term leasedeposits include long-term deposits for facilities and motor vehicles leasing.

 

i.            Long-term cash deposits:

 

Bank deposits withmaturities of more than one year are included in long-term cash deposits, andpresented at their cost.

 

j.            Property and equipment:

 

Property andequipment are stated at cost, net of accumulated depreciation. Depreciation iscalculated using the straight-line method over the estimated useful lives ofthe assets at the following annual rates:

 

 

%

 

 

Computers,  software and related equipment

33

Office furniture  and laboratory equipment

6 - 15

Leasehold improvements

Over the term of the lease

 

 

 

The Company and itssubsidiaries` long-lived assets are reviewed for impairment in accordance withStatement of Financial Accounting Standard No.144 "Accounting for theImpairment or Disposal of Long-Lived Assets" ("SFAS No.144")whenever events or changes in circumstances indicate that the carrying amountof an asset may not be recoverable. Recoverability of assets to be held andused is measured by a comparison of the carrying amount of an asset to thefuture undiscounted cash flows expected to be generated by the assets. If suchassets are considered to be impaired, the impairment to be recognized ismeasured by the amount by which the carrying amount of the assets exceeds thefair value of the assets. As of December 31, 2002 no impairment losses have beenidentified.

 

k.          Research and development costs:

 

                 Researchand development costs are charged to the statement of operations as incurred.

                 SFAS No.86, "Accounting for the Costs of Computer Software to be Sold, Leased orOtherwise Marketed", requires capitalization of certain softwaredevelopment costs subsequent to the establishment of technological feasibility.

 

                 Based onthe Company's product development process, technological feasibility isestablished upon completion of a working model. The Company does not incurmaterial costs between the completion of the working model and the point at whichthe products are ready for general release. Therefore, research and developmentcosts associated with the development of software products are also charged tothe statement of operations as incurred.

 

 
**____(83)____ 

** **

**NOTE 2:-             SIGNIFICANT ACCOUNTING POLICIES (Cont.)**

 

l.            Revenue recognition:

 

                 To date,the Company and its subsidiaries have derived most of its revenue fromcollaborations and license fees of software products. The Company alsogenerates revenues from sales of services including maintenance, support,customization, training and installation as well as sale of products(OligoLibraries). In addition, the Company recognized revenues from researchand development grants (as described below). The Company and its subsidiariessell their products primarily through their direct sales force and resellers,both of whom are considered end users. 

 

The Company and itssubsidiaries recognize software license revenue in accordance with Statement ofPosition 97-2, "Software Revenue Recognition" ("SOP 97-2"), as amended. SOP 97-2generally requires revenue earned on software arrangements involving multipleelements to be allocated to each element based on the relative fair value ofthe elements. The Company and its subsidiaries have also adopted SOP 98-9,"Modification of SOP 97-2, Software Revenue Recognition with Respect to CertainTransactions" ("SOP 98-9"), for all transactions entered into after January 1, 2000. SOP98-9 requires that revenue be recognized under the "Residual Method" whenvendor specific objective evidence (VSOE) of fair value exists for allundelivered elements and no VSOE exists for the delivered elements.

 

                 Revenuefrom license fees is recognized when persuasive evidence of an agreementexists, delivery of the product has occurred, no significant obligations withregard to implementation remain, the fee is fixed or determinable, andcollectibility is probable. If the fee is not fixed or determinable, revenue isrecognized as payments become due from the customer provided that all otherrevenue recognition criteria have been met. 

 

                 Whencontracts contain multiple elements wherein VSOE of fair value exists for allundelivered elements, the Company accounts for the delivered elements inaccordance with the "Residual Method" prescribed by SOP 98-9. Maintenance andsupport revenue included in these arrangements is deferred and recognized on astraight-line basis over the term of the maintenance and support agreement. TheVSOE of fair value of the undelivered elements (maintenance, support andprofessional services) is determined based on the price charged for theundelivered element when sold separately.

 

                 The Companyand its subsidiaries license products on a perpetual and on a term basis.License revenue arising from the sale of perpetual licenses and term licensesfor a period longer than one year is recognized in the accounting period thatthe sale takes place. License revenue arising from term license for a period ofless than one year is recognized over the contractual term of the license.

 

Revenues from softwarelicenses that require significant customization, integration and installationare recognized in accordance with Statement of Position 81-1 "Accountingfor Performance of Construction - Type and Certain Production - TypeContracts" ("SOP 81-1"), using contract accounting on a percentage ofcompletion method, based on the relationship of actual costs incurred to totalcosts estimated to be incurred over the duration of the contract. Milestonepayments are recognized only when performance is reasonably assured.
**____(84)____ 

 

**NOTE 2:-             SIGNIFICANT ACCOUNTING POLICIES (Cont.)**

 

                 Provisionsfor estimated losses on uncompleted contracts are made in the period in whichsuch losses are first determined, in the amount of the estimated loss on theentire contract. As of December 31, 2002, no such estimated losses were identified.

 

                 Arrangementsthat include consulting services are evaluated to determine whether thoseservices are essential to the functionality of other elements of thearrangement. When services are considered essential, revenue under thearrangement is recognized using contract accounting. When services are notconsidered essential, the revenue allocable to the software services isrecognized as the services are performed. 

 

                 Revenuefrom sales of hardware systems (including associated software) is recognized inaccordance with SOP 97-2, upon delivery, or at the end of the evaluation periodprovided all other revenue recognition criteria have been met. 

 

                 Revenuesfrom sales of products (OligoLibraries) are recognized in accordance with StaffAccounting Bulletin No. 101 "Revenue Recognition in Financial Statements" ("SABNo. 101") when the product has been delivered, persuasive evidence of anarrangement exists, the vendor`s fee is fixed or determinable and collectibilityprobable.

 

                 Revenuesfrom web-based services are recognized in accordance with SAB No. 101 when theservice has been rendered, persuasive evidence of an agreement exists, thevendor`s fee is fixed or determinable and collectibility probable.

 

The Company accountsfor equity instruments received in accordance with Emerging Issues Task Force("EITF") No.0-08 "Accounting by a Grantee for Equity Instruments to be Receivedin Conjunction with Providing Goods or Services". The Company deems the fair valueof the equity instruments received to date to be minimal and as a result norevenues were recognized.

 

                 Revenuefrom maintenance contracts is recognized ratably over the term of themaintenance contract. Revenues related to other services are recognized as theservices are rendered.

 

                 Royalty andnon royalty bearing grants from the Government of Israel through the Ministryof Industry and Trade - the Office of the Chief Scientist of Israel ("OCS")for funding approved research and development projects, are recognized asrevenues as the related research and development expenses are incurred. TheCompany is not obligated to repay any amounts received from the OCS if theresearch effort is unsuccessful, (See Note 11).

 

                 Deferredrevenue includes amounts received from customers for which revenue has not beenrecognized. 
**____(85)____ 

 

**NOTE 2:-             SIGNIFICANT ACCOUNTING POLICIES (Cont.)**

 

m.        Income taxes:

 

The Company and itssubsidiaries accounts for income taxes using the asset and liability method ofaccounting in accordance with the provisions of SFAS No. 109, "Accountingfor Income Taxes". Under the asset and liability method, deferred taxesare determined based on the differences between the financial statements andtax basis of assets and liabilities at enacted tax rates in effect in the yearin which the differences are expected to reverse.  Valuationallowances are established, when necessary, to reduce deferred tax assets tothe estimated realizable value.

 

n.          Fair value of financialinstruments:

 

                 Thefollowing methods and assumptions were used by the Company and its subsidiariesin estimating their fair value disclosures for financial instruments:

 

                 Thecarrying amounts of cash and cash equivalents, short-term cash deposits, tradereceivables and other accounts receivable and prepaid expenses, approximatetheir fair value due to the short-term maturity of such instruments.

 

                 The fairvalue of marketable securities is based on quoted marketable prices and doesnot differ significantly from the carrying amount.

 

o.          Share-based compensation:

 

                 The Companyhas elected to follow Accounting Principles Board Opinion No. 25"Accounting for Stock Issued to Employees" ("APB 25") andInterpretation No. 44 "Accounting for Certain Transactions Involving StockCompensation" ("FIN 44") in accounting for its employee shareoption plans. Under APB 25, when the exercise price of the Company`s shareoptions is less than the market price of the underlying shares on the date ofgrant, compensation expense is recognized. 

 

                 In December2002, the FASB issued SFAS 148, "Accounting for Stock Based CompensationTransmission and Disclosure" - an amendment of FASB Statement No. 123("SFAS 148"). SFAS 148 permits two additional transition methods forentities that adopt the fair value based method of accounting for stock-basedemployee compensation. The statement also requires new disclosures about theramp-up effect of stock-based employee compensation on reported results. TheStatement also requires that those effects be disclosed more prominently byspecifying the form, content, and location of those disclosures. The transitionguidance and annual disclosure provisions of SFAS 148 are effective for fiscalyears ending after December 15, 2002, with earlier application permitted in certaincircumstances. The interim disclosure provisions are effective for financialreports containing financial statements for interim periods beginning after December 15, 2002. Asat the balance sheet date, the Company continues to apply APB 25 (See also Note12c).
**____(86)____ 

 

**NOTE 2:-             SIGNIFICANT ACCOUNTING POLICIES (Cont.)**

 

Pro formainformation regarding the Company`s net loss and net loss per share is requiredby SFAS No. 123 and has been determined as if the Company had accounted for itsemployee stock options under the fair value method prescribed by SFAS No. 123.

 

For the purposes ofpro-forma disclosure the estimated fair value of the options is amortized toexpenses over the options vesting period which is generally 4 years based on anaccelerated method.

 

                 The fairvalue of each option grant is estimated on the date of grant using theBlack & Scholes option valuation model with the followingweighted-average assumptions for 2002, 2001 and 2000: expected life of 2.1, 2.5and 2.5 years, respectively; dividend yield of 0% for all years; expectedvolatility of 74%, 72% and 68%, respectively; and risk-free interest rate of1.25%, 1.75% and 6.5%, respectively.

 

Pro formainformation under SFAS No. 123, is as follows:

 

 

** **

Year ended December 31,

 

** **

2002

 

2001

 

2000

 

 

 

 

 

 

 

Net loss available to Ordinary shares - as reported

 

$    (12,204)

 

$     (15,144)

 

$    (38,327)

   Less - stock-based employee compensation - intrinsic value

 

1,001

 

2,593

 

3,751

   Add - stock-based employee compensation - fair value

 

(3,189)

 

(4,721)

 

(4,531)

 

 

 

 

 

 

 

Net loss available to Ordinary shares - proforma

 

$    (14,392)

 

$    (17,272)

 

$    (14,184)

 

 

 

 

 

 

 

Basic and diluted net loss per share - as reported

 

$                 (0.47)

 

$                 (0.58)

 

$                 (2.75)

 

 

 

 

 

 

 

Basic and diluted net loss per share - proforma

 

$                 (0.55)

 

$                 (0.66)

 

$                 (1.02)

 

                 The Companyapplies SFAS No. 123 and EITF 96-18 "Accounting for Equity Instruments that areIssued to Other than Employees for Acquiring, or in Conjunction with Selling,Goods or Services" with respect to options issued to non-employees. SFAS No.123requires use of an option valuation model to measure the fair value of theoptions on the date of grant.

 

p.          Net loss per share:

 

                 Basic netloss per share is computed based on the weighted average number of Ordinaryshares outstanding during each year. Net loss for the year ended December 31, 2000includes a non-cash charge of $ 24,923 for the Preferred share dividendrepresenting the value of the beneficial conversion feature. Diluted net lossper share is computed based on the weighted average number of Ordinary sharesoutstanding during each year, plus dilutive potential 
**____(87)____ 

** **

**NOTE 2:-             SIGNIFICANT ACCOUNTING POLICIES (Cont.)**

                 Ordinaryshares considered outstanding during the year, in accordance with SFAS No. 128,"Earnings per Share".

 

All convertiblePreferred shares, outstanding stock options, and warrants have been excludedfrom the calculation of the diluted net loss per share because all suchsecurities are anti-dilutive for all periods presented. The total number ofshares related to the outstanding convertible Preferred shares, options andwarrants excluded from the calculations of diluted net loss per share was4,969,057, 5,212,416 and, 3,781,916 for the years ended December 31, 2002, 2001and 2000, respectively.

 

q.          Concentrations of credit risks:

 

                 Financialinstruments that potentially subject the Company and its subsidiaries toconcentrations of credit risk consist principally of cash and cash equivalents,short-term and long-term cash deposits, marketable securities, tradereceivables and long-term lease deposits.

 

                 Cash andcash equivalents, and short-term and long-term deposits are invested in majorbanks in Israel and the United  States. Such deposits in the United Statesmay be in excess of insured limits and are not insured in other jurisdictions.Management believes that the financial institutions that hold the Company`sinvestments are financially sound and, accordingly, minimal credit risk existswith respect to these investments. 

 

                 The tradereceivables of the Company and its subsidiaries are mainly derived from salesto customers located primarily in the United  States, Europe and the Far East (seealso Note 13). The Company and its subsidiaries perform ongoing creditevaluations of its customers and to date have not experienced any materiallosses. An allowance for doubtful accounts is determined with respect tospecific amounts that the Company and its subsidiaries have determined to bedoubtful of collection. 

 

                 TheCompany`s marketable securities include investments in corporate bonds and U.S.government agencies. Management believes that those corporations arefinancially sound, the portfolio is well diversified, and accordingly, minimalcredit risk exists with respect to these marketable securities.

 

                 The Companyand its subsidiaries have no significant off-balance-sheet concentration ofcredit risk such as foreign exchange contracts, option contracts or otherforeign hedging arrangements.

 

r.           Reclassification:

 

                 Certainprior year amounts have been reclassified to conform to the current yearpresentation.

 

s.          Severance pay:

 

The Company andEvogene`s liability for severance pay is calculated pursuant to Israeliseverance pay law based on the most recent salary of the employees multipliedby the number 
**____(88)____ 

 

**NOTE 2:-             SIGNIFICANT ACCOUNTING POLICIES (Cont.)**

 

                 of years ofemployment, as of the balance sheet date. Employees are entitled to one month`ssalary for each year of employment or a portion thereof. The Company andEvogene`s liability for all of its employees, is fully provided by monthly depositswith insurance policies and by an accrual. The value of these policies isrecorded as an asset in the Company`s balance sheet.

 

                 Thedeposited funds may be withdrawn only upon the fulfillment of the obligationpursuant to Israeli severance pay law or labor agreements. The value of thedeposited funds are based on the cash surrendered value of these policies, andinclude immaterial profits accumulated up to the balance sheet date.

 

                 Severanceexpenses for the years ended December 31, 2002, 2001, 2000 amounted toapproximately $ 724, $ 747 and $ 500, respectively.

 

t.           Recently issued accountingpronouncements:

 

In June 2002, theFASB issues Statement of Financial Accounting Standard No. 146,"Accounting for Costs Associated with Exit or Disposal Activities"("SFAS No. 146"), which addresses significant issue regarding therecognition, measurement, and reporting of costs associated with exit anddisposal activities, including restructuring activities. SFAS No. 146 requiresthat costs associated with exit or disposal activities be recognized when theyare incurred rather than at the date of a commitment to an exit or disposalplan.  SFAS No. 146 is effective for all exit or disposal activitiesinitiated after December 31, 2002.  The Company does not expect the adoptionof SFAS No. 146 to have a material impact on its results of operations orfinancial position.

 

 

**NOTE 3:-             FORMATION OF A MAJORITY OWNED SUBSIDIARY -EVOGENE LTD.**

 

In 2000 Compugen andcertain individuals (the "Founders") reached an understanding as tothe formation of an agricultural biology activity ("AgBio"). Duringthe entrepreneurial phase, and until the establishment of a company dedicatedto the Agbio activity, such activity was conducted in house at Compugen.

 

On January 1, 2002,pursuant to the original understanding, the Company established a majorityowned-subsidiary together with the Founders by the name of Evogene Ltd. Evogeneand Compugen entered into an Asset Purchase Agreement, whereby certain propertyand equipment, vehicle leasing contracts, patents and intellectual property,were transferred at their book value of $286 for consideration in the form of1,640,000 Ordinary shares of Evogene. In addition, Compugen granted to Evogenea license to use its computational tools free of charge until December 31, 2003. Aspart of the formation of Evogene, Evogene issued 360,000 Ordinary shares to theFounders. In connection with the formation of Evogene Compugen recordedexpenses in the amount of $51. On January 10, 2002,the Company signed a convertible loan agreement with Evogene. According to 

the Agreement,Evogene received an amount of $900 from Compugen. The loan bears interest atthe annual rate of 7%.

 
**____(89)____ 

 

**NOTE 3:-             FORMATION OF A MAJORITY OWNED SUBSIDIARY -EVOGENE LTD. (Cont.)**

 

Compugen shall beentitled, upon its sole discretion, until the earlier of (i) December 31, 2006(ii) the closing of an initial public offering ("IPO"), or (iii) amerger or consolidation of Evogene, whereby Evogene is not the survivingentity, to convert the loan, in connection with an external equity financing inEvogene, into the same class of shares of Evogene that were issued in theexternal financing. The price per share shall equal the price per share paid inthe external financing, less 5%-25%, based on the date of conversion (see alsoNote 17).                 

 

** **

**NOTE 4:-             CASH AND CASH EQUIVALENTS**

** **

 

** **

December 31,

 

** **

2002

 

2001

 

 

 

 

 

Bank deposits in U.S. dollars (bearing an annual  average interest rate of 0.73%(*))

 

$                 2,568

 

$                 1,173

Bank deposits in NIS (bearing an annual average interest rate of  8.77%(*)) 

 

2,400

 

5,695

Cash in banks  (current accounts)

 

321

 

1,570

 

 

 

 

 

 

 

$                 5,289

 

$                 8,438

(*)               Rates asof December 31, 2002.

 

** **

**NOTE 5:-             SHORT-TERM CASH DEPOSITS**

 

** **

December 31,

 
 

** **

2002

 

2001

 
 

 

 

 

 

 
Bank deposits in U.S. dollars (bearing an annual  average interest rate of 4.7% (*))

 

$                 30,195

 

$                 5,355

 

 

 

 

 

Bank deposits in NIS 

 

-

 

3,886

 

 

 

 

 

 

 

$                 30,195

 

$                 9,241

 

(*)           Rates as ofDecember 31, 2002.

 
**____(90)____ 

 

 

**NOTE 6:-             MARKETABLE SECURITIES**

 

Short-termmarketable securities: 

** **

 

 

December 31,

 

 

2002

 

2001

 

 

Amortized

cost

 

Gross unrealized gains

 

Market value

 

Amortized cost

 

Gross unrealized gains

 

Market value

 

 

 

 

 

 

 

 

 

 

 

 

 

Corporate bonds

 

$12,918

 

$125

 

$13,043

 

$14,688

 

$161

 

$14,849

 

Long-term marketablesecurities:

** **

U.S. Government institutions

 

$1,493

 

$4

 

$1,497

 

$-

 

$-

 

$-

 

 

 

 

 

 

 

 

 

 

 

 

 

Corporate bonds

 

17,447

 

315

 

17,762

 

15,953

 

261

 

16,214

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

$18,940

 

$                 319

 

$19,259

 

$15,953

 

$                 261

 

$16,214

** **

The Company`slong-term marketable securities mature after one year through three years.

 

** **

**NOTE 7:-             OTHER ACCOUNTS RECEIVABLE AND PREPAIDEXPENSES**

** **

 

 

December 31, 

 

 

2002

 

2001

 

 

 

 

 

Accrued  interest

 

$                 1,661

 

$                 807

Grants  receivable from the Office of the Chief Scientist

 

392

 

106

Government  authorities

 

176

 

459

Employee  loans

 

46

 

75

Prepaid  expenses and other

 

855

 

590

 

 

 

 

 

 

 

$                 3,130

 

$                 2,037

** **

** **

**NOTE 8:-             LONG-TERM CASH DEPOSITS**

** **

 

 

December 31,

 
 

 

2002

 

2001

 
 

 

 

 

 

 
Bank deposits in U.S. dollars (bearing an annual  average interest rate of 4.57% (*))

 

$                 -

 

$                 30,195

 

 

 

 

 

(*)         Rates as of December 31, 2001.
****____(91)____ 

** **

** **

**NOTE 9:-             PROPERTY AND EQUIPMENT, NET**

** **

 

 

December 31,

 

 

2002

 

2001

 

 

 

 

 

Cost

 

 

 

 

Computers,  software and related equipment

 

$                 7,031

 

$                 6,052

Laboratory equipment

 

2,305

 

1,916

Office  furniture and leasehold improvements

** **

939

 

881

 

 

 

 

 

 

 

10,275

 

8,849

Accumulated  Depreciation

 

 

 

 

Computers,  software and related equipment

 

5,225

 

3,681

Laboratory equipment

 

870

 

575

Office  furniture and leasehold improvements

** **

379

 

321

 

 

 

 

 

 

 

(6,474)

 

(4,577)

 

 

 

 

 

Depreciated  cost

 

$                 3,801

 

$                 4,272

** **

For the years ended December 31, 2002,2001 and 2000, depreciation expense was approximately $ 1,897,$ 1,682 and $ 1,242, respectively.

 

** **

**NOTE 10:-         ACCOUNTS PAYABLE AND ACCRUED EXPENSES**

** **

 

 

December 31,

 

 

2002

 

2001

 

 

 

 

 

Trade  payables

 

$                 2,479

 

$                 2,271

Employees  and related accruals

 

1,358

 

2,041

Other  accrued expenses

 

1,112

 

575

 

 

 

 

 

 

 

$                 4,949

 

$                 4,887

 

** **

**NOTE 11:-         COMMITMENTS AND CONTINGENCIES**

 

a.         The Company`s research anddevelopment efforts have been partially financed through both royalty bearingand non-royalty bearing programs sponsored by the Office of the Chief Scientistof Israel ("OCS"). Under the royalty bearing programs, the Company isnot obligated to repay any amounts received from the OCS if the researchprogram that such grant relates to is unsuccessful. If the research program issuccessful, the Company is committed to pay royalties at a rate of 3% to 5% ofsales of the products arising from such research program, up to a maximum of100% of the amount received (for grants received under programs approvedsubsequent to January 1, 1999 the maximum to be repaid is 100% plus interest atLIBOR).

For the year ended December 31, 2002,the Company has paid and accrued royalties to the OCS in the amount of $ 40. Asof December 31, 2002, the Company`s potential maximum 
****____(92)____ 

 

**NOTE 11:-         COMMITMENTS AND CONTINGENCIES (Cont.)**

 

obligation forroyalties, based on royalty-bearing Government participation received oraccrued, net of royalties paid or accrued, totaled approximately $1,876 as of December 31, 2002. The liability for royalties to the OCS is recordedas cost of revenues at the time the related royalty-bearing sales arerecognized as revenues in the statement of operations.

 

b.         The Company`s and its Israelisubsidiary, Evogene`s headquarters and research facilities are located in Israel. The Company`s U.S. operations are located in Jamesburg, New Jersey andSunnyvale, California. Annual minimum future rental payments undernon-cancelable operating leases for such facilities as well as operating leaseagreements for vehicles, are approximatelyas follows:

 

2003

 

$                 681

2004

 

101

2005

 

79

 

 

 

 

 

$                 861

 

Rent expense wasapproximately $ 675, $ 1,020 and $ 566 for the years ended December 31, 2002,2001 and 2000, respectively.

 

c.         The Company obtained bankguarantees in the amount of $ 18 in favor of its lessor in Israel.

 

 

**NOTE 12:-         SHAREHOLDERS EQUITY**

 

a.         Ordinary shares:

 

The Ordinary sharesconfer upon their holders the right to receive notice, to participate and votein general shareholders meetings of the Company, and the right to receivedividends, if declared.

 

b.         Public offering:

 

In July 2000, theCompany completed a private placement of 5,538,462 Series C convertiblePreferred shares at a price of $6.50 per share, for an aggregate considerationof approximately $ 36,000 ($ 35,513 net of issuance expenses).  Asa result of the initial public offering in August 2000, the Company recorded anon-cash charge for Preferred share dividends of approximately $ 24,923,representing the value of the beneficial conversion feature of this issuancebased on the difference between the conversion price of $6.50 per share and theassumed offering price of $ 11.00 per share in the initial publicoffering.

 

c.         Share option plans:

 

In September 1996,the Company adopted the Compugen Ltd. Employee Share Option Plan, (1996) (the"Plan"), which provides for the grant of options to purchase 559,750Ordinary shares to employees and consultants of the Company and its subsidiaries.
**____(93)____ 

 

**NOTE 12:-SHAREHOLDERS' EQUITY (Cont.)**

 

In June 1998, theCompany adopted the Compugen Ltd. Share Option Plan (1998) (the "1998Plan"), which provides for the grant of options to purchase up to anaggregate of 2,500,000 Ordinary shares to directors, employees and consultantsof the Company and its subsidiaries. In March 2000, the Company adopted theCompugen Ltd. Share Option Plan (2000) (the "2000 Plan"), whichprovides for the grant of options to purchase 1,500,000 Ordinary shares toemployees and consultants of the Company and its subsidiaries. The number ofshares authorized for issuance under the 2000 plan automatically increases eachJanuary 1 by the lesser of 1,500,000 or 4% of the total number of the Company`sthen outstanding shares or such lower amount as shall be determined by theboard of directors. 

 

In general, optionsgranted under these plans vest over a four year period and expire ten yearsfrom the date of issuance. The exercise price of the options granted under theplans may not be less than the nominal amount of the shares into which suchoptions are exercised. Any options which are cancelled or forfeited beforeexpiration, become available for future grants. Subject to the 1998 and 2000plans, there were 626,969 and 335,911 options to purchase shares available forfuture grants as of December 31, 2002, respectively.

 

Transactions relatedto the grant of options to employees, directors and consultants under the aboveplans during the years ended December 31, 2002, 2001 and 2000, were as follows:

 

 

 

Year ended December 31,

 

 

2002

 

2001

 

2000

 

 

Shares

 

Weighted average exercise

price 

 

Shares

 

Weighted

average

exercise

price 

 

Shares

 

Weighted

average

exercise

price 

 

 

 

 

$

 

 

 

$

 

 

 

$

 

 

 

 

 

 

 

 

 

 

 

 

 

Options outstanding at beginning of year

 

4,877,416

 

3.71

 

3,446,916

 

3.66

 

 

2,614,486

 

1.44

Options granted

 

1,416,019

 

3.50

 

1,828,500

 

4.16

 

1,504,937

 

6.60

Options exercised

 

(114,022)

 

1.41

 

(66,968)

 

1.64

 

(578,981)

 

1.37

Options forfeited

 

(1,245,356)

 

4.18

 

(331,032)

 

6.04

 

(93,526)

 

3.00

 

 

 

 

 

 

 

 

 

 

 

 

 

Options outstanding at end of year

 

4,934,057

 

3.65

 

4,877,416

 

3.71

 

3,446,916

 

3.66

 

 

 

 

 

 

 

 

 

 

 

 

 

Exercisable at end of year

 

2,664,721

 

3.34

 

2,095,792

 

2.53

 

1,337,580

 

1.79

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average fair value of options granted 

 

 

 

1.49

 

 

 

1.68

 

 

 

5.78

 
**____(94)____ 

** **

**NOTE 12:-SHAREHOLDERS' EQUITY (Cont.)**

 

The following tablesummarizes information about options outstanding at December 31, 2002:

 

 

 

Options outstanding

 

Options exercisable

Range of exercise Price

 

Number outstanding at December 31, 2002

 

Weighted-average remaining contractual

life

 

Weighted-average exercise price

 

Number outstanding at December 31, 2002

 

Weighted-average exercise price

$

 

 

 

Years

 

$

 

 

 

$

** **

 

** **

 

** **

 

** **

 

** **

 

** **

1.33 - 1.80

 

1,623,013

 

6.97

 

1.52

 

1,110,817

 

1.48

2.03 - 2.06

 

316,000

 

4.44

 

2.04

 

307,248

 

2.04

3.00 - 4.49

 

2,040,513

 

8.64

 

4.19

 

639,767

 

4.16

5.00 - 6.88

 

644,072

 

7.20

 

5.50

 

420,919

 

5.42

9.00 - 10.00

 

310,459

 

7.46

 

9.06

 

185,970

 

9.06

 

 

 

 

 

 

 

 

 

 

 

 

 

4,934,057

 

 

 

 

 

2,664,721

 

 

 

Compensationexpenses recognized by the Company, related to its employee stock-basedcompensation awards, amounted to $ 1,001, $ 2,593 and $ 3,751 for the yearsended December 31, 2002, 2001 and 2000, respectively. Compensation expenses(income) related to the granting of stock options and warrants to consultantsamounted to $ (139), $ (1) and $ 1,930 for the years ended December 31, 2002,2001 and 2000, respectively (See also Note 12d), and are included in thefollowing expenses categories:

 

 

 

Year ended

December 31,

 

 

2002

 

2001

 

2000

 

 

 

 

 

 

 

Cost of  revenues

 

$                   (29)

 

$                   (11)

 

$                   156

Research and  development expenses

 

621

 

1,636

 

2,380

Sales and  marketing expenses

 

197

 

510

 

505

General and  administrative expenses

 

73

 

457

 

2,640

 

 

 

 

 

 

 

 

 

$                 862

 

$                 2,592

 

$                 5,681

 

For pro formainformation under SFAS No. 123, see Note 2o.

 

 

 
**____(95)____ 

 

**NOTE 12:-SHAREHOLDERS' EQUITY (Cont.)**

 

d.         Options and warrants toconsultants:

 

Issuance

Date

 

In connection

with

 

Number of

Options granted

 

 

 

Options

exercisable

 

 

Exercise

  price

per share

 

Exercisable

through

 

 

 

 

 

 

 

 

**$**

 

 

October 1998

 

Advisory board

 

30,000

 

30,000

 

1.33

 

October 2008

July 1999

 

Advisory board

 

15,000

 

12,520

 

1.35

 

July 2009

October 1999

 

Advisory board

 

30,000

 

30,000

 

1.33

 

October 2009

July 1999

 

Consulting

 

150,000

 

128,125

 

1.35

 

July 2009

March 2000

 

Consulting

 

75,000

 

51,579

 

5.00

 

March 2010

May 2000

 

Consulting

 

10,000

 

7,284

 

3.00

 

May 2010

May 2000

 

Consulting

 

35,000

 

35,000

 

10.00

 

May 2005

January 2002

 

Consulting

 

20,000

 

9,587

 

4.49

 

January  2012

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

365,000

 

304,095

 

 

 

 

 

The Company accountsfor its options and warrants to consultants under the fair value method of SFASNo. 123 and EITF 96-18. The fair value of these options was estimated using aBlack-Scholes option-pricing model. Changes in the fair value of the optionsand warrants prior to completion of performance are reflected as an adjustmentto the expense to be included in future periods over the vesting period. As forcompensation expenses, see Note 12c.

 

 

**NOTE 13:-         GEOGRAPHIC INFORMATION AND MAJOR CUSTOMERS**

 

The Company`sbusiness is currently comprised of one operating segment, the research,development and commercialization of products and services in the field ofcomputational genomics and proteomics. The nature of the products and servicesprovided by the Company and the type of customers for these products andservices are similar. Operation in Israel and the United  States include research anddevelopment, sales and marketing. Total revenues are attributed to geographic  areasbased on the location of the end customer. The Company has adopted SFAS No. 131"Disclosures About Segments of an Enterprise and Related Information".

 

The followingrepresents the total revenues for the years ended December 31, 2002, 2001 and 2000and long-lived assets as of December 31, 2002, 2001 and 2000:

 

 

 

Year ended December 31, 

 

 

2002

 

2001

 

2000

Revenues  from sales to unaffiliated customers:

 

 

 

 

 

 

       United    States

 

$                 6,273

 

$                 7,061

 

$                 6,469

       Europe

 

1,822

 

2,235

 

178

       Far East

 

680

 

875

 

144

       Other

 

487

 

195

 

100

 

 

 

 

 

 

 

 

 

$                 9,262

 

$                 10,366

 

$                 6,891

 

 

 

 

 

 

 

 
**____(96)____ 

** **

**NOTE 13:-         GEOGRAPHIC INFORMATION AND MAJOR CUSTOMERS(Cont.)**

 

 

 

Year ended December 31, 

 

 

2002

 

2001

 

2000

Long-lived  assets:

 

 

 

 

 

 

       Israel

 

$                 3,145

 

$                 3,241

 

$                 2,092

       United    States 

 

656

 

4,023

 

1,097

 

 

 

 

 

 

 

 

 

$                 3,801

 

$                 4,272

 

**$**3,189

 

 

 

Year ended December 31, 

 

 

2002

 

2001

 

2000

 

 

%

 

%

 

%

Sales to a  single customer exceeding 10%:

 

 

 

 

 

 

       Customer A

 

14

 

30

 

35

       Customer B

 

(*)

 

17

 

24

       Customer C

 

-

 

(*)

 

22

       Customer D

 

18

 

17

 

(*)

       Customer E

 

12

 

-

 

-

 

(*)   Lessthan 10%.

** **

** **

**NOTE 14:-         FINANCIAL AND OTHER INCOME, NET**

** **

 

 

Year ended December 31,

 

 

2002

 

2001

 

2000

Income  (expense):

 

 

 

 

 

 

Interest  income

 

$                 3,262

 

$                 4,253

 

$                 2,736

Interest expense and bank fees

 

(48)

 

(30)

 

(24)

Other  (includes exchange rate differences)

 

(374)

 

(348)

 

60

 

 

 

 

 

 

 

 

 

$                 2,840

 

$                 3,875

 

$                 2,772

** **

** **

**NOTE 15:-         TAXES ON INCOME**

 

a.         Measurement of taxable incomeunder the Income Tax (Inflationary Adjustments) Law, 1985:

 

Results for taxpurposes are measured in terms of earnings in NIS after certain adjustmentsfor increases in the Israeli CPI. As explained in Note 2b, the financialstatements are measured in U.S. dollars. The difference between the annualchange in the Israeli CPI and in the NIS/dollar exchange rate causes a furtherdifference between taxable income and the income before taxes shown in thefinancial statements. In accordance with paragraph 9(f) of SFAS No. 109, theCompany has not provided deferred income taxes on the difference between thefunctional currency and the tax bases of assets and liabilities.

 
**____(97)____ 

 

**NOTE 15:-         TAXES ON INCOME (Cont.)**

 

b.         Tax benefits under the Law for theEncouragement of Capital Investments, 1959 ("the Law"):

 

In 1994 theproduction facilities of the Company related to its computational technologieswere granted the status of an "Approved Enterprise" under the Law. In1996 and 2000 two expansion programs related to the Company's computationaltechnologies were granted the status of "Approved Enterprise". In 2000 and2001, the production facilities of the Company related to the Company`smolecular biology "wet lab" and manufacturing of seed species were grantedstatus of an "Approved Enterprise".

 

According to theprovisions of the Law, the Company has chosen to enjoy the "AlternativeBenefits" program - and accordingly, its income from the "ApprovedEnterprise" is tax-exempt for a period of 2 years, commencing in the firstyear the Company has taxable income, and subject to an additional period of 5to 8 years of reduced tax rates between 10% to 25%, depending upon theproportion of foreign ownership in the Company in each taxable year. Due to thereported losses the benefit period has not commenced. The period of taxbenefits is subject to limits of the earlier of 12 years from the commencementof production, or 14 years, from the approval date. Given the aforementionedconditions the period of tax benefits will terminate in the years 2008 to 2015.

 

The entitlement tothe above benefits is conditional upon the Company's fulfilling the conditionsstipulated by the above law, regulations published thereunder and theinstruments of approval for the specific investments in "approvedenterprises". In the event of failure to comply with these conditions, thebenefits may be canceled and the Company may be required to refund the amountof the benefits, in whole or in part including interest.

 

As of December 31, 2002,management believes that the Company is meeting all of the aforementionedconditions.

 

In the event ofdistribution of cash dividends from income that is tax exempt as mentionedabove, the Company would have to pay income tax equal to 10% to 25% of theamount distributed. The tax-exempt income attributable to the "ApprovedEnterprise" can be distributed to shareholders without subjecting theCompany to taxes only upon the complete liquidation of the Company. The Companycurrently has no plans to distribute dividends and intends to retain futureearnings to finance the development of its business.

 

Should the Companyderive income from sources other than the "Approved Enterprise"during the relevant period of benefits, such income will be taxable at theregular corporate tax rate of 36%. 

 

c.         Tax benefit under the Law for theEncouragement of Industry (Taxation), 1969:

 

The Company iscurrently qualified as an "industrial company" under the above law and as suchis entitled to certain tax benefits, including accelerated depreciation anddeduction of public offering expenses in three equal installments. 

 
**____(98)____ 

 

**NOTE 15:-         TAXES ON INCOME (Cont.)**

 

d.         Net operating lossescarryforwards:

 

Compugen Ltd. andEvogene Ltd. have a tax loss carryforward resulting from the years up to andincluding 2002  amounting to approximately $ 34 million which may becarried forward indefinitely. The Company`s tax assessments are consideredfinal through 1998.

 

Compugen Inc. issubject to U.S. income taxes and has a loss carryforward resultingfrom the years up to and including 2002 amounting to approximately $ 15million, which expires in the years 2012 to 2022.

 

Utilization of the U.S. netoperating losses may be subject to substantial annual limitation due to the"change in ownership" provisions of the Internal Revenue Code of 1986and similar state provisions. The annual limitation may result on theexpiration of net operating losses before utilization.

 

e.         Loss before taxes is comprised asfollows:

 

 

Year ended December 31,

 

 

2002

 

2001

 

2000

 

 

 

 

 

 

 

Domestic (Israel)

 

$                 7,532

 

$                 9,627

 

$                 11,176

Foreign

 

4,672

 

5,517

 

2,228

 

 

 

 

 

 

 

 

 

$                 12,204

 

$                 15,144

 

$                 13,404

 

Due to operatinglosses and the inability to recognize the benefits there from, there is noprovision for income taxes for the years ended December 31, 2002, 2001 and 2000.

 

f.          Deferred taxes:

 

The Company and itssubsidiaries' deferred tax assets amount to approximately $ 14,200 and  $ 9,800as of December 31, 2002 and 2001, respectively and are comprised of operatingloss carryforwards, non-cash dividends related to convertible Preferred sharesand other temporary differences mainly reserves and allowances.

 

As of December 31, 2002,the Company and its subsidiaries have provided valuation allowances ofapproximately $ 14,200 in respect of deferred tax assets resulting fromoperating loss carryforwards, non-cash dividend related to convertiblePreferred shares and other temporary differences. For the years ended December 31, 2002 and2001, the valuation allowance increased by $ 4,400 and $ 3,100, respectively.

 

Management currentlybelieves that since the Company and its subsidiary have a history of losses itis more likely than not that the deferred tax regarding the loss carryforwardsand other  temporary differences will not be realized in theforeseeable future.

 
**____(99)____ 

** **

**NOTE 16:-         RELATED PARTY TRANSACTIONS**

 

 

 

Year ended December 31,

 

 

2002

 

2001

 

2000

 

 

 

 

 

 

 

Consulting fees to director and shareholder

 

$                 150

 

$                 165

 

$                 150

 

 

**NOTE 17:-         SUBSEQUENT EVENTS (UNAUDITED)**

 

On January 6, 2003Evogene signed a convertible loan agreement with new investors for theaggregate amount of up to $ 2,000. Evogone has received an amount of $ 1,950out of the $ 2,000 available. Compugen did not participate in the investmentround. As part of the investment round Compugen agreed to forgive the entireconvertible loan amount and all accrued interest and to extend the term of thelicense granted until December 31, 2005 (see also Note 3).
**____(100)____ **************************************************************************************************************************************************************************************************************************************