RETALIX LTD.

The increase in cost of product sales as a percentage of product sales in 2005 was primarily attributable to the amortization of intangibles associated
with acquisitions. In 2004 and 2003, this increase resulted primarily from an increase in hardware associated sales attributable to our StoreNext USA
initiative. In July of 2002, we began to consolidate the results of StoreNext USA into our financial statements. Although historically we generated revenues
primarily from the sale of software and related services, StoreNext USA also generates revenues from the sale of third party point-of-sale hardware, which
generally has a higher associated cost of revenues and lower gross margins. We expect our gross margins for future periods to be lower than our historical
gross margins as a result of both the consolidation of the StoreNext USA results and our acquisition of IDS and OMI International, which generate a larger
portion of revenues from services, with a lower associated gross margin.
Operating Expenses
Research and Development Expenses, Net. These expenses are presented net of grants under programs of the Office of the Chief Scientist of the Ministry
of Industry, Trade and Labor of the Government of Israel. For more information, please see the discussion in Item 5.C below under “Grants from the
Office of the Chief Scientist”. The significant growth in research and development expenses reflects our considerable investments in integrating our
recently acquired supply chain and warehouse management systems into our synchronized suite of products as well as the efforts invested in developing
our next-generation applications and our recently introduced products. Although we believe that in 2004 and in 2005 our research and development
expenses were relatively high in comparison to what we expect in the long run as a percentage of revenues, we intend to continue to invest considerable
resources in research and development as we believe that this is essential to enable us to establish ourselves as a market leader in our fields of operation.
We view our research and development efforts as essential to our ability to successfully develop innovative products that address the needs of our
customers as the market for enterprise-wide retail software solutions evolves.
Selling and Marketing Expenses. During 2004 and 2005, we invested significant marketing efforts in increasing awareness of our new offerings in the
supply chain management area and in establishing a presence in new markets in Europe and Asia. During 2003, we focused primarily on the strengthening
of our sales and marketing force in the United States by recruiting highly experienced industry personnel, in order to better target the U.S. grocery sector.
We anticipate that selling and marketing expenses will continue to increase in absolute dollars as we expand our operations.
General and Administrative Expenses. In 2005, our general and administrative expenses continued to decrease as a percentage of sales, continuing the
trend from 2003 and 2004, largely because we were able to rely on our existing infrastructure to support our growth in revenues.
Financial Income (Expenses), Net
Year ended December 31, % Change % Change
2003 2004 2005 2003 2004 2005 2004 vs. 2003 2005 vs. 2004
(U.S. $ in millions) % of revenues
Research and development, net $ 18.3 $ 34.1 $ 44.7 20% 28% 24% 86% 31%
Selling and marketing 21.5 24.8 33.4 23% 20% 18% 15% 35%
General and administrative 13.4 15.9 23.1 15% 13% 12% 19% 45%
Other general income (expenses) 0.1 ----- ----- ----- ----- -----
Total operating expenses $ 53.3 $ 74.8 $ 101.2 58% 61% 54% 40% 35%
Financial income (expenses), net, totaled income of $202,000 in 2005 compared to income of $85,000 in 2004, and expenses of $95,000 in 2003.
The net income in 2004 and 2005 resulted primarily from interest earned on deposits and securities, net of financial expenses incurred on bank loans,
expenses resulting from sale of receivables and other bank charges. The net expense in 2003 resulted primarily from financial expenses incurred on bank
loans used to finance acquisitions.
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