UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 20-F
[ ] REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE
SECURITIES EXCHANGE ACT OF 1934
OR
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2001
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _________________ to ________________
Commission file number 000-26495
COMMTOUCH SOFTWARE LTD.
(Exact name of Registrant as specified in its charter and
translation of Registrant's name into English)
Israel
(Jurisdiction of incorporation or organization)
6 Hazoran Street Poleg Industrial Park, P.O. Box 8511 Netanya 42504,
Israel 011-972-9-863-6888
(Address of principal executive offices)
Securities registered or to be registered pursuant to Section 12(b) of the Act.
Title of each class Name of each exchange on which registered
------------------- -----------------------------------------
N/A None
Securities registered or to be registered pursuant to Section
12(g) of the Act.
Ordinary Shares, par value NIS 0.05 per share
---------------------------------------------
(Title of Class)
Securities for which there is a reporting obligation pursuant to
Section 15(d) of the Act.
None
Indicate the number of outstanding shares of each of the issuer's classes of
capital or common stock as of the close of the period covered by the annual
report (December 31, 2001).
Ordinary Shares, par value NIS 0.05 17,496,819
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter 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 statement item the registrant has
elected to follow. Item 17 [ ] Item 18 [X]
PART I
Item 1. Identity of Directors, Senior Management and Advisers.
Not applicable.
Item 2. Offer Statistics and Expected Timetable.
Not Applicable
Item 3. Key Information.
Unless otherwise indicated, all references in this document to "Commtouch," "the
Company," "we," "us" or "our" are to Commtouch Software Ltd. or its wholly-owned
subsidiaries, Commtouch Inc., Commtouch (UK) Ltd, Commtouch Latin America Inc.,
Wingra, Inc. and its majority-owned subsidiary, Commtouch K.K. (Japan).
The selected consolidated statements of operations data for the years ended
December 31, 1999, 2000 and 2001 and the selected consolidated balance sheet
data as of December 31, 2000 and 2001 have been derived from the Consolidated
Financial Statements of Commtouch included elsewhere in this report. The
selected consolidated statements of operations data for the years ended December
31, 1997 and 1998 and the selected consolidated balance sheet data as of
December 31, 1997, 1998 and 1999 have been derived from the Consolidated
Financial Statements of Commtouch not included elsewhere in this report. Our
historical results are not necessarily indicative of results to be expected for
any future period. The data set forth below should be read in conjunction with
"Item 5. Operating and Financial Review and Prospects" and the Consolidated
Financial Statements and the Notes thereto included elsewhere herein:
Year Ended December 31,
--------------------------------------------------------
1997 1998 1999 2000 2001
--------- -------- -------- -------- --------
(USD in thousands, except per share data)
Consolidated Statements of Operations Data:
Revenues:
Email services .................................. $ -- $ 389 $ 4,251 $ 17,965 $ 14,697
Software licenses, maintenance and services ..... 899 -- -- 1,150 621
--------- -------- -------- -------- --------
Total revenues ................................ 899 389 4,251 19,115 15,318
Cost of revenues:
Email services .................................. -- 569 3,643 11,864 14,605
Software licenses, maintenance and services ..... 165 -- -- -- --
--------- -------- -------- -------- --------
Total cost of revenues ........................ 165 569 3,643 11,864 14,605
--------- -------- -------- -------- --------
Gross profit (loss) ............................. 734 (180) 608 7,251 713
--------- -------- -------- -------- --------
Operating expenses:
Research and development, net ................... 1,108 1,149 2,942 10,357 7,278
Sales and marketing ............................. 2,202 2,001 7,722 26,585 13,496
General and administrative ...................... 829 604 4,328 13,621 11,236
In-process research and development ............. -- -- -- 1,280 --
Amortization of prepaid marketing expenses ...... -- -- 3,263 4,508 --
Amortization of goodwill and other purchased
intangibles ................................... -- -- -- -- 2,794
Write-off of impaired goodwill and other
intangible assets ............................. -- -- -- -- 13,280
Write-off of impaired property, equipment
and other ..................................... -- -- -- -- 10,166
Amortization of stock-based employee deferred
compensation .................................. -- 91 3,436 3,050 2,204
--------- -------- -------- -------- --------
Total operating expenses ...................... 4,139 3,845 21,691 59,401 60,454
Operating loss .................................... (3,405) (4,025) (21,083) (52,150) (59,741)
Interest and other income (expenses), net ......... (68) (326) 1,232 2,870 449
Write-off of impaired long-term investments ....... -- -- -- (5,000) (2,000)
Minority interest ................................. -- -- -- 55 285
--------- -------- -------- -------- --------
Net loss .......................................... $ (3,473) $ (4,351) $(19,851) $(54,225) $(61,007)
Basic and diluted net loss per share .............. $ (2.40) $ (3.00) $ (2.65) $ (3.51) $ (3.56)
Weighted average number of shares used in
Computing basic and diluted net loss per share .... 1,450 1,450 7,487 15,462 17,152
--------- -------- -------- -------- --------
2
December 31,
------------------------------------------------------------------
1997 1998 1999 2000 2001
-------- -------- --------- ------- --------
(in thousands)
Consolidated Balance Sheet Data:
Cash and cash equivalents........ $ 324 $ 834 $ 65,996 $20,831 $ 2,248
Marketable securities............ -- -- 18,050 8,607 --
Working capital (deficit)........ (1,264) (1,440) 88,053 23,768 (607)
Total assets..................... 1,065 2,366 100,336 77,280 9,545
Long-term liabilities............ 366 530 497 1,825 940
Shareholders' equity (deficit)... (1,108) (815) 95,312 61,728 4,059
The following data is presented:
o On an actual basis and
o On a pro forma as adjusted basis to give effect to the sale of
4,434,931 million ordinary shares in the private placement
approved by the shareholders on April 8, 2002, at an assumed price
of $0.292 per share.
December 31, December 31,
------------ ------------
2001 2001
---- ----
Pro Forma As
------------
Actual Adjusted
------ --------
(in thousands) (in thousands)
Consolidated Balance Sheet Data:
Cash and cash equivalents........ $ 2,248 $ 3,543
Working capital (deficit)........ (607) 688
Total assets..................... 9,545 10,840
Long-term liabilities............ 940 940
Shareholders' equity (deficit)... 4,059 5,354
FORWARD LOOKING STATEMENTS
This report contains forward-looking statements that involve risks and
uncertainties. These statements relate to our future plans, objectives, beliefs,
expectations and intentions. In some cases, you can identify forward-looking
statements by our use of words such as "expects," "anticipates," "believes,"
"intends," "plans," "seeks" and "estimates" and similar expressions. Our actual
results, levels of activity, performance or achievements may differ materially
from those expressed or implied by these forward-looking statements. Factors
that could cause or contribute to these differences include those discussed
below and elsewhere in this report.
RECENT DEVELOPMENTS
a. Private Placement
In February 27, 2002, Commtouch entered into a private placement agreement with
a few of its founders and new investors whereby Commtouch will issue
approximately 4.4 million ordinary shares against the investment of
approximately $1.3 Million in a private placement to private investors;
approximately one-third of the shares are being purchased by Commtouch's
founders, who are currently Commtouch directors and/or executive officers. The
purchasers in the private placement will also receive five-year warrants to
purchase up to an additional 2.66 million ordinary shares
3
(approximately). The exercise price for one-third of the warrants will be $0.37
per share, the exercise price for an additional one-third of the warrants will
be $1.00 per share and the exercise price for the final one-third of the
warrants will be $2.00 per share. This agreement was approved by the
shareholders on April 8, 2002. The Company plans to use the proceeds of this
placement for general corporate working capital. The funds were received on
April 15, 2002.
b. Sale of Wingra
Commtouch sold off its migration service business, Wingra, Inc. to Wingra's
senior management at the end of February 2002. The terms include mutual release
of all liabilities, obligations and rights of the parties to the agreement. This
sale reduced the Company's net liabilities by approximately $0.7 million.
c. Sale of Hosted Exchange
In January 2002, Commtouch sold its Hosted Exchange business to Telecomputing,
Inc. Terms of the transaction include the transference of the Company's customer
base and certain equipment to Telecomputing, in exchange for certain cash
payments and royalties. Furthermore, the Company assigned equipment leases to
Telecomputing, thereby eliminating the Company's obligation to make lease
payments thereunder.
d. Strategic Agreement with MailCentro
Within the framework of an agreement with MailCentro Inc. ("MC"), MC (a wholly
owned subsidiary of CP Software Group, Inc.) assumed all aspects of servicing
most of the Company's consumer customers, including its free email service known
as Zap Zone service. According to the agreement entered into with MC, the
Company transferred customers to MC and is expected to realize royalties on
payments made by these former customers to MC (primarily in 2002). Additionally,
certain Commtouch trademarks, domain names, software licenses and equipment were
sold to MC.
e. As a part of the Company's cost containment efforts, it reached settlement
agreements with a few of its vendors. Some of the settlement agreements included
issuance of shares or warrants while others included only cash payments. The
amount written off totaled approximately $0.8 million, which was deducted from
the relevant categories of operating expenses, and the Company also recorded
approximately $0.1 million compensation expenses regarding the warrants issued
and agreed to pay a letter of credit for approximately $1.0 million it had
previously issued to its landlord.
f. During 2001, the Company announced that it was implementing strategic
initiatives intended to further reduce costs. In connection with the strategic
initiatives, the Company recorded restructuring charges of approximately $11.2
million. The restructure included curtailing expenses and reducing the number of
employees. The cash and non-cash elements of the restructuring charge
approximate $2.0 million and $9.2 million, respectively (the non-cash charge
represents property, equipment and other write-downs).
g. Repricing
On April 30, 2001 the Company's Board of Directors approved the "repricing" of
options previously granted to employees according to certain criteria's.
Accordingly, the Company filed a Tender Offer which expired on September 14,
2001, and Commtouch has accepted for exchange options to purchase 1,273,513
Ordinary Shares. Previously granted options were cancelled and new options were
issued with an exercise price equal to the par value of the shares.
As of December 31, 2001, we had approximately $2.2 million of cash to fund
operations in 2002. In 2001 we utilized $24.7 million of cash to fund operating
losses and $5.7 million from investing activities, mainly proceeds from sales of
marketable securities. Net cash provided by financing activities was
approximately zero, after repayment of bank loans and notes payable of
approximately $1.0 million, net of approximately $1.0 million of proceeds from
issuance of shares and from minority interest in 2001. To limit our cash
expenses in 2002, we have significantly reduced staff, curtailed discretionary
expenses and limited capital expenditures. These actions were taken due to a
decline in our revenue growth resulting from competitive factors and a slowing
economic environment. To enhance our overall financial
4
position, we have entered into a private investment round, sold our Wingra
subsidiary to its senior management, entered into a strategic agreement with MC
(see item d, Recent Developments) and sold the Hosted Exchange business, such
that we may concentrate on providing software messaging solutions to service
providers.
Based on the cash balance at December 31, 2001, current projections of revenues,
related expenses, the ability to further curtail certain discretionary expenses,
sale of the Wingra subsidiary's net liabilities and completion of the private
investment round (as discussed below under Item 5, "Operating and Financial
Review and Prospects - Liquidity and Capital Resources"), the Company believes
it has sufficient cash to continue operations for at least the next twelve
months.
RISK FACTORS
You should carefully consider the following risk factors before you decide to
buy our ordinary shares. You should also consider the other information in this
report. If any of the following risks actually occur, our business, financial
condition, operating results or cash flows could be materially adversely
affected. This could cause the trading price of our ordinary shares to decline,
and you could lose part or all of your investment. The risks described below are
not the only ones facing us. Additional risks not presently known to us, or that
we currently deem immaterial, may also impair our business operations.
Business Risks
If the market does not respond favorably to our new messaging solutions and
related technologies, we will fail to generate revenues.
Our success will depend on the acceptance and use of our software messaging
solutions by service providers to provide email services to their customers. We
cannot estimate the size or growth rate of the potential market for our software
offerings. If the market for email software fails to grow or grows more slowly
than we currently anticipate, our business will suffer dramatically. Even if
that market grows, our solutions may not achieve broad market acceptance. Since
we have only recently released our new messaging platform for general
distribution, we do not have experience to evaluate whether it will achieve
broad market acceptance. Also, because a preponderance of our future revenue
will be derived directly or indirectly from our software messaging solutions, if
that market does not grow, our business will likely fail.
Our future revenues are unpredictable and our quarterly operating results may
fluctuate which could adversely affect the value of your investment.
Because we have a limited history with our new email solutions and because of
the emerging nature of the markets in which we compete, our revenue is
unpredictable. Our current and future expense levels (although greatly reduced)
are to a large extent fixed. We may be unable to adjust spending quickly to
compensate for any revenue shortfall, and any significant revenue shortfall
would have an immediate negative effect on our results of operations and share
price.
A number of factors, many of which are enumerated in this "Risk Factors"
section, are likely to cause fluctuations in our operating results and/or cause
our share price to decline. Other factors which may cause such fluctuations
include:
o The market acceptance of our new software messaging platform and
related solutions
o The size, timing and fulfillment of orders for our new software
messaging solutions;
o The success of our selling efforts to service providers;
o The rate of adoption of new software messaging solutions by
enterprise customers in the current economic environment;
o The threat of de-listing by the NASDAQ;
o The receipt or payment of irregular or nonrecurring revenues or
expenses;
5
o Our ability to successfully develop and market new solutions, as
may be needed;
o Pricing of our solutions; and
o Effectiveness of our customer support.
Because of differing operational factors and the material changes to our
business model, period-to-period comparisons of our operating results are not a
good indication of our future performance. It is likely that our operating
results in some quarters will be below market expectations. Because we are going
to market with new solutions and have sold most of our hosted email service
businesses, it is difficult to evaluate our business and prospects.
We commenced operations in 1991, but we are only beginning to try to sell our
new software messaging solutions after having sold outsourced Web-based email
services from 1998 through 2001, which itself was a change from our initial
focus on the sale, maintenance and servicing of stand-alone email client
software products for mainframe and personal computers. In late 2001 and early
2002, we sold essentially all of our hosted email service businesses to focus
exclusively on developing and selling new software messaging technologies. This
change required us to adjust our business processes and to restructure
Commtouch. Therefore, we have no operating history as a provider of our new
email technologies upon which you may be able to evaluate our business and
prospects. It is too early to judge the success of this business.
We have many established competitors who are offering similar solutions
The market for messaging technologies is intensely competitive and we expect it
to be increasingly competitive. Increased competition could result in pricing
pressures, low operating margins and the realization of little or no market
share, any of which could cause our business to suffer.
In the market for email and messaging software solutions, we compete directly
with software solution providers, including Critical Path, OpenWave, iPlanet
(Sun Microsystems), Mirapoint, Sendmail and Rockcliff, as well as with companies
that develop and maintain in-house email solutions, such as Microsoft and IBM.
Furthermore, certain small-scale email software providers offer low-cost basic
solutions, but with limited scalability or value-added functionality. These and
other companies could potentially leverage their existing capabilities and
relationships to enter the service provider email solutions industry.
Our market's level of competition is likely to increase as current competitors
increase the sophistication of their offerings and as new participants enter the
market. In the future, as we expand our offerings, we may encounter increased
competition in the development and distribution of these solutions. Many of our
current and potential competitors have longer operating histories, larger
customer bases, greater brand recognition and greater financial, marketing and
other resources than we do and may enter into strategic or commercial
relationships on more favorable terms. In addition, new technologies and the
expansion of existing technologies may increase competitive pressures on us. We
may not be able to compete successfully against current and future competitors.
Our ability to increase our revenues will depend on our ability to successfully
execute our sales and marketing plan.
The complexity of our software messaging solutions and the email software market
require highly trained sales and marketing personnel to educate prospective
customers regarding the use and benefits of our solutions. We have limited
experience in selling software solutions to service provider customers. It will
take time for our current and future employees to learn how to market our
solutions. Additionally, we are unable to predict the success in selling newly
introduced solutions in which we have no experience marketing and are relying on
these solutions to produce a substantial portion of our revenues in the future.
As a result of these factors, our sales and marketing organization may not be
able to compete successfully against the bigger and more experienced sales and
marketing organizations of our competitors.
We have a history of losses and may never achieve profitability.
We incurred net losses of approximately $19.9 million in 1999, $54.2 million in
2000 and $61.0 in 2001. As of December 31, 2001, we had an accumulated deficit
of approximately $146.8 million. We have not achieved profitability
6
in any period, and we might continue to incur net losses in the future. If we do
not achieve profitability, our share price may decline further.
Possible Need For Additional Funds
The Company is very thinly capitalized. As such, we might become dependent upon
raising additional funds to finance our business. Our cash balance at December
31, 2001 was $2.2 million. If we are unable to raise additional funds, the
Company could fail. There can be no assurance that we will be able to raise
necessary funds or that we will be able to do so on terms acceptable to us. If
needed, our inability to obtain adequate capital would limit our ability to
continue our operations. Any such additional funding may result in significant
dilution to existing stockholders.
Risk of Recession
Some of our former customers continue to operate in the dot-com market based on
internet-centric business models and are experiencing a significant economic
slowdown and an inability to raise additional capital.
These former customers were assigned to MailCentro, Inc. (a wholly owned
subsidiary of CP Software Group, Inc.) and Telecomputing, Inc. in connection
with the Company's agreements with these companies. According to these
agreements entered with MailCentro, Inc. and Telecomputing, Inc., the Company is
expected to realize royalties on payments made by these former customers to
MailCentro and Telecomputing (primarily in 2002). The ability of MailCentro and
Telecomputing to collect outstanding receivables is significantly impacted by
the liquidity issues of these customers, which may negatively impact our ability
to recognize future revenue based on the afore-stated royalties. As a result, we
may experience shortfalls in our future revenues.
The loss of our key employees would adversely affect our ability to manage our
business, therefore causing our operating results to suffer and the value of
your investment to further decline.
Our success depends on the skills, experience and performance of our senior
management and other key personnel. The loss of the services of any of our
senior management or other key personnel, including Gideon Mantel, our Chief
Executive Officer and Amir Lev, our President and Chief Technical Officer, could
materially and adversely affect our business. The loss of our software
developers may also adversely affect our messaging platform product, therefore
causing our operating results to suffer and the value of your investment to
decline. We do not have employment agreements inclusive of set periods of
employment with any of these key personnel. We cannot prevent them from leaving
at any time. We do not maintain key-person life insurance policies on any of our
employees.
Our recent head-count reduction from 210 employees to approximately 35 employees
is significantly straining our operational resources. We have significantly
curtailed sales and marketing resources and this may compromise our ability to
enhance revenues.
Our business and operating results could suffer if we do not successfully
address the risks inherent in doing business overseas.
At December 31, 2001 we had sales offices in Israel, United States and Japan. We
intend to continue to seek ways to market our software messaging solutions in
international markets by utilizing appropriate distributorship channels, i.e. by
way of our joint strategic relationship with Unisys and other foreign
representatives. We may not be able to compete effectively in international
markets due to various risks inherent in conducting business internationally,
such as:
o differing technology standards;
o inability of distribution channels to successfully market our
software messaging solutions;
o export restrictions, including export controls relating to
encryption technologies;
o difficulties in collecting accounts receivable and longer
collection periods;
7
o unexpected changes in regulatory requirements;
o political and economic instability;
o potentially adverse tax consequences; and
o potentially reduced protection for intellectual property rights.
Any of these factors could adversely affect the Company's international sales
and, consequently, business and operating results.
Terrorist attacks such as the attacks that occurred in New York and Washington,
D.C. on September 11, 2001 and other attacks or acts of war may adversely affect
the markets on which our ordinary shares trade, our financial condition and our
results of operations.
On September 11, 2001, the United States was the target of terrorist attacks of
unprecedented scope. These attacks have caused major instability in the U.S. and
other financial markets. There could be further acts of terrorism in the United
States or elsewhere that could have a similar impact. Leaders of the U.S.
government have announced their intention to actively pursue and take military
and other action against those behind the September 11, 2001 attacks and to
initiate broader action against national and global terrorism. Armed hostilities
or further acts of terrorism would cause further instability in financial
markets and could directly impact our financial condition and our results of
operations.
Technology Risks
We might not have the resources or skills required to adapt to the changing
technological requirements and shifting preferences of our customers and their
users.
The internet messaging industry is characterized by rapid technological change,
changes in end user requirements and preferences, and the emergence of new
industry standards and practices that could render our solutions and proprietary
technology obsolete. Our success depends, in part, on our ability to continually
enhance our existing email and messaging solutions and to develop new solutions,
functions and technology that address the increasingly sophisticated and varied
needs of our prospective customers and their users. The development of
proprietary technology and necessary enhancements entails significant technical
and business risks and requires substantial expenditures and lead-time. We may
not be able to keep pace with the latest technological developments. We may not
be able to use new technologies effectively or adapt to customer or end user
requirements or emerging industry standards. Also, we must be able to act more
quickly than our competition.
Our software may be adversely affected by defects, which could cause our
customers or end users to stop using our solutions.
Our solutions are based upon new and complex software. Complex software often
contains defects, particularly when first introduced or when new versions are
released. Although we conduct extensive testing, we may not discover software
defects that affect our new or current solutions or enhancements until after
they are delivered. Although we have not experienced any material software
defects to date in our service offering, it is possible that, despite testing by
us, defects may exist in the software we sell. These defects could cause service
interruptions for our customers that could damage our reputation, create legal
risks, cause us to lose revenue, delay market acceptance or divert our
development resources, any of which could cause our business to suffer.
Investment Risks
We may need additional capital.
8
We have invested heavily in technology development. We expect to continue to
spend financial and other resources on developing and introducing new offerings
and maintaining our corporate organizations and strategic relationships. We also
expect to invest resources in research and development projects to develop
enhanced service provider messaging solutions.
Based on the cash balance at December 31, 2001, current projections of revenues,
related expenses, the sale of the Wingra subsidiary and completion of the
private investment round (as discussed below under Item 5, "Operating and
Financial Review and Prospects - Liquidity and Capital Resources"), the Company
believes it has sufficient cash to continue operations for at least the next
twelve months.
We are subject to a class action lawsuit which may have a material adverse
effect on us.
Following our restatement of revenues for the first three quarters of 2000,
several class action lawsuits were filed in the United States District Court for
the Northern District of California against the Company and certain of our
officers and a director, alleging violations of the antifraud provisions of the
Securities Exchange Act of 1934 arising from the Company's financial statements.
These lawsuits were consolidated into one action in late 2001. Thereafter, the
Company filed a Motion to Dismiss, which has been granted, though the plaintiffs
have been granted leave to amend the complaint, which they are expected to do.
While we are unable to predict the ultimate outcome of the consolidated claim,
we believe that it is without merit and intend to continue to vigorously defend
ourselves.
If we cannot satisfy Nasdaq's maintenance requirements, it may delist our
ordinary shares and we may not have an active public market for our ordinary
shares, which would likely make our shares an illiquid investment.
Our ordinary shares are quoted on the Nasdaq National Market. To continue to be
listed, our shares must have a minimum bid price of $1.00 per share and we must
maintain a minimum market value of our publicly held shares of $5,000,000, among
other requirements. Our shares have a minimum bid price of less than $1.00 per
share and the minimum market value is under $5,000,000. Consequently, we do not
satisfy the Nasdaq listing requirements and may not be able to so in the future.
Nasdaq has recently notified us that our stock may be delisted as of May 15,
2002. If this occurs, trading in the shares may be conducted in the
over-the-counter market in the so-called "pink sheets" or, if available, the
"OTC Bulletin Board Service." As a result, an investor would likely find it
significantly more difficult to dispose of, or to obtain accurate quotations as
to the value of, our shares.
Nasdaq also may delist our shares if it deems it necessary to protect investors
and the public interest.
If our shares are delisted, they may become subject to the SEC's "penny stock"
rules and be more difficult to sell.
SEC rules require brokers to provide information to purchasers of securities
traded at less than $5.00 and not traded on a national securities exchange or
quoted on the Nasdaq Stock Market. If our shares become "penny stock" that is
not exempt from these SEC rules, these disclosure requirements may have the
effect of reducing trading activity in our shares and making it more difficult
for investors to sell. The rules require a broker-dealer to deliver a
standardized risk disclosure document prepared by the SEC that provides
information about penny stocks and the nature and level of risks in the penny
market. The broker must also give bid and offer quotations and broker and
salesperson compensation information to the customer orally or in writing before
or with the confirmation. The SEC rules also require a broker to make a special
written determination that the penny stock is a suitable investment for the
purchaser and receive the purchaser's written agreement to the transaction
before a transaction in a penny stock.
Our directors, executive officers and principal shareholders will be able to
exert significant influence over matters requiring shareholder approval and
could delay or prevent a change of control.
Our directors and affiliates of our directors, our executive officers and our
shareholders who currently individually own over five percent of our ordinary
shares, beneficially own, in the aggregate, approximately 18.5% of our
outstanding ordinary shares. If they vote together, these shareholders will be
able to exercise significant influence over all matters requiring shareholder
approval, including the election of directors and approval of significant
corporate transactions. This concentration of ownership could also delay or
prevent a change in control of Commtouch.
9
Jan Eddy, the President and Chief Executive Officer of Wingra Technologies,
beneficially owns approximately 5% of our outstanding ordinary shares issued to
her in connection with our acquisition of Wingra Technologies on November 24,
2000.
InfoSpace beneficially owns approximately 5% of our outstanding ordinary shares.
InfoSpace merged with Go2Net in October 2000. In connection with this merger
InfoSpace assumed Go2Net shares, warrants and rights. In 1999, in connection
with entering into an email services agreement, we issued to InfoSpace a warrant
to purchase 1,136,000 ordinary shares at an exercise price of $12.80 per share.
Concurrent with Commtouch Inc. entering into the email services agreement, we
issued 896,057 ordinary shares to InfoSpace and 448,029 in ordinary shares to
Vulcan Ventures in a private placement at $14.88 per share. We believe that
Vulcan Ventures divested itself of all of its shareholdings in the Company. The
warrant is non-forfeitable, fully vested and immediately exercisable, and will
expire in July 2004. Assuming exercise of the InfoSpace warrant on a net
issuance basis, the warrant currently has no impact on beneficial ownership, as
the warrant is currently underwater.
These significant shareholders will be able to significantly influence and
possibly exercise control over most matters requiring approval by our
shareholders, including the election of directors and approval of significant
corporate transactions. This concentration of ownership may also have the effect
of delaying or preventing a change in control. InfoSpace will also have the
right to name one director to our Board as long as it continues to hold at least
620,022 shares, including the shares issuable upon exercise of the InfoSpace
warrant. It named Thomas Camp to the Board under this provision, who resigned on
August 22, 2001 and was not replaced by Infospace. In addition, conflicts of
interest may arise as a consequence of these significant shareholders control
relationship with us, including:
o conflicts between significant shareholders, and our other
shareholders whose interests may differ with respect to, among
other things, our strategic direction or significant corporate
transactions;
o conflicts related to corporate opportunities that could be pursued
by us, on the one hand, or by these shareholders, on the other
hand; or
o conflicts related to existing or new contractual relationships
between us, on the one hand, and these shareholders, on the other
hand.
Substantial sales of our ordinary shares could adversely affect our share price.
The sale, or availability for sale, of substantial quantities of our ordinary
shares may have the effect of further depressing its market price. A large
number of our ordinary shares which were previously subject to resale
restrictions, are currently eligible for resale. In addition a significant
number of shares will be eligible for resale at various dates in the future,
should the private investment round close (as discussed below under Item 5,
"Operating and Financial Review and Prospects - Liquidity and Capital
Resources").
As previously announced and as discussed under Item 5, "Operating and Financial
Review and Prospects--Liquidity and Capital Resources," we have entered into a
private placement to issue shares and raise approximately $1.3 million. The
shares we will issue under this round will dilute existing shareholders.
Risk of failure to obtain registration rights for the private placement
As previously announced and as discussed under Item 5, "Operating and Financial
Review and Prospects--Liquidity and Capital Resources," we have entered into a
private placement, pursuant to which we are obligated to register with the SEC
the shares to be issued to investors. According to the agreement with the
investors, should the Company fail to meet certain deadlines for filing the
registration statement and achieving the effectiveness thereof, the Company
risks having imposed on it liquidated damages as defined in the agreement.
Intellectual Property Risks
If we fail to adequately protect our intellectual property rights or face a
claim of intellectual property infringement by a third party, we could lose our
intellectual property rights or be liable for significant damages.
10
We regard our copyrights, service marks, trademarks, trade secrets and similar
intellectual property as critical to our success, and rely on trademark and
copyright law, trade secret protection and confidentiality or license agreements
with our employees and customers to protect our proprietary rights. Third
parties may infringe or misappropriate our copyrights, trademarks and similar
proprietary rights. Although we have not filed any patent applications, we may
seek to patent certain software or other technology in the future. Any such
future patent applications may not be issued within the scope of the claims we
seek, or at all. We cannot be certain that our software does not infringe issued
patents that may relate to our software products. In addition, because patent
applications in the United States are not publicly disclosed until the patent is
issued, applications may have been filed which relate to our software products.
Despite our precautions, unauthorized third parties may copy certain portions of
our technology or reverse engineer or obtain and use information that we regard
as proprietary. In addition, the laws of some foreign countries do not protect
proprietary rights to the same extent as do the laws of the United States. Our
means of protecting our proprietary rights in the United States or abroad may
not be adequate and competitors may independently develop similar technology.
Governmental regulation and legal uncertainties could impair the growth of the
internet and decrease demand for our software messaging solutions or increase
our cost of doing business.
There are currently few laws and regulations directly applicable to the internet
and commercial email services. However, a number of laws have been proposed
involving the internet, including laws addressing user privacy, pricing,
content, copyright, antitrust, distribution and characteristics and quality of
products and services. Further, the growth and development of the market for
email may prompt calls for more stringent consumer protection laws that may
impose additional burdens on companies conducting business online. Moreover, the
applicability to the internet of existing laws in various jurisdictions
governing issues such as property ownership, sales and other taxes, libel and
personal privacy is uncertain and may take years to resolve. The adoption of
additional laws or regulations, or the application of existing laws or
regulations to the internet, may impair the growth of the internet or commercial
online services. This could decrease the demand for our software and increase
our cost of doing business, or otherwise harm our business and operating
results.
Risks Relating to Operations in Israel
We have important facilities and resources located in Israel, which has
historically experienced severe economic instability and military and political
unrest.
We are incorporated under the laws of the State of Israel. Our principal
research and development facilities are located in Israel. Although
substantially all of our past sales were made to customers outside Israel, we
are nonetheless directly influenced by the political, economic and military
conditions affecting Israel. Any major hostilities involving Israel, or the
interruption or curtailment of trade between Israel and its present trading
partners, could significantly harm our business, operating results and financial
condition.
Israel's economy has been subject to numerous destabilizing factors, including a
period of rampant inflation in the early to mid-1980's, low foreign exchange
reserves, fluctuations in world commodity prices, military conflicts and civil
unrest. In addition, Israel and some companies doing business with Israel have
been the subject of an economic boycott by Arab countries since Israel's
establishment. These restrictive laws and policies may have an adverse impact on
our operating results, financial condition or expansion of our business.
Since the establishment of the State of Israel in 1948, a state of hostility has
existed, varying in degree and intensity, between Israel and certain Arab
countries. Since September 2000, a continuous armed conflict with the
Palestinian Authority has been taking place. Although Israel has entered into
various agreements with certain Arab countries and the Palestinian Authority,
and various declarations have been signed in connection with efforts to resolve
some of the economic and political problems in the Middle East, Israel continues
to face hostile actions and threats from various elements in the region. We
cannot predict whether or in what manner these problems will be resolved.
Our results of operations may be negatively affected by the obligation of key
personnel to perform military service.
11
Certain of our officers and employees are currently obligated to perform annual
reserve duty in the Israel Defense Forces and are subject to being called for
active military duty at any time. Although Commtouch has operated effectively
under these requirements since its inception, we cannot predict the effect of
these obligations on Commtouch in the future. Our operations could be disrupted
by the absence, for a significant period, of one or more of our officers or key
employees due to military service.
Because a substantial portion of our revenues are generated in U.S. dollars and
a portion of our expenses are incurred in New Israeli Shekels, our results of
operations may be adversely affected by inflation and currency fluctuations.
We generate a substantial portion of our revenues in U.S. dollars and incur a
portion of our expenses, principally salaries and related personnel expenses in
Israel, in New Israeli Shekels, commonly referred to as NIS. As a result, we are
exposed to the risk that the rate of inflation in Israel will exceed the rate of
devaluation of the NIS in relation to 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 the dollar has generally exceeded the rate of
inflation, which is a reversal from prior years, we cannot be sure that this
reversal will continue. If the dollar cost of our operations in Israel
increases, our dollar-measured results of operations will be adversely affected.
Our operations also could be adversely affected if we are unable to guard
against currency fluctuations in the future. Accordingly, we may enter into
currency hedging transactions to decrease the risk of financial exposure from
fluctuations in the exchange rate of the dollar against the NIS. These measures,
however, may not adequately protect us from material adverse effects due to the
impact of inflation in Israel.
The government programs and benefits which we currently receive require us to
meet several conditions and may be terminated or reduced in the future.
Prior to 1998, we received grants from the Government of Israel, through the
OCS, for the financing of a significant portion of our research and development
expenditures in Israel. In 2001 and 2002, we applied for additional grants and
we may apply for additional grants in the future. In 1999 and 2000, we did not
receive any grants from the OCS. In 2001 we received $0.6 million and we expect
the percentage of our research and development expenditures financed from OCS
grants will continue to remain quite low. The OCS budget has been subject to
reductions which may affect the availability of funds for these grants in the
future. Therefore, we cannot be certain that we will continue to receive grants
at the same rate, or at all. In addition, the terms of any future OCS grants may
be less favorable than our past grants. In connection with research and
development grants received from the OCS, we must pay royalties to the OCS on
the revenue derived from the sale of products, technologies and services
developed with grants from the OCS.
The terms of the OCS grants and the law pursuant to which the grants are made
restrict our ability to manufacture products or transfer technologies developed
using OCS grants outside of Israel. This restriction may limit our ability to
enter into agreements for those products or technologies, without OCS approval.
We cannot be certain that the approvals of the OCS will be obtained on terms
that are acceptable to us, or at all. In connection with our grant applications,
we have made representations and covenants to the OCS. The funding from the OCS
is subject to the accuracy of these representations and covenants and to our
compliance with the conditions and restrictions imposed by the OCS. If we fail
to comply with any of these conditions or restrictions, we could be required to
repay any grants previously received, together with interest and penalties, and
would likely be ineligible to receive OCS grants in the future.
The Company received grants from the Government of Israel, through the OCS, for
the financing of a significant portion of its research and development
expenditures in Israel. The related funded projects ultimately failed and the
relevant payments were made for the revenues generated from these projects. The
Company will not be obligated to pay future royalties for such projects through
2001, since no future revenue is expected from these projects. Accordingly, the
Company decided to write down the $0.4 million accrual it recorded in past years
and determined that as of December 31, 2001 there are no contingent liabilities
for royalties from these projects. In March 2002, the Company submitted an
application for project failure with regard to these projects. However, the
ultimate liability is subject to the review of the Israeli government. With
regard to the grant received in 2001, a contingent liability of $0.6 million
exists.
The tax benefits we are currently entitled to from the Government of Israel may
be reduced or terminated in the future.
Pursuant to the Law for the Encouragement of Capital Investments, the Government
of Israel through the Investment Center has granted "approved enterprise" status
to a portion of our capital investment programs. The portion of our
12
income derived from our approved enterprise program will be exempt from tax for
a limited period of two years commencing in the first year in which we have
taxable income, and will be subject to a reduced tax for an additional period of
five to eight years dependent on the percentage of foreign shareholders. The
benefits available to an approved enterprise are conditioned upon the
fulfillment of conditions regarding a required amount of investments in fixed
assets and a portion of these investments being made with net proceeds of equity
capital raised by us as stipulated in applicable law and in the specific
certificates of approval. If we fail to comply with these conditions, in whole
or in part, we may be required to pay additional taxes for the period in which
we benefited from the tax exemption or reduced tax rates and would likely be
denied these benefits in the future. From time to time, the Government of Israel
has discussed reducing or eliminating the benefits available under the approved
enterprise program. It is possible that these tax benefits may not be continued
in the future at their current levels or at all.
Israeli courts might not enforce judgments rendered outside of Israel and it
might therefore be difficult for an investor to recover any judgment against any
of our officers or directors resident in Israel.
We are organized under the laws of Israel, and we maintain significant
operations in Israel. Certain of our officers and directors named in this report
reside outside of the United States. Therefore, you might not be able to enforce
any judgment obtained in the U.S. against us or any of such persons. You might
not be able to bring civil actions under U.S. securities laws if you file a
lawsuit in Israel. However, we have been advised by our Israeli counsel that,
subject to certain limitations, Israeli courts may enforce a final judgment of a
U.S. court for liquidated amounts in civil matters after a hearing in Israel. We
have appointed Commtouch Software Inc., our U.S. subsidiary, as our agent to
receive service of process in any action against us arising from this report. We
have not given our consent for our agent to accept service of process in
connection with any other claim and it may therefore be difficult for an
investor to effect service of process against us or any of our non-U.S.
officers, directors and experts relating to any other claims. If a foreign
judgment is enforced by an Israeli court, it may be payable in Israeli currency.
Provisions of Israeli law may delay, prevent or make difficult an acquisition of
Commtouch, which could prevent a change of control and therefore depress the
price of our shares.
Israeli corporate law regulates mergers, votes required to approve mergers and
acquisitions of shares through tender offers, requires special approvals for
transactions involving significant shareholders and regulates other matters that
may be relevant to these types of transactions. Furthermore, Israel tax
considerations may make potential transactions unappealing to us or to some of
our shareholders.
Proposed tax reform in Israel may reduce our tax benefits, which might adversely
affect our profitability.
On May 4, 2000, a committee chaired by the former Director General of the
Israeli Ministry of Finance issued a report recommending a sweeping reform in
the Israeli system of taxation. The proposed reform would significantly alter
the taxation of individuals, and would also affect corporate taxation. In
particular, the proposed reform would reduce, but not eliminate, the tax
benefits available to approved enterprises such as ours. The Israeli cabinet
approved the recommendations in principle, but implementation of the reform
requires legislation by Israel's Knesset. In the interim there have been
significant political and economic changes. On February 26, 2002 the Minister of
Finance appointed a new committee to recommend tax reforms, and this committee
is expected to submit a report within 90 days. The Company cannot be certain
whether the proposed reform will be adopted, when it will be adopted or what
form any reform will ultimately take.
Item 4. Information on the Company.
Overview
We are a provider of email services and software for email and messaging
solutions to service providers that target both residential and business
subscriber users.
Our main target customers include companies that specialize in providing
communications applications to enterprises, such as, ASPs, ISPs, telecoms,
CLECs, wireless carriers, data centers, systems integrators, and IT consultants.
13
Email and messaging is complex and requires focus to implement, deliver and
maintain. Today's solutions include the ability to address both front-end and
back-end requirements, anytime-anywhere access, and features such as anti-virus
protection, unified messaging, calendaring, group scheduling, file sharing, and
collaboration. Technologies for the future are necessitating that email and
messaging adapt and change with the new innovations. Our flexible technology and
economies of scale enable us to provide email solutions in a cost-effective
manner, intended to allow businesses to achieve desirable economic advantages.
These technologies have been conceived, developed and refined over the course of
the past 11 years, during which we have provided both services and software to a
multitude of customers.
Commtouch Offerings
We offer software for email and messaging solutions to service providers, mainly
small and medium size enterprises (SME). Service providers receive a license to
install and use our software and technology in order to provide messaging and
email services from their own data center facility. Our service provider
solution enables service providers to easily manage the email and messaging
features/services that they in turn provide to their end users.
We deliver a comprehensive software solution that -
o Enables ISP business subscribers to enjoy advanced messaging
applications.
o Enables service providers to offer packages of email services.
With Commtouch Classes of Service (CoS), service providers can
create different packages of service to their diversified
subscribers and market each package separately.
o Enables service providers to simplify deployment and manageability
of a highly-scalable messaging platform for residential and
business subscribers, and to achieve high performance and
maximized utilization at a competitive low cost (i.e. low
hardware, bandwidth and administration costs).
Our solution provides:
o Access to accounts from standard desktop email clients (e.g.
Microsoft Outlook and Qualcomm Eudora), Web browsers and wireless
devices, such as, WAP-enabled mobile phones.
o Message notification on an advanced platform, to pagers, mobile
phones, instant messengers and other email addresses.
o Integrated, Web-based applications, including calendar, task
manager, contact center, notes, short message service (SMS), and
more.
o Customization of the Web email client interface to extend an
organization's brand.
o Multiple language support for a multilingual user base.
Competitive Landscape
Discussed above under Item 3 - RISK FACTORS/Business Risks
14
Intellectual Property
We regard our copyrights, service marks, trademarks, trade secrets and similar
intellectual property as critical to our success, and rely on trademark and
copyright law, trade secret protection and confidentiality and/or license
agreements with our employees, customers, partners and others to protect our
proprietary rights. We have the following registered trademarks: COMMTOUCH
(registered in the U.S., Israel, European Union, China, Mexico, New Zealand,
Norway, South Korea and Australia); PRONTO (Canada and South Korea); COMMTOUCH
SOFTWARE (Australia and New Zealand); PRONTO FAMILY, PRONTO SECURE (Japan);
PRONTO MAIL (Japan and New Zealand); We also have the following pending
trademark applications: COMMTOUCH (Taiwan, Russian Federation, Japan, India,
Canada and Brazil), and PRONTO (European Community). At the end of 2001, we
assigned our ZAPZONE and ZZN trademarks to CP Software Group, Inc., within the
framework of our transaction with MailCentro.
It may be possible for unauthorized third parties to copy or reverse engineer
certain portions of our products or obtain and use information that we regard as
proprietary. In addition, the laws of some foreign countries do not protect
proprietary rights to the same extent as do the laws of the United States. There
can be no assurance that our means of protecting our proprietary rights in the
United States or abroad will be adequate or that competing companies will not
independently develop similar technology.
Other parties may assert infringement claims against us. We may also be subject
to legal proceedings and claims from time to time in the ordinary course of our
business, including claims of alleged infringement of the trademarks and other
Intellectual property rights of third parties by ourselves and our licensees.
Such claims, even if not meritorious, could result in the expenditure of
significant financial and managerial resources.
We also continue to hold a perpetual mail server license which was utilized in
our hosted service offering and is still being utilized to service certain
customers, and may continue to license SSL encryption and other technology as
the need arises. We cannot be certain that, apart from the mail server license,
other third-party content licenses will be available to us on commercially
reasonable terms or that we will be able to successfully integrate the
technology into our products. These third-party in-licenses may expose us to
increased risks, including risks associated with the assimilation of new
technology, the diversion of resources from the development of our own
proprietary technology, and our inability to generate revenues from new
technology sufficient to offset associated acquisition and maintenance costs.
The inability to obtain any of these licenses could result in delays in product
development until equivalent technology can be identified, licensed and
integrated. Any such delays could cause our business/financial condition and
operating results to suffer.
Government Regulation
Since the September 11, 2001 terrorist attacks on the United States, governments
worldwide are taking a closer look at various issues that may affect the privacy
of individuals. In the U.S., the Federal Trade Commission chairman announced a
broad privacy agenda and stricter enforcement of current privacy rules, relating
to both online and offline activities. Further, the U.S. Congress recently
passed the USA Patriot Act which, among other things, broadens the powers of law
enforcement officials to intercept electronic communications in the name of the
fight against terrorism. Other laws and regulations directly applicable to the
internet and commercial email services include the Electronic Communications
Privacy Act, Children's Online Privacy Protection Act and related regulations in
the U.S. and restrictions on the export of personal data from the European
Community (according to the European Directive, which has been adopted in
various forms by many European Community member states). It is possible that a
number of laws and regulations may be adopted in the future with respect to the
internet or commercial email services covering issues such as user privacy,
pricing, content, copyright, distribution, antitrust and characteristics and
quality of products and services. Further, the growth and development of the
market for online email may prompt calls for more stringent consumer protection
laws that may impose additional burdens on companies conducting business online.
The adoption of additional laws or regulations may impair the growth of the
internet or commercial online services, which could, in turn, decrease the
demand for our products and increase our cost of doing business, or otherwise
have a material adverse effect on our business, operating results and financial
condition. Moreover, the applicability to the internet of existing laws in
various jurisdictions governing issues such as property ownership, sales and
other taxes, libel and personal privacy is uncertain and may take years to
resolve. Any such new legislation or regulation, the application of laws and
regulations from jurisdictions whose laws do not currently apply to our business
or the application of existing laws and regulations to the internet could have a
material adverse effect on our business, operating results and financial
condition.
15
Employees
As of December 31, 2001, 2000 and 1999, we had 92, 486 and 214 full-time
employees, respectively. We sold the Hosted exchange business and our migration
services subsidiary in early 2002, and on March 1, 2002, we had 35 full-time
employees. None of our U.S. employees are covered by a collective bargaining
agreement. We believe that our relations with our employees are good.
Israeli law and certain provisions of the nationwide collective bargaining
agreements between the Histadrut (General Federation of Labor in Israel) and the
Coordinating Bureau of Economic Organizations (the Israeli federation of
employers' organizations) apply to Commtouch's Israeli employees. These
provisions principally concern the maximum length of the workday and workweek,
minimum wages, contributions to a pension fund, insurance for work-related
accidents, procedures for dismissing employees, determination of severance pay
and other conditions of employment. Furthermore, pursuant to such provisions,
the wages of most of Commtouch's Israeli employees are subject to cost of living
adjustments, based on changes in the Israeli Consumer Price Index. The amounts
and frequency of such adjustments are modified from time to time. Israeli law
generally requires the payment of severance pay upon the retirement or death of
an employee or upon termination of employment by the employer or, in certain
circumstances, by the employee. We currently fund our ongoing severance
obligations by making monthly payments for insurance policies and by an accrual.
A general practice in Israel followed by Commtouch, although not legally
required, is the contribution of funds on behalf of certain employees to an
individual insurance policy known as "Managers' Insurance." This policy provides
a combination of savings plan, insurance and severance pay benefits to the
insured employee. It provides for payments to the employee upon retirement or
death and secures a substantial portion of the severance pay, if any, to which
the employee is legally entitled upon termination of employment. Each
participating employee contributes an amount equal to 5% of such employee's base
salary, and the employer contributes between 13.3% and 15.8% of the employee's
base salary. Full-time employees who are not insured in this way are entitled to
a savings account, to which each of the employee and the employer makes a
monthly contribution of 5% of the employee's base salary. We also provide
certain Israeli employees with an Education Fund, to which each participating
employee contributes an amount equal to 2.5% of such employee's base salary, and
the employer contributes an amount equal to 7.5% of the employee's base salary.
Description of Property
Our principal executive offices are located at 6 Hazoran Street, Poleg
Industrial Park, Netanya 42504, Israel, where our telephone number is
011-972-9-863-6888, and 2029 Stierlin Court, Mountain View, California 94043,
where our telephone number is (650) 864-2000. All of our facilities are leased.
We were incorporated in Israel under the laws of Israel on February 5, 1991. Our
Articles of Association are on file in Israel with the office of the Israeli
Registrar of Companies and available for public inspection from the Registrar.
Item 5. Operating and Financial Review and Prospects.
The following discussion should be read in conjunction with the Consolidated
Financial Statements and the Notes thereto included elsewhere in this report.
This discussion contains forward-looking statements based upon current
expectations that involve risks and uncertainties. Any statements contained
herein that are not statements of historical fact may be deemed to be
forward-looking statements. For example, the words "expects," "anticipates,"
"believes," "intends," "plans," "seeks" and "estimates" and similar expressions
are intended to identify forward-looking statements. Commtouch's actual results
and the timing of certain events may differ significantly from those projected
in the forward-looking statements. Factors that might cause future results to
differ materially from those projected in the forward-looking statements
include, but are not limited to, those set forth under "Item 3. Key
Information." and in the Company's other filings with the Securities and
Exchange Commission.
Overview
During 2001, our main business was providing outsourced integrated Web-based
email and messaging solutions to businesses. Our solutions are flexible, highly
customizable and enable us to satisfy the unique email and messaging needs of
our customers worldwide. Our customers are large and small businesses who offer
our Web-based email through their website to their end users and employees.
Commtouch is currently the developer and provider of comprehensive and highly
scalable messaging solutions through its Commtouch Messaging Platform (CMP) for
service providers such as ISPs, ASPs, Data Centers, telcos and Wireless
Operators. The CMP offers service providers an opportunity to increase revenue
from their business and residential subscribers utilizing CMP's advanced
messaging services, which can be deployed and managed easily and quickly.
16
Critical Accounting Policies and Estimates
Operating and Financial Review and Prospects are based upon the Company's
consolidated financial statements, which have been prepared in accordance with
accounting principles generally accepted in the United States. The preparation
of these financial statements requires management to make estimates and
judgments that affect the reported amounts of assets, liabilities, revenues and
expenses and related disclosure of contingent assets and liabilities. Management
believes the critical accounting policies and areas that require the most
significant judgments and estimates to be used in the preparation of the
consolidated financial statements are revenue recognition, allowance for
doubtful accounts, impairment and commitments and contingencies.
Revenue recognition
Revenue is recognized when the earnings process is complete, as evidenced by an
agreement between the customer and the company, when delivery has occurred or
services have been rendered, when the fee is fixed or determinable and when
collection is probable. The company's revenue recognition policy is discussed in
Note 2 of Notes to Consolidated Financial Statements. The recognition of revenue
in conformity with accounting principles generally accepted in the United States
requires the company to make estimates and assumptions that affect the reported
amounts of revenue. Estimates related to the recognition of revenue include the
accumulated provision for revenues subject to refund and other. As additional
information becomes available, or actual amounts are determinable, the recorded
estimates are revised. Consequently, operating results can be affected by
revisions to prior accounting estimates.
Allowance for Doubtful Accounts
We maintain allowances for doubtful accounts for estimated losses from our
customers' inability to make payments they owe us. In order to estimate the
appropriate level of this allowance, we analyze historical bad debts, customer
concentrations, current customer credit-worthiness, current economic trends and
changes in our customer payment patterns. If the financial condition of our
customers were to deteriorate and to impair their ability to make payments to
us, additional allowances might be required in future periods.
Impairment
We assess the fair value and recoverability of our long-lived assets, including
goodwill, whenever events and circumstances indicate the carrying value of an
asset may not be recoverable from estimated future cash flows expected to result
from its use and eventual disposition. In doing so, we make assumptions and
estimates regarding future cash flows and other factors to make our
determination. The fair value of our long-lived assets and goodwill is dependent
upon the forecasted performance of our business, changes in our industry and the
overall economic environment. When we determine that the carrying value of our
long-lived assets and goodwill may not be recoverable, we measure any impairment
based upon a forecasted discounted cash flow method. If these forecasts are not
met, we may have to record additional impairment charges not previously
recognized.
During 2001, we performed an assessment of the goodwill and other intangible
assets related to our acquisition of Wingra, Inc., pursuant to SFAS No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed Of." In 2001, a change in the business environment resulted in
significantly less demand for Wingra's migration services and the number of
potential customers seeking these services diminished greatly. Consequently, we
revised our forecasted cash flows from the migration service and determined that
the decline in the market conditions was material and other than temporary.
After using an undiscounted cash flow model of the future cash flows forecasted
to be generated from sales of migration services and discussions with potential
buyers for Wingra, we determined that there was an impairment and the size of
the impairment. As a result, we recorded a charge of approximately $13.2 million
during 2001 to reduce goodwill and other intangible assets associated with the
purchase of Wingra to zero. During 2001, we recorded approximately $2.8 million
of amortization of goodwill and other intangible assets relating to Wingra.
17
Contingencies
Commtouch periodically records the estimated impacts of various conditions,
situations or circumstances involving uncertain outcomes. These events are
called "contingencies", and Commtouch's accounting for such events is prescribed
by Statement of Financial Accounting Standards No. 5, "Accounting for
Contingencies" ("SFAS No. 5") SFAS No. 5 defines a contingency as "an existing
condition, situation, or set of circumstances involving uncertainty as to
possible gain or loss to an enterprise that will ultimately be resolved when one
or more future events occur or fail to occur."
SFAS No. 5 does not permit the accrual of gain contingencies under any
circumstances. For loss contingencies, the loss must be accrued if (1)
information is available that indicates it is probable that the loss has been
incurred, given the likelihood of the uncertain future events; and (2) that the
amount of the loss can be reasonably estimated.
The accrual of a contingency involves considerable judgment on the part of
management. Commtouch uses its internal expertise, and outside experts (such as
lawyers, tax specialists and engineers), as necessary, to help estimate the
probability that a loss has been incurred and the amount (or range) of the loss.
The Company has recorded contingencies in situations where management determined
it was probable a loss had been incurred and it could be reasonably estimated.
Revenue Sources
Service Fees. During 2001 and 2000, most of our email service revenues resulted
from contracts that required our customers to pay us a monthly per emailbox
price subject to a minimum commitment fee and fees for direct marketing and
communications services. In addition, the Company recognized revenue from sales
of software licenses to end users.
Prior to 1999, some of our contracts with customers provided for email service
fees based solely on a share of banner advertising revenue, recognized only when
such revenues were earned by the customers, with no minimum annual commitment.
Direct E-marketing. E-commerce vendors seek channels through which they can
market goods and services. Because of our installed user base and our agreements
with our customers, we can assist e-commerce companies in distributing their
services to our customers' end users who have opted to receive offers by email.
We share with our customers the revenues from this direct e-marketing, which are
earned either on a per-message basis, a referral basis, or as a commission on
products sold. In the fourth quarter of 1998, we began to offer direct
e-marketing opportunities to e-commerce vendors on a test basis. In 1999, we
recognized 11% of our total revenues from MyPoints, a permission based email
service company. In 2001 and 2000, no direct e-marketing customer provided more
then 10% of revenues.
Strategic Transaction with Go2Net (InfoSpace)
InfoSpace merged with Go2Net in October 2000. In connection with this merger
InfoSpace assumed Go2Net shares, warrants and rights.
In 1999, concurrent with the sale of our shares in the initial public offering,
we entered into a service agreement with InfoSpace, a network of branded,
technology- and community-driven websites focused on personal finance, commerce,
and games. InfoSpace also develops Web-related software. Pursuant to the
agreement we were offering InfoSpace's end users a private label email service,
including our email, calendaring and other services. The services were
customized to the look and feel of InfoSpace's websites. The terms of this
agreement were substantially the same as our commercial agreements with other
customers except that we had agreed to share a materially greater portion of our
advertising revenues with InfoSpace than we are sharing under other similar
agreements. In addition, in connection with the agreement, we issued to
InfoSpace a warrant to purchase 1,136,000 ordinary shares at a per share
exercise price of $12.80, subject to adjustment as set forth in the warrant. The
warrant is fully vested and non-forfeitable. The warrant will expire on July 16,
2004, the fifth anniversary of the initial public offering. The fair value of
the warrant, estimated at $5.8 million, was amortized to operating expenses
ratably over the minimum term of the agreement (one year) and was fully
amortized at the end of 2000. Simultaneously with the sale of the shares in the
initial public offering, we issued a total of 1,344,086 ordinary shares to
InfoSpace and Vulcan Ventures Incorporated at $14.88 per share in a
18
private placement. In the future, we may have to issue in-the-money warrants to
acquire our ordinary shares to marketing channels who provide us with a large
base of potential end users. We may also have to provide these customers with
more favorable commercial terms than we have previously provided to our
customers. The issuance of in-the-money warrants and the grant of more favorable
terms to marketing channels may further dilute our shareholders, increase our
operating loss in the future and cause our stock price to fall. Recently, the
service agreement of 1999 was replaced by a new agreement, effective February 1,
2002 having a one year duration, but InfoSpace has the right to terminate the
agreement at any time upon thirty (30) days written notice. InfoSpace also has
the right to terminate the agreement if there are technical problems with the
products or services provided. The performance specifications set forth in the
agreement include the maintenance of certain levels of email system availability
and response time. Infospace is to pay a quarterly fee of $7,500 for use of up
to 10,000 mailboxes. This agreement has been assigned to MailCentro, Inc., the
party which assumed the servicing of most of our consumer business, effective
March 1, 2002. Commtouch Inc. will continue to receive a portion of the revenues
from this agreement for a maximum period of one year from the above date of
assignment.
Results of Operations
The following table sets forth financial data for the years ended December 31,
1999, 2000 and 2001 (in thousands):
Year Ended December 31,
--------------------------------
1999 2000 2001
-------- -------- --------
Revenues:
Email services .................................... $ 4,251 $ 17,965 $ 14,697
Software license revenues ......................... -- 1,150 621
-------- -------- --------
Total revenues .................................... 4,251 19,115 15,318
-------- -------- --------
Cost of revenues:
Email services .................................... 3,643 11,864 14,605
Software license revenues ......................... -- -- --
-------- -------- --------
Total cost of revenues ............................ 3,643 11,864 14,605
-------- -------- --------
Gross profit ...................................... 608 7,251 713
-------- -------- --------
Operating expenses:
Research and development, net ..................... 2,942 10,357 7,278
Sales and marketing ............................... 7,722 26,585 13,496
General and administrative ........................ 4,328 13,621 11,236
In-process research and development ............... -- 1,280 --
Amortization of prepaid marketing expenses ........ 3,263 4,508 --
Amortization of stock-based employee deferred ..... 3,436 3,050 2,204
compensation
Amortization of goodwill and other purchased ...... -- -- 2,794
intangibles
Write-off of impaired goodwill and other intangible -- -- 13,280
assets
Write-off of impaired property, equipment and other -- -- 10,166
-------- -------- --------
Total operating expenses .......................... 21,691 59,401 60,454
-------- -------- --------
Operating loss ..................................... (21,083) (52,150) (59,741)
Interest and other income, net .................... 1,232 2,870 449
Write-off impaired long-term investments .......... -- (5,000) (2,000)
Minority interest ................................. -- 55 285
-------- -------- --------
Net loss ........................................... $(19,851) $(54,225) $(61,007)
======== ======== ========
Comparison of Years Ended December 31, 2001 and 2000
Revenues. Email service revenues decreased 18% from $18.0 million in 2000 to
$14.7 million in 2001. We recognized revenue of $0.6 million and $1.1 million,
from the sale of licenses in 2001 and 2000, respectively. In 2001 and 2000, no
customer accounted for more than 10% of revenues.
19
Cost of Revenues. Cost of revenues increased 23% from $11.9 million in 2000 to
$14.6 million in 2001, due to the increase in depreciation costs as we ramped up
during 2000. Cost of revenues consisted primarily of costs related to internet
data center services from third-party providers, depreciation of equipment,
internet access, personnel and related costs. In 2000 we sized our hosting
infrastructure for substantial growth. Recently, in light of the agreement with
MailCentro and sale of the Hosted Exchange business, we have decreased our
hosting infrastructure costs.
Research and Development, Net. Research and development expenses decreased 28%
from $10.4 million in 2000 to $7.3 million in 2001 due to the decrease in
personnel and other related costs. In 2001, we received royalty-bearing grants
totaling $0.6 million from the Israeli government, which were recorded as a
reduction of research and development costs. The Israeli government requires
beneficiaries of such grants to pay royalties to the Israeli government based on
the revenues derived from the sale of products, technologies and services
developed with such grants. We believe that we have no obligation for royalties
in 2001, related to the 2001 grants, since we had not started generating revenue
for the product developed with such grants, but we may have obligations for
royalties in 2002 and future years. Moreover, we believe that we have no
obligation for royalties in 2001 for the previous years' funded projects as
these projects failed and we do not generate revenue or expect to generate
revenue from these projects. Nevertheless, the ultimate liability is subject to
review by the OCS.
During 2001, we reduced research and development personnel by eliminating
certain projects, while only maintaining a core project aligned with our
strategic direction. Based on these eliminations, we expect to maximize the
benefits of this cost reduction during 2002.
Sales and Marketing. Sales and marketing expenses decreased 49% from $26.6
million in 2000 to $13.4 million in 2001, due to decreased personnel and related
costs, public relations, other marketing expenses and direct sales costs in line
with reduced expected revenue levels and the Company's channel selling and
marketing focus in 2001. Previously, Company personnel were focused on direct
sales efforts. We expect these costs to decrease in absolute terms in 2002 due
to the agreement with MailCentro and sale of the Hosted Exchange business, as
well as the change in business strategy.
General and Administrative. General and administrative expenses decreased 18%
from $13.6 million in 2000 to $11.2 million in 2001, due primarily to
curtailment of costs.
Amortization of Prepaid Marketing Expenses. Our amortization of prepaid
marketing expenses related to the InfoSpace and Microsoft warrants decreased
from $4.5 million in 2000 to zero in 2001, since it was fully amortized at the
end of 2000. The prepaid marketing expense was amortized using the straight-line
method over the one-year minimum term of each of the commercial agreements.
Amortization of Stock-Based Employee Deferred Compensation. Our stock-based
employee deferred compensation expenses decreased 28% from $3.1 million for 2000
to $2.2 million for 2001. The deferred compensation is being amortized using the
sum-of-digits method over the vesting schedule, generally four years.
Amortization of these amounts will conclude during the third quarter of 2003.
Deferred compensation expenses also included $0.3 million related to the
repricing of stock options during 2001. The total amortization charge of $1.0
million related to the repricing will be amortized using the straight-line
method over a three year vesting schedule.
Write-off of Impaired Intangibles and Other Assets. Impairment and other charges
consist of costs and/or charges that are not directly associated with other
expense classification or ongoing operations. The Company periodically assesses
the recoverability of the carrying amount of intangible assets, property and
equipment and provides for any possible impairment loss based upon the
difference between the carrying amount and fair value of such assets. Impairment
and other charges of $23.4 million included a $13.3 million impairment of
goodwill and other intangibles related to our acquisition of Wingra, Inc., $4.4
million impairment of leasehold improvements at unused leased facilities, $3.6
million impairment of computer hardware which is idle and not being used, an
accrual of $1.0 million for costs related to early termination of these unused
facilities and a $1.1 million write-off of a customer relationship module (a
software tool for managing customer relations), which portion will no longer be
utilized.
Interest and Other Income, Net. Our interest and other income, net, decreased
from a net income of $2.9 million for 2000 to a net income of $0.4 million for
2001, due primarily to decreased interest income earned from cash equivalents
and marketable securities, as the funds depleted in 2001.
20
Write-Off of Impaired Long-term Investments. The Company invested $7 million in
the first nine months of 2000 in certain internet centric companies in which the
company believed it had a significant ongoing strategic interest. However, due
to the economic slowdown and the significant decline in capital available to and
in valuations of these privately funded internet centric companies, the Company
believes that these investments are fully impaired. Accordingly, the Company
recorded a charge of $5 million and $2.0 million, in 2000 and 2001,
respectively, to reflect impairment of these assets.
Minority Interest. Minority interest represents a stockholders' proportionate
share of the equity of Commtouch, K.K. (Japan) or 29.4%. At December 31, 2000
and 2001, the Company owned 94.17% and 70.6%, respectively, of the equity and
voting rights of Commtouch, K.K. (Japan).
Income Taxes. As of December 31, 2001, we had approximately $38.0 million of
Israeli net operating loss carry-forwards and $67.6 million of U.S. federal net
operating loss carry-forwards available to offset future taxable income. The
U.S. net operating loss carry-forwards will expire in various amounts in the
years 2008 to 2022. The Israeli net operating loss carry-forwards have no
expiration date.
Comparison of Years Ended December 31, 2000 and 1999
Revenues. Email service revenues increased 323% from $4.3 million in 1999 to
$18.0 million in 2000. We recognized revenue of $1.1 million from the sale of
licenses in 2000. Revenues from MyPoints, a permission based email service
company, represented 11% of total revenues during 1999. In 2000, no customer
accounted for more than 10% of revenues.
Cost of Revenues. Cost of revenues increased 226% from $3.6 million in 1999 to
$11.9 million in 2000, due to the increase in contracts with customers during
2000 and the related service provided. Cost of revenues consisted primarily of
costs related to internet data center services from third-party providers,
depreciation of equipment, internet access, personnel and related costs. In 2000
we sized our hosting infrastructure for substantial growth.
Research and Development. Research and development expenses increased 252% from
$2.9 million in 1999 to $10.4 million in 2000 due to an increase in personnel
and other related costs. In previous years, we received royalty-bearing grants
from the Israeli government, recorded as a reduction of research and development
costs. The Israeli government requires beneficiaries of such grants to pay
royalties to the Israeli government based on the revenues derived from the sale
of products, technologies and services developed with such grants. We believe
that we have no obligation for royalties since the programs ultimately failed
and we do not expect to generate future revenue from products developed with
such grants. Nevertheless, the ultimate liability is subject to review by the
OCS.
Sales and Marketing. Sales and marketing expenses increased 244% from $7.7
million in 1999 to $26.6 million in 2000, due to increased personnel and related
costs, public relations, other marketing expenses and direct sales costs to
support the growth of our email service revenues.
General and Administrative. General and administrative expenses increased 215%
from $4.3 million in 1999 to $13.6 million in 2000, due primarily to
substantially higher personnel and related costs, facility costs, higher fees
for outside professional services and other costs to support the growth of our
email service revenues.
Amortization of Prepaid Marketing Expenses. Our amortization of prepaid
marketing expenses related to the InfoSpace and Microsoft warrants increased 38%
from $3.3 million for 1999 to $4.5 million for 2000. The prepaid marketing
expense is being amortized using the straight-line method over the one-year
minimum term of each of the commercial agreements.
Amortization of Stock-Based Employee Deferred Compensation. Our stock-based
employee deferred compensation expenses decreased 11% from $3.4 million for 1999
to $3.1 million for 2000. The deferred compensation is being amortized using the
sum-of-digits method over the vesting schedule, generally four years.
Interest and Other Income, Net. Our interest and other income (expense), net,
increased from a net income of $1.2 million for 1999 to a net income of $2.9
million for 2000, due primarily to increased interest income earned from cash
equivalents and marketable securities.
21
Write-Off of Impaired Long-term Investments. The Company invested $7 million in
the first nine months of 2000 in certain internet centric companies in which the
Company believed it had a significant ongoing strategic interest. However, due
to the economic slowdown and the significant decline in capital available to and
in valuations of these privately funded internet centric companies, the Company
believes a portion of these investments are impaired. Accordingly, the Company
recorded a charge of $5 million to reflect impairment of this asset below its
recorded cost.
Minority Interest. Minority interest represents a stockholders' proportionate
share of the equity of Commtouch, K.K. (Japan) or 5.83%. At December 31, 2000,
the Company owned 94.17% of the equity and voting rights of Commtouch, K.K.
(Japan).
Income Taxes. As of December 31, 2000, we had approximately $38.0 million of
Israeli net operating loss carry-forwards and $33.6 million of U.S. federal net
operating loss carry-forwards available to offset future taxable income. The
U.S. net operating loss carry-forwards will expire in various amounts in the
years 2008 to 2021. The Israeli net operating loss carry-forwards have no
expiration date.
Quarterly Results of Operations (Unaudited)
The following table sets forth certain unaudited quarterly statements of
operations data for the eight quarters ended December 31, 2001. This information
has been derived from the Company's consolidated unaudited financial statements,
which, in management's opinion, have been prepared on the same basis as the
audited consolidated financial statements, and include all adjustments,
consisting only of normal recurring adjustments, necessary for a fair
presentation of the information for the quarters presented. This information
should be read in conjunction with our audited consolidated financial statements
and the notes thereto included elsewhere in this report. The operating results
for any quarter are not necessarily indicative of the operating results for any
future period.
Three Months Ended
--------------------------------------------------------------------------------------------
Mar. 31, Jun. 30, Sept. 30, Dec. 31, Mar. 31, Jun. 30, Sept. 30, Dec. 31,
2000 2000 2000 2000 2001 2001 2001 2001
-------- -------- -------- -------- -------- -------- -------- --------
(in thousands)
(unaudited)
Email service revenues ............. $ 3,597 $ 5,009 $ 4,747 $ 4,612 $ 4,009 $ 3,974 $ 3,923 $ 2,791
Software license revenues .......... -- -- 500 650 -- 383 67 171
-------- -------- -------- -------- -------- -------- -------- --------
Total revenues ..................... 3,597 5,009 5,247 5,262 4,009 4,357 3,990 2,962
-------- -------- -------- -------- -------- -------- -------- --------
Cost of email service revenues ..... 2,121 2,784 3,025 3,934 4,844 3,734 3,713 2,314
Cost of software license revenues .. -- -- -- -- -- -- -- --
-------- -------- -------- -------- -------- -------- -------- --------
Total cost of revenues ............. 2,121 2,784 3,025 3,934 4,844 3,734 3,713 2,314
-------- -------- -------- -------- -------- -------- -------- --------
Gross profit (loss) ................ 1,476 2,225 2,222 1,328 (835) 623 277 648
-------- -------- -------- -------- -------- -------- -------- --------
Operating expenses:
Research and development, net ..... 1,993 2,270 2,561 3,533 2,946 2,520 1,420 392
Sales and marketing ............... 4,746 6,404 6,337 9,098 6,495 2,856 2,594 1,551
General and administrative ........ 2,107 2,576 3,185 5,755 5,752 2,886 2,170 428
In-process research and development -- -- -- 1,280 -- -- -- --
Amortization of prepaid
marketing expenses ................ 1,941 1,941 476 150 -- -- -- --
Amortization of stock-based
employee compensation ............. 762 762 762 762 481 481 694 548
Amortization of goodwill and
Other purchased intangibles ...... -- -- -- -- 909 891 890 104
22
Write-off of impaired
goodwill and other intangible
assets ........................... -- -- -- -- -- -- 12,077 1,203
Write-off of impaired
property, equipment and other...... -- -- -- -- -- -- 6,485 3,681
-------- -------- -------- -------- -------- -------- -------- --------
Total operating expenses .......... 11,549 13,953 13,321 20,578 16,583 9,634 26,330 7,907
-------- -------- -------- -------- -------- -------- -------- --------
Operating loss ..................... (10,073) (11,728) (11,099) (19,250) (17,418) (9,011) (26,053) (7,259)
Interest and other income
(expenses), net ................... 938 931 883 118 265 464 70 (350)
Write-off of impaired long-term
investments ...................... -- -- -- (5,000) -- -- (2,000) --
Minority interest .................. -- -- -- 55 22 21 137 105
-------- -------- -------- -------- -------- -------- -------- --------
Net loss ........................... $ (9,135) $(10,797) $(10,216) $(24,077) $(17,131) $ (8,526) $(27,846) $ (7,504)
======== ======== ======== ======== ======== ======== ======== ========
Fluctuations in Quarterly Results
We have incurred operating losses since inception, and we cannot be certain that
we will achieve profitability on a quarterly or annual basis in the future. Our
results of operations have fluctuated and are likely to continue to fluctuate
significantly from quarter to quarter as a result of a variety of factors, many
of which are outside of our control. A relatively large expense in a quarter
could have a negative effect on our financial performance in that quarter.
Additionally, as a strategic response to a changing competitive environment, we
may elect from time to time to make certain pricing, service, marketing or
acquisition decisions that could have a negative effect on our quarterly
financial performance. Other factors that may cause our future operating results
to fluctuate include, but are not limited to:
o continued growth of the internet and of email usage;
o demand for email and messaging solutions;
o our ability to attract and retain customers and maintain customer
satisfaction;
o our ability to upgrade, develop and maintain our systems and
infrastructure;
o the amount and timing of operating costs and capital expenditures
relating to expansion of our business and infrastructure;
o the size, timing and fulfillment of orders for our email and
messaging solutions;
o the receipt or payment of irregular or nonrecurring revenues or
expenses;
o technical difficulties or system outages;
o foreign exchange rate fluctuations;
o the announcement or introduction of new or enhanced services by
our competitors;
o our ability to attract and retain qualified personnel with
internet industry expertise, particularly sales and marketing
personnel;
o the pricing policies of our competitors;
o failure to increase our sales; and
o governmental regulation relating to the internet, and email in
particular.
In addition to the factors set forth above, our operating results will be
impacted by the extent to which we incur non-cash charges associated with
stock-based arrangements with employees and non-employees.
23
Liquidity and Capital Resources
We have financed our operations principally from the issuance of equity
securities and to a lesser extent from bank loans and research and development
grants from the Israeli government.
As of December 31, 2001, we had approximately $2.2 million of cash to fund
operations in 2002. In 2001 we utilized $24.7 million of cash to fund operating
losses and $5.7 million from investing activities, mainly proceeds from sales of
marketable securities. Net cash provided by financing activities was
approximately zero, after repayment of bank loans and notes payable of
approximately $1.0 million, net of approximately $1.0 million of proceeds from
issuance of shares and from minority interest in 2001. To limit our cash
expenses in 2002 we have further reduced staff from 92 at December 31, 2001 to
approximately 35 at March 1, 2002. These actions were possible due to a
significant decline in our revenue growth due to competitive factors, a slowing
economic environment, the sale of Hosted Exchange and Wingra, in early 2002.
Furthermore, we were able to reduce our future obligations for facility and
equipment leases by way of settlements with the Mountain View landlord and
Compaq, which will result in cost reductions in 2002.
Recent developments
a. Sale of Wingra
Commtouch sold off its migration service business, Wingra, Inc. to Wingra's
current senior management at the end of February 2002. The terms include mutual
release of all liabilities, obligations and rights of the parties to the
agreement. This sale reduced the Company's net liabilities by approximately $0.7
million.
b. Private Placement
On February 27, 2002, Commtouch entered into a private placement agreement,
whereby Commtouch will issue approximately 4.4 million ordinary shares against
the investment of approximately $1.3 Million in a private placement to private
investors; approximately one-third of the shares are being purchased by
Commtouch's founders, who are currently Commtouch directors and/or executive
officers. The purchasers in the private placement will also receive five-year
warrants to purchase up to an additional 2.66 million ordinary shares
(approximately). The exercise price for one-third of the warrants will be $0.37
per share, the exercise price for an additional one-third of the warrants will
be $1.00 per share and the exercise price for the final one-third of the
warrants will be $2.00 per share. This agreement was approved by shareholders on
April 8, 2002. The Company plans to use the proceeds of this placement for
general corporate working capital. The funds were received on April 15, 2002.
c. Sale of Hosted Exchange
In January 2002, Commtouch sold its Hosted Exchange business unit to
Telecomputing, Inc. Terms of the transaction include the transference of the
Company's customer base and certain equipment to Telecomputing, in exchange for
certain cash payments and royalties. Furthermore, the Company assigned equipment
leases to Telecomputing, thereby eliminating the Company's obligation to make
lease payments thereunder.
d. Strategic Agreement with MailCentro
Within the framework of an agreement with MailCentro Inc. ("MC"), MC (a wholly
owned subsidiary of CP Software Group, Inc.) assumed all aspects of servicing
most of the Company's consumer customers, including its free email service known
as Zap Zone service. According to the agreement entered into with MC, the
Company transferred customers to MC and is expected to realize royalties on
payments made by these former customers to MC (primarily in 2002). Additionally,
certain Commtouch trademarks, domain names, software licenses and equipment were
sold to MC.
As of December 31, 2001, we had negative net working capital of $0.6 million.
24
Based on the cash balance at December 31, 2001, current projections of revenues,
related expenses, and the completion of the private placement, the Company
believes it has sufficient cash to continue operations for at least the next
twelve months.
Class Action Litigation
Following our restatement of revenues for the first three quarters of 2000,
several class action lawsuits were filed in the United States District Court for
the Northern District of California against the Company and certain of our
officers and a director, alleging violations of the antifraud provisions of the
Securities Exchange Act of 1934 arising from the Company's restatement of the
financial statements for the first three quarters of 2000. These lawsuits were
consolidated into one action in late 2001. Thereafter, the Company filed a
Motion to Dismiss, which was granted, though the plaintiffs have been granted
leave to amend the complaint, which they have done. While we are unable to
predict the ultimate outcome of the consolidated claim, we believe that it is
without merit and intend to continue to vigorously defend ourselves.
Effective Corporate Tax Rates
Our tax rate will reflect a mix of the U.S. statutory tax rate on our U.S.
income and the Israeli tax rate discussed below. We expect that most of our
taxable income will be generated in Israel. Israeli companies are generally
subject to corporate tax at the rate of 36% of taxable income. A part of our
income, however, is derived from the Company's capital investment program with
Approved Enterprise status under the Law for the Encouragement of Capital
Investments in three separate plans, and is therefore eligible for certain tax
benefits. Pursuant to these benefits, we will enjoy a tax exemption on income
derived during the first two years in which such investment plans produce
taxable income (provided that we do not distribute such income as a dividend)
and a reduced tax rate of 10% to 25% for an additional period of five to eight
years depending on the level of foreign investment in Commtouch. All of these
tax benefits are subject to various conditions and restrictions. There can be no
assurance that we will obtain approval for additional Approved Enterprise
programs, or that the provisions of the law will not change. Moreover,
notwithstanding these tax benefits, to the extent we receive income from
countries other than Israel, such income may be subject to withholding tax.
Since we have incurred tax losses in every year through 2001, we have not yet
used the tax benefits for which we are eligible.
Impact of Inflation and Currency Fluctuations
Most of our sales are in U.S. dollars. However, a portion of our costs relates
to our operations in Israel. A substantial portion of our operating expenses in
Israel, primarily our research and development expenses, is denominated in NIS.
Costs not denominated in U.S. dollars are translated to U.S. dollars, when
recorded, at prevailing rates of exchange. This is done for the purposes of our
financial statements and reporting. Costs not denominated in U.S. dollars will
increase if the rate of inflation in Israel exceeds the devaluation of the
Israeli currency as compared to the U.S. dollar or if the timing of such
devaluation lags considerably behind inflation. Consequently, we are and will be
affected by changes in the prevailing NIS/U.S. dollar exchange rate. We might
also be affected by the dollar exchange rate to the major European and Asian
currencies, due to the fact that we derive revenues from customers in Europe and
Asia.
The annual rate of inflation in Israel was 1.013% in 2001, 0% in 2000 and 1.3%
in 1999. The NIS was devalued against the U.S. dollar by approximately 9.3% in
2001, -2.7% in 2000 and 0.17% in 1999. The representative dollar exchange rate
for converting the NIS to U.S. dollars, as reported by the Bank of Israel, was
NIS 4.416 for one U.S. dollar on December 31, 2001. Note that the representative
dollar exchange rate was NIS 4.675 at March 1, 2002.
Because exchange rates between the NIS and the dollar fluctuate continuously,
exchange rate fluctuations and especially larger periodic devaluations will have
an impact on our profitability and period-to-period comparisons of our results.
The effects of foreign currency re-measurements are reported in the consolidated
financial statements for relevant periods in the statement of operations.
Item 6. Directors, Senior Management and Employees
25
The following table sets forth certain information regarding our executive
officers and directors at March 1, 2002:
Beneficial
Ownership
Name Age >1%(3) Position
----------------------- ------- ---------- -------------------------------------------------
Amir Lev................ 42 2.1% President, Chief Technology Officer and Director
Carolyn Chin............ 54 -- Chairman of the Board of Directors
Gideon Mantel(1)........ 42 3.1% Chief Executive Officer and Director
Nahum Sharfman(1)(2).... 54 2.2% Director
Richard Sorkin.......... 40 -- Director
Udi Netzer (2).......... 46 -- Director
Ofer Segev(1)(2)........ 42 -- Director
Avner Amram............. 40 -- Chief Operating Officer
---------------------
(1) Member of the Compensation Committee
(2) Member of the Audit Committee
(3) For purposes of this table, a person or group of persons is deemed to have
beneficial ownership of shares of the Company's common stock which such
person or group has the right to acquire on or within 60 days after
December 31, 2001. Unless otherwise indicated, to the Company's knowledge
the person named has sole voting and investment power and the right to
receive the economic benefits, or share such power and rights with such
person's spouse, with respect to all shares held by that person.
Other Management Employees:
The following table sets forth the names and positions of other management
employees:
Name Age Position
------------------------------ ------ ---------------------------------------------------
Devyani Patel................. 41 Vice President, Finance
Brian Fox..................... 38 Vice President, Corporate and Business Development,
Commtouch Inc.
Gary Davis.................... 40 General Counsel and Corporate Secretary
Udi Trugman................... 31 Vice President, Research and Development Commtouch
Software Ltd.
Michal Kofman ................ 35 Vice President, Sales, Commtouch Software Ltd.
Haggai Carmon ................ 43 Vice President, Marketing, Commtouch Software Ltd.
Amir Lev is a co-founder of Commtouch and has served as its Chief Technology
Officer and as a Director since its inception in 1991. Mr. Lev has also been the
General Manager of Commtouch since January 1997 and in May 2000 became
President. Mr. Lev received a B.A. in Computer Science and Economics from Hebrew
University, Jerusalem.
Carolyn Chin has served as the Chairman of the Board of Directors since May
2001. Ms. Chin has served as a Director of Commtouch since August 2000. Ms. Chin
has 30 years of experience in information technology, marketing, media,
telecommunications, retailing, health care, education and small business market
segments. She has held a number of senior executive positions including at:
Reuters, Market XT, IBM, Citibank, AT&T, Macy's and in the US Government. She
has served on over 30 boards and committees. Ms. Chin has also received numerous
honors including selection as a White House Fellow and the Committee of 100
(prominent Chinese-Americans). She graduated with an MBA from the Harvard
Business School and a BS in Management Engineering from Rensselaer Polytechnic
Institute.
Gideon Mantel is a co-founder of Commtouch and served as its Chief Financial
Officer from its inception in February 1991 until October 1995, when he became
Commtouch's Chief Operating Officer. In November 1997, he became Commtouch's
Chief Executive Officer. He has also served as a director of Commtouch since
inception. Mr. Mantel received a B.A. in Political Science and an M.B.A from Tel
Aviv University.
26
Nahum Sharfman rejoined the Board in March 2000. Mr. Sharfman is a co-founder of
Commtouch and served as its Chief Executive Officer and Chairman of the Board
from its inception in February 1991. In November 1997 Mr. Sharfman resigned as
Chief Executive Officer to become a founder of Dealtime.com. Mr. Sharfman
remained Chairman of the Board of Commtouch and a Director until January 1999.
Prior to founding Commtouch, Mr. Sharfman spent eleven years with National
Semiconductor Corporation in various development and management roles. Mr.
Sharfman received a Ph.D. in High Energy Nuclear Physics from Carnegie Mellon
University and M.S. and B.S. degrees in Physics from the Technion- Israel
Institute of Technology, Haifa.
Richard Sorkin has served as a Director of Commtouch since July 1999. Since June
1998 Mr. Sorkin has served as an advisor to several early-stage internet
companies and is a director of several private companies. From June 1998 to
April 1999 he was the Chairman of the Board of Directors of ZIP2, an internet
media company which was sold to Compaq. From May 1996 to June 1998, he was Chief
Executive Officer of ZIP2 and from May 1993 to March 1996 he held various
executive positions with Creative Technology, Ltd., a leading provider of
multi-media hardware. Mr. Sorkin received a B.A. with honors in Economics from
Yale University and an M.B.A. from Stanford University.
Udi Netzer has served as a Director of Commtouch since February 2002. Mr. Netzer
is also currently the active Chairman of Eyeblaster, Inc., a rich media ad
management system that allows publishers, agencies and advertisers to
independently create and manage out-of-banner advertising campaigns. Mr. Netzer
has over 15 years' experience in various sales, marketing and executive
positions with companies such as 3Com, Netmanage, and VCON. As a partner in
Evergreen, Mr. Netzer was one of the first venture capitalists in Israel.
Ofer Segev has served as a Director of Commtouch since February 2002. Mr. Segev
is also currently Chief Executive Officer of TeleKnowledge, Inc., a leading
provider of advanced content monetization software solutions for commercial
content providers. Mr. Segev has over 15 years of experience in strategic
financial management. He most recently served as CFO for Tundo, a developer of
an IP-based voice and media services platform Prior to his position at Tundo,
Mr. Segev was a partner in Ernst & YoungIsrael, where he spent 15 years. From
1996 through 2000 Mr. Segev led the High Tech Industry practice group for Ernst
& Young Israel. He has a BA in Economics and Accounting from Bar Ilan University
in Israel, and has studied at the Kellogg Graduate School of Management at
Northwestern University.
Avner Amram has served as Chief Operating Officer of Commtouch since November
2001. From April 1999 until that time, he served as Senior Vice President,
Operations of Commtouch Inc.. Mr. Amram was Director of Operations of Commtouch
Inc. from March 1998 to April 1999 and a Software Team Leader from March 1996 to
March 1998. Mr. Amram received a B.Sc. in Computer Science from the Technion-
Israel Institute of Technology, Haifa.
Devyani Patel joined Commtouch in 1996 as a consultant and became a full-time
employee in early 1999. She served as Corporate Controller for Commtouch until
November 2001 when she was appointed as the Vice President of Finance. Ms. Patel
has nearly 20 years of accounting and finance experience, including technology
industry experience. Ms. Patel graduated from the University of Kent,
Canterbury, England in Accounting and Law.
Brian Fox has served as Vice President, Corporate and Business Development of
Commtouch since October 2001. From the time he joined the Company in February
2000 until that time, Mr. Fox served as Director of Corporate Development and
Senior Director of Corporate Development. Prior to joining the Company, Mr. Fox
was President of Fox Advisory Services, a Manager in the Consulting Group at
Deloitte & Touche and a Senior Consultant at Price Waterhouse. Mr. Fox earned a
B.A. in Economics and Business from UCLA (magna cum laude) and an MBA from the
Wharton School of the University of Pennsylvania.
Gary Davis joined Commtouch in September 1999 and serves as General Counsel and
Corporate Secretary. Mr. Davis has over 16 years of legal experience in both
private law firm and corporate practices. Mr. Davis is certified to practice law
in both the State of Israel and California. Prior to September 1999, Mr. Davis
was in-house counsel to Israel Military Industries and Elta Electronics
Industries. He received a B.A. in Political Economy of Industrial Societies from
U.C. Berkeley and a J.D. in law from Golden Gate University.
Udi Trugman joined Commtouch in December 1996 and serves as Vice President of
Research and Development. Prior to 2002, Mr. Trugman was Senior Director of
Systems in the R&D group. Mr. Trugman has over 15 years of software development
and management experience. Prior to working at Commtouch, Mr. Trugman
specialized in development of commercial applications.
27
Michal Kofman joined Commtouch in 2000 and serves as Vice President of
International Sales. Prior to 2002, Ms. Kofman was a Director of Business
Development. Prior to joining Commtouch, Ms. Kofman was a Director of Sales at
TIS, a public software vendor for document management and served as Director of
International Sales at Hotel Guide, a Swiss company that advertises hotels via
the internet. Ms. Kofman has over 10 years of experience in international sales
and management.
Haggai Carmon joined Commtouch in January 2002 and serves as Vice President of
Marketing. From 1998 to 2002, Mr. Carmon was Vice President of Corporate
Marketing and of Sales in Asia-Pacific for VCON Telecommunications, a public
vendor of corporate videoconferencing solutions, and was also responsible for
international pre-sales and technical support. Prior to that, Mr. Carmon was at
NetManage Ltd., a public software company of TCP/IP applications for Windows, a
founder and CEO of Applico, a Computer-aided Design for Architecture service
firm and managed a college of Fine Arts. Mr. Carmon has over 15 years of
experience in technology and international management.
Election of Directors
Directors (other than outside directors, as explained below) are elected by
shareholders at the annual general meeting of the shareholders and hold office
until the next annual general meeting following the general meeting at which
such Director is elected and until his successor is elected, or until he is
removed. An annual general meeting must be held at least once in every calendar
year, but not more than fifteen months after the preceding annual general
meeting. Directors may be removed and other directors may be elected in their
place or to fill vacancies in the Board of Directors at any time by the holders
of a majority of the voting power at a general meeting of the shareholders.
Until a vacancy is filled by the shareholders, the Board of Directors may
appoint new directors temporarily to fill vacancies on the Board of Directors.
The Articles of Association of Commtouch authorize the shareholders to
determine, from time to time, the number of directors. The number was most
recently fixed at nine directors. There are no family relationships among any of
the directors, officers or key employees of Commtouch.
Alternate Directors
The Articles of Association of Commtouch provide that any director may appoint
another person to serve as an alternate director and may remove such alternate.
Any alternate director possesses all the rights and obligations of the director
who appointed him, except that the alternate has no standing at any meeting
while the appointing director is present, the alternate may not in turn appoint
an alternate for himself (unless the instrument appointing him otherwise
expressly provides) and the alternate is not entitled to remuneration. A person
who is not qualified to be appointed as a director, or a person who already
serves as a director or an alternate director, may not be appointed as an
alternate director. Unless the appointing director limits the time or scope of
the appointment, the appointment is effective for all purposes until the
appointing director ceases to be a director or terminates the appointment. The
appointment of an alternate director does not in itself diminish the
responsibility of the appointing director as a director.
Independent and Outside Directors
The Israel Companies Law requires Israeli companies with shares that have been
offered to the public in or outside of Israel to appoint at least two outside
directors. No person may be appointed 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 or within the two years preceding the date of the
person's appointment to serve as outside director, any affiliation with the
company or any entity controlling, controlled by or under common control with
the company. The term affiliation includes:
o an employment relationship;
o a business or professional relationship maintained on a regular
basis;
o control; and
o service as an office holder.
No person may serve as an outside director if the person's position or other
business activities create, or may create, a conflict of interest with the
person's responsibilities as an outside director or may otherwise interfere with
28
the person's ability to serve as an outside director. If, at the time outside
directors are to be appointed, all current members of the Board of Directors are
of the same gender, then at least one outside director must be of the other
gender.
Outside directors are to be elected by a majority vote at a shareholders'
meeting, provided that either:
o such majority includes at least one-third of the shares held by
non-controlling shareholders who are present and voting at the
meeting; or
o the total number of shares held by non-controlling shareholders
voting against the election of the director at the meeting does
not exceed one percent of the aggregate voting rights in the
company.
The initial term of an outside director is three years and may be extended for
an additional three years. Outside directors may be removed only by the same
percentage of shareholders as is required for their election, or by a court, and
then only if the outside director ceases to meet the statutory qualifications
for their appointment or if they violate their fiduciary duty to the company.
Each committee of a company's Board of Directors must include at least one
outside director and the audit committee must include both outside directors. An
outside director is entitled to compensation as provided in the regulations
adopted under the Companies Law and is otherwise prohibited from receiving any
other compensation, directly or indirectly, in connection with service provided
as an outside director.
In addition, the Nasdaq National Market requires Commtouch to have at least two
independent directors on the Board of Directors and to establish an audit
committee, at least a majority of whose members are independent of management.
We have appointed directors who qualify both as independent directors under the
Nasdaq National Market requirements and as outside directors under the Companies
Law.
Audit Committee
The Companies Law requires public companies to appoint an audit committee. The
responsibilities of the audit committee include identifying irregularities in
the management of the company's business and approving related party
transactions as required by law. An audit committee must consist of at least
three directors, including all of the outside directors. The chairman of the
Board of Directors, any director employed by or otherwise providing services to
the company, and a controlling shareholder or any relative of a controlling
shareholder, may not be a member of the audit committee.
Internal Auditor
Under the Companies Law, the Board of Directors must appoint an internal
auditor, nominated by the audit committee. The role of the internal auditor is
to examine, among other matters, whether the company's actions comply with the
law and orderly business procedure. Under the Companies Law, the internal
auditor may be an employee of the company but not an interested party or office
holder, or a relative of an interested party or office holder, and he or she may
not be the company's independent accountant or its representative. The Company
appointed a qualified internal auditor during 2001.
Approval of Certain Transactions; Obligations of Directors, Officers and
Shareholders
The Israel Companies Law codifies the fiduciary duties that office holders,
including directors and executive officers, owe to a company. An office holder's
fiduciary duties consist of a duty of care and a duty of loyalty. The duty of
loyalty includes avoiding any conflict of interest between the office holder's
position in the company and such person's personal affairs, avoiding any
competition with the company, avoiding exploiting any corporate opportunity of
the company in order to receive personal advantage for such person or others,
and revealing to the company any information or documents relating to the
company's affairs which the office holder has received due to his or her
position as an office holder. Each person listed in the first table that appears
above at the beginning of this Item 6 is an office holder.
Under the Israel Companies Law, all arrangements as to compensation of office
holders who are not directors require approval of the Board of Directors unless
the Articles of Association provide otherwise. Arrangements regarding the
compensation of directors also require audit committee and shareholder approval.
The Israel Companies Law requires that an office holder promptly disclose any
personal interest that he or she may have and all related material information
29
known to him or her, in connection with any existing or proposed transaction by
the company. In addition, if the transaction is an extraordinary transaction,
the office holder must also disclose any personal interest held by the office
holder's spouse, siblings, parents, grandparents, descendants, spouse's
descendants and the spouses of any of the foregoing, or by any corporation in
which the office holder is a five percent or greater shareholder, director or
general manager or in which he or she has the right to appoint at least one
director or the general manager. An extraordinary transaction is defined as a
transaction not in the ordinary course of business, a transaction that is not on
market terms, or a transaction that is likely to have a material impact on the
company's profitability, assets or liabilities.
In the case of a transaction that is not an extraordinary transaction, after the
office holder complies with the above disclosure requirement, only Board
approval is required unless the Articles of Association of the company provide
otherwise. Such approval must determine that the transaction is not adverse to
the company's interest. If the transaction is an extraordinary transaction, then
in addition to any approval required by the Articles of Association, it also
must be approved by the audit committee and by the Board and, under specified
circumstances, by a meeting of the shareholders. An Israeli company whose shares
are publicly traded shall not be entitled to approve such a transaction unless,
at the time the approval was granted, two members of the audit committee were
outside directors and at least one of them was present at the meeting at which
the audit committee decided to grant the approval. An office holder who has a
personal interest in a matter that is considered at a meeting of the Board of
Directors or the audit committee generally may not be present at this meeting or
vote on this matter.
The Israel Companies Law applies the same disclosure requirements to a
controlling shareholder of a public company, which includes a shareholder that
holds 25% or more of the voting rights if no other shareholder owns more than
50% of the voting rights in the company. Extraordinary transactions with a
controlling shareholder or in which a controlling shareholder has a personal
interest, and the terms of compensation of a controlling shareholder who is an
office holder, require the approval of the audit committee, the Board of
Directors and the shareholders of the company. The shareholder approval must
either include at least one-third of the disinterested shareholders who are
present, in person or by proxy, at the meeting or, alternatively, the total
shareholdings of the disinterested shareholders who vote against the transaction
must not represent more than one percent of the voting rights in the company.
Under the Israel Companies Law, a shareholder has a duty to act in good faith
towards the company and other shareholders and refrain from abusing his or her
power in the company, including, among other things, in respect to his or her
voting at the general meeting of shareholders on the following matters:
o any amendment to the Articles of Association;
o an increase of the company's authorized share capital;
o a merger; or
o approval of interested party transactions that require shareholder
approval.
In addition, any controlling shareholder, any shareholder who can determine the
outcome of a shareholder vote and any shareholder who, under the company's
Articles of Association, can appoint or prevent the appointment of an office
holder, is under a duty to act with fairness towards the company. The Israel
Companies Law does not describe the substance of this duty.
Compensation Committee Interlocks
The Compensation Committee, which was established by the Board in January 1996,
is responsible for determining salaries, incentives and other forms of
compensation for Commtouch's directors, officers and other employees and for
administering various incentive compensation and benefit plans. The Compensation
Committee consists of the Chief Executive Officer and two other Directors. Ofer
Segev, as an outside director, and Nahum Sharfman are currently the two other
directors on the Compensation Committee.
Indemnification of Directors and Officers; Limitations on Liability
Israeli law permits a company to insure an office holder in respect of
liabilities incurred by him or her as a result of the breach of his or her duty
of care to the company or to another person, or as a result of the breach of his
or her fiduciary duty to the company, to the extent that he or she acted in good
faith and had reasonable cause to believe that the act would not prejudice the
company. A company can also insure an office holder for monetary liabilities as
30
a result of an act or omission that he or she committed in connection with his
or her serving as an office holder. Moreover, a company can indemnify an office
holder for (a) monetary liability imposed upon him or her in favor of other
persons pursuant to a court judgment, including a compromise judgment or an
arbitrator's decision approved by a court, and (b) reasonable litigation
expenses, including attorneys' fees, actually incurred by him or her or imposed
upon him or her by a court, in an action, suit or proceeding brought against him
or her by or on behalf of the company or other persons, or in connection with a
criminal action which does not require criminal intent in which he or she was
convicted, in each case in connection with his or her activities as an office
holder. Our Articles of Association allow us to insure and indemnify office
holders to the fullest extent permitted by law provided such insurance or
indemnification is approved in accordance with the Israel Companies Law. The
Company has acquired directors' and officers' liability insurance covering the
officers and directors of the Company and its subsidiaries for certain claims.
In addition, the Company has entered into an undertaking to indemnify the
directors of the Company subject to certain limitations, and this undertaking
has been ratified by shareholders.
Compensation of Directors and Officers.
The directors of Commtouch can be remunerated by Commtouch for their services as
directors to the extent such remuneration is approved by Commtouch's audit
committee, Board of Directors and shareholders. Apart from Carolyn Chin and
Richard Sorkin, directors currently do not receive cash compensation for their
services as directors but are reimbursed for their expenses for each Board of
Directors meeting attended. However, see "Nonemployee Directors Stock Option
Plan," below.
The aggregate direct remuneration paid by Commtouch to all directors and
executive officers (13 persons) in 2001 was approximately $1.4 million. During
the same period Commtouch accrued or set aside approximately $25,000 for the
same group to provide pension, retirement or similar benefits. As of December
31, 2001, directors and executive officers of Commtouch (8 persons) held stock
options to purchase an aggregate of 825,080 ordinary shares.
Options to Purchase Securities from Registrant or Subsidiaries.
As of December 31, 2001, stock options to purchase ordinary shares had been
granted to employees, consultants, executive officers and non-employee directors
under the Company's stock option plans, net of cancelled options. Of that number
had not been exercised and had exercise prices ranging from $0.01 to $35.56 per
share and a weighted average per share exercise price of $2.20, and were held by
61 persons; these options have termination dates ranging from February 2006 to
August 2011. At December 31, 2001, the persons named in Item 6 as a group (8
persons) held options to acquire 298,538 ordinary shares. Reference is also made
to the information contained in Item 7 below.
Employees
See Item 4: Employees
Item 7. Major Shareholders and Related Party Transactions.
The following table presents information with respect to beneficial ownership of
our ordinary shares as of December 31, 2001, including:
o each person or entity known to Commtouch to own beneficially more
than five percent of Commtouch's ordinary shares, and
o all executive officers and directors as a group.
Beneficial ownership is determined in accordance with the rules of the
Securities and Exchange Commission and includes voting or investment power, or
the right to receive the economic benefits of ownership, with respect to shares.
To our knowledge, except under applicable community property laws or as
otherwise indicated, the persons named in the table have sole voting and sole
investment control and rights to receive economic benefits with respect to all
shares beneficially owned. The applicable percentage of ownership for each
shareholder is based on 17,496,819 ordinary shares outstanding as of December
31, 2001 (since the InfoSpace warrant of 1,136,000 shares is underwater based on
the market price of an ordinary share on December 31, 2001 and an exercise price
of $12.80 per share, the warrants have no impact on the percentage of ownership
31
computation). Ordinary shares issuable upon exercise of options and other rights
held and exercisable on or within sixty days of December 31, 2001 are deemed
outstanding for the purpose of computing the percentage ownership of the person
holding those options and other rights and for all directors and officers as a
group, but are not deemed outstanding for computing the percentage ownership of
any other person.
Amount Percent of
Owned Class
--------- ---------
InfoSpace 896,057 5.11%
Jan Eddy (President: Wingra Technologies, LLC.) 877,081 5.00%
All directors and officers as a group (8 persons) 1,462,298 8.36%
Interest of Management in Certain Transactions.
Relationship with InfoSpace
Concurrent with the closing of the initial public offering, our U.S. subsidiary,
Commtouch Inc., entered into a Customized Web-based Email Service Agreement with
InfoSpace. Under that agreement, we provided customer email services, including
calendaring and other products and services, to end users of InfoSpace's various
properties, which may have included cable subscribers of Charter Communications
and its affiliates, users of services offered by High Speed Access Corp. and any
browser, website, ISP or similar service that InfoSpace sponsored or to which it
provided content. This agreement was replaced by a new agreement, effective
February 1, 2002 having a one year duration, but InfoSpace has the right to
terminate the agreement at any time upon thirty (30) days written notice.
InfoSpace also has the right to terminate the agreement if there are technical
problems with the products or services provided. The performance specifications
set forth in the agreement include the maintenance of certain levels of email
system availability and response time. Infospace is to pay a quarterly fee of
$7,500 for use of up to 10,000 mailboxes. This agreement has been assigned to
MailCentro, Inc., the party to whom we sold our consumer business, effective
March 1, 2002. Commtouch Inc. will continue to receive a portion of the revenues
from this agreement for a maximum period of one year from the above date of
assignment.
In connection with Commtouch Inc. entering into the original email services
agreement, we issued to InfoSpace a warrant to purchase 1,136,000 ordinary
shares at an exercise price of $12.80 per share. The warrant is non-forfeitable,
fully vested and immediately exercisable, and will expire five years from the
date of the original email service agreement.
Concurrent with Commtouch Inc. entering into the email services agreement in
1999, we issued 896,057 ordinary shares to InfoSpace and 448,029 ordinary shares
to Vulcan Ventures in a private placement at $14.88 per share. Pursuant to the
share purchase agreement, InfoSpace and Vulcan Ventures have the right to name
one director to our board as long as they continue to hold at least 25% of the
combined number of shares purchased by them in the private placement and the
shares issuable to InfoSpace upon exercise of the warrant. Mr. Thomas Camp, who
was appointed to the board pursuant to that agreement, resigned on August 22,
2001 and was not replaced by InfoSpace and Vulcan Ventures, and we believe that
Vulcan Ventures divested itself of all of its shareholdings in the Company. In
connection with this transaction, we agreed to pay U.S. Bancorp Piper Jaffray an
advisory fee of $550,000 under the terms of an engagement letter agreement dated
as of July 5, 1999.
We agreed to register the shares and warrant described above promptly after the
closing of the initial public offering. The registration statement became
effective on January 7, 2000.
At InfoSpace's option, the warrant is exercisable pursuant to a cashless
exercise based on the average closing price of the ordinary shares for the five
days preceding the exercise. The holder of the warrant is required to avoid
becoming a 10% or greater shareholder of the Company as a result of any exercise
of the warrant. The holder of the warrant is given the opportunity to profit
from a rise in the market price of the ordinary shares and the warrant. The
warrant includes provisions which adjust the exercise and price upon the
occurrence of certain events which might otherwise dilute the value of the
warrant.
32
Option Exercises and Purchases of Shares By Certain Officers
Gideon Mantel is the Chief Executive Officer and a Director of Commtouch. On
March 17, 1999, Mr. Mantel exercised certain options granted to him by
Commtouch. In consideration for the ordinary shares purchased pursuant to the
exercise of the options, he provided Commtouch with a full-recourse promissory
note dated March 17, 1999 in the original principal amount of $341,272. The
promissory note bears interest at 4.83% annually, with payments of interest only
due on March 17 of each year and with the balance due and payable on the fourth
anniversary of the date of the promissory note. This loan was used by Mr. Mantel
to purchase 286,120 ordinary shares of Commtouch at a weighted average purchase
price of $1.19 per share. The promissory note is collateralized by a pledge of
the stock purchased. The outstanding principal amount of the note as of January
31, 2002 is $341,272.
Item 8. Financial Information.
See Item 18: Financial Statements
Item 9. The Offer and Listing.
The Company's Ordinary Shares have traded publicly on The Nasdaq Stock Market
under the symbol "CTCH" since July 13, 1999.
The following table lists the high and low closing sales prices for the
Company's Ordinary Shares, for the periods indicated, as reported by The Nasdaq
Stock Market:
High Low
-------- -------
1999:
Third Quarter (beginning July 13, 1999) $ 22.62 $ 11.0625
Fourth Quarter 49.12 14.3125
2000:
First Quarter ........................ $ 66.50 $ 35.5625
Second Quarter ....................... 38.56 14.625
Third Quarter 33.93 16.50
Fourth Quarter ....................... $ 19.25$ 7.44
2001:
First Quarter ........................ $ 3.81 $ 0.75
Second Quarter ....................... 1.19 0.28
Third Quarter 0.67 0.20
Fourth Quarter ........................ $ 0.46$ 0.20
Most Recent Six Months:
September 2001 ........................ $ 3.81 $ 0.75
October 2001 .......................... 0.42 0.22
November 2001 ......................... 0.46 0.20
December 2001 ......................... 0.35 0.25
January 2002 .......................... 0.43 0.24
February 2002 ......................... 0.36 0.25
If the Company decides to distribute a cash dividend out of income that has been
tax exempt due to an "Approved Enterprise" status under the Law for the
Encouragement of Capital Investments, 1959, the amount of cash dividend will be
subject to corporate tax at the rate that would have been applicable to its
income had the Company not been tax. The Company has never declared or paid cash
dividends on its ordinary shares and does not anticipate paying any cash
dividends in the foreseeable future. The Company intends to retain future
earnings to finance the development of its business.
33
Item 10. Additional Information.
Under current Israeli regulations, any dividends or other distributions paid in
respect of ordinary shares purchased by non-residents of Israel with certain
non-Israeli currencies (including dollars) will be freely repatriable in such
non-Israeli currencies at the rate of exchange prevailing at the time of
conversion, provided that Israeli income tax has been paid on, or withheld from,
such payments.
Neither the Articles of Association of the Company nor the laws of the State of
Israel restrict in any way the ownership or voting of ordinary shares by
non-residents of Israel, except with respect to subjects of countries which are
at a state of war with Israel.
DESCRIPTION OF SHARES
Set forth below is a summary of the material provisions governing our share
capital. This summary is not complete and should be read together with our
Memorandum of Association and Articles of Association, copies of which have been
filed as exhibits to our Annual Report on Form 20-F, as amended, subject to
amendment of our Articles of Association from time to time.
As of December 31, 2001, our authorized share capital consisted of 40,000,000
ordinary shares, NIS 0.05 par value. As of December 31, 2001, there were
17,496,819 ordinary shares and no preferred shares issued and outstanding.
DESCRIPTION OF ORDINARY SHARES
All issued and outstanding ordinary shares of Commtouch are duly authorized and
validly issued, fully paid and nonassessable. The ordinary shares do not have
preemptive rights. Neither our Memorandum of Association, Articles of
Association nor the laws of the State of Israel restrict in any way the
ownership or voting of ordinary shares by non-residents of Israel, except with
respect to subjects of countries which are in a state of war with Israel.
DIVIDEND AND LIQUIDATION RIGHTS
The ordinary shares are entitled to their full proportion of any cash or share
dividend declared.
Subject to the rights of the holders of shares with preferential or other
special rights that may be authorized, the holders of ordinary shares are
entitled to receive dividends in proportion to the sums paid up or credited as
paid up on account of the nominal value of their respective holdings of the
shares in respect of which the dividend is being paid (without taking into
account the premium paid up on the shares) out of assets legally available
therefor and, in the event of our winding up, to share ratably in all assets
remaining after payment of liabilities in proportion to the nominal value of
their respective holdings of the shares in respect of which such distribution is
being made, subject to applicable law. Declaration of a dividend requires Board
of Director approval.
VOTING, SHAREHOLDER MEETINGS AND RESOLUTIONS
Holders of ordinary shares have one vote for each ordinary share held on all
matters submitted to a vote of shareholders. Such rights may be affected by the
future grant of any special voting rights to the holders of a class of shares
with preferential rights. Once the creation of a class of shares with preference
rights has been approved, the Board of Directors may issue preferred shares,
unless the Board is limited from doing so by the Articles of Association or a
contractual provision.
An annual general meeting must be held once every calendar year at such time
(not more than 15 months after the last preceding annual general meeting) and at
such place, either within or outside the State of Israel, as may be determined
by the Board of Directors. The quorum required for a general meeting of
shareholders consists of at least two shareholders present in person or by proxy
and holding, or representing, more than one-quarter of the voting rights of the
issued share capital. A meeting adjourned for lack of a quorum may be adjourned
to the same day in the next week at the same time and place, or to such time and
place as the Board of Directors may determine in a notice to shareholders. At
such reconvened meeting any two shareholders entitled to vote present in person
or by proxy will constitute a quorum. Shareholder resolutions will be deemed
adopted if approved by the holders of a majority of the voting power represented
at the meeting, in person or by proxy, and voting thereon.
34
ANTI-TAKEOVER PROVISIONS UNDER ISRAELI LAW
Under the Companies Law, a merger is generally required to be approved by the
shareholders and board of directors of each of the merging companies. If the
share capital of the company that will not be the surviving company is divided
into different classes of shares, the approval of each class is also required.
In addition, a merger can be completed only after all approvals have been
submitted to the Israeli Registrar of Companies and at least seventy days have
passed from the time that a proposal for approval of the merger was filed with
the Registrar.
The Companies Law provides that an acquisition of shares in a public company
must be made by means of a tender offer if as a result of the acquisition the
purchaser would become a 25% shareholder of the company. This rule does not
apply if there is already another 25% shareholder of the company. Similarly, the
Companies Law provides that an acquisition of shares in a public company must be
made by means of tender offer if as a result of the acquisition the purchaser
would become a 45% shareholder of the company, unless someone else already holds
a majority of the voting power of 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 offer requirements do not apply to
companies whose shares are listed for trading outside of Israel if, according to
the law in the country in which the shares are traded, including the rules and
regulations of the stock exchange on which the shares are traded, either:
o there is a limitation on acquisition of any level of control of
the company; or
o the acquisition of any level of control requires the purchaser to
do so by means of a tender offer to the public.
Finally, Israeli tax law treats specified acquisitions, including a
stock-for-stock swap between an Israeli company and a foreign company, less
favorably than does U.S. tax law. For example, Israeli tax law may subject a
shareholder who exchanges his ordinary shares for shares in a foreign
corporation to taxation before it would become taxable in the United States, and
even though the investment has not become liquid.
TRANSFER OF SHARES AND NOTICES
Fully paid ordinary shares that are issued and not subject to any legal
restrictions on transference may be transferred freely. Each shareholder of
record is entitled to receive at least twenty-one days' prior notice of
shareholder meetings. For purposes of determining the shareholders entitled to
notice and to vote at such meeting, the Board of Directors may fix a record date
not exceeding 40 days prior to the date of any shareholder meeting.
MODIFICATION OF CLASS RIGHTS
If at any time the share capital is divided into different classes of shares,
then, unless the conditions of allotment of such class provide otherwise, the
rights, additional rights, advantages, restrictions and conditions attached or
not attached to any class, at any given time, may be modified, enhanced, added
or abrogated by resolution at a meeting of the holders of the shares of such
class.
DESCRIPTION OF INVESTOR OPTIONS AND WARRANTS
INFOSPACE WARRANT
The discussion regarding the Infospace warrant under Item 5. Operating and
Financial Review and Prospects--Strategic Transaction with Go2Net (InfoSpace)
and Item 7. "Major Shareholders and Related Party Transactions-- Interest of
Management in Certain Transactions--Relationship with InfoSpace" is incorporated
herein by reference.
WINGRA WARRANTS AND OPTIONS
In connection with our acquisition of Wingra, we assumed warrants and options to
purchase 137,233 shares issued to the Wingra investors (subsequently reduced to
121,329 due to expiration of certain options), and options to purchase 168,382
ordinary shares issued to Wingra employees (subsequently reduced to 162,257 due
35
to expiration of options of terminating employees). Upon effectiveness of the
merger, these warrants and options became immediately exercisable.
The assumed investor warrants and options were originally issued by Wingra in
connection with loans to Wingra by banks and shareholders. The exercise prices
of those warrants and options range from $6.29 to $9.35 and the expiration dates
range from July 2002 through March 2004.
The employee stock options were originally granted to Wingra employees under the
Wingra Technologies, LLC 1998 Unit Option Plan. The exercise prices of those
options range from $0.2010 to $3.5010 and the expiration dates range from August
2008 through July 2010. At the time of the merger, we assumed the rights and
obligations under that Option Plan.
EQUITY OFFICE PROPERTIES WARRANT
The discussion regarding the Equity Office Properties warrant under Item 19,
Note 13 to the Notes to Consolidated Financial Statements - Shareholders' Equity
is incorporated herein by reference.
COMPAQ WARRANT
The discussion regarding the Compaq warrant under Item 19, Note 13 to the Notes
to Consolidated Financial Statements - Shareholders' Equity is incorporated
herein by reference.
INVESTMENT ROUND WARRANTS
The discussion regarding the February investment round warrant under Item 19,
Note 13 to the Notes to Consolidated Financial Statements - Shareholders' Equity
is incorporated herein by reference.
REGISTRATION RIGHTS
The holders of convertible preferred shares which were converted into 7,109,800
ordinary shares (the "Registrable Securities") upon effectiveness of the initial
public offering, have certain rights to register those shares under the
Securities Act. If requested by holders of a majority of the Registrable
Securities after the second anniversary of the date of the initial public
offering, Commtouch must file a registration statement under the Securities Act
covering all Registrable Securities requested to be included by all holders of
such Registrable Securities. Commtouch may be required to effect up to two such
registrations. Commtouch has the right to delay any such registration for up to
120 days under certain circumstances, but not more than once during any 12-month
period.
In addition, if Commtouch proposes to register any of its ordinary shares under
the Securities Act other than in connection with a company employee benefit plan
or a corporate reorganization pursuant to Rule 145 under the Securities Act, or
a registration on any registration form that does not permit secondary sales or
does not include substantially the same information as would be required to be
included in a registration statement covering the sale of Registrable
Securities, the holders of Registrable Securities may require Commtouch to
include all or a portion of their shares in such registration, although the
managing underwriter of any such offering has certain rights to limit the number
of shares in such registration.
Further, a majority of the holders of Registrable Securities may require
Commtouch to register all or any portion of their Registrable Securities on Form
F-3, subject to certain conditions and limitations. All expenses incurred in
connection with all registrations (other than fees, expenses and disbursements
of counsel retained by the holders of the Registrable Shares, and underwriters'
and brokers' discounts and commissions) will be borne by Commtouch.
The registration rights described in the preceding three paragraphs expire five
years after the closing date of our initial public offering (July 16, 2004).
In addition, the Company granted registration rights to InfoSpace, Vulcan
Ventures and Microsoft pursuant to which their holdings in the Company
(including the warrant issued to InfoSpace) were registered on January 7, 2000.
36
Also, under the terms of the Wingra acquisition agreement, we were required to
register the 1,568,869 shares issuable to the Wingra investors and employees,
including shares currently issuable under options and warrants described above.
The registration statements were filed to fulfill this requirement and became
effective, respectively, on September 6, 2001 and July 20, 2001.
ACCESS TO INFORMATION
We file reports with the Israeli Registrar of Companies regarding our registered
address, our registered capital, our shareholders of record and the number of
shares held by each, the identity of the directors and details regarding
security interests on our assets. In addition, Commtouch must file with the
Israeli Registrar of Companies its Articles of Association and any amendments
thereto The information filed with the Registrar of Companies is available to
the public. In addition to the information available to the public, our
shareholders are entitled, upon request, to review and receive copies of all
minutes of meetings of our shareholders.
TRANSFER AGENT AND REGISTRAR
The transfer agent and registrar for our ordinary shares is Wells Fargo Bank
Minnesota N.A.
Material Contracts.
Stock Purchase Agreement between Commtouch Software Ltd. and Rideau Ltd., dated
June 1, 2001
This agreement relates to the purchase by Rideau Ltd. of 315,789 of the
Company's ordinary shares at $0.95 per share, for an aggregate purchase price of
$300,000.
Wingra Technologies, LLC 1998 Unit Option Agreement
Commtouch assumed the above unit option agreement as part of its acquisition of
Wingra.
Form of Wingra Technologies, LLC Investor Option Agreement
Commtouch assumed the above investor option agreement as part of its acquisition
of Wingra. This agreement was entered into by Wingra prior to the Commtouch
acquisition in relation to certain loans provided by investors.
Form of Wingra Technologies, LLC Investor Warrant Agreement
Commtouch assumed the above investor warrant agreement as part of its
acquisition of Wingra. This agreement was entered into by Wingra prior to the
Commtouch acquisition in relation to certain loans provided by investors.
Stock Purchase Agreement between Commtouch Software Ltd. And Hughes Holdings
L.L.C., dated June 5, 2001
Pursuant to the agreement with Hughes, Commtouch intended to sell 850,000
ordinary shares in increments of at least $250,000 worth of ordinary shares per
week. Hughes was also granted an option to purchase an additional 1,400,000
ordinary shares, plus warrant coverage of 10%. With the price per ordinary share
having fallen below $0.75, Hughes had the right and chose not to fund the
transactions. Despite the above, the agreement has not formally terminated.
Agreement of Commercial Lease between Am-Ram Pituah Drom Netanya (South Netanya
Development) Ltd. As Lessor and Commtouch Software Ltd. As Lessee dated June 3,
2000 for premises in Netanya, Israel.
37
This is the facilities lease agreement for the Israel office which binds
Commtouch for a minimum period of three years.
Conditional Lease Termination Agreement between EOP-Shoreline Technology Park,
L.L.C. and Commtouch Inc. dated December 21, 2001
Pursuant to the agreement with EOP, Commtouch and EOP agreed to terminate the
then existing facilities lease agreement. Within the framework of this agreement
Commtouch made certain payments to EOP, assigned rights to a sub-tenancy
agreement , transferred ownership to certain furniture and issued a warrant for
175,000 ordinary shares, and EOP released Commtouch from the remainder
(approximately five years) of the lease term under the original agreement.
Settlement between Compaq Financial Services Corporation and Commtouch Inc. and
Commtouch Software Ltd. dated December 21, 2001
Pursuant to the agreement with Compaq, Commtouch and Compaq, agreed to terminate
four separate equipment lease schedules under a master lease agreement. In
relation thereto, Commtouch made certain payments and returned the related
equipment to Compaq, and Compaq released Commtouch from the remainder of the
lease term.
Settlement and Termination of Services Agreement between Exodus Communications,
Inc. and Commtouch Inc. dated January 10, 2002
Pursuant to the agreement with Exodus, Commtouch and Exodus, agreed to terminate
the services agreement and settle on an amount that was paid in full
satisfaction of all service fees claimed by Exodus.
Amended and Restated 1996 CSI Stock Option Plans and form of agreement.
In 1996, the Company adopted the 1996 CI Stock Option Plan for granting options
to its U.S. employees to purchase ordinary shares of the Company. The options
generally vest ratably over a 4-year period, though certain repriced shares
offered to employees in a Tender Offer Statement of July 20, 2001, as amended,
vest over a three year period. The exercise price of the options granted under
the individual agreements may not be less than the nominal value of the shares
into which such options are exercisable. Any options that are canceled or not
exercised within the options period become available for future grant.
Amended and Restated 1999 Section 3(i) Share Option Plan
In 1999 the Company approved the 1999 Section 3(i) Share Option Plan for its
Israeli employees, which was amended in 2001 to include Section 102
applicability (the sections relate to code sections under the Israel tax law).
The options generally vest ratably over a 4-year period, though certain repriced
shares offered to employees in a Tender Offer Statement of July 20, 2001, as
amended, vest over a three year period. The exercise price of the options
granted under the individual agreements may not be less than the nominal value
of the shares into which such options are exercisable. Any options that are
canceled or not exercised within the options period become available for future
grant.
Amended 1999 Non-Employee Directors Stock Option Plan
The Company adopted the 1999 Non-Employee Directors Stock Option Plan. The
original allotment of shares was in the amount of 180,000 ordinary shares, with
an additional allotment in 2000 bringing the plan's total allotment to 500,000
shares and a further allotment in 2001 bringing the plan's total to 750,000
ordinary shares. During 1999, each individual who first joined the Board of
Directors as a non-employee director on or after the effective date of the
initial public offering received an option grant for 10,000 shares. Subsequent
to July 2000, individuals who joined the board received an initial grant of
30,000 options. Directors who are reelected at the annual meeting of
shareholders are generally entitled to additional grants of 10,000 shares,
though those directors reelected at the August 22, 2001 annual meeting of
shareholders were entitled to a grant of 33,750 and those directors in office
immediately after the extraordinary general meeting of shareholders on February
25, 2002 were granted a one-time option grant of 150,000 ordinary shares. Also,
in addition to the grant of shares for her reelection as a director in August
2001, Carolyn Chin, on behalf of her activities as Chairman of the Board,
38
received an additional grant of 221,250 ordinary shares. Each option granted
under the Non-Employee Directors Plan originally was to have become exercisable
with respect to one-fourth of the number of shares covered by such option three
months after the date of grant and with respect to one-third of the remaining
shares subject to the option every three months thereafter; however, this
changed pursuant to an amendment to the plan approved by shareholders at the
August 10, 2000 annual meeting of shareholders, such that options become
exercisable at a rate of 1/16th of the shares every three months. Each option
has an exercise price equal to the fair market value of the ordinary shares on
the grant date of such option. However, certain options outstanding and
unexercised at the time of the effective date of the Tender Offer Statement of
July 20, 2001, as amended, were repriced in accordance with the terms of the
Tender Offer Statement, as amended. Each option has a maximum term of ten years,
but will terminate earlier if the optionee ceases to be a member of the Board of
Directors.
Agreement of Merger between CP Software Group Inc., Commtouch Software Ltd,
MailCentro, Inc. and CPSGNEWCO, Inc. dated November 16, 2001
Within the framework of an agreement with MailCentro Inc. ("MC"), MC (a wholly
owned subsidiary of CP Software Group, Inc.) assumed all aspects of servicing
most of the Company's consumer customers, including its free email service known
as Zap Zone service. According to the agreement entered into with MC, the
Company transferred customers to MC and is expected to realize royalties on
payments made by these former customers to MC (primarily in 2002). Additionally,
certain Commtouch trademarks, domain names, software licenses and equipment were
sold to MC.
Business Unit Purchase Agreement by and between Telecomputing, Inc. and
Commtouch Inc.
In January 2002, Commtouch sold its Hosted Exchange business unit to
Telecomputing, Inc. Terms of the transaction include the transference of the
Company's customer base and certain equipment to Telecomputing, in exchange for
certain cash payments and royalties. Furthermore, the Company assigned equipment
leases to Telecomputing, thereby eliminating the Company's obligation to make
lease payments thereunder.
Sale and Purchase Agreement by and between Commtouch Software Ltd., Commtouch
Inc., Wingra, Incorporated, Wingra Technologies, L.L.C., Jan Eddy and Steven
Entine
Commtouch sold off the net liabilities of its migration service business,
Wingra, Inc. to Wingra's senior management at the end of February 2002. The
terms include mutual release of all liabilities, obligations and rights of the
parties to the agreement. This sale is expected to reduce our Company's
operating losses and its net liabilities by approximately $0.7 million.
See the discussion under Item 4 "Information on the Company--Description of
Property" for an indication of where the Company's Articles of Association may
be inspected.
ISRAELI TAXATION AND INVESTMENT PROGRAMS
The following discussion summarizes the material Israeli tax consequences
relating to Commtouch, its shareholders and ownership and disposition of its
ordinary shares. This summary does not discuss all aspects of Israeli tax law
that may be relevant to a particular investor in light of his personal
investment circumstances or to certain types of investors subject to special
treatment under Israeli law (for example, traders in securities or persons that
own, directly or indirectly, 10% or more of Commtouch's outstanding voting
shares). The following also includes a discussion of certain Israeli government
programs benefiting various Israeli businesses such as Commtouch. To the extent
that the discussion is based on new legislation yet to be subject to judicial or
administrative interpretation, there can be no assurance that the views
expressed herein will accord with any such interpretation in the future. This
discussion does not cover all possible tax consequences or situations, and
investors should consult their tax advisors regarding the tax consequences
unique to their situation.
39
Proposed Tax Reform
On May 4, 2000, a committee chaired by the former Director General of the
Israeli Ministry of Finance issued a report recommending a sweeping reform in
the Israeli system of taxation. The proposed reform would significantly alter
the taxation of individuals, and would also affect corporate taxation. In
particular, the proposed reform would reduce, but not eliminate, the tax
benefits available to approved enterprises such as ours. The Israeli cabinet
approved the recommendations in principle, but implementation of the reform
requires legislation by Israel's Knesset. In the interim there have been
significant political and economic changes. On February 26, 2002 the Minister of
Finance appointed a new committee to recommend tax reforms, and this committee
is expected to submit a report within 90 days. The Company cannot be certain
whether the proposed reform will be adopted, when it will be adopted or what
form any reform will ultimately take.
General Corporate Tax Structure
The regular general corporate tax rate in Israel is 36%. However, the effective
rate payable by a company which derives income from an Approved Enterprise (as
further discussed below) may be considerably less. See "Law for the
Encouragement of Capital Investments, 1959."
Taxation Under Inflationary Conditions
The Income Tax Law (Adjustment for Inflation), 1985 (the "Adjustment for
Inflation Law") attempts to overcome some of the problems experienced in a
traditional tax system by an economy experiencing rapid inflation, which was the
case in Israel at the time the Adjustment for Inflation Law was enacted.
Generally, the Adjustment for Inflation Law was designed to neutralize for
Israeli tax purposes the erosion of capital investments in businesses and to
prevent unintended tax benefits resulting from the deduction of inflationary
financing expenses. The Adjustment for Inflation Law applies a supplementary set
of inflationary adjustments to a normal taxable profit computed according to
regular historical cost principles.
The Adjustment for Inflation Law introduced a special adjustment for the
preservation of equity for tax purposes based on changes in the Israeli CPI,
whereby corporate assets are classified broadly into fixed (inflation resistant)
assets and non-fixed assets. Where shareholders' equity, as defined in the
Adjustment for Inflation Law, exceeds the depreciated cost of fixed assets, a
corporate tax deduction - which takes into account the effect of inflationary
change on such 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
an inflation-linked basis with no ceiling). If the depreciated cost of fixed
assets exceeds shareholders' equity, then such excess multiplied by the annual
rate of inflation is added to taxable income.
In addition, subject to certain limitations, depreciation on fixed assets and
loss carry forwards are adjusted for inflation based on changes in the Israeli
CPI. The net effect of the Adjustment for Inflation Law on Commtouch might be
that Commtouch's taxable income, as determined for Israeli corporate tax
purposes, will be different from Commtouch's U.S. dollar income, as reflected in
its financial statements, due to the difference between the annual changes in
the CPI and in the NIS exchange rate with respect to the U.S. Dollar, causing
changes in the actual tax rate.
Law for the Encouragement of Industry (Taxes), 1969
Commtouch is currently viewed as qualifying as an "Industrial Company" within
the meaning of the Law for the Encouragement of Industry (Taxes), 1969 (the
"Industry Encouragement Law"). According to the Industry Encouragement Law, an
"Industrial Company" is a company resident in Israel, at least 90% of the income
of which in any tax year, determined in Israeli currency (exclusive of income
from defense loans, capital gains, interest and dividends) is derived from an
"Industrial Enterprise" that it owns. An "Industrial Enterprise" is defined by
that law as an enterprise whose major activity in a given tax year is industrial
production activity.
Included among the tax benefits for an Industrial Company are:
o deductions of 12.5% per annum of the purchase price of a patent or
of know-how that is utilized in the development or advancement of
its enterprise;
o an election under certain conditions to file a consolidated return
with additional related industrial companies;
o accelerated depreciation rates on equipment and buildings; and
40
o deduction of expenses incurred in connection with a public
issuance of shares listed for trading over a three year period.
The tax authorities may construe this benefit to be relevant only
upon a public issuance of shares in Israel.
Eligibility for the benefits under the Industry Encouragement Law is not subject
to receipt of prior approval from any governmental authority. No assurance can
be given that Commtouch is and will continue to be considered as an "Industrial
Company" or that the benefits described above will be available in the future.
Law for the Encouragement of Capital Investments, 1959
The Law for the Encouragement of Capital Investments, 1959, as amended (the
"Investment Law"), provides that a capital investment in production facilities
(or other eligible facilities) may, upon application to the Israel Investment
Center, be designated as an Approved Enterprise. Each certificate of approval
for an Approved Enterprise relates to a specific capital investment program
delineated both by its financial scope, including its capital sources, and its
physical characteristics, i.e. the equipment to be purchased and utilized
pursuant to the program. The tax benefits derived from any such certificate of
approval relate only to taxable profits attributable to the specific Approved
Enterprise.
Commtouch's investment plans have been granted the status of an Approved
Enterprise under the Investment Law, in three separate investment programs, one
of which was cancelled in early 2002. These programs provide Commtouch with
certain tax benefits as described below; with regard to the first program,
Commtouch also received long-term loans guaranteed by the State of Israel. Under
the terms of Commtouch's Approved Enterprise programs, income earned by
Commtouch from its Approved Enterprises will be tax exempt for a period of two
years, commencing with the year in which it first earns taxable income, and
subject to a reduced corporate tax rate of 10% to 25% for an additional period
of five to eight years (provided that the total period of tax benefits will not
extend past (i) 12 years from the year of commencement of production or (ii) 14
years from the year of approval of approved enterprise status). The reduced
corporate tax rate, to which Commtouch's Approved Enterprise program will be
subject, is dependent on the level of foreign investment in Commtouch. In the
event a company operates under more than one approval or only part of its
capital investments are approved (a "Mixed Enterprise"), its effective corporate
tax rate is the result of a weighted combination of the various applicable
rates. Notwithstanding these tax benefits, to the extent Commtouch receives
income from countries other than Israel, such income may be subject to
withholding tax.
Dividends paid by companies owning approved enterprises, the source of which is
income derived from an approved enterprise during the applicable benefits
period, are generally taxed at a reduced rate of 15% if the dividends are paid
during the benefits period or at any time up to 12 years after the benefits
period. This tax must be withheld at source by the company paying the dividend.
In the case of a "foreign investor's company," the 12 year limitation on reduced
withholding tax on dividends does not apply. Subject to various conditions, a
foreign investor's company is a company more than 25% of whose share capital, in
terms of shares, rights to profits, voting and appointment of directors, and of
whose combined share and loan capital, is owned by non-Israeli residents. A
dividend paid from income derived from an enterprise owned by a company which
has elected the "alternative benefits program" during the period in which it is
exempt from tax is also generally subject to the 15.0% tax rate; this would
render the company liable for corporate tax on the amount distributed, which is
defined for this purpose as including the amount of the corporate tax that
applies as a result of the distribution, at the rate that would have been
applicable had the company not elected the alternative benefits program, which
is generally 25.0%. Generally, any dividends distributed are considered to be
attributable to the entire enterprise, and the effective tax rate is the result
of a weighted combination of the various applicable tax rates. However, a
company may elect to attribute any dividend distributed by it only to income not
subject to the alternative benefits program.
The Investment Law also provides that a company with an Approved Enterprise is
entitled to accelerated depreciation on its property and equipment included in
an approved investment program.
Future applications to the Investment Center will be reviewed separately, and
decisions as to whether or not to approve such applications will be based, among
other things, on the then prevailing criteria set forth in the Investment Law,
on the specific objectives of the applicant company set forth in such
applications and on certain financial criteria of the applicant company.
Accordingly, there can be no assurance that any such applications will be
approved. In addition, the benefits available to an Approved Enterprise are
conditional upon the fulfillment of certain conditions stipulated in the
Investment Law and its regulations and the criteria set forth in the specific
41
certificate of approval, as described above. In the event that these conditions
are violated, in whole or in part, the Company would be required to refund the
amount of tax benefits, with the addition of the CPI linkage adjustment and
interest.
Capital Gains and Income Taxes Applicable to Non-Israeli Resident Shareholders
Under existing regulations any capital gain realized by an individual
shareholder with respect to the ordinary shares acquired on or after the listing
of such shares for trading will be exempt from Israeli capital gains tax if the
ordinary shares are listed on an approved foreign securities market (which
includes Nasdaq in the United States), provided that the company continues to
qualify as an Industrial Company under Israeli law and provided the individual
does not hold such shares for business purposes.
If we do not maintain our status as an Industrial Company, then subject to any
applicable tax treaty the Israeli capital gains tax rates would be up to 50% for
non-Israeli resident individuals and 36% for companies. Upon a distribution of
dividends other than bonus shares (stock dividends), income tax is generally
withheld at source at the rate of 25% (or the lower rate of 15% payable with
respect to Approved Enterprises), unless double taxation treaty is in effect
between Israel and the shareholder's country of residence that provides for a
lower tax rate in Israel on dividends.
A tax treaty between the United States and Israel (the "Treaty"), provides for a
maximum tax of 25% on dividends paid to a resident of the United States (as
defined in the Treaty). Dividends distributed by an Israeli company and derived
from the income of an approved enterprise are subject to a 15% dividend
withholding tax. The Treaty further provides that a 12.5% Israeli dividend
withholding tax applies to dividends paid to a United States corporation owning
10% or more of an Israeli company's voting shares throughout the current year to
the date the dividend is paid and the preceding taxable year (as applicable).
The 12.5% rate applies only on dividends from a company that does not have an
Approved Enterprise in the applicable period.
If for any reason shareholders do not receive the above exemption for a sale of
shares in an Industrial Company, the Treaty provides U.S. resident investors
with an exemption from Israeli capital gains tax in certain circumstances (there
may still be U.S. taxes) upon a disposition of shares in Commtouch if they held
under 10% of the Company's voting stock throughout the 12 months before the
share disposition. If Israeli capital gains tax is payable, it can be credited
against U.S. federal tax under the circumstances specified in the Treaty.
A non-resident of Israel who has had dividend income derived or accrued in
Israel from which the applicable tax was withheld at source is currently exempt
from the duty to file an annual Israeli tax return with respect to such income,
provided such income was not derived from a business carried on in Israel by
such non-resident and that such non-resident does not derive other non-passive
income from sources in Israel.
Tax Benefits for Research and Development
Israeli tax law allows under certain conditions a tax deduction in the year
incurred for expenditures in scientific research and development projects, if
the expenditures are approved by the relevant Israeli Government Ministry
(determined by the field of research) and the research and development is for
the promotion of the enterprise. Expenditures not so approved are deductible
over a three-year period. However, expenditures made out of the proceeds of
government grants are not deductible, i.e. Commtouch will be able to deduct the
unfunded portion of the research and development expenditures and not the gross
amount.
Law for the Encouragement of Industrial Research and Development, 1984
Under the Law for the Encouragement of Industrial Research and Development, 1984
(the "Research Law") and the Instructions of the Director General of the
Ministry of Industry and Trade, research and development programs and the plans
for the intermediate stage between research and development, and manufacturing
and sales approved by a governmental committee of the Office of Chief Scientist
(OCS) (the "Research Committee") are eligible for grants of up to 50% of the
project's expenditure if they meet certain criteria. These grants are issued in
return for the payment of royalties from the revenues derived from the sale of
the product developed in accordance with the program, as follows: 3% of revenues
during the first three years, 4% of revenues during the following three years,
and 5% of revenues in the seventh year and thereafter, with the total royalties
not to exceed 100% of the dollar value of the OCS grant (or in some cases up to
300%). Following the full payment of such royalties, there is no further
liability for payment.
42
The Israeli government further requires that products developed with government
grants be manufactured in Israel. However, in the event that any portion of the
manufacturing is not conducted in Israel, if approval is received from the OCS,
the Company would be required to pay royalties that are adjusted in proportion
to manufacturing outside of Israel as follows: when the manufacturing is
performed outside of Israel by the Company or an affiliate company, the
royalties are to be paid as described above with the addition of 1%, and when
the manufacturing outside of Israel is not performed by the Company or an
affiliate the royalties paid shall be equal to the ratio of the amount of grant
received from the OCS divided by the amount of grant received from the OCS and
the investment(s) made by the Company in the project. The payback will also be
adjusted to 120%, 150% or 300% of the grant if the portion of manufacturing that
is performed outside of Israel is up to 50%, between 50% and 90%, or more than
90%, respectively. The technology developed pursuant to the terms of these
grants may not be transferred to third parties without the prior approval of the
Research Committee. Such approval is not required for the export of any products
resulting from such research or development. Approval of the transfer of
technology may be granted only if the recipient abides by all the provisions of
the Research Law and regulations promulgated thereunder, including the
restrictions on the transfer of know-how and the obligation to pay royalties in
an amount that may be increased. The Company is subject to various provisions of
the Research Law and regulations and derivatives thereunder.
In order to meet certain conditions in connection with the grants and programs
of the OCS, the Company has made certain representations to the Israel
government about the Company's future plans for its Israeli operations. From
time to time the extent of the Company's Israeli operations has differed and may
in the future differ, from the Company's representations. If, after receiving
grants under certain of such programs, the Company fails to meet certain
conditions to those benefits, including, with respect to grants received from
the OCS, the maintenance of a material preserve in Israel, or if there is any
material deviation from the representations made by the Company to the Israeli
government, the Company could be required to refund to the State of Israel taxes
or other benefits previously received (including interest and CPI linkage
difference) and would likely be denied receipt of such grants or benefits, and
participation of such programs, thereafter.
The Company has participated in programs sponsored by the OCS for the support of
research and development activities. Through December 31, 2001, the Company had
recorded grants from OCS aggregating approximately $1.2 million for certain of
the Company's research and development projects. These grants were recorded as a
reduction of research and development costs. As noted, the Israeli government
requires beneficiaries of such grants to pay royalties to the Israeli government
based on the revenues derived from the sale of products, technologies and
services developed with such grants. We believe that we have no obligation for
royalties in 2001, related to the 2001 grants, since we had not started
generating revenue for the product developed with such grants, but we may have
obligations for royalties in 2002 and future years. As of December 31, 2001, we
believe we have contingent liabilities of $0.6 million for royalties to the OCS
regarding the 2001 grants.
With regard to grants before 2001, the Company claims that all of these
programs, which were funded at a total of $0.6 million, had failed and therefore
it will not be obligated to pay royalties. In March 2002, the Company submitted
an application for project failure with regard to these projects. Accordingly,
the Company decided to write down the $0.4 million accrual it recorded in past
years and determined that as of December 31, 2001 there is no contingent
liabilities for royalties for those projects.
Each application to the OCS is reviewed separately, and grants are based on the
program approved by the Research Committee. Expenditures supported under other
incentive programs of the State of Israel are not eligible for OCS grants. As a
result, there can be no assurance that applications to the OCS will be approved
or, if approved, what the amounts of the grants will be. On January 31, 2001,
the Company submitted an application to the OCS. In the application, the Company
described relevant R&D expenses for the year 2001 amounting to approximately
$3.2 million, which would entitle it to funding up to 50% of those expenses upon
approval of the application. The application was approved on May 8, 2001. Under
this program, Commtouch has received the sum of $0.6 million in 2001.
Fund for the Encouragement of Marketing Activities
The Company has received grants relating to its overseas marketing expenses from
the Marketing Fund. These grants are awarded for specific expenses incurred by
the Company for overseas marketing and are based upon the expenses reported by
the Company to the Marketing Fund. All marketing grants recorded from the
Marketing Fund until 1997 are linked to the dollar and are repayable as
royalties at the rate of 3% of the amount of increases in export sales realized
43
by the Company from the Marketing Fund. Grants recorded beginning January 1,
1998 bear royalties of 4% plus interest at LIBOR rates. The Company will face
royalty obligations on grants from the Marketing Fund only to the extent it
actually achieves increases in export sales. The proceeds of these grants are
presented in the Company's consolidated Financial Statements as offsets to
marketing expenses. Through December 31, 2000, the Company had received grants
from the Marketing Fund in the amount of approximately $279,000.
U.S. TAX CONSIDERATIONS REGARDING ORDINARY SHARES ACQUIRED BY U.S. TAXPAYERS
The following discussion summarizes the material U.S. federal income tax
consequences arising from the purchase, ownership and sale of the ordinary
shares. This summary is based on the provisions of the Internal Revenue Code of
1986, as amended (the "Code"), final, temporary and proposed U.S. Treasury
Regulations promulgated thereunder, and administrative and judicial
interpretations thereof, in effect as of the date of this report, all of which
are subject to change, possibly with retroactive effect. Commtouch will not seek
a ruling from the Internal Revenue Service with regard to the United States
federal income tax treatment relating to investment in the ordinary shares and,
therefore, no assurance exists that the Internal Revenue Service will agree with
the conclusions set forth below. The summary below does not purport to address
all federal income tax consequences that may be relevant to particular
investors. This summary does not address the consequences that may be applicable
to particular classes of taxpayers, including investors that hold ordinary
shares as part of a hedge, straddle or conversion transaction, insurance
companies, banks or other financial institutions, broker-dealers, tax-exempt
organizations and investors who own (directly, indirectly or through
attribution) 10% or more of Commtouch's outstanding voting stock. Further, it
does not address the alternative minimum tax consequences of an investment in
ordinary shares or the indirect consequences to U.S. Holders, as defined below,
of equity interests in investors in ordinary shares. This summary is addressed
only to holders that hold ordinary shares as a capital asset within the meaning
of Section 1221 of the Code, are U.S. citizens, individuals resident in the
United States for purposes of U.S. federal income tax, domestic corporations or
partnerships and estates or trusts treated as "United States persons" under
Section 7701 of the Code ("U.S. Holders").
EACH INVESTOR SHOULD CONSULT WITH HIS OR HER OWN TAX ADVISOR AS TO THE
PARTICULAR U.S. FEDERAL INCOME TAX CONSEQUENCES OF THE PURCHASE, OWNERSHIP AND
SALE OF ORDINARY SHARES, INCLUDING THE EFFECTS OF APPLICABLE STATE, LOCAL,
FOREIGN OR OTHER TAX LAWS AND POSSIBLE CHANGES IN THE TAX LAWS.
Tax Basis of Ordinary Shares
A U.S. Holder's tax basis in his or her ordinary shares will be the purchase
price paid therefore by such U.S. Holder. The holding period of each ordinary
share owned by a U.S. Holder will commence on the day following the date of the
U.S. Holder's purchase of such ordinary share and will include the day on which
such U.S. Holder sells the ordinary share.
Sale or Exchange of Ordinary Shares
A U.S. Holder's sale or exchange of ordinary shares will result in the
recognition of gain or loss by such U.S. Holder in an amount equal to the
difference between the amount realized and the U.S. Holder's basis in the
ordinary shares sold. Subject to the following discussion of the consequences of
Commtouch being treated as a Passive Foreign Investment Company or a Foreign
Investment Company, such gain or loss will be capital gain or loss if such
ordinary shares are a capital asset in the hands of the U.S. Holder. Gain or
loss realized on the sale of ordinary shares will be long-term capital gain or
loss if the ordinary shares sold had been held for more than one year at the
time of their sale. Long-term capital gains recognized by certain taxpayers
generally are subject to a reduced rate of federal tax (currently a maximum of
20%). If the U.S. Holder's holding period on the date of the sale or exchange
was one year or less, such gain or loss will be short-term capital gain or loss.
Short-term capital gains generally are subject to tax at the same rates as
ordinary income. In general, any capital gain recognized by a U.S. Holder upon
the sale or exchange of ordinary shares will be treated as U.S.-source income
for U.S. foreign tax credit purposes.
See discussion under "Israeli Taxation and Investment Programs--Capital Gains
and Income Taxes Applicable to Non-Israeli Shareholders" for a discussion of
taxation by Israel of capital gains realized on sales of capital assets.
44
Treatment of Dividend Distributions
For U.S. federal income tax purposes, gross dividends (including the amount of
any Israeli taxes withheld therefrom) paid to a U.S. Holder with respect to his
or her ordinary shares will be included in his or her ordinary income to the
extent made out of current or accumulated earnings and profits of Commtouch, as
determined based on U.S. tax principles, at the time the dividends are received
and will be treated as foreign source dividend income for purposes of the
foreign tax credit limitation described below. Such dividends will not be
eligible for the dividends received deduction allowed to U.S. corporations under
Section 243 of the Code. Dividend distributions in excess of Commtouch's current
and accumulated earnings and profits will be treated first as a non-taxable
return of the U.S. Holder's tax basis in his or her ordinary shares to the
extent thereof and then as a gain from the sale of ordinary shares. Dividends
paid in NIS will be includible in income in a U.S. dollar amount based on the
exchange rate at the time of their receipt, and any gain or loss resulting from
currency fluctuations during the period from the date a dividend is paid to the
date such payment is converted into U.S. dollars generally will be treated as
ordinary income or loss.
Any Israeli withholding tax imposed on dividends paid to a U.S. Holder will be a
foreign income tax eligible for credit against such U.S. Holder's U.S. federal
income tax liability subject to certain limitations. Alternatively, a U.S.
Holder may claim a deduction for such amount, but only for a year in which a
U.S. Holder elects to do so with respect to all foreign income taxes. The
overall limitation on foreign taxes eligible for credit is calculated separately
with respect to specific classes of income. Dividends distributed by Commtouch
with respect to ordinary shares will generally constitute "passive income".
Foreign income taxes exceeding the credit limitation for the year of payment or
accrual may be carried back for two taxable years and forward for five taxable
years in order to reduce U.S. federal income taxes, subject to the credit
limitation applicable in each of such years. Other restrictions on the foreign
tax credit include a general prohibition on the use of the credit to reduce
liability for the U.S. individual and corporation alternative minimum taxes by
more than 90% and an allowance of foreign tax credits for alternative minimum
tax purposes only to the extent of foreign-source alternative minimum taxable
income. See "Israeli Taxation and Investment Programs -- Capital Gains and
Income Taxes Applicable to Non-Israeli Shareholders."
Information Reporting and Backup Withholding
Any dividends paid on, or proceeds derived from a sale of, the ordinary shares
to, or by, U.S. Holders may be subject to U.S. information reporting
requirements and the 30% U.S. backup withholding tax unless the holder (i) is a
corporation or other exempt recipient or (ii) provides a United States taxpayer
identification number, certifies as to no loss of exemption from backup
withholding and otherwise complies with any applicable withholding requirements.
Any amounts withheld under the U.S. backup withholding tax rules will be allowed
as a refund or a credit against the U.S. Holder's U.S. federal income tax,
provided the required information is furnished to the U.S. Internal Revenue
Service.
Tax Status of Commtouch for U.S. Federal Income Tax Purposes
Passive Foreign Investment Company. If Commtouch were deemed to be a passive
foreign investment company (a "PFIC") for U.S. federal income tax purposes, any
gain recognized by a U.S. Holder upon the sale of ordinary shares (or the
receipt of certain distributions) generally would be treated as ordinary income,
such income would be allocated over such U.S. Holder's holding period for such
ordinary shares and an interest charge would be imposed on the amount of
deferred tax on such income which is allocated to prior taxable years.
Generally, Commtouch will be treated as a PFIC for any tax year if, in such tax
year or any prior tax year, either (i) 75% or more of its gross income is
passive in nature, or (ii) on average, 50% or more of its assets by value
produce or are held for the production of passive income. Commtouch does not
believe it satisfies either of the tests for PFIC status for any of its pre-2002
tax years. Commtouch expects that the majority of its assets will continue to
generate sufficient levels of active income, and the percentage (by value) of
its assets not producing or held for the production of passive income will
continue to be sufficient, for it to avoid PFIC treatment for U.S. federal
income tax purposes in post-2001 tax years. However, since the determination
whether Commtouch is a PFIC will be made annually based on facts and
circumstances that, to some extent, may be beyond Commtouch's control, there can
be no assurance that Commtouch will not become a PFIC at some time in the
future. If Commtouch were determined to be a PFIC, however, a U.S. Holder could
elect to treat his or her ordinary shares as an interest in a qualified electing
fund (a "QEF Election"), in which case, the U.S. Holder would be required to
include in income currently his or her proportionate share of Commtouch's
earnings and profits in years in which Commtouch is a PFIC whether or not
distributions of such earnings and profits are actually made to such U.S.
Holder, but any gain subsequently recognized upon the sale by such U.S. Holder
of his or her ordinary shares generally would be taxed as a capital gain.
Alternatively, a U.S. Holder may elect to mark the ordinary shares to market
annually, recognizing ordinary income or loss (subject to certain limitations)
equal to the difference between the fair market value of its ordinary shares and
the adjusted basis of such stock. See "U.S. Tax Considerations Regarding
45
Ordinary Shares Acquired by U.S. Taxpayers--Sale or Exchange of Ordinary Shares"
above. U.S. Holders should consult with their own tax advisers regarding the
eligibility, manner and advisability of making a QEF Election if Commtouch is
treated as a PFIC.
Controlled Foreign Corporations. Sections 951 through 964 and Section 1248 of
the Code relate to controlled foreign corporations ("CFC"). The CFC provisions
may impute some portion of such a corporation's undistributed income to certain
U.S. shareholders on a current basis and convert into dividend income some
portion of gains on dispositions of stock which would otherwise qualify for
capital gains treatment. In general, the CFC provisions will apply to Commtouch
only if U.S. shareholders, who are U.S. Holders and who own, directly or
indirectly or by attribution, 10% or more of the total combined voting power of
all classes of voting stock own in the aggregate (or are deemed to own after
application of complex attribution rules) more than 50% (measured by voting
power or value) of the outstanding ordinary shares of Commtouch. It is possible
that Commtouch could become a CFC in the future. Even if Commtouch were
classified as a CFC in a future year, however, the CFC rules referred to above
would apply only with respect to U.S. shareholders, who are U.S. Holders and who
own, directly or indirectly or by attribution, 10% or more of the total combined
voting power of all classes of voting stock of Commtouch.
Personal Holding Company/Foreign Personal Holding Company/Foreign Investment
Company. A corporation will be classified as a personal holding company, or a
PHC, if (i) five or fewer individuals at any time during the last half of a tax
year (without regard to their citizenship or residence) directly or indirectly
or by attribution own more than 50% in value of the corporation's stock and (ii)
at least 60% of its ordinary gross income for the taxable year, as specially
adjusted, consists of personal holding company income (defined generally to
include dividends, interest, royalties, rents and certain other types of passive
income). A PHC is subject to a United States federal income tax of 38.6% on its
undistributed personal holding company income (generally limited, in the case of
a foreign corporation, to United States source income).
A corporation will be classified as a foreign personal holding company, or an
FPHC, and not a PHC if at any time during a tax year (i) five or fewer
individual United States citizens or residents directly or indirectly or by
attribution own more than 50% of the total combined voting power or value of the
corporation's stock and (ii) at least 60% of its gross income consists of (50%
for years following the first year it becomes a FPHC) FPHC income (defined
generally to include dividends, interest, royalties, rents and certain other
types of passive income). Each United States shareholder in an FPHC is required
to include in gross income, as a dividend, an allocable share of the FPHC's
undistributed foreign personal holding company income (generally the taxable
income of the FPHC, as specially adjusted).
A corporation will be classified as a foreign investment company, or an FIC, if
for any taxable year it (i) is registered under the Investment Company Act of
1940, as amended, as a management company or unit investment trust or is engaged
primarily in the business of investing or trading in securities or commodities
(or any interest therein) and (ii) 50% or more of the total value or the total
combined voting power of all classes of the corporation's stock is owned
directly or indirectly (including stock owned through the application of
attribution rules) by United States persons. In general, unless an FIC elects to
distribute 90% or more of its taxable income (determined under United States tax
principles as specially adjusted) to its shareholders, any gain on the sale or
exchange of stock in a foreign corporation which was a FIC at any time during
the period during which a taxpayer held such stock is treated as ordinary income
(rather than capital gain) to the extent of such shareholder's ratable share of
the corporation's accumulated earnings and profits.
CONDITIONS IN ISRAEL
Commtouch is incorporated under the laws of the State of Israel, and
substantially all of our research and development and significant executive
facilities are located in Israel. Accordingly, Commtouch is directly affected by
political, economic and military conditions in Israel. Our operations would be
materially adversely affected if major hostilities involving Israel should occur
or if trade between Israel and its present trading partners should be curtailed.
Political Conditions
Since the establishment of the State of Israel in 1948, a number of armed
conflicts have taken place between Israel and its Arab neighbors. A state of
hostility, varying from time to time in intensity and degree, has led to
security and economic problems for Israel. Despite a peace agreement between
Israel and Egypt signed in 1979, a peace agreement between Israel and Jordan
signed in 1994 and, since 1993, several agreements between Israel and
46
Palestinian representatives, Israel continues to face hostile actions and
threats from various elements in the region. Further, Israel has not entered
into any peace agreement with Syria or Lebanon, and there have been major
difficulties accompanied by violence in the negotiations with the Palestinians.
We cannot be certain as to how the current hostilities affecting the region will
develop or what effect they may have upon Commtouch.
Certain countries, companies and organizations continue to participate in a
boycott of Israeli firms. Commtouch does not believe that the boycott has had a
material adverse effect on Commtouch, but restrictive laws, policies or
practices directed towards Israel or Israeli businesses may have an adverse
impact on the expansion of Commtouch's business.
Generally, all male adult citizens and permanent residents of Israel under the
age of 51 are obligated to perform up to 39 days, or longer under certain
circumstances, of military reserve duty annually. Additionally, all such
residents are subject to being called to active duty at any time under emergency
circumstances. Currently, a majority of our officers and employees are obligated
to perform annual reserve duty. While we have operated effectively under these
requirements since we began operations, no assessment can be made as to the full
impact of such requirements on our workforce or business if conditions should
change, and no prediction can be made as to the effect on us of any expansion or
reduction of such obligations.
Economic Conditions
Israel's economy has been subject to numerous destabilizing factors, including a
period of rampant inflation in the early to mid-1980s, low foreign exchange
reserves, fluctuations in world commodity prices, military conflicts and civil
unrest. The Israeli government has, for these and other reasons, intervened in
various sectors of the economy, employing, among other means, fiscal and
monetary policies, import duties, foreign currency restrictions and controls of
wages, prices and foreign currency exchange rates. The Israeli government has
periodically changed its policies in all these areas.
Until May 1998, Israel imposed restrictions on transactions in foreign currency.
These restrictions affected our operations in various ways, and also affected
the right of non-residents of Israel to convert into foreign currency amounts
they received in Israeli currency, such as the proceeds of a judgment enforced
in Israel. Despite these restrictions, foreign investors who purchased shares
with foreign currency were able to repatriate in foreign currency both dividends
(after deduction of withholding tax) and the proceeds from the sale of the
shares. There are currently no Israeli currency control restrictions on
remittances of dividends on the ordinary shares or the proceeds from the sale of
the shares; however, legislation remains in effect pursuant to which currency
controls can be imposed by administrative action at any time.
Trade Agreements
Israel is a member of the United Nations, the International Monetary Fund, the
International Bank for Reconstruction and Development and the International
Finance Corporation. Israel is also a signatory to the General Agreement on
Tariffs and Trade, which provides for reciprocal lowering of trade barriers
among its members. In addition, Israel has been granted preferences under the
Generalized System of Preferences from Australia, Canada and Japan. These
preferences allow Israel to export the products covered by such programs either
duty-free or at reduced tariffs.
Israel has entered into preferential trade agreements with the European Union,
the United States and the European Free Trade Association. In recent years,
Israel has established commercial and trade relations with a number of the other
nations, including Russia, China and India, with which Israel had not previously
had such relations.
Assistance from the United States
Israel receives significant amounts of economic and military assistance from the
United States, averaging approximately $3 billion annually over the last several
years. In addition, in 1992, the United States approved the issuance of up to
$10 billion of loan guarantees during U.S. fiscal years 1993 to 1998 to help
Israel absorb a large influx of new immigrants, primarily from the republics of
the former Soviet Union. Under the loan guarantee program, Israel may issue up
to $2 billion in principal amount of guaranteed loans each year, subject to
reduction in certain circumstances. There is no assurance that foreign aid from
the United States will continue at or near amounts received in the past. If the
grants for economic and military assistance or the United States loan guarantees
are eliminated or reduced significantly, the Israeli economy could suffer
material adverse consequences.
47
Item 11. Qualitative and Quantitative Disclosure about Market Risk.
We develop our technology in Israel and seek to provide our software products
worldwide. As a result, our financial results could be affected by factors such
as changes in foreign currency exchange rates or weak economic conditions in
foreign markets. As most of our sales are currently made in U.S. dollars, a
strengthening of the dollar could make our services less competitive in foreign
markets. Due to the nature and level of our debts, we have concluded that there
is currently no material market risk exposure. Therefore, no quantitative
tabular disclosures are required.
Item 12. Description of Securities Other than Equity Securities.
Not applicable.
PART II
Item 13. Defaults, Dividend Arrearages and Delinquencies.
Not applicable.
Item 14. Material Modifications to the Rights of Security Holders and Use of
Proceeds.
Not applicable.
Item 15. Reserved
Item 16. Reserved
48
PART III
Item 17. Financial Statements.
The Company has responded to Item 18.
Item 18. Financial Statements
(a) Financial Statements
Page
----
Report of Independent Auditors....................... F-1
Consolidated Balance Sheets.......................... F-2
Consolidated Statements of Operations................ F-3
Statement of Changes in Shareholders' Equity......... F-4
Consolidated Statements of Cash Flows................ F-5
Notes to Consolidated Financial Statements........... F-8
(b) Financial Statement Schedule:
The following financial statement schedule of Commtouch Software Ltd. for each
of the three years in the period ended December 31, 2001 is filed as part of the
Annual Report and should be read in conjunction with the consolidated financial
statements of Commtouch Software, Ltd.
Schedule II --Valuation and Qualifying Accounts
Schedules not listed above have been omitted because the information
required to be set forth therein is not applicable or is shown in the
consolidated financial statements or notes thereto.
Item 19 Exhibits
The list of exhibits required by this Item is incorporated by reference to
the Exhibit Index which precedes the exhibits to this report.
49
REPORT OF INDEPENDENT AUDITORS
To the Shareholders of COMMTOUCH SOFTWARE LTD.
We have audited the accompanying consolidated balance sheets of Commtouch
Software Ltd. ("the Company") and its subsidiaries as of December 31, 2000 and
2001, and the related consolidated statements of operations, changes in
shareholders' equity, and cash flows for each of the three years in the period
ended December 31, 2001. Our audits also included the financial statement
schedules listed in the Index at item 18(b). These financial statements and
schedules are the responsibility of the Company's management. Our responsibility
is to express an opinion on these financial statements and schedules based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards, in the United States. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatements. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by the Company's management, as well as evaluating
the overall financial statements presentation. We believe that our audits
provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above, present
fairly, in all material respects, the consolidated financial position of
Commtouch Software Ltd. and its subsidiaries as of December 31, 2000 and 2001,
and the consolidated results of their operations and cash flows for each of the
three years in the period ended December 31, 2001, in conformity with accounting
principles generally accepted in the United States. Also, in our opinion, the
related financial statment schedules, when considered in relation to the basic
financial statements taken as a whole, present fairly in all material respect
the information set forth therein.
Tel-Aviv, Israel
February 27, 2002
KOST, FORER & GABBAY
A Member of Ernst & Young International
F-1
COMMTOUCH SOFTWARE LTD.
CONSOLIDATED BALANCE SHEETS
(USD in thousands, except share and per share data)
December 31,
----------------------
2000 2001
--------- ---------
Assets
Current Assets:
Cash and cash equivalents .............................................. $ 20,831 $ 2,248
Marketable securities .................................................. 8,607 --
Trade receivables, net ................................................. 4,355 864
Prepaid expenses and other accounts receivable ......................... 3,626 700
--------- ---------
Total current assets ................................................... 37,419 3,812
--------- ---------
Long-term lease deposits ................................................ 1,440 261
Severance pay fund ...................................................... 949 320
Property and equipment, net ............................................. 19,417 5,152
Long-term investment .................................................... 2,000 --
Goodwill and other purchased intangibles, net ........................... 16,055 --
--------- ---------
$ 77,280 $ 9,545
--------- ---------
Liabilities and Shareholders' Equity
Current Liabilities:
Bank credit line and current maturities of bank loans and capital leases $ 1,115 $ 799
Accounts payable ....................................................... 4,205 1,374
Employees and payroll accruals ......................................... 3,279 633
Deferred revenues ...................................................... 1,523 839
Accrued expenses and other liabilities ................................. 3,529 774
--------- ---------
Total current liabilities .............................................. 13,651 4,419
--------- ---------
Long-term maturities of bank loans and capital leases .................. 841 260
Other liabilities ...................................................... -- 255
Accrued severance pay .................................................. 984 425
--------- ---------
1,825 940
--------- ---------
Minority interest ...................................................... 76 127
--------- ---------
Commitments and Contingencies
Shareholders' Equity
Ordinary Shares, nominal value NIS 0.05 par value-
Authorized: 40,000,000 shares as of
December 31, 2000 and 2001; Issued and
outstanding: 16,925,022 and 17,496,819 shares
as of December 31, 2000 and 2001, respectively ......................... 236 239
Additional paid-in capital ............................................. 150,994 152,162
Deferred stock compensation ............................................ (2,729) (828)
Notes receivable from shareholders ..................................... (1,041) (754)
Accumulated other comprehensive income ................................. 21 --
Accumulated deficit .................................................... (85,753) (146,760)
--------- ---------
Total shareholders' equity ............................................. 61,728 4,059
--------- ---------
$ 77,280 $ 9,545
========= =========
The accompanying notes are an integral part of these consolidated financial
statements.
F-2
COMMTOUCH SOFTWARE LTD.
CONSOLIDATED STATEMENTS OF OPERATIONS
(USD in thousands, except per share data)
Year ended
December 31,
--------------------------------
1999 2000 2001
-------- -------- --------
Revenues:
Email services ............................................... $ 4,251 $ 17,965 $ 14,697
Software licenses ............................................ -- 1,150 621
-------- -------- --------
Total revenues ............................................... 4,251 19,115 15,318
-------- -------- --------
Cost of revenues:
Email services ............................................... 3,643 11,864 14,605
Software licenses ............................................ -- -- --
-------- -------- --------
Total cost of revenues ....................................... 3,643 11,864 14,605
-------- -------- --------
Gross profit .................................................. 608 7,251 713
-------- -------- --------
Operating expenses:
Research and development, net ................................ 2,942 10,357 7,278
Sales and marketing .......................................... 7,722 26,585 13,496
General and administrative ................................... 4,328 13,621 11,236
In-process research and development .......................... -- 1,280 --
Amortization of the prepaid marketing expenses ............... 3,263 4,508 --
Amortization of stock-based employee deferred compensation(1) 3,436 3,050 2,204
Amortization of goodwill and other purchased intangibles ..... -- -- 2,794
Write-off of impaired goodwill and other intangible assets ... -- -- 13,280
Write-off of impaired property, equipment and other .......... -- -- 10,166
-------- -------- --------
Total operating expenses ..................................... 21,691 59,401 60,454
-------- -------- --------
Operating loss ................................................ (21,083) (52,150) (59,741)
Interest and other income, net ............................... 1,232 2,870 449
Write-off impaired long-term investments ..................... -- (5,000) (2,000)
Minority interest ............................................ -- 55 285
-------- -------- --------
Net loss ...................................................... $(19,851) $(54,225) $(61,007)
======== ======== ========
Basic and diluted net loss per share .......................... $ (2.65) $ (3.51) $ (3.56)
======== ======== ========
Weighted average number of shares used in computing
basic and diluted net loss per share ......................... 7,487 15,462 17,152
======== ======== ========
Year ended
December 31,
--------------------------------
1999 2000 2001
-------- -------- --------
(1) Stock-based Employee Compensation Relates to the following:
Cost of revenues ............................................. $ 113 $ 102 $ 82
Research and development, net ................................ 320 284 226
Sales and marketing .......................................... 897 795 554
General and administrative ................................... 2,106 1,869 1,342
-------- -------- --------
Total ........................................................ $3,436 $3,050 $2,204
======== ======== ========
The accompanying notes are an integral part of these consolidated financial
statements.
F-3
COMMTOUCH SOFTWARE LTD.
STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY (DEFICIENCY)
(USD in thousands, except share data)
Convertible
Preferred shares Ordinary shares Additional
--------------------- ----------------------- paid-in
Shares Amount Shares Amount capital
-------- --------- ---------- ---------- ----------
Balance as of January 1, 1999 ..................... 221,265 74 1,450,040 27 11,256
Issuance of shares, net .......................... 134,225 33 -- -- 18,417
Issuance of shares at initial public offering,
net .............................................. -- -- 4,794,086 58 65,948
Conversion of preferred shares to ordinary
shares ........................................... (355,490) (107) 7,109,800 107 --
Fair value of warrants issued for services
and bank line of credit .......................... -- -- -- -- 8,131
Deferred stock compensation ...................... -- -- -- -- 8,797
Ordinary shares issued for notes ................. -- -- 670,180 8 1,029
Issuance of shares upon exercise of warrants,
net .............................................. -- -- 1,105,378 12 19,808
Issuance of shares upon exercise of options ...... -- -- 69,860 1 17
Amortization of deferred stock compensation ...... -- -- -- -- --
Repayment of notes receivable .................... -- -- -- -- --
Other comprehensive income-unrealized
holding gains on marketable securities ........... -- -- -- -- --
Net loss ......................................... -- -- -- -- --
Total comprehensive loss ......................... -- -- -- -- --
-------- --------- ---------- ---------- ----------
Balance as of December 31, 1999 ................... -- -- 15,199,344 213 133,403
Issuance of shares upon exercise of options ...... -- -- 440,384 6 1,701
Amortization of deferred stock compensation ...... -- -- -- -- --
Repayment of notes receivable .................... -- -- -- -- --
Other comprehensive income-unrealized
holding losses on marketable securities .......... -- -- -- -- --
Issuance of shares to minority interest in
Japan-Note 2i .................................... -- -- -- -- 1,090
Issuance of shares and vested options and warrants
in consideration of the acquisition of Wingra .... -- -- 1,285,294 17 14,800
Net loss ......................................... -- -- -- -- --
Total comprehensive loss ......................... -- -- -- -- --
-------- --------- ---------- ---------- ----------
Balance as of December 31, 2000 ................... -- -- 16,925,022 236 150,994
Issuance of shares, net .......................... -- -- 315,789 2 256
Issuance of shares upon exercise of options ...... -- -- 256,008 1 116
Stock based compensation related to warrants
granted to a service provider .................... -- -- -- -- 53
Amortization of deferred stock compensation ...... -- -- -- -- --
Deferred stock compensation ...................... -- -- -- -- 303
Repayment of notes receivable .................... -- -- -- -- --
Forgiveness of notes receivable .................. -- -- -- -- --
Other comprehensive income-unrealized
holding losses on marketable securities .......... -- -- -- -- --
Issuance of shares to minority interest in
Japan-Note 2i .................................... -- -- -- -- 440
Net loss ......................................... -- -- -- -- --
Total comprehensive loss ......................... -- -- -- -- --
-------- --------- ---------- ---------- ----------
Balance as of December 31, 2001 ................... -- $ -- 17,496,819 $ 239 $ 152,162
======== ========= ========== ========== ==========
F-4
Stock-based Notes Accumulated
employee receivable other
deferred from comprehensive Accumulated
compensation shareholders income deficit Total
----------- ------------ --------- --------- ---------
Balance as of January 1, 1999 ..................... (418) (77) -- (11,677) (815)
Issuance of shares, net .......................... -- -- -- -- 18,450
Issuance of shares at initial public offering,
net .............................................. -- -- -- -- 66,006
Conversion of preferred shares to ordinary
shares ........................................... -- -- -- -- --
Fair value of warrants issued for services
and bank line of credit .......................... -- -- -- -- 8,131
Deferred stock compensation ...................... (8,797) -- -- -- --
Ordinary shares issued for notes ................. -- (1,037) -- -- --
Issuance of shares upon exercise of warrants,
net .............................................. -- -- -- -- 19,820
Issuance of shares upon exercise of options ...... -- -- -- -- 18
Amortization of deferred stock compensation ...... 3,436 -- -- -- 3,436
Repayment of notes receivable .................... -- 54 -- -- 54
Other comprehensive income--unrealized
holding gains on marketable securities ........... -- -- 63 -- 63
Net loss ......................................... -- -- -- (19,851) (19,851)
Total comprehensive loss ......................... -- -- -- -- (19,788)
-------- --------- --------- --------- ---------
Balance as of December 31, 1999 ................... (5,779) (1,060) 63 (31,528) 95,312
Issuance of shares upon exercise of options ...... -- -- -- -- 1,707
Amortization of deferred stock compensation ...... 3,050 -- -- -- 3,050
Repayment of notes receivable .................... -- 19 -- -- 19
Other comprehensive income--unrealized
holding losses on marketable securities .......... -- -- (42) -- (42)
Issuance of shares to minority interest in
Japan-Note 2i .................................... -- -- -- -- 1,090
Issuance of shares and vested options and warrants
in consideration of the acquisition of Wingra .... -- -- -- -- 14,817
Net loss ......................................... -- -- -- (54,225) (54,225)
---------
Total comprehensive loss ......................... -- -- -- -- (54,267)
-------- --------- --------- --------- ---------
Balance as of December 31, 2000 ................... (2,729) (1,041) 21 (85,753) 61,728
Issuance of shares, net .......................... -- -- -- -- 258
Issuance of shares upon exercise of options ...... -- -- -- -- 117
Amortization of deferred stock compensation ...... 2,204 -- -- -- 2,204
Stock based compensation related to warrants
granted to a service provider .................... -- -- -- -- 53
Deferred stock compensation ...................... (303) -- -- -- --
Repayment of notes receivable .................... -- 144 -- -- 144
Forgiveness of notes receivable .................. -- 143 -- -- 143
Other comprehensive income--unrealized
holding losses on marketable securities .......... -- -- (21) -- (21)
Issuance of shares to minority interest in
Japan-Note 2i .................................... -- -- -- -- 440
Net loss ......................................... -- -- -- (61,007) (61,007)
Total comprehensive loss ......................... -- -- -- -- (61,028)
-------- --------- --------- --------- ---------
Balance as of December 31, 2001 ................... $ (828) $ (754) $ -- $(146,760) $ 4,059
======== ========= ========= ========= =========
The accompanying notes are an integral part of these consolidated financial
statements.
F-5
COMMTOUCH SOFTWARE LTD.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(USD in thousands)
Year Ended
December 31,
-----------------------------------
1999 2000 2001
--------- --------- ---------
Cash flows from operating activities:
Net loss ................................................................ $ (19,851) $ (54,225) $ (61,007)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization ................................... 1,706 6,009 10,256
Amortization of stock-based employee deferred
compensation and warrants issued for services received
and bank line of credit ......................................... 3,796 3,050 2,204
Amortization of prepaid marketing expenses ...................... 3,263 4,508 --
Amortization of in-process research and development ............. -- 1,280 --
Write-off of impaired long-term investments ..................... -- 5,000 2,000
Write-off of impaired goodwill and other intangible assets ...... -- -- 13,280
Write-off of impaired property, equipment and other.............. -- -- 10,166
Loss on sale of property and equipment .......................... -- -- 695
Changes in assets and liabilities:
Trade receivables, net ......................................... (2,245) (1,719) 3,491
Prepaid expenses and other accounts receivable ................. (1,028) (1,933) 2,926
Accounts payable ............................................... 1,064 2,142 (2,831)
Employee and payroll accruals and other liabilities ............ 1,645 4,076 (5,146)
Deferred revenues .............................................. 487 656 (684)
Accrued severance pay, net ..................................... (44) (64) 70
Forgiveness of notes receivable ................................ -- -- 143
Minority interest in losses of a subsidiary .................... -- (55) (285)
Other .......................................................... (9) (5) 3
--------- --------- ---------
Net cash used in operating activities .................................... (11,216) (31,280) (24,719)
--------- --------- ---------
Cash flows from investing activities:
Proceeds from sales of marketable securities ............................ -- 18,969 8,586
Purchases of marketable securities ...................................... (17,987) (9,568) --
Purchase of long-term investments ....................................... -- (7,000) --
Long-term lease deposits ................................................ (1,254) (163) 204
Advance to related party ................................................ (364) -- --
Proceeds from acquisition of Wingra ..................................... -- 305 --
Proceeds from sale of property and equipment ............................ 13 337 160
Purchase of property and equipment ...................................... (6,938) (19,102) (3,265)
--------- --------- ---------
Net cash (used) provided in investing activities ......................... (26,530) (16,222) 5,685
--------- --------- ---------
Cash flows from financing activities:
Short-term bank credit, net ............................................. (1,328) -- --
Repayment of note receivable by shareholder ............................. 54 19 144
Repayment of bank loans and notes payable ............................... -- -- (873)
Principal payment of capital lease ...................................... (112) (610) (204)
Proceeds from issuance of shares, net ................................... 104,294 1,707
428
Proceeds from minority interest in subsidiary ........................... -- 1,090 440
Contribution from minority interest of consolidated subsidiary .......... -- 131 336
--------- --------- ---------
Net cash provided by financing activities ................................ 102,908 2,337 451
--------- --------- ---------
Increase (decrease) in cash and cash equivalents ......................... 65,162 (45,165) (18,583)
Cash and cash equivalents at the beginning of the year ................... 834 65,996 20,831
--------- --------- ---------
Cash and cash equivalents at the end of the year ......................... $ 65,996 $ 20,831 $ 2,248
========= ========= =========
F-6
Supplemental disclosure of cash flows activity: Cash paid during the year:
Interest ................................................................ $ 117 $ 31 $ 161
Supplemental disclosure of non-cash activity:
Ordinary shares issued for notes receivable from shareholders ........... $ 1,037 $ -- $ --
Issuance of Warrants for Prepaid Marketing Expenses ..................... $ 7,771 $ -- $ --
The proceeds from the acquisition of Wingra, for year ended December 31, 2000
were as follows (in thousands):
Net Tangible liabilities assumed
Tangible assets: $ 475
Tangible liabilities (3,054)
Net tangible liabilities assumed: (2,579)
Intangibles assumed:
Customer base 1,340
Workforce-in-place 550
Intellectual Property 1,660
In-process research & development expenses 1,280
Goodwill 12,590
Intangibles assumed: 17,420
Cash acquired: 305
Purchase price $ 15,146
The accompanying notes are an integral part of these consolidated financial
statements.
F-7
COMMTOUCH SOFTWARE LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1: GENERAL
Commtouch Software Ltd. was incorporated under the laws of Israel in 1991.
Unless otherwise indicated, all references in these notes to "Commtouch," "the
Company," "we," "us" or "our" are to Commtouch Software Ltd. or/and its
wholly-owned subsidiaries, Commtouch Inc., Commtouch (UK) Ltd, Commtouch Latin
America Inc., Wingra, Inc. and its majority-owned subsidiary, Commtouch K.K.
(Japan). We are a provider of email and messaging solutions to service providers
that target both residential and business subscriber users. Until December 31,
2001, our customers were large and small businesses who offered our Web-based
email through their website to their end users. The Company generated revenues
by providing email services to its customers. Email service revenues were
derived from contracts that provide for either a monthly per-email box fee and
fees for direct marketing and communications services or a share of advertising
revenues subject to a minimum annual revenue commitment. In September 2000, the
Company began to derive revenue from the sale of software licenses to
enterprises. In 2002, the Company sold its, migration and most of its hosted
email service businesses and changed its focus to providing email and messaging
solutions to service providers (see Note 15).
During 2001 and 2000, no single customer accounted for more than 10% of the
revenues. During 1999, approximately 11% of the revenues were derived from a
single customer.
NOTE 2: SIGNIFICANT ACCOUNTING POLICIES
The consolidated financial statements have been prepared in accordance with
accounting principles generally accepted in the United States.
a. Use of Estimates:
The preparation of consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the amounts reported in the consolidated financial
statements and accompanying notes. Actual results could differ from those
estimates.
b. Financial Statements in U. S. Dollars:
Most of the Company's revenues are denominated in U. S. dollars. In addition, a
substantial portion of the Company's costs are incurred in dollars. Since the
dollar is the primary currency in the economic environment in which the Company
and its subsidiaries operate, the dollar is their functional currency, and,
accordingly, monetary accounts maintained in currencies other than the dollar
are re-measured into U.S. dollars in accordance with Statement of Financial
Accounting Standards No. 52 "Foreign Currency Transactions." Operational
accounts and non-monetary balance sheet accounts are measured and recorded at
the rate in effect at the date of the transaction. The effects of foreign
currency re-measurement are reported as financial income or expense as
appropriate.
c. Principles of Consolidation:
The consolidated financial statements include the accounts of the Company and
its wholly-owned subsidiaries and majority-owned subsidiary. All inter-company
balances and transactions have been eliminated in consolidation.
d. Cash, Cash Equivalents and Marketable Securities:
F-8
The Company considers all highly liquid investments originally purchased with
maturities of three months or less to be cash equivalents.
The Company accounts for its marketable securities in accordance with Statement
of Financial Accounting Standards No. 115, "Accounting for Certain Investments
in Debt and Equity Securities". All debt securities are designated as
available-for-sale. Available-for-sale securities are carried at fair value,
which is determined based upon the quoted market prices of the securities, with
unrealized gains and losses reported in accumulated other comprehensive
income(loss), a separate component of shareholders' equity.
e. Prepaid Marketing Expenses:
The Company recorded prepaid marketing expenses, representing the fair value of
warrants which have been issued to InfoSpace Inc. and Microsoft Corporation in
connection with commercial agreements into which the Company entered during
1999.
The prepaid marketing expenses are amortized using the straight-line method over
the minimum term of the agreements (twelve months). These amounts were fully
amortized as of December 31, 2000.
f. Property and Equipment:
Property and equipment are stated at cost and depreciated using the straight
line method over the estimated useful lives of the assets ranging from two to
seven years. Leasehold improvements are amortized by the straight-line method
over the lease term.
The Company periodically assesses the recoverability of the carrying amount of
property and equipment and provides for any possible impairment loss based upon
the difference between the carrying amount and fair value of such assets in
accordance with Statement of Financial Accounting Standard No. 121 "Accounting
for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed
Of". During 2001, due to the economic slowdown, the reduction of the employee
headcount and the transfer into its new facilities, the Company determined that
an impairment loss exists. As of December 31, 2001, the Company had impairment
losses totaling $9.2 million which were recorded as operating expenses.
g. Long-Term Investments:
Long-term investments are recorded at lower of cost or estimated fair value,
since the Company does not have the ability to exercise significant influence
over operating and financial policies of the investee. Long-term investments are
reviewed for impairment whenever events or changes in circumstances indicate
that the carrying amount of such investments may not be recoverable.
Determination of recoverability is based on an estimate of undiscounted future
cash flows resulting from the use of the investment. Measurement of an
impairment loss for long-term investments that management expects to hold are
based on the fair value of the investment. Impaired long-term investments are
reported at the lower of carrying amount or fair value less costs to sell.
Due to the economic slowdown and the significant decline in capital available to
and in valuations of these privately funded internet centric companies, the
Company believes all of these investments are impaired. During 2000 and 2001,
based on a comprehensive review of the Company's investments, the Company
recorded a non-cash charge of $5 million and $2 million, respectively, to
write-down the recorded investment values.
h. Goodwill and Other Purchased Intangible Assets:
The Company amortized goodwill using the straight-line method over its estimated
useful life, which is five years.
Workforce in place, intellectual property and customer base are amortized using
the straight-line method over their useful lives, which are three, four and
three years, respectively.
The carrying value of goodwill and other purchased intangible assets are
periodically reviewed by management, based on the expected future undiscounted
operating cash flows over the remaining goodwill amortization period in
accordance with Accounting Principles Board Opinion No. 17, "Intangible Assets.
F-9
If this review indicates that goodwill and other purchased intangible assets
will not be recoverable the carrying value of goodwill and other purchased
intangible assets is reduced to estimated fair value.
At December 31, 2001, due to the economic slowdown, the Company performed a
comprehensive review of the Company's goodwill and other purchased intangible
assets. As a result, the Company recorded a non-cash charge of $13.3 million, to
write-down the recorded values to zero.
i. Minority Interest:
Minority interest represents a stockholders' proportionate share of the equity
of Commtouch, K.K. (Japan). At December 31, 2000 and 2001, the Company owned
94.17% and 70.6%, respectively, of the equity and voting rights of Commtouch,
K.K. (Japan).
During 2000 and 2001, the Company's strategic partner in Japan, CSK, invested
approximately $1.2 million and $0.8 million in Commtouch, K.K. (Japan),
respectively. According to Staff Accounting Bulletin No. 84 "Accounting for
Sales of Stock by a Subsidiary", the Company had not recognized gains from this
issuance of shares (since it is considered to be an early stage company) and
thus classified it to Shareholders' Equity section of the balance sheet under
Additional paid-in capital.
j. Research and Development Costs:
Research and development costs are charged to the statement of operations as
incurred. Statement of Financial Accounting Standards No. 86 "Accounting for the
Costs of Computer Software to be Sold, Leased or Otherwise Marketed" requires
capitalization of certain software development costs subsequent to the
establishment of technological feasibility.
Based on the Company's product development process, technological feasibility is
established upon completion of a working model. The Company did not incur any
material costs between the completion of the working model and the point at
which the product is ready for general release. Therefore, through December 31,
1999, 2000 and 2001, the Company has charged all software development costs to
research and development expense in the period incurred.
k. Advertising Costs:
The Company accounts for advertising costs as expense in the period in which the
costs are incurred. Advertising expense for the years ended December 31, 1999,
2000 and 2001 were $0.6 million, $3.1 million and $0.1 million, respectively.
l. Revenue Recognition:
Since 1998, the Company has derived its revenues from providing Web-based email
services. Revenues from Email services are recognized in accordance with Staff
Accounting Bulletin No. 101 "Revenue Recognition in Financial Statements" ("SAB
No. 101") when delivery has occured, persuasive evidence of an agreement exists,
the vendor's fee is fixed and determinable and collectibilty is probable.
Revenues from contracts that are not dependent upon the number of mailboxes and
provide non-refundable fixed payments are recognized ratably over the contract
term. Revenues from contracts specifying a contractual rate per mailbox per
month are recognized monthly for mailboxes covered by the respective contracts.
Revenues from contracts based on a share of advertising revenues earned by
business partners are recognized when such revenues are earned. Amounts received
in advance of service delivery are recorded as deferred revenues. Other service
revenues are primarily comprised of revenues from consulting and training fees.
Consulting services are billed at an agreed upon rate plus out-of-pocket
expenses and training services on a per session basis. The Company recognizes
service revenues from consulting and training when provided to the customer.
Revenues from non-recurring engineering services are recognized upon meeting
specified milestones as deemed earned by the agreement.
F-10
The Company recognizes software license revenue in accordance with Statement of
Position 97-2, "Software Revenue Recognition" ("SOP 97-2"), as amended. SOP 97-2
generally requires revenue earned on software arrangements involving multiple
elements to be allocated to each element based on the relative fair value of the
elements. The Company has also adopted SOP 98-9, "Modification of SOP 97-2,
Software Revenue Recognition with Respect to Certain Transactions" ("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 all undelivered elements
and no VSOE exists for the delivered elements.
Revenue from software licenses fees to end users are recognized when persuasive
evidence of an arrangement exists, delivery of the software has occurred, no
significant obligation with regard to the implementation remain, fee is fixed
and determinable and collectibility is probable.
m. Concentrations of Credit Risk:
Financial instruments that potentially subject the Company to concentrations of
credit risk consist principally of trade receivables, cash equivalents and
marketable securities. The majority of the Company's cash, cash equivalents and
marketable securities are invested in dollar and dollar linked investments and
are deposited in major banks in United States, Israel and Ireland. Such
investments in the United States may be in excess of insured limits and are not
insured in other jurisdictions. Management believes that the financial
institutions that hold the Company's investments are financially sound and,
accordingly, minimal credit risk exists with respect to these investments.
The Company's trade receivables are derived from transactions with companies
located primarily in North America, Europe, Latin America, Israel and the Far
East. The Company maintains an allowance for doubtful trade receivables based
upon the expected collectibility of trade receivables. The allowance for
doubtful accounts was $0.9 million and $0.6 million at December 31, 2000 and
2001, respectively. Bad debt expense for the years-ended December 31, 1999, 2000
and 2001 were $0.4 million, $2.0 million and $0.3 million, respectively.
n. Accounting for Stock-Based Compensation:
The Company has elected to follow Accounting Principles Board Opinion No. 25
("APB 25") "Accounting for Stock Issued to Employees" and Interpretation No. 44
"Accounting for Certain Transactions Involving Stock Compensation," in
accounting for its employee stock option plans. Under APB 25, when the exercise
price of the Company's stock options equals or is above the market value of the
underlying stock on the date of grant, no compensation expense is recognized.
The pro-forma information with respect to the fair value of the options is
provided in accordance with the provisions of Statement of Financial Accounting
Standard No. 123 "Accounting for Stock-Based Compensation"(" SFAS No. 123") (See
also Note 13 f).
In accounting for warrants granted to those other than employees, the Company
applied the provisions of SFAS No. 123, and Emerging Issues Task Force 96-18
"Accounting for Equity Instruments That Are Issued to Other than Employees for
Acquiring or in Conjunction with Selling, Goods or Services." The fair value of
these warrants was estimated at the grant date, using the Black-Scholes
option-pricing model.
o. Royalty-bearing Grants;
Royalty-bearing grants from the Government of Israel for funding approved
research and development projects are recognized at the time the Company is
entitled to such grants, on the basis of the costs incurred and included as a
deduction of research and development costs. Research and development grants
amounted to zero, zero and $0.6 million in 1999, 2000 and 2001, respectively.
p. Basic and Diluted Net Loss Per Share:
Basic and diluted net loss per share are presented in accordance with Statement
of Financial Accounting Standard No. 128, "Earnings per Share", for all periods
presented.
Basic net loss per share has been computed using the weighted-average number of
ordinary shares outstanding during the year. Diluted net loss per share is
computed based on the weighted average number of ordinary shares outstanding
during each year, plus the weighted average number of dilutive potential
ordinary shares considered outstanding during the year.
F-11
All convertible preferred shares, outstanding stock options, and warrants have
been excluded from the calculation of the diluted loss per share because all
such securities are anti-dilutive for all periods presented. The total number of
shares related to the convertible preferred shares, outstanding options and
warrants excluded from the calculations of diluted net loss per share were
2,497,470, 4,096,455 and 4,990,673 for 1999, 2000 and 2001, respectively.
q. Severance Pay:
The Company's liability for severance pay is calculated pursuant to Israeli
severance pay law based on the most recent salary of the employees multiplied by
the number of years of employment as of the balance sheet date. Employees are
entitled to one month's salary for each year of employment or a portion thereof.
The Company's liability for all of its employees is fully provided by monthly
deposits with severance pay fund's insurance policies and by an accrual.
The deposited funds include profits accumulated up to the balance sheet date.
The deposited funds may be withdrawn only upon the fulfillment of the obligation
pursuant to Israeli severance pay law or labor agreements. The value of the
deposited funds is based on the cash surrender value of these policies, and
includes immaterial profits.
Severance expenses for 1999, 2000 and 2001 were approximately $0.1 million, $0.5
million and $1.0 million, respectively.
r. Fair Value of Financial Instruments:
The following methods and assumptions were used by the Company in estimating its
fair value disclosures for financial instruments. The carrying amounts of cash
and cash equivalents, trade receivables, other accounts receivable and accounts
payable, approximate their fair values due to the short-term maturities of these
instruments.
The fair value for marketable securities are based on quoted market prices.
The fair value of long-term deposits and loans is estimated based on current
interest rates available to the Company for debt instruments with similar terms,
degrees of risk and remaining maturities. The carrying value of these
obligations approximates their respective fair values as of December 31, 2000
and 2001.
s. Reclassification:
Certain amounts from prior years have been reclassified to conform to the
current year's presentation. The reclassification had no effect on previously
reported net loss, shareholder's equity or cash flows.
t. Recently Issued Accounting Pronouncements:
In June 2001, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards No. 141, "Business Combinations" and No. 142,
"Goodwill and other Intangible Assets", effective for fiscal years beginning
after December 15, 2001. Under the new rules, goodwill and intangible assets
deemed to have indefinite lives will no longer be amortized but will be subject
to annual impairment tests in accordance with the Statements. Other intangible
assets will continue to be amortized over their useful lives. The Company does
not expect that the adoption of the Statement will have an impact on the
Company's financial position and results of operations.
In August 2001, FASB issued Statement of Financial Accounting Standards No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets" (SFAS No. 144),
which addresses financial accounting and reporting for the impairment or
disposal of long-lived assets and supersedes FAS No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of",
and the accounting and reporting provisions of APB Opinion No. 30, "Reporting
the Results of Operations for a disposal of a segment of a business". SFAS 144
is effective for fiscal years beginning after December 15, 2001, with earlier
application encouraged. The Company expects to adopt SFAS 144 as of January 1,
2002. The sale of Wingra (see Note 15a) will be treated as a discontinued
operation and reported on a separate line item in the first quarter Statement of
Operations, since Wingra is considered to be a component of the Company. The
accounting will result in revenues, net loss and loss per share from continuing
F-12
operations being reduced by $1.7 million, $1.9 million and $0.11 respectively
for 2001. The 2000 results will not materially change since Wingra was acquired
in late November 2000.
NOTE 3: MARKETABLE SECURITIES
December 31,
------------------
2000 2001
------- ------
Marketable securities are comprised of
the following (in thousands):
Government securities........................... $ 2,003 $ --
Corporate debt securities....................... 6,604 --
------- ------
$ 8,607 $ --
------- ------
During 2000, the unrealized net holding losses on marketable securities were
$21,000.
Note 4: WINGRA ACQUISITION:
On November 24, 2000, the Company entered into a definitive acquisition
agreement to acquire Wingra Technologies Inc. ("Wingra"). Wingra is a provider
of messaging integration and migration solutions for large enterprises.
Pursuant to the Wingra Agreement, the shareholders of Wingra received an
aggregate of 1,285,294 of Commtouch ordinary shares. In addition, all
outstanding Wingra options and warrants converted into fully-vested options and
warrants to purchase 305,615 of Commtouch ordinary shares. The Company also
assumed certain operating assets and liabilities of Wingra. The 137,500 assumed
warrants were granted by Wingra in connection with loans granted to Wingra by
banks and shareholders. The exercise price of those warrants range from $6.25 to
$9.39 and the expiration dates range from March 2001 through August 2002. The
acquisition was accounted for under the purchase method, for accounting
purposes, in accordance with Accounting Principles Board 16 "Business
Combinations". The purchase price was allocated to the assets acquired and
liabilities assumed based on their respective fair values. The purchase price
was determined to be $15.1 million (based on the closing price of Commtouch
ordinary shares on the date of the final agreement). The consolidation of the
assets and liabilities affected the Company's balance sheet at December 31,
2000, as described in the following tables:
Total purchase price (in thousands):
Ordinary shares $ 11,970
Options and warrants 2,846
Acquisition expenses 330
--------
$ 15,146
--------
The purchase price was allocated to the acquired assets and assumed liabilities
in the accompanying consolidated financial statements as follows (in thousands):
Estimated
Useful
Life
(In Years)
------------
Customer base 3 $ 1,340
Workforce-in-place 3 550
Intellectual Property 4 1,660
In-process research & development expensed 1,280
Goodwill 5 12,590
Less assumed net tangible liabilities n/a (2,274)
--------
$ 15,146
========
F-13
The Company recorded a one-time charge of $1.3 million in the fourth quarter of
2000 for purchased in-process technology related to a development project that
had not reached technological feasibility, had no alternative future use, and
for which successful development was uncertain.
The fair value of the in-process technology was determined using the income
approach. Under the income approach, the expected future cash flows from each
project under development are estimated and discounted to their net present
value at an appropriate risk-adjusted rate of return. Significant factors
considered in the calculation of the rate of return are the weighted-average
cost of capital and return on assets, as well as the risks inherent in the
development process, including the likelihood of achieving technological success
and market acceptance. Each project was analyzed to determine the unique
technological innovations, the existence and reliance upon core technology, the
existence of any alternative future use or current technological feasibility,
and the complexity, cost and time to complete the remaining development. Future
cash flows for each project were estimated based upon forecasted revenues and
costs, taking into account product life cycles, and market penetration and
growth rates. Pro forma is not disclosed due to the sale of Wingra in early
2002, see Note 15a.
See Note 2 h for impairment charges during 2001.
NOTE 5: PREPAID EXPENSES AND OTHER ACCOUNTS RECEIVABLES
December 31,
---------------
2000 2001
------ ------
Prepaid expenses and other accounts receivables are comprised of the
following (in thousands):
Prepaid Expenses ................................................... $2,159 $ 374
Other accounts receivable .......................................... 1,467 326
------ ------
Prepaid expenses and other accounts receivables .................... $3,626 $ 700
====== ======
NOTE 6: PROPERTY AND EQUIPMENT, NET
December 31,
--------------------
2000 2001
-------- --------
Property and equipment are comprised of the following (in thousands):
Computers and peripheral equipment .................................. $ 20,687 $ 7,314
Office furniture and equipment ...................................... 977 1,168
Motor vehicles ...................................................... 143 88
Leasehold improvements .............................................. 5,908 1,217
-------- --------
27,715 9,787
Less accumulated depreciation ....................................... (8,298) (4,635)
-------- --------
Property and equipment, net ......................................... $ 19,417 $ 5,152
======== ========
Depreciation expenses amounted to approximately $1.7 million, $5.9 million and
$7.5 million for 1999, 2000 and 2001, respectively.
See Note 2 f and Note 11 for impairment charges during 2001.
NOTE 7: LONG-TERM INVESTMENTS
The Company invested $7.0 million in the first nine months of 2000 in three
internet centric companies in which the Company believed it had a significant
ongoing strategic interest. See Note 2 g for impairment charges during 2000 and
2001.
F-14
NOTE 8: GOODWILL AND OTHER PURCHASED INTANGIBLES
December 31, December 31,
------------ ------------
2000 2001
------- -------
Goodwill and other purchased intangibles are comprised of
the following (in
thousands):
Customer Base................................................. $ 1,340 $ --
Workforce in Place............................................ 550 --
Intellectual Property......................................... 1,660 --
Goodwill...................................................... 12,590 --
------- -------
16,140 --
Less accumulated amortization................................. (85) --
------- -------
Goodwill and other purchased intangibles, net................. $16,055 $ --
======= =======
Amortization expenses amounted to approximately none, $0.1 million and $2.8
million for 1999, 2000 and 2001, respectively.
See Note 2 h for impairment charges.
NOTE 9: LONG TERM BANK LOANS AND CAPITAL LEASES
Bank loans and capital leases comprised of the following (in thousands except
for percentages):
Weighted Weighted
Average Average
Interest December 31, Interest December 31,
Rate 2000 Rate 2001
-------- ----------- --------- ------------
Promissory notes with shareholders............ 9.28% $ 886 9.74% $ 585
Promissory notes with financial institutions.. 10.78% 692 11.00% 126
Capital lease obligations..................... 69 45
Royalties in connection with Wingra's product 218 218
--------- ----------
1,865 974
Less - current maturities..................... (1,024) (714)
--------- ----------
Total Long-term debt.......................... $ 841 $ 260
========= ==========
Future maturities of long-term debt at December 31, 2001 are as follows (in
thousands):
2002 $714
2003 260
----
$974
====
NOTE 10: COMMITMENTS AND CONTINGENCIES
a. Operating Leases:
The Company leases certain facilities and equipment under operating lease
agreements expiring through 2007. Future minimum lease payments under these
non-cancelable leases are as follows (in thousands):
2002....................... $ 366
2003....................... 382
2004....................... 201
2005....................... 103
2006....................... 107
Thereafter................. 100
--------
$ 1,259
========
F-15
Rent expenses for 1999, 2000 and 2001 were approximately $0.6 million, $2.3
million and $2.8 million, respectively. The above rent expense includes
sub-lease rental income from various of the Company's unused premises totaling
approximately $0.7 million in 2001 and none in 1999 and 2000.
b. Royalties:
In 2001, the Company received royalty-bearing grants totaling $0.6 million from
the Israeli government, which were recorded as a reduction of research and
development expenses. The Israeli government requires beneficiaries of such
grants to pay royalties to the Israeli government based on the revenues derived
from the sale of products, technologies and services developed with such grants.
The Royalties amount to 3%-5% of the above-mentioned revenues, up to an amount
equal to 100% - 150% of the grants received linked to the US dollar and bears
interest at an annual rate of LIBOR. We believe that we have no obligation for
royalties in 2001, related to the 2001 grants, since we had not started
generating revenue from the product developed with such grants, but we may have
obligations for royalties in 2002 and future years. The ultimate liability is
subject to the review of the Israeli government. As of December 31, 2001 the
Company had a contingent liability to pay royalties of approximately $0.6
million.
In previous years, the Company participated in programs sponsored by the Israeli
Government for the support of research and development activities. The Company
is obligated to pay royalties to the Office of the Chief Scientist ("OCS"),
amounting to 3%-5% of the sales of the products and other related revenues
generated from such projects, up to an amount equal to 100% - 150% of the grants
received linked to the US dollar. The Company received grants from the
Government of Israel, through the OCS, for the financing of a portion of its
research and development expenditures in Israel. The related funded projects had
ultimately failed and the relevant payments were made for the revenues generated
from these projects but it will not be obligated to pay future royalties for
such projects through 2001 as the Company does not expect any future revenue
from these projects. In March 2002, the Company submitted an application for
project failure with regard to these projects. Accordingly, the Company decided
to write down the $0.4 million accrual it recorded in past years and determined
that as of December 31, 2001 there are no contingent liabilities for royalties
for these projects. However, The ultimate liability is subject to the review of
the Israeli government.
c. Employee Options Withholding Tax
In April 2001, the Israeli Tax Authority ("ITA") demanded withholding tax from
the Company on behalf of former employees who exercised options, and immediately
confiscated the bank account in Israel and demanded to receive from the Company
a bank guarantee. The Company issued a bank guarantee of $650 thousand to the
ITA and accrued a reserve for the amount of $300 thousand as of December 31,
2000. The Company's position is that there was no obligation to withhold tax
since that at the date of the exercise of the options, the Company did not have
an employer-employee relations with those former employees. Consequent to
negotiations with the ITA, the ITA cancelled its confiscation of the bank
account and the bank guarantee and began demanding the tax from the former
employees directly. Accordingly, as of December 31, 2001, the Company does not
believe it has any liability and thus the reserve was cancelled.
d. Bank Line of Credit:
Due to the acquisition of Wingra, Inc., the Company assumed a revolving credit
arrangement with a financial institution. The credit agreement is collateralized
by certain assets of the Company. The provisions of the credit agreement enable
the Company to borrow up to $100,000 on a revolving line of credit at annual
interest rate of 14.25%. The amount outstanding at December 31, 2001 was
approximately $0.1 million.
e. Collateral and Guarantees:
Due to the Acquisition of Wingra, Inc., the Company assumed a revolving line of
credit in the amount of $0.1 million, collateralized by a chattel security
agreement and the personal guarantee of a shareholder.
F-16
f. Class Action Litigation
Following the restatement of revenues for the first three quarters of 2000,
several class action lawsuits were filed in the United States District Court for
the Northern District of California against the Company and certain of its
officers and a director, alleging violations of the antifraud provisions of the
Securities Exchange Act of 1934 arising from the Company's financial statements.
These lawsuits were consolidated into one action in late 2001. Thereafter, the
Company filed a Motion to Dismiss, which has been granted, though the plaintiffs
have been granted leave to amend the complaint. On April 22, 2002, an amended
lawsuit was filed. While the Company and its legal counsel is unable to predict
the ultimate outcome of the consolidated claim, the Company believes that it is
without merit and intends to continue to vigorously defend itself.
NOTE 11: RESTRUCTURING CHARGES
During 2001, the Company announced that it was implementing strategic
initiatives intended to further reduce costs. In connection with the strategic
initiatives, and in accordance with SFAS 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets To Be Disposed Of", SAB 100
"Restructuring and Impairment Charges" and EITF 94-3, "Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an Activity
(Including Certain Costs in a Restructuring)", the Company recorded
restructuring and other non-recurring charges of approximately $11.2 million .
The restructure included curtailing expenses and reducing the number of
employees. The cash and non-cash elements of the restructuring charge
approximate $2.0 million and $9.2 million, respectively (the non-cash charge
represents property, equipment and other write-downs).
The cash charges consisted of $1.0 million in severance pay which was recorded
in the statement of operations under operating expenses according to the
relevant section and $1.0 million for other exit costs was recorded in the
statement of operations as write off of property and equipment.
As a result of strategic initiatives, approximately 118 positions were
eliminated in the Company.
As of December 31, 2001, there are no accruals recorded in the financial
statements.
As a part of the Company's cost containment efforts, it reached settlements
agreements with a few of its vendors. Some of the settlement agreements included
issuance of shares or warrants while other included only cash payments. The
amount written off totaled approximately $0.8 million, which was deducted from
the relevant categories of operating expenses, and the Company also recorded
approximately $0.1 million compensation expenses regarding the warrants issued
(see Note 13 b) and agreed to pay a letter of credit for approximately $1.0
million it granted its landlord.
NOTE 12: INCOME TAXES
Israeli Income Tax:
The Company's production facilities in Israel have been granted "Approved
Enterprise" status for three separate investment programs in 1992, 1996 and 2000
by the Israeli Investment Center under the Law for Encouragement of Capital
Investments, 1959 ("the Law").
During 2001, the "Approved Enterprise" status for the 1996 investment program
was cancelled.
The Company's first program was approved in 1995. The Company's second program
(which was later cancelled) received a letter of approval in April 1996 and the
Company's third program received a letter of approval in December 2000.
Undistributed Israeli income derived from each of its "Approved Enterprise"
programs entitle the Company to a tax-exemption for a period of two years
commencing with the first year it will earn taxable income (not commenced yet)
and to a reduced tax rate of 10%-25% for an additional period of five to eight
years (depending on the level of foreign investment in the Company). These tax
benefits cannot continue beyond the earlier of twelve years from commencement of
operations, or fourteen years from receipt of approval. Thereafter, the
Company's income will be subject to the regular income tax rate of 36%. Income
that was not derived from "Approved Enterprise" during the benefits period is
taxed at the regular rate of 36%. Distribution of cash dividends from income
F-17
that was not derived from "Approved Enterprise" generally is subject to 25%
withholding tax. As currently only a part of the Company's capital investments
are approved (a "Mixed Enterprise"), its effective corporate tax rate will be
the determined by the weighted combination of the various applicable rates.
Distribution of cash dividends from income that was tax exempt due to the
"Approved Enterprise" status is subject to corporate tax at the rate that would
have been applicable to the income of the Company had the Company not been tax
exempt. In addition, these dividends will generally be subject to a 15%
withholding tax.
The tax exempt income attributable to the "Approved Enterprise" can be
distributed to shareholders without subjecting the Company to taxes only upon
the complete liquidation of the Company.
The entitlement to the above benefits is conditional upon the Company's
fulfilling the conditions stipulated by the above law, regulations published
thereunder and the instruments of approval for the specific investments in
"approved enterprises". In the event of failure to comply with these conditions,
the benefits may be canceled and the Company may be required to refund the
amount of the benefits, in whole or in part, including interest.
As the Company currently has no taxable income, the benefits have not yet
commenced for all programs.
The Company's Board of Directors has determined that such tax exempt income will
not be distributed as dividends. The Company is currently viewed as qualifying
as an "industrial company" under the Law for the Encouragement of Industry
(Taxation), 1969 and as such is entitled to certain tax benefits, mainly
accelerated rates of depreciation and the right to deduct public issuance
expenses.
Results for tax purposes are measured in terms of earnings in NIS after certain
adjustments for increases in the Israeli Consumer Price Index "CPI". As
explained in Note 2 b, the financial statements are measured in U.S. dollars.
The difference between the annual change in the Israeli CPI and in the
NIS/dollar exchange rate causes a further difference between taxable income and
the income before taxes shown in the financial statements. In accordance with
paragraph 9(f) of SFAS No. 109, the Company has not provided deferred income
taxes on the difference between the functional currency and the tax bases of
assets and liabilities.
As of December 31, 2001, Israeli net operating loss carry-forwards amounted to
$38.0 million. Such net operating loss may be carried forward indefinitely and
offset against future taxable income.
U.S. Income Tax:
Commtouch, Inc. is taxed based upon tax laws in the U.S.
As of December 31, 2001, Commtouch, Inc. had a U.S. federal net operating loss
carry-forward of approximately $66.6 million. The net operating loss expires in
various amounts between the years 2008 and 2022. Utilization of U.S. net
operating losses may be subject to the substantial annual limitation due to the
"change in ownership" provisions of the Internal Revenue Code of 1986 and
similar state provisions. The annual limitation may result in the expiration of
net operating losses before utilization.
Deferred Income Taxes:
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
the Company's deferred tax liabilities and assets are as follows:
December 31,
-------------------
2000 2001
-------- --------
Deferred tax assets are as follows (in thousands):
U.S. operating loss carry-forwards....................... $ 12,594 $ 25,020
Reserves and allowances not currently deductible......... 4,144 2,565
-------- --------
Net deferred tax asset before valuation allowance........ 16,738 27,585
Valuation allowance...................................... (16,738) (27,585)
-------- --------
Net deferred tax asset................................... $ -- $ --
======== ========
As of December 31, 2001, the Company and its subsidiary have provided a 100%
valuation allowance with respect to deferred tax assets resulting from tax loss
carry-forwards. The valuation allowance has increased by 10,847 during 2001.
Management currently believes that since the Company and its subsidiary have a
history of losses it is more likely than not that the deferred tax regarding the
loss carry-forwards and other temporary differences will not be realized in the
foreseeable future.
F-18
Pretax loss:
Pretax losses are as follows (in thousands):
1999 2000 2001
-------- -------- --------
Israel.................................. $ 11,259 $ 23,209 $ 26,951
U.S..................................... 8,592 27,821 33,419
Other................................... -- 3,140 352
-------- -------- --------
$ 19,851 $ 54,170 $ 60,722
======== ======== ========
NOTE 13: SHAREHOLDERS' EQUITY
The ordinary shares of the Company are traded on the NASDAQ National Market.
a. Shares Issued:
In April 1999, the Company's Board of Directors approved: a 20 for 1 split of
ordinary shares, a change in the conversion ratio of preferred shares to
ordinary shares to 1 to 20 and an increase to the authorized ordinary shares to
40,000,000 shares of NIS 0.05 par value. The consolidated financial statements
have been retroactively adjusted to reflect such changes for all periods
presented.
In July 1999, the Company completed an Initial Public Offering ("IPO") of its
ordinary shares. The Company sold 3,450,000 shares to the public at $16 per
share. Concurrent with the closing of the IPO, the Company sold 1,344,086 shares
at $14.88 per share to InfoSpace, Inc. In addition, the holders of Series A,
Series B, Series C and Series D convertible preferred shares received ordinary
shares pursuant to an automatic conversion, resulting in the issuance of
7,109,800 ordinary shares in exchange for all outstanding convertible preferred
shares.
On June 1, 2001, the Company entered into an ordinary share purchase agreement
with Rideau Ltd. ("Rideau"), a Bahamian limited liability company. According to
the agreement the Company issued 315,789 shares to Rideau for a total
consideration of approximately $0.3 million. The price per share was determined
according to the then trading prices of the Company's shares on the Nasdaq
National Market, less a discount of 10% or $0.106 per share.
b. Warrants Issued:
Warrants to Investors. In 1996, the Company issued to certain Series B investors
warrants to purchase 13,873 Series B Convertible Preferred shares at an exercise
price of $44.04. These warrants were exercised concurrently with the closing of
the IPO.
Warrants to Vendors in connection with Settlement Agreements. In furthering the
settlement of significant outstanding and future lease obligations to Commtouch
Inc's Mountain View facility lessor, Equity Office Properties ("EOP"), as well
as Commtouch Inc's equipment vendor, Compaq Financial Services, the Company
issued warrants to these companies. The Compaq fully vested warrant was issued
in January 2002 and allows for purchase of up to 200,000 ordinary shares at a
price of $0.29 per share, and the EOP warrant was issued in December 2001 and
allows for purchase of up to 175,000 ordinary shares at a price of $0.26. These
warrants expire in December 2006 and January 2007.
The fair value for the EOP warrant was estimated at the date of grant using a
Black-Scholes Option Pricing Model with the following weighted-average
assumptions: risk-free interest rates of 4.0%, dividend yields of 0%, volatility
factors of the expected market price of the Company's ordinary shares of 1.482
and an expected life of the option of 6 months after the option is vested.
Accordingly, the Company recorded approximately $53,000 as compensation expense
and included the amount in operating expenses.
Warrants Issued for Services Received and Financing Transactions. Through 1999,
the Company granted warrants in connection with a bank line of credit, loans and
consulting services received. At December 31, 1999, one warrant for 4,860
ordinary shares with an exercise price of $3.61 per share remained outstanding.
This warrant was net exercised into 4,461 shares in January 2000.
F-19
In connection with the amounts of the warrants, the Company recorded $0.4
million in 1999 and, none in 2000 and 2001, as compensation expenses that were
included in interest expenses.
Warrants Issued to Strategic Partners and Customers. Concurrent with the closing
of the IPO, the Company entered into a customary commercial email service
agreement with InfoSpace (Formerly, Go2Net), a related party. Under this
agreement, the Company provides email services to the end users of InfoSpace's
various email properties. In connection with this agreement, the Company issued
a warrant expiring in July 2004 to purchase 1,136,000 ordinary shares at an
exercise price of $12.80 per share. As of December 31, 2001, this warrant had
not been exercised. At the grant date, the fair value of this warrant was
estimated as $5.8 million and was amortized to operating expenses over the
minimum term of the contract (twelve months through July 2000).
c. Issuance of Ordinary Shares Against Promissory Notes:
From February 1, 2000 through August 10, 2000 the Company granted certain loans
to certain officers and directors to enable them to finance an early exercise of
their options into restricted shares. In December 2000, the Company was notified
by its legal counsel, that under the new Israeli Companies Law, effective
February 1, 2000, the Company was currently prohibited from financing a third
party purchase of its shares. Accordingly, the loans to officers and directors
were in violation of Israeli corporate law and considered null and void. Upon
notification, the Company decided to void the loans and the underlying exercise
of options.
During 1999, several employees and officers early exercised 670,180 options
granted to them by Commtouch. In consideration for the ordinary shares purchased
pursuant to the early exercise of the options, they provided Commtouch with full
recourse promissory notes in the original principal amount of approximately $1.0
million. The promissory notes bear interest at 4.83%, with interest payment due
at the end of each calendar year, with the principal due on the fourth
anniversary of the date of the promissory notes. The shares purchased are
subject to a right of repurchase in favor of Commtouch according to the original
vesting schedule of the options exercised, generally four years. As of December
31, 2001, approximately 6,308 shares are subject to this right of repurchase.
During 2001, the Company had forgiven a promissory note of $143,000 for one of
its employees and demanded the then current value of the shares ($7,266 relating
to the 7,500 shares) and the full interest on the original note. Both interest
and the adjusted note was repaid in March 2001. The Company accounted for this
note in accordance with EITF 00-23 "Issues Related to the Accounting for Stock
Compensation under APB Opinion No. 25 and FASB Interpretation No. 44" and EITF
95-16 "Accounting for Stock Compensation Arrangements with Employer Loan
Features under APB Opinion No. 25". A note for $137,112 was repaid by another
employee for 94,560 shares.
d. Employee Stock Purchase Plan:
Commtouch reserved a total of 1,229,156 shares for issuance under the plan.
Eligible employees were able to purchase ordinary shares at 85% of the lower of
the market value of the Company's Ordinary shares on the first day of the
applicable offering period or the last day of the applicable purchase period.
The total shares issued under the plan were zero, 80,545 and 136,782 for the
years 1999, 2000 and 2001, respectively. This Plan terminated in late 2001.
e. Repricing
On April 30, 2001 the Company's Board of Directors approved the "repricing" of
options previously granted to employees according to the criteria stated below.
Accordingly, the Company filed a Tender Offer which expired on September 14,
2001, and Commtouch has accepted for exchange options to purchase 1,273,513
Ordinary Shares. Previously granted options were cancelled and new options were
issued with an exercise price equal to the par value of the shares.
In order to enjoy the repricing mechanism, previously granted stock options must
have met the following conditions:
o The exercise price of the original options exceeds $10
o The option is issued but not exercised
The repriced stock options vest over three years with 1/3 vesting on February
15, 2002 and the remaining 2/3 vesting every six months for the following two
years. In connection with this repricing, the Company charged approximately $0.3
million as compensation expense in 2001.
F-20
During October 2001, the Company decided that 1/3 of the options granted on
September 14, 2001 to employees dismissed during October 2001 will not expire
upon termination of employment. The Company decided that this portion of the
options will vest according to the original grant terms on February 15, 2002 and
will be exercisable until August 15, 2002.
The modification of the grant term was accounted for under APB 25 and
Interpretation No. 44 "Accounting for Certain Transactions Involving Stock
Compensation," and resulted in no effect.
f. Stock Options:
The Company has reserved 5,219,574 ordinary shares for issuance under employee
stock option plans and agreements. As of December 31, 2001, an aggregate of
2,303,885 ordinary shares of the Company are still available for future grant.
Options granted under such plans and agreements expire generally after 10 years
from the date of grant and terminate upon termination of the optionee's
employment or other relationship with the Company. The options generally vest
ratably over a 4-year period, though certain repriced stock options offered to
employees in a Tender Offer Statement of July 20, 2001, as amended, vest over a
three year period. The exercise price of the options granted under the
individual agreements may not be less than the nominal value of the shares into
which such options are exercisable. Any options that are canceled or not
exercised within the options period become available for future grant.
In 1996, the Company adopted the 1996 CI Stock Option Plan for granting options
to its U.S. employees and consultants to purchase ordinary shares of the
Company. Until 1999, the Company issued options to purchase ordinary shares to
its Israeli employees pursuant to individual agreements. In 1999 the Company
approved the 1999 Section 3(i) Share Option Plan for its Israeli employees and
consultants, which was amended in 2001 to include Section 102 applicability (the
sections relate to code sections under the Israel tax law).
As a result of the Wingra acquisition, the Company assumed stock options granted
to employees under Wingra's stock option plan. At the date of acquisition these
stock options were immediately converted into approximately 168,000 fully vested
stock options convertible into Commtouch Ordinary Shares.
A summary of the Company's share option activity under the plans is as follows:
Weighted Average
Number of Shares Exercise Price
-------------------------------------------- ---------------------------------------
1999 2000 2001 1999 2000 2001
---------- ---------- ---------- ----------- ----------- -----------
Outstanding at beginning of period 849,520 1,383,110 2,650,455 $ 1.20 $ 9.62 $ 19.91
Granted ......................... 1,342,670 2,046,520 3,009,388* 10.13 24.10 0.2
Exercised ....................... (740,040) (359,839) (119,268) 1.42 2.66 0.39
Canceled ........................ (69,040) (419,336) (2,624,886) 4.49 21.77 19.68
--------- --------- --------- ----------- ----------- -----------
Outstanding at end of period ..... 1,383,110 2,650,455 2,915,689 $ 9.62 $ 19.91 $ 0.46
========= ========= ========= =========== =========== ===========
Exercisable at end of period ..... 381,315 526,986 281,830 $ 3.50 $ 8.61 $ 2.70
========= ========= ========= =========== =========== ===========
* - Includes 1,273,513 options repriced to par value during 2001.
For exercise prices on the date of grant that:
----------------------------------------------
Equals market price Are less than market price
--------------------------------------- -----------------------------------
Year ended December 31, Year ended December 31,
1999 2000 2001 1999 2000 2001
----------- ----------- ----------- ----------- ------ -----------
Weighted average exercise prices ............ $ 15.75 $ 24.10 $ 0.27 $ 3.65 $-- $ 0.01
Weighted average fair values on date of grant $ 11.98 $ 20.20 $ 0.10 $ 14.80 $-- $ 0.44
F-21
The options outstanding as of December 31, 2001, have been separated into ranges
of exercise price, as follows:
Weighted
Options Average Options Weighted Average
Outstanding as of Remaining Weighted Exercisable as of Price of
December 31, Contractual Life Average Exercise December 31, Exercisable
Exercise Price 2001 (years) Price 2001 Options
----------------- ----------------- ---------------- ---------------- ----------------- ----------------
$0.01 1,429,317 9.62 $ 0.10 1,291 $ 0.01
$0.20-$1.47 1,349,773 8.41 $ 0.52 216,818 $ 1.26
$2.25-$6.88 120,100 8.89 $ 4.90 50,769 $ 3.50
$14.19-$17.75 5,928 8.37 $ 16.55 3,340 $ 17.13
$21.13-$35.56 10,571 8.24 $ 26.41 9,612 $ 25.95
--------- ---- ---------- ------- ------------
$ 0.01-$35.56 2,915,689 9.26 $ 0.46 281,830 $ 2.70
========= ==== ========== ======= ============
Under SFAS 123, pro forma information regarding net income (loss) and earnings
(loss) per share is required and has been determined as if the Company had
accounted for its employee stock options under the fair value method of that
Statement. The fair value for these options was estimated at the date of grant
using a Black-Scholes Option Pricing Model with the following weighted-average
assumptions for 1999, 2000 and 2001: risk-free interest rates of 5.5% for 1999,
5.5% for 2000, and 4.0% for 2001, dividend yields of 0%, volatility factors of
the expected market price of the Company's ordinary shares of 0.5 - 0.56 for
1999, 1.348 for 2000, and 1.482 for 2001 and an expected life of the option of 6
months after the option is vested for 1999, 2000 and 2001.
The Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options that have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions, including the expected stock price volatility. Because
the Company's employee stock options have characteristics significantly
different from those of traded options, and because changes in the subjective
input assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its employee stock options.
Pro forma information under SFAS 123 are as follows (in thousands except per
share amounts):
1999 2000 2001
--------- --------- ---------
Net loss as reported.............................. $ (19,851) $ (54,225) $ (61,007)
========= ========= =========
Pro forma net loss................................ $ (20,224) $ (68,309) $ (65,734)
========= ========= =========
Pro forma basic and diluted net loss per share $ (2.70) $ (4.42) $ (3.83)
========= ========= =========
The Company recorded deferred compensation representing the difference between
the exercise price and the deemed fair value of the Company's ordinary shares at
the date of grant. Such amount is being amortized using the sum-of-digits method
over the vesting period of the options, generally four years.
Deferred compensation is as follows (in thousands):
Balance as of January 1, 2001..................................... $ 2,729
Deferred compensation related to options issued to employees...... 1,028
Less amounts reduced for terminated employees..................... (725)
Less amortization of deferred compensation........................ (2,204)
--------
Balance as of December 31, 2001................................... $ 828
========
g. Non-Employee Directors Stock Option Plan:
The Company adopted the 1999 Non-Employee Directors Stock Option Plan. The
original allotment of shares was in the amount of 180,000 ordinary shares, with
an additional allotment in 2000 bringing the plan's total allotment to 500,000
shares and a further allotment in 2001 bringing the plan's total to 750,000
ordinary shares. During 1999, each individual who first joined the Board of
Directors as a non-employee director on or after the effective date of the
initial public offering received an option grant for 10,000 shares. Subsequent
to July 2000, individuals who joined the board received an initial grant of
30,000 options. Directors who are reelected at the annual meeting of
shareholders are generally entitled to additional grants of 10,000 shares,
though those directors reelected at the August 22, 2001 annual meeting of
shareholders were entitled to a grant of 33,750 and those directors in office
immediately after the extraordinary general meeting of shareholders on February
25, 2002 were granted a one-time option grant of 150,000 ordinary shares. In
addition a senior board member received a grant of 221,250 ordinary shares. Each
F-22
option granted under the Non-Employee Directors Plan originally was to have
become exercisable with respect to one-fourth of the number of shares covered by
such option three months after the date of grant and with respect to one-third
of the remaining shares subject to the option every three months thereafter;
however, this changed pursuant to an amendment to the plan approved by
shareholders at the August 10, 2000 annual meeting of shareholders, such that
options become exercisable at a rate of 1/16th of the shares every three months.
Each option has an exercise price equal to the fair market value of the ordinary
shares on the grant date of such option. However, certain options outstanding
and unexercised at the time of the effective date of the Tender Offer Statement
of July 20, 2001, as amended, were repriced in accordance with the terms of the
Tender Offer Statement, as amended. Each option has a maximum term of ten years,
but will terminate earlier if the optionee ceases to be a member of the Board of
Directors.
During 2001, the Company granted 623,750 options to non-employee directors at a
weighted average exercise price of $0.20 per share. As of December 31, 2001,
66,013 options were exercisable and 563,894 were outstanding.
NOTE 14: GEOGRAPHIC INFORMATION
The Company conducts its business on the basis of one reportable segment (see
Note 1 for brief description of the Company's business). The Company has adopted
Statement of Financial Accounting Standard No. 131, "Disclosures About Segments
of an Enterprise and Related Information".
Revenues from external customers (in thousands):
Revenues
---------------------------
1999 2000 2001
------- -------- --------
Israel............................ $ 369 $ 196 $ 451
U.S.A............................. 3,056 11,047 7,536
Europe............................ 344 1,927 2,500
Japan............................. 250 1,295 656
Latin America..................... 38 4,085 2,910
Other............................. 194 565 1,265
------- -------- --------
$ 4,251 $ 19,115 $ 15,318
======= ======== ========
The Company's long-lived assets as follows (in thousands):
2000 2001
-------- -------
Israel............................. $ 18,911 $ 2,953
U.S.A.............................. 18,016 1,773
Other.............................. 545 426
-------- -------
$ 37,472 $5,152
======== =======
NOTE 15: SUBSEQUENT EVENTS (UNAUDITED)
a. Sale of Wingra
Commtouch sold off its migration service business, Wingra, Inc. to Wingra's
current senior management at the end of February 2002. The terms include mutual
release of all liabilities, obligations and rights of the parties to the
agreement. This sale reduced the Company's net liabilities by approximately $0.7
million.
b. Private Placement
On February 17, 2002, Commtouch signed a private placement agreement according
to which it will issue approximately 4.4 million ordinary shares to private
investors for approximately $1.3 million; one-third of the shares are being
purchased by Commtouch's founders, who are currently Commtouch directors and/or
executive officers. The purchasers in the private placement will also receive
five-year warrants to purchase up to an additional 2.66 million ordinary shares
(approximately). The exercise price for one-third of the warrants will be $0.37
F-23
per share, the exercise rice for an additional one-third of the warrants will be
$1.00 per share and the exercise price for the final one-third of the warrants
will be $2.00 per share. The funds were received on April 15, 2002.
c. Sale of Hosted Exchange
In January 2002, Commtouch sold its Hosted Exchange business unit to
Telecomputing, Inc. Terms of the transaction include the transference of the
Company's customer base and certain equipment to Telecomputing, in exchange for
certain cash payments and royalties. Furthermore, the Company assigned equipment
leases to Telecomputing, thereby eliminating the Company's obligation to make
lease payments thereunder. In consideration for the transaction, the Company is
entitled to receive royalty payment of 20% from sales in 2002 , additional
royalty payment of 20% from sales performed in 2002 to potential customers and
royalties of 10% from sales in 2002 and 2003 to customers referred to be the
Company. No material loss or gain resulted from the transaction.
d. Strategic Agreement with MailCentro
Within the framework of an agreement with MailCentro Inc. ("MC"), MC (a wholly
owned subsidiary of CP Software Group, Inc.) assumed all aspects of servicing
most of the Company's consumer customers, including its free email service known
as Zap Zone service. According to the agreement entered into with MC, the
Company transferred customers to MC and is expected to realize royalties on
payments made by these former customers to MC (primarily in 2002). Additionally,
certain Commtouch trademarks, domain names, software licenses and equipment were
sold to MC.
In consideration for the transaction, the Company is entitled to receive royalty
payment from sales at a rate of 70% in Q1 , 50% from sales in Q2 and Q3, and 25%
of sales in Q4 of year 2002.
F-24
SIGNATURES
Pursuant to the requirements of Section 12 of the Securities and Exchange Act of
1934, the registrant certifies that it meets all of the requirements for filing
on Form 20-F and has duly caused this annual report to be signed on its behalf
by the undersigned, thereunto duly authorized.
COMMTOUCH SOFTWARE LTD.
By: /s/ Devyani Patel
------------------------------------
Devyani Patel
V.P. Finance
April 26, 2002
F-25
COMMTOUCH SOFTWARE LTD.
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
U.S. Dollars in thousands
Balance at
the Charged to Balance at
beginning of cost and end of the
the period expenses Deductions period
------------ ---------- ---------- ----------
Year ended December 31, 1999:
Bad debt........................................ $ -- $ 405 $ -- $ 405
====== ======= ======= =====
Year ended December 31, 2000:
Bad debt........................................ $ 405 $ 1,990 $(1,533) $ 862
====== ======= ======= =====
Year ended December 31, 2001:
Bad debt........................................ $ 862 $ 259 $ (551) $ 570
====== ======= ======= =====
Item 19. Exhibits
Exhibit
Number Description of Document
------ -----------------------
1.1 Memorandum of Association of the Registrant.(1)
1.2 Articles of Association of the Registrant.(6)
2.1 Specimen Certificate of Ordinary Shares.(1)
2.2 Amended and Restated Registration Rights Agreement dated as of
April 19, 1999.(1)
2.2.1 Amendment No. 1 to Amended and Restated Registration Rights
Agreement dated as of December 29, 1999.(4)
2.2.2 Amendment No. 2 to Amended and Restated Registration Rights
Agreement dated as of March 10, 2000.(5)
2.3 Form of Tag-Along Rights (Right of First Refusal and Co-Sale)
Agreement dated as of December 23, 1998.(1)
2.4 Form of Drag-Along Letter dated as of April 15, 1999.(1)
2.5 Ordinary Shares Purchase Agreement between Commtouch Software Ltd.
And Torneaux Fund Ltd., dated January 23, 2001.(9)
2.6 Amended and Restated Merger and Exchange Agreement dated November
24, 2000 among Commtouch Software Ltd., Commtouch Inc., CW
Acquisition Corporation, Wingra, Incorporated, the holder of
certain of the outstanding capital stock of Wingra, Incorporated,
and the holders of all the outstanding membership interests in
Wingra Technologies, LLC other than that owned by Wingra,
Incorporated.(10)
2.7 Registrant hereby agrees to furnish the Securities and Exchange
Commission, upon request, with the instruments defining the rights
of holders of long-term debt of the registrant with respect to
which the total amount of securities authorized does not exceed
10% of the total assets of the Registrant.
2.8 Ordinary Shares and Warrants Purchase Agreement dated as of
February 27, 2002 by and between Commtouch Software Ltd., and the
Investors Listed on Exhibit A Thereto
4.1 Registrant's 1996 CSI Stock Option Plan and forms of agreements
thereunder.(1)
4.2 Registrant's form of Stock Option Agreement for Israeli
Employees.(1)
4.3 Registrant's 1999 Stock Option Plan and form of agreement
thereunder.(1)
4.4 Commtouch Software Ltd. 1999 Nonemployee Directors Stock Option
Plan.(1)
4.4.1 Amendment to Commtouch Software Ltd. 1999 Nonemployee Directors
Stock Option Plan.(7)
4.5 Commtouch Software Ltd. 1999 Employee Stock Purchase Plan and
forms thereunder.(1)
4.6 Sublease between ASCII of America, Inc. and Commtouch for
Commtouch's offices in Santa Clara, California, dated December 16,
1998.(1)
4.7 Lease between DeAnza Building and Commtouch for Commtouch's
offices in Sunnyvale, California, dated February 5, 1996, as
amended.(1)
4.8 Form of Letter Agreement between the Registrant and U.S. Bancorp
Piper Jaffray.(2)
4.9 Form of Customized Web-based Email Service Agreement by and
between Go2Net, Inc. and the Registrant.(3)
4.9.1 Form of Share Warrant for Go2Net, Inc. to purchase ordinary shares
of the Registrant.(3)
4.9.2 Form of Share Warrant for Microsoft Corporation to purchase
ordinary shares of the Registrant dated October 26, 1999.(4)
4.9.3 Amendment dated December 29, 1999 to Form of Share Warrant for
Microsoft Corporation to purchase ordinary shares of the
Registrant.(4)
4.9.4 Lockup Agreement between the Registrant and Microsoft Corporation
dated December 29, 1999.(4)
4.10 Form of Share Purchase Agreement by and among the Registrant,
Go2Net, Inc. and Vulcan Ventures Incorporated.(3)
4.10.1 Form of Registration Rights Agreement by and among the Registrant,
Go2Net, Inc. and Vulcan Ventures Incorporated.(3)
4.10.2 Form of Letter Agreement between the Registrant and Selling.
Securityholders extending deadline for SEC registration.(4)
4.11 Commtouch Software Ltd. 1999 Section 3(I) Share Option Plan.(8)
4.12 Office Lease between EOP-Shoreline Technology Park, L.L.C. and
Commtouch Software, Inc. dated October 28, 1999.(11)
4.13 Wingra Technologies, LLC 1998 Unit Option Plan (13)
4.14 Stock Purchase Agreement between Commtouch Software Ltd. and
Rideau Ltd., dated June 1, 2001 (12)
4.15 Form of Wingra Technologies, LLC Investor Option Agreement (14)
4.16 Form of Wingra Technologies, LLC Investor Warrant Agreement (15)
4.17 Stock Purchase Agreement between Commtouch Software Ltd. and
Hughes Holdings LLC., dated June 5, 2001 (16)
4.18 Agreement of Commercial Lease between Am-Ram Pituah Drom Netanya
(South Netanya Development) Ltd. as Lessor and Comtouch Software
Ltd. as Lessee dated June 3, 2000 for premises in Netanya,
Israel.(17)
4.19 Conditional Lease Termination Agreement between EOP-Shoreline
Technology Park, L.L.C. and Commtouch Inc. dated December 21, 2001
4.20 Settlement between Compaq Financial Services Corporation and
Commtouch Inc. and Commtouch Software Ltd. dated December 21, 2001
4.21 Settlement and Termination of Services Agreement between Exodus
Communications, Inc. and Commtouch Inc. dated January 10, 2002
4.22 Amended and Restated 1996 CSI Stock Option Plans and form of
agreement thereunder (18)
4.23 Amended and Restated 1999 Section 3(i) Share Option Plan and form
of option agreement thereunder (19)
4.24 Amended 1999 Non-Employee Directors Stock Option Plan and form of
agreement thereunder (20)
4.25 Agreement of Merger between CP Software Group Inc., Commtouch
Software Ltd, MailCentro, Inc. and CPSGNEWCO, Inc. dated November
16, 2001
4.26 Business Unit Purchase Agreement by and between Telecomputing,
Inc. and Commtouch Inc. dated January 15, 2002
4.27 Sale and Purchase Agreement by and between Commtouch Software
Ltd., Commtouch Inc., Wingra, Incorporated, Wingra Technologies,
L.L.C., Jan Eddy and Steven Entine dated February 25, 2002
8 Subsidiaries of the Company.
10.1 Consent of Kost, Forer & Gabbay, independent auditors.
10.2 Memorandum of Understanding between the Registrant, Go2Net, Inc.
and Vulcan Ventures Incorporated, dated July 7, 1999.(2)
-------------------------
(1) Incorporated by reference to similarly numbered exhibit in Amendment No. 1
to Registration Statement on Form F-1 of Commtouch Software Ltd., File No.
333-78531.
(2) Incorporated by reference to similarly numbered exhibit in Amendment No. 4
to Registration Statement on Form F-1 of Commtouch Software Ltd., File No.
333-78531.
(3) Incorporated by reference to similarly numbered exhibit in Amendment No. 5
to Registration Statement on Form F-1 of Commtouch Software Ltd., File No.
333-78531.
(4) Incorporated by reference to similarly numbered exhibit in Amendment No. 1
to Registration Statement on Form F-1 of Commtouch Software Ltd., File No.
333-89773.
(5) Incorporated by reference to similarly numbered exhibit in Amendment No. 2
to Registration Statement on Form F-1 of Commtouch Software Ltd., File No.
333-89773, filed March 28, 2000.
(6) Incorporated by reference to Exhibit 2 to Report on Form 6-K for the month
of August 2000.
(7) Incorporated by reference to Exhibit 3 to Report on Form 6-K for the month
of August 2000.
(8) Incorporated by reference to Exhibit 10.2 to Registration Statement on Form
S-8 No. 333-94995.
(9) Incorporated by reference to Exhibit 2 to Report on Form 6-K for the month
of January 2001.
(10) Incorporated by reference to Exhibit 3 to Report on Form 6-K for the month
of January 2001.
(11) Incorporated by reference to Exhibit 1 to Report on Form 6-K for the month
of January 2001.
(12) Incorporated by reference to Exhibit 1 to Report on Form 6-K for the month
of May 2001, filed June 1, 2001.
(13) Incorporated by reference to Exhibit 2 to Report on Form 6-K for the month
of May 2001, filed June 1, 2001.
(14) Incorporated by reference to Exhibit 3 to Report on Form 6-K for the month
of May 2001, filed June 1, 2001.
(15) Incorporated by reference to Exhibit 4 to Report on Form 6-K for the month
of May 2001, filed June 1, 2001.
(16) Incorporated by reference to Exhibit 4 to Report on Form 6-K for the month
of May 2001, filed June 12, 2001.
(17) Incorporated by reference to Exhibit 10.13 to Amendment No. 1 to Annual
Report on Form 20-F for the year ended December 31, 2000.
(18) Incorporated by reference to Exhibit 4 to Schedule TO, filed July 20, 2001.
(19) Incorporated by reference to Exhibit 5 to Schedule TO, filed July 20, 2001.
(20) Incorporated by reference to Exhibit 6 to Schedule TO, filed July 20, 2001.