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, 2002
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)
1A 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, 2002).
Ordinary Shares, par value NIS 0.05 22,219,696
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
Recent Development: Transition to Anti-Spam Business
During 2002, concurrent with the divestiture of the Company's outsourced email
businesses in transactions with MailCentro Inc. and Telecomputing, Inc. (see
discussion under "Item 5. Operating and Financial Review and Prospects" below),
and the sale of the Company's subsidiary Wingra, Inc., the Company began
marketing to service providers its "Commtouch Messaging Platform" ("CMP"), which
had been in development by the Company prior to that time. Following a concerted
effort to penetrate the email server market and a determination that the
continuing unfavorable economic conditions would hamper potential sales of CMP,
and given the Company's inherent knowledge of anti-spam solutions based on its
many years as an ASP in the outsourced email market and the growing worldwide
attention that has been directed to the problem of spam, the Company
transitioned its focus to the anti-spam market in mid-2002. While no uniform
definition of spam exists, the Company generally defines "spam" as the sending
of unsolicited bulk email for commercial and non-commercial purposes.
During the latter half of 2002, the Company directed all of its research and
development resources into completing the development of its anti-spam solution
for the enterprise market. In early 2003, the Company completed the first
version of its anti-spam solution known as ASAP!(TM) (Anti-Spam Adaptive
Protection), which offers real-time enterprise protection against spam based on
a patent-pending technology. ASAP!, which integrates with the Microsoft(R)
Exchange Server, adapts its detection capabilities to recognize and counter spam
attacks as they are launched over the Internet to pre-emptively block spam. This
adaptability feature is derived from ASAP!'s architecture, which combines an
Enterprise Gateway application (i.e. software) with a remote Service Center to
deliver to customers the benefits of in-house installation and outsourced
service in a single solution.
The Service Center enables Commtouch to analyze daily the characteristics of
millions of email messages, so that a spam attack can be identified and a
detection 'signature' created and communicated to the Enterprise Gateway before
the attack can reach the corporate customer. The Enterprise Gateway provides the
customer's IT managers with the ability to customize ASAP!'s detection
parameters to the needs of the organization and its employees.
The Company is marketing and selling ASAP! through a reseller (channel) program,
and as of June 9, 2003, the Company has contracted with 25 resellers. The
Company's current market focus is on enterprise customers located in North
America. The Company anticipates that it will begin commercially shipping ASAP!
by mid to late June 2003.
In or about the period that the Company transitioned to the anti-spam business,
it entered into two strategic agreements with AxcessNet Ltd., under which the
Company is receiving consulting and fundraising services from AxcessNet (see
discussion under "Item 10. Additional Information - Material Contracts" below).
As the Company shifted its focus to the anti-spam market during 2002, it
continued to receive royalty payments from MailCentro and Telecomputing.
However, it is noted that these royalty payments will not recur to any
significant extent during 2003 and thereafter. Furthermore, revenues in 2002
from the few customers previously retained by the Company in connection with its
prior email business are currently insignificant, as most of the related
agreements have terminated.
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. and Commtouch (UK) Ltd and, as relating to
consolidated financial information contained herein former wholly-owned
subsidiaries Commtouch Latin America Inc. and Wingra, Inc., which were dissolved
and sold respectively during 2002, and former majority-owned
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subsidiary, Commtouch K.K. (Japan) (during 2002 Commtouch divested itself of its
majority holdings and retained an equity interest in this company, which is now
known as Imetrix).
The selected consolidated statements of operations data for the years ended
December 31, 2000, 2001 and 2002 and the selected consolidated balance sheet
data as of December 31, 2001 and 2002 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, 1998 and 1999 and the selected consolidated balance sheet data as of
December 31, 1998, 1999 and 2000 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,
---------------------------------------------------
1998 1999 2000* 2001* 2002
------- -------- -------- -------- --------
(USD in thousands, except per share data)
Consolidated Statements of Operations Data:
Revenues:
Email services ......................................... $ 389 $ 4,251 $ 17,771 $ 13,318 $ 3,238
Software licenses, maintenance and services ............ -- -- 1,000 270 200
------- -------- -------- -------- --------
Total revenues ....................................... 389 4,251 18,771 13,588 3,438
Cost of revenues:
Email services ......................................... 569 3,643 11,800 13,962 1,675
Software licenses, maintenance and services ............ -- -- -- -- --
------- -------- -------- -------- --------
Total cost of revenues ............................... 569 3,643 11,800 13,962 1,675
------- -------- -------- -------- --------
Gross profit (loss) .................................... (180) 608 6,971 (374) 1,763
------- -------- -------- -------- --------
Operating expenses:
Research and development, net .......................... 1,149 2,942 10,244 5,884 2,246
Sales and marketing .................................... 2,001 7,722 26,534 12,894 1,176
General and administrative ............................. 604 4,328 13,455 10,337 2,588
Amortization of prepaid marketing expenses ............. -- 3,263 4,508 -- --
Write-off of property and equipment and other
.................................................... -- -- -- 10,166 750
Amortization of stock-based employee deferred
compensation ......................................... 91 3,436 3,050 2,204 551
------- -------- -------- -------- --------
Total operating expenses ............................. 3,845 21,691 57,791 41,485 7,311
------- -------- -------- -------- --------
Operating loss ........................................... (4,025) (21,083) (50,820) (41,859) (5,548)
Interest and other income (expenses), net ................ (326) 1,232 2,886 583 (60)
Equity in losses of affiliate ............................ -- -- -- -- (56)
Write-off of impaired long-term investments .............. -- -- (5,000) (2,000) --
Minority interest ........................................ -- -- 55 285 74
------- -------- -------- -------- --------
Loss from continuing operations ........................... (4,351) (19,851) (52,879) (42,991) $ (5,590)
Gain on disposal of Wingra ............................... -- -- -- -- 1,014
Discontinued operations - Wingra ......................... -- -- (1,346) (18,016) (335)
------- -------- -------- -------- --------
Income (Loss) from sale of discontinued operations ....... -- -- (1,346) (18,016) 679
------- -------- -------- -------- --------
Net Loss .................................................. $(4,351) $(19,851) $(54,225) $(61,007) $ (4,911)
Basic and diluted net loss per share
Loss from continuing operations ........................ $ (3.00) $ (2.65) $ (3.42) $ (2.51) $ (0.27)
Income (Loss) from sale of discontinued operations ..... -- -- (0.09) (1.05) $ 0.03
------- -------- -------- -------- --------
Net loss ................................................. $ (3.00) $ (2.65) $ (3.51) $ (3.56) $ (0.24)
------- -------- -------- -------- --------
Weighted average number of shares used in
Computing basic and diluted net loss per share ........... 1,450 7,487 15,462 17,152 20,854
------- -------- -------- -------- --------
3
December 31,
---------------------------------------------
1998 1999 2000 2001 2002
------- -------- ------- ------- ------
(in thousands)
Consolidated Balance Sheet Data:
Cash and cash equivalents ..... $ 834 $ 65,996 $20,831 $ 2,248 $1,388
Marketable securities ......... -- 18,050 8,607 -- --
Working capital (deficit) ..... (1,440) 88,053 23,768 (607) 549
Total assets .................. 2,366 100,336 77,280 9,545 2,984
Long-term liabilities ......... 530 497 1,825 940 413
Shareholders' equity (deficit) (815) 95,312 61,728 4,059 1,437
* - Reclassified to conform to the current years classification mainly due to
divestiture of Wingra.
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.
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 anti-spam solutions, we will
fail to generate revenues.
Our success will depend on the acceptance and use of our anti-spam solutions by
enterprise customers. We cannot estimate the size or growth rate of the
potential market for our anti-spam offerings. If the market for anti-spam
solutions 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 anti-spam solution 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 anti-spam solutions, if that market does not grow, our business will likely
fail.
Dependence upon resellers and product concentration
The Company expects that it will continue to be dependent upon resellers for a
significant portion of its revenues. If anticipated orders from these resellers
fail to materialize, the Company's business, operating results and financial
condition will be materially adversely affected.
The Company expects to derive the vast majority of its revenues in the
foreseeable future from sales of its anti-spam solutions. See "Item 5 --
"Operating and Financial Review and Prospects" and "Item 4 - Information on the
Company."
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 anti-spam solutions and because
of the emerging nature of the markets in which we compete, our revenue is
unpredictable. Our current and future expense levels 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.
4
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 Our ability to successfully develop and market our anti-spam solutions
to new markets;
o The market acceptance of our new anti-spam solutions
o The size, timing and fulfillment of orders for our new anti-spam
solutions;
o Our ability to expand our workforce with qualified personnel, as may be
needed;
o Unanticipated bugs or other problems arising in providing our new
anti-spam solutions to enterprise customers;
o The success of our resellers sales efforts to potential enterprise
customers;
o The solvency of our resellers and their ability to allocate sufficient
resources towards the marketing of our new anti-spam solutions to their
potential enterprise customers;
o The rate of adoption of anti-spam 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;
o Our ability to successfully develop and market new, modified and/or
upgraded solutions, as may be needed;
o The substantial decrease in information technology spending in general;
o Pricing of our solutions;
o Our ability to timely collect fees owed by resellers/customers; and
o Effectiveness of our customer support, whether provided by our
resellers or directly by Commtouch.
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 not had anti-spam solution sales during
2002, 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 anti-spam solutions after having ceased our efforts to sell our software
messaging solution during 2002 and, prior to that time, having provided
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 mid-2002, we began focusing exclusively on completing development
of and selling our new anti-spam solutions. This change required us to once
again adjust our business processes and to readjust the workforce at Commtouch
(predominantly, the sales force). Therefore, we have no operating history as a
provider of our new anti-spam solutions upon which you may be able to evaluate
our business and prospects. It is too early to judge whether this business will
succeed.
We have many established competitors who are offering a multitude of solutions
to the spam problem
The market for anti-spam solutions 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.
5
In the market for anti-spam solutions, there are a large number of providers
offering "content filtering" solutions (solutions focusing solely on the content
of potential spam email). Other providers that offer forms of software (gateway)
and/or service based solutions and which may be viewed as direct competitors to
Commtouch include Brightmail(R) and Postini(R). There is a great likelihood
that, as the market for anti-spam solutions further develops and given the
difficult technological hurdles in attempting to create an effective solution,
established Internet security players will enter the market, who may be able to
leverage their market position and resources to capture a portion of the
anti-spam market.
As this market continues to develop, a number of companies with greater
resources than ours could attempt to increase their presence in this market by
acquiring or forming strategic alliances with our competitors or business
partners. Competitors could introduce products with superior features,
scalability and functionality at lower prices than our products and could also
bundle existing or new products with other more established products that
discourage users from purchasing our products. In addition, because there are
relatively low barriers to entry for the software market, we expect additional
competition from other established and emerging companies. Increased competition
is likely to result in price reductions, reduced gross margins and loss of
market share, any of which could harm our business.
Also, there are companies that develop and maintain in-house anti-spam
solutions, such as Microsoft(R)and Yahoo(R). These and other companies could
potentially leverage their existing capabilities and relationships to enter the
anti-spam industry.(R)Brightmail, Postini, Microsoft and Yahoo are trademarks of
Brightmail, Inc., Postini, Inc., Microsoft Corporation and Yahoo! Inc.
respectively.
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, technical,
sales, marketing and other resources than we do and may enter into strategic or
commercial relationships on more favorable terms. Some of these competitors have
research and development capabilities that may allow them to develop new or
improved products that may compete with product lines we market and distribute.
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 the underlying technological base of our anti-spam solutions
and the current landscape of the anti-spam market require highly trained sales
and marketing personnel to educate prospective resellers and customers regarding
the use and benefits of our solutions. We have limited experience in selling
anti-spam solutions to enterprise customers. It will take time for our current
and future employees and resellers to learn how to market our solutions.
Additionally, we are unable to predict the possibility of success selling newly
introduced solutions for which we have no marketing experience 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 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 $54.2 million in 2000, $61.0 in 2001,
$4.9 million in 2002 and a net loss of $1.14 million for the first quarter of
2003. As of December 31, 2002 and March 31, 2003, we had an accumulated deficit
of approximately $151.7 million and approximately $152.8 million, respectively.
We have not achieved profitability 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 remains very thinly capitalized. As such, we might become dependent
upon raising additional funds to finance our business. Our cash balance at
December 31, 2002 and March 31, 2003 was approximately $1.4 million and
approximately $1.1 million, respectively. 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.
6
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.
As discussed below under "Item 10. Additional Information. ISRAELI TAXATION AND
INVESTMENT PROGRAMS--Law for the Encouragement of Industrial Research and
Development, 1984," in the past we have received funds for the development of
our business from the OCS. However, under our Convertible Loan Agreement, we
have agreed to limit our total funding received or receivable from the OCS to a
maximum in the aggregate of $1,500,000 during the term of the loan. Grants
received from the OCS through 2002 that the Company potentially will be
obligated to repay totaled $800,000 approximately, and the Company has been
informed that the OCS has approved an additional grant of approximately $480,000
in 2003.
Risk of Litigation
Legal proceedings can be expensive, lengthy and disruptive to normal business
operations, regardless of their merit. Moreover, the results of complex legal
proceedings are difficult to predict and an unfavorable resolution of a lawsuit
or proceeding could have a material adverse effect on the Company's business,
results of operations or financial condition.
Indemnification of Directors and Officers
The Company has agreements with its directors, subject to Israeli law (Item 5 -
"Operating and Financial Review and Prospects"), that provide for the Company to
indemnify these directors for (a) any monetary obligation imposed upon them for
the benefit of a third party by a judgment, including a settlement agreed to in
writing by the Company, or an arbitration decision certified by the court, as a
result of an act or omission of such person in his capacity as a director of the
Company, and (b) reasonable litigation expenses, including legal fees, incurred
by such a director for which he/she is obligated to pay by a court order, in a
proceeding brought against him/her by or on behalf of the Company or by others,
or in connection with a criminal proceeding in which he/she was acquitted, in
each case relating to acts or omissions of such person in his/her capacity as a
director of the Company.
Risk due to economic conditions
Should economic conditions fail to improve, our ability to sell our new
anti-spam solutions could be negatively impacted. Furthermore, even if we are
successful in selling our solutions, our ability to collect outstanding
receivables may be significantly impacted by liquidity issues of our resellers'
customers and/or our resellers themselves, which may negatively affect our
ability to recognize future revenue based on sales. 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 anti-spam solutions, 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 low head-count of 32 employees (as of May 2003) continues to strain our
operational resources, and although the Company added additional sales personnel
in the early months of 2003, the lack of sufficient personnel 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, 2002, we had sales offices in Israel and the United States.
Depending on the success of our marketing efforts in North America, we may
pursue the marketing of our anti-spam solutions in international markets by
utilizing
7
appropriate distributorship channels. However, 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 anti-spam
solutions;
o export restrictions, including export controls relating to encryption
technologies;
o difficulties in collecting accounts receivable and longer collection
periods;
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 prospective
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 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. In this regard,
the U.S. recently led a coalition of forces in attacks on Afghanistan and Iraq.
The worldwide ramifications of such attacks are unknown at this time. 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 spam and anti-spam industry is characterized by difficult technological
challenges, sophisticated "spammers" and constantly evolving spam practices and
targets that could render our anti-spam solutions and proprietary technology
ineffective. Our success depends, in part, on our ability to continually enhance
our existing anti-spam solutions and to develop new solutions, functions and
technology that address the potential needs of 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, and
may not be able to do so. See "Item 4 - Information on the Company."
Our software may be adversely affected by defects, which could cause our
customers or end users to stop using our solutions.
Our anti-spam solutions are based in part 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.
8
Although we have not experienced any material software defects to date in our
anti-spam solutions offering, it is possible that, despite testing by us,
defects may exist in the software we license. These defects could cause
interruptions in our anti-spam solutions for 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.
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 anti-spam solutions for enterprises and, possibly, other target
markets.
Based on the cash balance at March 31, 2003, current projections of revenues,
related expenses, the ability to further curtail certain discretionary expenses
and completion of the convertible loan transaction (as discussed above under
paragraph a of this Item 3 and 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 was granted. The plaintiffs then filed
a second amended and consolidated complaint, and our second motion to dismiss
was only partially accepted, with the end result being that the plaintiffs filed
a third amended and consolidated complaint. We (including the individual
defendants) filed an answer to that complaint, and the case then moved into the
discovery stage, with the case being set for trial in January 2004. In May 2003,
a settlement agreement was signed between the plaintiffs and defendants and the
court thereafter issued a preliminary order approving the settlement. The
settlement calls for the payment of $15 million to the plaintiffs, with this
amount to be fully funded by the Company's Directors and Officers policy. While
the payment to plaintiffs under this settlement should not cause the Company any
financial hardship, we are unable to predict whether the whole or a substantial
portion of the class members will choose to participate in the settlement and
whether ultimately the court will issue a final order approving the settlement.
The settlement does not contain any admissions or findings of wrongdoing on the
part of the defendants, and we continue to maintain that the Company and
individual defendants acted properly at all times.
If we cannot satisfy Nasdaq's maintenance requirements, it may delist our
ordinary shares from its Smallcap Market and we may not have an active public
market for our ordinary shares. The absence of an active trading market would
likely make our ordinary shares an illiquid investment.
Our ordinary shares are quoted on the Nasdaq SmallCap Market. To continue to be
listed, we are required to maintain shareholders' equity of at least $2,500,000,
or market value of our outstanding shares (excluding shares held by company
insiders and principal shareholders) of at least $35,000,000, or we must have
realized at least $500,000 in net income from continuing operations in our last
fiscal year or in two of our last three fiscal years.
Currently, we are not in compliance with any of these tests and Nasdaq may
delist our ordinary shares. If this occurs, trading in our 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. The Company recently has been advised
by Nasdaq that it no longer meets the requirements for listing on the SmallCap
Market and is in the process of discussing with Nasdaq appropriate efforts to
become compliant.
Also, Nasdaq may delist our ordinary shares if it deems it necessary to protect
investors and the public interest.
9
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
stock 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 beneficially own over five percent of
our ordinary shares, beneficially own, in the aggregate, approximately 31.3% of
our outstanding ordinary shares as of February 7, 2003 plus warrants and options
exercisable within 60 days thereof. If they vote together (especially if they
were to convert all beneficial holdings into shares entitled to voting rights in
the Company), 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. The
above percentage of beneficial ownership includes warrants and options totaling
11.24% of the outstanding ordinary shares which are underwater as of February 7,
2003.
InfoSpace beneficially owns approximately 8.7% of our outstanding ordinary
shares (inclusive of a warrant underwater as of February 7, 2003 constituting
4.9% of the 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.
Pursuant to the Ordinary Shares and Warrants Purchase Agreement dated February
27, 2002:
o OZF Ltd. acquired beneficial ownership of approximately 7.2% of our
outstanding ordinary shares (inclusive of warrants underwater as of
February 7, 2003 constituting 2.7% of the outstanding ordinary shares);
o Gideon Mantel, CEO and a director in the Company, acquired additional
shares and warrants to purchase shares in the Company. Together with
his prior holdings in the Company, Mr. Mantel beneficially owns
approximately 7.9% of our outstanding ordinary shares (inclusive of
warrants underwater as of February 7, 2003 constituting 1.8% of the
outstanding ordinary shares); and
o Nahum Sharfman, a director in the Company, acquired additional shares
and warrants to purchase shares in the Company. Together with his prior
holdings in the Company, Mr. Sharfman beneficially owns approximately
6.1% of our outstanding ordinary shares (inclusive of warrants and
options underwater as of February 7, 2003 constituting 1.8% of the
outstanding ordinary shares).
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
10
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 are eligible for resale in the future (i.e. those shares
covered by warrants issued in the private round of financing of February 2002
and those shares that may be issued if the lenders in the convertible loan
transaction decide to exercise warrants and/or convert the Company's loan
obligations to equity, as discussed below under paragraph a of Item 3 and Item
5, "Operating and Financial Review and Prospects - Liquidity and Capital
Resources").
Also, the shares that could be issued under the Convertible Loan Agreement would
dilute existing shareholders
Risk of occurrence of event of default under Convertible Loan Agreement
The Company is required to abide by the terms and provisions of the Convertible
Loan Agreement. Upon failure to do so, for example, failure to pay principal or
interest, failure to obtain the registration with the SEC of the shares that may
be issued to lenders under the agreement, failure to maintain consolidated cash
reserves of at least $500,000, upon the lenders' demand, we would be in default
of the agreement. The lenders were granted security interests in all of the
Company's assets. If an event of default is not cured by the Company, the loan
would accelerate and all amounts due under the loan would immediately become due
and payable. If the Company is unable to repay the loan amounts, the lenders,
among other things, would have the right to foreclose on their security
interests in the Company's assets by seizing and selling all the Company's
assets. See the discussion under Item 4 "Information on the Company".
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.
We regard our patent pending technology, copyrights, service marks, trademarks,
trade secrets and similar intellectual property as critical to our success, and
rely on patent, 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
patent pending technology, trade secrets, copyrights, trademarks and similar
proprietary rights. We have recently filed a provisional patent application
covering certain aspects of our anti-spam technology, and we may convert this
application into a formal patent application or seek to patent certain
additional 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 anti-spam solutions. In addition, because patent
applications in the United States are not publicly disclosed until the patent is
issued, applications previously may have been filed which relate to our
anti-spam solutions.
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 patents, trademarks
11
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.
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.
We also continue to hold a perpetual mail server license which was utilized in
our hosted service offering and is still being utilized by us to service a
current customer, and may license 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 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.
Governmental regulation and legal uncertainties could impair the growth of the
Internet, decrease the distribution of unsolicited bulk (spam) email and
decrease demand for our anti-spam solutions or increase our cost of doing
business.
While laws aimed at curtailing the spread of spam have been adopted by some
states, enforcement has not been widespread and the lack of a body of federal
anti-spam law has highlighted an increase in the amount of spam traffic. The
growth and development of the spam market may prompt calls for more stringent
Internet user protection laws that may limit the ability of companies promoting
or delivering spam 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. All or some of the above
laws could decrease the demand for our anti-spam solutions 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.
12
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 historically have been generated
in U.S. dollars and a portion of our expenses have been incurred in New Israeli
Shekels, our results of operations may be adversely affected by inflation and
currency fluctuations.
We have generated a substantial portion of our revenues in U.S. dollars and
incurred 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 have been 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. In 2002 and
for a number of prior to 1999, the rate of devaluation of the NIS against the
dollar exceeded the rate of inflation. We cannot be assured 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
Office of the Chief Scientist (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 in 2002 we received $0.2 million. While we have
applied for an additional grant in 2003, the OCS budget has been subject to
reductions which may affect the availability of funds for this prospective grant
and other 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 relating to some of Commtouch's previous products. The
related funded projects ultimately failed and the relevant royalty payments were
made by the Company to the OCS on behalf of the revenues generated from these
projects. The Company will not be obligated to pay future royalties for such
projects undertaken in 2001 or earlier years, 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 were no contingent liabilities for royalties from these
projects. In March 2002, the Company submitted an application for project
failure with regard to these projects, and the OCS subsequently approved the
application. Also, we received royalty-bearing grants in 2002 totaling $0.2
million. The OCS is entitled to revisit the status of past projects it has
confirmed as "failed" to ensure that the Company is not currently utilizing
technology developed under such projects.
13
Also, under our Convertible Loan Agreement, we have agreed to limit our total
funding received or receivable from the OCS to a maximum in the aggregate of
$1,500,000 during the term of the loan. Grants received from the OCS through
2002 that the Company potentially will be obligated to repay totaled $800,000
approximately, and the Company has been informed that the OCS has approved an
additional grant of approximately $480,000 in 2003.
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 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. In addition, the law and regulations
prescribing the benefits provide for an expiration date for the grant of new
benefits. The expiration date has been extended several times in the past. The
expiration date currently is end of December 2003 and no new benefits will be
granted after that date unless the expiration date is extended. We cannot assure
you that new benefits will be available after December 2003 or that benefits
will be continued in the future at their current levels or at all. Out of our
three approved enterprise programs, two were cancelled as of December 31, 2002.
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 several 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 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.
Tax reform in Israel may reduce our tax benefits, which might adversely affect
our profitability.
Item 4. Information on the Company.
Overview
We are a provider of anti-spam solutions to enterprise customers (See PART I,
"Recent Development: Transition to Anti-Spam Business" for additional detailed
information). The Company offers its anti-spam solutions to small, medium and
large enterprises through a variety of distribution channels, namely various
reseller channels. The solutions are also available for integration with
security, content filtering, anti-virus and other filtering solutions through
alliances and strategic partnerships.
14
In its previous capacity as a dedicated email service provider to millions of
users, the Company found it necessary to design an effective strategy to
eliminate millions of unsolicited commercial email messages daily. It is this
strategy that has led the Company to develop and deliver its current anti-spam
solutions, which are positioned to tackle sophisticated spam attacks. A
combination of proprietary and patent-pending technologies makes it possible for
Commtouch to detect, alert and block most spam attacks as they are distributed
over the Internet.
Commtouch Offerings
We offer a comprehensive anti-spam solution (known as "ASAP!"), consisting of
both a software element (the "Enterprise Gateway") and a service component (the
"Service Center"). At the Enterprise Gateway, messages are filtered at the
organization's entry point, before being distributed to recipients, with added
user-level controls and a top level of secure spam detection services from the
Service Center, all allowing for real-time reaction to worldwide spam attacks.
At the heart of the ASAP! solution, however, is the Service Center, which
detects new spam attacks as soon as they are launched and distributed over the
Internet. The Service Center provides real-time spam detection services to
enterprise customers by maintaining constant communication with Enterprise
Gateways that are locally installed at customer premises in different locations
worldwide. The Service Center collects information from multiple sources about
new spam attacks, analyzes the input using Commtouch patent-pending technology,
identifies and detects spam, classifies the data, matches its stored information
against outstanding queries for spam detection from Enterprise Gateways and
replies in real-time back to the Enterprise Gateways with a prioritized and
accurate resolution. The whole process takes no more than 300ms. Enterprise
privacy is kept at a maximum because the content of incoming email messages is
not seen by the Service Center.
In particular, ASAP! operates to help eliminate spam as follows:
Inbound email enters the ASAP! Enterprise Gateway, a software add-on to the
enterprise SMTP server.
The ASAP! Enterprise Gateway matches key characteristics of the message
with predefined spam policies created by IT managers or end-users.
If ASAP! does not match the message to a known source, either spam or not
spam, it compares characteristics of the incoming message against the ASAP!
Gateway database of recently identified spam.
If the message remains suspicious, but cannot be confirmed as spam, the
ASAP! Gateway queries the ASAP! Service Center for remote spam detection
and classification services.
The outgoing query consists of encrypted digital signatures taken from
e-mail header information to ensure enterprise security and
confidentiality.
The ASAP! Service Center weighs the values of the outstanding query against
its vast database of real-time information about known spam messages and
sources of spam, and replies to the ASAP! Enterprise Gateway with a unique
and up-to-date classification.
The ASAP! Enterprise Gateway applies a locally predefined action to the
message and may store the information internally to match against new
incoming messages bearing similar characteristics.
We also offer an ASAP! Software Development Kit ("SDK"). The ASAP! SDK enables
third-party vendors to integrate ASAP! advantages into their existing offerings,
providing them with full spam identification and spam classification services
from the ASAP! Service Center. These vendors benefit from ASAP! expertise in
blocking spam and other unwanted email traffic without the need to develop and
dedicate a service department in-house. The SDK communicates fully with the
remote Service Center, receiving results to queries about suspicious messages
and acting according to set policies on the customer side. Each such vendor has
the flexibility to determine how best to integrate the SDK results into their
solution. For example, if the Service Center classifies a specific message as
spam, the
15
vendor's application may respond by either quarantining the message, rejecting
it completely or sending a bounce-back message to its sender or any other option
provided by the vendor's specific application.
The SDK consists of a set of APIs, which receive characteristics of incoming
messages as input from the vendor's application, returning the status of the
message as output from the Service Center. The vendor has the option of
installing an API, which returns a deterministic result classifying messages as
either spam or non-spam, or using an API that classifies messages based on the
level of suspicion that the message is spam. Each vendor can implement its
solution differently, making the unique advantages of SDK flexible to match
particular needs.
Products that may benefit from integration of the SDK solution include:
o Anti-virus applications
o Content filtering solutions
o Firewall systems
o Security servers
o Other network appliances
Competitive Landscape
The markets in which Commtouch competes are intensely competitive and rapidly
changing. We believe there is no single competitor that offers the complete
package of anti-spam protection that Commtouch provides. We are aware of
competitors that provide anti-spam products either alone or as part of a
complete messaging system or email security system.
Commtouch's principal competition are companies that offer various e-mail
content filtering products. Companies that sell products that compete with some
of the features within our products include Brightmail(R), Postini(R),
Tumbleweed, CipherTrust, SurfControl, Clearswift Technologies, CipherTrust,
Inc., and Trend Micro Incorporated.
The principal competitive factors in our industry include price, product
functionality, product integration, platform coverage and ability to scale,
worldwide sales infrastructure and global technical support. Some of our
competitors have greater financial, technical, sales, marketing and other
resources than we do, as well as greater name recognition and a larger installed
customer base. Additionally, some of these competitors have research and
development capabilities that may allow them to develop new or improved products
that may compete with product lines we market and distribute.
We expect that the market for anti-spam solutions will become more consolidated
with larger companies being better positioned to compete in such an environment
in the long term. As this market continues to develop, a number of companies
with greater resources than ours could attempt to increase their presence in
this market by acquiring or forming strategic alliances with our competitors or
business partners. Our success will depend on our ability to adapt to these
competing forces, to develop more advanced products more rapidly and less
expensively than our competitors, and to educate potential customers as to the
benefits of licensing our products rather than developing their own products.
Competitors could introduce products with superior features, scalability and
functionality at lower prices than our products and could also bundle existing
or new products with other more established products that discourage users from
purchasing our products. Increased competition is likely to result in price
reductions, reduced gross margins and loss of market share, any of which could
harm our business.
See also disclosure under "Item 3. Key Information- RISK FACTORS--Business
Risks--We have many established competitors who are offering solutions to the
spam problem."
Convertible Loan Transaction
To enhance the Company's overall financial position, on January 29, 2003,
Commtouch entered into a Convertible Loan Agreement ("Convertible Loan
Agreement"), including certain ancillary agreements and documents attached as
exhibits thereto, with certain lenders identified in Exhibit "A" to such
Convertible Loan Agreement. The Convertible Loan Agreement allowed for a maximum
possible loan amount of $1,250,000. As of March 26, 2003, the lenders had agreed
to advance Commtouch a loan of $905,000. On March 28, 2003, by way of Addendum 1
to the Convertible Loan Agreement, the Company and the lenders amended the
Convertible Loan Agreement to provide an option to certain of
16
the lenders, their affiliates and investors from the Company's previous round of
financing the right to loan the Company an amount of up to $345,000,
representing the difference between the maximum loan amount originally
contemplated and the amount of the loan as at March 26, 2003. This option was
exercised on May 11, 2003.
The Company has received the total loan amount of $1,250,000 from the lenders.
The loan is to be repaid after three years, unless converted into equity by the
lenders or a defined default or other event triggering early repayment is met,
and it bears interest at a rate of ten percent per annum to be paid with
priciple. Furthermore, the loan principal and interest may be converted by the
lenders into equity in the Company at any time during the loan term, at a
conversion price of $0.25 per Ordinary Share ("Conversion Price"). Warrants
exercisable for purchase of up to 5,000,000 of the Company's ordinary shares
have been issued to the lenders (based on loan amounts advanced divided by the
Conversion Price). Each one-third of the warrants are exercisable at prices per
Ordinary Share of $0.25, $0.33 and $0.50 respectively, and the warrants are
exercisable at any time within five years of issuance. Warrants shall also be
issued on an annual basis for any accumulated interest on the loan.
As security for repayment of the loaned amounts, the lenders have been granted
security interests in all of the assets of the Company. Also, the lenders are
entitled to nominate one director for election to the Board of Directors of the
Company or appoint one observer to the Board.
Also, the Company has agreed that, among other things, until all loans are
repaid, it will;
o not pay any dividends or make any distribution on its outstanding
Ordinary Shares, or redeem any Shares for consideration without the
prior written consent of 50% of all the lenders;
o not alter its capital structure or permit any corporate reorganization
and/or disposal of assets outside the ordinary course of business,
except as authorized by vote of its board of directors and
shareholders;
o secure approval of 50% of the lenders before issuing preferred shares
or other preferential liquidation rights;
o not create any security interests on indebtedness that will rank prior
to advances under the Convertible Loan Agreement and the security
interest granted under the instruments provided for in the Agreement,
without approval of 50% of the lenders;
o along with its subsidiaries, continue to engage substantially in the
same businesses and not to enter into certain business combination
transactions;
o limit its total funding received or receivable from the Israeli Office
of Chief Scientist ("OCS") to a maximum in the aggregate of $1,500,000
during the term of the loan.
Lenders comprising not less than 50% of all the lenders may require the Company
to register with the SEC the resale of all Ordinary Shares issuable to the
lenders under the Agreement. The lenders may also sell their shares in other
registration statements that the Company files for its own benefit or that of
third parties who wish to sell shares. This right expires three (3) months after
the third anniversary of the last applicable Warrant issuance date. The maximum
number of shares that may be registered is 13,310,000. The Company will pay the
expenses of these registrations, except for underwriting discounts and
commissions and the fees and expenses of any lender's counsel. The Company has
also agreed to indemnify the lenders against certain liabilities arising from
the public offer and sale of their shares pursuant to the registration.
The Company will be in default under the Convertible Loan Agreement and subject
to prior conversion in accordance unless agreed otherwise by the Lender Majority
(""Lender Majority" shall mean those Lenders who have lent collectively to the
Company over 50% of the Loan Amount"), all amounts due thereunder will
accelerate and immediately become due and payable if certain events occur,
including the following:
o the Company's failure to repay amounts due under the Convertible Loan
Agreement;
o the Company's failure to repay amounts due on any debt ranking prior to
or on a parity with the Convertible Loan Agreement or the occurrence of
any event of default in any loan arrangement ranking prior to or on a
parity with the Convertible Loan Agreement;
17
o if certain statements made by the Company in connection with the
Convertible Loan Agreement were materially untrue
o if the Company's cash reserves on a consolidated basis fall below
$500,000;
o the Company admits in writing to a lender under the Convertible Loan
Agreement its inability to pay its debts;
o the filing any proceedings regarding the Company in bankruptcy,
insolvency, winding up, dissolution, liquidation, moratorium,
receivership or reorganization for the benefit of creditors, which in
the case of proceedings brought against the Company, have not been
withdrawn or dismissed within ninety (90) days;
o the commencement by a third party creditor of a proceeding to foreclose
a security interest or lien in any property or assets of the Company
upon default in the payment or performance of any debt of the Company,
in excess of $250,000 which is secured thereby; and
o the entry against the Company of a final judgments in excess of
$250,000 that are not discharged, provided for, stayed or appealed in
thirty days an attachment is levied against the assets of the Company
involving an amount in excess of $250,000 and the levy is not vacated,
bonded or otherwise terminated within thirty days.
In some cases, the Convertible Loan Agreement provides the Company will a cure
period for an event of default, and if the Company is unable to cure the breach
it will be in default.
A more complete description of this convertible loan transaction may be found in
the Company's Form 6-K filed with the SEC for the month of April 2003, which is
incorporated herein by reference under Exhibit 2.9 to this Form 20-F. This
description is qualified in its entirety by reference to the text of the
Convertible Loan Agreement which is incorporated by reference into this Form
20-F as Exhibit 2.9.1.
Intellectual Property
We regard our patent pending anti-spam techonolgy, copyrights, service marks,
trademarks, trade secrets and similar intellectual property as critical to our
success, and rely on patent, 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 are only
actively maintaining our registered trademark for "COMMTOUCH", which is
currently registered in the U.S., Israel, European Union, China, Mexico, Norway,
Taiwan, Russian Federation, South Korea and Australia. While previous
registrations of PRONTO (Canada and South Korea); COMMTOUCH SOFTWARE (Australia
and New Zealand); PRONTO MAIL (New Zealand) may still be in force, we are not
currently actively maintaining these trademarks. The Company may decide to
actively maintain some or all of these trademarks in the future, as
circumstances may justify. We also have the following pending trademark
applications: COMMTOUCH (India, Canada and Brazil). We are also claiming
trademark rights in "ASAP!", as applicable to our anti-spam solutions, as from
the beginning of 2003.
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 by us to service a
current customer, and may license 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
18
reasonable terms or that we will be able to successfully integrate the
technology into our products. These third-party 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
While laws aimed at curtailing the spread of spam have been adopted by some
states, enforcement has not been widespread and the lack of a body of federal
anti-spam law has highlighted an increase in the amount of spam traffic. The
growth and development of the spam market may prompt calls for more stringent
Internet user protection laws that may limit the ability of companies promoting
or delivering spam 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. All or some of the above
laws could decrease the demand for our anti-spam solutions and increase our cost
of doing business, or otherwise harm our business and operating results.
Employees
As of December 31, 2002, 2001 and 2000, we had 22, 92 and 486 full-time
employees, respectively. None of our U.S. employees are covered by a collective
bargaining agreement. As of June 9, 2003, we had 32 employees. 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,
up to a certain maximum base salary.
Description of Property
Our principal executive offices are located at 1A Hazoran Street, Poleg
Industrial Park, P.O.Box 8511, Netanya 42504, Israel, where our telephone number
is 011-972-9-863-6888, and 1300 Crittenden Lane, Suite 102, 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.
19
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 2002, our main business was providing outsourced integrated Web-based
email and messaging solutions to a few businesses that remained as customers
following the transfer of our consumer outsource web-based email business and
sale of our Hosted Exchange email business during late 2001 and early 2002 in
transactions with MailCentro Inc. and Telecomputing, Inc. respectively. During
early 2002, concurrent with the divestiture of the Company's above-stated
businesses, the Company began marketing to service providers its messaging
software platform ("CMP"), which had been in development by the Company prior to
that time. Following a concerted effort to penetrate the email server market and
a determination that the continuing unfavorable economic conditions would hamper
potential sales of CMP, and given the Company's inherent knowledge of anti-spam
solutions based on its many years as an ASP in the outsourced email market and
the growing worldwide attention that has been directed to the problem of spam,
the Company transitioned its focus to the anti-spam market in mid-2002. While no
uniform definition of spam exists, the Company generally defines "spam" as the
sending of unsolicited bulk email for commercial and non-commercial purposes.
In February 2002, the Company sold off its migration service business, Wingra,
to Wingra's senior management. The operations of Wingra have been eliminated
from the operations of the entity as a result of the disposal transaction. The
Company has no intent to continue its activity in the migration service.
The results of operations including revenue, operating expenses and other income
and expense of Wingra for 2000, 2001 and 2002 have been reclassified in the
accompanying statements of operations as discontinued operations.
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 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, current operating results can be affected
by revisions to prior accounting estimates.
Allowance for Doubtful Accounts and promissory notes
We maintain allowances for doubtful accounts for estimated losses from our
customers' inability to make payments they owe us and for estimated losses from
our former employees inability to pay amounts guaranteed by promissory notes. 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/employees were to deteriorate and to impair their
ability to make payments to us, additional allowances might be required in
future periods.
Impairment of long-lived assets
We assess the fair value and recoverability of our long-lived assets 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 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 2002, we performed an assessment of the our property and equipment,
pursuant to SFAS No. No.144 "Accounting for the Impairment or Disposal of
Long-Lived Assets" ("SFAS No.144"). Pursuant to SFAS No. No.144, whenever events
or changes in circumstances indicate that the carrying amount of an asset may
not be recoverable. Recoverability of assets to be held and used is measured by
a comparison of the carrying amount of an asset to the future undiscounted cash
flows expected to be generated by the assets. If such assets are considered to
be impaired, the impairment to be recognized is measured by the amount by which
the carrying amount of the assets exceeds the fair value of the assets. Assets
to be disposed of by sale are reported at the lower of the carrying amount or
fair value less costs to sell. For the year ended December 31, 2002 the Company
recognized impairment losses totaling $ 0.8 million, which were recorded as
operating expenses.
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")
20
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 the amount could be reasonably
estimated.
Revenue Sources
Service Fees. During 2000 - 2002, 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. During that time, we recognized no revenues
from our new anti-spam offering.
Direct E-marketing. During 2002, we did not recognize any revenues from this
type of activity, as our business model had changed (see above discussion under
"Overview"). Prior to 2002, because of our installed user base and our
agreements with our customers, we could assist e-commerce companies (those
seeking marketing channels) in distributing their services to our customers' end
users who opted to receive offers by email. We shared with our customers the
revenues from this direct e-marketing, which were earned either on a per-message
basis, a referral basis, or as a commission on products sold. 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 were 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 private
placement. In the future, we may have to issue in-the-money warrants to acquire
our ordinary shares to marketing channels or strategic partners who provide us
with business leads. The issuance of in-the-money warrants to marketing channels
or strategic partners may further dilute our shareholders, increase our
operating loss in the future and cause our stock price to fall. The service
agreement of 1999 was replaced by a new agreement, effective February 1, 2002
having a one year duration, but InfoSpace had the right to terminate the
agreement at any time upon thirty (30) days written notice. InfoSpace also had
the right to terminate the agreement if there were 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 was to pay a quarterly fee of $7,500 for use of up
to 10,000 mailboxes. This agreement was assigned to MailCentro, Inc., the party
which assumed the servicing of
21
most of our consumer business, effective March 1, 2002. As of March 1, 2003,
Commtouch Inc. was no longer entitled to receive a portion of the revenues from
this agreement.
Results of Operations
The following table sets forth financial data for the years ended December 31,
2000, 2001 and 2002 (in thousands):
Year Ended December 31,
-------------------------------------
2000* 2001* 2002
--------- --------- ---------
Revenues:
Email services..................................................... $ 17,771 $ 13,318 $ 3,438
Software license revenues.......................................... 1,000 270 --
--------- --------- ---------
Total revenues..................................................... 18,771 13,588 3,438
--------- --------- ---------
Cost of revenues:
Email services..................................................... 11,800 13,962 1,675
Software license revenues.......................................... -- -- --
--------- --------- ---------
Total cost of revenues............................................. 11,800 13,962 1,675
--------- --------- ---------
Gross profit (loss)................................................ 6,971 (374) 1,763
--------- ---------- ---------
Operating expenses:
Research and development, net...................................... 10,244 5,884 2,246
Sales and marketing................................................ 26,534 12,894 1,176
General and administrative......................................... 13,455 10,337 2,588
Amortization of prepaid marketing expenses......................... 4,508 -- --
Amortization of stock-based employee deferred compensation......... 3,050 2,204 551
Write-off of property and equipment and other...................... -- 10,166 750
--------- --------- ---------
Total operating expenses........................................... 57,791 41,485 7,311
--------- --------- ---------
Operating loss...................................................... (50,820) (41,859) (5,548)
Interest and other income, net..................................... 2,886 583 (60)
Equity in losses of affiliate...................................... -- -- (56)
Write-off impaired long-term investments........................... (5,000) (2,000) --
Minority interest.................................................. 55 285 74
--------- --------- ---------
Loss from continuing operations..................................... (52,879) (42,991) (5,590)
Gain on disposal of Wingra.......................................... -- -- 1,014
Discontinued Operations - Wingra.................................... (1,346) (18,016) (335)
----------- ------------ ------------
Income (Loss) from sale of discontinued operations.................. (1,346) (18,016) 679
----------- ------------ -----------
Net loss............................................................ $ (54,225) $ (61,007) $ (4,911)
========= ========= =========
* - Reclassified to conform to the current years classification mainly due to
divestiture of Wingra.
Comparison of Years Ended December 31, 2002 and 2001
Revenues. Email service revenues decreased 74% from $13.3 million in 2001 to
$3.4 million in 2002. We recognized revenue of $0.3 million, from the sale of
licenses in 2001 and none in 2002. In 2002 we had two customers whose revenue
exceeded 10%, representing 57% of the 2002 revenues. No customer accounted for
more than 10% of revenues in 2001.
Cost of Revenues. Cost of revenues decreased 88% from $14.0 million in 2001 to
$1.7 million in 2002.We have decreased our hosting infrastructure costs due to
the agreement with MailCentro and sale of the Hosted Exchange business.
Research and Development, Net. Research and development expenses decreased 62%
from $5.9 million in 2001to $2.2 million in 2002 due to the decrease in
personnel and other related costs. In 2002 and 2001, we received royalty-bearing
grants totaling $0.2 and $0.6 million, respectively, 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
22
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.
Sales and Marketing. Sales and marketing expenses decreased 91% from $12.9
million in 2001 to $1.2 million 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 75%
from $10.3 million in 2001 to $2.6 million in 2002, due primarily to curtailment
of costs.
Amortization of Stock-Based Employee Deferred Compensation. Our stock-based
employee deferred compensation expenses decreased 75% from $2.2 million for 2001
to $0.6 million for 2002. 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 $0.2 million and $0.3 million in
2002 and 2001, respectively, relating 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. In 2002,
the company had written off $0.8 million regarding unused property and
equipment. In 2001, 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. The impairment charges of the goodwill
and other intangible assets were classified to discontinued operation due to the
divestiture of Wingra.
Interest and Other Income, Net. Our interest and other income, net, decreased
from a net income of $.6 million for 2001 to a net loss of $0.1 million for
2002, due primarily to decreased interest income earned from cash equivalents,
as the funds depleted in 2002.
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
valuations of these privately funded Internet centric companies, the Company
believes that these investments are fully impaired. Accordingly, the Company
recorded a charge of $2.0 million in 2001 to reflect impairment of these assets.
Minority Interest. At December 31, 2001 and 2002, the Company owned 70.6% and
32%, respectively, of the equity and voting rights of Commtouch, K.K. (Japan).
Income Taxes. As of December 31, 2002, we had approximately $28.0 million of
Israeli net operating loss carry-forwards and $73.6 million of U.S. federal net
operating loss carry-forwards available to offset future taxable income. The
Israeli net operating loss carry-forwards have no expiration date. The U.S. net
operating loss carry-forwards will expire in various amounts in the years 2008
to 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.
Comparison of Years Ended December 31, 2001 and 2000 -
23
Revenues. Email service revenues decreased 25% from $17.8 million in 2000 to
$13.3 million in 2001. We recognized revenue of $0.3 million and $1.0 million,
from the sale of licenses in 2001 and 2000, respectively. In 2001 and 2000, no
customer accounted for more than 10% of revenues.
Cost of Revenues. Cost of revenues increased 18% from $11.8 million in 2000 to
$14.0 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.
Research and Development, Net. Research and development expenses decreased 43%
from $10.2 million in 2000 to $5.9 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.
Sales and Marketing. Sales and marketing expenses decreased 51% from $26.5
million in 2000 to $12.9 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.
General and Administrative. General and administrative expenses decreased 24%
from $13.5 million in 2000 to $10.3 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. During
2001, 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 $0.6 million for
2001, due primarily to decreased interest income earned from cash equivalents
and marketable securities, as the funds depleted in 2001.
24
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 5.83%. 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 $22.6 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. 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.
Quarterly Results of Operations (Unaudited)
The following table sets forth certain unaudited quarterly statements of
operations data for the eight quarters ended December 31, 2002. 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,
2001* 2001* 2001* 2001* 2002 2002 2002 2002
-------- -------- -------- ------- ------- ------- ------- -------
(in thousands)
(unaudited)
Email service revenues ............. $ 3,658 $ 3,838 $ 3,495 $ 2,597 $ 1,271 $ 1,005 $ 525 $ 637
Cost of email service revenues ..... 4,656 3,573 3,553 2,180 933 406 153 183
-------- -------- -------- ------- ------- ------- ------- -------
Gross profit (loss) ................ (998) 265 (58) 417 338 599 372 454
-------- -------- -------- ------- ------- ------- ------- -------
Operating expenses:
Research and development, net ..... 2,587 2,166 1,078 53 573 530 621 522
Sales and marketing ............... 6,346 2,683 2,447 1,418 521 244 221 190
General and administrative ........ 5,504 2,639 1,958 236 766 421 379 1,022
Amortization of stock-based
employee compensation ............. 481 481 694 548 138 138 138 137
Write-off of property and equipment
and other .......................... -- -- 6,485 3,681 -- -- -- 750
-------- -------- -------- ------- ------- ------- ------- -------
Total operating expenses .......... 14,918 7,969 12,662 5,936 1,998 1,333 1,359 2,621
-------- -------- -------- ------- ------- ------- ------- -------
Operating loss ..................... (15,916) (7,704) (12,720) (5,519) (1,660) (734) (987) (2,167)
Interest and other income
(expenses), net ................... 344 492 89 (342) 44 (20) (48) (36)
Write-off of impaired long-term
investments ...................... -- -- (2,000) -- -- -- -- --
Eequity interesting losses of
affiliate........................... -- -- -- -- -- 18 (47) (27)
Minority interest .................. 22 21 137 105 63 11 -- --
-------- -------- -------- ------- ------- ------- ------- -------
Loss from continuing operations .... (15,550) (7,191) (14,494) (5,756) (1,553) (725) (1,082) (2,230)
-------- -------- -------- ------- ------- ------- ------- -------
Gain on disposal of Wingra ......... -- -- -- -- 1,014 -- -- --
Discontinued operations - Wingra ... (1,581) (1,335) (13,352) (1,748) (335) -- -- --
-------- -------- -------- ------- ------- ------- ------- -------
Income (Loss) from sale of
discontinued operations ............ (672) (444) (385) (441) 679 -- -- --
-------- -------- -------- ------- ------- ------- ------- -------
Net loss ........................... $(17,131) $ (8,526) $(27,846) $(7,504) $ (874) $ (725) $(1,082) $(2,230)
======== ======== ======== ======= ======= ======= ======= =======
25
* - Reclassified to conform to the current quarters classification mainly due to
divestiture of Wingra.
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, email usage and the spread of spam
email;
o demand for anti-spam 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 anti-spam 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 solutions 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 spam practices 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.
Liquidity and Capital Resources
We have financed our operations principally from the issuance of equity
securities and, to a lesser extent from private loans, bank loans and research
and development grants from the Israeli government.
As of December 31, 2002 and March 31, 2003 respectively, we had approximately
$1.4million and approximately $1.1 million of cash to fund operations in 2003.
In 2002 we utilized $2.8 million of cash to fund operating losses. Net cash
26
provided by financing activities and investing activities were approximately
$1.3 million and $ 0.6 million, respectively, mainly due to proceeds from
issuance of shares and proceeds from sale of property and equipment,
respectively. To limit our cash expenses in 2003 we have further reduced staff
from 35 at March 1, 2002 to 32 on June 9, 2003. These actions were possible due
to the transition of our business from outsourced email services to anti-spam
solutions. Furthermore, we have reduced our office lease commitments both in
Israel and the United States, resulting in both a lowering of actual rental
expenditures and future obligations.
Convertible Loan
See discussion under "Item 3. Key Information - Recent Developments -
Convertible Loan Agreement.
As of December 31, 2002 and March 31, 2003, we had working capital of $0.5
million and $0.1 million, respectively.
Based on the cash balance at December 31, 2002, current projections of revenues,
related expenses, and the completion of the convertible loan transaction, the
Company believes it has sufficient cash to continue operations for at least the
next twelve months through December 31, 2003.
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 financial statements.
These lawsuits were consolidated into one action in late 2001. Thereafter, the
Company filed a Motion to Dismiss, which was granted. The plaintiffs then filed
a second amended and consolidated complaint, and our second motion to dismiss
was only partially accepted, with the end result being that the plaintiff's
filed a third amended and consolidated complaint. We (including the individual
defendants) filed an answer to that complaint, and the case then moved into the
discovery stage, with the case being set for trial in January 2004. In May 2003,
a settlement agreement was signed between the plaintiffs and defendants and the
court thereafter issued a preliminary order approving the settlement. The
settlement calls for the payment of $15 million to the plaintiffs, with this
amount to be fully funded by the Company's Directors and Officers policy. While
the payment to plaintiffs under this settlement should not cause the Company any
financial hardship, we are unable to predict whether the whole or a substantial
portion of the class members will choose to participate in the settlement and
whether ultimately the court will issue a final order approving the settlement.
The settlement does not contain any admissions or findings of wrongdoing on the
part of the defendants, and we continue to maintain that the Company and
individual defendants acted properly at all times.
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.
See item 10 for tax reform
27
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.
The annual rate of inflation in Israel was 6.5% in 2002, 1.4% in 2001 and 0% in
2000. The NIS was devalued against the U.S. dollar by approximately 7.3% in
2002, 9.3% in 2001 and -2.7% in 2000. The representative dollar exchange rate
for converting the NIS to U.S. dollars, as reported by the Bank of Israel, was
NIS 4.737 for one U.S. dollar on December 31, 2002. Note that the representative
dollar exchange rate was NIS _4.474 at May 14, 2003.
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
The following table sets forth certain information regarding our directors at
February 7, 2003:
Beneficial
Ownership
Name Age >1%(3) Position
---- --- ------------ --------
Amir Lev.................... 43 3.3% Director
Carolyn Chin................ 55 1.2% Chairman of the
Board of Directors
Gideon Mantel(1)............ 43 7.9% Director
Nahum Sharfman(1)........... 55 6.1% Director
Richard Sorkin.............. 41 -- Director
Udi Netzer (2).............. 47 -- Director
Ofer Segev(1)(2)............ 43 -- Director
----------------
(1) Member of the Compensation Committee
(2) Member of the Audit Committee and Outside Director
(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 February 7, 2003. 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. Warrants and options that were underwater as of February 7,
2003 were included in the calculation of beneficial ownership.
Other Management Employees:
The following table sets forth the names and positions of our management
employees at February 7, 2003:
Name Age Ownership >1% Position
---- --- --------
Gideon Mantel 43 See table above CEO
Amir Lev 43 See table above President and Chief Technical Officer
Devyani Patel...... 42 ___ Vice President, Finance
Avner Amram........ 41 ___ Executive Vice President, Commtouch Inc.
Gary Davis......... 41 ___ General Counsel and Corporate Secretary
Udi Trugman........ 32 ___ Vice President, Research and Development, Commtouch
___ Software Ltd.
Ronni Zehavi....... 37 ___ Vice President, Operations, Commtouch Software Ltd.
Haggai Carmon...... 44 ___ Vice President, Marketing, Commtouch Software Ltd.
28
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 was also the
General Manager of Commtouch from January 1997 through April 2000, 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.
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
has been CEO of Teleknowledge since January 2002 and its CFO from May 2001. From
May 2000 to April 2001 served as CFO for Tundo. Prior to his position at Tundo,
Segev spent 15 years with Ernst & Young. Segev 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 joined Commtouch in 1996 and currently serves as Executive Vice
President. Mr. Amram has over 15 years of experience in the areas of technology,
operational management and leadership, and is also a founder of CVDO. Before
2002, Mr. Amram served as COO of Commtouch and was responsible for worldwide
operations. Mr. Amram also held a number of positions at Commtouch prior to
being appointed COO. From 1995 to 1996, Mr. Amram served
29
as project manager for Medatech, a leading provider of customer relationship
management (CRM) solutions, developing and managing complex installations at
large organizations. Prior to Medatech, Mr. Amram acted as General Manager of
Fuga Nursery in Israel, where he was responsible for operations, production,
marketing and distribution. Mr. Amram holds a Bachelors of Science (BSC), in
Computer Engineering and graduated Cum Laude from the Technion, Israel Institute
of Technology.
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.
Gary Davis joined Commtouch in September 1999 and serves as General Counsel and
Corporate Secretary. Mr. Davis has over 17 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.
Ronni Zehavi joined Commtouch in June 1999 and serves as Vice President of
Operations. Prior to joining Commtouch, Mr. Zehavi was Human Resources and
Training Manager for "Mondex - ecach", a subsidiary company of International
Mastercard from 1997 to 1999. From 1994 to 1997, Mr. Zehavi was an
Organizational Consultant in a counseling firm. Mr. Zehavi received his M.A.
degree in Organizational Sociology from Bar-Ilan University and his B.A. degree
in History and Educational Psychology from Tel-Aviv University.
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
30
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
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
31
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 2002.
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
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
32
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
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 entered into an undertaking to indemnify the directors
of the Company in connection with the shareholder-instigated class action
lawsuit, subject to certain limitations, and this undertaking was ratified by
shareholders. Further, at the annual meeting of shareholders held on November
18, 2002, the shareholders approved a form of indemnification, exculpation and
insurance agreement that is applicable to all directors serving the Company.
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. 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 (7 persons) in 2002 was approximately $0.5million. During the
same period Commtouch accrued or set aside approximately $23,000 for the same
group to provide pension, retirement or similar benefits. As of December 31,
2002, directors and executive officers of Commtouch (7 persons) held stock
options to purchase an aggregate of 2,217,580 ordinary shares. In addition, at a
meeting of the Board of Directors on April 28, 2003 option grant allocations
totaling 975,000 options to certain executive officers, approved previously by
the shareholders on November 18, 2002, were approved for grant, subject to the
attainment of certain milestones. The grant date will be as of the date of
shareholder approval.
Options to Purchase Securities from Registrant or Subsidiaries.
As of December 31, 2002, 4,597,687 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 4,041,474 had not been exercised and had exercise prices ranging
from $0.01 to $35 per share and a weighted average per share exercise price of
$0.18, and were held by 24 persons; these options have termination
33
dates ranging from February 2006 to December 2012. At December 31, 2002, the
persons named in Item 6 as a group (7 persons - executive officers and directors
only) held vested options to acquire 1,144,189 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, 2002, 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 22,219,696ordinary shares outstanding as of December 31,
2002. Ordinary shares issuable upon exercise of options and other rights held
and exercisable on or within sixty days of February 7, 2003 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 2,032,057 8.7%(1)
Gideon Mantel 1,815,803 7.94%(2)
OZF Ltd. 1,643,834 7.2%(3)
Nahum Sharfman 1,369,787 6.05%(4)
All directors and officers as a group (7 persons) 4,356,578 16.4%(5)
(1) The above percentage includes warrants and options which are underwater as
of February 7, 2003: 4.86% of class
(2) The above percentage includes warrants and options which are underwater as
of February 7, 2003: 1.84% of class
(3) The above percentage includes warrants and options which are underwater as
of February 7, 2003: 2.70% of class
(4) The above percentage includes warrants and options which are underwater as
of February 7, 2003: 1.76% of class
(5) The above percentage includes warrants and options which are underwater as
of February 7, 2003: 5.16% of class
Interest of Management in Certain Transactions.
Private Placement of February 2002
34
In February 27, 2002, Commtouch entered into a private placement agreement with
a few of its founders (Gideon Mantel, Nahum Sharfman and Amir Lev) and new
investors, whereby Commtouch issued approximately 4.4 million ordinary shares
against the investment of approximately $1.3 Million in a private placement;
approximately one-third of the shares were purchased by Commtouch's founders,
who are also currently Commtouch directors and/or executive officers. The
purchasers in the private placement also received five-year warrants to purchase
up to an additional 2.66 million ordinary shares (approximately). The exercise
price for one-third of the warrants is $0.37 per share, the exercise price for
an additional one-third of the warrants is $1.00 per share and the exercise
price for the final one-third of the warrants is be $2.00 per share. This
agreement was approved by the shareholders on April 8, 2002. The Company has
used the proceeds of this placement for general corporate working capital. The
funds were received on April 15, 2002.
Relationship with 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 were sharing under other similar
agreements. The service agreement of 1999 was replaced by a new agreement,
effective February 1, 2002 having a one year duration, but InfoSpace had the
right to terminate the agreement at any time upon thirty (30) days written
notice. InfoSpace also had the right to terminate the agreement if there were
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 was to pay a
quarterly fee of $7,500 for use of up to 10,000 mailboxes. This agreement was
assigned to MailCentro, Inc., the party which assumed the servicing of most of
our consumer business, effective March 1, 2002. As of March 1, 2003, Commtouch
Inc. was no longer entitled to receive a portion of the revenues from this
agreement.
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 (July 16, 2004).
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.
Option Exercises and Purchases of Shares By Certain Officers
35
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 December
31, 2002 is $341,272.
Item 8. Financial Information.
See Item 18: Financial Statements
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 then in effect under Israeli law. 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.
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
2002:
First Quarter ........................ $ 0.42 $ 0.23
Second Quarter ....................... $ 0.25 $ 0.11
Third Quarter ........................ $ 0.15 $ 0.08
Fourth Quarter ....................... $ 0.06 $ 0.22
Most Recent Six Months:
November 2002 ......................... $ 0.22 $ 0.09
December 2002 ......................... 0.21 0.11
January 2003 .......................... 0.16 0.14
February 2003 ......................... 0.15 0.13
March 2003 ............................ 0.14 0.10
April 2003 ............................ 0.41 0.12
36
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 Restated and Amended Articles of Association,
copies of which have been filed as exhibits to this and our prior Annual Reports
on Form 20-F, as amended (subject to further amendment of our Articles of
Association from time to time).
As of December 31, 2002, our authorized share capital consisted of 40,000,000
ordinary shares, NIS 0.05 par value. As of December 31, 2002, there were
22,219,696 ordinary 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
37
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.
38
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
to expiration of options of terminating employees). Upon effectiveness of the
merger, these warrants and options became immediately exercisable.
39
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 2002 investment round warrants under Item
19, Note 13 to the Notes to Consolidated Financial Statements - Shareholders'
Equity is incorporated herein by reference.
CONVERTIBLE LOAN WARRANTS
The discussion regarding the January 2003 convertible loan warrants under Item
19, Note 13 to the Notes to Consolidated Financial Statements - Shareholders'
Equity is incorporated herein by reference.
AXCESSNET WARRANT
The discussion regarding the AxcessNet warrant under Item 19, Note 13 to the
Notes to Consolidated Financial Statements - Shareholders' Equity is
incorporated herein by reference.
AGRON WARRANT
The discussion regarding the Agron 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.
40
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 as follows:
a. 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;
b. 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 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;
c. to investors under the private placement of February 27, 2002, whereby
Commtouch issued approximately 4.4 million ordinary shares against the
investment of approximately $1.3 million. The investors in the private
placement also received five-year warrants to purchase up to an
additional 2.66 million ordinary shares (approximately). The shares
issued under this private placement, including shares to be issued upon
the exercise of the warrants, were registered on May 28, 2002;
d. to lenders under the convertible loan agreement of January 29, 2003, as
amended, whereby a maximum possible loan amount of $1,250,000 will be
provided to the Company. The Company has received the total loan amount
of $1,250,000 from the lenders. The loan principal and interest may be
converted by the lenders into equity in the Company at any time during
the loan term, at a conversion price of $.25 per Ordinary Share
("Conversion Price"). Also, warrants exercisable for purchase of up to
5,000,000 of the Company's ordinary shares have been issued to the
lenders covering the stated loan amount, based on such loan amount
divided by the Conversion Price. Warrants shall also be issued on an
annual basis for any accumulated interest on the loan. Registration
rights have been granted to the lenders in connection with the
conversion rights and warrants described above, covering a total of
13,310,000 shares. Demand registration rights (exercisable by the
"Lender Majority", as defined in the agreement) shall be in effect
until three (3) months following the third anniversary of the last
applicable warrant issuance date. No demand served on the Company shall
be effective until at least the Lender Majority has effected a
conversion of the loan into equity; and
e. piggy-back registration rights were included in all warrants detailed
above in this Item 10.
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 IN 2002.
Consulting and Fundraising Agreements
On September 1, 2002, Commtouch entered into two agreements with AxcessNet Ltd.,
one for the providing of consulting services to Commtouch ("agreement 1") and
the other for the facilitating of fundraising and strategic commercial
transactions ("agreement 2"). Under agreement 1, AxcessNet is to receive a
payment of $200,000, comprised of cash of $140,000 and warrants valued at
$60,000. Under agreement 2, as amended on December 1, 2002,
41
AxcessNet is entitled to receive 5% of proceeds received by Commtouch from
fundraising activities (and in the case of a business combination, a minimum fee
of $100,000), as well as from commercial transactions entered into by Commtouch
through the efforts of AxcessNet. The compensation to be paid under agreement 2
is payable in either cash or warrants, at AxcessNet's discretion, but if the
warrants are to exceed 250,000, Commtouch has the right to pay any excess in
cash. Furthermore, in the event that Commtouch is acquired by a third party, any
continuing payment obligations of Commtouch to AxcessNet under agreement 2 at
the time of such acquisition may be fully liquidated by a payment of the lesser
of twenty four months worth of payments or the number of months remaining under
Commtouch's obligations to AxcessNet. During their relationship under agreement
1 and agreement 2, Commtouch and AxcessNet have been working together closely in
furtherance of the Company's business, and are in constant communications with
one another. AxcessNet is also a lender under the convertible loan agreement
entered into in early 2003. See "Item 3. Key Information - Recent Developments -
Convertible Loan Transaction."
Private Placement of February 2002
See "Item 7. Major Shareholders and Related Party Transactions - Private
Placement of February 2002".
Lease Termination Agreement between Young Woo & Assoc., LLC and Commtouch Inc.
and Commtouch Software Ltd. (as guarantor) dated September 6, 2002
Pursuant to the agreement with Young Woo, Commtouch and Young Woo agreed to
terminate the New York facilities lease agreement. Within the framework of this
agreement Commtouch made certain payments to Young Woo and transferred ownership
to certain furniture, and Young Woo released Commtouch from the remainder
(approximately two years) of the lease term under the original agreement and the
related guarantee.
Surrender Agreement between Omni South Beach, L.P. and Commtouch Latin America
Inc. dated August 31, 2002
Pursuant to the agreement with Omni, Commtouch and Omni agreed to terminate the
Miami facilities lease agreement. Within the framework of this agreement
Commtouch made certain payments to Omni, terminated a sublease agreement with a
third party sublessee of Commtouch and transferred ownership to certain
furniture to Omni, and Omni released Commtouch from the remainder (approximately
five years) of the lease term under the original agreement.
Amended and Restated 1999 Non-Employee Directors Stock Option Plan
The allotment of shares under the original 1999 Non-Employee Directors Stock
Option Plan 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, an
allotment in 2001 bringing the plan's total to 750,000 ordinary shares and two
allotments during 2002 totaling 700,000 ordinary shares bringing the plan's
total to 1,450,000. 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, 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 and
those directors in office immediately after the annual meeting of shareholders
on November 18, 2002 were granted a one-time option grant of 50,000 ordinary
shares. Also, in addition to the grant of shares for her reelection as a
director in August 2001, Carolyn Chin, in recognition of her activities as
Chairman of the Board, 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
42
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.
See the discussion under Item 4 "Information on the Company - Description of
Property" for an indication of where the Company's Amended and Restated Articles
of Association may be inspected. In addition, the Articles are attached as an
exhibit to this Form 20-F.
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.
Tax Reform
On January 1, 2003 a comprehensive tax reform took effect in Israel. Pursuant to
the reform, resident companies are subject to Israeli tax on income accrued or
derived in Israel or abroad. In addition, the concept of controlled foreign
corporation was introduced according to which an Israeli company may become
subject to Israeli taxes on certain income of a non-Israeli subsidiary if the
subsidiaries primary source of income is passive income (such as interest,
dividends, royalties, rental income or capital gains). The tax reform also
substantially changed the system of taxation of capital gains.
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.
43
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
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
44
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
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,
45
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.
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, 2002, the Company had
recorded grants from OCS aggregating approximately $_1.4_ 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 2002, related to the 2002 grants, since we had
46
not started generating revenue for the product developed with such grants, but
we may have obligations for royalties in 2003 and future years.
With regard to grants before 2002, the Company claims that all of these
programs, which were funded at a total of $1.2 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 projects from 2001 and prior
years. This application was accepted by the OCS in August 2002. Accordingly, the
Company has determined that as of December 31, 2002 there are no contingent
liabilities for royalties under 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.
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
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.
47
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
15%). 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 this Item 10 "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.
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 under this Item 10 "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 28% 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
48
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-2003
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-2002 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
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 15% 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)
49
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
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 extensive restrictions on transactions in foreign
currency. These restrictions were largely lifted in May 1998, and since January
1, 2003, all exchange control restrictions have been removed, although there are
still reporting requirements for foreign currency transactions. However,
legislation remains in effect pursuant to which currency controls can be imposed
by administrative action at any time. Nonresidents of Israel who purchase our
ordinary shares are able to repatriate in non-Israeli currency both dividends
(after deduction of withholding tax) and the proceeds from the sale of the
shares.
50
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.
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. Controls and Procedures
(a) Under the supervision and with the participation of our management,
including our principal executive officer and principal financial officer, we
conducted an evaluation of the effectiveness of our disclosure controls and
procedures, as such term is defined under Rule 13a-14(c) promulgated under the
Exchange Act, within 90 days of the filing date of this report. Based on their
evaluation, our principal executive officer and principal financial officer
concluded that the Company's disclosure controls and procedures are effective.
(b) There have been no significant changes (including corrective actions with
regard to significant deficiencies or material weaknesses) in our internal
controls or in other factors that could significantly affect these controls
subsequent to the date of the evaluation referenced in paragraph (a) above,
including any corrective actions with regard to significant deficiencies and
material weaknesses.
51
Item 16. Reserved
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, 2002 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.
52
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, 2001 and
2002, 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, 2002. Our audits also included the financial statement
schedule listed in the Index at item 18(b). These financial statements and
schedule are the responsibility of the Company's management. Our responsibility
is to express an opinion on these financial statements and schedule 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, 2001 and 2002,
and the consolidated results of their operations and cash flows for each of the
three years in the period ended December 31, 2002, in conformity with accounting
principles generally accepted in the United States. Also, in our opinion, the
related financial statement schedule, 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
March 7, 2003
KOST, FORER & GABBAY
A Member of Ernst & Young Global
F-1
COMMTOUCH SOFTWARE LTD.
CONSOLIDATED BALANCE SHEETS
(USD in thousands, except share and per share data)
December 31,
----------------------
2001 2002
--------- ---------
Assets
Current Assets:
Cash and cash equivalents...................................................... $ 2,248 $ 1,388
Trade receivables, net......................................................... 864 64
Prepaid expenses and other accounts receivable................................. 700 231
--------- ---------
Total current assets........................................................... 3,812 1,683
--------- ---------
Long-term lease deposits....................................................... 261 5
Severance pay fund............................................................. 320 264
Property and equipment, net.................................................... 5,152 1,029
Equity investment.............................................................. -- 3
--------- ---------
$ 9,545 $ 2,984
--------- ---------
Liabilities and Shareholders' Equity
Current Liabilities:
Bank credit line and current maturities of bank loans and capital leases $ 799 $ ---
Accounts payable............................................................... 1,374 338
Employees and payroll accruals................................................. 633 424
Deferred revenues.............................................................. 839 --
Accrued expenses and other liabilities......................................... 774 372
--------- ---------
Total current liabilities...................................................... 4,419 1,134
--------- ---------
Long-term bank loans and capital leases........................................ 260 --
Other liabilities.............................................................. 255 135
Accrued severance pay.......................................................... 425 278
--------- ---------
940 413
--------- ---------
Minority interest.............................................................. 127 ---
--------- ---------
Commitments and Contingencies
Shareholders' Equity
Ordinary Shares, nominal value NIS 0.05 par value-
Authorized: 40,000,000 shares as of
December 31, 2001 and 2002; Issued and
outstanding: 17,496,819 and 22,219,696 shares
as of December 31, 2001 and 2002, respectively................................. 239 290
Additional paid-in capital..................................................... 152,162 153,460
Deferred stock compensation.................................................... (828) (277)
Notes receivable from shareholders............................................. (754) (365)
Accumulated deficit............................................................ (146,760) (151,671)
--------- ---------
Total shareholders' equity..................................................... 4,059 1,437
--------- ---------
$ 9,545 $ 2,984
========= =========
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 share and per share data)
Year ended
December 31,
----------------------------------
2000* 2001* 2002
----------- ---------- ---------
Revenues:
Email services.......................................................... $ 17,771 $ 13,318 $ 3,238
Software licenses....................................................... 1,000 270 200
--------- -------- --------
Total revenues.......................................................... 18,771 13,588 3,438
--------- -------- --------
Cost of revenues:
Email services.......................................................... 11,800 13,962 1,675
Software licenses....................................................... -- -- --
--------- -------- --------
Total cost of revenues.................................................. 11,800 13,962 1,675
--------- -------- --------
Gross profit (loss)........................................................ 6,971 (374) 1,763
--------- --------- --------
Operating expenses:
Research and development, net........................................... 10,244 5,884 2,246
Sales and marketing..................................................... 26,534 12,894 1,176
General and administrative.............................................. 13,455 10,337 2,588
Amortization of the prepaid marketing expenses.......................... 4,508 -- --
Amortization of stock-based employee deferred compensation (1) 3,050 2,204 551
Write-off of property and equipment and other........................... -- 10,166 750
--------- --------- ---------
Total operating expenses................................................ 57,791 41,485 7,311
--------- --------- ---------
Operating loss............................................................. (50,820) (41,859) (5,548)
Interest and other income (expense), net................................ 2,886 583 (60)
Equity in losses of affiliate .......................................... -- -- (56)
Write-off of impaired long-term investments............................. (5,000) (2,000) --
Minority interest....................................................... 55 285 74
--------- -------- --------
Loss from continuing operations............................................ (52,879) (42,991) (5,590)
---------- --------- ---------
Discontinued operations
Gain from disposal of Wingra............................................ -- -- 1,014
Discontinued operations - Wingra........................................ (1,346) (18,016) (335)
--------- -------- --------
Income (Loss) from discontinued operations................................. (1,346) (18,016) 679
--------- -------- --------
Net loss................................................................... $ (54,225) $(61,007) $ (4,911)
========= ======== ========
Basic and diluted net loss per share
Loss from continuing operations......................................... $ (3.42) $ (2.51) $ (0.27)
Income (Loss) from discontinued operations.............................. (0.09) $ (1.05) $ 0.03
--------- -------- --------
Net loss................................................................... $ (3.51) $ (3.56) $ (0.24)
========= ======== ========
Weighted average number of shares used in computing
basic and diluted net loss per share.................................... 15,462 17,152 20,854
========= ======== ========
Year ended
December 31,
----------------------------------
2000 2001 2002
---------- --------- ---------
(1) Stock-based Employee Compensation Relates to the following:
Cost of revenues........................................................ $ 102 $ 82 $ 20
Research and development, net........................................... 284 226 56
Sales and marketing..................................................... 795 554 139
General and administrative.............................................. 1,869 1,342 336
--------- -------- --------
Total................................................................... $ 3,050 $ 2,204 $ 551
========= ======== ========
* - Reclassified to conform to the current years classification mainly due to
divestiture of Wingra. The accompanying notes are an integral part of these
consolidated financial statements.
F-3
COMMTOUCH SOFTWARE LTD.
STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
(USD in thousands, except share and per share data)
Ordinary shares Additional
---------------------- paid-in
Shares Amount capital
------------ ------ --------
Balance as of January 1, 2000 15,199,344 213 133,403
Issuance of shares upon exercise of 440,384 6 1,701
options........................................
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 -- -- 1,090
Japan-Note 2i..................................
Issuance of shares and vested options
and warrants 1,285,294 17 14,800
in consideration of the acquisition
of Wingra......................................
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 256,008 1 116
options........................................
Stock based compensation
related to warrants -- -- 53
granted to a service provider..................
Amortization of deferred stock -- -- --
compensation...................................
Deferred stock based 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
Issuance of shares, net.......................... 4,434,932 48 1,295
Issuance of shares upon exercise of 287,945 3 3
options........................................
Amortization of deferred
stock based compensation......................... -- -- --
Repayment of notes receivable.................... -- -- --
Valuation allowance for notes receivable......... -- -- --
Net loss......................................... -- -- --
------------ ----- --------
Balance as of December 31, 2002..................... 22,219,696 $ 290 $153,460
============ ===== ========
F-4
Stock-based Notes Accumulated
employee receivable other
deferred from comprehensive Accumulated
compensation shareholders income deficit Total
------------ ------------ ------ ------- -----
Balance as of January 1, 2000 ....................... (5,779) (1,060) 63 (31,528) 95,312
Issuance of shares upon exercise of options ...... -- -- -- -- 1,707
Amortization of deferred stock based 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 ............ -- -- -- -- 14,817
of Wingra
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 based 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
Issuance of shares, net .......................... -- -- -- -- 1,343
Issuance of shares upon exercise of options ...... -- -- -- -- 6
Amortization of deferred stock based compensation 551 -- -- -- 551
Repayment of notes receivable .................... -- 4 -- -- 4
Valuation allowance for notes receivable ......... -- 385 -- -- 385
Net loss ......................................... -- -- -- (4,911) (4,911)
------- ------- ---- --------- --------
Balance as of December 31, 2002 ..................... $ (277) $ (365) $-- $(151,671) $ 1,437
======= ======= ==== ========= ========
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,
-----------------------------
2000* 2001* 2002
-------- -------- -------
Cash flows from operating activities:
Net loss .................................................................. $(54,225) $(61,007) $(4,911)
Less loss for the period from discontinued operations .................. 1,346 18,016 335
Adjustments to reconcile net loss to net cash used in Operating activities:
Depreciation and amortization ......................................... 5,891 7,432 1,988
Amortization of stock-based employee deferred compensation and warrants
issued for services received and bank line of credit ................ 3,050 2,204 551
Amortization of prepaid marketing expenses ............................ 4,508 -- --
Write-off of impaired long-term investments ........................... 5,000 2,000 --
Write-off of property, equipment and other ............................ -- 10,166 750
Loss from sale of property and equipment .............................. -- 751 247
Gain from sale of discontinued operations ............................. -- -- (1,014)
Loss from sale of shares in consolidated subsidiary ................... -- -- 153
Share of equity interest .............................................. -- -- (56)
Valuation allowance of notes receivable ............................... -- -- 385
Changes in assets and liabilities:
Trade receivables, net ................................................ (1,541) 3,712 114
Prepaid expenses and other accounts receivable ........................ (1,931) 2,932 379
Accounts payable ...................................................... 2,118 (3,052) (981)
Employee and payroll accruals, accrued expenses and other liabilities . 4,109 (5,164) (496)
Deferred revenues ..................................................... 612 (739) (445)
Accrued severance pay, net ............................................ (64) 216 (91)
Forgiveness of notes receivable ....................................... -- 143 --
Minority interest in losses of a consolidated subsidiary .............. (55) (285) (74)
Other ................................................................. (99) (1,969) 366
-------- -------- -------
Net cash used in operating activities ........................................ (31,281) (24,644) (2,800)
-------- -------- -------
Cash flows from investing activities:
Proceeds from sales of marketable securities .............................. 18,969 8,586 --
Purchases of marketable securities ........................................ (9,568) -- --
Purchase of long-term investments ......................................... (7,000) -- --
Long-term lease deposits .................................................. (163) 202 100
Proceeds from acquisition of Wingra ....................................... 305 -- --
Sale of Wingra ............................................................ -- -- (193)
Sale of consolidated subsidiary ........................................... -- -- 1
Proceeds from sale of property and equipment .............................. 337 160 719
Purchase of property and equipment ........................................ (19,092) (3,265) --
-------- -------- -------
Net cash (used) provided in investing activities ............................. (16,212) 5,683 627
-------- -------- -------
Cash flows from financing activities:
Repayment of note receivable by shareholder ............................... 19 144 4
Repayment of bank loans and notes payable ................................. -- (946) (40)
Principal payment of capital lease ........................................ (619) (24) --
Proceeds from issuance of shares, net ..................................... 1,707 428 1,349
Proceeds from minority interest in consolidated subsidiary ................ 1,090 440 --
Contribution from minority interest of consolidated subsidiary ............ 131 336 --
-------- -------- -------
Net cash provided by financing activities .................................... 2,328 378 1,313
-------- -------- -------
Decrease in cash and cash equivalents ........................................ (45,165) (18,583) (860)
Cash and cash equivalents at the beginning of the year ....................... 65,996 20,831 2,248
-------- -------- -------
Cash and cash equivalents at the end of the year ............................. $ 20,831 $ 2,248 $ 1,388
======== ======== =======
* - Reclassified to conform to the current years classification mainly due to divestiture of Wingra.
F-6
Supplemental disclosure of cash flows activity: Cash paid during the year:
Interest................................................................ $ 31 $ 161 $ 3
Proceeds from acquisition of Wingra, for year ended December 31, 2000 were as
follows:
Tangible assets acquired $ 475
Liabilities assumed (3,054)
---------
Net liabilities assumed: (2,579)
Customer base 1,340
Workforce-in-place 550
Intellectual Property 1,660
In-process research & development expenses 1,280
Goodwill 12,590
---------
Intangibles acquired: 17,420
Cash acquired: 305
---------
Purchase price $ 15,146
The proceeds from the sale of Wingra, for year ended December 31, 2002 were as
follows:
Tangible assets sold $ 314
Liabilities transferred (1,521)
---------
Net liabilities transferred: (1,207)
Cash transferred: 193
---------
Gain from sale of Wingra $ (1,014)
The proceeds from the of shares in consolidated subsidiary (Commtouch K.K.
(Japan), now known as Imetrix), for year ended December 31, 2002 were as
follows:
Tangible assets $ 421
Liabilities (267)
---------
Net assets transferred: 154
Cash received: 1
---------
Loss from sale of consolidated subsidiary $ 153
The accompanying notes are an integral part of these consolidated financial
statements.
F-7
Commtouch Software Ltd.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share and per share data)
NOTE 1: GENERAL
a. Commtouch Software Ltd. ("Commtouch", "the Company") was incorporated under
the laws of Israel in 1991. Commtouch has five subsidiaries: Commtouch Inc.,
Commtouch (UK) Ltd, Commtouch Latin America Inc. (dissolved during 2002),
Wingra, Inc. ("Wingra") (sold during 2002) and Commtouch K.K. (Japan) (now known
as Imetrix) (majority owned during a portion of 2002, and in which Commtouch
currently holds a 32% interest). The Company and its subsidiaries develop and
provide email anti-spam solutions to enterprises. Until December 31, 2002, the
Company and its subsidiaries provided email and messaging solutions, to
customers ranging from service providers to large and small businesses, who
offered the Company's Web-based email through their website to their end users.
In 2002, the Company sold its migration service business and most of its hosted
email services and, while it initially changed its focus to providing email and
messaging solutions to service providers (see Note 1b below), it subsequently
ceased promoting its email and messaging solutions and began concentrating
solely on developing its anti-spam solutions.
In consideration of the sale of most of its hosted email services, the Company
received up front non-refundable license fee and is entitled to royalties from
the sales to its past customers. Royalties are paid according to the collection
from these customers.
During 2002, approximately 57% of the revenues were derived from two customers
(39% from customer A and 18% from customer B). During 2001 and 2000, no single
customer accounted for more than 10% of the revenues.
b. Discontinued operations
In November 2000, the Company acquired Wingra Technologies Inc. ("Wingra"), a
provider of messaging integration and migration solutions for large enterprises
(see also Note 3).
In February 2002, the Company sold off its migration service business, Wingra,
to Wingra's senior management. The results of operations of Wingra have been
eliminated from the consolidated results of operations of Commtouch as a result
of the disposal transaction.
The proceeds from the sale of Wingra, for year ended December 31, 2002 were as
follows:
Tangible assets: $ 314
Liabilities transferred (1,521)
--------
Net liabilities transferred: (1,207)
Cash transferred: 193
--------
Gain from sale of Wingra $ 1,014
The results of operations including revenue, operating expenses and other income
and expense of Wingra for 2000, 2001 and 2002 have been reclassified in the
accompanying statements of operations as discontinued operations.
Obligations to employees for severance and other benefits resulting from the
discontinuation have been reflected in the financial statements on an accrual
basis.
Summary operating results from the discontinued operation for the years ended
December 31, 2000, 2001 and 2002 are as follows:
F-8
Commtouch Software Ltd.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share and per share data)
Year Ended December 31,
---------------------------------------------------
2000 2001 2002
----------------- ---------------- ---------------
Revenues $ 344 $ 1,730 $ 157
Cost of revenues 64 643 76
----------------- ---------------- ---------------
Gross profit 280 1,087 81
Operating expenses 261 3,029 416
Amortization and impairment
of goodwill and other
intangible assets 85 16,074 --
In-process research
and development 1,280 -- --
----------------- ---------------- ---------------
Operating loss $ (1,346) $ (18,016) $ (335)
================= ================ ===============
NOTE 2: SIGNIFICANT ACCOUNTING POLICIES
The consolidated financial statements have been prepared in accordance with
accounting principles generally accepted in the United States ("U.S. GAAP").
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:
A majority of the revenues of the Company and its subsidiaries is made in United
States dollars ("dollars"). In addition, a substantial portion of their costs is
incurred or determined in dollars. The Company's management believes that the
dollar is the primary currency of the economic environment in which the Company
and each of its subsidiaries operate. Thus the dollar is their functional and
reporting currency. Accordingly, monetary accounts maintained in currencies
other than the dollar are remeasured into U.S. dollars, in accordance with
Statement of Financial Accounting Standard No. 52 "Foreign Currency Translation"
("SFAS No. 52"). All transaction gains and losses of the remeasured monetary
balance sheet items are reflected in the statements of operations as financial
income or expenses, 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 and Cash Equivalents:
The Company considers all highly liquid investments originally purchased with
maturities of three months or less to be cash equivalents.
e. 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 and its subsidiary's long-lived assets are reviewed for impairment
in accordance with Statement of Financial Accounting Standard No.144 "Accounting
for the Impairment or Disposal of Long-Lived Assets" ("SFAS No.144") whenever
events or changes in circumstances indicate that the carrying amount of an asset
may not be recoverable. Recoverability of assets to be held and used is measured
by a comparison of the carrying amount of an asset to the future undiscounted
cash flows expected to be generated by the assets. If such assets are considered
to be impaired, the impairment to be recognized is measured by the amount by
which the carrying amount of the assets exceeds the fair value of the assets.
Assets to be disposed of are reported at the lower of the carrying amount or
fair
F-9
Commtouch Software Ltd.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share and per share data)
value less costs to sell. For the year ended December 31, 2002 the Company had
impairment losses totaling $ 750, which were recorded as operating expenses.
During 2001, due to the economic slowdown, the reduction of the employee
headcount and the transfer into new facilities, the Company 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". According to the evaluation the
Company decided to record impairment losses totaling $10,166, which were
recorded as operating expenses.
f. Long-Term Investments:
Long-term investments are recorded at lower of cost or estimated fair value
according to Accounting Principle Board Opinion No. 18 "The Equity Method of
Accounting for Investments in Common Stocks", 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. Measurements of an impairment loss for long-term investments
that management expects to hold are based on the fair value of the investment.
The Company invested $7,000 in the first nine months of 2000 in three Internet
centric companies in which the Company believed it had a significant ongoing
strategic interest.
Due to the economic slowdown and the significant decline in capital available to
and in valuations of its investment in 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 $5,000 and $2,000, respectively, to
write-down the recorded investment values.
g. Goodwill and Other Purchased Intangible Assets:
Goodwill represents excess of the costs over the net assets of businesses
acquired. Goodwill arose from acquisition prior July 1, 2001 was amortized until
December 31, 2001 on a straight-line basis over 5 years. Under Statement of
Financial Accounting Standard No. 142, "Goodwill and Other Intangible Assets"
("SFAS No.142") goodwill acquired in a business combination for which date is on
or after July 1, 2001, shall not be amortized.
Intangible assets included workforce-in-place, intellectual property and
customer base subject to amortization arose from acquisition prior July 1, 2001,
are being amortized on a straight-line basis over their useful lives, which are
three, four and three years, respectively in accordance with APB Opinion No. 17
"Intangible Assets" ("APB 17").
The carrying value of goodwill and other purchased intangible assets were
periodically reviewed by management, based on the expected future undiscounted
operating cash flows over the remaining goodwill amortization period in
accordance with APB No. 17.
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 $13,280, to
write-down the recorded values to zero.
h. Minority Interest:
Minority interest represents a shareholders' proportionate share of the equity
of Commtouch, K.K. (Japan). At December 31, 2001 and 2002, the Company owned
70.6% and 32%, respectively, of the equity and voting rights of Commtouch, K.K.
(Japan) (now known as Imetrix).
F-10
Commtouch Software Ltd.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share and per share data)
During 2001, the Company's strategic partner in Japan, CSK, invested
approximately $800 in Commtouch, K.K. (Japan). 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. In April 2002, as part of
the Company's focus change, the Japanese subsidiary's employees purchased 38% of
Commtouch, K.K. (Japan) shares from the Company for approximately $1 (the par
value of the shares). Consequently the Company's holdings decreased from 70% to
approximately 32%. The sale of the shares resulted in a loss of $153 that was
recorded as part of the equity in losses of an affiliate.
i. 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,
2000, 2001 and 2002, the Company has charged all software development costs to
research and development expense in the period incurred.
j. Revenue Recognition:
During 2002, the Company derives its revenues from providing hosted email
services, royalties for the sale of its hosted Email services and from software
license agreements.
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 occurred, persuasive evidence of an agreement exists, the
vendor's fee is fixed and determinable and collectibility 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.
The Company accounts for software license revenue in accordance with Statement
of Position 97-2, "Software Revenue Recognition", as amended ("SOP 97-2"). 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 multiple elements 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, the fee is
fixed and determinable and collectibility is probable.
Royalties for the sale of the hosted email services are recognized when
persuasive evidence of an arrangement exists, services are provided, no
significant obligation with regard to the implementation remain, the fee is
fixed and determinable and collectibility is probable.
k. Concentrations of Credit Risk:
F-11
Commtouch Software Ltd.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share and per share data)
SFAS No. 105, "Disclosure of Information About Financial Instruments with
off-Balance-Sheet Risk and Financial Instruments with Concentration of Credit
Risk" requires disclosure of any significant off-balance-sheet and credit risk
concentrations. The Company and its subsidiaries have no significant
off-balance-sheet concentration of credit risk such as foreign exchange
contracts, option contracts or other foreign hedging arrangements.
Financial instruments that potentially subject the Company to concentrations of
credit risk consist principally of trade receivables and cash and cash
equivalents. The majority of the Company's cash and cash equivalents are
invested in dollar and dollars linked investments and are deposited in major
banks in United States and Israel. 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 trade receivables of the Company are derived from transactions with
companies located primarily in North America, Europe, Israel and the Far East.
An allowance for doubtful accounts is determined with respect to those amounts
that the Company and its subsidiaries have determined to be doubtful of
collection. The allowance for doubtful accounts is composed of specific debts
that are doubtful of collection amounting to $582 and $41 at December 31, 2001
and 2002, respectively. Bad debt expense (recovery) for the years-ended December
31, 2000, 2001 and 2002 were $2,000, $260 and $(40), respectively.
l. 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 FASB Interpretation
No. 44 "Accounting for Certain Transactions Involving Stock Compensation," ("FIN
44") 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.
In December 2002, the FASB issued SFAS 148, "Accounting for Stock Based
Compensation Transition and Disclosure" - an amendment of FASB Statement No. 123
("SFAS 148"). SFAS 148 permits two additional transition methods for entities
that adopt the fair value based method of accounting for stock-based employee
compensation. The statement also requires new disclosures about the ramp-up
effect of stock-based employee compensation on reported results. The Statement
also requires that those effects be disclosed more prominently by specifying the
form, content, and location of those disclosures. The transition guidance and
annual disclosure provisions of SFAS 148 are effective for fiscal years ending
after December 15, 2002, with earlier application permitted in certain
circumstances. The interim disclosure provisions are effective for financial
reports containing financial statements for interim periods beginning after
December 15, 2002. As at the balance sheet date, the Company continues to apply
APB 25 (See also Note 13f).
Pro forma information under SFAS 123 is as follows:
2000 2001 2002
--------- --------- ---------
Net loss as reported............................. $ (54,225) $ (61,007) $ (4,911)
========= ========= =========
Pro forma net loss............................... $ (68,309) $ (65,734) $ (8,627)
========= ========= =========
Pro forma basic and diluted net loss per share... $ (4.42) $ (3.83) $ (0.41)
========= ========= =========
The Company applies SFAS 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" ("EITF 96-18") with respect to
options issued to non-employees. SFAS 123 requires use of an option valuation
model to measure the fair value of these options at the grant date. In
accounting for warrants granted to those other than employees, the Company
applied the provisions of SFAS No. 123, and EITF 96-18. The fair value of these
warrants was estimated at the grant date, using the Black-Scholes option-pricing
model.
m. 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, $600 and $200 in 2000, 2001 and 2002, respectively.
F-12
Commtouch Software Ltd.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share and per share data)
n. 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 dilative potential
ordinary shares considered outstanding during the year.
All outstanding stock options and warrants have been excluded from the
calculation of the diluted loss per share because all such securities are
anti-dilative for all periods presented. The total number of shares related to
outstanding options and warrants excluded from the calculations of diluted net
loss per share were 4,096,455, 4,990,673 and 8,525,460 for 2000, 2001 and 2002,
respectively.
o. Severance Pay:
The Company's liability for severance pay in Israel 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 Israeli employees is
fully provided by monthly deposits with severance pay fund's insurance policies
and by an accrual. The value of those funds and policies are recorded as an
asset in the Company's balance sheet.
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 2000, 2001 and 2002 were approximately $483, $754 and $
58, respectively.
p. 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.
q. 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.
r. Recently Issued Accounting Pronouncements:
In June 2002, The FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities" ("SFAS No. 146"). This statement addresses
financial accounting and reporting for costs associated with exit or disposal
activities and nullifies EITF Issue No. 94-3, "Liability Recognition for Certain
Employee Termination Benefits and Other Costs to Exit an Activity (including
Certain Costs Incurred in a Restructuring)" ("EITF 94-3"). SFAS No. 146 requires
that a liability for a cost associated with an exit or disposal activity be
recognized when the liability is incurred. EITF 94-3 allowed for an exit cost
liability to be recognized at the date of an entity's commitment to an exit
plan. SFAS No. 146 also requires that liabilities recorded in connection with
exit plans be initially measured at fair value. SFAS No. 146 will be effective
for exit or disposal activities that are initiated after December 27, 2002.
F-13
Commtouch Software Ltd.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share and per share data)
In November 2002, the EITF issued No. 00-21, "Accounting for Revenue
Arrangements with Multiple Deliverables." EITF No. 00-21 addresses certain
aspects of the accounting by a vendor for arrangements under which it will
perform multiple revenue-generating activities. EITF No. 00-21 establishes three
principles: revenue should be recognized separately for separate units of
accounting, revenue for a separate unit of accounting should be recognized only
when the arrangement consideration is reliably measurable and the earnings
process is substantially complete, and consideration should be allocated among
the separate units of accounting in an arrangement based on their relative fair
values. EITF No. 00-21 is effective for all revenue arrangements entered into in
fiscal periods beginning after June 15, 2003, with early adoption permitted.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities" ("FIN 46"). The objective of FIN 46 is to improve
financial reporting by companies involved with variable interest entities. A
variable interest entity is a corporation, partnership, trust, or any other
legal structure used for business purposes that either (a) does not have equity
investors with voting rights or (b) has equity investors that do not provide
sufficient financial resources for the entity to support its activities. FIN 46
requires a variable interest entity to be consolidated by a company if that
company is subject to a majority of the risk of loss from the variable interest
entity's activities or entitled to receive a majority of the entity's residual
returns or both. FIN 46 also requires disclosures about variable interest
entities that the company is not required to consolidate but in which it has a
significant variable interest. The consolidation requirements of FIN 46 apply
immediately to variable interest entities created after January 31, 2003. The
consolidation requirements apply to older entities in the first fiscal year or
interim period beginning after June 15, 2003. Certain of the disclosure
requirements apply in all financial statements issued after January 31, 2003,
regardless of when the variable interest entity was established.
The Company does not expect the adoption of the above mentioned pronouncements
to have a material impact, if any, on the Company's consolidated financial
statements.
Note 3: WINGRA:
a. Acquisition of Wingra Technologies Inc. ("Wingra")
On November 24, 2000, the Company entered into a definitive acquisition
agreement to acquire 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 $0.00625
to $0.00939 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 $15,146 (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:
Ordinary shares $11,970
Options and warrants 2,847
Acquisition expenses 329
-------
Purchase price $15,146
-------
The purchase price was allocated to the acquired assets and assumed liabilities
in the accompanying consolidated financial statements as follows:
F-14
Commtouch Software Ltd.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share and per share data)
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
========
The Company recorded a one-time charge of $1,280 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.
Pursuant to a review of the Company's goodwill and other purchased intangible
assets, the Company recorded during 2001 a non-cash charge of $13,280, to
write-down the recorded values to zero. Amortization expenses amounted to
approximately $85, $2,794 and zero for 2000, 2001 and 2002, respectively.
See Notes 2h and 2i for impairment charges during 2001.
b. Sale of Wingra - see Note 1b.
The results of operations of Wingra have been reclassified in the statements of
operations as discontinued operations, See Note 1a.
NOTE 4: PREPAID EXPENSES AND OTHER ACCOUNTS RECEIVABLES
December 31,
-------------
2001 2002
---- ----
Prepaid Expenses....................................... $ 374 $ 138
Other accounts receivable.............................. 326 93
----- -----
Prepaid expenses and other accounts receivables........ $ 700 $ 231
===== =====
F-15
Commtouch Software Ltd.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share and per share data)
NOTE 5: PROPERTY AND EQUIPMENT, NET
December 31,
----------------
2001 2002
---- ----
Cost:
Computers and peripheral equipment.................... $ 7,314 $ 5,222
Office furniture and equipment........................ 1,168 477
Motor vehicles........................................ 88 88
Leasehold improvements................................ 1,217 694
------- -------
9,787 6,481
Less accumulated depreciation......................... (4,635) (5,452)
------- -------
Property and equipment, net........................... $ 5,152 $ 1,029
======= =======
Depreciation expenses amounted to approximately $5,846, $7,462 and $1,988 for
2000, 2001 and 2002, respectively.
See Note 2 e for impairment charges during 2001 and 2002.
NOTE 6: LONG TERM BANK LOANS AND CAPITAL LEASES
Weighted
Average
Interest December 31,
Rate 2001
---- ----
Promissory notes with shareholders-Wingra......... 9.74% $ 585
Promissory notes with financial institutions-Wingra 11.00% 126
Capital lease obligations-Wingra.................. 45
Royalties in connection with Wingra's product 218
--------
974
Less - current maturities......................... (714)
--------
Total Long-term debt.............................. $ 260
========
The long term bank loans and capital leases were transferred in the beginning of
2002 as part of Wingra sale (see Note 1b).
NOTE 7: COMMITMENTS AND CONTINGENCIES
a. Operating Leases:
The Company leases its facility in Israel under an operating lease agreement
expiring through 2003. 2003 minimum lease payments under this non-cancelable
lease are $300.
The Company leases its facility in the US under operating lease agreement
expiring through 2003. 2003 minimum lease payments under this non-cancelable
lease are $8.
Rent expenses for 2000, 2001 and 2002 were approximately $2,300, $2,800 and
$400, respectively. The above rent expense is net of sub-lease rental income
from various of the Company's unused premises totaling approximately $700 in
2002, $100 in 2001 and none in 2000.
b. Royalties:
From 1993 until 2000 the Company received funding from the OCS. In 2001, the
Company reversed the $400 accrual it recorded in past years and determined that
as of December 31, 2001 there are no contingent liabilities for royalties for
these projects. In March 2002, the Company received an approval for project
failure from the OCS, stating that there are no contingent liabilities for
royalties for these projects.
In 2002 and 2001, the Company received royalty bearing grants totaling $200 and
$600, respectively, from the Israeli government, which were recorded as a
reduction of research and development expenses. The Company is committed to pay
royalties of 3% to 5% to the Government of Israel on proceeds from sales of
products resulting from the research and development projects in which the
Government participated in financing such projects through the Office of the
Chief Scientist ("the OCS"), up to the amount equal to 100% of the grants
received by the Company, linked to the dollar
F-16
Commtouch Software Ltd.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share and per share data)
and bears interest at an annual rate of LIBOR. As of December 31, 2002 the
Company had a contingent liability to pay royalties of approximately $800.
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 a reserve
was recorded. As of December 31, 2001, the Company did not believe it had any
liability and thus the reserve was cancelled. During 2002, the Company received
a final assessment from the ITA, according to which the Company does not have
any withholding tax liability.
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 was
collateralized by certain assets of the Company. The provisions of the credit
agreement enable the Company to borrow up to $100 on a revolving line of credit
at annual interest rate of 14.25%. The amount outstanding at December 31, 2001
was approximately $100.
Due to the sale of Wingra in the beginning of 2002 there is no outstanding bank
line of credit as of December 31, 2002.
e. 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 was granted. The plaintiffs then filed
a second amended and consolidated complaint, and the Company's second motion to
dismiss was only partially accepted, with the end result being that the
plaintiff's filed a third amended and consolidated complaint. The Company
(including the individual defendants) filed an answer to that complaint, and the
case then moved into the discovery stage, with the case being set for trial in
January 2004 (See also Note 12 for subsequent events).
NOTE 8: 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)" (EITF 94-3), the Company recorded
restructuring and other non-recurring charges of approximately $11,166. The
restructure included curtailing expenses and reducing the number of employees.
As a part of the cost containment efforts, the Company 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 $800, which was deducted from the
relevant categories of operating expenses, and the Company also recorded
approximately $100 compensation expenses regarding the warrants issued (see Note
12b) and agreed to pay a letter of credit for approximately $1,000 it granted
its landlord.
As a result of strategic initiatives, approximately 118 positions were
eliminated in the Company during 2001.
F-17
Commtouch Software Ltd.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share and per share data)
The following table summarizes the restructuring accruals status as of December
31, 2001:
Utilized Balance at
Restructuring ---------------------------- December 31,
charge Cash Non-cash 2001
---------------- ------------ ------------- -------------------
Employee termination benefits $ 1,000 $ 575 $ -- $425
and related costs
Impairment of property and
equipment 9,191 -- 9,191 --
Written down due to settlement
agreement 975 -- 975 --
------- ------- ------- ----
$11,166 $ 575 $10,166 $425
======= ======= ======= ====
During 2002, the Company continued implementing strategic initiatives intended
to further reduce costs. In connection with the strategic initiatives, and in
accordance with SFAS 142 and EITF 94-3, the Company recorded restructuring and
other non-recurring charges of approximately $1,125. The restructure included
curtailing expenses and reducing the number of employees. As a result of
strategic initiatives, approximately 37 positions were eliminated in the Company
during 2002
The following table summarizes the restructuring accruals status as of December
31, 2002:
Utilized Balance at
Restructuring ---------------------------- December 31,
charge Cash Non-cash 2002
---------------- ------------ ------------- -------------------
Lease deposits and termination fees $ 128 $128 $-- $--
Impairment of property and
equipment 750 -- 750 --
Loss on sale of assets 247 -- 247 --
------ ---- ----- ----
$1,125 $128 $ 997 $--
====== ==== ===== ====
NOTE 9: 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"). The Company's first program was approved in 1995.
The Company's second and third programs (which were later cancelled) received a
letter of approval in April 1996 and in December 2000, respectively.
During 2001, the "Approved Enterprise" status for the 1996 investment program
was cancelled. During 2002, the "Approved Enterprise" status for the 2000
investment program was cancelled.
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%. As currently only a part of the Company's
capital investments are approved (a "Mixed Enterprise"), its effective corporate
tax rate (once it earns taxable income) will be the determined by the weighted
combination of the various applicable rates.
As of December 31, 2002, the tax benefits period for the outstanding valid
program has not yet commenced.
F-18
Commtouch Software Ltd.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share and per share data)
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.
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 Company's Board of Directors has determined that such tax-exempt income will
not be distributed as dividends.
Distribution of cash dividends from income that was not derived from "Approved
Enterprise" generally is subject to 25% withholding tax.
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.
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 2b, 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.
On January 1, 2003, a comprehensive tax reform took effect in Israel. Pursuant
to the reform, resident companies are subject to Israeli tax on income accrued
or derived in Israel or abroad. In addition, the concept of "controlled foreign
corporation" was introduced, according to which an Israeli company may become
subject to Israeli taxes on certain income of a non-Israeli subsidiary if the
subsidiary's primary source of income is passive income (such as interest,
dividends, royalties, rental income or capital gains). The tax reform also
substantially changed the system of taxation of capital gains.
As of December 31, 2002, Israeli net operating loss and capital losses
carry-forwards amounted to $44,000. Such net operating loss may be carried
forward indefinitely and offset against future taxable income. The Company
expects that during the period these tax losses are utilized its income would be
substantially tax exempted. Accordingly, there will be no tax benefit from such
losses and no deferred income taxes have been included in these financial
statements.
U.S. Income Tax:
Commtouch Inc. is taxed based upon tax laws in the U.S.
As of December 31, 2002, Commtouch Inc. had a U.S. federal net operating loss
carry-forward of approximately $73,600. The net operating loss expires in
various amounts between the years 2008 and 2023. 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:
F-19
Commtouch Software Ltd.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share and per share data)
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,
---------------
2001 2002
---- ----
Deferred tax assets are as follows:
U.S. operating loss carry-forwards..................... $ 25,020 $ 27,699
Reserves and allowances not currently deductible....... 2,565 496
-------- --------
Net deferred tax asset before valuation allowance...... 27,585 28,195
Valuation allowance.................................... (27,585) (28,195)
-------- --------
Net deferred tax asset................................. $ -- $ --
======== ========
As of December 31, 2002, the Company has provided a 100% valuation allowance
with respect to deferred tax assets resulting from tax loss carry-forwards.
Management currently believes that since the Company and Commtouch Inc. 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.
Pretax loss:
Pretax losses are as follows:
2000 2001 2002
-------- -------- --------
Israel.................. $ 23,209 $ 26,951 $ 4,320
U.S..................... 27,821 33,419 1,940
Other................... 3,195 637 (1,349)
-------- -------- --------
$ 54,225 $ 61,007 $ 4,911
======== ======== ========
NOTE 10: SHAREHOLDERS' EQUITY
The ordinary shares of the Company are traded on the NASDAQ National Market,
since July 1999.
Warrants to Private Placement Investors.
On February 27, 2002, Commtouch entered into a private placement agreement,
whereby Commtouch issued approximately 4.4 million ordinary shares against the
investment of approximately $1,343 in a private placement to private investors.
The purchasers in the private placement also received five-year warrants to
purchase up to an additional 2.66 million ordinary shares. The exercise price
for one-third of the warrants is $0.37 per share, the exercise price for an
additional one-third of the warrants is $1.00 per share and the exercise price
for the final one-third of the warrants is $2.00 per share. These warrants
expire on April 15, 2007.
As of December 31, 2002, Commtouch outstanding warrants issued to consultants,
were as follows:
Warrants for Exercise
Issuance Common price Warrants
Date shares per share exercisable Exercisable through
------------------------------ -------------- ----------------- ------------ ---------------------
July 1999 1,136,000 $ 12.80 1,136,000 July 2004
December 2001 175,000 $ 0.26 175,000 December 2006
January 2002 200,000 $ 0.29 200,000 January 2007
September 2002 206,897 $ 0.01 206,897 August 2007
October 2002 26,754 $ 0.01 26,754 October 2007
-------------- ------------
Total 1,744,651 1,744,651
============== ============
F-20
Commtouch Software Ltd.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share and per share data)
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, 2002, this warrant had not been exercised. At the grant date, the
fair value of this warrant was estimated as $5,800 and was amortized to
operating expenses over the minimum term of the contract (twelve months through
July 2000).
Warrants to service providers in connection with Settlement Agreements.
As part of 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 services providers. The
EOP fully vested warrant was issued in December 2001 and allows for purchase of
up to 175,000 ordinary shares at a price of $0.26, and 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. These warrants expire in December
2006 and January 2007, respectively.
The fair value for the EOP and Compaq warrants were 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 warrant of 5 years after the warrant
is vested. Accordingly, the Company recorded approximately $113 as compensation
expense and included the amount in operating expenses.
Warrants to AxcessNet Resources LLC.
As consideration for consulting services, on September 1, 2002 the Company
issued a fully vested warrant to AxcessNet Resources LLC for purchase of up to
206,897 of the Company's ordinary shares at a price of $0.01 per share. The
warrant expires on August 31, 2007.
The fair value for the 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 3.7%, 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 warrant of 5 years. The fair value of the warrant
was immaterial.
Warrants to service provider.
As consideration for consulting services, on October 1, 2002 the Company issued
a fully vested warrant to a service provider to purchase of up to 26,754 of the
Company's ordinary shares at a price of $0.01 per share. The warrant expires on
October 1, 2007.
The fair value for the 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 3.7%, 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 warrant of 5 years. The fair value of the warrant
was immaterial.
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
F-21
Commtouch Software Ltd.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share and per share data)
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
$1,060. 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.
During 2001, the Company had forgiven a promissory notes of $143 for one of its
employees and demanded the then current value of the shares ($7 relating to the
7,500 shares) and the full interest on the original note. Both interest and the
adjusted note were 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 25 and FASB Interpretation No. 44" and EITF 95-16
"Accounting for Stock Compensation Arrangements with Employer Loan Features
under APB Opinion No. 25". During 2001, a note for $137 was repaid by another
employee for 94,560 shares.
As of December 31, 2002, three notes remain outstanding. One pertains to a
current executive officer. As the Company and such officer have agreed that the
Company will withhold all of the officer's salary (since September 2002) as
security and/or payment on behalf of the relevant note, and the officer has made
a commitment to repay the note by the end of 2003, the Company believes that the
loan will be fully repaid during 2003. The Company continues to negotiate with
one former employee in connection with the employee's note, and believes that a
resolution will be reached that is agreeable to both parties. Regarding the last
outstanding note, while the Company has attempted to resolve the matter with an
ex-employee, it has been unsuccessful to date. As the Company has been unable to
collect the principal and interest amounts under the notes from the two former
employees, a doubt exists if such notes will be satisfied. Accordingly, the
Company recorded a valuation allowance on the full amounts of the notes in the
sum of $439, and recorded an expense in the statement of operations.
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 80,545, 136,782 and zero for the
years 2000, 2001 and 2002, 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 $300
as compensation expense in 2002 and 2001.
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
F-22
Commtouch Software Ltd.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share and per share data)
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 FIN 44 and
resulted in no effect.
f. Stock Options:
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).
The Company has reserved 6,406,100 ordinary shares for issuance under employee
stock option plans and agreements. As of December 31, 2002, an aggregate of
3,672,555 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. 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.
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
------------------------------------------ --------------------------------
2000 2001 2002 2000 2001 2002
---------- ----------- ----------- ------- ------- -------
Outstanding at beginning of period 1,383,110 2,650,455 2,915,689 $ 9.62 $ 19.91 $ 0.46
Granted....................... 2,046,520 3,009,388* 2,058,521 24.10 0.2 0.16
Exercised..................... (359,839) (119,268) (261,490) 2.66 0.39 0.02
Canceled...................... (419,336) (2,624,886) (1,979,175) 21.77 19.68 0.60
---------- ----------- ----------- ------- ------- -------
Outstanding at end of period... 2,650,455 2,915,689 2,733,545 $ 19.91 $ 0.46 $ 0.17
========== =========== =========== ======= ======= =======
Exercisable at end of period... 526,986 281,830 716,407 $ 8.61 $ 2.70 $ 0.21
========== =========== =========== ======= ======= =======
* - Includes 1,273,513 options repriced to par value during 2001.
The options outstanding as of December 31, 2002, have been separated into ranges
of exercise price, as follows:
Weighted
Options Average Weighted Options Weighted Average
Outstanding as of Remaining Average Exercisable as of Price of
December 31, Contractual Life Exercise December 31, Exercisable
Exercise Price 2002 (years) Price 2002 Options
-------------- ---- ------- ----- ---- -------
$0.01-$0.11 1,888,335 8.83 $ 0.04 584,550 $ 0.04
$0.28-$1.45 844,210 7.41 $ 0.37 131,232 $ 0.83
$35 1,000 7.48 $ 35 625 $ 35.00
--------- ---- ------- ------- -------
$ 0.01-$35 2,733,545 8.29 $ 0.17 716,407 $ 0.21
========= ==== ======= ======= =======
Weighted average fair values and weighted average exercise prices of options
whose exercise price is less or equals market price of the shares at date of
grant are as follows:
F-23
Commtouch Software Ltd.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share and per share data)
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,
---------------------------------------- --------------------------------
2000 2001 2002 2000 2001 2002
------------ ------------ ------------ ------------ ------------ --------
Weighted average exercise prices................ $ 24.10 $ 0.27 $ 0.16 $-- $ 0.01 $ 0.01
Weighted average fair values on date of grant... $ 20.20 $ 0.10 $ 0.16 $-- $ 0.44 $ 0.16
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 valuation model with the following weighted-average
assumptions for 2000, 2001 and 2002: risk-free interest rates of 5.5% for 2000,
4.0% for 2001, and 3.7% for 2002, dividend yields of 0%, volatility factors of
the expected market price of the Company's ordinary shares of 1.348 for 2000,
1.482 for 2001, and 1.416 for 2002 and an expected life of the option of 6
months after the option is vested for 2000, 2001 and 2002.
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.
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 or the
straight-line method over the vesting period of the options, generally four
years.
Deferred stock based compensation is as follows:
Balance as of January 1, 2002.............................. $ 828
Less amortization of deferred stock based compensation..... (551)
--------
Balance as of December 31, 2002............................ $ 277
========
g. Amended and Restated Non-Employee Directors Stock Option Plan:
The Company adopted the 1999 Non-Employee Directors Stock Option Plan. The
original allotment of shares in this plan was in the amount of 180,000 ordinary
shares. The Company, with shareholder approval, has amended this allotment over
the past few years as follows:
a. In 2000, an increase was approved bringing the plan's total allotment
to 500,000 shares;
b. In 2001, an increase was approved bringing the plan's total allotment
to 750,000 ordinary shares; and
c. In 2002, two increases were approved bringing the plan's total
allotment to 1,450,000.
Further, 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. This amount was increased
at a shareholders meeting in 2000, such that going forward, individuals first
joining the Board receive 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. However, this amount has been
increased over the past few years pursuant to shareholder approvals, such that:
a. Directors reelected at the August 22, 2001 annual meeting of
shareholders were entitled to a grant of 33,750;
F-24
Commtouch Software Ltd.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share and per share data)
b. 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; and
c. Directors in office immediately after the annual meeting of
shareholders on November 18, 2002 were granted a one-time option grant
of 50,000 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,
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 under subsequent grants 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 2002, the Company granted 1,000,000 options to non-employee directors at
a weighted average exercise price of $0.24 per share. As of December 31, 2002,
291,560 options were vested and 1,378,750 were outstanding under the Amended and
Restated 1999 Non-Employee Directors Stock Option Plan.
NOTE 11: 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:
Revenues
-----------------------------
2000 2001 2002
--------- -------- --------
Israel.................... $ 196 $ 451 $ 416
U.S.A..................... 10,703 5,806 1,207
Europe.................... 1,927 2,500 1,436
Japan..................... 1,295 656 356
Latin America............. 4,085 2,910 23
Other..................... 565 1,265 ---
------- -------- --------
$18,771 $ 13,588 $ 3,438
======= ======== ========
The Company's long-lived assets are as follows:
2001 2002
---- ----
Israel............. $ 2,953 $ 441
U.S.A.............. 1,773 588
Other.............. 426 ---
------- -------
$ 5,152 $ 1,029
======= =======
NOTE 12: SUBSEQUENT EVENTS (UNAUDITED)
a. Convertible Loan Transaction
On January 29, 2003 Commtouch entered into a Convertible Loan Agreement with
certain lenders according to which the Company is entitled to receive up to a
maximum possible loan (the "Loan") amount of $1,250.
F-25
Commtouch Software Ltd.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share and per share data)
Through June 2003 the Company has received the total Loan amount of $1,250 from
the lenders. The Loan is to be repaid after three years, unless converted into
Commtouch shares by the lenders or a defined event triggering early repayment is
met. The Loan bears interest at a rate of ten percent per annum and is to be
repaid together with the loan. Furthermore, the Loan's principal and interest
may be converted by the lenders into equity in the Company at any time during
the Loan term, at a conversion price of $0.25 per ordinary share ("Conversion
Price"). Warrants exercisable for purchase of up to 5,000,000 of the Company's
ordinary shares have been issued to the lenders (based on such Loan amounts
advanced divided by the Conversion Price). Each one-third of the warrants are
exercisable at prices per ordinary share of $0.25, $0.33 and $0.50 respectively,
and the warrants are exercisable at any time within five years of issuance.
Warrants shall also be issued on an annual basis for any accumulated interest on
the Loan.
b. Class action litigation
In May 2003, a settlement agreement was signed between the plaintiffs and
defendants and the court thereafter issued a preliminary order approving the
settlement. The settlement calls for the payment of $15,000 to the plaintiffs,
with this amount to be fully funded by the Company's Directors and Officers
insurance policy. While the payment to plaintiffs under this settlement should
not cause the Company any financial hardship, the Company is unable to predict
whether the whole or a substantial portion of the class members will choose to
participate in the settlement and whether ultimately the court will issue a
final order approving the settlement. The settlement does not contain any
admissions or findings of wrongdoing on the part of the defendants, and the
Company continues to maintain that it and individual defendants acted properly
at all time.
F-26
SIGNATURES
The registrant hereby certifies that it meets all of the requirements for filing
on Form 20-F and that it has duly caused and authorized the undersigned to sign
this annual report on its behalf.
COMMTOUCH SOFTWARE LTD.
By: /s/ Devyani Patel
---------------------------------------
Devyani Patel
V.P. Finance July 15, 2003
CERTIFICATIONS
I, Gideon Mantel, certify that:
1. I have reviewed this annual report on Form 20-F of Commtouch Software Ltd.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this annual report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this annual
report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the effectiveness of
the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal controls
which could adversely affect the registrant's ability to record, process,
summarize and report financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officer and I have indicated in this annual
report whether or not there were significant changes in internal controls or in
other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: July 15, 2003
/s/Gideon Mantel
----------------
Gideon Mantel
Chief Executive Officer
I, Devyani Patel, certify that:
1. I have reviewed this annual report on Form 20-F of Commtouch Software Ltd.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this annual report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this annual
report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the effectiveness of
the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal controls
which could adversely affect the registrant's ability to record, process,
summarize and report financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officer and I have indicated in this annual
report whether or not there were significant changes in internal controls or in
other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: July 15, 2003
/s/Devyani Patel
----------------
Devyani Patel
V.P. Finance
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, 2000:
Bad debt...................................... $ 405 $ 1,990 $(1,533) $ 862
======== ======== ======= ======
Year ended December 31, 2001:
Bad debt...................................... $ 862 $ 259 $ (551) $ 570
======== ======== ======= ======
Year ended December 31, 2002:
Bad debt...................................... $ 570 $ 40 $ (569) $ 41
======== ======== ======= ======
Item 19. Exhibits
Exhibit
Number Description of Document
------ -----------------------
1.1 Memorandum of Association of the Registrant.(1)
1.2 Amended and Restated Articles of Association of the Registrant,
as amended on May 15, 2003.
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 Reserved.
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 consolidated 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(31)
2.9 Text of Report on Form 6-K filed by the Registrant for the month
of April 2003 (21)
2.9.1 Convertible Loan Agreement dated January 29, 2003, inclusive of
Exhibits "A" through "D" thereto. (22)
2.9.2 Exhibit "F" to Convertible Loan Agreement dated January 29, 2003
- Form of Guaranty (23)
2.9.3 Exhibit "G" to Convertible Loan Agreement dated January 29,
2003- Form of U.S. Subsidiary Security Agreement (24)
2.9.4 Exhibit "H" to Convertible Loan Agreement dated January 29, 2003
- Form of Company Security Agreement (25)
2.9.5 Exhibit "I" to Convertible Loan Agreement dated January 29, 2003
- Form of Collateral Agency Agreement (26)
2.9.6 Exhibit "J" to Convertible Loan Agreement dated January 29,
2003- Form of Patent and Trademark Security Agreement (27)
2.9.7 Exhibit "K" to Convertible Loan Agreement dated January 29, 2003
- Opinion of Israeli Counsel to the Company (28)
2.9.8 Exhibit "L" to Convertible Loan Agreement dated January 29,
2003- Opinion of US Counsel to the Company (29)
2.9.9 Addendum 1 to Convertible Loan Agreement (30)
2.9.10 Addendum 2 to Convertible Loan Agreement
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 Section 3(i) Share Option Plan and form of
agreement thereunder.(1)
4.4 Form of Share Warrant for Go2Net, Inc. to purchase ordinary
shares of the Registrant.(3)
4.5 Form of Share Purchase Agreement by and among the Registrant,
Go2Net, Inc. and Vulcan Ventures Incorporated.(3)
4.5.1 Form of Registration Rights Agreement by and among the
Registrant, Go2Net, Inc. and Vulcan Ventures Incorporated.(3)
4.6 Commtouch Software Ltd. 1999 Section 3(I) Share Option Plan.(8)
4.7 Wingra Technologies, LLC 1998 Unit Option Plan (13)
4.8 Stock Purchase Agreement between Commtouch Software Ltd. and
Rideau Ltd., dated June 1, 2001 (12)
4.9 Form of Wingra Technologies, LLC Investor Option Agreement (14)
4.10 Form of Wingra Technologies, LLC Investor Warrant Agreement (15)
4.11 Stock Purchase Agreement between Commtouch Software Ltd. and
Hughes Holdings LLC dated June 5, 2001 (16)
4.12 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)
4.13 Conditional Lease Termination Agreement between EOP-Shoreline
Technology Park, L.L.C. and Commtouch Inc. dated December 21,
2001
4.14 Settlement between Compaq Financial Services Corporation and
Commtouch Inc. and Commtouch Software Ltd. dated December 21,
2001
4.15 Settlement and Termination of Services Agreement between Exodus
Communications, Inc. and Commtouch Inc. dated January 10, 2002
4.16 Amended and Restated 1996 CSI Stock Option Plans and form of
agreement thereunder (18)
4.17 Amended and Restated 1999 Section 3(i) Share Option Plan and
form of option agreement thereunder (19)
4.18 Amended and Restated 1999 Non-Employee Directors Stock Option
Plan
4.19 Agreement of Merger between CP Software Group Inc., Commtouch
Software Ltd, MailCentro, Inc. and CPSGNEWCO, Inc. dated
November 16, 2001
4.20 Business Unit Purchase Agreement by and between Telecomputing,
Inc. and Commtouch Inc. dated January 15, 2002
4.21 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
4.22 Lease Termination Agreement between Young Woo & Assoc., LLC and
Commtouch Inc. and Commtouch Software Ltd. (as guarantor) dated
September 6, 2002
4.23 Surrender Agreement between Omni South Beach, L.P. and Commtouch
Latin America Inc. dated August 31, 2002
4.24 Agreement of September 1, 2002 between AxcessNet Ltd. and
Commtouch Software Ltd. plus Warrant for purchase of
Registrant's ordinary shares
4.25 Agreement of September 1, 2002 between AxcessNet Ltd. and
Commtouch Software Ltd., plus Amendment 1 thereto
8 Subsidiaries of the Company (1. Commtouch Inc., a California
corporation, and 2. Commtouch (UK) Ltd. - in process of winding
up)
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)
12(a).1 Certification of Registrant's Chief Executive Officer Pursuant
to 18 U.S.C. Section 1350
12(a).2 Certification of Registrant's Chief Financial Officer Pursuant
to 18 U.S.C. Section 1350
----------
(1) Incorporated by reference to exhibits in Amendment No. 1 to
Registration Statement on Form F-1 of Commtouch Software Ltd., File No.
333-78531.
(2) Reserved.
(3) Incorporated by reference to exhibits in Amendment No. 5 to
Registration Statement on Form F-1 of Commtouch Software Ltd., File No.
333-78531.
(4) Incorporated by reference to 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 exhibits in Amendment No. 2 to
Registration Statement on Form F-1 of Commtouch Software Ltd., File No.
333-89773, filed March 28, 2000.
(6) Reserved.
(7) Reserved.
(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) Reserved.
(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) Reserved
(21) Incorporated by reference to Report on Form 6-K for the month of April
2003, filed April 2, 2003.
(22) Incorporated by reference to Exhibit 1 to Report on Form 6-K for the
month of April 2003, filed April 2, 2003.
(23) Incorporated by reference to Exhibit 2 to Report on Form 6-K for the
month of April 2003, filed April 2, 2003.
(24) Incorporated by reference to Exhibit 3 to Report on Form 6-K for the
month of April 2003, filed April 2, 2003.
(25) Incorporated by reference to Exhibit 4 to Report on Form 6-K for the
month of April 2003, filed April 2, 2003.
(26) Incorporated by reference to Exhibit 5 to Report on Form 6-K for the
month of April 2003, filed April 2, 2003.
(27) Incorporated by reference to Exhibit 6 to Report on Form 6-K for the
month of April 2003, filed April 2, 2003.
(28) Incorporated by reference to Exhibit 7 to Report on Form 6-K for the
month of April 2003, filed April 2, 2003.
(29) Incorporated by reference to Exhibit 8 to Report on Form 6-K for the
month of April 2003, filed April 2, 2003.
(30) Incorporated by reference to Exhibit 9 to Report on Form 6-K for the
month of April 2003, filed April 2, 2003.
(31) Incorporated by reference to Exhibit 2.8 to Annual Report on Form 20-F
for the year ended December 31, 2001.