As filed with the Securities and Exchange Commission on March , 2000
Registration No. 333-31836
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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
---------------
AMENDMENT NO. 3
TO
FORM F-1
REGISTRATION STATEMENT
Under
THE SECURITIES ACT OF 1933
COMMTOUCH SOFTWARE LTD.
(Exact name of Registrant as specified in its charter)
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Israel 7389 Not Applicable
(State or other jurisdiction of (Primary Standard Industrial (I.R.S. Employer
incorporation or organization) Classification Code Number) Identification No.)
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6 Hazoran Street
Poleg Industrial Park, P.O. Box 8511
Netanya 42504, Israel
011-972-9-863-6888
(Address, including zip code, and telephone number, including area code,
of Registrant's principal executive offices)
c/o Commtouch Software Inc.
James E. Collins, Chief Financial Officer
3945 Freedom Circle, Suite 400
Santa Clara, California 95054
(408) 653-4330
(Name, address, including zip code, and telephone number, including area code,
of agent for service of process)
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Copies to:
<S> <C> <C> <C>
Lior O. Nuchi Aaron M. Lampert David B. Miller Barry P. Levenfeld
Venrice R. Palmer Noga Devesceri Spira P. Graham van der Leeuw Sheryl Silver Ochayon
Irene Song Sharkansky Naschitz, Brandes & Co. Michael K. Coddington Yigal Arnon & Co.
McCutchen, Doyle, 5 Tuval Street Faegre & Benson LLP 22 Rivlin St.
Brown & Enersen, LLP Tel Aviv 67987 Israel 90 South Seventh Street P.O. Box 33777
3150 Porter Drive Minneapolis, MN 55402 Jerusalem, 91000 Israel
Palo Alto, CA 94304
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Approximate date of commencement of proposed sale to the public:
As soon as practicable after the Registration Statement becomes effective.
If any of the securities being registered on this Form are to be offered
on a delayed or continuous basis pursuant to Rule 415 under the Securities Act
of 1933, please check the following box. [ ]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following
box and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. [ ]
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
If this Form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [ ]
The Registrant hereby amends this Registration Statement on such date or
dates as may be necessary to delay its effective date until the Registrant
shall file a further amendment which specifically states that this Registration
Statement shall thereafter become effective in accordance with Section 8(a) of
the Securities Act of 1933 or until the Registration Statement shall become
effective on such date as the Commission, acting pursuant to said Section 8(a),
may determine.
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The information in this prospectus is not complete and may be changed. We may
not sell these securities until the Securities and Exchange Commission declares
our registration statement effective. This prospectus is not an offer to sell
these securities and is not soliciting an offer to buy these securities in any
state where the offer or sale is not permitted.
Subject to completion, dated March 8, 2000
3,000,000 Shares
COMMTOUCH SOFTWARE LTD.
Ordinary Shares Commtouch (R)
$ . per share
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o Commtouch Software Ltd. is offering o Our ordinary shares are currently
1,669,000 shares and selling traded on the Nasdaq National Market
shareholders are offering 1,331,000 under the symbol "CTCH." On March 7,
shares. 2000, the last reported sales price
of an ordinary share on the Nasdaq
National Market was $62.00 per share.
-------------------------------
This investment involves risk. See "Risk Factors" beginning on page 7.
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Per Share Total
----------- -------
Public offering price ................................. $ $
Underwriting discounts ................................ $ $
Proceeds to Commtouch ................................. $ $
Proceeds to selling shareholders ...................... $ $
================================================================================
The underwriters have a 30-day option to purchase up to 450,000 additional
ordinary shares from us to cover over-allotments, if any.
Neither the Securities and Exchange Commission nor any state securities
commission has approved of anyone's investment in these securities or
determined if this prospectus is truthful or complete. Any representation to
the contrary is a criminal offense.
The Israel Securities Authority has granted us an exemption from the obligation
to publish an Israeli prospectus relating to this offering. This exemption shall
not be construed as a determination that this prospectus is truthful or complete
or as an expression of opinion as to the securities offered.
U.S. Bancorp Piper Jaffray
Thomas Weisel Partners LLC
Warburg Dillon Read LLC
William Blair & Company
The date of this prospectus is March __, 2000.
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TABLE OF CONTENTS
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Page
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Summary ............................................................................. 4
Risk Factors ........................................................................ 7
Use of Proceeds ..................................................................... 18
Market Price and Price Range for Ordinary Shares .................................... 18
Dividend Policy ..................................................................... 19
Capitalization ...................................................................... 20
Dilution ............................................................................ 21
Selected Consolidated Financial Information ......................................... 22
Management's Discussion and Analysis of Financial Condition and Results of Operations 23
Business ............................................................................ 30
Management .......................................................................... 45
Certain Transactions ................................................................ 56
Principal and Selling Shareholders .................................................. 60
Description of Share Capital ........................................................ 62
Shares Eligible for Future Sale ..................................................... 66
U.S. Tax Considerations Regarding Ordinary Shares Acquired by U.S. Taxpayers ........ 68
Israeli Taxation and Investment Programs ............................................ 71
Conditions In Israel ................................................................ 76
Underwriting ........................................................................ 78
Legal Matters ....................................................................... 80
Experts ............................................................................. 80
ISA Exemption ....................................................................... 80
Where You Can Find More Information ................................................. 81
Enforceability of Civil Liabilities ................................................. 81
Index to Consolidated Financial Statements .......................................... F-1
</TABLE>
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You should rely only on the information contained in this prospectus. We have
not, and the underwriters have not, authorized any other person to provide you
with different information. This prospectus is not an offer to sell, nor is it
seeking an offer to buy, these securities in any state where the offer or sale
is not permitted. The information in this prospectus is complete and accurate
as of the date on the front cover, but the information may have changed since
that date.
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SUMMARY
The items in the following summary are described in more detail later in this
prospectus. This summary provides an overview of selected information and does
not contain all the information you should consider. Therefore, you should also
read the more detailed information set out in this prospectus, the financial
statements and the other information incorporated by reference into this
prospectus.
Unless otherwise indicated, all references in this prospectus to "Commtouch,"
"the Company," "we," "us" or "our" are to Commtouch Software Ltd. or its
wholly-owned subsidiaries, Commtouch Software, Inc. and Commtouch (UK) Ltd.
Except as set forth in the Consolidated Financial Statements and the Notes
thereto, or as otherwise indicated, all information in this prospectus assumes
the issuance of 901,471 ordinary shares upon the assumed net exercise at an
assumed share price of $62.00 per share of an in-the-money warrant to purchase
1,136,000 ordinary shares issued to Go2Net, Inc. at an exercise price of $12.80
per share.
Commtouch
We are a leading global provider of outsourced integrated Web-based email and
messaging solutions to businesses. Our solutions are flexible, highly
customizable and enable us to satisfy the unique email and messaging needs of
our customers worldwide. Our customers are large and small businesses who offer
our Web-based email through their websites to their end users and employees.
Email is one of the most widely used applications on the Internet and has
become a primary platform for business and personal communication. According to
Forrester Research, over 80% of Internet users access their email while online,
making this activity the most popular use of the Internet. International Data
Corporation estimates that at the end of 1999 there were over 180 million
emailboxes in the United States and over 130 million outside of the United
States. IDC projects that by the end of 2003, these numbers will increase to
over 280 million emailboxes in the United States and over 305 million
emailboxes outside the United States.
As of December 31, 1999, we had over 250 global customers. Through our
customers' sites we serve approximately 8.4 million active emailboxes. We also
serve over 1.0 million active emailboxes to small businesses and websites
through our ZapZone Network. Our comprehensive Web-based email and messaging
solutions offer the following benefits:
o Extensive email features. Our services are easy to use, and include a broad
set of email capabilities, including a highly integrated contact book and
calendar.
o Ability to support hundreds of millions of emailboxes. Our system architecture
and software platform have been designed to support hundreds of millions of
emailboxes across millions of domains while maintaining a highly reliable
service.
o Customization. Our customers use our proprietary customization tool to make
the look and feel of their Web-based email interface consistent with their own
brand image.
o Rapidly deployable and cost-effective solutions. Our solutions can be quickly
implemented and can save our customers the significant costs of developing and
maintaining an email service in-house.
o Extensive language capabilities. Our email services are available in 18
languages. Additionally, we can support more than one language on any of our
customers' websites.
o Increased website usage. We believe that our services increase the frequency
and duration of users' visits to our customers' websites.
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o Online marketing capabilities. Our customers and third parties selling goods
and services online can leverage our services and the demographic information
of our end users to conduct one-to-one direct marketing and targeted
advertising campaigns.
Office Location
Our principal executive offices are located at 6 Hazoran Street, Poleg
Industrial Park, Netanya 42504, Israel, where our telephone number is
011-972-9-863-6888, and 3945 Freedom Circle, Santa Clara, California 95054,
where our telephone number is (408) 653-4330. Our website addresses are
www.commtouch.com and www.zzn.com. The information contained on our websites is
not a part of this prospectus.
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The Offering
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Ordinary shares offered:
By Commtouch Software Ltd. .................. 1,669,000 shares
By selling shareholders ..................... 1,331,000 shares
---------
Total ................................. 3,000,000 shares
Ordinary shares outstanding after the offering 18,131,449 shares
Offering price ................................. $ per share
Use of proceeds ................................. Expansion of sales and marketing
activities; capital expenditures; expansion
of research and development activities;
expansion of international operations;
working capital and other general
corporate purposes. See "Use of
Proceeds." We will not receive any of the
proceeds from the sale of the shares by the
selling shareholders in this offering.
NASDAQ National Market Symbol .................. CTCH
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Except as set forth in the Consolidated Financial Statements and the Notes
thereto included as part of this prospectus and as otherwise specified, all
information in this prospectus (except for the information set forth above
regarding the ordinary shares offered and the ordinary shares to be outstanding
after the offering, which includes shares being offered by the Company in this
prospectus) is based on the number of shares outstanding as of February 29,
2000,and:
o assumes the issuance of 901,471 ordinary shares upon the assumed net
exercise at an assumed share price of $62.00 per share of the
in-the-money warrant to purchase 1,136,000 ordinary shares issued to
Go2Net, at an exercise price of $12.80 per share;
o with respect to financial information, is reported in U.S. dollars;
and does not include:
o 1,370,792 ordinary shares issuable to employees and consultants upon
exercise of outstanding options under our stock option plans and stock
option agreements as of February 29, 2000 at a weighted average exercise
price of $21.20 per share;
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5
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o 2,544,439 ordinary shares available for future grant or issuance under
our stock option and stock purchase plans as of February 29, 2000; and
o 381,180 ordinary shares issuable upon exercise of options granted to
executive officers and directors as of February 29, 2000 at a weighted
average exercise price of $20.41 per share.
Summary Consolidated Financial Data
(in thousands, except per share data)
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The following tables set forth our summary consolidated financial data. You
should read the following information together with our Consolidated Financial
Statements and the Notes thereto beginning on page F-1 of this prospectus, the
information under "Selected Consolidated Financial Information" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
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Year Ended December 31,
-------------------------------------
1997 1998 1999
-------- -------- ---------
(in thousands, except per share data)
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Consolidated Statement of Operations Data:
Revenues:
Email services .................................... $ -- $ 389 $ 4,251
Software licenses, maintenance and services ...... 899 -- --
-------- -------- ---------
Total revenues ................................. 899 389 4,251
Operating loss .................................... (3,405) (4,025) (21,083)
Net loss .......................................... (3,473) (4,351) (19,851)
Basic and diluted net loss per share ............... (2.40) (3.00) (2.65)
Weighted average number of shares -- basic
and diluted ....................................... 1,450 1,450 7,487
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The following data is presented:
o on an actual basis; and
o on a pro forma as adjusted basis to give effect to (1) the sale of
1,669,000 ordinary shares in this offering, at an assumed offering price
of $62.00 per share (after deducting estimated underwriting discounts and
commissions and estimated offering expenses) and (2) the issuance of
901,471 ordinary shares upon the assumed net exercise at an assumed share
price of $62.00 per share, of an in-the-money warrant held by Go2Net,
Inc. to purchase 1,136,000 ordinary shares an exercise price of $12.80
per share.
December 31, 1999
-----------------------
Pro Forma
Actual As Adjusted
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(in thousands)
Consolidated Balance Sheet Data:
Cash and cash equivalents ............................ $ 65,996 $162,912
Marketable securities ................................ 18,050 18,050
Working capital ...................................... 88,053 184,969
Total assets ......................................... 100,336 197,252
Long-term liabilities ................................ 497 497
Shareholders' equity ................................. 95,312 192,228
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6
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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
prospectus. 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.
This prospectus 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. You will find forward-looking statements under the
captions "Summary," "Risk Factors," "Use of Proceeds," "Management's Discussion
and Analysis of Financial Condition and Results of Operations" and "Business"
and elsewhere in this prospectus. 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 prospectus.
Risks Relating to the Company
Because we have a limited operating history as a Web-based email service
provider, it is difficult to evaluate our business and prospects.
We commenced operations in 1991, but we began commercially selling Web-based
email services only in 1998 after changing our strategic focus from the sale
and service of stand-alone email client software products for mainframe and
personal computers. This change required us to adjust our business processes
and to restructure Commtouch to become a Web-based email service provider.
Therefore, we have only a limited operating history as a provider of Web-based
email services upon which you can evaluate our business and prospects.
We have a history of losses and may never achieve profitability.
We incurred net losses of approximately $3.5 million in 1997, $4.4 million in
1998 and $19.9 million in 1999. As of December 31, 1999, we had an accumulated
deficit of approximately $31.5 million. We have not achieved profitability in
any period, and we expect to continue to incur net losses for the foreseeable
future.
We have invested heavily in technology and infrastructure development. We
expect to continue to spend substantial financial and other resources on
developing and introducing new service offerings and expanding our sales and
marketing organizations, strategic relationships and operating infrastructure.
We expect that our expenses will continue to increase in absolute dollars. If
our revenues do not correspondingly increase, our operating results and
financial condition will be negatively affected. We may never attain sufficient
revenues to achieve profitability. If we do achieve profitability, we may not
sustain or increase profitability in the future. This may, in turn, cause our
stock price to decline.
Our future email services revenues are unpredictable and our quarterly
operating results may fluctuate and fluctuations could adversely affect the
value of your investment.
Because we have a limited operating history in the provision of Web-based email
services 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 stock price.
A number of factors, many of which are enumerated in this "Risk Factors"
section, are likely to cause fluctuations in our operating results. Other
factors which may cause such fluctuations include:
o the size, timing and fulfillment of orders for our email services;
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o the receipt or payment of irregular or nonrecurring revenues or expenses;
o our mix of service offerings, including our ability to successfully
implement new services;
o pricing of our services; and
o effectiveness of our customer support.
Because of these factors, 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.
We have recently changed our fee structure and cannot predict the effect this
change will have on our future revenues.
In recent months we have moved from a pricing strategy based primarily on a
share of advertising revenues with a minimum annual service fee to one based
primarily on charging a per-emailbox fee with a minimum annual commitment fee.
While we believe that this new fee structure will result in a higher and more
predictable revenue stream compared with one based on a share of advertising
revenues, we cannot predict whether this new pricing strategy will in fact be
successful in generating higher and more predictable revenues. We may need to
change our pricing strategy again from time to time.
If the market for our Web-based email services does not grow rapidly, we will
fail to generate revenues.
Our success will depend on the widespread acceptance and use of Web-based email
by our customers as a means to increase the value of their services or as a
means of communication. The market for Web-based email services is new and
rapidly evolving. We cannot estimate the size or growth rate of the potential
market for our service offerings. If the market for Web-based email fails to
grow or grows more slowly than we currently anticipate, our business will
suffer dramatically. Even if that market grows, our service may not achieve
broad market acceptance. Since we have only recently introduced our services,
we do not have sufficient experience to evaluate whether they will achieve
broad market acceptance. Also, because all of our revenue is derived directly
or indirectly from our Web-based email solutions, if that market does not grow,
our business will likely fail.
If we do not expand our sales and marketing organization we will not be able to
increase our revenues.
Our ability to increase our revenues will depend on our ability to successfully
expand our sales and marketing organization. The complexity of our Internet
messaging services and the emerging nature of the Web-based email market
require highly trained sales and marketing personnel to educate prospective
customers regarding the use and benefits of our services. The majority of our
sales and marketing personnel have only recently joined Commtouch and have
limited experience working together. It will take time for these employees to
learn how to market our solutions and to be integrated into our sales and
marketing organization. Some of them may not succeed in making this transition.
Additionally, we are planning to introduce additional services that we have no
experience marketing and will rely on these services to produce a substantial
portion of our revenues in the future. As a result of these factors, our sales
and marketing organization may not be able to compete successfully against the
bigger and more experienced sales and marketing organizations of our
competitors.
Even if our email services are successful with our customers, we may not derive
revenue from the users of the emailboxes, which would prevent our business from
growing.
Even if our services are a success with our customers, we will not succeed if
we do not derive revenue from the email users that our customers give us access
to. We plan to derive revenue from these email users primarily by charging our
customers per-emailbox fees for our email services, as well as by selling
access to email users for direct marketing services and from the sale of
advertisements that the email users will see. If one or more of these revenue
sources is not successful, we will not succeed. To
8
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date, we have generated only limited revenue from these potential revenue
sources and they may not be successful. Our existing and potential customers
may not be willing to pay for our email services. Advertisers and direct
marketers may not accept email as a means of placing advertisements and
conducting direct marketing and email users may not want to receive direct
marketing materials.
Our ability to generate revenues from the emailbox base that our customers
bring to us also depends on the emailboxes being used on a regular basis. On an
ongoing basis, many of our end users will not regularly use their emailboxes,
and a significant number will cease using our services each month. Accordingly,
there may be no relationship between the number of active emailboxes and our
revenues.
We have a strategic relationship with Go2Net pursuant to which we issued a
warrant to Go2Net that diluted our shareholders, but we may not realize
substantial revenues or other business benefits from this or any similar
transaction.
We entered into a strategic relationship with Go2Net simultaneously with the
closing of our initial public offering. Our Customized Web-Based Email Service
Agreement with Go2Net provides that we share revenues from advertising and
premium services offered to Go2Net's end users through our email service. The
terms of this agreement are substantially the same as our commercial agreements
with other customers except that we have agreed that Go2Net will receive a
materially greater portion of advertising revenues than other customers receive
under other similar agreements. As part of this transaction, we issued to
Go2Net a warrant to purchase up to 1,136,000 ordinary shares at an exercise
price of $12.80 per share. This warrant is exercisable at any time until it
expires on July 16, 2004. We agreed to register these shares, the warrant and
the shares issuable upon exercise of the warrant with the Securities and
Exchange Commission and the registration statement relating to those securities
became effective on January 7, 2000. Exercise of the warrant will cause
existing investors significant dilution. However, we may not realize any
revenues or any other business benefits from this strategic relationship with
Go2Net because we and Go2Net may not be able to sell significant amounts of
advertising and premium Web-based email services to Go2Net's end users. In the
future, we may have to issue in-the-money warrants to acquire our ordinary
shares to customers who provide us with a large base of potential end users. We
may also have to provide these customers with more favorable commercial terms
than we have previously provided to our customers. The issuance of in-the-money
warrants and the grant of more favorable terms to customers may further dilute
our shareholders, increase our operating loss in the future and cause our stock
price to fall.
We entered into an email services agreement with Microsoft Corporation in
connection with which we issued a warrant to Microsoft that diluted our
shareholders, but we may not realize substantial revenues or other business
benefits from this transaction.
We entered into an Email Services Agreement dated October 26, 1999 with
Microsoft Corporation. Under this agreement, Commtouch will, at Microsoft's
option, customize, host and maintain email services for Microsoft websites in
the U.S. and internationally. Microsoft will pay one-time fees for the set-up
and customization of the email service for each website with respect to which
Microsoft chooses to use our services, as well as quarterly service fees for
the email service based on the number of mailboxes hosted. The term of the
agreement shall continue for 12 months after the first commercial distribution
date of the email service and Microsoft may extend the initial term on a
quarterly or annual basis upon 60 days prior written notice. The agreement may
be terminated by Microsoft for convenience upon 90 days' prior written notice,
or by either party upon a material breach by the other party upon the terms
specified in the agreement. In connection with the agreement, Commtouch issued
to Microsoft a warrant, exercisable until December 29, 1999, to purchase
707,965 of Commtouch's ordinary shares at an exercise price of $28.25 per share
for an aggregate exercise price of approximately $20.0 million. On December 29,
1999, Microsoft exercised the warrant and now holds 707,965 ordinary shares. We
agreed to register these shares with the Commission. The registration became
effective on January 7, 2000. However, we may not realize any revenues or any
other business benefits from this transaction because Microsoft is not
obligated to use our services with respect to any website and has not agreed to
provide us with any other business benefits.
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We depend on our customer relationships, which are based on relatively short
term, nonexclusive agreements, and the loss of one or more customers could harm
our business.
Our ability to increase revenues depends upon successful marketing of our
services through new and existing customers. Our agreements with our customers
generally can be terminated for any or for no reason after the first year. The
agreements with our customers are non-exclusive and do not restrict them from
introducing competing services. Also, some of our relationships allow
termination earlier than one year. Loss of one or a few key customers could
damage our reputation and hurt our ability to develop new relationships. If we
fail to develop new relationships or if our customers terminate or do not renew
their contracts with us, our business will suffer, as we will lose potential
revenue from the lost customers and from their underlying base of email users.
One customer, Excite, accounted for 54% of our revenues in 1998. Revenues from
MyPoints, a permission based email service company, represented 11% of our
revenues in 1999. Customers may provide us with a large number of users but pay
a relatively small minimum annual service fee.
We have many established competitors who are offering the same or similar
services and we will not be able to compete effectively against them if they
provide superior services at better prices.
The market for Web-based email services is intensely competitive and we expect
it to be increasingly competitive. Increased competition could result in
pricing pressures, reduced operating margins and loss of market share, any of
which could cause our business to suffer.
In the market for email and messaging services, we compete directly with
Web-based email service providers, including Critical Path, Mail.com and
USA.NET, as well as with companies that develop and maintain in-house email
solutions. In addition, companies such as Software.com currently offer email
software products to ISPs, web hosting companies, web portals and corporations.
Furthermore, numerous small-scale email providers offer low-cost basic
services, but without scalable systems or value-added functionality. These and
other companies could potentially leverage their existing capabilities and
relationships to enter the email service industry by redesigning their system
architecture, pricing and marketing strategies to sell through to the entire
market. The ability of these competitors to offer a broader suite of
complementary services may give them a considerable advantage over us. In the
future, ISPs, web hosting companies and outsourced application companies may
broaden their service offerings to include outsourced email.
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 service offerings, we may encounter
increased competition in the development and delivery of these services. Many
of our current and potential competitors have longer operating histories,
larger customer bases, greater brand recognition and greater financial,
marketing and other resources than we do and may enter into strategic or
commercial relationships on more favorable terms. Further, certain of our
competitors may offer services at or below cost. In addition, new technologies
and the expansion of existing technologies may increase competitive pressures
on us. We may not be able to compete successfully against current and future
competitors and increased competition may result in reduced operating margins
and loss of market share.
We are experiencing rapid internal growth which has and likely will strain our
management resources.
We recently began to expand our operations rapidly and intend to continue this
expansion. The number of our employees increased from 45 on December 31, 1998
to 214 on December 31, 1999. This expansion has placed, and is expected to
continue to place, a significant strain on our managerial, operational and
financial resources. To manage any further growth, we will also need to improve
or replace our existing operational, customer service and financial systems,
procedures and controls.
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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 decline.
Our success depends on the skills, experience and performance of our senior
management and other key personnel, many of whom have worked together for only a
short period of time. The loss of the services of any of our senior management
or other key personnel, including Gideon Mantel, our Chief Executive Officer,
Isabel Maxwell, the President of our United States subsidiary, and Amir Lev, our
President and Chief Technical Officer, could materially and adversely affect our
business. We do not have employment agreements with any of our senior management
or other 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.
Because our business is based on communications and messaging services, we are
susceptible to system interruptions and capacity constraints, which could harm
our business and reputation.
Our ability to successfully receive and send our end users' email messages and
provide acceptable levels of service largely depends on the efficient and
uninterrupted operation of our computer and communications hardware and network
systems and those of our outsourced hosting service. In addition, the growth in
the use of the Internet has caused frequent interruptions and delays in
accessing the Internet and transmitting data over the Internet. We do not
possess insurance to cover losses caused by unplanned system interruptions and
software defects. In the past, we have experienced some interruptions in our
email service. We believe that these interruptions will continue to occur from
time to time. These interruptions may be due to hardware failures, unsolicited
bulk email (also known as "spam"), operating system failures, inadequate
Internet infrastructure capacity, and other mechanical and human causes. We
expect to experience occasional, temporary capacity constraints due to sharply
increased traffic, which may cause unanticipated system disruptions, slower
response times, impaired quality and degradation in levels of customer service.
If we experience frequent or long system interruptions that reduce our ability
to provide email services, we may have fewer users of our email services. In
addition, we have entered into service agreements with some of our customers
that require minimum performance standards. If we fail to meet these standards,
our customers could terminate their relationships with us.
We must continue to expand and adapt our network infrastructure to changing
requirements and increasing numbers of end users. The expansion and adaptation
of our network infrastructure will require substantial financial, operational
and managerial resources. In addition, we depend on improvements being made to
the entire Internet infrastructure to alleviate overloading and congestion of
the Internet. The ability of our network to continue to connect and manage an
expanding number of customers, end users and messages at high transmission
speeds is unproven and uncertain. We face risks related to our network's and
the Internet's ability to operate with higher use levels while maintaining
expected performance levels.
We are a relatively small competitor in the electronic messaging industry and,
as a result, we may not have the resources to adapt to the changing
technological requirements and the shifting consumer preferences of our
industry.
The Internet messaging industry is characterized by rapid technological change,
changes in end user requirements and preferences, and the emergence of new
industry standards and practices that could render our existing services and
proprietary technology obsolete. Our success depends, in part, on our ability
to continually enhance our existing email and messaging services and to develop
new services, functions and technology that address the increasingly
sophisticated and varied needs of our prospective customers. The development of
proprietary technology and necessary service 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
our services to customer or end user requirements or emerging industry
standards. Also, in addition to addressing changing technologies and end user
needs, we must also do so more quickly than our competition.
11
<PAGE>
Our services may be adversely affected by software defects, which could cause
our customers or end users to stop using our services.
Our service offerings depend on 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 services or enhancements until after
they are deployed. Although we have not experienced any material software
defects to date, it is possible that, despite testing by us, defects may exist
in the software we use. These defects could cause service interruptions that
could damage our reputation or increase our service costs, cause us to lose
revenue, delay market acceptance or divert our development resources, any of
which could cause our business to suffer. Some of our services are based on
software provided by third parties. We have no control over the quality of such
software.
We rely on the integrity of our network security, which may be susceptible to
breaches that could harm our reputation and business.
A fundamental requirement for online communications is the secure transmission
of confidential information over public networks. Third parties may attempt to
breach our security or that of our customers. Despite our implementation of
third party encryption technology and network security measures, our servers
are vulnerable to computer viruses, physical or electronic break-ins and
similar disruptions, which could lead to interruptions, delays or loss of data.
We may be liable to our customers and their end users for any breach in our
security, including claims for impersonation or other similar fraud claims, as
well as claims for other misuses of personal information, for example for
unauthorized marketing purposes. Also, such a breach could harm our reputation
and consequently our business. We may also be required to expend significant
capital and other resources to license encryption technology and additional
technologies to protect against security breaches or to alleviate problems
caused by any breach. Our failure to prevent security breaches could have a
material adverse effect on our business and operating results.
In addition, the Federal Trade Commission and several states have been
investigating some Internet companies regarding their use of personal
information. We could incur additional expenses if new regulations regarding
the use of personal information are introduced, if our privacy practices are
investigated or if our privacy policies are viewed unfavorably by users or
potential users.
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 copyrights, service marks, trademarks, trade secrets and similar
intellectual property as critical to our success, and rely on trademark and
copyright law, trade secret protection and confidentiality or license
agreements with our employees and customers to protect our proprietary rights.
Third parties may infringe or misappropriate our copyrights, trademarks and
similar proprietary rights. Although we have not filed any patent applications,
we may seek to patent certain software or other technology in the future. Any
such future patent applications may not be issued with the scope of the claims
we seek, or at all. We cannot be certain that our software does not infringe
issued patents that may relate to our software products. In addition, because
patent applications in the United States are not publicly disclosed until the
patent is issued, applications may have been filed which relate to our software
products.
Despite our precautions, unauthorized third parties may copy certain portions
of our technology or reverse engineer or obtain and use information that we
regard as proprietary. End user license provisions protecting against
unauthorized use, copying, transfer and disclosure of the licensed program may
be unenforceable under the laws of some jurisdictions and foreign countries. 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.
Our ZapZone Network service allows webmasters to select the email service name
of their choice (although we reserve the right to eliminate their account or to
change their email service name).
12
<PAGE>
There is, therefore, the possibility that they will select email service names
that may infringe the rights of others. We have received several complaints
about ZapZone Network service webmasters' registered email service names and we
have referred these complainants directly to the ZapZone Network service
subscribers who are allegedly engaging in the infringing activities. However,
these complainants may seek to enforce their rights against us in addition to,
or instead of, the infringing webmasters.
We may have liability for email content and we may not have adequate liability
insurance.
As a provider of email services, we face potential liability for defamation,
negligence, copyright, patent or trademark infringement and other claims based
on the nature and content of the materials transmitted via email. We do not and
cannot screen all of the content generated by end users, and we could be
exposed to liability with respect to this content. Some foreign governments,
such as the government of Germany, have enforced laws and regulations related
to content distributed over the Internet that are more strict than those
currently in place in the United States. Although we carry general and
professional liability insurance coverage, our insurance may not adequately
protect us from such claims. Any imposition of liability, particularly
liability that is not covered by insurance, or is in excess of insurance
coverage, could damage our reputation and hurt our business and operating
results, or could result in criminal penalties.
Governmental regulation and legal uncertainties could impair the growth of the
Internet and decrease demand for our services or increase our cost of doing
business.
There are currently few laws and regulations directly applicable to the
Internet and commercial email services. However, a number of laws have been
proposed involving the Internet, including laws addressing user privacy,
pricing, content, copyright, antitrust, distribution and characteristics and
quality of products and services. Further, the growth and development of the
market for email may prompt calls for more stringent consumer protection laws
that may impose additional burdens on companies conducting business online.
Moreover, the applicability to the Internet of existing laws in various
jurisdictions governing issues such as property ownership, sales and other
taxes, libel and personal privacy is uncertain and may take years to resolve.
The adoption of additional laws or regulations, or the application of existing
laws or regulations to the Internet, may impair the growth of the Internet or
commercial online services. This could decrease the demand for our services and
increase our cost of doing business, or otherwise harm our business and
operating results.
Due to the global nature of the Web, it is possible that, although our
transmissions currently originate in California, the governments of other
states or foreign countries might attempt to regulate our transmissions or levy
sales or other taxes relating to our activities. The European Union recently
adopted a directive addressing data privacy that may result in limits on the
collection and use of user information.
On October 20, 1999, The Federal Trade Commission issued the final rule to
implement the Children's Online Privacy Protection Act of 1998 ("COPPA"). The
main goal of the COPPA and the rule is to protect the privacy of children using
the Internet. As of April 21, 2000, certain commercial websites and online
services directed to, or that knowingly collect information from, children must
obtain parental consent before collecting, using, or disclosing personal
information from children under 13. The COPPA regulations could reduce our
ability to engage in direct marketing. The cost to the Company of complying with
the new requirements is not known and such cost may have a material effect upon
operating results or financial condition.
We may need additional capital and raising additional capital may dilute
existing shareholders.
We believe that our existing capital resources will enable us to maintain our
current and planned operations for at least the next 12 months. However, we may
be required to raise additional funds due to unforeseen circumstances. If our
capital requirements vary materially from those currently planned, we may
require additional financing sooner than anticipated. Such financing may not be
available in
13
<PAGE>
sufficient amounts or on terms acceptable to us and may cause dilution to
existing shareholders. Also, we may raise additional capital in the future by
issuing securities that have superior rights and preferences to our ordinary
shares.
Purchasers of our ordinary shares may suffer immediate and substantial
dilution.
The offering price of the shares may be substantially higher than the book value
per share of our ordinary shares. Some elements of our market value do not
originate from measurable transactions. Therefore, there is not a corresponding
rise in "book," or historical cost accounting, value for our rise in market
value, if any. Examples of these elements include the perceived growth prospects
of our core commercial market, perceived growth prospects of our Web-based email
services and our perceived competitive position within the market for Web-based
email services. Purchasers of the ordinary shares in this offering will
experience immediate dilution of approximately $51.44, measured by the excess of
an assumed public offering price of $62.00 per share over the pro forma as
adjusted net tangible book value per share of ordinary shares. Purchasers may
also experience additional dilution upon the exercise of outstanding stock
options.
If we or any of our vendors do not adequately address "Year 2000" issues, we
may incur significant unanticipated expenses to remedy any resulting problems,
and our business and reputation could suffer.
The "Year 2000" issue is the result of computer programs and embedded hardware
systems having been developed using two digits rather than four to define the
applicable year. These computer programs or hardware that have date-sensitive
software or embedded chips may recognize a date using "00" as the year 1900
rather than the year 2000. This could result in system failures or
miscalculations, causing disruptions of operations including, among other
things, a temporary inability to process transactions, send invoices or engage
in normal business activities. We have tested our internally developed software
and have made it Year 2000 compliant. Many of our customers maintain their
Internet operations on commercially available operating systems that may be
impacted by Year 2000 complications. In addition, we rely on third-party
vendors for certain software and hardware included within our services, which
may not be Year 2000 compliant. Failure of our internal computer systems or
third-party equipment or software, or of systems maintained by our suppliers,
to operate properly with regard to the year 2000 and thereafter, could require
us to incur significant unanticipated expenses to remedy any problems and could
cause system interruptions and loss of data. Any of these events could harm our
reputation, business and operating results.
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 own over five percent of our ordinary shares
beneficially own approximately 30% of our outstanding ordinary shares.
Immediately following the offering, they will own approximately 20% of our
outstanding ordinary shares (whether or not the underwriters' overallotment
option is exercised in full). If they vote together, these shareholders will be
able to exercise significant influence over all matters requiring shareholder
approval, including the election of directors and approval of significant
corporate transactions. This concentration of ownership could also delay or
prevent a change in control of Commtouch.
Go2Net and Vulcan Ventures beneficially own approximately 14% of our
outstanding ordinary shares (assuming exercise of the Go2Net warrant on a net
issuance basis). Immediately following the offering, they will own
approximately 12% of our outstanding ordinary shares (whether or not the
underwriters' overallotment option is exercised in full). Vulcan Ventures is a
significant shareholder of Go2Net. Accordingly, Go2Net and Vulcan Ventures will
be able to significantly influence and possibly exercise control over most
matters requiring approval by our shareholders, including the election of
directors and approval of significant corporate transactions. This
concentration of ownership may also have the effect of delaying or preventing a
change in control. Go2Net and Vulcan also have the right to name one director
to our Board as long as they continue to hold at least 620,022 shares,
including
14
<PAGE>
the shares issuable upon exercise of the Go2Net warrant. They have named Thomas
Camp to the Board under this provision. In addition, conflicts of interest may
arise as a consequence of Go2Net's control relationship with us, including:
o conflicts between Go2Net and Vulcan Ventures, as 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 Go2Net, on the other hand; or
o conflicts related to existing or new contractual relationships between
us, on the one hand, and Go2Net and its other affiliates, on the other
hand.
Our business and operating results could suffer if we do not successfully
address the risks inherent in the expansion of our international operations.
At present, we have sales offices in the United States, Israel and England. We
intend to continue to expand into international markets and to spend
significant financial and managerial resources to do so. We have limited
experience in international operations and may not be able to compete
effectively in international markets. The Company will face risks inherent in
conducting business internationally, such as:
o difficulties and costs of staffing and managing international operations;
o fluctuations in currency exchange rates;
o imposition of currency exchange controls;
o differing technology standards;
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 international
operations and, consequently, business and operating results. Specifically,
failure to successfully manage international growth could result in higher
operating costs than anticipated or could delay or preclude altogether the
Company's ability to generate revenues in key international markets.
Substantial sales of our ordinary shares could adversely affect our stock price.
The sale, or availability for sale, of substantial quantities of our ordinary
shares may have the effect of depressing its market price by potentially
introducing a large number of sellers into the market. A large number of our
ordinary shares are currently eligible for resale. In addition a significant
number of shares will be eligible for resale at various dates in the future.
See "Shares Eligible for Future Sale."
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 sales currently are being made to customers outside
Israel, we are nonetheless directly influenced by the political, economic and
military
15
<PAGE>
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 companies doing business with Israel have been
the subject of an economic boycott by the 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 the Arab
countries. 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, 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.
In addition, certain of our officers and employees are currently obligated to
perform annual reserve duty in the Israel Defense Forces and are subject to
being called for active military duty at any time. Although Commtouch has
operated effectively under these requirements since its inception, we cannot
predict the effect of these obligations on Commtouch in the future. Our
operations could be disrupted by the absence for a significant period of one or
more of our officers or key employees due to military service.
Because a substantial portion of our revenues are generated in U.S. dollars,
while a significant portion of our expenses are incurred in New Israeli
Shekels, our results of operations may be adversely affected by inflation and
currency fluctuations.
We generate a substantial portion of our revenues in U.S. dollars but incur a
significant portion of our expenses, principally salaries and related personnel
expenses, in New Israeli Shekels, commonly referred to as NIS. As a result, we
are exposed to the risk that the rate of inflation in Israel will exceed the
rate of devaluation of the NIS in relation to the dollar or that the timing of
any devaluation may lag behind inflation in Israel. While in recent years the
rate of devaluation of the NIS against the dollar has exceeded the rate of
inflation, which is a reversal from prior years, we cannot be sure that this
reversal will continue. If the dollar cost of our operations in Israel
increases, our dollar-measured results of operations will be adversely
affected. Our operations also could be adversely affected if we are unable to
guard against currency fluctuations in the future. Accordingly, we may enter
into currency hedging transactions to decrease the risk of financial exposure
from fluctuations in the exchange rate of the dollar against the NIS. These
measures, however, may not adequately protect us from material adverse effects
due to the impact of inflation in Israel.
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
prospectus reside outside of the United States. Therefore, you might not be able
to enforce any judgment obtained in the U.S. against us or any of such persons.
You might not be able to bring civil actions under U.S. securities laws if you
file a lawsuit in Israel. However, we have been advised by our Israeli counsel
that, subject to certain limitations, Israeli courts may enforce a final
judgment of a U.S. court for liquidated amounts in civil matters after a hearing
in Israel. We have appointed Commtouch Software Inc., our U.S. subsidiary, as
our agent to receive service of process in any action against us arising out of
this offering. 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
16
<PAGE>
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 will 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 stock.
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.
The new Israeli Companies Law imposes substantial duties on shareholders and
may cause uncertainties regarding corporate governance.
The new Israeli Companies Law, which became effective on February 1, 2000, has
brought about significant changes to Israeli corporate law. The new law includes
provisions imposing substantial duties on certain controlling and
non-controlling shareholders. (See "Management--Approval of Certain
Transactions"). In addition, there may be uncertainties regarding corporate
governance in some areas. These uncertainties will persist until this new law
has been adequately interpreted, and these uncertainties could inhibit takeover
attempts or other transactions and inhibit other corporate decisions.
17
<PAGE>
USE OF PROCEEDS
Offering by the Company and the Selling Shareholders
The net proceeds we will receive from the sale of the 1,669,000 ordinary shares
offered by us, at an assumed public offering price of $62.00 per share, after
deducting the underwriting discounts and commissions and the estimated offering
expenses payable by us (which are estimated to be $6.8 million, or $8.5 million
if the underwriters' over-allotment option is exercised in full) are estimated
to be $96.7 million ($122.9 million if the underwriters' over-allotment option
is exercised in full).
We intend to use the proceeds of this offering for the following:
o expansion of our sales and marketing activities;
o capital expenditures, including purchase of equipment, primarily for our
hosting facilities;
o expansion of research and development activities;
o expansion of our international operations; and
o working capital and other general corporate purposes.
The amounts and timing of these expenditures will vary significantly depending
on a number of factors, including, but not limited to, the amount of cash
generated by our operations and the market response to the introduction of any
new service offerings.
In addition, we may use a portion of the net proceeds of this offering from
time to time to acquire or invest in businesses, products, services or
technologies complementary to our current business, through mergers,
acquisitions, joint ventures or otherwise. Accordingly, our management will
retain broad discretion as to the use and allocation of the net proceeds of
this offering. Pending the above uses, we intend to invest the net proceeds of
this offering in short-term, interest-bearing investment grade securities.
We will not receive any proceeds from the sale of the shares by the selling
shareholders in this offering.
MARKET PRICE AND PRICE RANGE FOR ORDINARY SHARES
The Company's ordinary shares have been quoted on the Nasdaq National Market
since July 13, 1999, under the symbol CTCH. There is no non-United States
trading market for the shares. As of December 31, 1999, there were 82 record
holders of ordinary shares, of which approximately 50 represented United States
record holders holding approximately 45% of the outstanding ordinary shares of
the Company. The Company believes that some beneficial holders of its ordinary
shares hold in nominee or street name, and that there may be more than 3,000
beneficial holders. On March 7, 2000 the last reported sales price of an
ordinary share on the Nasdaq National Market was $62.00 per share.
<TABLE>
<CAPTION>
Ordinary Share Price
-----------------------
High Low
---------- ----------
<S> <C> <C>
Fiscal Year Ended December 31, 1999
Quarter ended September 30, 1999 (from July 13, 1999) ....... $ 25.88 $ 9.75
Quarter ended December 31, 1999 ............................. $ 59.50 $ 13.88
Fiscal Year Ending December 31, 2000
Period from January 1, 2000 through March 24, 2000 .......... $ 66.50 $ 35.56
</TABLE>
18
<PAGE>
DIVIDEND POLICY
We have never paid cash dividends to our shareholders and we currently do not
intend to pay dividends for the foreseeable future. We intend to reinvest
earnings in the development and expansion of our business. We may only pay cash
dividends in any fiscal year out of profits, as determined under Israeli law,
so long as the Company reasonably believes that such payment will not prevent
it from paying all of its current and future debts. The declaration of any
final cash dividend requires shareholder approval. Shareholders may reduce, but
not increase, the amount of dividends from the amount proposed by the Board of
Directors.
Because of Commtouch's investment programs' Approved Enterprise status, the
payment of dividends by Commtouch may subject Commtouch to certain Israeli
taxes to which it would not otherwise be subject. The tax exempt income
attributable to the Approved Enterprise can be distributed to shareholders
without subjecting Commtouch to taxes only upon the complete liquidation of
Commtouch. If Commtouch decides to distribute cash dividends out of income that
has been exempt from tax, the income out of which the dividend is distributed
will be subject to Israeli corporate tax (currently 25%). We have decided to
reinvest the amount of tax exempt income derived from our Approved Enterprise
and not to distribute such income as dividends. (For a description of our
Approved Enterprise status, please see "Israeli Taxation and Investment
Programs.")
19
<PAGE>
CAPITALIZATION
The following table sets forth the capitalization of Commtouch as of December
31, 1999:
The following data is presented:
o on an actual basis; and
o on a pro forma as adjusted basis to give effect to (1) the sale of
1,669,000 ordinary shares in this offering, at an assumed offering price
of $62.00 per share and (2) the issuance of 901,471 ordinary shares upon
the assumed net exercise at an assumed share price of $62.00 per share,
of an in-the-money warrant held by Go2Net to purchase 1,136,000 ordinary
shares at an exercise price of $12.80 per share.
<TABLE>
<CAPTION>
December 31, 1999
-------------------------
Pro forma
Actual As Adjusted
--------- -----------
(in thousands)
<S> <C> <C>
Long-term liabilities .................................................. $ 497 $ 497
Shareholders' equity:
Ordinary shares, NIS 0.05 par value; 40,000,000 shares
authorized, 15,199,344 shares issued and outstanding;
17,769,815 shares issued and outstanding pro forma as adjusted ...... 213 245
Additional paid-in capital ............................................ 133,403 230,040
Stock-based employee deferred compensation ............................ (5,779) (5,779)
Notes receivable from shareholders .................................... (1,060) (813)
Accumulated other comprehensive income ................................ 63 63
Accumulated deficit ................................................... (31,528) (31,528)
--------- ---------
Total shareholders' equity ....................................... 95,312 192,228
--------- ---------
Total capitalization ............................................. $ 95,809 192,725
========= =========
</TABLE>
The number of ordinary shares to be outstanding after this offering does not
include the following:
o 1,383,110 ordinary shares issuable upon exercise of stock options
outstanding under our stock option plans and stock option agreements as
of December 31, 1999 at a weighted average exercise price of $9.62 per
share;
o 2,876,850 ordinary shares available for future grant or issuance under
our stock option plans as of December 31, 1999;
o 773,420 ordinary shares issuable upon exercise of options granted to
executive officers and directors prior to December 31 1999 at a weighted
average price of $8.20; and
o 4,860 ordinary shares issuable upon exercise of a warrant at an exercise
price of $3.61 per share; this warrant was net exercised into 4,461
ordinary shares subsequent to December 31, 1999.
20
<PAGE>
DILUTION
<TABLE>
Our net tangible book value as of December 31, 1999 was $90.8 million or $5.97
per ordinary share. Net tangible book value per share is determined by dividing
the amount of our total tangible assets less total liabilities by the number of
ordinary shares outstanding at that date. Dilution in net tangible book value
per share represents the difference between the amount per share paid by
purchasers of ordinary shares in the offering made hereby and the net tangible
book value per ordinary share immediately after the completion of this offering.
After giving effect to the sale of 1,669,000 ordinary shares by Commtouch in
this offering (at an assumed public offering price of $62.00 per share and after
deducting the underwriting discounts and commissions and our estimated offering
expenses), and assuming an estimated 901,471 ordinary shares issuable upon the
net exercise of an in-the-money warrant held by Go2Net to purchase 1,136,000
ordinary shares at an exercise price of $12.80, the pro forma as adjusted net
tangible book value of Commtouch at December 31, 1999 would have been $187.7
million, or $10.56 per share. This represents an immediate increase in pro forma
as adjusted net tangible book value of $4.59 per share to the existing
shareholders and an immediate dilution of $51.44 per share to new investors
purchasing ordinary shares in this offering. The following table illustrates
this per-share dilution:
<S> <C> <C>
Assumed offering price per share ................................................. $ 62.00
Net tangible book value per share as of December 31, 1999 ........................ $ 5.97
Increase in pro forma as adjusted net tangible book value per share attributable
to this offering ............................................................... 4.92
Decrease in pro forma as adjusted net tangible book value per share attributable to
the exercise of the in-the-money warrant held by Go2Net .......................... (0.33)
--------
Pro forma as adjusted net net tangible book value per share after the offering .... 10.56
---------
Dilution per share to new investors ............................................. $ 51.44
=========
</TABLE>
The above table assumes no exercise of the underwriters' over-allotment option
and no exercise of options or warrants after December 31, 1999. As of December
31, 1999, there were outstanding options to purchase a total 1,383,110 and
773,420 ordinary shares under our stock option plans and option agreements with
our employees and consultants, and executive officers and directors,
respectively, at a weighted average exercise price of $9.62 and $8.20 per share,
respectively; 4,860 ordinary shares issuable upon exercise of outstanding
warrants at a weighted average exercise price of $3.61 per share; and 2,876,850
ordinary shares available for future grant under our stock option grants. If all
of these options and warrants had been exercised on December 31, 1999, our pro
forma as adjusted net tangible book value on that date would have been $207.4
million, or $10.41 per share, the increase in net tangible book value per share
attributable to the existing investors would have been $4.44 per share and the
dilution in net tangible book value to new investors would have been $51.59 per
share.
21
<PAGE>
SELECTED CONSOLIDATED FINANCIAL INFORMATION
<TABLE>
The selected consolidated statements of operations data for the years ended
December 31, 1997, 1998 and 1999 and the selected consolidated balance sheet
data as of December 31, 1998 and 1999 have been derived from the Consolidated
Financial Statements of Commtouch included elsewhere in this prospectus. The
selected consolidated statement of operations data for the years ended December
31, 1995 and 1996 and the selected consolidated balance sheet data as of
December 31, 1995, 1996 and 1997 have been derived from the Consolidated
Financial Statements of Commtouch not included elsewhere in this prospectus.
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 "Management's Discussion and Analysis of Financial Condition and Results
of Operations" and the Consolidated Financial Statements and the Notes thereto
included elsewhere in this prospectus.
<CAPTION>
Year Ended December 31,
-------------------------------------------------------------------
1995 1996 1997 1998 1999
-------- --------- --------- --------- ---------
(in thousands, except per share data)
<S> <C> <C> <C> <C> <C>
Consolidated Statement of Operations Data:
Revenues:
Email services ..................................... $ -- $ -- $ -- $ 389 $ 4,251
Software licenses, maintenance and services ........ 1,733 3,134 899 -- --
-------- --------- --------- --------- ---------
Total revenues ................................... 1,733 3,134 899 389 4,251
Cost of revenues:
Email services ..................................... -- -- -- 569 3,643
Software licenses, maintenance and services ........ 327 463 165 -- --
-------- --------- --------- --------- ---------
Total cost of revenues ........................... 327 463 165 569 3,643
-------- --------- --------- --------- ---------
Gross profit (loss) ................................. 1,406 2,671 734 (180) 608
-------- --------- --------- --------- ---------
Operating expenses
Research and development, net ...................... 463 1,478 1,108 1,149 2,942
Sales and marketing, net ........................... 832 1,965 2,202 2,001 7,722
General and administrative ........................ 369 465 829 604 4,328
Amortization of prepaid marketing expenses ......... -- -- -- -- 3,263
Amortization of stock-based employee
deferred compensation ............................ -- -- -- 91 3,436
-------- --------- --------- --------- ---------
Total operating expenses ......................... 1,664 3,908 4,139 3,845 21,691
Operating loss ...................................... (258) (1,237) (3,405) (4,025) (21,083)
Interest and other income (expenses), net ........... (62) (45) (68) (326) 1,232
-------- --------- --------- --------- ---------
Net loss ............................................ $ (320) $ (1,282) $ (3,473) $ (4,351) $ (19,851)
======== ========= ========= ========= =========
Basic and diluted net loss per share ................ $ (0.11) $ (0.66) $ (2.40) $ (3.00) $ (2.65)
======== ========= ========= ========= =========
Weighted average shares -- basic and diluted ........ 2,885 1,934 1,450 1,450 7,487
======== ========= ========= ========= =========
</TABLE>
<TABLE>
<CAPTION>
December 31,
-------------------------------------------------------------
1995 1996 1997 1998 1999
--------- -------- ----------- ----------- ----------
(in thousands)
<S> <C> <C> <C> <C> <C>
Consolidated Balance Sheet Data:
Cash and cash equivalents ................ $ 54 $ 690 $ 324 $ 834 $ 65,996
Marketable securities .................... -- -- -- -- 18,050
Working capital (deficit) ................ (734) 539 (1,264) (1,440) 88,053
Total assets ............................. 773 2,180 1,065 2,366 100,336
Long-term liabilities .................... 324 371 366 530 497
Shareholders' equity (deficit) ........... (650) 777 (1,018) (815) 95,312
</TABLE>
22
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the Consolidated
Financial Statements and the Notes thereto included elsewhere in this
prospectus. 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 discussed in "Risk Factors" and
elsewhere in this prospectus.
Overview
We are a leading global provider of outsourced integrated Web-based email and
messaging solutions to businesses. Our solutions are flexible, highly
customizable and enable us to satisfy the unique email and messaging needs of
our customers worldwide. Our customers are large and small businesses who offer
our Web-based email through their website to their end users and employees. As
of December 31, 1999, we had over 250 global customers. Through our customers'
sites we serve approximately 8.4 million active emailboxes. We also serve over
1.0 million active emailboxes to small businesses and websites through our
ZapZone Network.
Business History and Transition
Email Client Software Business (1991-1997). From 1991 to 1997, we generated all
of our revenue from sales of software licenses, maintenance and service for
stand-alone email client software for both mainframes and personal computers.
In 1996, we generated approximately $3.1 million in revenues from such software
licenses.
Transition to Web-Based Email Services (1997). During 1996, the popularity of
email at home and at work began to increase rapidly. Microsoft began bundling
Outlook, its email client software, in "office suite" packages. At the same
time, Netscape began to provide its email client software bundled in its
Internet browser software. The entrance into the email client software market
by both Microsoft and Netscape resulted in the rapid adoption of email as a
mass-market communications channel. At the same time, use of the Web began to
expand rapidly, and the market for stand-alone email client software began to
be dominated by companies which bundled such software with operating systems
and/or browsers. We recognized an opportunity to leverage our technology and
experience in developing email software to pursue the market created by these
two rapidly growing phenomena: email and the Web. As a result, we redeployed
the efforts of our existing research and development personnel and independent
contractors to adapt the technology embedded in our email client software for
use as a Web-based email service. We ceased all stand-alone email software
license sales during 1997 and, as a result, revenues in 1997 decreased to
$899,000. To further support our transition to providing Web-based email
services, in 1997 we opened a marketing, sales and support office in Silicon
Valley in order to have better access to Web-based customers.
Web-Based Email Service Business (January 1998-Present). In January 1998, we
began to offer Web-based email services to customers. Our services allow our
customers to provide free Web-based email to their end users, thus enhancing
the customer's online presence, increasing the frequency and duration of visits
to the customer's website and creating an opportunity for the customer to
generate advertising and direct e-marketing revenue through email. Meanwhile,
we recognized that webmasters on small sites were seeking a method to promote
their sites and offer email to their users. In November 1998, we launched our
ZapZone Network service which enables small sites to provide email to their end
users at no cost in a matter of minutes. Throughout 1999, we transitioned our
23
<PAGE>
revenue model from one based on advertising with minimum commitment fee to a
price per emailbox fee structure with a minimum commitment fee and also
introduced enhanced functionality which allowed us to increase prices.
Revenue Sources
Service Fees. During 1999, most of our email service revenue resulted from
contracts that required our customers to pay us either a share of advertising
revenues subject to a minimum annual revenue commitment or a monthly per
emailbox price subject to a minimum commitment fee, and fees for direct
marketing and communications services.
Prior to 1999, some of our contracts with customers provided for email service
fees based solely on a share of banner advertising revenue, recognized only
when such revenues were earned by the customers, with no minimum annual
commitment.
Direct E-marketing. Ecommerce vendors seek channels through which they can
market goods and services. Because of our installed user base and our agreements
with our customers, we can assist ecommerce companies in distributing their
services to our customers' end users who have opted to receive offers by email.
We share with our customers the revenues from this direct e-marketing, which are
earned either on a per-message basis, a referral basis, or as a commission on
products sold. In the fourth quarter of 1998, we began to offer direct
e-marketing opportunities to ecommerce vendors on a test basis. In 1999, direct
e-marketing revenues became a meaningful portion of revenue. We recognized 11%
of our total revenues from MyPoints, a permission based email service company.
Strategic Transaction with Go2Net
Concurrent with the sale of our shares in the initial public offering we
entered into an agreement with Go2Net, a network of branded, technology- and
community-driven websites focused on personal finance, commerce, and games.
Go2Net also develops Web-related software. Pursuant to the agreement we are
offering Go2Net's end users a private label email service, including our email,
calendaring and other services. The services are customized to the look and
feel of Go2Net's websites. The terms of this agreement are substantially the
same as our commercial agreements with other customers except that we have
agreed to share a materially greater portion of our advertising revenues with
Go2Net than we are sharing under other similar agreements. In addition, in
connection with the agreement, we issued to Go2Net 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, is being amortized to operating expenses ratably
over the minimum term of the agreement, which is one year. Simultaneously with
the sale of the shares in the initial public offering, we sold a total of
1,344,086 ordinary shares to Go2Net 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 customers who provide
us with a large base of potential end users. We may also have to provide these
customers with more favorable commercial terms than we have previously provided
to our customers. The issuance of in-the-money warrants and the grant of more
favorable terms to customers may further dilute our shareholders, increase our
operating loss in the future and cause our stock price to fall.
Issuance of Shares Upon Exercise of Microsoft Warrant
We entered into an Email Services Agreement with Microsoft Corporation dated
October 26, 1999. Under this agreement, Commtouch will, at Microsoft's option,
customize, host and maintain email services for Microsoft websites in the U.S.
and internationally. Microsoft will pay one-time fees for the set-up and
customization of the email service for each website with respect to which
Microsoft chooses to use our services, as well as quarterly service fees for
the email service based on the number of mailboxes hosted. The term of the
agreement shall continue for 12 months after the first commercial
24
<PAGE>
distribution date of the email service and Microsoft may extend the initial
term on a quarterly or annual basis upon 60 days prior written notice. The
agreement may be terminated by Microsoft for convenience upon 90 days' prior
written notice, or by either party upon a material breach by the other party
upon the terms specified in the agreement. In connection with the agreement,
Commtouch issued to Microsoft a fully vested warrant, exercisable until
December 29, 1999, to purchase 707,965 of Commtouch's ordinary shares at an
exercise price of $28.25 per share for an aggregate exercise price of $20.0
million. On December 29, 1999, Microsoft exercised the warrant and now holds
707,965 ordinary shares. The fair value of the warrant, estimated at $1.9
million, is amortized to operating expenses over the minimum term of the
agreement (12 months).
Results of Operations
<TABLE>
The following table sets forth financial data for the years ended December 31,
1997, 1998 and 1999
(in thousands):
<CAPTION>
Year Ended December 31,
------------------------------------------
1997 1998 1999
----------- ------------ -------------
<S> <C> <C> <C>
Revenues:
Email services ............................................... $ -- $ 389 $ 4,251
Software licenses, maintenance and services .................. 899 -- --
-------- -------- ---------
Total revenues ............................................. 899 389 4,251
-------- -------- ---------
Cost of revenues:
Email services ............................................... -- 569 3,643
Software licenses, maintenance and services .................. 165 -- --
-------- -------- ---------
Total cost of revenues ..................................... 165 569 3,643
-------- -------- ---------
Gross profit (loss) .......................................... 734 (180) 608
-------- -------- ---------
Operating expenses:
Research and development, net ................................ 1,108 1,149 2,942
Sales and marketing .......................................... 2,202 2,001 7,722
General and administrative ................................... 829 604 4,328
Amortization of prepaid marketing expenses ................... -- -- 3,263
Amortization of stock-based employee deferred compensation -- 91 3,436
-------- -------- ---------
Total operating expenses ................................... 4,139 3,845 21,691
-------- -------- ---------
Operating loss ................................................ (3,405) (4,025) (21,083)
Interest and other income (expenses), net ..................... (68) (326) 1,232
-------- -------- ---------
Net loss ...................................................... $ (3,473) $ (4,351) $ (19,851)
======== ======== =========
</TABLE>
Comparison of Years Ended December 31, 1997, 1998 and 1999
In 1997, we ceased all sales of stand-alone email client software licenses,
maintenance and services and focused on developing our Web-based email service
business. Accordingly, comparisons between 1997 and 1998 are not meaningful.
Revenues. Email service revenues increased 993% from $389,000 in 1998 to $4.3
million in 1999. One customer, Excite, represented 54% of the revenue in 1998.
Revenues from MyPoints, a permission based email service company, represented
11% of total revenues during 1999. As of December 31, 1999, the Company had
backlog from contracts amounting to approximately $13.1 million, which will be
recognized as revenue over future quarters.
Cost of Revenues. Cost of revenues increased 540% from $569,000 in 1998 to $3.6
million in 1999, due to the increase in contracts with customers during 1999
and the related service provided. Cost of revenues consisted primarily of costs
related to Internet data center services from a third-party provider,
depreciation of equipment, Internet access, personnel and related costs. We
expect cost of revenues to increase on an absolute basis, primarily as a result
of an increase in our email service revenues, but to decrease as a percentage
of email service revenues due to economies of scale.
25
<PAGE>
Research and Development Costs, Net. Research and development expenses
increased 156% from $1.1 million in 1998 to $2.9 million in 1999 due to an
increase in personnel and other related costs. In previous years, we received
royalty-bearing grants from the Israeli government, recorded as a reduction of
research and development costs. We have an obligation to pay royalties to the
Israeli government with a remaining future liability of $270,000. In 1998, we
transferred several key research and development personnel into our operations
group to support and maintain our newly developed Web-based email services
infrastructure. Costs relating to these personnel were included in cost of
revenues in 1998. We expect that research and development costs will increase
due to increased personnel and related costs associated with the accelerated
development of new email service offerings.
Sales and Marketing. Sales and marketing expenses increased 286% from $2.0
million in 1998 to $7.7 million in 1999, due to increased personnel and related
costs, public relations, other marketing expenses and direct sales costs to
support the growth of our email service revenues. We expect sales and marketing
expenses to increase significantly in the future in absolute dollar amounts due
to increases in personnel costs related directly to new employees being hired
to conduct sales and the related market support to further develop our brand.
Sales and marketing expenses were $2.2 million in 1997 and related only to the
software license sales that were discontinued in 1997.
General and Administrative. General and administrative expenses increased 617%
from $604,000 in 1998 to $4.3 million in 1999, due primarily to substantially
higher personnel and related costs, facility costs, higher fees for outside
professional services and other costs to support the growth of our email
service revenues. We expect general and administrative costs to increase on an
absolute basis due to increased personnel and related costs, higher facility
costs associated with additional personnel and other costs necessary to support
and develop the email service business. General and administrative expenses
were $829,000 in 1997 and related only to the software license sales that were
discontinued
in 1997.
Amortization of Prepaid Marketing Expenses. Amortization of prepaid marketing
expenses related to the Go2Net and Microsoft warrants and totaled $3.3 million
for 1999. The prepaid marketing expense is being amortized using the
straight-line method over the one-year minimum term of each of the commercial
agreements.
Amortization of Stock-based Employee Deferred Compensation. Our stock-based
employee deferred compensation expenses increased 3,676% from $91,000 for 1998
to $3.4 million for 1999. The deferred compensation is being amortized using
the sum-of-digits method over the vesting schedule, generally four years.
Interest and Other Income (Expense), Net. Our interest and other income
(expense), net, increased from a net expense of $326,000 for 1998 to a net
income of $1.2 million for 1999, due primarily to increased interest income
earned from cash equivalents and marketable securities.
Income Taxes. As of December 31, 1999, we had approximately $22.5 million of
Israeli net operating loss carryforwards and $14.2 million of U.S. federal net
operating loss carryforwards available to offset future taxable income. The
U.S. net operating loss carryforwards will expire in various amounts in the
years 2008 to 2020. The Israeli net operating loss carryforwards have no
expiration date.
26
<PAGE>
Quarterly Results of Operations
<TABLE>
The following table sets forth certain unaudited quarterly statements of
operations data for the eight quarters ended December 31, 1999. 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
prospectus. The operating results for any quarter are not necessarily
indicative of the operating results for any future period.
<CAPTION>
Three Months Ended
---------------------------------------------------------------------------------------------
Mar. 31, Jun. 30, Sept. 30, Dec. 31, Mar. 31, Jun. 30, Sept. 30, Dec. 31,
1998 1998 1998 1998 1999 1999 1999 1999
---------- ---------- ----------- ---------- ---------- ---------- ----------- -------------
(in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Email service revenues ............... $ 32 $ 59 $ 130 $ 168 $ 346 $ 552 $ 1,117 $ 2,236
Cost of email service revenues ....... 59 85 166 259 435 605 1,043 1,560
------ -------- -------- -------- -------- -------- -------- --------
Gross profit (loss) .................. (27) (26) (36) (91) (89) (53) 74 676
------ -------- -------- -------- -------- -------- -------- --------
Operating expenses:
Research and development,
net ............................... 266 305 308 270 340 510 857 1,235
Sales and marketing ................ 459 506 509 527 608 1,363 2,368 3,383
General and administrative .......... 138 137 151 178 617 683 1,345 1,683
Amortization of prepaid
marketing expenses ................ -- -- -- -- -- -- 1,464 1,799
Amortization of stock-based
employee compensation ............. 2 8 18 63 386 1,013 1,096 941
------ -------- -------- -------- -------- -------- -------- --------
Total operating expenses .......... 865 956 986 1,038 1,951 3,569 7,130 9,041
------ -------- -------- -------- -------- -------- -------- --------
Operating loss ....................... (892) (982) (1,022) (1,129) (2,040) (3,622) (7,056) (8,365)
Interest and other income
(expenses), net ..................... (27) (59) (28) (212) (271) 6 577 920
------ -------- -------- -------- -------- -------- -------- --------
Net loss ............................. $ (919) $(1,041) $ (1,050) $(1,341) $(2,311) $(3,616) $ (6,479) $ (7,445)
====== ======== ======== ======== ======== ======== ======== ========
</TABLE>
Fluctuations in Quarterly Results
We have incurred operating losses since inception, and we cannot be certain
that we will achieve profitability on a quarterly or annual basis in the
future. Our results of operations have fluctuated and are likely to continue to
fluctuate significantly from quarter to quarter as a result of a variety of
factors, many of which are outside of our control. A relatively large expense
in a quarter could have a negative effect on our financial performance in that
quarter. Additionally, as a strategic response to a changing competitive
environment, we may elect from time to time to make certain pricing, service,
marketing or acquisition decisions that could have a negative effect on our
quarterly financial performance. Other factors that may cause our future
operating results to fluctuate include, but are not limited to:
o continued growth of the Internet and of email usage;
o demand for Web-based email services;
o our ability to attract and retain customers and maintain customer
satisfaction;
o our ability to upgrade, develop and maintain our systems and
infrastructure;
o the amount and timing of operating costs and capital expenditures
relating to expansion of our business and infrastructure;
o the size, timing and fulfillment of orders for our email services;
o the receipt or payment of irregular or nonrecurring revenues or expenses;
o technical difficulties or system outages;
o foreign exchange rate fluctuations;
27
<PAGE>
o the announcement or introduction of new or enhanced services by our
competitors;
o our ability to attract and retain qualified personnel with Internet
industry expertise, particularly sales and marketing personnel;
o the pricing policies of our competitors;
o failure to increase our sales; and
o governmental regulation relating to the Internet, and email in
particular.
In addition to the factors set forth above, our operating results will be
impacted by the extent to which we incur non-cash charges associated with
stock-based arrangements with employees and non-employees.
Liquidity and Capital Resources
We have financed our operations principally from the sale of equity securities
and to a lesser extent from bank loans, research and development and
royalty-bearing marketing grants from the Israeli government. In the first
quarter of 1999, we issued Series C Convertible Preferred Shares to investors
resulting in net proceeds of $5.3 million. In the second quarter of 1999, we
issued to investors Convertible Promissory Notes which later converted into
42,081 Series D Convertible Preferred Shares, resulting in net proceeds of
approximately $13.2 million. All of our convertible preferred shares
automatically converted into ordinary shares upon the closing of our initial
public offering on July 16, 1999. On July 16, 1999, we raised $70.8 million,
net of underwriters commissions, from our initial public offering (including
the exercise of the underwriters' overallotment option) and the private
placement of our ordinary shares in connection with the strategic partnership
with Go2Net and Vulcan Ventures. On December 29, 1999 we raised an additional
$20.0 million from the sale of ordinary shares to Microsoft Corporation upon
the exercise of a warrant issued in connection with an email services agreement
with Microsoft. As of December 31, 1999, we had $66.0 million in cash and cash
equivalents and $18.1 million in marketable securities.
Net cash provided by financing activities was $102.9 million in 1999. Net cash
used in operating activities was $11.2 million in 1999. Net cash used for
operating activities is primarily comprised of a net loss for 1999, partially
offset by depreciation and amortization expenses, increases in other accounts
receivable and prepaid expenses. Net cash used in investing activities was
$26.5 million in 1999. These investing activities consisted primarily of
purchases of property and equipment and purchases of marketable securities.
As of December 31, 1999, we had net working capital of $88.1 million.
We believe that the net proceeds from this offering, together with existing
cash and our other financing arrangements, provide us with sufficient funds to
finance operations and continued growth through the next 12 months.
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. The majority of
our income, however, is derived from our 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.
28
<PAGE>
Since we have incurred tax losses in every year through 1999, we have not yet
used the tax benefits for which we are eligible.
Impact of Inflation and Currency Fluctuations
Most of our sales are in dollars. However, a large portion of our costs relates
to our operations in Israel. A substantial portion of our operating expenses,
primarily our research and development expenses, is denominated in NIS. For the
purposes of our financial statements, costs not effectively denominated in
dollars are translated to dollars at prevailing exchange rates when recorded,
and will increase if the rate of inflation in Israel exceeds the devaluation of
the NIS as compared to the dollar or if the timing of such devaluations lags
considerably behind inflation. Consequently, we are and will be affected by
changes in the prevailing NIS/dollar exchange rate. We might also be affected
by the dollar exchange rate to the major European and Asian currencies, due to
the fact that we derive revenues from customers in Europe and Asia.
The rate of inflation in Israel was 8.1% and 10.6% in 1995 and 1996. The rate of
devaluation in Israel was 3.9% and 3.7% in 1995 and 1996. This imbalance was
reversed when the rate of inflation was 7.0% and 8.6% in 1997 and 1998. The rate
of devaluation in Israel was 8.8% and 17.6% in 1997 and 1998. In 1999, the rate
of inflation was 1.3% and the rate of devaluation in Israel was 0.2%.
Because exchange rates between the NIS and the dollar fluctuate continuously
(albeit with a historically declining trend in the value of the NIS), 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 remeasurements are reported in the Consolidated
Financial Statements in current operations.
The representative exchange rate, as reported by the Bank of Israel, was NIS
4.153 for one dollar on December 31, 1999 (NIS 4.160 on December 31, 1998 and
NIS 3.536 on December 31, 1997).
Qualitative and Quantitative Disclosure about Market Risk
We develop our technology in Israel and provide our services in North America,
India, Europe and the Far East. 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. Our interest expense on our capital lease
obligations with a U.S. leasing company is sensitive to changes in the general
level of U.S. interest rates. 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.
29
<PAGE>
BUSINESS
Company Overview
We are a leading global provider of outsourced integrated Web-based email and
messaging solutions to businesses. Our solutions are flexible, highly
customizable and enable us to satisfy the unique email and messaging needs of
our customers worldwide. Our customers are large and small businesses who offer
our Web-based email through their website to their end users. As of December
31, 1999, we had over 250 global customers. Through our customers' sites we
serve approximately 8.4 million active emailboxes. We also serve over 1.0
million active emailboxes to small businesses and websites through our ZapZone
Network.
Industry Background
Growth of the Internet Worldwide and Proliferation of Email
The Internet has become a vitally important global medium for communication,
commerce, content distribution and advertising. International Data Corporation,
or IDC, estimates that as of December 1999, there were over 80 million Web
users in the United States and over 115 million users outside of the U.S. IDC
projects that, by the end of 2003, these numbers will increase to over 175
million Web users in the United States and over 325 million users outside of
the U.S. This growth in the global usage of the Web provides significant
opportunities for emerging Web-based businesses and other companies developing
an online presence.
Email is one of the most widely used applications on the Internet and has become
a primary platform for business and personal communication. According to
Forrester Research, over 80% of Internet users access their email while online,
making this activity the most popular use of the Internet. IDC estimates that at
the end of 1999 there were over 180 million emailboxes in the United States and
over 130 million outside of the United States. IDC projects that by the end of
2003, these numbers will increase to over 280 million emailboxes in the United
States and over 305 million emailboxes outside the United States.
Web-based Email
Historically, most email systems were provided by employers, Internet service
providers (ISPs) or universities to individuals or closed groups of end users
through software applications located on the users' desktops or local area
networks. Such email systems, however, only permit access through the computer
or network on which the email software resides or through cumbersome remote
access systems. The emergence of email systems that use Internet browsers as
the application for sending and receiving email has resulted in tremendous
advances in email access, functionality and ease of use. This email standard is
commonly referred to as "Web-based email."
Web-based email offers the following benefits over traditional closed systems:
o anytime, anywhere (universal) access to both business and personal email
accounts;
o advanced integrated communication services over the Web, such as unified
messaging (receiving faxes and voicemail via email) and integrated
calendars and directories; and
o easy to use registration, setup and administration.
Businesses worldwide are seeking to differentiate themselves online. A
Web-based email service provides an optimal solution to address this business
need because it increases brand awareness, builds and reinforces a loyal,
connected member base and facilitates commerce in the following ways:
o Companies embracing Web-based email can enhance their brand identity by
controlling the look and feel of their Web-based email interface and also
by providing end users with distinctive branded email addresses such as
[email protected].
30
<PAGE>
o Web-based email significantly enhances the frequency and duration of
website visits, commonly referred to as the website's "stickiness." The
personalized nature of email and the ability to bundle it with additional
services, such as calendaring, scheduling and unified messaging,
establishes an important one-to-one relationship with email users.
o Email is emerging as an effective application for direct marketing
online, as email users provide important demographic data when they
register for and use email services. This information can be used to
create highly targeted marketing campaigns with minimal distribution
costs.
The Opportunity to Provide Outsourced Web-based Email Services
While many organizations worldwide recognize the advantages of Web-based email
services, they often lack the infrastructure, expertise and resources to fully
realize these benefits through internal development. Due to the growing
complexity of in-house email systems and the increasing levels of
infrastructure investment and management resources needed to provide
comprehensive email services, organizations around the world are seeking to
outsource email services. Businesses worldwide seek to partner with a dedicated
provider of Web-based email to quickly implement high quality, feature-rich
email services without having to invest internally in email management and
systems.
The Commtouch Solution
We are a leading global provider of outsourced Web-based email and other
messaging services to businesses worldwide. Our flexible and highly
customizable solutions enable us to satisfy the different email and messaging
needs of a wide range of customers.
Benefits of The Commtouch Solution
Extensive Email Features. Our solution is easy to use and provides a broad
range of industry-leading functionality. This includes the ability for end
users to collect email from other email accounts, to create folders, to attach
electronic documents, to store messages, to maintain a contact center, to
maintain an integrated calendar to create distribution lists and to establish
user profiles and signatures. Our service uses IMAP4, an advanced email
protocol, which allows email folders to be accessed from multiple email
environments.
The value of our solution is increased by our provision of premium services,
which allow end users to send and receive faxes, voicemail and pages from the
emailbox; access the Web-based emailbox from an off-line client (such as
Microsoft Outlook); and have email forwarded to other addresses. We believe
that, by providing a single platform which integrates multiple communication
services and devices, the Web-based emailbox we provide has the potential to
become our end users' primary online communications center.
Ability to Support Hundreds of Millions of Emailboxes. Our modular technology
architecture enables the rapid set up of full-service hosting facilities and
enables us to rapidly and easily expand our system as our user base grows. In
addition, we utilize redundant servers and server load balancing to re-direct
traffic to prevent service interruptions. Our system architecture and software
platform have been designed to provide high quality service to hundreds of
millions of emailboxes across millions of domains. We believe that our robust
and flexible technology platform enables us to maintain one of the highest
service performance levels in the industry.
Customization. Our solutions enable our customers to leverage their email as a
brand building tool. Customers offer our email and messaging services to their
end users with the customer's domain name. For example, a customer can provide
email at its website with an address such as [email protected]. This
repeated visibility of the customer's name on every email message promotes
brand awareness and customer loyalty. In addition, our customers can use our
proprietary customization tool to design the look and feel of their Web-based
email interface so that it reflects their own brand image.
Rapidly Deployable and Cost-Effective Solutions. Our solutions for customers
can be implemented in as few as several days.
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Our flexible technology and economies of scale enable us to provide email
solutions in a cost-effective manner, allowing businesses to achieve
significant economic advantages.We believe that this rapid time to market is
critical to our customers, who desire to realize the benefits of Web-based
email as quickly as possible. We also provide comprehensive maintenance and
administration of our email service, which eliminates the need for our
customers to undertake the significant burden of developing and maintaining an
in-house email system.
Extensive Language Capabilities. We provide email services in the following 18
languages: English, Chinese (Simplified and Traditional), Japanese, Spanish,
French, German, Portuguese, Dutch, Finnish, Danish, Norwegian, Swedish,
Russian, Hebrew, Icelandic, Korean and Italian. Additionally, we can support
multiple languages on the same site for any of our customers and offer
spell-checking in many of these languages. Our multi-lingual capabilities
enable us to serve the needs of businesses worldwide as well as multinational
organizations.
Increased Website Usage. Our solutions increase the potential for our customers
to generate revenue by increasing the stickiness of their websites. We believe
that traffic to our customers' websites increases as end users frequently visit
the website to check their email. The benefits of increased website stickiness
include more frequent communication with end users, enhanced customer loyalty
and the opportunity to generate revenues from advertising, direct marketing and
ecommerce transactions.
Online Marketing Capabilities. Our customers can leverage our email solutions
along with the demographic information of their end users to conduct one-to-one
marketing and targeted advertising campaigns. We collect demographic
information from end users when they register for their emailbox. We believe
this information provides a powerful platform on which to design targeted
marketing campaigns. To enhance our customers' marketing capabilities, we
provide our MailTarget tool which enables them to select and deliver tailored
messages to targeted segments of their user population.
Commtouch Strategy
Our objective is to be the leading global provider of outsourced, Web-based
integrated email and messaging services. We plan to achieve this goal by
pursuing the following key strategies:
Focus Sales and Marketing Efforts on Acquiring New Business Customers
We are focused on selling our outsourced email communications solution to
business customers, which enables them to rapidly provide our service to their
users and customers without needing to build or maintain an infrastructure to
support the service. We target customers who are increasingly relying on the
Internet to conduct their business and communications but do not want to devote
the time and resources to develop, support, or maintain an integrated email
service. Commtouch enables our business customers to quickly implement our
co-branded "Powered by Commtouch" service with minimal upfront investment while
retaining their direct user and customer relationships.
We are focusing our business-to-business sales efforts on several target
markets which we believe are particularly receptive to using our solution.
These include application service providers (ASPs), Internet service providers
(ISPs), large corporations, and web portals. Businesses in these target markets
are experiencing increasing pressure to offer enhanced Web-based email to their
customers. However, because they need to remain focused on their own core
business operations, we believe that they will outsource their email
capabilities.
Accelerate Transition to a Price-Per-Emailbox Fee Structure
We generate an increasing share of our revenue through a pricing strategy based
on a per-emailbox fee. We believe that this fee structure results in a higher
and more predictable revenue stream compared with one based on a share of
advertising revenue. Contracts with individual business customers typically
include a guaranteed revenue component and fees per emailbox based on the total
number of emailboxes and level of service provided.
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Leverage Business Accounts Through Focused Sales Force
We believe that there is a significant opportunity for us to further penetrate
and derive increasing revenues from our existing customer base. A portion of
our sales force is dedicated to building our relationships with existing
accounts, selling them product upgrades and enhancements and keeping abreast of
their growing email and messaging requirements. As our customers grow, develop
new online strategies and expand geographically, our sales force plans to
identify new ways we can offer them enhanced messaging services. We believe
this sales effort will also serve to solidify our business relationships.
Extend International Leadership
We plan to continue to aggressively market our solutions to businesses in
non-U.S. markets that we believe will experience significant growth in
Web-based email usage. We have developed multiple language interfaces for our
email services to be used in the world's most widely used non-English
languages. We have also established marketing groups in Israel, to support our
expansion in Europe and Asia, and in the United States to support our expansion
in North America and Latin America. We have a sales office in London, England
and we plan to open a sales office in Japan. Additionally, we plan to pursue
joint ventures with local partners in attractive non-U.S. markets to accelerate
our penetration globally. We believe that our multi-language capabilities,
targeted international sales efforts and experience in penetrating non-U.S.
markets positions us favorably in non-U.S. markets.
Enhance Technology Leadership in Email Services
We intend to leverage our core technology, software platform and expertise in
developing and managing a comprehensive Web-based email service to deliver
industry-leading functionality and advanced messaging services. We have
recently added new services, including calendar integration, webmaster
administration tools, message boards, list server features and HTML editing. We
also plan to offer new services including email message language translation
and integration of our email services with remote personal devices and wireless
access. We intend to continue to work closely with our customers to identify
new trends and functionality that will be popular with end users. In addition
to internal development, we plan to seek, partner with and invest in companies
developing leading edge technologies to enhance our existing functionality.
Maintain Our Cost-Effective Technology Platform
Our proprietary, open and scalable architecture gives us the flexibility to use
servers that provide us with the best cost-quality combination and to leverage
third-party hosting providers. This enables us to achieve a low service
cost-per-emailbox while maintaining a high level of service quality. We will
seek to maintain this cost-effective technology platform as we add additional
functionality and features to our solution.
Leverage Relationships with Go2Net, Vulcan Ventures and Microsoft
Go2Net, Vulcan Ventures and Microsoft have invested an aggregate of $40 million
in our Company. Go2Net and Vulcan Ventures have a joint representative on our
Board of Directors and we have entered into business relationships with both
Go2Net and Microsoft. We will seek to leverage our relationships with these
customers to expand our service offerings to them and to gain access to other
potential customers with whom they have relationships.
Services
We provide outsourced email and messaging services to customers of all sizes.
Our solutions enable these organizations to attract, retain, communicate and
conduct ecommerce with their end users.
We provide our email and messaging solutions through a variety of licensing
arrangements. These arrangements typically consist of one of the following:
o price-per-emailbox, subject to a minimum annual service fee;
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o a minimum annual service fee plus advertising revenue sharing; or
o advertising revenue sharing only.
We also provide direct marketing and communications services for a fee.
For our ZapZone Network service members, we provide our email and messaging
solutions free of charge. We currently derive revenue from this network through
advertising and direct online marketing.
Classic Service
<TABLE>
Our Classic Service provides the following features:
<CAPTION>
- ----------------------------------------------------------------------------------------------
Feature Description
- ----------------------------------------------------------------------------------------------
<S> <C>
Web-based Emailbox Includes a full range of industry-standard functionality,
such as the ability for end users to create folders, attach
electronic documents, store messages, maintain a contact
center, distribute lists, and establish user profiles and
signatures.
- ----------------------------------------------------------------------------------------------
Highly Customized Interface Customers offer our email services to their end users
with the customer's name included in the domain
address. This repeated visibility of the customer's name
promotes brand awareness and customer loyalty.
Additionally, our customers can design the look and feel
of their Web-based email interfaces with our proprietary
customization wizard tool.
- ----------------------------------------------------------------------------------------------
Unified Messaging This service enables the emailbox to become an
integrated communications platform allowing the user to
access email and send and receive voicemail messages,
faxes and pages via land or mobile phones or personal
computers.
- ----------------------------------------------------------------------------------------------
Enhanced Management Features Includes advanced email functionality such as the ability
to collect email from other email accounts, sort email
and access a sent messages folder. Also includes a draft
folder option, message notification upon login and
IMAP4 support, which allows email folders to be
accessed from multiple email environments.
- ----------------------------------------------------------------------------------------------
Contact Center Enhanced address book functionality that includes the
ability to create and manage groups and to import
personal information from the contact databases.
- ----------------------------------------------------------------------------------------------
Calendar Integration The web-based calendar feature allows users to access
their events and tasks from any browser. Functionality
includes adding, modifying, and viewing appointments,
to-do tasks, notes or events. Create recurring
appointments and tasks on a daily, weekly or monthly
basis setting notifications for upcoming events via email,
ICQ (instant messaging) or pager.
- ----------------------------------------------------------------------------------------------
Spam Protection Advanced anti-spamming controls and email filtering.
- ----------------------------------------------------------------------------------------------
</TABLE>
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<PAGE>
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------
Feature Description
- ----------------------------------------------------------------------------------------------
<S> <C>
Multiple Language Capability Our email services are provided in 18 languages:
English, Chinese (Simplified and Traditional), Japanese,
Spanish, French, German, Portuguese, Dutch, Finnish,
Danish, Norwegian, Swedish, Russian, Hebrew,
Icelandic, Korean and Italian. Additionally, we provide
spell-checking in many of these languages and can
support more than one language on any of our customer
websites, except websites using Hebrew.
- ----------------------------------------------------------------------------------------------
Kids' Email An email option that enables parents to control who
may correspond electronically with their children.
- ----------------------------------------------------------------------------------------------
Unified Registration Allows our customers to capture important demographic
information as new email users sign up in conjunction
with our customer's website registration process. As a
result, the user will be capable of entering a single
username and password for accessing other online
services offered by our customers.
- ----------------------------------------------------------------------------------------------
Integrated Instant Messaging This integrated software application enables users to
chat with one another and provide users with
notification of new messages and events.
- ----------------------------------------------------------------------------------------------
New Message Notification For the mobile professionals, important email messages
need to be alerted via offline as well as online modes.
When a new message or event arrives in a user's inbox,
a notification alert may be enabled via fax, pager, or
voicemail. Notification at login page is also available.
- ----------------------------------------------------------------------------------------------
Secure Login (SSL) Secure Socket Layer (SSL) encryption protects the
privacy of the login and password information
transferred between end-users and the email system
during sign up.
- ----------------------------------------------------------------------------------------------
Direct Marketing Tools With the Custom Mail Opt-In and Mail Target
programs, customers have access to low-cost direct
marketing tools. Includes Custom Mail Opt-In which
allows users to select specific product categories from
which to receive special offers and promotions targeted
to their interests. Also includes Mail Target which
allows our customers to send targeted marketing
messages to their email user database or to an imported
list.
- ----------------------------------------------------------------------------------------------
Online Statistics Includes around the clock online access to password
protected online email usage reports that include
detailed information on the number of daily users,
number of page views, number of active accounts, and
other important usage data for auditing and billing
purposes.
- ----------------------------------------------------------------------------------------------
</TABLE>
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<PAGE>
Premium Services
<TABLE>
Our premium services combine all of the features included in our Classic
Service, plus the following features:
<CAPTION>
- ----------------------------------------------------------------------------------------------
Feature Description
- ----------------------------------------------------------------------------------------------
<S> <C>
Offline Email Client Access End users can access their emailbox using either a Web
browser or their offline client software, such as
Microsoft Outlook or Eudora.
- ----------------------------------------------------------------------------------------------
Additional Disk Space Storage End users can increase their storage capacity up to an
additional ten megabytes of disk space to maintain more
folders and messages in their emailbox.
- ----------------------------------------------------------------------------------------------
Automated, User-Defined Incoming emails can be automatically forwarded to an
Email Forwarding alternate emailbox based on the end user's pre-set
criteria.
- ----------------------------------------------------------------------------------------------
Automated, Rules-Based Incoming emails can be automatically forwarded to the
Pager Notification end user's pager based on the end user's pre-set criteria.
- ----------------------------------------------------------------------------------------------
</TABLE>
The unified messaging, email-by-phone and IP telephony services integrate third
party technology.
Planned Services
<TABLE>
We are developing new messaging services to complement our existing services.
We actively monitor the email and communication needs of our customers and end
users and work to develop new features and enhancements to meet their evolving
requirements. The following services are currently in, or planned for,
development:
<CAPTION>
- ----------------------------------------------------------------------------------------------
Feature Description
- ----------------------------------------------------------------------------------------------
<S> <C>
Enhanced Email Security Support for SSL encryption and technologies with
enhanced anti-virus and anti-vandal security measures.
(Anticipated in the fourth quarter of 2000.)
- ----------------------------------------------------------------------------------------------
Community-Building Applications Additional functionality such as message boards and list
servers, which enable frequent communication among
end users. (Anticipated in the third quarter of 2000.)
- ----------------------------------------------------------------------------------------------
Email Message Language Email messages will be automatically translated between
Translation languages according to pre-defined user preferences.
(Anticipated in the fourth quarter of 2000.)
- ----------------------------------------------------------------------------------------------
</TABLE>
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<PAGE>
The statements in this prospectus regarding planned service offerings and
anticipated features of such offerings are forward-looking statements. Actual
service offerings and benefits could differ materially from those projected.
Direct Online Marketing Services.
We have a large and growing network of end users. As of December 31, 1999,
through our customers we serve approximately 8.4 million active emailboxes and
through our ZapZone Network service, which has over 190,000 sites registered,
we were serving approximately 1.0 million active emailboxes. This extensive
user network, along with our advanced technologies and strategic relationships,
allows us to offer value-added direct marketing services to our customers and
third parties. We currently provide the following services:
Opt-in. Users can elect to receive specific newsletters or commerce
offerings. Whenever end users choose to establish a direct communication
with one of our opt-in partners, we receive a referral fee.
MailTarget. We provide our customers with a Web-based tool which enables
them to select and send tailored messages to targeted segments of their end
user base. We earn revenues by charging customers a fee for each message
sent with this tool.
Third-party marketing programs. In addition to our own internal opt-in
program, we also provide other third-party direct marketing companies with
the opportunity to leverage our extensive user base to market their
products. We earn revenues by charging third-party direct marketing
companies a fee for each message sent.
The ZapZone Network Email Service
Our ZapZone Network service delivers email messaging solutions to small
websites and homepages. This service enables individuals and website
administrators to set up Web-based email online, often in under ten minutes.
ZapZone Network-enabled sites are able to provide our core Web-based email
services to their end users in multiple languages. Our ZapZone Network service
enables websites to collect valuable user demographic information, which
facilitates their ability to conduct targeted marketing campaigns with their
members. Webmasters can then communicate with and market to those users.
Customers
We offer email and messaging communications services to businesses worldwide.
As of December 31, 1999, we provided our email services to over 250 global
customers. Our customer base includes Internet-centric businesses like
community sites and portals, and companies where a significant online presence
is integral to the overall enterprise. These customers represent a broad range
of businesses and services and are geographically diverse. We also have
customers comprised of small websites and website owners who offer Web-based
email and messaging to their end users through our ZapZone Network service.
Sales and Marketing
Sales Strategy
Our sales strategy is to target businesses worldwide through a combination of
direct, indirect and online selling initiatives. While our salespeople are
responsible for selling our solutions in a geographic area, they often
collaborate to recruit new customers, particularly when dealing with
multinational organizations. Our sales offices are located in Santa Clara,
California, New York, New York, London, England, and Netanya, Israel. We plan
to extend our sales force into Europe and Japan within the next 12 months. Our
sales force includes salespeople who focus on acquiring new customers, as well
as dedicated salespeople who cultivate existing customers and seek to sell them
premium and other services. As of December 31, 1999, we had 30 salespeople. We
also plan to pursue joint ventures with local partners in attractive non-U.S.
markets to assist us in the penetration of those markets.
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<PAGE>
Marketing Strategy
Our marketing strategy is focused on increasing global awareness of our
solution and building our brand as a leading international provider of email
and messaging services. We plan to market our solution primarily through a mix
of print advertising, direct marketing, public relations and online
initiatives. Through our "Powered by Commtouch" co-branding of our email
solution on customers' websites, we increase our brand awareness and receive a
significant number of click-through business leads. We plan to aggressively
promote our premium services to our customers and their end users and our
direct e-marketing services to our customers and third parties. We intend to
leverage our direct sales force and develop co-branding and marketing
opportunities with other online organizations to augment our marketing efforts.
Customer Support
Commtouch provides its customers rapid callback technical support 24 hours a
day, seven days a week. We initally developed a proprietary software tool that
provides end users with immediate online support without intervention from
customer service representatives or technical staff and subsequently have begun
implementation of other customer relationship management applications. We
believe that this technical support model enables us to provide high quality
and cost-effective support service to our customers and end users.
Technology
We leverage our nine years of email and technology experience to create
world-class, robust, full-featured, reliable email solutions. We believe that
our Web-based email solutions possess three major advantages over other
Web-based email solutions:
Scalable and Reliable Modular System Architecture
Our Web-based email system is designed to provide maximum flexibility. We have
developed a system architecture consisting of three main components: Web
servers, mail servers and database servers. Web servers are responsible for the
front-end email application, mail servers are responsible for the storage and
transmittal of email messages and database servers are responsible for storing
all other important end user and customer information. These servers interact
through standard communications protocols such as HTTP, IMAP4, POP3 and SMTP
and ODBC.
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<PAGE>
Hardware Infrastructure
[GRAPHIC OMITTED]
The modularity of our network architecture provides several key technological
advantages:
Rapidly deployable and cost-effective. The design of our system enables us to
significantly reduce our deployment time as well as costs to support each
mailbox.
o We outsource server hosting and Internet backbone access to third party
providers because they are able to offer such services at bulk rates. In
addition, there are numerous third-party providers from whom we can
obtain these services, so our capacity is not limited and we are able to
obtain favorable rates. This significantly reduces our Internet
connectivity and server maintenance costs.
o The modularity of our system architecture allows us to choose from among
a broad range of industry-standard mail servers, and select the servers
with optimal price/performance characteristics. Again, we are able to
obtain these servers from a number of vendors, so our capacity is not
limited.
o The outsourcing of our server needs enables us to focus on the rapid
deployment of applications for our clients rather than on the costly and
time-consuming maintenance and development of an internal hardware
infrastructure.
o Because third-party mail servers are constantly upgraded with the most
advanced features (LDAP support, HTML messaging, etc.), we are able to
reduce our development time by leveraging existing off-the-shelf
technology and immediately integrating these features into our service
offerings.
Scalable and reliable. Our modular technology architecture enables the rapid
setup of full-service email hosting facilities and enables us to quickly and
seamlessly expand our system as our user base grows. In addition, we utilize
redundant servers and server load balancing capabilities to re-direct traffic
if a server malfunctions. Our system architecture and software platform have
been designed to provide excellent service to hundreds of millions of
emailboxes across millions of domains. We believe that our robust and flexible
technology platform enables us to maintain one of the highest service
performance levels in the industry.
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<PAGE>
Portable. As the market for outsourced email systems evolves, some
organizations may demand their own in-house hosting facility. The highly
modular nature of our system architecture provides us with the ability to
duplicate a system in another location within a period of several days. As a
result, we are well-equipped to rapidly deploy email services to this growing
subset of the outsourced email systems market.
Proprietary Development Language
We have custom-built a proprietary software development language called
Application Dynamic Markup Language (ADML) in order to maximize the flexibility
and minimize the development time of our email solutions.
The ADML environment encapsulates the functionality and layout of a generic
Web-based email interface, while allowing our developers to rapidly customize a
business partner's email system with specific features. All external resources,
such as text strings, images and site-dependent parameters are stored in
various databases. When a new site is built, the ADML code is compiled into ASP
(Microsoft's Active Server Pages technology) code which runs on the web servers
and translates the ADML code into HTML. This enables the developer to build an
email interface for a business partner without having to write a single line of
HTML code. This provides us with a competitive advantage for several reasons:
o we can add new functionality and features (languages, premium and direct
marketing services, etc.) to any business partner's existing email system
in as little as a few hours;
o we can simultaneously upgrade more than one email system (for example,
immediately making additional languages available to any end user of a
ZapZone Network service email site); and
o we can offer automated email customization tools to our end users. For
example, the ZapZone Network service takes advantage of the flexibility
provided by ADML to allow webmasters to build, customize and deploy
ready-to-use email sites in very little time.
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ADML Flow chart
[GRAPHIC OMITTED]
Advanced Proprietary Technologies
We have developed the following proprietary technologies:
o Complex Foreign Language Support. Currently, our system is fully
double-byte-enabled to handle intricate character languages such as
Chinese, Korean and Japanese, as well as right-to-left support for
languages like Hebrew and Arabic.
o Integrated Open Platform Interface. We have developed an integrated
platform and series of application programming interfaces that enable us
to rapidly and fully integrate additional communications features and
functionality into our service offering.
o Advanced Direct Marketing Technology. Our MailTarget service is a
Web-based tool which provides customers with a user-friendly method of
selecting and delivering tailored messages to a targeted segment of their
user populations.
o Customization Wizard Tool. We have developed a proprietary technology
tool which enables customers to design the look and feel of their
Web-based email interface so that it is consistent with their own brand
images.
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Competition
In the market for email and messaging services, we compete directly with
Web-based email service providers, including Critical Path, Mail.com and
USA.NET, as well as with companies that develop and maintain in-house email
solutions. In addition, companies such as Software.com currently offer email
software products to ISPs, web hosting companies, web portals and corporations.
Furthermore, numerous small-scale email providers offer low-cost basic
services, but without scalable systems or value-added functionality. These and
other companies could potentially leverage their existing capabilities and
relationships to enter the email service industry by redesigning their system
architecture, pricing and marketing strategies to sell through to the entire
market. The ability of these competitors to offer a broader suite of
complementary services may give them a considerable advantage over us. In the
future, ISPs, web hosting companies and outsourced application companies may
broaden their service offerings to include outsourced email.
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 service offerings, we may encounter
increased competition in the development and delivery of these services. Many
of our current and potential competitors have longer operating histories,
larger customer bases, greater brand recognition and greater financial,
marketing and other resources than we do and may enter into strategic or
commercial relationships on more favorable terms. Further, certain of our
competitors may offer services at or below cost. In addition, new technologies
and the expansion of existing technologies may increase competitive pressures
on us. Increased competition may result in reduced operating margins and loss
of market share.
We believe that our solution has the following competitive advantages:
o highly customizable and flexible;
o rapidly deployable;
o available in 18 languages;
o designed to integrate numerous messaging applications; and
o has the ability to effectively address multiple market needs.
However, despite our competitive positioning, we may not be able to compete
successfully against current and future competitors.
Intellectual Property
We regard our copyrights, service marks, trademarks, trade secrets and similar
intellectual property as critical to our success, and rely on trademark and
copyright law, trade secret protection and confidentiality and/or license
agreements with our employees, customers, partners and others to protect our
proprietary rights. We have the following registered trademarks: COMMTOUCH
(registered in the U.S.); PRONTO (U.S. and other countries); COMMTOUCH SOFTWARE
(Australia and New Zealand); PRONTO FAMILY, PRONTO SECURE (Japan); PRONTO MAIL
(Japan and New Zealand). We also have the following pending trademark
applications: COMMTOUCH (Israel and other countries), ZAPZONE NETWORK, ZZN
(U.S., Israel and other countries) and PRONTO (Mexico, European Community and
India). 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. Certain end user license provisions protecting against
unauthorized use, copying, transfer and disclosure of the licensed program may
be unenforceable under the laws of certain jurisdictions and foreign countries.
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
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<PAGE>
infringement of the trademarks and other intellectual property rights of third
parties by us and our licensees. Such claims, even if not meritorious, could
result in the expenditure of significant financial and managerial resources.
Our ZapZone Network service allows webmasters to select the email service name
of their choice. There is, therefore, the possibility that they will select
email service names that may infringe the rights of others under U.S. state
and/or federal or foreign trademark and/or anti-dilution or similar laws.
ZapZone Network service's placement of ZapZone Network service icons and
advertisements on ZapZone Network service webmasters' web pages may contribute
to our perceived liability for any allegedly infringing acts. We do not audit
webmasters' email service name choices for compliance with any intellectual
property rights of others. However, in our current webmaster license
agreements, we require webmasters to indemnify us for claims resulting from
their chosen email service names; we also require users to indemnify us in
their license agreements. Furthermore, in our license agreements with
webmasters and users, we expressly reserve the right to eliminate their account
or to change their email service names, in our sole discretion. We have
received complaints from several parties that email service names chosen and
registered by ZapZone Network service users are similar or identical to domain
names and/or trademarks in which the complainants claim an interest. We have
responded by reviewing the content of the complainants' complaints, and either
(a) sought additional substantiating information (b) requested a response to
the complaint from the relevant webmaster, and/or (c) changed or deleted the
email service name in question.
We also intend to continue to strategically license certain technology from
third parties, including our mail server and SSL encryption technology. In the
future, if we add certificate technology to our systems, we may license
additional technology from third-party vendors. We cannot be certain that these
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 and services. These third-party in-licenses may expose us to increased
risks, including risks associated with the assimilation of new technology, the
diversion of resources from the development of our own proprietary technology,
and our inability to generate revenues from new technology sufficient to offset
associated acquisition and maintenance costs. The inability to obtain any of
these licenses could result in delays in product and service development until
equivalent technology can be identified, licensed and integrated. Any such
delays in services could cause our business, financial condition and operating
results to suffer.
Government Regulation
There are currently few laws and regulations directly applicable to the
Internet and commercial email services. Examples include the Children's Online
Privacy Protection Act and related regulations in the U.S. and restrictions on
the export of personal data from the European Community. However, it is
possible that a number of laws and regulations may be adopted with respect to
the Internet or commercial email services covering issues such as user privacy,
pricing, content, copyright, distribution, antitrust and characteristics and
quality of products and services. Further, the growth and development of the
market for online email may prompt calls for more stringent consumer protection
laws that may impose additional burdens on companies conducting business
online. The adoption of additional laws or regulations may impair the growth of
the Internet or commercial online services, which could, in turn, decrease the
demand for our products and services and increase our cost of doing business,
or otherwise have a material adverse effect on our business, operating results
and financial condition. Moreover, the applicability to the Internet of
existing laws in various jurisdictions governing issues such as property
ownership, sales and other taxes, libel and personal privacy is uncertain and
may take years to resolve. Any such new legislation or regulation, the
application of laws and regulations from jurisdictions whose laws do not
currently apply to our business or the application of existing laws and
regulations to the Internet could have a material adverse effect on our
business, operating results and financial condition.
Employees
As of December 31, 1999, we had 214 full-time employees. None of our U.S.
employees is covered by a collective bargaining agreement. We believe that our
relations with our employees are good.
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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 work day and work
week, 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 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. Commtouch currently funds its
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. Commtouch
also provides certain 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.
Office Locations
Our principal executive offices are located at 6 Hazoran Street, Poleg
Industrial Park, Netanya 42504, Israel, where our telephone number is
011-972-9-863-6888, and 3945 Freedom Circle, Santa Clara, California 95054,
where our telephone number is (408) 653-4330. In addition, we have sales
offices in London and New York. All of our properties are leased.
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MANAGEMENT
Executive Officers and Directors
<TABLE>
The following table sets forth certain information regarding our executive
officers and directors:
<CAPTION>
Name Age Position
- ---- --- --------
<S> <C> <C>
Gideon Mantel(1) ...... 40 Chief Executive Officer and Director
Amir Lev ............... 40 President, Chief Technology Officer and Director
Isabel Maxwell ......... 49 President, Commtouch Software, Inc.
James Collins ......... 41 Chief Financial Officer and Secretary
Allan Barkat(1) ......... 40 Chairman of the Board of Directors
Yair Safrai(2) ......... 41 Director
Yoseph Sela(1)(2) ...... 47 Director
Nahum Sharfman ......... 52 Director
Richard Sorkin ......... 38 Director
Thomas Camp .............. 36 Director
<FN>
- ------------
(1) Member of the Compensation Committee
(2) Member of the Audit Committee
</FN>
</TABLE>
Other Management Employees
<TABLE>
The following table sets forth the names and positions of other management
employees:
<CAPTION>
Name Age Position
- ---- --- --------
<S> <C> <C>
Robert "Rip" Gerber ........ 37 Vice President, Marketing and Ecommerce,
Commtouch Software, Inc.
Avner Amram ................ 38 Vice President, Operations, Commtouch
Software, Inc.
Yael Elish ................. 31 Vice President, Strategic Development, Commtouch
Software, Inc.
Igor Gusak ................. 44 Vice President and General Manager, Custom Mail
(US), a division of Commtouch Software, Inc.
Yuval Neria ............... 40 Vice President, International Sales
Ronen Rosenblatt ........... 34 Vice President, Research and Development
Ronni Zahavi ............... 33 Vice President, Human Resources
Scott Slater ............... 45 Vice President, Corporate Development
</TABLE>
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.
Amir Lev is a co-founder of Commtouch and has served as its Chief Technology
Officer and as a director since its inception in 1991. Mr. Lev has also been the
General Manager of Commtouch since January 1997 and in January 2000 became
President. Mr. Lev received a B.A. in Computer Science and Economics from Hebrew
University, Jerusalem.
Isabel Maxwell has served as the President of Commtouch Software, Inc. since
February 1997. Ms. Maxwell was a co-founder, and from March 1993 to August 1996
served as the Senior Vice President of International Business Development,
Corporate Affairs and Investor Relations, of The McKinley Group Inc., an
Internet search engine company. From August 1996 to October 1996, Ms. Maxwell
was an Executive Vice President of Excite, Inc. Ms. Maxwell received a B.A. and
M.A. in History and Modern Languages from Oxford University.
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James Collins has served as the Chief Financial Officer of Commtouch since March
1999 and as the Secretary of Commtouch since April 1999. From ctober 1997 to
February 1999, Mr. Collins was a private investor. From March 1992 to December
1996, Mr. Collins served as the Chief Financial Officer and Secretary, and from
January 1997 to September 1997 as the Vice President of Operations, of Pete's
Brewing Company, a specialty brewer. Mr. Collins received a B.S. in Business
Administration from the University of the Pacific and is a Certified Public
Accountant in the State of California.
Allan Barkat has served as a Director of Commtouch since February 1996 and
Chairman of the Board of Directors since April 1999. From June 1999 to the
present, Mr. Barkat has been a Managing Director of Apax Partner Ventures
Israel, Ltd. From March 1997 to the present, Mr. Barkat has been a Managing
Director of Apax-Leumi Partners, Ltd. the investment advisor to Israel Growth
Fund, LP, a technology-focused venture capital fund. From January 1995 to March
1997, Mr. Barkat served as an Assistant Director of Apax-Leumi Partners Ltd.
From 1992 to 1994, Mr. Barkat served as Vice President of Marketing & Sales of
DSP Communications Group, Inc., a wireless semiconductor company. Mr. Barkat
has also served as a director of Fundtech Ltd. Mr. Barkat received a B.Sc. from
the Technion, Haifa.
Yair Safrai has served as a Director of Commtouch since January 1999. From
September 1996 to the present, Mr. Safrai has been the Managing Partner of
Concord Ventures, a technology-focused venture capital fund. From July 1994 to
September 1996, Mr. Safrai served as Vice President of Nitzanim, a venture
capital fund. Mr. Safrai received a B.A. in Management and Economics from Tel
Aviv University, an M.A. from the University of Pennsylvania, and an M.B.A.
from the Wharton Business School, University of Pennsylvania.
Yoseph Sela has served as a Director of Commtouch since February 1996. From
January 1993 to the present, Mr. Sela has served as Executive Vice President of
Gemini Capital Fund Management, a technology-focused venture capital fund. Mr.
Sela received a B.Sc. from the Technion, Haifa and an M.B.A. from Tel Aviv
University.
Nahum Sharfman will join 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
stepped down as Chief Executive Officer to become a founder of Dealtime.com.
Mr. Sharfman remained Chairman of the Board of Commtouch until he resigned in
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,
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.
Thomas Camp has served as a Director of Commtouch since July 1999. Since April
1999, Mr. Camp has served as Vice President, Business Development at Go2Net, a
network of branded, technology-and community-driven websites. From September
1990 to April 1999, he was an attorney with the law firm of Hutchins, Wheeler &
Dittmar, most recently as a stockholder. Mr. Camp received a B.A. from Tufts
University, an M.B.A. from Boston College Graduate School of Management and a
J.D. from Boston College Law School. Go2Net and Vulcan Ventures Incorporated
entered into an agreement with us in which they purchased shares and received a
warrant to purchase additional shares. Under that agreement, they have the
right to name one director to our board, as long as they continue to hold at
least 25% of their combined number of shares and the shares available to Go2Net
upon exercise of the warrant. Mr. Camp was appointed to the board pursuant to
that agreement.
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<PAGE>
Robert "Rip" Gerber has served as Vice President, Marketing and Ecommerce of
Commtouch Software, Inc. since March 1999. Mr. Gerber was the founder of @Once,
an email direct marketing company, and from February 1998 to February 1999
served as its President. From September 1995 to January 1998, Mr. Gerber served
as Managing Director of Pantheon Consulting Group LLC, a marketing and planning
services company. From August 1992 to August 1995, Mr. Gerber was a consultant
for Deloitte & Touche LLP, a public accounting firm. Mr. Gerber received a B.S.
in Chemical Engineering from the University of Virginia and an M.B.A. from
Harvard Business School.
Avner Amram has served as Vice President, Operations of Commtouch Software,
Inc. since April 1999. Mr. Amram was Director of Operations of Commtouch
Software, Inc. from March 1998 to April 1999 and a Software Team Leader from
March 1996 to March 1998. Mr. Amram received a B.Sc. in Computer Science from
the Technion, Haifa.
Yael Elish has served as the Vice President, Strategic Development of Commtouch
Software, Inc. since April 1999. Ms. Elish was Commtouch's Director of Business
Development from August 1998 to March 1999 and was Commtouch's Director of
Sales from December 1996 to August 1998. From August 1993 to August 1996, Ms.
Elish was a Marketing Manager of Widecom Ltd., a provider of Internet
integration services and software development. Ms. Elish received a B.A. in
International Relations from Hebrew University in Jerusalem.
Igor Gusak has served as the Vice President and General Manager, Custom Mail
(US), a division of Commtouch Software, Inc., since April 1999. Dr. Gusak was
the Director of Sales and Marketing
of Commtouch from February 1997 to March 1999 and the Director of Original
Equipment Manufacturer Sales for Commtouch from January 1995 to January 1997.
Dr. Gusak received a Ph.D. in Mathematics from Urals University, Ekaterinburg,
Russia.
Yuval Neria has served as the Vice President, International Sales of Commtouch
since April 1999. Mr. Neria was the Director of International Marketing and
Sales for Commtouch from March 1997 to April 1999, the Director of Pacific Rim
Operations for Commtouch from March 1996 to April 1997, a Product Manager for
Commtouch from March 1995 to April 1996, and a Quality Assurance Manager for
Commtouch from March 1993 to April 1995. Mr. Neria received a B.A. in Computer
Science from the City University of New York.
Ronen Rosenblatt has served as the Vice President, Research and Development of
Commtouch since April 1999. Mr. Rosenblatt served as the Director of Research
and Development for Commtouch from November 1994 to March 1999. Mr. Rosenblatt
received a B.Sc. in Electronics and Computer Engineering from Tel Aviv
University.
Ronni Zahavi has served as a Vice President Human Resources for Commtouch
Software Ltd. since July 1999. From June 1997 to July 1999, Mr. Zehavi was
Human Resources and Training Manager at Mondex -- Electronic Cash, a subsidiary
of Mastercard International. From January 1994 to June 1997, he was an
organizational consultant. Mr. Zehavi received his BA in Educational Psychology
and History from Tel Aviv University, and received his M.A. in Organizational
Sociology from Bar-Ilan University.
Scott Slater has served as the Vice President, Corporate Development of
Commtouch since December 1999. From February 1998 to December 1999, Mr. Slater
was Senior Vice President, Business Development for NewsReal, Inc. and from
September, 1996 to February, 1998, Mr. Slater was President and Chief Executive
Officer of O2Works, Inc. Mr. Slater studied psychology at Boston University
from 1972 to 1976.
Election of Directors
Directors are elected by shareholders at the annual general meeting of the
shareholders and hold office until the annual general meeting next following
the annual general meeting or general meeting at which such Director is elected
and until his successor is elected or until he is removed. An annual general
meeting shall be held at least once in every calendar year, but not more than
fifteen months after the last preceding annual general meeting. Directors may
be removed and other directors may
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<PAGE>
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 as aforesaid,
the Board of Directors may appoint new directors temporarily to fill vacancies
on the Board of Directors. The Articles of Association of Commtouch authorize
nine directors or such greater number as may be determined from time to time by
an ordinary resolution of the shareholders. 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, and the alternate is not entitled to
remuneration. A person who is not qualified to be appointed as a director, or a
person who already serves as a director or an alternate director, may not be
appointed as an alternate director. Unless the appointing director limits the
time or scope of the appointment, the appointment is effective for all purposes
until the appointing director ceases to be a director or terminates the
appointment. The appointment of an alternate director does not in itself
diminish the responsibility of the appointing director as a director.
Independent and Outside Directors
The new Israeli Companies Law, which took effect on February 1, 2000, 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, as that term is defined in the Companies
Law, 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 her appointment or if she violates her fiduciary duty to the
company. Each committee of a company's Board of Directors must include at least
one outside director. 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.
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<PAGE>
In addition, the Nasdaq National Market requires us to have at least two
independent directors on our Board of Directors and to establish an audit
committee, at least a majority of whose members are independent of management.
We intend to appoint new directors who will qualify both as independent
directors under the Nasdaq National Market requirements and as outside directors
under the Companies Law at our next annual shareholders meeting, which will be
held no later than August 1, 2000.
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. An audit committee may
not approve an action or a transaction with a controlling shareholder, or with
an office holder, unless at the time of approval two outside directors are
serving as members of the audit committee and at least one of the outside
directors was present at the meeting in which an approval was granted.
Internal Auditor
Under the Companies Law, the Board of Directors must appoint an internal
auditor, nominated by the audit committee. The role of the internal auditor is
to examine, among other matters, whether the company's actions comply with the
law and orderly business procedure. Under the Companies Law, the internal
auditor may be an employee of the company but not an office holder, or an
affiliate, or a relative of an office holder or affiliate, and he or she may
not be the company's independent accountant or its representative.
Compensation Committee Interlocks and Insider Participation
The Compensation Committee, which was established by the Board in January 1996,
is responsible for determining salaries, incentives and other forms of
compensation for our 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 outside
directors. Allan Barkat and Yoseph Sela are currently the two outside directors
on our Compensation Committee.
Conflicts of interest may arise as a consequence of the relationship of one of
our directors, Thomas Camp, with Vulcan and Go2Net, including conflicts related
to corporate opportunities that could be pursued by us, on the one hand, or by
Go2Net, Vulcan Ventures or their affiliates, on the other hand, or conflicts
related to existing or new contractual relationships between us, on the one
hand, or by Go2Net, Vulcan Ventures or their affiliates, on the other hand.
Transactions between us and our officers and directors, and extraordinary
transactions between us and our principal shareholders or a third party if a
principal shareholder has a personal interest in such transaction generally
require the approval of a majority of the board of directors, including a
majority of the independent and disinterested outside directors, and in some
circumstances, audit committee and shareholder approvals as well (See "Approval
of Certain Transactions").
Compensation of Officers and Directors
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 at a general meeting. 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 (10 persons) in 1999 was approximately $800,000. During the
same period Commtouch accrued or set
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<PAGE>
aside approximately $27,000 for the same group to provide pension, retirement
or similar benefits. As of February 29, 2000, directors and executive officers
of Commtouch (10 persons) held stock options to purchase an aggregate of
466,180 ordinary shares.
U.S. Stock Option Plan
Our 1996 CSI Stock Option Plan, which is the plan for U.S. employees and
consultants, is administered by our Compensation Committee. Our Compensation
Committee consists of at least two directors who are non-employee directors, as
that term is defined in Rule 16b-3. The Board of Directors may amend the option
plan as desired without further action by Commtouch's shareholders, except as
required by applicable law. The plan will continue in effect until terminated
by the Board or until January, 2006.
The consideration for each award under the plan is established by the
Compensation Committee, and in no event shall the exercise price for ISOs be
less than 100% of the fair market value of the underlying stock on the date of
grant. Awards have such terms and are exercisable in such manner and at such
times as the Compensation Committee may determine. Typically, an option granted
under the plan vests with respect to one-fourth of the shares subject to the
option on the first anniversary of the grant date and with respect to 1/36 of
the remaining shares each month thereafter. However, the Compensation Committee
may, in its discretion, permit an optionee to exercise unvested options,
provided that such shares are subjected to a right of repurchase in favor of
Commtouch Software, Inc. according to the original vesting schedule. Each ISO
expires not more than 10 years from the date of grant.
The 1996 CSI Stock Option Plan had originally reserved 1,000,000 shares for
issuance under the plan. In April of 1999, the Board of Directors amended the
Plan to provide for a pool of 5,000,000 shares which may be issued under the
1996 CSI Stock Option Plan, the 1999 Israeli Share Option Plan, and the Israeli
Option Agreements issued to Israeli employees.
Israeli Option Agreements and 1999 Israeli Share Option Plan
To date we have granted options to Israeli employees and consultants pursuant to
individual option agreements (the "Israeli Option Agreements") rather than
pursuant to a stock option plan. Typically, options granted pursuant to the
Israeli Option Agreements vest in four equal annual installments and expire no
later than ten years from the date of grant. Substantially all of the Israeli
Option Agreements provide that only the grantee can exercise options under the
Israeli Option Agreements, and the grantee cannot assign or transfer the
options. Moreover, if a grantee ceases to be employed by Commtouch on a full
time basis, then the grantee will have a limited period from the cessation of
employment in which to exercise any vested options. Grantees are responsible for
paying all taxes and mandatory payments upon the exercise of options.
In connection with the initial public offering, the Board of Directors has
approved the 1999 Section 3(i) Share Option Plan (the "1999 Israeli Share
Option Plan"). The 1999 Israeli Share Option Plan will be administered by the
Board of Directors, or by a Share Option Committee appointed by the Board of
Directors (currently the Compensation Committee). The Board or the committee
has full power to designate the persons entitled to receive options and the
terms and provisions of the option agreements (including the number and price
of shares subject to each grant and the acceleration of the right of an
optionee to exercise in whole or in part any previously granted option).
Typically, an option granted under the plan vests with respect to one-fourth of
the shares subject to the option on the first anniversary of the grant date and
with respect to one-36th of the remaining shares each month thereafter. Options
are exercisable only during the lifetime of the optionee, and are not
transferable other than by will or laws of descent.
Outstanding Options
As of February 29, 2000, stock options to purchase 2,829,342 ordinary shares had
been granted to employees, consultants, executive officers and nonemployed
directors under the Company's stock option plans, net of cancelled options. Of
that number 1,751,972 had not been exercised and had exercise prices ranging
from $1.45 to $48.56 per share and a weighted average per share exercise price
of $23.26, and were held by 271 persons; these options have termination dates
ranging from April 2005 to February 2010.
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<PAGE>
Certain of the option agreements for options granted to employees (pursuant to
the Israeli Option Agreements) and to key employees (pursuant to the 1996 CSI
Stock Option Plan) provide for acceleration of vesting in a change of control.
Pursuant to these agreements, 50 percent of such an employee's unvested options
will vest at the closing of the change of control. In such event, the remainder
of the unvested options, if granted pursuant to an Israeli Option Agreement,
shall be subject to the vesting provisions set forth in the Israeli Option
Agreement, and if granted pursuant to the 1996 CSI Stock Option Plan, shall
vest on the first anniversary of the change of control.
The total number of shares which can be issued under our 1999 Israeli Share
Option Plan, 1996 CSI Stock Option Plan and the Israeli Option Agreements
previously issued to Israeli employees is 5,000,000. The remaining 2,876,850
shares will be allocated from time to time by the Board of Directors to the
1999 Israeli Share Option Plan and the 1996 CSI Stock Option Plan.
Employee Stock Purchase Plan
Our 1999 Employee Stock Purchase Plan, or ESPP, which was adopted by our board
of directors on April 18, 1999 and was approved by our shareholders on June 8,
1999, took effect upon the closing of the initial public offering. The ESPP
provides employees with an opportunity to purchase ordinary shares of Commtouch
through accumulated payroll deductions. We have reserved 150,000 ordinary
shares for issuance under the ESPP, of which 26,219 shares were issued on
February 15, 2000. The number of ordinary shares reserved shall be increased
each January 1 by 110 percent of the number of shares purchased under the ESPP
in the previous year. The ESPP is intended to qualify for favorable tax
treatment under Section 423 of the Internal Revenue Code. Generally, the ESPP
will be implemented through a series of offering periods of 24 months'
duration, with new offering periods commencing on the first trading day on or
after February 15 and August 15 of each year. However, the first offering
period will commence on the first business day on which price quotations for
Commtouch's ordinary shares are available on the Nasdaq National Market and
will expire on August 14, 2001. Each 24-month Offering Period will contain four
six-month Purchase Periods, starting on each February 15 and August 15.
However, the first Purchase Period will commence on the first trading day after
the closing of the offering and will end on February 14, 2000. Shares may be
purchased at the end of each purchase period.
The ESPP will be administered by a plan administrator appointed by our Board of
Directors. Each employee of ours or of any majority-owned subsidiary of ours
who is customarily employed by us or a majority-owned subsidiary for more than
20 hours per week and more than five months per calendar year will be eligible
to participate in the ESPP. No employee shall be permitted to participate in
the ESPP:
o if such employee, immediately after his or her election to participate,
would own shares possessing five percent or more of the total combined
voting power or value of all classes of stock of the Company; or
o if under the terms of the ESPP the right of the employee to purchase
shares would accrue at a rate that exceeds $25,000 of the fair market
value of such shares for each calendar year for which such right is
outstanding.
The ESPP permits an eligible employee to purchase ordinary shares through
payroll deductions, which may not exceed 15 percent of his or her compensation,
including incentive compensation, commissions and other bonuses. The shares are
purchased at a price equal to 85 percent of the lesser of:
o the fair market value of the ordinary shares at the beginning of the
offering period (provided, however, in the case of the first offering
period, this number is the price per share at which the ordinary shares
were offered to the public in the initial public offering); or
o the fair market value of the ordinary shares at the end of each purchase
period.
Employees may terminate their participation in the ESPP at any time during the
offering period; they may change their level of participation in the ESPP only
one time during the offering period. Participation in the ESPP terminates
automatically on the participant's termination of employment with us.
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In the event of a merger, consolidation, dissolution or liquidation of the
Company, the ESPP shall terminate unless the plan of merger, consolidation or
reorganization provides otherwise. The Board of Directors shall have the right
to amend, modify or terminate the ESPP at any time, except in cases where
shareholder approval is required by law.
1999 Nonemployee Directors Stock Option Plan
Our 1999 Nonemployee Directors Stock Option Plan (Directors Plan), which was
adopted by our board of directors on April 18, 1999 and was approved by our
shareholders on June 8, 1999, took effect upon the closing of the initial
public offering. Under the 1999 Nonemployee Directors Stock Option Plan,
nonemployee members of the board of directors are eligible for automatic option
grants. The Directors Plan will continue in effect until terminated by the
Board or until the tenth anniversary of its effective date.
A maximum of 250,000 ordinary shares has been authorized for issuance under the
Directors Plan. No shares have yet been issued under the Directors Plan. The
Board of Directors, or a committee consisting of at least two nonemployee
directors, will make all administrative determinations under the Directors
Plan.
Each individual who first joins the Board of Directors as a nonemployee
director on or after the effective date of the initial public offering will
receive at that time an option grant for 10,000 ordinary shares. In addition,
on the date of the first board meeting immediately following the annual
shareholders meeting, commencing with the annual shareholders meeting held in
2000, the Company shall grant to each nonemployee director then in office
(other than nonemployee directors who received their initial 10,000 share grant
under the plan on or after the record date for such annual meeting) an option
to purchase 10,000 ordinary shares. In 1999, the grant was made on the first
business day on which price quotations for Commtouch's ordinary shares were
available on the Nasdaq National Market, and the fair market value of the
ordinary shares on that day is the price at which ordinary shares were offered
to the public on that day. Each option granted under the Directors Plan shall
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. Each option will have an exercise price equal to the fair market
value of the ordinary shares on the grant date of such option. Each option will
have a maximum term of ten years, but will terminate earlier if the optionee
ceases to be a member of the Board of Directors. In the event of such earlier
termination, an optionee may exercise options held at the date of termination
to the extent then exercisable, within three months after such date, but not
thereafter; provided, however, the optionee has two years from the date of
termination to exercise vested options if such termination is due to death or
disability. Each option will vest automatically upon a change in control.
401(k) Plan
The Company has adopted the Commtouch Software, Inc. 401(k) Savings Plan (the
"401(k) Plan"), which is intended to qualify under Section 401 of the Internal
Revenue Code of 1986, as amended. All full-time employees of Commtouch
Software, Inc. are eligible to participate in the 401(k) Plan at any time after
their date of hire. Participants may make pre-tax contributions to the 401(k)
Plan of up to 20% of their gross wages, subject to a statutory prescribed
annual limit. Each participant will be fully vested in his or her
contributions. The Company may make matching contributions on a discretionary
basis to fund the 401(k) Plan. Any employer contributions would be vested under
a 6-year graded schedule. Contributions by the Company, if any, will be
generally deductible by the Company when made. Contributions by the
participants or the Company to the 401(k) Plan and the income earned on such
contributions will be held in trust as required by law. Individual participants
may direct the trustee to invest their accounts in authorized investment
alternatives.
Approval of Certain Transactions
The Companies Law codifies the fiduciary duties that office holders, including
directors and executive officers, owe to a company. An office holder, as
defined in the Companies Law, is a director, general
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<PAGE>
manager, chief business manager, deputy general manager, vice general manager,
chief business manager, executive vice president, vice president, other manager
directly subordinate to the managing director or any other person assuming the
responsiblities of any of the foregoing positions without regard to the
person's title. 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 table under "Management" above is an office holder. Under the
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 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, as
defined under Israeli law, 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 which 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 provides
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 of Directors 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
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. This
provision shall not apply to companies whose shares are publicly traded abroad
until August 1, 2000. 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 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 that 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.
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<PAGE>
Under the 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, voting in the general meeting of
shareholders on the following matters:
o any amendment to the Articles of Association;
o an increase of the company's authorized share capital;
o a merger; or
o approval of interested party transactions that require shareholder
approval.
In addition, any controlling shareholder, any shareholder who can determine the
outcome of a shareholder vote and any shareholder who, under the company's
Articles of Association, can appoint or prevent the appointment of an office
holder, is under a duty to act with fairness towards the company. The Companies
Law does not describe the substance of this duty.
For information concerning the direct and indirect personal interests of some
of our office holders and principal shareholders in transactions with us, see
"Certain Relationships and Related Transactions." See also "Anti-Takeover
Provisions Under Israeli Law" below.
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 fiduciary duty to the company, to the extent that he 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 committed in connection with his serving
as an Office Holder. Moreover, a company can indemnify an Office Holder for (a)
monetary liability imposed upon him 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 imposed upon him by a court, in an
action, suit or proceeding brought against him 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 was convicted, in each case in connection
with his activities as an Office Holder.
The Articles of Association of Commtouch allow Commtouch to insure and
indemnify Office Holders to the fullest extent permitted by law provided such
insurance or indemnification is approved by the Audit Committee. The
Registration Rights Agreement which we entered into with Go2Net and Vulcan,
contains certain provisions relating to indemnification of our directors and
officers.
Certain members of our management team are officers of our subsidiary,
Commtouch Software, Inc. a California corporation, or reside in California. The
Articles of Incorporation of Commtouch Software, Inc. provide that the
liability of the directors of Commtouch Software, Inc. for monetary damages
shall be eliminated to the fullest extent permissible under California law and
that the corporation is authorized to provide for the indemnification of agents
of the corporation, as defined in Section 317 of the California General
Corporation Law, in excess of that expressly permitted by Section 317 for
breach of duty to the corporation and its shareholders to the fullest extent
permissible under California law.
With respect to all proceedings other than shareholder derivative actions,
Section 317 permits a California corporation to indemnify any of its directors,
officers or other agents only if such person acted in good faith and in a
manner such person reasonably believed to be in the best interests of the
corporation and, in the case of a criminal proceeding, had no reasonable cause
to believe the conduct of such person was unlawful. In the case of derivative
actions, a California corporation may indemnify any of its directors, officers
or agents only if such person acted in good faith and in a manner such person
believed to be in the best interests of the corporation and its shareholders.
Furthermore, in derivative actions, no indemnification is permitted (i) with
respect to any matter with respect to which the person to be indemnified has
been held liable to the corporation, unless such indemnification is approved by
the court; (ii) of amounts paid in settling or otherwise disposing of a pending
action
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<PAGE>
without court approval; or (iii) of expenses incurred in defending a pending
action which is settled or otherwise disposed of without court approval. To the
extent that a director, officer or agent of a corporation has been successful
on the merits in defense of any proceeding for which indemnification is
permitted by Section 317, a corporation is obligated by Section 317 to
indemnify such person against expenses actually and reasonably incurred in
connection with the proceeding.
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<PAGE>
CERTAIN TRANSACTIONS
Relationship with Go2Net
Concurrent with the closing of the initial public offering, our U.S.
subsidiary, Commtouch Software, Inc., entered into a Customized Web-based Email
Service Agreement with Go2Net. Under that agreement, we provide customer email
services, including calendaring and other products and services, to end users
of Go2Net's various properties, which may include cable subscribers of Charter
Communications and its affiliates, users of services offered by High Speed
Access Corp. and any browser, website, ISP or similar service that Go2Net
sponsors or provides content to. Under the agreement, Commtouch hosts, serves
and maintains the email, calendaring and other services and Go2Net sells
advertising to be displayed in the products and services. Go2Net will pay
Commtouch a share of revenues from advertising generated from email,
calendaring or other services and related upgrades provided by Commtouch for
Go2Net's users. The agreement between Commtouch and Go2Net has a three year
duration, but Go2Net has the right on each anniversary to terminate the
agreement. Go2Net also has the right to terminate the agreement if there are
technical problems with the products or services provided by Commtouch. The
performance specifications set forth in the agreement include requiring us to
maintain certain levels of email system availability and response time, as well
as technical support to Go2Net's email end users and to Go2Net, among other
things.
In connection with entering into the email services agreement, we issued to
Go2Net 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 email service
agreement.
Concurrent with our entering into the email services agreement, we issued $13.3
million in ordinary shares to Go2Net and $6.7 million in ordinary shares to
Vulcan Ventures in a private placement at $14.88 per share. Pursuant to the
share purchase agreement, Go2Net 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 Go2Net upon exercise of the warrant. Mr. Camp was appointed
to the board pursuant to that agreement. 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.
Ordinary Share Financings
Mr. Yiftah Atir, a director of Commtouch, is a Managing Director of Evergreen
Canada Management Ltd., the general partner of Harbour Vest-Evergreen L.P.
Pursuant to several Share Purchase Agreements we issued and sold ordinary
shares to Evergreen Canada Israel Investments and Company Ltd., Yarok Ad Fund
Investment Partnership L.P. and Gmul Investment Company Ltd (the "Evergreen
Investors"). These shares were subsequently converted into Series A Convertible
Preferred Shares and certain of these shares were transferred to
HarbourVest-Evergreen L.P.
Preferred Share Financings
Series B Convertible Preferred Shares. Mr. Yoseph Sela, a director of
Commtouch, is an Executive Vice President of Gemini Capital Fund Management,
which manages Gemini Israel Fund L.P. ("GIF"), and Mr. Allan Barkat, also a
director of Commtouch, is a Managing Director of Apax-Leumi Partners, which is
the investment advisor to Israel Growth Fund L.P. ("IGF"). Pursuant to a
Preferred Share Purchase Agreement entered into in January 1996, we issued and
sold 51,085 Series B Convertible Preferred Shares and 13,873 warrants for
Series B Convertible Preferred Shares to IGF, GIF, Dr. Ed Mlavsky, Mr. Yoseph
Sela, and certain of the Evergreen Investors for a total investment of
approximately $2.3 million. The Evergreen Investors subsequently transferred
their shares to HarbourVest Evergreen L.P.
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<PAGE>
Series C Convertible Preferred Shares. Mr. Yair Safrai, a director of Commtouch,
is a Managing Partner of Concord Ventures, which manages the Concord Funds (as
defined below). Pursuant to Preferred Share Letter Agreements entered into in
December 1998 and February 1999, we issued and sold (i) 41,570 Series C
Convertible Preferred Shares to k.t. Concord Venture Fund (Cayman) L.P., k.t.
Concord Venture Fund (Israel) L.P., k.t. Concord Venture Advisors (Cayman) L.P.
and k.t. Concord Venture Advisors (Israel) L.P. (the "Concord Funds"), for a
total investment of approximately $3.0 million; (ii) 16,249 Series C Convertible
Preferred Shares to IGF for a total investment of approximately $1.2 million;
and (iii) 12,779 Series C Convertible Preferred Shares to GIF for approximately
$922,000.
Option Exercises and Purchases of Shares Subject to Repurchase By Certain
Officers
Gideon Mantel is the Chief Executive Officer and a Director of Commtouch. On
March 17, 1999, Mr. Mantel exercised certain options granted to him by
Commtouch. In consideration for the ordinary shares purchased pursuant to the
exercise of the options, he provided Commtouch with a full-recourse promissory
note dated March 17, 1999 in the original principal amount of $341,272. The
promissory note bears interest at 4.83% annually, with payments of interest only
due on March 17 of each year and with the balance due and payable on the fourth
anniversary of the date of the promissory note. This loan was used by Mr. Mantel
to purchase 286,120 ordinary shares of Commtouch at a weighted average purchase
price of $1.19 per share. The promissory note is collateralized by a pledge of
the stock purchased. The outstanding principal amount of the note as of February
29, 2000 is $341,272.
Isabel Maxwell is the President of Commtouch Software, Inc. On March 17, 1999,
Ms. Maxwell exercised certain options granted to her by Commtouch. As
consideration for the ordinary shares purchased pursuant to the exercise of the
options, she provided Commtouch with a full-recourse promissory note dated March
17, 1999 in the original principal amount of $295,858. 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 Ms. Maxwell to purchase
204,040 ordinary shares of Commtouch at a purchase price of $1.45 per share. The
promissory note is collateralized by a pledge of the stock purchased. The
outstanding principal amount of the note as of February 29, 2000 is $295,858.
James Collins is the Chief Financial Officer of Commtouch. On March 17, 1999,
Mr. Collins exercised certain options granted to him by Commtouch. As
consideration for the ordinary shares purchased pursuant to the exercise of the
options, Mr. Collins provided Commtouch with a full-recourse promissory note
dated March 17, 1999 in the original principal amount of $137,112. 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.
Collins to purchase 94,560 ordinary shares of Commtouch at a purchase price of
$1.45 per share. The promissory note is collateralized by a pledge of the stock
purchased. The outstanding principal amount of the note as of February 29, 2000
is $137,112.
Robert "Rip" Gerber is the Vice President of Marketing and Ecommerce of
Commtouch Software, Inc. On March 17, 1999, Mr. Gerber exercised certain options
granted to him by Commtouch. As consideration for the ordinary shares purchased
pursuant to the exercise of the options, Mr. Gerber provided Commtouch with a
promissory note dated March 17, 1999 in the original principal amount of
$103,617. The full-recourse 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. Gerber to purchase 71,460 ordinary shares of Commtouch
at a purchase price of $1.45 per share. The promissory note is collateralized by
a pledge of the stock purchased. The outstanding principal amount of the note as
of February 29, 2000 is $103,617.
Scott Slater is the Vice President of Corporate Development of Commtouch
Software, Inc. On December 3, 1999, Mr. Slater exercised certain options
granted to him by Commtouch. As consideration for the ordinary shares purchased
pursuant to the exercise of the options, Mr. Slater
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provided Commtouch with a full-recourse promissory note dated December 3, 1999
in the original principal amount of $150,000. The promissory note bears interest
at 4.83% annually, with payments of interest only due on December 3 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. Slater to purchase 7,500 ordinary
shares of Commtouch at a purchase price of $20.00 per share. The promissory note
is collateralized by a pledge of the stock purchased. The outstanding principal
amount of the note as of February 29, 2000 is $150,000.
Loan to Dr. Nahum Sharfman and Relationship among Commtouch and DealTime.com
Ltd., Dr. Nahum Sharfman and Amir Ashkenazi
Dr. Nahum Sharfman was a co-founder of Commtouch and served as a director and
Chairman of the Board of Directors of Commtouch from inception until January
1999. Dr. Sharfman also served as the Chief Executive Officer of Commtouch
until March 31, 1998. Dr. Sharfman rejoined the Board as a director in March
2000. On December 31, 1995, Commtouch made a loan of approximately $58,000 to
Dr. Sharfman. The loan plus linkage to the Israeli Consumer Price Index was to
have been repaid within three years, or within 30 days of the termination of
Dr. Sharfman's employment, if earlier. At December 31, 1998 the outstanding
balance of this loan was approximately $55,000, payable in NIS.
In 1997 Dr. Sharfman established DealTime.com Ltd. (formerly known as
Papricom), together with Mr. Amir Ashkenazi, a former employee of Commtouch.
During an interim period in which Commtouch and DealTime.com Ltd. were
negotiating a technology exchange agreement, which ultimately was not signed,
Commtouch provided DealTime.com Ltd. with certain services (office and
secretarial services, computers and other facilities including, without
limitation, all payments made for or on behalf of DealTime.com Ltd.) and access
to certain of Commtouch's technology. At the request of DealTime.com Ltd.,
Commtouch also entered into a Product Distribution Agreement (the "Stock Alert
Agreement") with News Alert Inc. DealTime.com has provided technical support
and services to News Alert Inc. in connection with the Stock Alert Agreement.
Commtouch has entered into three agreements to clarify the rights and
obligations of Commtouch, DealTime.com, Dr. Sharfman and Mr. Amir Ashkenazi.
Under the first agreement, Dr. Sharfman and Mr. Ashkenazi acknowledge that
Commtouch is the sole owner of all of their inventions invented during their
employment with Commtouch and for two years following the termination of their
employment, which inventions relate to Commtouch's business and research
activities as of April 1, 1998 (except in the field of e-commerce). They also
acknowledge Commtouch's rights to inventions that result from work that they
performed for Commtouch at any time, or which are the subject matter of a
specified patent application. Dr. Sharfman and Mr. Ashkenazi also agreed not to
compete with Commtouch's actual business and research activities as they were on
April 1, 1998 (except in the field of e-commerce), through March 31, 2000.
The second agreement, which is between Commtouch and DealTime.com Ltd.,
confirms that DealTime.com Ltd. shall be solely responsible for all obligations
of Commtouch under the Stock Alert Agreement. DealTime.com Ltd. also
acknowledges that Commtouch is the sole owner of the Multimedia Desktop
Software Technology that Commtouch developed and that was licensed to News
Alert Inc., and Commtouch grants DealTime.com Ltd. a royalty-free,
non-exclusive, limited license to use that technology to provide support
services under the Stock Alert Agreement. DealTime.com Ltd. also agreed to pay
$50,000 to Commtouch for all of the services rendered by Commtouch and for the
license fees that DealTime.com Ltd. received under the Stock Alert Agreement,
and to divide any future revenues and license fees received under the Stock
Alert Agreement equally with Commtouch. Commtouch, for its part, waived any
claim to an equity interest in DealTime.com Ltd., and agreed that it does not
own intellectual property developed by DealTime.com Ltd. other than in breach
of the agreements with DealTime.com Ltd. and Messrs. Sharfman and Ashkenazi.
Finally, Commtouch and Dr. Sharfman entered into a Termination of Employment
Agreement requiring the repayment by Dr. Sharfman of Commtouch's loan to him by
December 31, 1999 and the release to Dr. Sharfman of funded and unfunded
severance pay within 20 days of the date of approval
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<PAGE>
of the Termination of Employment Agreement by our shareholders and containing a
waiver by Dr. Sharfman of any rights under stock options that were granted to
him. Dr. Sharfman repaid the loan and Commtouch released the severance payments
in the third quarter of 1999.
Loan to Amir Lev
Amir Lev has been a director and executive officer of Commtouch since its
inception in 1991. In 1999, Mr. Lev exercised options for Commtouch ordinary
shares. We loaned him $364,000 so that he could make an estimated tax payment
in connection with this option. This full recourse loan was linked to the
Israeli Consumer Price Index and interest accrued at a rate of 2% per annum.
The loan was repaid in full on February 10, 2000.
Amendment to Registration Rights Agreement
The Company and certain shareholders are parties to a registration rights
agreement. On March 10, 2000, the Company and these shareholders amended the
registration rights agreement to provide piggyback registration rights to James
Collins, Amir Lev, Gideon Mantel, Isabel Maxwell and Nahum Sharfman for this
offering as long as it is closed within 60 days of the date of the amendment.
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PRINCIPAL AND SELLING SHAREHOLDERS
The following table presents information with respect to beneficial ownership
of our ordinary shares as of February 29, 2000 and as adjusted to reflect the
sale of the shares offered by this prospectus by:
o each person or entity known to Commtouch to own beneficially more than
five percent of Commtouch's ordinary shares,
o each of our directors and officers known to Commtouch to own beneficially
more than one percent of Commtouch's ordinary shares,
o all executive officers and directors as a group, and
o the Selling Shareholders.
The table includes all shares issuable within 60 days of February 29, 2000 upon
the exercise of options, warrants and other rights beneficially owned by the
indicated shareholders on that date. Beneficial ownership is determined in
accordance with the rules of the Securities and Exchange Commission and includes
voting and investment power 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 with respect to
all shares beneficially owned. The applicable percentage of ownership for each
shareholder is based on 16,462,449 ordinary shares outstanding as of February
29, 2000, (assuming in each case the issuance of 901,471 ordinary shares upon
the assumed net exercise at an assumed share price of $62.00 per share of the
in-the-money warrant to purchase 1,136,000 ordinary shares issued to Go2Net at
an exercise price of $12.80 per share) and 18,131,449 ordinary shares
outstanding immediately following the completion of this offering, assuming no
exercise of the underwriters' over-allotment option, together with applicable
options and/or warrants for that shareholder. Ordinary shares issuable upon
exercise of options and other rights beneficially owned are deemed outstanding
for the purpose of computing the percentage ownership of the person holding
those options and other rights, but are not deemed outstanding for computing the
percentage ownership of any other person.
<TABLE>
<CAPTION>
Shares Beneficially Shares Beneficially
Owned Prior to Offering Shares Owned After Offering
----------------------- Being -----------------------
Name of Beneficial Owner Number Percent Offered Number Percent
- ---------------------------------------- ----------- --------- --------- ----------- ---------
<S> <C> <C> <C> <C> <C>
Thomas Camp(1) ......................... 2,253,057 13.7 0 2,253,057 12.4
c/o Go2Net, Inc.
999 3rd Avenue, Suite 4700
Seattle, WA 98104
Allan Barkat(2) ........................ 761,842 4.6 400,000 361,842 2.0
Israel Growth Fund L.P.
c/o Apax-Leumi Inc.
15 Portland Place
London, England
Gideon Mantel(3) ....................... 427,863 2.6 100,000 327,863 1.8
3945 Freedom Circle, Suite 730
c/o Commtouch Software, Inc.
Santa Clara, California 95054
Amir Lev(4) ............................ 422,866 2.6 100,000 322,866 1.8
c/o Commtouch Software Ltd.
6 Hazoran Street
Poleg Industrial Park, P.O. Box 8511
Netanya 42504, Israel
Yair Safrai(5) ......................... 408,900 2.5 401,400 7,500 *
Entities affiliated with Concord Group
11 Galgaley Haplada St. Bldg. 3
P.O. Box 12226, Herzelia
46733 Israel
Nahum Sharfman ......................... 365,000 2.2 165,000 200,000 1.1
22 Hameyasdim St., Karkur
37064 Israel
</TABLE>
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<TABLE>
<CAPTION>
Shares Beneficially Shares Beneficially
Owned Prior to Offering Shares Owned After Offering
------------------------------ Being -----------------------
Name of Beneficial Owner Number Percent Offered Number Percent
- ------------------------------------------------------- ------------------ --------- ----------- ----------- ---------
<S> <C> <C> <C> <C> <C>
Isabel Maxwell(6) ..................................... 207,142 1.3 50,000 157,142 *
c/o Commtouch Software, Inc.
3945 Freedom Circle, Suite 730
Santa Clara, California 95054
James E. Collins(7) ................................... 127,108 * 20,000 107,108 *
c/o Commtouch Software, Inc.
3945 Freedom Circle, Suite 730
Santa Clara, California 95054
Nomura International plc .............................. 63,580 * 31,000 32,580 *
Nomura House
1 St. Martin's-Le-Grand
London EC1A 4NP England
Oceanic Bank and Trust Limited ........................ 31,800 * 31,800 0 0
Fourth Fl., Euro Canadian Center
Malborough St. and Navy Lyon Rd.
Nassau, Bahamas
Rumson Capital, L.L.C. ................................ 31,800 * 31,800 0 0
Galleria Bldg. 1, 3rd Fl.
2 Bridge Ave.
Red Bank, NJ 07701
All executive officers and directors as a group
(10 persons) ......................................... 4,997,944(8) 30.1 1,236,400 3,761,544 20.6
All selling shareholders, including executive officers
and directors: ....................................... 5,125,124 31.1 1,331,000 3,794,124 20.9
<FN>
- ------------
* Less than one percent.
(1) Includes 896,057 shares purchased in the private placement by Go2Net and 901,471 shares exercisable under a warrant
granted to Go2Net on a net exercise basis based on the assumptions set forth in the paragraph preceding the table. All
such shares as well as the warrant itself have been registered for resale under a separate prospectus. Mr. Camp, who is
a director of the Company, is the Vice President, Business Development of Go2Net, and as such, may be deemed to
beneficially own such shares. Also includes 448,029 shares purchased in the private placement by Vulcan Ventures, which
beneficially owns approximately 30.0% of Go2Net. Mr. Camp disclaims beneficial ownership of all such ordinary shares.
Also includes 7,500 shares subject to an option held by Mr. Camp. William D. Savoy, Vice-President of Vulcan Ventures,
and Diane Daggatt, an investment analyst at Vulcan Northwest Inc., an affiliate of Vulcan Ventures, are members of the
board of directors of Go2Net.
(2) Represents 754,342 ordinary shares owned by Israel Growth Fund, L.P., which is advised by Apax-Leumi Partners, its
investment advisor and 7,500 shares subject to an option held by Mr. Barkat. Mr. Barkat, a director of the Company, is
the Managing Director of Apax-Leumi Partners and, as such, may be deemed to beneficially own such ordinary shares. Mr.
Barkat disclaims beneficial ownership of all such ordinary shares except to the extent of his proportional interest
therein.
(3) Certain of such shares are subject to a right of repurchase in favor of Commtouch Software, Inc. Includes 26,100 shares
subject to options held by Mr. Mantel. Does not include 185,000 ordinary shares subject to option grants to Mr. Mantel
which are subject to future vesting.
(4) Includes 40,250 shares subject to options held by Mr. Lev. Does not include 138,460 ordinary shares subject options
granted to Mr. Lev which are subject to future vesting.
(5) Includes 331,819 ordinary shares owned by k.t. Concord Venture Fund (Cayman), L.P. ("CVF"), 66,337 ordinary shares owned
by k.t. Concord Venture Fund (Israel), L.P. ("CVF Israel"), 2,713 ordinary shares owned by k.t. Concord Venture Advisors
(Cayman), L.P. ("CVA"), and 531 ordinary shares owned by k.t. Concord Venture Advisors (Israel), L.P. ("CVA Israel") and
7,500 shares subject to an option held by Mr. Safrai. Mr. Safrai, a director of the Company, is the Managing Partner of
Concord Ventures, which manages CVF, CVF Israel, CVA and CVA Israel, and, as such, may be deemed to beneficially own
such ordinary shares. Mr. Safrai disclaims beneficial ownership of all such ordinary shares except to the extent of his
proportional interest therein.
(6) Certain of such shares are subject to a right of repurchase in favor of Commtouch Software, Inc. Includes 2,350 shares
subject to options held by Ms. Maxwell. Does not include 3,750 ordinary shares subject to an option granted to Ms.
Maxwell.
(7) Certain of such shares are subject to a right of repurchase in favor of Commtouch Software, Inc. Includes 2,500 shares
subject to an option held by Mr. Collins. Does not include 7,500 ordinary shares subject to an option granted to Mr.
Collins under the 1996 CSI Stock Option Plan.
(8) Includes 118,136 ordinary shares issuable upon exercise of options exercisable within 60 days of February 29, 2000.
</FN>
</TABLE>
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DESCRIPTION OF SHARE CAPITAL
Description of Shares
Set forth below is a summary of the material provisions governing our share
capital. This summary is not complete and should be read together with our
Memorandum of Association and Articles of Association, copies of which have
been filed as exhibits to the Registration Statement of which this prospectus
forms a part.
As of February 29, 2000, our authorized share capital consisted of 40,000,000
ordinary shares, NIS 0.05 par value. As of February 29, 2000, there were
16,462,449 ordinary shares (assuming the net exercise of the Go2Net warrant) and
no preferred shares issued and outstanding.
Description of Ordinary Shares
All issued and outstanding ordinary shares of Commtouch are, and the ordinary
shares offered upon exercise of the Go2Net warrant when issued and paid for
will be, 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 offered by this prospectus, when issued, will be entitled
to their full proportion of any cash or share dividend declared from the date
of the consummation of the offering.
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. Our Board of Directors may declare
interim dividends and recommend a final annual dividend only out of profits and
in such amounts as the Board of Directors may determine. Declaration of the
final annual dividend requires shareholder approval at a general meeting, which
may reduce but not increase such dividend from the amount recommended by the
Board of Directors. See "Dividend Policy."
In case of a share dividend, holders of shares can receive shares of a class
whether such class existed prior thereto or was created therefor or shares of
the same class that conferred upon the holders the right to receive such
dividend.
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. Any change in the registered capital of Commtouch,
including the creation of a new class of shares with rights superior or
inferior to existing classes of shares may be adopted by a "special resolution"
(the resolution of the holders of 75 percent or more of the shares
participating in a general meeting). 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-third of the voting rights of
the issued share capital. A
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<PAGE>
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 Chairman
may determine with the consent of the holders of a majority of the shares
present in person or by proxy and voting on the question of adjournment. At
such reconvened meeting any two shareholders present in person or by proxy (and
not in default under the articles) will constitute a quorum.
Most shareholder resolutions, including resolutions for the election of
directors, the declaration of dividends, the appointment of auditors or the
approval of transactions with Office Holders as required by the Companies
Ordinance (See "Management -- Approval of Certain Transactions"), 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. Certain
corporate actions such as:
o amending the Articles of Association;
o amending the Memorandum of Association;
o changing our name;
o making changes in the capital structure of Commtouch, such as a reduction
of capital, increase of capital or share split;
o merger or consolidation;
o voluntary winding up; and
o authorizing a new class of shares or changing special rights of a class
of shares
must be approved by a "special resolution" and will be deemed adopted only if
approved by the holders of not less than 75 percent of the voting power
represented in person or by proxy at the meeting and voting thereon, and in
some cases 75 percent of the voting power of the affected class of shares.
As of December 31, 1999, our executive officers, directors, affiliates of
directors (excluding Go2Net and Vulcan) and five percent or greater
shareholders owned beneficially an aggregate of approximately 52% of the
Company's outstanding ordinary shares. See "Principal Shareholders."
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.
The Companies Law provides that the articles of association of companies, such
as ours, that were incorporated prior to February 1, 2000 are deemed to include
a provision whereby the approval of a merger requires a majority of three
quarters of those present and voting at a general meeting of shareholders. In
addition, a merger can be completed only after all approvals have been
submitted to the Israeli Registrar of Companies and 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 acquistion of any level of control of the
company; or
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<PAGE>
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 immediate taxation.
Transfer of Shares and Notices
Fully paid ordinary shares are issued in registered form and may be transferred
freely. Each shareholder of record is entitled to receive at least seven days'
prior notice of shareholder meetings. A special resolution can be adopted only
if shareholders are given 21 days' prior notice of the meeting at which such
resolution will be voted on (unless all shareholders entitled to vote agree
that the meeting may be held on a shorter notice period). For purposes of
determining the shareholders entitled to notice and to vote at such meeting,
the Board of Directors may fix the record date not exceeding 90 days prior to
the date of any general meeting.
Modification of Class Rights
If at any time the share capital is divided into different classes of shares,
the rights attached to any class (unless otherwise provided by our Articles of
Association) may be modified or abrogated by Commtouch by a special resolution
subject to the consent in writing of the holders of the issued shares of the
class, or by the adoption of a special resolution passed at a separate general
meeting of the holders of the shares of such class.
Description of Warrants
Description of Go2Net Warrant
In connection with the Customized Web-based Email Service Agreement entered
into between Commtouch and Go2Net, Commtouch issued to Go2Net a fully vested,
non-forfeitable, warrant to purchase 1,136,000 ordinary shares at a per-share
exercise price of $12.80, subject to adjustment as provided in the warrant. The
warrant is exercisable at any time until it expires on July 16, 2004. At
Go2Net'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 Company extended registration rights to Go2Net
covering the warrant and the shares issuable upon exercise of the warrant and a
registration statement relating to the resale of the shares and the warrant
became effective on January 7, 2000.
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. To the extent that the
warrant is exercised, dilution of the interests of the Company's shareholders
will occur. In addition, 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.
Description of Other Warrants
Commtouch and Microsoft Corporation entered into an Email Services Agreement
dated October 26, 1999. Under this agreement, Commtouch will, at Microsoft's
option, customize, host and maintain email services for Microsoft websites in
the U.S. and internationally. Microsoft will pay one-time fees for the set-up
and customization of the email service for each website with respect to which
Microsoft chooses to use our services, as well as quarterly service fees for
the email service based on the number of mailboxes hosted. The term of the
agreement shall continue for 12 months after the first commercial distribution
date of the email service and Microsoft may extend the initial term on a
quarterly or annual basis upon 60 days prior written notice. The agreement may
be terminated by Microsoft for convenience upon 90 days' prior written notice,
or by either party upon a material breach by the other party upon the terms
specified in the agreement. In connection with the agreement, Commtouch granted
Microsoft a warrant, exercisable until December 29, 1999, to purchase 707,965
of Commtouch's ordinary shares at an exercise price of $28.25 per share for an
aggregate
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<PAGE>
exercise price of $20.0 million. On December 29, 1999, Microsoft exercised the
warrant and now holds 707,965 ordinary shares. We agreed to register the resale
of these shares with the SEC. The registration statement became effective on
January 7, 2000.
As of December 31, 1999, Commtouch had outstanding a warrant to purchase 4,860
ordinary shares issued to a consultant. This warrant was net exercised into
4,461 ordinary shares in January 2000.
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, which include certain of the Selling Shareholders, have certain
rights to register those shares under the Securities Act. If requested by
holders of a majority of the Registrable Securities after the second anniversary
of the date of the initial public offering, Commtouch must file a registration
statement under the Securities Act covering all Registrable Securities requested
to be included by all holders of such Registrable Securities. Commtouch may be
required to effect up to two such registrations. Commtouch has the right to
delay any such registration for up to 120 days under certain circumstances, but
not more than once during any 12-month period.
In addition, if Commtouch proposes to register any of its ordinary shares under
the Securities Act other than in connection with a company employee benefit
plan or a corporate reorganization pursuant to Rule 145 under the Securities
Act, or a registration on any registration form that does not permit secondary
sales or does not include substantially the same information as would be
required to be included in a registration statement covering the sale of
Registrable Securities, the holders of Registrable Securities may require
Commtouch to include all or a portion of their shares in such registration,
although the managing underwriter of any such offering has certain rights to
limit the number of shares in such registration.
Further, a majority of the holders of Registrable Securities may require
Commtouch to register all or any portion of their Registrable Securities on
Form F-3 when such form becomes available to Commtouch, 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 the initial public offering. The Company filed
the registration statement of which this prospectus is a part pursuant to those
registration rights, to allow the Selling Securityholders to sell a portion of
their shareholdings.
In addition, the Company granted registration rights to Go2Net, Vulcan Ventures
and Microsoft pursuant to which their holdings in the Company were registered
on January 7, 2000.
James Collins, Amir Lev, Gideon Mantel, Isabel Maxwell and Nahum Sharfman, all
executive officers and/or directors of the Company, were granted certain
piggyback registration rights in connection with this offering. See "Certain
Transactions--Amendment to Registration Rights Agreement."
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 a copy
of any special resolution adopted by a general meeting of shareholders. 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 Norwest Bank
Minnesota, N.A.
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SHARES ELIGIBLE FOR FUTURE SALE
Future sales of substantial amounts of our ordinary shares in the public market,
or the possibility of these sales occurring, could adversely affect prevailing
market prices for our ordinary shares or our future ability to raise capital
through an offering of equity securities. Upon completion of this offering, we
will have outstanding 18,131,449 ordinary shares (18,581,449 shares if the
overallotment option is exercised), based on shares outstanding as of February
29, 2000 (assuming the issuance of 901,471 ordinary shares upon the assumed net
exercise at an assumed share price of $62.00 per share of the in-the-money
warrant to purchase 1,136,000 ordinary shares issued to Go2Net at an exercise
price of $12.80 per share). 3,000,000 ordinary shares to be sold by us and the
selling shareholders in this offering (3,450,000 ordinary shares if the
underwriters' over-allotment option is exercised in full); the 3,450,000
ordinary shares sold in our initial public offering; and the 1,344,086 ordinary
shares and the warrant exercisable for 1,136,000 ordinary shares registered in
January 2000 on behalf of Go2Net and Vulcan Ventures, as well as the 707,965
ordinary shares registered at that time on behalf of Microsoft, are freely
tradable in the public market without restriction under the Securities Act,
unless the shares are held by "affiliates" of the Company, as that term is
defined in Rule 144 under the Securities Act.
The remaining ordinary shares outstanding upon completion of this offering will
be "restricted securities" as that term is defined under Rule 144. We issued
and sold these restricted securities in private transactions in reliance on
exemptions from registration under the Securities Act. Restricted securities
may be sold in the public market only if they are registered or if they qualify
for an exemption from registration under Rule 144 or Rule 701 under the
Securities Act, as summarized below.
Shares Subject to Lock-Up Agreements and Other Restrictions
The selling shareholders have signed lock-up agreements with the underwriters
in which they have agreed not to sell, pledge or otherwise dispose of their
shares (other than shares being offered by this prospectus) for a period of 90
days from the date of this prospectus, subject to limited exceptions. U.S.
Bancorp Piper Jaffray may release this restriction wholly or partially at any
time with or without notice but has no current plans to do so. In addition to
the restrictions imposed by the securities laws, 700,180 of the restricted
shares were issued to certain Commtouch employees under agreements which give
Commtouch Software, Inc. a repurchase option on any unvested shares. The
repurchase option lapses ratably over time. As of February 29, 2000,
approximately 235,618 ordinary shares are subject to repurchase. Microsoft has
agreed with Commtouch not to sell, pledge or otherwise dispose of its 707,965
ordinary shares (or any other of our ordinary shares which it may acquire)
until after June 29, 2000.
Shares Subject to Restriction under Rule 144
Most of the restricted shares are subject to certain volume and other resale
restrictions pursuant to Rule 144 because the holders are affiliates of
Commtouch. In general, under Rule 144, an affiliate of Commtouch, or a person
(including a group of related persons whose shares must be aggregated under the
Rule) who has beneficially owned restricted shares for at least one year, will
be entitled to sell in any three-month period a number of shares that does not
exceed the greater of
* 1% of the then outstanding ordinary shares (approximately 181,314 shares
immediately following completion of the offering, assuming net exercise
of the Go2Net warrant upon the assumptions noted above), or
* the average weekly trading volume during the four calendar weeks
preceding the date on which notice of the sale is filed with the SEC.
Sales pursuant to Rule 144 are subject to certain requirements relating to
manner of sale, notice and availability of current public information about
Commtouch. A person who was not an affiliate of Commtouch for 90 days before
the sale and who has beneficially owned the shares for at least two years may
sell under Rule 144(k) without regard to the above limitations.
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<PAGE>
Registration Rights
Some of our shareholders have contractual rights which require us to register
their shares with the SEC. The registration statement of which this prospectus
is a part includes 832,400 ordinary shares subject to these registration rights.
Pursuant to the registration rights of Go2Net, Vulcan Ventures and Microsoft,
the Company filed a registration statement covering the resale of 1,344,086
shares and the warrant granted to Go2Net to purchase 1,136,000 ordinary shares
and the ordinary shares issuable upon exercise of the warrant, as well as the
707,965 shares issued to Microsoft. The registration statement became effective
on January 7, 2000. In addition to shares previously registered pursuant to
these rights, and shares to which this prospectus relates, the holders of an
additional approximately 2,851,240 ordinary shares have registration rights
under certain circumstances.
Shares Under Employee Benefit Plans
On January 20, 2000, we filed a Form S-8 registration statement under the
Securities Act to register 5,400,000 ordinary shares issuable in connection with
option exercises and shares reserved for issuance under all stock plans and
agreements as well as 150,000 ordinary shares under the Company's Employee Stock
Purchase Plan which the Company may issue to employees from time to time. The
Company also may issue employee and director stock options from time to time.
Such options are subject to vesting periods after which the shares may be resold
by the holders, subject to Rule 144 limitations if the holder is an affiliate.
Of 2,829,342 options issued, 117,840 option shares were vested and unexercised
as of February 29, 2000 and 1,077,370 options had been exercised.
The following table illustrates the above discussion:
<TABLE>
<CAPTION>
Shares Not Subject to Restrictions:
- -------------------------------------------------------------------------------------------------
<S> <C>
3,450,000 shares issued by the Company in initial public offering
1,344,086 shares registered on behalf of Go2Net and Vulcan Ventures offered under
separate prospectus
1,136,000 shares underlying Go2Net warrant offered under separate prospectus(1)
1,669,000 shares being registered by the Company in this offering (not including 450,000
shares covered by the over-allotment option, if exercised)
1,331,000 shares being registered by the selling shareholders in this offering
5,313,530 shares registered on Form S-8(2)
</TABLE>
<TABLE>
<CAPTION>
Other Shares:
- ---------------------------------------------------------------------------------------------------
<S> <C>
235,618 restricted shares currently held by employees and subject to Company's
repurchase option
707,965 shares registered on behalf of Microsoft (not freely tradable until
June 29, 2000)(3)
86,470 option shares registered on Form S-8 (see above) but subject to lock-up.
1,430,431 shares held by selling shareholders not being registered in this offering and
subject to lockup agreements with underwriters expiring on June , 2000
3,763,360 shares held by other shareholders, of which 3,016,360 shares became eligible for
resale under Rule 144 through February 2000 and 747,020 shares which become
eligible for resale under Rule 144 on April 23, 2000 (approximately 3,690,000 of
these shares are subject to registration rights agreements with the Company)
<FN>
- ------------
(1) Shares are issuable at the time of exercise and are not yet outstanding.
(2) A total of 5,400,000 shares were registered, but 86,470 shares will be
subject to lock-up. Includes 5,250,000 option shares, as well as 150,000
shares under the Company's Employee Stock Purchase Plan which the Company
may issue to employees from time to time. The Company also may issue
employee and director stock options from time to time. Such options are
subject to vesting periods after which the shares may be resold by the
holders, subject to Rule 144 limitations if the holder is an affiliate. Of
2,829,342 options issued, 117,840 option shares were vested and unexercised
as of February 29, 2000 and 1,077,370 options had been exercised.
(3) Microsoft has agreed not to sell, pledge or otherwise dispose of its
707,965 ordinary shares (or any other of our ordinary shares which it may
acquire) until after June 29, 2000.
</FN>
</TABLE>
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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 prospectus, 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 therefor 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
the ordinary share is sold by such U.S. Holder.
Sale or Exchange of Ordinary Shares
A U.S. Holder's sale or exchange of ordinary shares will result in the
recognition of gain or loss by such U.S. Holder in an amount equal to the
difference between the amount realized and the U.S. Holder's basis in the
ordinary shares sold. Subject to the following discussion of the consequences
of Commtouch being treated as a Passive Foreign Investment Company or a Foreign
Investment Company, such gain or loss will be capital gain or loss if such
ordinary shares are a capital asset in the hands of the U.S. Holder. Gain or
loss realized on the sale of ordinary shares will be long-term capital gain or
loss if the ordinary shares sold had been held for more than one year at the
time of their sale. Long-term capital gains recognized by certain taxpayers
generally are subject to a reduced rate of federal tax (currently a maximum of
20%). If the U.S. Holder's holding period on the date of the sale or exchange
was one year or less, such gain or loss will be short-term capital gain or
loss. Short-term capital gains generally are subject to tax at the same rates
as ordinary income. In general, any capital gain recognized by a U.S. Holder
upon the sale or exchange of ordinary shares will be treated as U.S.-source
income for U.S. foreign tax credit purposes.
See discussion under "Israeli Taxation and Investment Programs--Capital Gains
and Income Taxes Applicable to Non-Israeli Shareholders" for a discussion of
taxation by Israel of capital gains realized on sales of capital assets.
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Treatment of Dividend Distributions
For U.S. federal income tax purposes, gross dividends (including the amount of
any Israeli taxes withheld therefrom) paid to a U.S. Holder with respect to his
or her ordinary shares will be included in his or her ordinary income to the
extent made out of current or accumulated earnings and profits of Commtouch, as
determined based on U.S. tax principles, at the time the dividends are received
and will be treated as foreign source dividend income for purposes of the
foreign tax credit limitation described below. Such dividends will not be
eligible for the dividends received deduction allowed to U.S. corporations
under Section 243 of the Code. Dividend distributions in excess of Commtouch's
current and accumulated earnings and profits will be treated first as a
non-taxable return of the U.S. Holder's tax basis in his or her ordinary shares
to the extent thereof and then as a gain from the sale of ordinary shares.
Dividends paid in NIS will be includible in income in a U.S. dollar amount
based on the exchange rate at the time of their receipt, and any gain or loss
resulting from currency fluctuations during the period from the date a dividend
is paid to the date such payment is converted into U.S. dollars generally will
be treated as ordinary income or loss.
Any Israeli withholding tax imposed on dividends paid to a U.S. Holder will be a
foreign income tax eligible for credit against such U.S. Holder's U.S. federal
income tax liability subject to certain limitations. Alternatively, a U.S.
Holder may claim a deduction for such amount, but only for a year in which a
U.S. Holder elects to do so with respect to all foreign income taxes. The
overall limitation on foreign taxes eligible for credit is calculated separately
with respect to specific classes of income. Dividends distributed by Commtouch
with respect to ordinary shares will generally constitute "passive income".
Foreign income taxes exceeding the credit limitation for the year of payment or
accrual may be carried back for two taxable years and forward for five taxable
years in order to reduce U.S. federal income taxes, subject to the credit
limitation applicable in each of such years. Other restrictions on the foreign
tax credit include a general prohibition on the use of the credit to reduce
liability for the U.S. individual and corporation alternative minimum taxes by
more than 90% and an allowance of foreign tax credits for alternative minimum
tax purposes only to the extent of foreign-source alternative minimum taxable
income. See "Israeli Taxation and Investment Programs -- Capital Gains and
Income Taxes Applicable to Non-Israeli Shareholders."
Information Reporting and Backup Withholding
Any dividends paid on, or proceeds derived from a sale of, the ordinary shares
to, or by, U.S. Holders may be subject to U.S. information reporting
requirements and the 31% U.S. backup withholding tax unless the holder (i) is a
corporation or other exempt recipient or (ii) provides a United States taxpayer
identification number, certifies as to no loss of exemption from backup
withholding and otherwise complies with any applicable withholding
requirements. Any amounts withheld under the U.S. backup withholding tax rules
will be allowed as a refund or a credit against the U.S. Holder's U.S. federal
income tax, provided the required information is furnished to the U.S. Internal
Revenue Service.
Tax Status of Commtouch for U.S. Federal Income Tax Purposes
Passive Foreign Investment Company. If Commtouch were deemed to be a passive
foreign investment company (a "PFIC") for U.S. federal income tax purposes, any
gain recognized by a U.S. Holder upon the sale of ordinary shares (or the
receipt of certain distributions) generally would be treated as ordinary
income, such income would be allocated over such U.S. Holder's holding period
for such ordinary shares and an interest charge would be imposed on the amount
of deferred tax on such income which is allocated to prior taxable years.
Generally, Commtouch will be treated as a PFIC for any tax year if, in such tax
year or any prior tax year, either (i) 75% or more of its gross income is
passive in nature, or (ii) on average, 50% or more of its assets (by value or,
if Commtouch elects or if Commtouch is treated as a "controlled foreign
corporation" under the Code, by their adjusted basis for computing earnings and
profits) 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-1999 tax years. Because Commtouch acquired substantial cash in
connection with its initial public
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offering in 1999, it is possible that Commtouch became a PFIC in its 1999 tax
year. Commtouch will not be able to determine whether it in fact became a PFIC
in its 1999 tax year until its operating results for the last quarter of 1999
are available. If Commtouch did not become a PFIC in its 1999 tax year, then
Commtouch expects that the majority of its assets will continue to generate
sufficient levels of active income for it to avoid PFIC treatment for U.S.
federal income tax purposes in post-1999 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, if
Commtouch did not become a PFIC in its 1999 tax year, 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. Consequences 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 stock of Commtouch. Commtouch does not
believe that it will be a CFC after this Offering. 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 39.6% on its undistributed personal holding company income (generally
limited, in the case of a foreign corporation, to United States source income).
A corporation will be classified as a foreign personal holding company, or an
FPHC, and not a PHC if at any time during a tax year (i) five or fewer
individual United States citizens or residents directly or indirectly or by
attribution own more than 50% of the total combined voting power or value of
the corporation's stock and (ii) at least 60% of its gross income consists of
(50% for years following the first year it becomes a FPHC) FPHC income (defined
generally to include dividends, interest, royalties, rents and certain other
types of passive income). Each United States shareholder in an
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FPHC is required to include in gross income, as a dividend, an allocable share
of the FPHC's undistributed foreign personal holding company income (generally
the taxable income of the FPHC, as specially adjusted).
A corporation will be classified as a foreign investment company, or an FIC, if
for any taxable year it (i) is registered under the Investment Company Act of
1940, as amended, as a management company or unit investment trust or is
engaged primarily in the business of investing or trading in securities or
commodities (or any interest therein) and (ii) 50% or more of the total value
or the total combined voting power of all classes of the corporation's stock is
owned directly or indirectly (including stock owned through the application of
attribution rules) by United States persons. In general, unless an FIC elects
to distribute 90% or more of its taxable income (determined under United States
tax principles as specially adjusted) to its shareholders, any gain on the sale
or exchange of stock in a foreign corporation, which was a FIC at any time
during the period during which a taxpayer held such stock, is treated as
ordinary income (rather than capital gain) to the extent of such shareholder's
ratable share of the corporation's accumulated earnings and profits.
Commtouch will not be able to determine whether it became a PFIC in its 1999
tax year until its operating results for the last quarter of 1999 are
available. If Commtouch did not become a PFIC in its 1999 tax year, Commtouch
believes that it will not be a PFIC after this Offering. Commtouch also
believes that it is not and will not be a PHC, FPHC or FIC after this Offering.
However, no assurance can be given as to Commtouch's future status.
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.
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."
Israeli tax loss carryforwards were approximately $22.5 million as of December
31, 1999. The amount of our tax loss carryforwards will be reduced by our
future taxable income.
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 the tax purpose based on changes in the Israeli CPI,
whereby corporate assets are classified broadly
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into fixed (inflation resistant) assets and non-fixed assets. Where
shareholders' equity, as defined in the Adjustment for Inflation Law, exceeds
the depreciated cost of fixed assets, a corporate tax deduction which takes
into account the effect of inflationary change on such excess is allowed (up to
a ceiling of 70% of taxable income in any single tax year, with the unused
portion permitted to be carried forward on an inflation-linked basis with no
ceiling). If the depreciated cost of fixed assets exceeds shareholders' equity,
then such excess multiplied by the annual rate of inflation is added to taxable
income.
In addition, subject to certain limitations, depreciation on fixed assets and
loss carried 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 considered to qualify 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 two separate investment programs. 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
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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.
The implementation of the investments under the first plan was finalized by
Commtouch in 1995. In early 2000, we filed an application to supplement our
second plan and we also filed an application for a new, third plan.
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 15.0% if the dividends are
paid during the benefits period or at any time up to 12 years after the
benefits period. This tax must be withheld at source by the company paying the
dividend. In the case of a "foreign investor's company," the 12 year limitation
on reduced withholding tax on dividends does not apply. Subject to various
conditions, a foreign investor's company is a company more than 25.0% 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 would also generally be subject to the 15.0% tax
rate but 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, 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 provide 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
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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 a
double taxation treaty is in effect between Israel and the shareholder's
country of residence that provides for a lower tax rate in Israel on dividends.
A tax treaty between the United States and Israel (the "Treaty"), provides for
a maximum tax of 25% on dividends paid to a resident of the United States (as
defined in the Treaty). Dividends distributed by an Israeli company and derived
from the income of an approved enterprise are subject to a 15% dividend
withholding tax. The Treaty further provides that a 12.5% Israeli dividend
withholding tax applies to dividends paid to a United States corporation owning
10% or more of an Israeli company's voting shares throughout the current year
to the date the dividend is paid and the preceding taxable year (as
applicable). The 12.5% rate applies only on dividends from a company that does
not have an Approved Enterprise in the applicable period.
If for any reason shareholders do not receive the above exemption for a sale of
shares in an Industrial Company, the Treaty provides U.S. resident investors
with an exemption from Israeli capital gains tax in certain circumstances
(there may still be U.S. taxes) upon a disposition of shares in Commtouch if
they held under 10% of the Company's voting stock throughout the 12 months
before the share disposition. If Israeli capital gains tax is payable, it can
be credited against U.S. federal tax under the circumstances specified in the
Treaty.
A non-resident of Israel who has had dividend income derived or accrued in
Israel from which the applicable tax was withheld at source is currently exempt
from the duty to file an annual Israeli tax return with respect to such income,
provided such income was not derived from a business carried on in Israel by
such non-resident and that such non-resident does not derive other non-passive
income from sources in Israel.
Tax Benefits for Research and Development
Israeli tax law allows under certain conditions a tax deduction in the year
incurred for expenditures in scientific research and development projects, if
the expenditures are approved by the relevant Israeli Government Ministry
(determined by the field of research) and the research and development is for
the promotion of the enterprise. Expenditures not so approved are deductible
over a three-year period. However, expenditures made out of the proceeds of
government grants are not deductible, i.e. Commtouch will be able to deduct the
unfunded portion of the research and development expenditures and not the gross
amount.
Law for the Encouragement of Industrial Research and Development, 1984
Under the Law for the Encouragement of Industrial Research and Development,
1984 (the "Research Law") and the Instructions of the Director General of the
Ministry of Industry and Trade, research and development programs and the plans
for the intermediate stage between research and development, and manufacturing
and sales approved by a governmental committee of the Office of Chief Scientist
(OCS) (the "Research Committee") are eligible for grants of up to 50% of the
project's expenditure if they meet certain criteria. These grants are issued in
return for the payment of royalties from the 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
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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 tax 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 participated in programs sponsored by the OCS for the support of
research and development activities. Through December 31, 1999, the Company had
recorded grants from OCS aggregating $653,000 for certain of the Company's
research and development projects. The Company is obligated to pay royalties to
the OCS of 3% to 5% of the sales of the products and other related revenues
developed from such projects, up to an amount equal to 100% to 150% of the
grants received.
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, 1999, the Company had
received grants from the Marketing Fund in the amount of approximately
$279,000.
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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. However, a peace agreement between
Israel and Egypt was signed in 1979, a peace agreement between Israel and
Jordan was signed in 1994 and, since 1993, several agreements between Israel
and Palestinian representatives have been signed. In addition, Israel and
several Arab States have announced their intention to establish trade and other
relations and are discussing certain projects. Israel has not entered into any
peace agreement with Syria or Lebanon, and there have been difficulties in the
negotiations with the Palestinians. We cannot be certain as to how the peace
process will develop or what effect it may have upon Commtouch.
Despite the progress towards peace between Israel and its Arab neighbors and
the Palestinians, 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 current Israeli
government elected in 1996 has expressed its intention to reduce government
involvement in the economy by various means, including relaxation of foreign
currency controls and certain budgetary restraints, and privatization of
certain government-owned companies. The Israeli government has periodically
changed its policies in all these areas.
Until May 1998, Israel imposed restrictions on transactions in foreign
currency. These restrictions affected our operations in various ways, and also
affected the right of non-residents of Israel to convert into foreign currency
amounts they received in Israeli currency, such as the proceeds of a judgment
enforced in Israel. Despite these restrictions, foreign investors who purchased
shares with foreign currency were able to repatriate in foreign currency both
dividends (after deduction of withholding tax) and the proceeds from the sale
of the shares. There are currently no Israeli currency control restrictions on
remittances of dividends on the ordinary shares or the proceeds from the sale
of the shares; however, legislation remains in effect pursuant to which
currency controls can be imposed by administrative action at any time.
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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.
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UNDERWRITING
The underwriters named below, for whom U.S. Bancorp Piper Jaffray Inc., Thomas
Weisel Partners LLC, Warburg Dillon Read LLC, a subsidiary of UBS AG, and
William Blair & Company, L.L.C. are acting as representatives, have agreed to
buy, subject to the terms of the underwriting agreement, the number of shares
listed opposite their names below. The underwriters are committed to purchase
and pay for all of the shares if any are purchased, other than those shares
covered by the over-allotment option described below.
Underwriters Number of Shares
------------ ------------------
U.S. Bancorp Piper Jaffray Inc. ........
Thomas Weisel Partners LLC .............
Warburg Dillon Read LLC ................
William Blair & Company, L.L.C. ........
-----------
Total ......................... 3,000,000
The underwriters have advised us and the selling shareholders that they propose
to offer the shares to the public at $ per share. The underwriters propose
to offer the shares to certain dealers at the same price less a concession of
not more than $ per share. The underwriters may allow and the dealers may
reallow a concession of not more than $ per share on sales to certain
other brokers and dealers. After the offering, these figures may be changed by
the representatives.
Thomas Weisel Partners LLC, one of the representatives of the underwriters, was
organized and registered as a broker-dealer in December 1998. Since December
1998, Thomas Weisel Partners LLC has been named as a lead manager or co-manager
on 135 filed public offerings of equity securities, of which 101 have been
completed. Since that time, it also has acted as a syndicate member in an
additional 73 public offerings of equity securities. Thomas Weisel Partners LLC
does not have any material relationship with us or any of our officers,
directors or other controlling persons, except with respect to the underwriting
agreement.
We have granted to the underwriters an option to purchase up to an additional
450,000 ordinary shares from us at the same price to the public, and with the
same underwriting discount, as set forth above. The underwriters may exercise
this option any time during the 30-day period after the date of this
prospectus, but only to cover over-allotments, if any. To the extent the
underwriters exercise the option, each underwriter will become obligated,
subject to certain conditions, to purchase approximately the same percentage of
the additional shares as it was obligated to purchase under the underwriting
agreement.
The following table shows the per share and total underwriting discount to be
paid by us and the selling shareholders to the underwriters in connection with
this offering. These amounts are shown assuming both no exercise and full
exercise of the over-allotment option.
No Exercise Full Exercise
------------- ---------------
Payable by Commtouch
Per share .......................... $ $
Total ............................. $ $
Payable by the selling shareholders
Per share .......................... $ $
Total ............................. $ $
The expenses of the offering, exclusive of the underwriting discount, include
the Securities and Exchange Commission registration fee, the National
Association of Securities Dealers filing fee, the Nasdaq National Market listing
fee, printing expenses, legal fees and expenses, accounting fees and expenses,
road show expenses, Blue Sky fees and expenses, transfer agent and registrar
fees and other miscellaneous fees. We estimate these fees and expenses will be
an aggregate of approximately $ . These fees and expenses are payable
entirely by us.
78
<PAGE>
We and the selling shareholders have agreed to indemnify the underwriters
against certain liabilities, including civil liabilities under the Securities
Act, or to contribute to payments that the underwriters may be required to make
in respect of those liabilities.
Pursuant to the agreements granting registration rights to the selling
shareholders, the Company has agreed to indemnify the selling shareholders
against such liabilities as they may incur as a result of any untrue statement
of a material fact in the Registration Statement of which this prospectus is a
part, or any omission herein or therein to state a material fact necessary in
order to make the statements made, in light of the circumstances under which
they were made, not misleading. Such indemnification includes liabilities under
the Securities Act, the Securities Exchange Act of 1934, state securities laws
and the rules thereunder, but excludes liabilities for statements or omissions
that were based on information provided by the selling shareholders, as to
which they have agreed to indemnify the Company and any underwriter.
We and the selling shareholders have agreed to certain restrictions on our
ability to sell additional ordinary shares (other than those shares which are
offered in this prospectus) for a period of 90 days after the date of this
prospectus. We have agreed not to directly or indirectly offer for sale, sell,
contract to sell, grant any option for the sale of, or otherwise issue or
dispose of, any ordinary shares, or any securities convertible into, or
exercisable or exchangeable for, ordinary shares, without the prior written
consent of U.S. Bancorp Piper Jaffray. The agreements provide exceptions for
(1) sales to underwriters pursuant to the underwriting agreement, (2) our sales
in connection with the exercise of options granted and the granting of options
to purchase shares under our existing stock option plans and (3) certain other
exceptions. However, U.S. Bancorp Piper Jaffray may, in its sole discretion and
at any time without notice, release all or any portion of the securities
subject to the lock-up agreements. As of the date of this prospectus, there are
no agreements between the representatives and any of our shareholders providing
consent by the representatives to the sales of ordinary shares prior to the
expiration of the lock-up period.
To facilitate the offering, the underwriters may engage in transactions that
stabilize, maintain or otherwise affect the price of the ordinary shares during
and after the offering. Specifically, the underwriters may over-allot or
otherwise create a short position in the ordinary shares for their own account
by selling more ordinary shares than have been sold to them by us and the
selling shareholders. The underwriters may elect to cover any such short
position by purchasing ordinary shares in the open market or by exercising the
over-allotment option granted by us to the underwriters. In addition, the
underwriters may stabilize or maintain the price of the ordinary shares by
bidding for or purchasing ordinary shares in the open market and may impose
penalty bids. If penalty bids are imposed, selling concessions allowed to
syndicate members or other broker-dealers participating in the offering are
reclaimed if ordinary shares previously distributed in the offering are
repurchased, whether in connection with stabilization transactions or
otherwise. The effect of these transactions may be to stabilize or maintain the
market price of the ordinary shares at a level above that which might otherwise
prevail in the open market. The imposition of a penalty bid may also effect the
price of the ordinary shares to the extent that it discourages resales of the
ordinary shares. The magnitude or effect of any stabilization or other
transactions is uncertain. These transactions may be effected on the Nasdaq
National Market or otherwise and, if commenced, may be discontinued at any
time.
In connection with this offering, certain underwriters (and selling group
members) may also engage in passive market making transactions in the ordinary
shares on the Nasdaq National Market. Passive market making consists of
displaying bids on the Nasdaq National Market limited by the prices of
independent market makers and effecting purchases limited by such prices and in
response to order flow. Rule 103 of Regulation M promulgated by the Securities
and Exchange Commission limits the amount of net purchases that each passive
market maker may make and the displayed size of each bid. Passive market making
may stabilize the market price of the ordinary shares at a level above that
which might otherwise prevail in the open market and, if commenced, may be
discontinued at any time.
79
<PAGE>
Each selling shareholder and any other persons participating in a distribution
of securities will be subject to applicable provisions of the Securities
Exchange Act and the rules and regulations thereunder, including, without
limitation, Regulation M, which may restrict certain activities of, and limit
the timing of purchases and sales of securities by, selling shareholders and
other persons participating in a distribution of securities. Furthermore, under
Regulation M, persons engaged in a distribution of securities are prohibited
from simultaneously engaging in market making and certain other activities with
respect to such securities for a specified period of time prior to the
commencement of such distribution, subject to specified exceptions or
exemptions. All of the foregoing may affect the marketability of the securities
offered hereby.
LEGAL MATTERS
Certain legal matters with respect to United States law are being passed upon
for Commtouch by McCutchen, Doyle, Brown & Enersen, LLP, Palo Alto, California.
The validity of the ordinary shares offered hereby is being passed upon for
Commtouch by Naschitz, Brandes & Co., Tel-Aviv, Israel. Certain legal matters
in connection with this offering will be passed upon for the underwriters by
Faegre & Benson LLP, Minneapolis, Minnesota with respect to United States law,
and by Yigal Arnon & Co., Jerusalem, Israel, with respect to Israeli law. The
partners of Naschitz, Brandes & Co. and McCutchen, Doyle, Brown & Enersen, LLP
beneficially own, in the aggregate, less than 1% of the outstanding shares of
the Company.
EXPERTS
The consolidated financial statements of Commtouch Software Ltd. as of December
31, 1998 and 1999 and for each of the three years in the period ended December
31, 1999 appearing in this prospectus and Registration Statement have been
audited by Kost, Forer & Gabbay, a member of Ernst & Young International,
independent auditors, as set forth in their report thereon appearing elsewhere
herein and are included in reliance upon such report given on the authority of
such firm as experts in auditing and accounting.
ISA EXEMPTION
The Israel Securities Authority has granted us an exemption from the obligation
to publish this prospectus in the manner required pursuant to the prevailing
laws of the State of Israel. Commtouch will make a copy of each report filed in
accordance with United States law available for public review at its principal
office in Israel.
80
<PAGE>
WHERE YOU CAN FIND MORE INFORMATION
We have filed a registration statement on Form F-1 with the SEC for the shares
we are offering by this prospectus. This prospectus does not include all of the
information contained in the registration statement. You should refer to the
registration statement and its exhibits for additional information. Whenever we
make reference in this prospectus to any of our contracts, agreements or other
documents, the references are not necessarily complete and you should refer to
the exhibits attached to the registration statement for copies of the actual
contract, agreement or other document. We are required to file annual and
special reports and other information with the SEC.
You can read our SEC filings, including the registration statement, over the
Internet at the SEC's web site at http://www.sec.gov. You may also read and
copy any document we file with the SEC at its public reference facilities at
450 Fifth Street, NW, Washington, DC 20549, 7 World Trade Center, Suite 1300,
New York, New York 10048 and Citicorp Center, 500 West Madison Street, Suite
1400, Chicago, Illinois 60661-2511. You may also obtain copies of the documents
at prescribed rates by writing to the Public Reference Section of the SEC at
450 Fifth Street, NW, Washington, DC 20549. Please call the SEC at
1-800-SEC-0330 for further information on the operation of the public reference
facilities. Our SEC filings are also available at the office of the Nasdaq
National Market. For further information on obtaining copies of our public
filings at the Nasdaq National Market, you should call (212) 656-5060.
Information contained on the Commtouch websites does not constitute part of
this prospectus.
We are subject to certain of the informational requirements of the Exchange
Act. We, as a "foreign private issuer," are exempt from the rules under the
Exchange Act prescribing certain disclosure and procedural requirements for
proxy solicitations and our officers, directors and principal shareholders are
exempt from the reporting and "short-swing" profit recovery provisions
contained in Section 16 of the Exchange Act, with respect to their purchases
and sales of ordinary shares. In addition, we are not required to file
quarterly reports or to file annual and current reports and financial
statements with the Securities and Exchange Commission as frequently or as
promptly as U.S. companies whose securities are registered under the Exchange
Act. However, we intend to file with the Securities and Exchange Commission,
within 180 days after the end of each fiscal year, an annual report on Form
20-F containing financial statements that will be examined and reported on,
with an opinion expressed by an independent accounting firm, as well as
quarterly reports on Form 6-K containing unaudited financial information for
the first three quarters of each fiscal year, within 60 days after the end of
each such quarter.
ENFORCEABILITY OF CIVIL LIABILITIES
We are incorporated in Israel, and most of our directors and many of the
executive officers and the Israeli experts named herein are not residents of
the United States and substantially all of their assets and our assets are
located outside the United States. Service of process upon our non-U.S.
resident directors and executive officers or the Israeli experts named herein
and enforcement of judgments obtained in the United States against us, and our
directors and executive officers, or the Israeli experts named herein, may be
difficult to obtain within the United States. Commtouch Software, Inc. is the
U.S. agent authorized to receive service of process in any action against us
arising out of this offering or any related purchase or sale of securities. We
have not given consent for this agent to accept service of process in
connection with any other claim.
We have been informed by our legal counsel in Israel, Naschitz, Brandes & Co.,
that there is doubt as to the enforceability of civil liabilities under the
Securities Act or the Exchange Act in original actions instituted in Israel.
However, subject to certain time limitations, an Israeli court may declare a
foreign civil judgment enforceable if it finds that:
o the judgment was rendered by a court which was, according to the laws of
the state of the court, competent to render the judgment,
o the judgment is no longer appealable,
81
<PAGE>
o the obligation imposed by the judgment is enforceable according to the
rules relating to the enforceability of judgments in Israel and the
substance of the judgment is not contrary to public policy, and
o the judgment is executory in the state in which it was given.
Even if the above conditions are satisfied, an Israeli court will not enforce a
foreign judgment if it was given in a state whose laws do not provide for the
enforcement of judgments of Israeli courts (subject to exceptional cases) or if
its enforcement is likely to prejudice the sovereignty or security of the State
of Israel. An Israeli court also will not declare a foreign judgment
enforceable if (i) the judgment was obtained by fraud, (ii) there was no due
process, (iii) the judgment was rendered by a court not competent to render it
according to the laws of private international law in Israel, (iv) the judgment
is at variance with another judgment that was given in the same matter between
the same parties and which is still valid, or (v) at the time the action was
brought in the foreign court a suit in the same matter and between the same
parties was pending before a court or tribunal in Israel. Judgments rendered or
enforced by Israeli courts will generally be payable in Israeli currency.
Judgment debtors bear the risk associated with converting their awards into
foreign currency, including the risk of unfavorable exchange rates.
82
<PAGE>
COMMTOUCH SOFTWARE LTD.
CONSOLIDATED FINANCIAL STATEMENTS
AS OF DECEMBER 31, 1999
In U.S. Dollars
INDEX
Page
------
Report of Independent Auditors ................................ F-2
Consolidated Balance Sheets ................................... F-3
Consolidated Statements of Operations ........................ F-4
Statement of Changes in Shareholders' Equity (Deficit) ........ F-5
Consolidated Statements of Cash Flows ......................... F-6
Notes to Consolidated Financial Statements .................... F-7
F-1
<PAGE>
REPORT OF INDEPENDENT AUDITORS
To the Shareholders of
COMMTOUCH SOFTWARE LTD.
We have audited the accompanying consolidated balance sheets of Commtouch
Software Ltd. and its subsidiaries as of December 31, 1998 and 1999, and the
related consolidated statements of operations, changes in shareholders' equity
(deficit), and cash flows for each of the three years in the period ended
December 31, 1999. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements 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 misstatement. 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 statement 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, 1998 and
1999, and the consolidated results of their operations, and their cash flows
for each of the three years in the period ended December 31, 1999, in
conformity with generally accepted accounting principles in the United States.
Tel-Aviv, Israel
January 31, 2000
KOST, FORER & GABBAY
A Member of Ernst & Young International
F-2
<PAGE>
COMMTOUCH SOFTWARE LTD.
CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share data)
<TABLE>
<CAPTION>
December 31,
-------------------------
1998 1999
--------- ---------
<S> <C> <C>
Assets
Current Assets:
Cash and cash equivalents ....................................... $ 834 $ 65,996
Marketable securities .......................................... -- 18,050
Trade receivables, net .......................................... 133 2,378
Prepaid marketing expenses ...................................... -- 4,508
Prepaid expenses and other accounts receivable .................. 244 1,648
--------- ---------
Total current assets ......................................... 1,211 92,580
--------- ---------
Long-term Lease Deposits ........................................... -- 1,254
Severance Pay Fund ................................................ 223 354
Property and Equipment, net ....................................... 932 6,148
--------- ---------
$ 2,366 $ 100,336
========= =========
Liabilities and Shareholders' Equity (Deficit)
Current Liabilities:
Short-term bank credit .......................................... $ 1,328 $ --
Current portion of capital leases .............................. 112 120
Accounts payable ................................................ 446 1,510
Employees and payroll accruals .................................. 313 1,032
Deferred revenue ................................................ 74 561
Accrued expenses and other liabilities .......................... 378 1,304
--------- ---------
Total current liabilities .................................... 2,651 4,527
--------- ---------
Long-term portion of capital leases ............................. 164 44
Accrued severance pay .......................................... 366 453
--------- ---------
530 497
--------- ---------
Commitments and Contingent Liabilities (Note 6) -- --
Shareholders' Equity (Deficit)
Convertible Preferred Shares --
Authorized: 524,250 shares of NIS 1 par value as of
December 31, 1998; and none as of December 31, 1999; Issued
and outstanding: 221,265 shares as of December 31, 1998 and
none as of December 31, 1999 Aggregate liquidation preference
of approximately $13,200 as of December 31, 1998 and none as of
December 31, 1999 .............................................. 74 --
Ordinary Shares --
Authorized: 11,515,000 and 40,000,000 shares of NIS 0.05 par
value as of December 31, 1998 and 1999, respectively; Issued and
outstanding: 1,450,040 and 15,199,344 shares as of December 31,
1998 and 1999, respectively .................................... 27 213
Additional paid-in capital ...................................... 11,256 133,403
Deferred compensation .......................................... (418) (5,779)
Notes receivable from shareholders .............................. (77) (1,060)
Accumulated other comprehensive income .......................... -- 63
Accumulated deficit ............................................. (11,677) (31,528)
--------- ---------
Total shareholders' equity (deficit) ......................... (815) 95,312
--------- ---------
$ 2,366 $ 100,336
========= =========
The accompanying notes are an integral part of these consolidated financial statements.
</TABLE>
F-3
<PAGE>
COMMTOUCH SOFTWARE LTD.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
<TABLE>
<CAPTION>
Year ended
December 31,
---------------------------------------
1997 1998 1999
--------- --------- ----------
<S> <C> <C> <C>
Revenues:
Email services ........................................ $ -- $ 389 $ 4,251
Software licenses ..................................... 711 -- --
Software maintenance and services ..................... 188 -- --
--------- --------- ----------
Total revenues .................................... 899 389 4,251
--------- --------- ----------
Cost of revenues:
Email services ....................................... -- 569 3,643
Software licenses .................................... 21 -- --
Software maintenance and services ..................... 144 -- --
--------- --------- ----------
Total cost of revenues ............................. 165 569 3,643
--------- --------- ----------
Gross profit (loss) ...................................... 734 (180) 608
--------- --------- ----------
Operating expenses:
Research and development, net ........................ 1,108 1,149 2,942
Sales and marketing ................................. 2,202 2,001 7,722
General and administrative ........................... 829 604 4,328
Amortization of the prepaid marketing expenses ........ -- -- 3,263
Amortization of stock-based employee compensation ..... -- 91 3,436
--------- --------- ----------
Total operating expenses ........................... 4,139 3,845 21,691
--------- --------- ----------
Operating loss .......................................... (3,405) (4,025) (21,083)
Interest and other income (expenses), net ............... (68) (326) 1,232
--------- --------- ----------
Net loss ................................................ $ (3,473) $ (4,351) $ (19,851)
========= ========= ==========
Basic and diluted net loss per share ..................... $ (2.40) $ (3.00) $ (2.65)
========= ========= ==========
Weighted average number of shares used in computing
basic and diluted net loss per share .................... 1,450 1,450 7,487
========= ========= ==========
The accompanying notes are an integral part of these consolidated financial statements.
</TABLE>
F-4
<PAGE>
COMMTOUCH SOFTWARE LTD.
STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY (DEFICIT)
(In thousands, except share data)
<TABLE>
<CAPTION>
Convertible
Preferred shares Ordinary shares Additional
----------------------- ------------------- paid-in
Shares Amount Shares Amount capital
--------- ------- ----------- ------ ----------
<S> <C> <C> <C> <C> <C>
Balance of January 1, 1997 ....................... 160,316 $ 56 1,450,040 $ 27 $ 4,624
Issuance of shares, net ........................ 23,321 7 -- -- 1,625
Warrants issued for services received and
bank line of credit ........................... -- -- -- -- 46
Net loss ....................................... -- -- -- -- --
--------- ------- ----------- ------ ----------
Balance as of December 31, 1997 .................. 183,637 63 1,450,040 27 6,295
Issuance of shares, net ........................ 37,628 11 -- -- 4,061
Warrants issued for services received and
bank line of credit ........................... -- -- -- -- 391
Deferred compensation ........................ -- -- -- -- 509
Amortization of deferred compensation ......... -- -- -- -- --
Net loss ....................................... -- -- -- -- --
--------- ------- ----------- ------ ----------
Balance as of December 31, 1998 .................. 221,265 74 1,450,040 27 11,256
Issuance of shares, net ........................ 134,225 33 -- -- 18,417
Issuance of shares at initial public offering,
net .......................................... -- -- 4,794,086 58 65,948
Conversion of preferred shares to ordinary
shares ....................................... (355,490) (107) 7,109,800 107 --
Fair value of warrants issued for services
and bank line of credit ........................ -- -- -- -- 8,131
Deferred compensation .......................... -- -- -- -- 8,797
Ordinary shares issued for notes ............... -- -- 670,180 8 1,029
Issuance of shares upon exercise of warrants,
net .......................................... -- -- 1,105,378 12 19,808
Issuance of shares upon exercise of options ..... -- -- 69,860 1 17
Amortization of deferred compensation ........... -- -- -- -- --
Repayment of notes receivable .................. -- -- -- -- --
Other comprehensive income--unrealized
holding gains on marketable securities ......... -- -- -- -- --
Net loss ....................................... -- -- -- -- --
Total comprehensive loss ........................ -- -- -- -- --
--------- ------- ----------- ------ ----------
Balance as of December 31, 1999 .................. -- $ -- 15,199,344 $ 213 $ 133,403
========= ======= =========== ====== ==========
<CAPTION>
Stock-based Notes Accumulated
employee receivable other
deferred from comprehensive Accumulated
compensation shareholders income deficit Total
-------------- -------------- --------------- ------------ ------------
<S> <C> <C> <C> <C> <C>
Balance of January 1, 1997 ........................ $ -- $ (77) $-- $ (3,853) $ 777
Issuance of shares, net ......................... -- -- -- -- 1,632
Warrants issued for services received and
bank line of credit ............................ -- -- -- -- 46
Net loss ........................................ -- -- -- (3,473) (3,473)
--------- --------- ----- ---------- ----------
Balance as of December 31, 1997 ................... -- (77) -- (7,326) (1,018)
Issuance of shares, net ......................... -- -- -- -- 4,072
Warrants issued for services received and
bank line of credit ............................ -- -- -- -- 391
Deferred compensation ......................... (509) -- -- -- --
Amortization of deferred compensation .......... 91 -- -- -- 91
Net loss ........................................ -- -- -- (4,351) (4,351)
--------- --------- ----- ---------- ----------
Balance as of December 31, 1998 ................... (418) (77) -- (11,677) (815)
Issuance of shares, net ......................... -- -- -- -- 18,450
Issuance of shares at initial public offering,
net ........................................... -- -- -- -- 66,006
Conversion of preferred shares to ordinary
shares ........................................ -- -- -- -- --
Fair value of warrants issued for services
and bank line of credit ......................... -- -- -- -- 8,131
Deferred compensation ........................... (8,797) -- -- -- --
Ordinary shares issued for notes ................ -- (1,037) -- -- --
Issuance of shares upon exercise of warrants,
net ........................................... -- -- -- -- 19,820
Issuance of shares upon exercise of options ..... -- -- -- -- 18
Amortization of deferred compensation ............ 3,436 -- -- -- 3,436
Repayment of notes receivable ................... -- 54 -- -- 54
Other comprehensive income--unrealized
holding gains on marketable securities .......... -- -- 63 -- 63
Net loss ........................................ -- -- -- (19,851) (19,851)
----------
Total comprehensive loss ......................... -- -- -- -- (19,788)
- - - - -
--------- --------- ----- ---------- ----------
Balance as of December 31, 1999 ................... $ (5,779) $ (1,060) $ 63 $ (31,528) $ 95,312
========= ========= ===== ========== ==========
The accompanying notes are an integral part of these consolidated financial statements.
</TABLE>
F-5
<PAGE>
COMMTOUCH SOFTWARE LTD.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
<TABLE>
<CAPTION>
Year Ended
December 31,
-------------------------------------------
1997 1998 1999
--------- --------- ----------
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss ................................................... $ (3,473) $ (4,351) $ (19,851)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization ........................... 206 236 1,709
Amortization of stock-based employee deferred
compensation and warrants issued for service
received and bank line of credit ........................ 46 482 3,796
Decrease (increase) in trade receivables, net ............ 738 (84) (2,245)
Amortization of prepaid marketing expenses ............... -- -- 3,263
Decrease (increase) in prepaid expenses and other
accounts receivable .................................... 14 (164) (1,028)
Increase in account payable .............................. 99 91 1,064
Increase (decrease) in employee and payroll accruals
and other liabilities ................................... (147) 128 1,645
Increase in deferred revenue ............................. -- 74 487
Increase (decrease) in accrued severance pay, net ........ (54) 19 (44)
Other ................................................... -- -- (12)
--------- --------- ----------
Net cash used in operating activities .......................... (2,571) (3,569) (11,216)
--------- --------- ----------
Cash flows from investing activities:
Purchase of available-for-sale marketable
securities ................................................... -- -- (17,987)
Long-term deposits .......................................... -- -- (1,254)
Advance to related party .................................... -- -- (364)
Proceeds from sale of property and equipment ............... -- -- 13
Purchase of property and equipment .......................... (93) (442) (6,938)
--------- --------- ----------
Net cash used in investing activities .......................... (93) (442) (26,530)
--------- --------- ----------
Cash flows from financing activities:
Short-term bank credit, net ................................. 733 595 (1,328)
Repayment of note receivable by shareholder ................. -- -- 54
Principal payment of capital lease .......................... (67) (146) (112)
Proceeds from issuance of shares, net ....................... 1,632 4,072 104,294
--------- --------- ----------
Net cash provided by financing activities ..................... 2,298 4,521 102,908
--------- --------- ----------
Increase (decrease) in cash and cash equivalents ............... (366) 510 65,162
Cash and cash equivalents at the beginning of the year ......... 690 324 834
--------- --------- ----------
Cash and cash equivalents at the end of the year ............... $ 324 $ 834 $ 65,996
========= ========= ==========
Supplemental disclosure of cash flows activity:
Cash paid during the year:
Interest ................................................... $ 48 $ 97 $ 117
========= ========= ==========
Supplemental disclosure of non-cash activity:
Capital lease obligations ................................... $ -- $ 328 $ --
========= ========= ==========
Ordinary shares issued for notes receivable from
shareholders ............................................... $ -- $ -- $ 1,037
========= ========= ==========
Issuance of Warrants for Prepaid Marketing Expenses ......... $ -- $ -- $ 7,771
========= ========= ==========
The accompanying notes are an integral part of these consolidated financial statements.
</TABLE>
F-6
<PAGE>
COMMTOUCH SOFTWARE LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1: GENERAL
Commtouch Software Ltd. (the "Company" or "Commtouch") was incorporated under
the laws of Israel in 1991. The Company, together with its United States
subsidiary, Commtouch Software Inc., ("CSI") a California corporation, is a
provider of Web-based email and communications solutions to customers who in
turn offer those solutions to their end-users. From inception through 1997, the
Company generated revenues primarily from sale maintenance and service of
stand-alone email client software products for both mainframe and personal
computers. From 1998, the Company began to generate revenues by providing email
services to its customers. Email service revenues are derived from contracts
that provide for either a share of advertising revenues subject to a minimum
annual revenue commitment or a monthly per-email box fee, and fees for direct
marketing and communications services. In November 1999, the Company
established a wholly-owned subsidiary in England, Commtouch Software (UK) Ltd.
(the "UK company"). The UK company had not yet commenced operations.
During 1999, approximately 11% of the revenues were derived from a single
customer. During 1998, approximately 54% of the revenues were derived from
another single customer.
NOTE 2: SIGNIFICANT ACCOUNTING POLICIES
The consolidated financial statements have been prepared in accordance with
generally accepted accounting principles in the United States.
a. Use of Estimates:
The preparation of consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the amounts reported in the consolidated financial
statements and accompanying notes. Actual results could differ from those
estimates.
b. Financial Statements Denominated in United States Dollars:
Most of the Company's revenues are denominated in United States dollars. In
addition, a substantial portion of the Company's costs are incurred in dollars.
Since the dollar is the primary currency in the economic environment in which
the Company and its subsidiaries operate, the dollar is their functional
currency, and, accordingly, monetary accounts maintained in currencies other
than the dollar are remeasured using the foreign exchange rate at the balance
sheet date. Operational accounts and non-monetary balance sheet accounts are
measured and recorded at the rate in effect at the date of the transaction. The
effects of foreign currency remeasurement are reported in current operations.
c. Principles of Consolidation:
The consolidated financial statements include the accounts of the Company and
its wholly-owned subsidiaries. All significant intercompany balances and
transactions have been eliminated in consolidation.
d. Cash, Cash Equivalents and Marketable Securities:
The Company considers all highly liquid investments originally purchased with
maturities of three months or less to be cash equivalents.
The Company accounts for its marketable securities in accordance with Statement
of Financial Accounting Standards ("SFAS") No. 115, "Accounting for Certain
Investments in Debt and Equity Securities". All debt securities are designated
as available-for-sale. Available-for-sale securities are
F-7
<PAGE>
COMMTOUCH SOFTWARE LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(Continued)
carried at fair value, which is determined based upon the quoted market prices
of the securities, with unrealized gains and losses reported in shareholders'
equity, as items of other comprehensive income.
e. Prepaid Marketing Expenses:
The Company recorded prepaid marketing expenses, representing the fair value of
warrants which have been issued to Go2Net Inc. and Microsoft Corporation in
connection with commercial agreements into which the Company entered during
1999.
The prepaid marketing expenses are amortized using the straight-line method
over the minimum term of the agreements (twelve months).
In 1999, operating expenses included amortization of prepaid marketing expenses
amounting to $3.3 million.
f. Property and Equipment:
Property and equipment are stated at cost and depreciated using the straight
line method over the estimated useful lives of the assets ranging from two to
sixteen years. Leasehold improvements are amortized by the straight-line method
over the lease term.
The Company periodically assesses the recoverability of the carrying amount of
property and equipment and provides for any possible impairment loss based upon
the difference between the carrying amount and fair value of such assets. As of
December 31, 1999, no impairment losses have been identified.
g. Research and Development:
Research and development costs are charged to the statement of operations as
incurred. Statement of Financial Accounting Standards Board 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 does not incur
any costs between the completion of the working model and the point at which
the product is ready for general release. Therefore, through December 31, 1999,
the Company has charged all software development costs to research and
development expense in the period incurred.
h. Revenue Recognition:
Since 1998, the Company has derived its revenues from providing Web-based email
services. 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. Revenues from set up and installation fees are recognized upon
installation. Amounts billed or received in advance of service delivery are
recorded as deferred revenue.
Revenues from software products sales that occurred through 1997 were
recognized upon delivery of the software master for reproduction and
distribution provided no significant vendor obligations remained, and
collection of the related receivable was probable in accordance with Statement
of Position 91-1.
F-8
<PAGE>
COMMTOUCH SOFTWARE LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(Continued)
i. 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, when expenses under such approved projects are
incurred. Development grants amounted to $288 in 1997 and none in 1998 and
1999.
j. Concentrations of Credit Risk:
Financial instruments that potentially subject the Company to concentrations of
credit risk consist principally of trade receivables, cash equivalents and
marketable securities. The majority of the Company's cash, cash equivalents and
marketable securities are invested in dollar and dollar linked investments and
are deposited in major banks in Israel and in the United States. Management
believes that the financial institutions that hold the Company's investments
are financially sound and, accordingly, minimal credit risk exists with respect
to these investments.
The Company's trade receivables are derived from transactions with companies
located primarily in North America, Europe and the Far East. The Company
maintains an allowance for doubtful trade receivables based upon the expected
collectibility of trade receivables. The allowance for doubtful accounts was
none and $405,000 at December 31, 1998 and 1999, respectively. In 1997, the
Company wrote off approximately $170,000 of trade receivables that were derived
from revenues recognized in 1996.
k. 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", in accounting for its
employee stock option plans. Under APB 25, when the exercise price of the
Company's stock options equals or is above the market value of the underlying
stock on the date of grant, no compensation expense is recognized. The
pro-forma information with respect to the fair value of the options is provided
in accordance with the provisions of Statement No. 123.
In accounting for warrants granted to those other than employees, the Company
applied the provisions of SFAS No. 123, "Accounting for Stock-Based
Compensation" and Emerging Issues Task Force ("EITF") 96-18 "Accounting for
Equity Instruments That Are Issued to other than Employees Acquiring or in
Conjunction with Selling, Goods or Services." . The fair value of these
warrants was estimated at the grant date, using the Black-Scholes
option-pricing model.
l. Basic and Diluted Net Loss Per Share:
Basic and diluted net loss per share are presented in accordance with SFAS No.
128, "Earnings per Share" ("SFAS 128"), for all periods presented.
Basic net loss per share has been computed using the weighted-average number of
ordinary shares outstanding during the period. Diluted net loss per share is
computed based on the weighted average number of ordinary shares outstanding
during each year, plus the weighted average number of dilutive potential
ordinary shares considered outstanding during the year.
All convertible preferred shares, outstanding stock options, and warrants have
been excluded from the calculation of the diluted loss per share because all
such securities are antidilutive for all periods presented. The total number of
shares related to the outstanding options and warrants excluded from the
calculations of diluted net loss per share were 911,680, 1,236,100 and
2,497,470 for 1997, 1998 and 1999, respectively.
F-9
<PAGE>
COMMTOUCH SOFTWARE LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(Continued)
m. Severance Pay:
The Company's liability for severance pay is calculated pursuant to Israeli
severance pay law based on the most recent salary of the employees multiplied
by the number of years of employment as of the balance sheet date. Employees
are entitled to one month's salary for each year of employment or a portion
thereof. The Company's liability for all of its employees is fully provided by
monthly deposits with severance pay funds insurance policies and by an accrual.
The deposited funds include profits accumulated up to the balance sheet date.
The deposited funds may be withdrawn only upon the fulfillment of the
obligation pursuant to Israeli severance pay law or labor agreements. The value
of the deposited funds is based on the cash surrender value of these policies,
and includes immaterial profits.
Severance expenses for 1997, 1998 and 1999 were approximately $73,000, $62,000
and $129,000, respectively.
n. Fair Value of Financial Instruments:
The carrying amounts of cash and cash equivalents, marketable securities, trade
receivables and accounts payable, approximate their fair values due to the
short-term maturities of these instruments.
The fair value of long term deposits is estimated based on current interest
rates available to the Company for debt instruments with similar terms, degrees
of risk and remaining maturities. The carrying value of these obligations
approximates their respective fair values as of December 31, 1999.
o. Future Adoption of New Accounting Standards:
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement No. 133 "Accounting for Derivative Instruments and Hedging
Activities" ("SFAS No. 133"). This statement establishes accounting and
reporting standards requiring that every derivative instrument (including
certain derivative instruments embedded in other contracts) be recorded in the
balance sheet as either an asset or liability measured at its fair value. The
statement also requires that changes in the derivative's fair value be
recognized currently in earnings unless specific hedge accounting criteria are
met. Special accounting for qualifying hedges allows a derivative's gains and
losses to offset related results on the hedged item in the income statement,
and requires that a company must formally document, designate, and assess the
effectiveness of transactions that receive hedge accounting.
The FASB has issued SFAS No. 137, "Accounting for Derivative Instruments and
Hedging Activities--Deferral of the Effective Date of FASB Statement No. 133".
The Statement defers for one year the effective date of SFAS No. 133. The rule
will apply to all fiscal quarters of all fiscal years beginning after June 15,
2000. The Company does not expect the impact of this new statement on the
consolidated financial statements to be material.
NOTE 3: MARKETABLE SECURITIES
December 31,
1999
--------------
Marketable securities are as follows (in thousands):
Commercial papers ................................. $ 2,230
Government securities .............................. 9,918
Corporate debt securities .......................... 5,902
---------
$ 18,050
=========
During 1999, the unrealized gross holding gains on marketable securities were
$80,000, while the unrealized gross holding losses were $17,000.
F-10
<PAGE>
COMMTOUCH SOFTWARE LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(Continued)
NOTE 4: PROPERTY AND EQUIPMENT
December 31,
--------------------
1998 1999
-------- ---------
Property and equipment are as follows (in thousands):
Computers and peripheral equipment .................. $1,260 $ 7,704
Office furniture and equipment ...................... 90 232
Motor vehicles ...................................... 118 135
Leasehold improvements .............................. 137 454
------- --------
1,605 8,525
Less accumulated depreciation ....................... 673 2,377
------- --------
$ 932 $ 6,148
======= ========
Computers and peripheral equipment under various capital lease agreements
amounted to approximately $328,000 and $328,000 as of December 31, 1998 and
1999, respectively, and their accumulated depreciation amounted to
approximately $38,000 and $185,000 as of December 31, 1998 and 1999,
respectively.
Depreciation expenses amounted to approximately $145,000, $236,000 and
$1,706,000 for 1997, 1998 and 1999, respectively.
NOTE 5: CAPITAL LEASES
During 1998, CSI leased computers and peripheral equipment under various
capital lease agreements, with an option to purchase the equipment upon the
expiration of the initial lease term, for the fair market value prevailing at
that time, not to exceed 10% of the original cost of the equipment. The annual
interest rate of such capital leases ranges between 19.5% and 23%.
NOTE 6: COMMITMENTS AND CONTINGENT LIABILITIES
Operating Leases:
The facilities of the Company and CSI are leased under operating lease
agreements expiring through 2007. Future minimum lease payments under these
leases are as follows (in thousands):
2000 ............................. $ 2,251
2001 ............................. 2,803
2002 ............................. 2,889
2003 ............................. 2,782
2004 ............................. 2,770
Thereafter ....................... 6,168
--------
$ 19,663
========
Rent expenses for 1997, 1998 and 1999 were approximately $55,000, $56,000 and
$578,000, respectively. In connection with the lease agreement on an office
building, CSI deposited $1.3 million in long term lease deposits of which $1.1
million was held as collateral.
Royalties:
The Company is required to pay royalties on grants received from the Government
of Israel for research and development projects and marketing activities at the
rate of 3%--5% of total revenues, up to an amount equal to 100% to 150% of the
original amount received linked to the dollar.
F-11
<PAGE>
COMMTOUCH SOFTWARE LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(Continued)
As of December 31, 1999, the Company had an outstanding contingent obligation
to pay royalties in the aggregate amount of $275,000.
NOTE 7: INCOME TAXES
Israeli Income Tax
The Company's production facilities in Israel have been granted "Approved
Enterprise" status for two separate investment programs approved in 1992 and
1996 by the Israeli Investment Center under the Law for Encouragement of
Capital Investments, 1959 ("the Law").
The Company's first approved program commenced operation in 1995. The Company's
second program received a letter of approval in April 1996. An application for
an enlargement was submitted in February 2000 and has not yet been approved.
In February 2000 the Company submitted an application for another expansion
(third program).
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" in is period of benefit
mentioned above is taxed at the regular rate of 36%.
Distribution of cash dividends from income that was tax exempt due to the
"approved enterprise" status are subject to a tax of 10%-25%. In addition,
these dividends will be subject to a 15% withholding tax.
The tax exempt income attributable to the "Approved Enterprise" can be
distributed to shareholders without subjecting the Company to taxes only upon
the complete liquidation of the Company.
The Company's Board of Directors has determined that such tax exempt income will
not be distributed as dividends. The Company is 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 claim public issuance expenses.
As of December 31, 1999, Israeli net operating loss carryforwards amounted to
approximately $22.5 million. Such net operating loss may be carried forward
indefinitely and offset against future taxable income.
U.S. Income Tax:
CSI is taxed based upon tax laws in the U.S.
As of December 31, 1999, CSI had a U.S. federal net operating loss carryforward
of approximately $14.2 million. The net operating loss expires in various
amounts between the years 2008 and 2020.
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.
F-12
<PAGE>
COMMTOUCH SOFTWARE LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(Continued)
Deferred Taxes:
The Company expects that during the period in which its Israeli tax losses are
utilized its Israeli income would be substantially tax exempt. Accordingly
there will be no tax benefit available from such losses and no Israeli deferred
income taxes have been included in these financial statements.
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,
----------------------
1998 1999
-------- --------
Deferred tax assets are as follows (in thousands):
U.S. operating loss carryforwards ..................... $ 1,656 $ 4,970
Reserves and allowances not currently deductible ...... 15 57
------- --------
Net deferred tax asset before valuation allowance ..... 1,671 5,027
Valuation allowance ................................... (1,671) (5,027)
------- --------
Net deferred tax asset ................................ $ -- $ --
======= ========
For the year ended December 31, 1999 the valuation allowance increased by
approximately $3.4 million. No utilization of CSI's tax losses carryforwards is
expected in the foreseeable future, because of its history of operating losses.
In 1997, 1998 and 1999, the Company provided a 100% valuation allowance against
the deferred tax assets in respect of these tax loss carryforward and other
temporary differences because of the uncertainty of realizing these deferred
tax assets.
Pretax loss:
Pretax losses are as follows (in thousands):
1997 1998 1999
------- ------- --------
Israel ................................. $ 1,602 $ 2,497 $ 11,259
U.S. ................................... 1,871 1,854 8,592
------- ------- --------
$ 3,473 $ 4,351 $ 19,851
======= ======= ========
NOTE 8: SHAREHOLDERS' EQUITY
The ordinary shares of the Company are traded on the NASDAQ National Market.
a. Capital Shares:
In April 1999, the Company's Board of Directors approved: a 20 for 1 split of
ordinary shares, a change in the conversion ratio of preferred shares to
ordinary shares to 1 to 20 and an increase to the authorized ordinary shares to
40,000,000 shares of NIS 0.05 par value. The consolidated financial statements
have been retroactively adjusted to reflect such changes.
In July 1999, the Company completed an Initial Public Offering ("IPO") of its
ordinary shares. The Company sold 3,450,000 shares to the public at $16 per
share. Concurrent with the closing of the IPO, the Company sold 1,344,086
shares at $14.88 per share to Go2Net, Inc. In addition, the holders of Series
A, Series B, Series C and Series D convertible preferred shares received
ordinary shares pursuant to an automatic conversion, resulting in the issuance
of 7,109,800 ordinary shares in exchange for all outstanding convertible
preferred shares.
F-13
<PAGE>
COMMTOUCH SOFTWARE LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(Continued)
b. Warrants Issued:
Warrants to Investors. In 1996, the Company issued to certain Series B
investors warrants to purchase 13,873 Series B Convertible Preferred shares at
an exercise price of $44.04. These warrants were exercised concurrently with
the closing of the IPO.
Warrants Issued for Services Received and Financing Transactions. Through 1999,
the Company granted warrants in connection with a bank line of credit, loans
and consulting services received. At December 31, 1999, one warrant for 4,860
ordinary shares with an exercise price of $3.61 per share remained outstanding.
This warrant was net exercised into 4,461 shares in January 2000.
The Company recorded $17,000, $264,000, and $360,000 as interest expenses in
1997, 1998 and 1999, respectively. The Company recorded $29,000, $127,000 and
none in 1997, 1998 and 1999, respectively, as compensation expense and included
these amounts in operating expenses.
Warrants Issued to Strategic Partners and Customers. Concurrent with the
closing of the IPO, the Company entered into a customary commercial email
service agreement with Go2Net, a related party. Under this agreement, the
Company provides email services to the end users of Go2Net'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, 1999, this warrant had not been
exercised. At the grant date, the fair value of this warrant was estimated as
$5.9 million and is being amortized to operating expenses over the minimum term
of the contract (twelve months).
In October 1999, the Company entered into a customary email service agreement
with Microsoft Corporation. Under this agreement, the Company delivers email
services to Microsoft Web sites. In connection with this agreement, the Company
issued a warrant to purchase 707,965 ordinary shares at an exercise price of
$28.25 per share. The warrant was exercised on December 29, 1999. At the grant
date, the fair value of this warrant was estimated at $1.9 million and is being
amortized to operating expenses over the minimum term of the contract (twelve
months).
c. Issuance of Ordinary Shares Against Promissory Notes:
During 1999, several employees and officers early exercised 670,180 options
granted to them by Commtouch. In consideration for the ordinary shares purchased
pursuant to the early exercise of the options, they provided Commtouch with full
recourse promissory notes in the original principal amount of approximately $1.0
million. The promissory notes bear interest at 4.83%, with interest payment due
at the end of each calendar year, with the principal due on the fourth
anniversary of the date of the promissory notes. The shares purchased are
subject to a right of repurchase in favor of Commtouch according to the original
vesting schedule of the options exercised, generally four years. As of December
31, 1999, approximately 279,584 shares are subject to this right of repurchase.
d. Employee Stock Purchase Plan:
Commtouch reserved a total of 150,000 shares for issuance under the plan.
Eligible employees may 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.
e. Stock Options:
The Company has reserved 5,000,000 ordinary shares for issuance under employee
stock option plans and agreements. 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. The exercise
price of the options granted under the individual agreements may not be less
than the nominal value
F-14
<PAGE>
COMMTOUCH SOFTWARE LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(Continued)
of the shares into which such options are exercisable or in the case of the
subsidiary's plan it may not be less than fair market value. Any options that
are canceled or not exercised within the options period become available for
future grant.
In 1996, the Company adopted the 1996 CSI Stock Option Plan for granting
options to its U.S. employees to purchase ordinary shares of the Company. 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.
A summary of the company's share option activity under the plans is as follows:
<TABLE>
<CAPTION>
Weighted Average
Number of Shares Exercise Price
---------------------------------------- -------------------------------
1997 1998 1999 1997 1998 1999
--------- -------- ---------- -------- ------- --------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at beginning of period ...... 457,520 607,040 849,520 $ 0.99 $ 1.10 $ 1.20
Granted ................................. 213,820 251,900 1,342,670 1.45 1.45 10.13
Exercised .............................. -- -- (740,040) -- -- 1.42
Canceled .............................. (64,300) (9,420) (69,040) 1.45 1.45 4.49
--------- -------- ---------- -------- ------- --------
Outstanding at end of period ............ 607,040 849,520 1,383,110 1.10 1.20 9.62
========= ======== ========== ======== ======= ========
Exercisable at end of period ............ 165,480 375,580 381,315 1.45 1.45 3.50
========= ======== ========== ======== ======= ========
Deemed fair value of options granted
at an exercise price of:
-- Less than fair market value at
date of grant ........................ $ -- $ 2.46 $ 3.65
========= ======== ==========
-- Equals to fair market value at
date of grant ........................ $ 0.61 $ -- $ 15.75
========= ======== ==========
-- Exceeds fair market value at
date of grant ........................ $ -- $ -- $ --
========= ======== ==========
</TABLE>
The options outstanding as of December 31, 1999, have been separated into
ranges of exercise price, as follows:
<TABLE>
<CAPTION>
Options Weighted Options Weighted Average
Outstanding as of Average Weighted Exercisable as of Price of
December 31, Remaining Average Exercise December 31, Exercisable
Exercise Price 1999 Contractual Life Price 1999 Options
- ---------------- ------------------- ------------------ ------------------ ------------------- ------------------
<S> <C> <C> <C> <C> <C>
$ 0.55-$ 2.50 660,760 8.23 $ 1.52 320,282 $ 1.42
$11.00-$15.75 522,500 9.56 $14.13 61,033 $14.43
$16.06-$48.56 199,850 9.84 $24.65 -- --
------------------- ------------------ ------------------ ------------------- ------------------
$ 0.55-$48.56 1,383,110 8.96 $ 9.62 381,315 $ 3.50
=================== ================== ================== =================== ==================
</TABLE>
Under SFAS 123, pro forma information regarding net income (loss) and earnings
(loss) per share is required and has been determined as if the Company had
accounted for its employee stock options under the fair value method of that
Statement. The fair value for these options was estimated at the date of grant
using a Black-Scholes Option Pricing Model with the following weighted-average
assumptions for 1997, 1998 and 1999: risk-free interest rates of 6% for 1997
and 1998 and 5.5% for 1999, dividend yields of 0%, volatility factors of the
expected market price of the Company's ordinary shares of 0.5 for 1997, 1998
and 0.5 - 0.56 for 1999 and an expected life of the option of 6 months after
the option is vested.
F-15
<PAGE>
COMMTOUCH SOFTWARE LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(Continued)
The Black-Scholes option valuation model was developed for use in estimating
the fair value of traded options that have no vesting restrictions and are
fully transferable. In addition, option valuation models require the input of
highly subjective assumptions, including the expected stock price volatility.
Because the Company's employee stock options have characteristics significantly
different from those of traded options, and because changes in the subjective
input assumptions can materially affect the fair value estimate, in
management's opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of its employee stock options.
Pro forma information under SFAS 123 are as follows (in thousands except per
share amounts):
<TABLE>
<CAPTION>
1997 1998 1999
-------- -------- ---------
<S> <C> <C> <C>
Net loss as reported ................................ $ (3,473) $ (4,351) $ (19,851)
======== ======== =========
Pro forma net loss .................................. $ (3,600) $ (4,402) $ (20,224)
======== ======== =========
Pro forma basic and diluted net loss per share ...... $ (2.48) $ (3.04) $ (2.60)
======== ======== =========
</TABLE>
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 based on an accelerated
vesting method over the vesting period of the options, generally 4 years.
Deferred compensation is as follows (in thousands):
Balance as of January 1, 1999 .................................... $ 418
Deferred compensation related to options issued to employees ...... 8,797
Less amortization of deferred compensation ........................ (3,436)
--------
Balance as of December 31, 1999 ................................. $ 5,779
========
f. Non-Employee Directors Stock Option Plan:
The Company adopted the 1999 Non-Employee Directors Stock Option Plan.
Commtouch reserved a total of 250,000 shares for issuance under this plan. Each
individual who first joined the Board of Directors as a nonemployee director on
or after the effective date of the initial public offering received an option
grant for 10,000 ordinary shares. Each option granted under the Non-Employee
Directors Plan would 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. Each option has an exercise price equal to the
fair market value of the ordinary shares on the grant date of such option. 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 1999, the Company granted 60,000 shares to directors at a weighted
average exercise price of $15.83 per share. As of December 31, 999, 25,000
exercisable and 60,000 shares were outstanding.
NOTE 9: RELATED PARTY TRANSACTION
Other accounts receivables includes an advance to a related party of the
Company. In October 1999, the Company advanced $364,000 to an officer who is
also a director.
The loan is linked to the Israeli Consumer Price Index, plus a 2% interest
rate. The loan was fully repaid on February 10, 2000.
F-16
<PAGE>
COMMTOUCH SOFTWARE LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(Continued)
NOTE 10: SELECTED STATEMENTS OF OPERATIONS DATA
Geographic information:
The Company conducts its business on the basis of one reportable segment.
Revenues from external customers (in thousands):
Revenues
----------------------------
1997 1998 1999
------ ------ --------
Israel ........................................ $ 1 $ -- $ 369
U.S.A ........................................ 543 109 3,056
Europe ........................................ 28 130 344
Japan ........................................ 282 103 250
Other ........................................ 45 47 232
------ ------ --------
$ 899 $ 389 $ 4,251
====== ====== ========
The Company's long-lived assets as of December 31, are as follows (in
thousands):
1998 1999
------ --------
Israel ....................................... $ 291 $ 789
U.S.A ....................................... 641 5,359
------ --------
$ 932 $ 6,148
====== ========
F-17
<PAGE>
3,000,000 Shares
COMMTOUCH SOFTWARE LTD.
Ordinary Shares
[GRAPHIC OMITTED]
-----------------------
PROSPECTUS
-----------------------
U.S. Bancorp Piper Jaffray
Thomas Weisel Partners LLC
Warburg Dillon Read LLC
William Blair & Company
, 2000
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
Item 13. Other Expenses of Issuance and Distribution.
The following table sets forth the expenses payable by the Company (the
"Registrant") in connection with the offering of the securities being
registered other than the underwriting discounts and commissions. All of the
amounts are estimates except for the SEC registration fee, the NASD filing fee
and the Nasdaq National Market filing fee.
SEC registration fee ................................. $ 49,468
----------
NASD filing Fee ....................................... $19,238
Nasdaq National Market filing fee .................... 17,500
Blue Sky fees and expenses ........................... 10,000
Printing and engraving expenses ....................... 50,000
Israeli stamp duty .................................... 1,034,780
Legal fees and expenses .............................. 50,000
Accounting fees and expenses .......................... 50,000
Transfer agent and registrar fees and expenses ........ 10,000
Miscellaneous expenses ................................ 343,794
----------
Total .......................................... $1,634,780
==========
Item 14. Indemnification of Directors and Officers.
Reference is made to Section 6 of the Underwriting Agreement, a copy of which is
filed as Exhibit 1.1 hereto, which provides for indemnification of the directors
and officers of the Registrant who sign the Registration Statement by the
Underwriters against certain liabilities, including those arising under the
Securities Act, in certain circumstances.
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 fiduciary duty to the company, to the extent that he 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 committed in connection with his serving
as an Office Holder. Moreover, a company can indemnify an Office Holder for (a)
monetary liability imposed upon him 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 imposed upon him by a court, in an
action, suit or proceeding brought against him 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 was convicted, in each case in connection
with his activities as an Office Holder.
The Articles of Association of Commtouch allow Commtouch to insure and
indemnify Office Holders to the fullest extent permitted by law provided such
insurance of indemnification is approved by the Audit Committee. The
Registration Rights Agreement which we entered into with Go2Net and Vulcan,
contains certain provisions relating to indemnification of our directors and
officers. Pursuant to these provisions, the Registrant has in effect insurance
policies in the amount of US $25 million covering its directors and officers.
Certain members of our management team are officers of our subsidiary,
Commtouch Software Inc., a California Corporation, or reside in California. The
Articles of Incorporation of Commtouch Software Inc. provide that the liability
of the directors of the corporation for monetary damages shall be eliminated to
the fullest extent permissible under California law and that the corporation is
authorized to provide for the indemnification of agents of the corporation, as
defined in Section 317 of the
II-1
<PAGE>
California General Corporation Law, in excess of that expressly permitted by
Section 317 for breach of duty to the corporation and its shareholders to the
fullest extent permissible under California law.
With respect to all proceedings other than shareholder derivative actions,
Section 317 permits a California corporation to indemnify any of its directors,
officers or other agents only if such person acted in good faith and in a
manner such person reasonably believed to be in the best interests of the
corporation and, in the case of a criminal proceeding, had no reasonable cause
to believe the conduct of such person was unlawful. In the case of derivative
actions, a California corporation may indemnify any of its directors, officers
or agents only if such person acted in good faith and in a manner such person
believed to be in the best interests of the corporation and its shareholders.
Furthermore, in derivative actions, no indemnification is permitted (i) with
respect to any matter with respect to which the person to be indemnified has
been held liable to the corporation, unless such indemnification is approved by
the court; (ii) of amounts paid in settling or otherwise disposing of a pending
action without court approval; or (iii) of expenses incurred in defending a
pending action which is settled or otherwise disposed of without court
approval. To the extent that a director, officer or agent of a corporation has
been successful on the merits in defense of any proceeding for which
indemnification is permitted by Section 317, a corporation is obligated by
Section 317 to indemnify such person against expenses actually and reasonably
incurred in connection with the proceeding.
Pursuant to the terms under which the ordinary shares were issued to the Selling
Shareholders, the Company has agreed to indemnify the Selling Shareholders and
any underwriter against such liabilities as they may incur as a result of any
untrue statement of a material fact in the Registration Statement of which this
prospectus is a part, or any omission herein or therein to state a material fact
necessary in order to make the statements made, in light of the circumstances
under which they were made, not misleading. Such indemnification includes
liabilities under the Securities Act, the Securities Exchange Act, state
securities laws and the rules thereunder, but excludes liabilities for
statements or omissions that were based on information provided by a Selling
Shareholder, as to which each Selling Shareholder has agreed to indemnify the
Company and any underwriter.
Item 15. Recent Sales of Unregistered Securities.
Since January 1997, we have sold and issued the securities listed below without
registering the securities under the Securities Act of 1933, as amended. None
of these transactions involved any underwriters, underwriting discounts or
commissions, or any public offering(a)
(1) Between July 1997 and March 1999, we issued and sold for cash 153,093
Series C Convertible Preferred Shares at a price of $72.17 per share to 22
investors.
(2) In April 1999, we issued Convertible Promissory Notes that have since
converted into 42,081 Series D Convertible Preferred Shares. The effective
price for each Series D Preferred Share was $314.56.
(3) Concurrently with our initial public offering on July 16, 1999, in a
private transaction we sold 896,057 ordinary shares to Go2Net for a purchase
price of $13,333,328 and an additional 448,029 shares to Vulcan Ventures
Incorporated for a purchase price of $6,666,672. The purchase price per share
was $14.88, equal to the initial public offering price less the underwriting
discount. In addition, we issued a warrant to Go2Net to purchase 1,136,000
ordinary shares at an exercise price of $12.80 per share.
(4) In connection with an Email Services Agreement dated October 27, 1999
between Commtouch's U.S. subsidiary Commtouch Software, Inc., and Microsoft
Corporation, Commtouch granted Microsoft a warrant, exercisable until December
29, 1999, to purchase 707,964 of Commtouch's ordinary shares at an exercise
price of $28.25 per share for an aggregate exercise price of $20,000,000. On
December 29, 1999, Microsoft exercised the warrant and now holds 707,965
shares.
(5) On August 26, 1998, we issued a Series C Preferred Stock Purchase
Warrant to the First Portland Corporation to purchase 243 shares at a purchase
price of $72.17 per share. In January 2000, Cross Point Leasing net exercised
the warrant and sold all the shares acquired pursuant to the exercise.
- ------------
(a) Share figures and price-per-share figures do not reflect the twenty-for-one
stock split which became effective concurrently with the initial public
offering.
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<PAGE>
We believe that each transaction listed above was exempt from the registration
requirements of the Securities Act of 1933, as amended, by virtue of Section
4(2) of the Securities Act, Regulation D, promulgated under the Securities Act
or Rule 701 with respect to compensatory benefit plans and contracts relating
to compensation as provided under Rule 701. The recipients of securities in
each such transaction represented their intentions to acquire the securities
for investment only and not with a view to or for sale in connection with any
distribution thereof and appropriate legends were affixed to the share
certificates and warrants issued in such transactions. All recipients had
adequate access, through their relationships with us, to information about us.
<TABLE>
Item 16. Exhibits and Financial Statement Schedules.
<CAPTION>
(a) Exhibits
Exhibit
Number Description of Document
- --------- --------------------------------------------------------------------------------------------
<S> <C>
1.1 Form of Underwriting Agreement.**
3.1 Memorandum of Association of the Registrant.(1)
3.2 Articles of Association of the Registrant.(1)
4.1 Specimen Certificate of Ordinary Shares.(1)
4.2 Amended and Restated Registration Rights Agreement dated as of April 19, 1999.(1)
4.2.1 Amendment No. 1 to Amended and Restated Registration Rights Agreement dated as of
December 29, 1999.(5)
4.2.2 Amendment No. 2 to Amended and Restated Registration Rights Agreement dated as of
March 10, 2000.**
4.3 Form of Tag-Along Rights (Right of First Refusal and Co-Sale) Agreement dated as of
December 23, 1998.(1)
4.4 Form of Drag-Along Letter dated as of April 15, 1999.(1)
5.1 Opinion of Naschitz, Brandes & Co., Israeli counsel to the Registrant, as to certain legal
matters with respect to the legality of the shares.**
10.1 Registrant's 1996 CSI Stock Option Plan and forms of agreements thereunder.(1)
10.2 Registrant's form of Stock Option Agreement for Israeli Employees.(1)
10.3 Registrant's 1999 Stock Option Plan and form of agreement thereunder.(1)
10.4 Commtouch Software Ltd. 1999 Nonemployee Directors Stock Option Plan.(1)
10.5 Commtouch Software Ltd. 1999 Employee Stock Purchase Plan and forms thereunder.(1)
10.6 Sublease between ASCII of America, Inc. and Commtouch for Commtouch's offices in
Santa Clara, California, dated December 16, 1998.(1)
10.7 Lease between DeAnza Building and Commtouch for Commtouch's offices in Sunnyvale,
California, dated February 5, 1996, as amended.(1)
10.8 Form of Letter Agreement between the Registrant and U.S. Bancorp Piper Jaffray.(2)
10.9 Form of Customized Web-based Email Service Agreement by and between Go2Net, Inc.
and the Registrant.(3)
10.9.1 Form of Share Warrant for Go2Net, Inc. to purchase ordinary shares of the Registrant.(3)
10.9.2 Form of Share Warrant for Microsoft Corporation to purchase ordinary shares of the
Registrant dated October 26, 1999.(5)
10.9.3 Amendment dated December 29, 1999 to Form of Share Warrant for Microsoft
Corporation to purchase ordinary shares of the Registrant.(5)
10.9.4 Lockup Agreement between the Registrant and Microsoft Corporation dated December 29,
1999.(5)
10.10 Form of Share Purchase Agreement by and among the Registrant, Go2Net, Inc. and
Vulcan Ventures Incorporated.(3)
10.10.1 Form of Registration Rights Agreement by and among the Registrant, Go2Net, Inc. and
Vulcan Ventures Incorporated.(3)
10.10.2 Form of Letter Agreement between the Registrant and Selling Securityholders extending
deadline for SEC registration.(5)
</TABLE>
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<PAGE>
<TABLE>
<CAPTION>
Exhibit
Number Description of Document
- -------- --------------------------------------------------------------------------------------
<S> <C>
21.1 Subsidiaries of the Registrant.(1)
23.1 Consent of Kost, Forer & Gabbay, independent auditors.**
23.2 Consent of Naschitz, Brandes & Co. (contained in Exhibit 5.1)
23.3 Consent of McCutchen, Doyle, Brown & Enersen, LLP.**
24.1 Power of Attorney of directors and certain officers of the Registrant.**
99.1 Press Release of the Registrant, dated July 7, 1999.(2)
99.2 Memorandum of Understanding between the Registrant, Go2Net, Inc. and Vulcan Ventures
Incorporated, dated July 7, 1999.(2)
<FN>
- ------------
(1) Incorporated by reference to similarly numbered exhibit in Amendment No. 1
to Registration Statement on Form F-1 of Commtouch Software Ltd., File No.
333-78531.
(2) Incorporated by reference to similarly numbered exhibit in Amendment No. 4
to Registration Statement on Form F-1 of Commtouch Software Ltd., File No.
333-78531.
(3) Incorporated by reference to similarly numbered exhibit in Amendment No. 5
to Registration Statement on Form F-1 of Commtouch Software Ltd., File No.
333-78531.
(4) Filed with Amendment No. 1 to Registration Statement on Form F-1 of
Commtouch Software Ltd., File No. 333-89773, filed on January 5, 2000.
(5) Incorporated by reference to similarly numbered exhibit in Amendment No. 1
to Registration Statement on Form F-1 of Commtouch Software Ltd., File No.
333-89773.
* To be filed by amendment.
** Previously filed.
</FN>
</TABLE>
(b) Financial Statement Schedules.
Schedule II
Item 17. Undertakings.
(a) The undersigned Registrant hereby undertakes:
(1) For the purpose of determining any liability under the Securities Act
of 1933, the information omitted from the form of prospectus filed as part of
this Registration Statement in reliance upon Rule 430A and contained in a form
of prospectus filed by the registrant pursuant to Rule 424(b)(1) or (4) or
497(h) under the Securities Act shall be deemed to be part of this Registration
Statement at the time it was declared effective.
(2) For the purpose of determining any liability under the Securities Act
of 1933, each post-effective amendment that contains a form of prospectus shall
be deemed to be a new registration statement relating to the securities offered
therein, and the offering of such securities at that time shall be deemed to be
the initial bona fide offering thereof.
(b) Insofar as indemnification for liabilities arising under the Securities Act
of 1933 may be permitted to directors, officers and controlling persons of the
Registrant pursuant to the foregoing provisions, or otherwise, the Registrant
has been advised that in the opinion of the Securities and Exchange Commission
such indemnification is against public policy as expressed in the Securities
Act and is, therefore, unenforceable. In the event that a claim for
indemnification against such liabilities (other than payment by the Registrant
of expenses incurred or paid by a director, officer or controlling person of
the Registrant in the successful defense of any action, suit or proceeding) is
asserted by such director, officer or controlling person in connection with the
securities being registered, the Registrant will, unless in the opinion of its
counsel the matter has been settled by controlling precedent, submit to a court
of appropriate jurisdiction the question whether such indemnification by it is
against public policy as expressed in the Securities Act and will be governed
by the final adjudication of such issue.
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<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the registrant has
duly caused this Amendment to the Registration Statement to be signed on its
behalf by the undersigned, thereunto duly authorized, in the city of Palo Alto,
state of California, on March 29, 2000.
COMMTOUCH SOFTWARE LTD.
By: /s/ JAMES E. COLLINS
-----------------------------------
James E. Collins
Chief Financial Officer
Pursuant to the requirements of the Securities Act of 1933, this Amendment to
the Registration Statement has been signed by the following persons in the
capacities and on the dates indicated.
<TABLE>
<CAPTION>
Name Title Date
- ----------------------------- -------------------------------------- ----------------
<S> <C> <C>
/S/ GIDEON MANTEL* Chief Executive Officer and Director March 29, 2000
- --------------------------- (Principal Executive Officer)
Gideon Mantel
/s/ JAMES E. COLLINS* Chief Financial Officer (Principal March 29, 2000
- --------------------------- Financial Officer)
James E. Collins
/s/ DEVYANI PATEL* Controller March 29, 2000
- ---------------------------
Devyani Patel
/s/ AMIR LEV* Director March 29, 2000
- ---------------------------
Amir Lev
/s/ ALLAN C. BARKAT* Director March 29, 2000
- ---------------------------
Allan C. Barkat
/s/ YAIR SAFRAI* Director March 29, 2000
- ---------------------------
Yair Safrai
/s/ YOSEPH SELA* Director March 29, 2000
- ---------------------------
Yoseph Sela
/s/ NAHUM SHARFMAN* Director March 29, 2000
- ---------------------------
Nahum Sharfman
/s/ THOMAS CAMP* Director March 29, 2000
- ---------------------------
Thomas Camp
/s/ RICHARD SORKIN* Director March 29, 2000
- ---------------------------
Richard Sorkin
/s/ JAMES E. COLLINS * Individually and as March 29, 2000
- --------------------------- Attorney-in-fact and
James E. Collins Authorized U.S. Representative
</TABLE>
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<PAGE>
COMMTOUCH SOFTWARE LTD.
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
U.S. Dollars in thousands
<TABLE>
<CAPTION>
Balance at
the Charged to Balance at
beginning of costs and end of the
the period expenses Deductions period
-------------- ------------ ------------ ------------
<S> <C> <C> <C> <C>
Year ended December 31, 1997:
Bad debt .................. -- 170 170 --
== ==== ==== ====
Year ended December 31, 1998:
Bad debt .................. -- -- -- --
== ==== ==== ====
Year ended December 31, 1999:
Bad debt .................. -- 405 -- 405
== ==== ==== ====
</TABLE>
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<PAGE>
[ERNST & YOUNG LETTERHEAD]
To: Board of Directors Commtouch Software LTD.
We have audited the consolidated financial statements of Commtouch Software
LTD. as of December 31, 1999 and 1998, and for each of the three years in the
period ended December 31, 1999, and have issued our report thereon dated
January 31, 2000 (included elsewhere in this Registration Statement). Our
audits also included the financial statement schedule listed in Item 16(b) of
this Registration Statement. This schedule is the responsibility of the
Company's management. Our responsibility is to express an opinion based on our
audits.
In our opinion, the financial statement schedule referred to above, when
considered in relation to the basic consolidated financial statements taken as
a whole, presents fairly in all material respects the information set forth
therein.
/s/ KOST, FORER & GABBAY
-------------------------------------
Kost, Forer & Gabbay
A member of Ernst & Young International
Tel-Aviv, Israel
January 31, 2000
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