COMMTOUCH SOFTWARE LTD
Filing Type: 20-F
Description: Annual Report for Foreign Private
Issuers
Filing Date:
Period End: Dec 31, 1999
Primary Exchange: NASDAQ - National Market System
Ticker: CTCH
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Table of Contents
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20-F
Item 17.......................................................................2
PART I........................................................................5
Item I........................................................................5
Item 2.......................................................................29
Item 3.......................................................................29
Item 4.......................................................................29
Item 5.......................................................................30
Item 6.......................................................................30
Item 7.......................................................................30
Item 8.......................................................................40
Item 9.......................................................................41
Income Statement.............................................................41
Item 10......................................................................48
Item 11......................................................................55
Item 12......................................................................55
Item 13......................................................................55
PART II.....................................................................58
Item 14......................................................................58
Part III.....................................................................58
Item 15......................................................................58
Item 16......................................................................58
Part IV......................................................................58
Item 17......................................................................58
Item 18......................................................................58
Item 19......................................................................59
Balance Sheet................................................................60
Income Statement.............................................................61
Cash Flow Statement..........................................................63
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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AMENDMENT NO. 1
TO
FORM 20-F
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1999
Commission file number 000-26495
COMMTOUCH SOFTWARE LTD.
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(Exact name of Registrant as specified in its charter and translation of
Registrant's name into English)
Israel
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(Jurisdiction of incorporation or organization)
6 Hazoran Street
Poleg Industrial Park, P.O. Box 8511
Netanya 42504, Israel
011-972-9-863-6888
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(Address of principal executive offices)
James E. Collins, Chief Financial Officer
2029 Stierlin Court
Mountain View, California 94043
(650) 864-2000
(name, address, including zip code, and telephone number,
including area code of agent for service of process)
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Securities registered or to be registered pursuant to Section 12(b) of the Act.
Title of each class Name of each exchange on which registered
---------------------- -------------------------------------------
N/A None
Securities registered or to be registered pursuant to Section 12(g) of the Act.
Ordinary Shares, par value NIS 0.05 per share
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(Title of Class)
Securities for which there is a reporting obligation pursuant to Section 15(d)
of the Act.
None
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Indicate the number of outstanding shares of each of the issuer's classes
of capital or common stock as of the close of the period covered by the annual
report.
Ordinary Shares, par value NIS 0.05 15,199,344
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No [_]
Indicate by check mark which financial statement item the registrant has
elected to follow.
Item 17 [_] Item 18 [X]
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PART I
Item 1. Description of Business.
This Annual Report on form 20-F contains forward-looking statements. These
forward-looking statements include, but are not limited to, statements about our
plans, objectives, expectations and intentions and other statements contained in
this annual report that are not historical facts. Prospective investors are
cautioned that any such forward-looking statements are not guarantees of future
performance and involve risks and uncertainties, and that actual results may
differ materially from those in the forward-looking statements as a result of
various factors. The information contained in this annual report identifies
important factors that could cause such differences.
Amounts and percentages appearing in this Annual Report may not total due to
rounding.
Overview
Commtouch Software Ltd. ("Commtouch" or the "Company") and its subsidiaries 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
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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].
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
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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.
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.
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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
<PAGE>
conduct ecommerce with their end users.
We provide our email and messaging solutions through a variety of service
arrangements. These arrangements typically consist of one of the following:
o price-per-emailbox, subject to a minimum annual service fee;
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
Our Classic Service provides the following features:
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Feature Description
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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.
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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.
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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.
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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.
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Contact Center Enhanced address book functionality that
includes the ability to create and manage
groups and to import personal information
from the contact databases.
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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.
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Spam Protection Advanced anti-spamming controls and email
filtering.
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Feature Description
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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.
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Kids' Email An email option that enables parents to
control who may correspond electronically
with their children.
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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.
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Integrated Instant Messaging This integrated software application enables
users to chat with one another and provide
users with notification of new messages and
events.
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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.
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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.
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Direct Marketing Tools With the Custom Mail Opt-In and Mail Target
programs, customers have access to low-cost
direct marketing tools. Custom Mail Opt-In
allows users to select specific product
categories from which to receive special
offers and promotions targeted to their
interests. Mail Target allows our customers
to send targeted marketing messages to their
email user database or to an imported list.
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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.
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Premium Services
Our premium services combine all of the features included in our Classic
Service, plus the following features:
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Feature Description
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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.
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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.
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Automated, User-Defined Incoming emails can be automatically
Email Forwarding forwarded to an alternate emailbox based on
the end user's pre-set criteria.
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Automated, Rules-Based Incoming emails can be automatically
Pager Notification forwarded to the end user's pager based on
the end user's pre-set criteria.
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The unified messaging, email-by-phone and IP telephony services integrate third
party technology.
Planned Services
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:
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Feature Description
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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.)
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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.)
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Email Message Language Email messages will be automatically
Translation translated between languages according to
pre-defined user preferences. (Anticipated in
the fourth quarter of 2000.)
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The statements in this report 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
are 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
<PAGE>
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.
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
<PAGE>
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.
Hardware Infrastructure
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.
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.
<PAGE>
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.
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.
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
<PAGE>
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 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
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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.
<PAGE>
employees is covered by a collective bargaining agreement. We believe that our
relations with our employees are good.
Israeli law and certain provisions of the nationwide collective bargaining
agreements between the Histadrut (General Federation of Labor in Israel) and the
Coordinating Bureau of Economic Organizations (the Israeli federation of
employers' organizations) apply to Commtouch's Israeli employees. These
provisions principally concern the maximum length of the 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.
RISK FACTORS
You should carefully consider the following risk factors before you decide to
buy our ordinary shares. You should also consider the other information in this
report. If any of the following risks actually occur, our business, financial
condition, operating results or cash flows could be materially adversely
affected. This could cause the trading price of our ordinary shares to decline,
and you could lose part or all of your investment.
This report contains forward-looking statements that involve risks and
uncertainties. These statements relate to our future plans, objectives, beliefs,
expectations and intentions. In some cases, you can identify forward-looking
statements by our use of words such as "expects," "anticipates," "believes,"
"intends," "plans," "seeks" and "estimates" and similar expressions. You will
find forward-looking statements under the captions "Summary," "Risk Factors,"
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and "Business" and elsewhere in this report. Our actual results,
levels of activity, performance or achievements may differ materially from those
expressed or implied by these forward-looking statements. Factors that could
cause or contribute to these differences include those discussed below and
elsewhere in this report.
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
<PAGE>
email services only in 1998 after changing our strategic focus from the sale,
maintenance 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.
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;
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
<PAGE>
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 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
<PAGE>
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.
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
<PAGE>
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 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.
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,
<PAGE>
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.
Although we are a leading global provider in our particular field of outsourced,
Web-based email, we are a relatively small competitor in the electronic
messaging industry as a whole. 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.
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
<PAGE>
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
<PAGE>
of their choice (although we reserve the right to eliminate their account or to
change their email service name).
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.
<PAGE>
We may need additional capital and raising additional capital may dilute
existing shareholders.
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.
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 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.
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. 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). 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 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;
<PAGE>
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 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.
<PAGE>
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 generally exceeded the
rate of inflation, which is a reversal from prior years, we cannot be sure that
this reversal will continue. If the dollar cost of our operations in Israel
increases, our dollar-measured results of operations will be adversely affected.
Our operations also could be adversely affected if we are unable to guard
against currency fluctuations in the future. Accordingly, we may enter into
currency hedging transactions to decrease the risk of financial exposure from
fluctuations in the exchange rate of the dollar against the NIS. These measures,
however, may not adequately protect us from material adverse effects due to the
impact of inflation in Israel.
Israeli courts might not enforce judgments rendered outside of Israel and it
might therefore be difficult for an investor to recover any judgment against any
of our officers or directors resident in Israel.
We are organized under the laws of Israel, and we maintain significant
operations in Israel. Certain of our officers and directors named in this report
reside outside of the United States. Therefore, you might not be able to enforce
any judgment obtained in the U.S. against us or any of such persons. You might
not be able to bring civil actions under U.S. securities laws if you file a
lawsuit in Israel. However, we have been advised by our Israeli counsel that,
subject to certain limitations, Israeli courts may enforce a final judgment of a
U.S. court for liquidated amounts in civil matters after a hearing in Israel. We
have appointed Commtouch Software Inc., our U.S. subsidiary, as our agent to
receive service of process in any action against us arising from this report. We
have not given our consent for our agent to accept service of process in
connection with any other claim and it may therefore be difficult for an
investor to effect service of process against us or any of our non-U.S.
officers, directors and experts relating to any other claims. If a foreign
judgment is enforced by an Israeli court, it 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.
<PAGE>
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.
Item 2. Description of Property.
Our principal executive offices are located at 6 Hazoran Street, Poleg
Industrial Park, Netanya 42504, Israel, where our telephone number is
011-972-9-863-6888, and 2029 Stierlin Court, Mountain View, California 94043,
where our telephone number is (650) 864-2000. In addition, we have sales offices
in London and New York. All of our properties are leased. Our principal research
and development facilities are located in our principal executive offices in
Israel. Our Mountain View office is used for sales, marketing, finance and
hosting operations.
Item 9. 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 report.
This discussion contains forward-looking statements based upon current
expectations that involve risks and uncertainties. Any statements
<PAGE>
contained herein that are not statements of historical fact may be deemed to be
forward-looking statements. For example, the words "expects," "anticipates,"
"believes," "intends," "plans," "seeks" and "estimates" and similar expressions
are intended to identify forward-looking statements. Commtouch's actual results
and the timing of certain events may differ significantly from those projected
in the forward-looking statements. Factors that might cause future results to
differ materially from those projected in the forward-looking statements
include, but are not limited to, those set forth under "Item 1--Risk Factors"
and in the Company's other filings with the Securities and Exchange Commission.
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.
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,
<PAGE>
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 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
-------- -------- --------
Revenues:
<S> <C> <C> <C>
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
-------- -------- --------
<PAGE>
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 firm
backlog from minimum commitments under take or pay 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.
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
<PAGE>
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.
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 report. 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
<PAGE>
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;
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 and research and development 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
<PAGE>
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. As of that
date, we had no material commitments for capital expenditures.
We believe that the 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.
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).
<PAGE>
PART IV
Item 17. Financial Statements.
The Company has responded to Item 18.
Item 18. Financial Statements
Reference is made to Item 19 for a list of all financial statements filed as
part of this Annual Report on Form 20-F.
<PAGE>
Item 19. Financial Statements and Exhibits
(a) (1) Financial Statements:
Page
------
Report of Independent Auditors ................................ F-1
Consolidated Balance Sheets ................................... F-2
Consolidated Statements of Operations ........................ F-3
Statement of Changes in Shareholders' Equity (Deficit) ........ F-4
Consolidated Statements of Cash Flows ......................... F-5
Notes to Consolidated Financial Statements .................... F-6
(a) (2) Financial Statement Schedules:
The following financial statement schedule of Commtouch Software Ltd. for each
of the three years in the period ended December 31, 1999 is filed as part of the
Annual Report and should be read in conjunction with the consolidated financial
statements of Commtouch Software, Inc.
Schedule II --Valuation and Qualifying Accounts
Schedules not listed above have been omitted because the information required
to be set forth therein is not applicable or is shown in the consolidated
financial statements or notes thereto.
(b) Exhibits
Exhibit 4.1--Consent of Independent Auditors
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Shareholders 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.
<PAGE>
Tel-Aviv, Israel
January 31, 2000
KOST, FORER & GABBAY
A Member of Ernst & Young International
<TABLE>
COMMTOUCH SOFTWARE LTD.
CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share data)
<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 revenues ................................................................... 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 of NIS 1 par value --
Authorized: 524,250 shares 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 of NIS 0.05 par value --
Authorized: 11,515,000 and 40,000,000 shares
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
========= =========
<FN>
The accompanying notes are an integral part of these consolidated financial statements.
</FN>
</TABLE>
<PAGE>
<TABLE>
COMMTOUCH SOFTWARE LTD.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
<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 (1) ............... -- 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
======== ======== ========
<FN>
Year ended
December 31,
------------------------------------------------
1997 1998 1999
-------- -------- --------
(1) Stock-based Employee Compensation Relates to the following:
Cost of revenues $ -- $ -- $ 113
Research and development, net 60 320
Sales and marketing 25 897
General and administrative 6 2,106
-------- -------- --------
Total $ -- $ 91 $ 3,436
======== ======== ========
The accompanying notes are an integral part of these consolidated financial statements.
</FN>
</TABLE>
<PAGE>
<TABLE>
COMMTOUCH SOFTWARE LTD.
STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY (DEFICIT)
(In thousands, except share data)
<CAPTION>
Convertible
Preferred shares Ordinary shares Additional
-------------------------- ------------------------- paid-in
Shares Amount Shares Amount capital
---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C>
Balance as 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
========== ========== ========== ========== ==========
</TABLE>
<TABLE>
<CAPTION>
Stock-based Notes Accumulated
employee receivable other
deferred from comprehensive Accumulated
compensation shareholders income deficit Total
------------ ------------ ------ ------- -----
<S> <C> <C> <C> <C> <C>
Balance as 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
======== ======== ======== ======== ========
<FN>
The accompanying notes are an integral part of these consolidated financial statements.
</FN>
</TABLE>
<PAGE>
<TABLE>
COMMTOUCH SOFTWARE LTD.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
<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 1,706
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 accounts payable ........................................ 99 91 1,064
Increase (decrease) in employee and payroll accruals
and other liabilities .............................................. (147) 128 1,645
Increase in deferred revenues ....................................... -- 74 487
Increase (decrease) in accrued severance pay, net ................... (54) 19 (44)
Other ............................................................... -- -- (9)
--------- --------- ---------
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 lease 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
========= ========= =========
<FN>
The accompanying notes are an integral part of these consolidated financial statements.
</FN>
</TABLE>
<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 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 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
<PAGE>
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
material costs between the completion of the working model and the point at
which the product is ready for general release. Therefore, through December 31,
1999, 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.
Amounts billed or received in advance of service delivery are recorded as
deferred revenues.
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.
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
<PAGE>
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, Israel and the Far East. The Company
maintains an allowance for doubtful trade receivables based upon the expected
collectibility of trade receivables. The allowance for doubtful accounts was
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.
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.
<PAGE>
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.
NOTE 4: PROPERTY AND EQUIPMENT
December 31,
---------------------
1998 1999
------ ------
Property and equipment are as follows (in thousands):
<PAGE>
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
non-cancelable 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 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.
As of December 31, 1999, the Company had an outstanding contingent obligation to
pay royalties in the aggregate amount of $275,000.
<PAGE>
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 program was approved in 1995. The Company's second program
received a letter of approval in April 1996 and 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.
Deferred Income 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.
<PAGE>
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 for all periods
presented.
In July 1999, the Company completed an Initial Public Offering ("IPO") of its
ordinary shares. The Company sold 3,450,000 shares to the public at $16 per
share. Concurrent with the closing of the IPO, the Company sold 1,344,086 shares
at $14.88 per share to 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.
<PAGE>
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
<PAGE>
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
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.
<TABLE>
A summary of the company's share option activity under the plans is as follows:
<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>
<TABLE>
The options outstanding as of December 31, 1999, have been separated into ranges
of exercise price, as follows:
<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
<PAGE>
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.
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.
<TABLE>
Pro forma information under SFAS 123 are as follows (in thousands except per
share amounts):
<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) $ (2.70)
========= ========= ========
</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, 1999, 25,000
shares were exercisable and 60,000 shares were outstanding.
<PAGE>
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.
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
====== ======
<TABLE>
COMMTOUCH SOFTWARE LTD.
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
U.S. Dollars in thousands
<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>
<PAGE>
CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration Statement on
Form S-8 (333-94995) pertaining to the 1996 CSI Stock Option Plan, the 1999
Section 3(i) Share Option Plan, the 1999 Employee Stock Purchase Plan and the
1999 Nonemployee Directors Stock Option Plan of Commtouch Software Ltd. of our
report dated January 31, 2000 with respect to the consolidated financial
statements and schedule of Commtouch Software Ltd. included in its Annual Report
on Form 20-F for the year ended December 31, 1999, as amended by Amendment No.
1, filed with the Securities and Exchange Commission.
Tel-Aviv, Israel
November 2, 2000
KOST, FORER & GABBAY
A member of Ernst & Young international
SIGNATURES
Pursuant to the requirements of Section 12 of the Securities and Exchange Act of
1934, the registrant certifies that it meets all of the requirements for filing
on Form 20-F and has duly caused this amendment to annual report to be signed on
its behalf by the undersigned, thereunto duly authorized.
COMMTOUCH SOFTWARE LTD.
By: /s/ JAMES E. COLLINS
-----------------------------------
James E. Collins
Chief Financial Officer
November 2, 2000
