Perion Network Ltd. 20-F 2011
Documents found in this filing:
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
For the fiscal year ended December 31, 2010
Date of event requiring this shell company report………………………………….
For the transition period from ____ to _____
Commission File No. 000-51694
(Exact Name of Registrant as specified in its charter)
(Translation of Registrant's name into English)
(Jurisdiction of incorporation or organization)
4 HaNechoshet Street
Tel Aviv, Israel 69710
(Address of principal executive offices)
Securities registered or to be registered pursuant to Section 12(b) of the Act.
Securities registered or to be registered pursuant to Section 12(g) of the Act.
(Title of Class)
Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act.
(Title of Class)
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.
As of December 31, 2010, the Registrant had outstanding 9,701,750 ordinary shares, par value NIS 0.01 per share.
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act
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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.
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Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes o No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of "accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange Act (Check one):
Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements included in this filing:
If "Other" has been checked in response to the previous question, indicate by check mark which financial statement item the registrant has elected to follow.
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If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act):
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As used herein, and unless the context suggest otherwise, the terms "IncrediMail", "Company", "we", "us" or "ours" refer to IncrediMail Ltd.
This annual report on Form 20-F contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). Forward-looking statements relate to future events or our future financial performance and involve known and unknown risks, uncertainties and other factors that may cause our, or our industry’s, actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed, implied or inferred by these forward-looking statements. In some cases, you can identify forward-looking statements by terminology such as "may", "will", "should", "could", "would", "expects", "plans", "intends", "anticipates", "believes", "estimates", "predicts", "projects", "potential" or "continue" or the negative of such terms and other comparable terminology.
Although we believe that the expectations reflected in the forward-looking statements are reasonable, we do not know whether we can achieve positive future results, levels of activity, performance, or goals. Actual events or results may differ materially from our current expectations. All forward-looking statements included in this report are based on information available to us on the date of this report. Except as required by applicable law, we undertake no obligation to update or revise any of the forward-looking statements after the date of this annual report to conform those statements to reflect the occurrence of unanticipated events, new information or otherwise.
You should read this annual report and the documents that we reference in this report completely and with the understanding that our actual future results, levels of activity, performance and achievements may be materially different from what we currently expect.
Factors that could cause actual results to differ materially from those expressed or implied by the forward-looking statements contained in this annual report include:
Assumptions relating to the foregoing involve judgment with respect to, among other things, future economic, competitive and market conditions, and future business decisions, all of which are difficult or impossible to predict accurately and many of which are beyond our control. In light of the significant uncertainties, inherent in the forward-looking information included herein, the inclusion of such information should not be regarded as a representation by us or any other person that our objectives or plans will be achieved. Factors that could cause actual results to differ from our expectations or projections include the risks and uncertainties relating to our business described in this annual report at "Item 3.D Risk Factors." Moreover, we operate in a very competitive and rapidly changing environment. New risks emerge from time to time and it is not possible for our management to predict all risks, nor can we assess the impact of all risks on our business or the extent to which any risk, or combination of risks, may cause actual results to differ from those contained in any forward-looking statements.
We obtained statistical data, market data and other industry data and forecasts used in preparing this annual report from market research, publicly available information and industry publications. Industry publications generally state that they obtain their information from sources that they believe to be reliable, but they do not guarantee the accuracy and completeness of the information. Similarly, while we believe that the statistical data, industry data and forecasts and market research are reliable, we have not independently verified the data, and we do not make any representation as to the accuracy of the information.
TABLE OF CONTENTS
ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS
ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE
ITEM 3. KEY INFORMATION
A. SELECTED FINANCIAL DATA
The following tables present selected financial data and should be read in conjunction with "Item 5 - Operating and Financial Review and Prospects" and our financial statements and related notes appearing elsewhere in this annual report. We derived the selected financial data below for the years ended December 31, 2008, 2009 and 2010 and as of December 31, 2009 and 2010 from our audited financial statements included elsewhere in this report. We derived the selected financial data below for the years ended December 31, 2006 and 2007 and as of December 31, 2006, 2007 and 2008 from our audited financial statements not included in this report. Our financial statements are prepared and presented in U.S. dollars and in accordance with accounting principles generally accepted in the United States, or U.S. GAAP.
B. CAPITALIZATION AND INDEBTEDNESS
C. REASONS FOR OFFER AND USE OF PROCEEDS
D. RISK FACTORS
Investing in our ordinary shares involves a high degree of risk. You should consider carefully the following risk factors, as well as the other information in this annual report before deciding to invest in our ordinary shares. Our business, financial condition or results of operations could be affected adversely by any of these risks. The trading price of our ordinary shares could decline due to any of these risks and you might lose all or part of your investment in our ordinary shares.
Risks Related to Our Business
If the Google AdSense for Search program is terminated or significantly changed by Google, we would be forced to immediately seek an alternative search provider, in which case we would be susceptible to a certain transition period during which we may experience a material reduction in our search generated revenues and, possibly a long-term decrease in search generated revenues and, in turn, an adverse effect on our financial condition.
Our business is currently very dependent on search based revenues, currently utilizing primarily the Google AdSense program, pursuant to which we receive a portion of the amount paid by advertisers to Google for the activity performed by those downloading the Company’s applications. This dependence continues to grow and we obtained approximately 70% of our revenues for the year ended December 31, 2010 from this venue, a percentage which is growing.
On July 1, 2009 we amended and extended our agreement with Google for two years. The agreement enabled termination by either side after one year with 90 days notice. In addition, Google was able to amend the agreement and had other limited termination rights. In the latter part of 2009 we had been informed by Google that it may alter its guidelines with respect to homepage resets and default search resets to Google services when providing downloadable applications on which we are heavily dependent; and consequently may terminate the then existing agreement, and renew it under different terms, effective as of July 1, 2010. This agreement was subsequently amended and extended under similar terms effective July 1, 2010 for half a year. In December 2010 we signed a new two year agreement with Google effective January 1, 2011. This agreement too enables termination by either side after one year with 90 days notice and in addition, Google is able to amend the agreement and has other limited termination rights. If this agreement is terminated, substantially amended, or not renewed on favorable terms, we would be forced to seek an alternative search provider. There are very few companies in the market that provide Internet search services similar to those provided by Google. Google is the most dominant player in this market, particularly on a global scale and other companies in the market do not have as much coverage with sponsored links. If we fail to quickly locate, negotiate and finalize alternative arrangements, or if the alternatives do not provide for terms that are as favorable as those provided for by the AdSense program, or if the alternative arrangement will not attract the same traffic as the traffic attracted by the Google AdSense program, or if the termination by Google effects our ability to contract other providers, we may experience a material reduction in our revenues and, in turn, our business, financial condition and results of operations would be adversely affected. The failure of IncrediMail to retain existing, or attract new users, as well as generate traffic to its search properties, could adversely affect our business, financial condition and results of operations.
We are increasingly relying on the ability to offer our search properties to users of our software products and subsequently retain them. Should this offering be blocked, constrained or made redundant, by the providers of the underlying platform, our ability to generate revenues from search could be significantly reduced.
Over 77% of our revenues for the year ended December 31, 2010 were generated from the acceptance and subsequent retention of our search properties by the users of our software products. The market for offering and retaining these search properties is very competitive. In addition, some companies offer a browser without a homepage, which is one of our main search properties. The guidelines imposed pursuant to our agreement with Google, with respect to homepage resets and default search resets to Google services when providing downloadable applications have changed as compared to the previous agreement, with potentially negative revenue implications. However, the potentially negative revenue implications caused by these changes are expected to be substantially offset by other changes made in this agreement. Should Google, or the other companies providing the internet browsers, effectively further restrict, discourage, or otherwise hamper other companies from offering or changing the search properties, or those providing browsers without a homepage increase their market share, there would be a material adverse affect on our search generating revenue model and our financial results.
The generation of revenues from searches has become subject to fierce competition. We obtain a significant portion of our revenues from searches made through our homepage and other search properties. If we cannot compete effectively in this market, our revenues are likely to decline.
We obtain a significant and growing portion of our revenues from searches made through the Company's home page (MyStart), as well as offering other search properties. We therefore are constantly looking for ways to convince our users to make MyStart their homepage and accept the other search properties offered. There are a growing number of companies that generate an increasing amount of their revenues from searches, some of them with a more significant presence than ours and with greater capability to offer substantially more content. In addition, with competition growing, even the larger and in the past more conservative companies, (such as Google, Microsoft and others), have become increasingly aggressive in their search service offering. Therefore, our ability to attract new users to install IncrediMail’s home page, and retaining existing users, could suffer, preventing or delaying us in increasing our revenues, or even cause them to decrease.
If we are unable to continually enhance our existing products and develop new products that achieve widespread market acceptance, our ability to attract and retain customers could be impaired, our competitive position may be harmed and we may be unable to generate additional revenues.
We believe that the number of downloads of our free products indicates that many consumers are interested in having a customized and entertaining email or instant messaging experience. Our future revenue and profit growth will depend, in part, on the percentage of registered or active users of our free product who become actual purchasers of our products and services, and increasing the number of downloads and acceptance of the search properties offered with them, as well as making our products and services attractive to new users. In order to induce those consumers to use our products, accept the search properties offered, and purchase or license our products, we must continually enhance our existing products by offering additional features and content that appeal to our unique user base. Maintaining the usability and relevance of existing products and the development and commercialization of new products can be very complex. Software product development and commercialization depends upon a number of factors, including:
We may be unable to maintain the usability and relevance of our existing products or to develop new products. Furthermore, we may not develop or introduce new products or product enhancements in time to take advantage of market opportunities or achieve a significant or substantial level of acceptance in new or existing markets. If we fail to do so, our ability to attract and retain customers could be impaired, our competitive position may be harmed and we may be unable to generate substantial revenues.
If we are unable to establish and increase market acceptance of our products, we will not expand our business and our revenues could decline.
Our basic software products are currently supplied to our customers free of charge. We will be able to increase product revenues only if we can create and maintain a substantial market demand for our products, including acceptance of the search properties offered with them, and to a certain extent our enhanced software products, for which we currently charge a one-time license, or subscription fee.
Our ability to execute our business strategy depends on market demand for software programs that are simple, safe and useful, and our ability to maintain these characteristics in our email client and offering it in other existing products or those that will be bought or internally developed in the future. For instance, the fact that many email users have multiple email clients and accounts, many of which are likely provided to them free of charge by large Internet and software companies, positively affects the potential market demand for our enhanced email software products. On the other hand, the growing popularity of web based mail and its increased functionality and mobility negatively affect the potential market demand for our PC based email client. The rate of adoption and acceptance of our products may be affected adversely by changing consumer preferences, product obsolescence, technological change, market competition, development and acceptance of non-Internet mediums of communication and our products’ quality and novelty.
Our results of operations and financial condition may be adversely impacted by worldwide economic conditions.
Our primary user base is composed of individual consumers. The current overall lack of growth in the U.S. and European economies following on a couple of years of weak performance have resulted in continued negative pressure on consumer spending and have impacted consumers in our territories in ways that could negatively affect our business. In the event that the United States or Europe experience a return to the economic downturn, or the current economic climate worsens, our current and potential software license subscribers may be unable or unwilling to purchase our licensing services. This would also have a negative impact on consumer internet spending and search generated revenues. A reduction in the purchasing of our licensing services, consumer internet spending and search generated revenues have had a negative impact in the past, and may possibly have a greater negative impact in the future, on our sales and revenue generation, margins and operating expenses, and consequently have a material adverse effect on our business, results of operations and financial condition.
Our continuing "viral growth" could be adversely affected if we do not increase the number of our registered users or if users stop using our software.
To date, we have relied primarily on "viral growth" to increase our user base, and this remains an important part of our growth strategy going forward. This method is of relatively low cost, however its effectiveness has been decreasing. Other marketing methods, while effective, are far more costly. If users of our products stop, reduce, or limit their usage, our viral growth will be diminished because they will no longer be forwarding links to our site via their emails, and our market share and revenues may decrease. Our historical experience with usage of our products indicates that usage of products declines rapidly, currently estimated to be up to six years. Therefore, in order to induce our existing users to continue to use our products, we must continuously enhance our existing products and periodically develop new ones. If we cannot offer such products, because of lack of resources, competition or other reasons described elsewhere in these Risk Factors, our distribution, revenues and results of operations will be adversely affected.
The market for email software products and services is declining, as web based solutions are gaining in their popularity.
Our products compete in the market for email software products and services that aim to offer a customized personal, productive and entertaining email experience for consumers. Our main competitors are those providing a web based email solution, not requiring the user to download software while providing a very mobile and accessible tool. Some of these are or will provide a downloadable email client as well. While there are advantages and disadvantages to each method and system and the markets for each of them remain large, the market for web based systems is growing at the expense of downloadable email clients. In addition, many of our competitors providing a web based solution have more established brands, products and customer relationships than we do, which could inhibit our market penetration efforts even if they may not offer features similar to IncrediMail®. For example, consumers may choose to receive an extensive package of Internet and email services from a more dominant and recognized company, such as Google (Gmail), Microsoft Corporation (HotMail), Facebook, or Yahoo! (Yahoo Mail).
Should this trend accelerate faster than the company’s ability to provide differentiating advantages to its downloadable solution, this could result in fewer downloads of our product and our ability to offer search services, less use of our product, fewer purchases of our products and services and loss of market share. See "Item 4.B Business Overview — Competition" for additional discussion of our competitive market.
The market for wallpapers, screensavers and photograph management tools is highly competitive, and if we cannot compete effectively, we may not be able to generate revenues or achieve significant market share.
Our Magentic product is a desktop enhancer and offers brand-new graphically enriched ways to view and enjoy personal photos. Our PhotoJoy product focuses on further enhancing the capability for enjoying personal photos. These products currently compete in the market for wallpapers, screensavers and PC software managing and presenting personal photographs, aiming to offer a creative, personal and entertaining experience for PC users. Our main competitors in these areas include Screensavers.com, Picasa by Google, and webshots© by American Greetings Corp. (NYSE: AM). Competition with these products could require increased investments in R&D and Marketing expenses as well as cause fewer downloads and registrations of our product.
Many of our competitors have more established brands, products and customer relationships than we do, which could inhibit our market penetration efforts even if they may not offer a similar variety, currently free of charge, such as American Greetings Corp. (webshots©). If we are unable to achieve continued market penetration, we will not be able to compete effectively.
In addition, many of our other current and potential competitors have significantly greater financial, research and development and sales and marketing resources than we have. These competitors could use their greater financial resources to acquire other companies to gain enhanced name recognition and market share, as well as to develop new technologies, products or features that could effectively compete with our product. Demand for our products could be diminished by equivalent or superior products and technologies offered by competitors. See "Item 4.B Business Overview — Competition" for additional discussion of our competitive market.
We may use a substantial portion of our invested resources to acquire an unspecified business. These acquisitions could divert our resources, cause dilution to our shareholders and adversely affect our financial results.
We may use a portion of our invested resources to acquire complementary products, technologies or businesses. In December 2006, we acquired the assets of a transaction processing company called BizChord Consulting Corporation and, although a relatively small acquisition, in December 2008, we decided to terminate BizChord’s independent activities and restrict its activity to processing the Company’s own transactions and have since reduced the use of that solution. As a result, since the acquisition, we have written off our entire investment. Prior to such acquisition our management had no experience making acquisitions or integrating acquired businesses. Negotiating potential acquisitions or integrating newly-acquired products, technologies or businesses could divert our management’s attention from other business concerns and could be expensive and time-consuming. Acquisitions could expose our business to unforeseen liabilities or risks associated with the business or assets acquired or with entering new markets. In addition, we might lose key employees while integrating new organizations. Consequently, we might not effectively integrate any acquired products, technologies or businesses, and might not achieve anticipated revenues or cost benefits. In addition, future acquisitions could result in customer dissatisfaction, performance problems with an acquired product, technology or company, or issuances of equity securities that cause dilution to our existing shareholders. Furthermore, we may incur contingent liability or possible impairment charges related to goodwill or other intangible assets or other unanticipated events or circumstances relating to the acquisition, and we may not have, or may not be able to enforce, adequate remedies in order to protect our Company. If any of these or similar risks relating to acquiring products, technologies or businesses should occur in the future on a scale that is larger than the effect of the acquisition described above, our business could be materially harmed.
Our investment portfolio may be impaired by disruptions in the financial and credit markets.
Our investment portfolio currently consists of US government debentures, US government agencies and corporate debt securities, which the Company classified at December 31, 2010 as "available-for-sale" marketable securities or cash equivalents. As of December 31, 2010, we hold approximately $7 million in corporate debt securities, $9 million in government debentures and $8 million in securities of US government agencies.
Due to significant disruptions in the financial and credit markets in the past, corporate debt securities in our portfolio could be subject to a possible increased risk of default due to bankruptcy, lack of liquidity, operational failure or other factors affecting the issuers of those securities. In addition, securities in our portfolio are subject to other risks, such as credit, liquidity, market and interest rate risks, which may be exacerbated by the recent market disruptions. We may be required to adjust the carrying value of our investment securities due to a default, lack of liquidity or other event.
Any such adjustment which is considered to be other-then-temporary would be recorded in our consolidated statement of income which could materially adversely impact our consolidated results of operations and financial condition.
If we are deemed to be not in compliance with applicable data protection laws, our operating results could be materially affected.
We collect and maintain certain information about our customers in our database. Such collection and maintenance of customer information is subject to data protection laws and regulations in Israel and may be subject to laws and regulations in, the United States and other countries as well. A failure to comply with applicable regulations could result in class actions, governmental investigations and orders, and criminal and civil liabilities, which could materially affect our operating results.
Although we strive to comply with the applicable laws and regulations and use our best efforts to comply with the world evolving standards of privacy and inform our customers of our business practices prior to any installations of our software, it is possible that these laws may be interpreted and applied in a manner that is inconsistent with our data practices or that it may be argued that our practices do not comply with other countries privacy laws. If so, in addition to the possibility of fines, this could result in an order requiring that we change our data practices, which in turn could have a material effect on our business. See "Item 4.B Business Overview — Government Regulation" for additional discussion of applicable regulations.
If there are privacy or security concerns regarding our collection, use and handling of personal information, we could incur substantial expenses.
Although we strive to comply with the strict data security requirements and take all reasonable steps to insure the security of personal information, concerns may be expressed, from time to time, about whether our products compromise the privacy or confidentiality of the information of users and others. Concerns about our collection, use, sharing or handling of personal information or other privacy related matters, even if unfounded, could damage our reputation and operating results. See "Item 4.B Business Overview — Government Regulation" for additional discussion of applicable regulations.
We depend on a third party Internet and telecommunication provider to operate our website. Temporary failure of these services would reduce our revenues and damage our reputation, and securing alternate sources for these services could significantly increase our expenses.
We depend on Bezeq International Ltd., a third party provider of Internet and related telecommunication services, including hosting and location facilities, to operate our website. This company may not continue to provide services to us without disruptions in services at the current cost or at all. Such a disruption in services, even temporary, would reduce our revenues from product sales, and possibly even from search, depending on the extent of disruption. While we believe that there are many alternative providers of hosting and other communication services available to us, and the company has a plan for adjusting and adapting in such an event, the costs associated with any transition to a new service provider could be substantial and require us to reengineer our computer systems and telecommunications infrastructure to accommodate a new service provider. This process could be both expensive and time consuming and could result in lost business both during the transition period and after.
Our servers and communications systems could be damaged or interrupted by fire, flood, power loss, telecommunications failure, earthquakes, acts of war or terrorism, acts of God, computer viruses, physical or electronic break-ins and similar events or disruptions. Although we maintain back-up systems for our servers, any of these events could cause system interruption, delays, loss of critical data and lost registered users and revenues.
We currently rely solely on the Internet as a means to sell our products. Accordingly, if we, or our customers, are unable to utilize the Internet due to a failure of technology or infrastructure, terrorist activity or other reasons, we could lose current or potential customers and revenues. While we have backup systems for most aspects of our operations, our systems are not fully redundant and our disaster recovery planning may not be sufficient for all eventualities. In addition, we may have inadequate insurance coverage or insurance limits to compensate us for losses from a major interruption. Furthermore, interruptions in our website could materially impede our ability to attract new companies to advertise on our website and to maintain relationships with current advertisers. Difficulties of this kind could damage our reputation, be expensive to remedy and curtail our growth.
Our products operate in a variety of computer configurations and could contain undetected errors or defects that could result in product failures, lost revenues and loss of market share.
Our software may contain undetected errors, failures or defects, especially when the products are first introduced or when new versions are released. Our customers’ computer environments are often characterized by a wide variety of standard and non-standard configurations that make pre-release testing for programming or compatibility errors very difficult and time-consuming. Therefore, there could be errors or failures in our products. In addition, despite testing by us and beta testing by some of our registered users, errors, failures or bugs may not be found in new products or releases until after commencement of commercial sales. In the past, we have discovered software errors, failures and defects in certain of our product offerings after their introduction and have likely experienced delayed or lost revenues during the period required to correct these errors.
Errors, failures or defects in products released by us could result in negative publicity, product returns, loss of or delay in market acceptance of our products, loss of competitive position or claims by customers. Alleviating any of these problems could require significant expense and could cause interruptions.
Due to our evolving business model and rapid changes in the Internet, we may not be able to predict our future performance or continue our revenue growth or profitability.
Since beginning operations in 2000, we have introduced many new products and initiatives, some of which have been unsuccessful. Consequently, we have a limited history of ongoing operations from which to predict our future performance. The future viability of our business will depend on our ability to increase product sales, introduce new products appealing to the Internet market, increase search generated, affiliate and advertising revenues, exploit our brand name and control our costs, which we may be unable to do. As a result, we may not be able to continue our revenue growth or profitability.
We may have difficulty managing our growth, which could limit our ability to increase our sales and control our costs.
The growth of our operations has slowed in recent years. Accelerated growth is required in order to achieve our business objectives, placing increased demands on our management and on our operational resources. This growth has, and continues to increase the challenges involved in:
If we cannot scale and manage our business appropriately, we will not experience our projected growth and our financial results will suffer.
A decline in market acceptance for Microsoft technologies on which our products rely could have a material adverse affect on us>.
Our products currently run on Microsoft Windows operating systems. A decline in market acceptance for Microsoft technologies or the increased acceptance of other operating systems could cause us to incur significant development costs and could have a material adverse effect on our ability to market our current products. Although we believe that Microsoft technologies will continue to be widely used by consumers, we cannot assure you that consumers will adopt these technologies as anticipated or will not in the future migrate to other computing technologies that we do not currently support. Moreover, although Microsoft technologies are still very dominant, competing technolgies such as from Apple and Linux are increasing their market share. In addition, our products and technologies must continue to be compatible with new developments in Microsoft technologies. We cannot assure you that we can maintain such compatibility or that we will not incur significant expenses in connection therewith.
More individuals are using non-PC devices to access the Internet, and our services are currently not usable on these competing platforms.
The number of individuals who access the Internet through devices other then personal computers, such as mobile phones, iPad, etc., has increased dramatically. Our products are not compatable with these altermnative platformns and devices. If this trend accelerates and an increasing number of consumers find our products difficult to access through such devices, we may fail to capture a sufficient share of an increasingly important portion of the market for online services, our product will become less relevant and may fail to attract advertisers and web traffic.
Exchange rate fluctuations may decrease our earnings if we are not able to hedge our currency exchange risks effectively.
A majority of our revenues are denominated in U.S. dollars. However, most of our costs, mainly personnel expenses, are incurred in New Israeli Shekels (NIS). Inflation in Israel may have the effect of increasing the U.S. dollar cost of our operations in Israel. If the U.S. dollar declines in value in relation to the New Israeli Shekel, it will become more expensive for us to fund our operations in Israel. A revaluation of one percent of the NIS as compared to the U.S. dollar could reduce our income before taxes by less than $0.1 million. The exchange rate of the U.S. dollar to the New Israeli Shekel has been very volatile in the past years, decreasing by approximately 13% in 2008, increasing by approximately 10% in 2009, and decreasing by 6% in 2010.
In addition, a significant portion of our sales is in currencies other than the U.S. dollar, of which a large portion is in, or originated in, Euros. In 2010, approximately 13% of our revenue was received directly in these currencies and an additional 58% indirectly originated in these currencies. To the extent such sales are not immediately exchanged for U.S. dollars, we bear a foreign currency fluctuation risk. As of December 31, 2010, we had a net foreign currency net asset of approximately $2.0 million and our total foreign exchange expense was approximately $45 thousand for the year ended December 31, 2010. In addition, in territories where our prices are based on local currencies, fluctuations in the dollar exchange rate could affect our gross profit margin. To assist us in hedging the risks associated with fluctuations in currency exchange rates, we have contracted a consultant proficient in this area, and are generally implementing his proposals. Based on the advice received from such consultant, we are advised that we are unable to hedge exchange risks associated with revenues indirectly originating in non-U.S. dollar currencies, but received in US dollars. We do not hedge the exchange risk from revenues received directly in non-US currencies, as this is not as material. However, due to the market conditions, volatility and other factors, we do not always implement our consultants proposals in full, our consultant’s proposals do not always prove to be effective and may even prove harmful. We may incur losses from unfavorable fluctuations in foreign currency exchange rates. See "Item 11 Quantitative and Qualitative Disclosure of Market Risks" for further discussion of the effects of exchange rate fluctuations on earnings.
A loss of the services of our senior management and other key personnel could adversely affect execution of our business strategy.
We depend on the continued services of our senior management, particularly Josef Mandelbaum, our Chief Executive Officer. Our current strategy is to a great extent a function of his capabilities and experience, in addition to the experience and knowledge of our other senior management. The loss of the services of these personnel could create a gap in management and could result in the loss of management and technical expertise necessary for us to execute our business strategy and thereby adversely affect execution of our business strategy. We do not currently have "key person" life insurance with respect to any of our senior management.
Further, our ability to execute our business strategy also depends on our ability to continue to attract, retain and motivate qualified and skilled technical and creative personnel and skilled management, marketing and sales personnel. If we cannot attract and retain additional key employees or lose one or more of our current key employees, our ability to develop or market our products and attract or acquire new users could be adversely affected. See "Item 6 Directors, Senior Management and Employees."
Under current Israeli law, we may not be able to enforce covenants not to compete and, therefore, may be unable to prevent our competitors from benefiting from the expertise of some of our former employees.
We have entered into non-competition agreements with all of our professional employees. These agreements prohibit our employees, if they cease working for us, from competing directly with us or working for our competitors for a limited period. Under current Israeli law, we may be unable to enforce these agreements, in whole or in part, and it may be difficult for us to restrict our competitors from gaining the expertise that our former employees gained while working for us. For example, Israeli courts have required employers seeking to enforce non-compete undertakings of a former employee to demonstrate that the competitive activities of the former employee will harm one of a limited number of material interests of the employer which have been recognized by the courts, such as the secrecy of a company’s confidential commercial information or its intellectual property. If we cannot demonstrate that harm would be caused to us, we may be unable to prevent our competitors from benefiting from the expertise of our former employees.
Our international operations involve special risks that could increase our expenses, adversely affect our operating results and require increased time and attention of our management.
We derive and expect to continue to derive a substantial portion of our revenues from customers outside United States. Our international sales and related operations are subject to a number of inherent risks, including risks with respect to:
Risks Related to Our Intellectual Property
Unlawful copying of our products or other third party violations of existing legal protections or reductions in the legal protection for intellectual property rights of software developers or use of open source software could adversely affect our distribution and revenue.
The software products that we sell incorporate a technology that reduces the ability of third parties to copy the software without having paid for it. Unlicensed copying and use of software and intellectual property rights represents a loss of users and potential revenue to us, which could be more significant in countries where laws are less protective of intellectual property rights. Continued educational and enforcement efforts may not affect revenue positively and further deterioration in compliance with existing legal protections or reductions in the legal protection for intellectual property rights of software developers could adversely affect our revenue.
In addition, certain of our products or services may now or in the future incorporate open source software, which are typically distributed "as-is" without warranties, such as warranties of performance or ownership or indemnities against intellectual property infringement claims. Moreover, to the extent that we incorporate open source software into our products or services, (although we do not currently intend to do so), the license for such open source software may obligate us, among other things, to pass on to our licensees without charge the rights to use, copy, modify and redistribute the underlying software source code, both with respect to the original open source code and any modifications to such code created by us.
If we fail to detect and stop misrepresentations of our site and products, or for some reason are perceived as promoting malware or "spamming", we could lose the confidence of our customers, or software could be blocked by software or utilities designed to detect such practices, thereby causing our business to suffer.
We are exposed to the risk of domains using our brand names (such as "IncrediMail") in various ways, and attracting in this manner our potential or existing users. Many times these domains are engaged with fraudulent or spam activities and using our brand names can result in damaging our reputation and losing our clients' confidence in our products. In addition, if we or our products were for some reason perceived as promoting "malware or "spamming", our software could be blocked by software or utilities designed to detect such practices. If we are unable to detect and terminate effectively this misrepresentation activity of others or the way we and our products are perceived, we may lose users and our ability to produce revenues will be harmed.
Third party claims of infringement or other claims against us could require us to redesign our products, seek licenses, or engage in future costly intellectual property litigation, which could adversely affect our financial position and our ability to execute our business strategy.
The appeal of our products is largely the result of the graphics, sound and multimedia content that we incorporate in our products. We enter into licensing arrangements with third parties for these uses. However, other third parties may from time to time claim that our current or future use of content, sound and graphics infringe their intellectual property rights, and seek to prevent, limit or interfere with our ability to make, use or sell our products. In the past there were examples of such occurrences, although ultimately with no material consequence.
If it appears necessary or desirable, we may seek to obtain licenses for intellectual property rights that we are allegedly infringing, may infringe or desire to use. Although holders of these types of intellectual property rights often offer these licenses, we cannot assure you that licenses will be offered or that the terms of any offered licenses will be acceptable to us. Our failure to obtain a license for key intellectual property rights from a third party for technology or content, sound or graphic used by us could cause us to incur substantial liabilities and to suspend the development and sale of our products. Alternatively, we could be required to expend significant resources to re-design our products or develop non-infringing technology. If we are unable to re-design our products or develop non-infringing technology, our revenues could decrease and we may not be able to execute our business strategy.
We may become involved in litigation not only as a result of alleged infringement of a third-party’s intellectual property rights, but also to protect our own intellectual property rights. If we do not prevail in any third-party action for infringement, we may be required to pay substantial damages and be prohibited from using intellectual property essential to our products.
We may also become involved in litigation in connection with the brand name rights associated with our Company name or the names of our products. We do not know whether others will assert that our Company name or brand name infringes their trademark rights. In addition, names we choose for our products may be claimed to infringe names held by others. If we have to change the name of our Company or products, we may experience a loss in goodwill associated with our brand name, customer confusion and a loss of sales. Any lawsuit, regardless of its merit, would likely be time-consuming, expensive to resolve and require additional management time and attention.
Risks Related to Our Industry
The Internet as a medium for commerce and communication is subject to uncertainty and there could be a shift in communication platforms away from email.
The Internet and electronic communication industry is rapidly evolving, as new means for electronic communication are offered to the public. Our ability to execute our business strategy is currently dependent upon the continued predominance of email as a means of electronic communication and upon the continued use of the Internet.
Although we are seeking to diversify our product portfolio, we may not be successful and currently our email product generates approximately 90% of our revenues. And although email software programs and services currently enjoy a large market, the development and consumer acceptance of other means of electronic communication, such as text messaging over phone networks, chat-boards, blogs and web-based social networks, could result in a substantial decrease in the size of this market, in which case our revenues could decrease and our products could become obsolete.
There is direct competition between web-based software and downloaded software.
There are different advantages and disadvantages to web-based software as compared to downloaded software. Currently, web-based software seems to be growing at a faster rate than downloaded software. Our business is currently reliant on the continued prevalence of downloaded software. If there were to be a more dramatic shift to web-based software this could cause a decrease in the distribution of our software and subsequently in our revenues.
The Internet and Internet companies are providing an increasing number of services for free.
The internet and internet based companies are providing an increasing number of services for free, including email clients and anti-spam software and services. A substantial part of our revenues comes from selling software products and services, currently accounting for approximately 18% of our revenues. We attribute part of the decline in our revenues from the sale of products and services to this trend. Should this trend accelerate or even continue for a prolonged period, this would cause our revenues from product sales and services to decrease even more.
New laws and regulations applicable to e-commerce, Internet advertising, privacy and data collection, and uncertainties regarding the application or interpretation of existing laws and regulations, could harm our business.
Our business is conducted through the Internet and therefore, among other things, we are also subject to the laws and regulations that apply to e-commerce. These laws and regulations are becoming more prevalent in the United States, Israel and elsewhere and may impede the growth of the Internet or other online services. These regulations and laws may cover taxation, user privacy, data protection, pricing, content, copyrights, electronic contracts and other communications, Internet advertising, consumer protection, the provision of online payment services, broadband residential Internet access, and the characteristics and quality of products and services.
For example, legislation has been enacted to regulate the use of "cookie" technology. Upon installation of our software, certain cookies generated by us and our advertisers are placed on our customers’ computers. It has been argued that Internet protocol addresses and cookies are intrinsically personally identifiable information that is subject to privacy standards. We cannot assure you that our current policies and procedures would meet these restrictive standards.
In addition, technology is changing constantly and data security regulations and standards are in a state of flux. Changes in law or regulations may require that we materially change the way we do business. For example, we may be required to implement physical, administrative and technological security measures different from those we have now, such as different data access controls or encryption technology. We may incur substantial expenses in implementing such security measures.
In addition, although current decisions of the U.S. Supreme Court restrict the imposition of obligations to collect state and local sales and use taxes with respect to sales made over the Internet, the U.S. Congress and a number of states have been considering or have adopted various initiatives that could limit or supersede these decisions. If any of these initiatives result in a reversal of the Court’s current position, we could be required to collect sales and use taxes on our U.S. sales. The imposition by state and local governments of various taxes upon Internet commerce could create administrative burdens for us and could decrease our future sales.
The EU has already enacted legislation regarding Value Added Tax imposed on certain software sold by companies outside the EU to consumers in the EU over the Internet. This legislation could be interpreted to include other parts of the Company’s business not yet accrued for by the Company, causing additional significant tax exposure, or alternatively, reduce the competitiveness of the Company’s pricing of its products.
The cost of compliance with the world taxation, consumer protection and privacy related laws and regulations could be material and we may not be able to comply with the applicable regulations in a timely or cost-effective manner. In response to evolving legal requirements, we may be compelled to change our business model and practices, which could reduce our sales, and we may not be able to replace the revenues lost as a consequence of the change. These changes could also require us to incur significant expenses, subject us to liability and require increased time and attention of our management. See "Item 4.B Business Overview — Government Regulation" for additional discussion of applicable regulations affecting our Company.
Risks Related to Our Operations in Israel
Political, economic and military instability in the Middle East may impede our ability to operate and harm our financial results.
Our principal executive offices are located in Israel. Accordingly, political, economic and military conditions in the Middle East may affect our business directly. Since the establishment of the State of Israel in 1948, a number of armed conflicts have occurred between Israel and its Arab neighbors. During the winter of 2008, Israel was engaged in an armed conflict with Hamas, a militia group and political party operating in the Gaza Strip, and during the summer of 2006, Israel was engaged in an armed conflict with Hezbollah, a Lebanese Islamist Shiite militia group and political party. These, including conflicts which involved missile strikes against civilian targets in various parts of Israel, negatively affected business conditions in Israel. Any hostilities involving Israel or the interruption or curtailment of trade between Israel and its present trading partners could affect adversely our operations. Ongoing and revived hostilities and the attempts to resolve the conflict between Israel and its Arab neighbors often results in political instability that affects the Israeli capital markets and can cause volatility in interest rates, exchange rates and stock market quotes. In addition, political unrest in the Middle East and North Africa could adversely affect us. These or other Israeli political or economic factors could harm our operations and product development and cause our sales to decrease. Furthermore, several countries, principally those in the Middle East, still restrict business with Israel and Israeli companies and, although the impact of these restrictions is not as important for a company such as ours that sells its products through the Internet, it may nevertheless have an adverse effect on our results of operations.
Our operations may be disrupted by the obligations of our personnel to perform military service.
Many of our male employees in Israel, including members of senior management, are obligated to perform up to 36 days of military reserve duty annually until they reach age 48 and, in the event of a military conflict, could be called to active duty. Our operations could be disrupted by the absence of a significant number of our employees related to military service or the absence for extended periods of military service of one or more of our key employees.
Investors and our shareholders generally may have difficulties enforcing a U.S. judgment against us, our executive officers and our directors or asserting U.S. securities laws claims in Israel.
We are incorporated in Israel and all of our executive officers and most of our directors reside outside the United States. Service of process upon them may be difficult to effect within the United States. Furthermore, all of our assets and most of the assets of our executive officers and directors are located outside the United States. Therefore, a judgment obtained against us or any of them in the United States, including one based on the civil liability provisions of the U.S. federal securities laws may not be collectible in the United States and may not be enforced by an Israeli court. It also may be difficult for you to assert U.S. securities law claims in original actions instituted in Israel.
The tax benefits available to us require us to meet several conditions and may be terminated or reduced in the future, which would increase our costs and taxes.
We have generated income and therefore, are able to take advantage of tax exemptions and reductions resulting from the "Approved Enterprise" and "Beneficiary Enterprise" status of our facilities in Israel, albeit, since instituting our dividend policy, to a limited extent. To remain eligible for these tax benefits, we must continue to meet certain conditions stipulated in the Law for the Encouragement of Capital Investments, 1959 (the "Investment Law"), and its regulations and the criteria set forth in the specific certificate of approval. If we fail to meet the required conditions in the future, the tax benefits would be canceled and we could be required to refund any tax benefits we have received with interest and adjustment for change in Israeli consumer price index. These tax benefits may not be continued in the future at their current levels or at any level.
Effective April 1, 2005, the Investment Law was amended. As a result, the criteria for investments qualified to receive tax benefits as an Approved Enterprise were revised (the “First Amendment”). As will be elaborated below, the Israeli Parliament approved recently an additional amendment to the Investment Law, which revises again the criteria for investments qualified to receive tax benefits as a “Preferred Enterprise” for new tax benefits programs from January 1, 2011 (the “Second Amendment”). No assurance can be given that we will, in the future, be eligible to receive additional tax benefits under this law and its amendments. The termination or reduction of these tax benefits would increase our tax liability in the future, which would reduce our profits or increase our losses. Additionally, if we increase our activities outside of Israel, for example, by future acquisitions, our increased activities might not be eligible for inclusion in Israeli tax benefit programs. If and when we were to discontinue our policy for not distributing dividends, with respect to earnings from 2011 and beyond, tax-exempt income generated under the provisions of the law will subject us to taxes upon distribution or liquidation and we may be required to record deferred tax liability with respect to such tax-exempt income, possibly affecting our results in the future. See "Item 10.E Taxation — Israeli Taxation — Law for the Encouragement of Capital Investments, 1959" for more information about these programs, the Investment Law and the abovementioned amendments.
Risks Related to our Ordinary Shares and their Listing on a Stock Exchange
Although we have paid dividends in the past, our policy going forward in 2011 and beyond is not to distribute dividends. Therefore, the return on investment in our ordinary shares will be limited to the value of our stock.
We have paid dividends in the past, however as we recently announced, our current policy is not to distribute further dividends, starting with the profits of 2011 and beyond. If we do not pay dividends, our stock may be less valuable because a return on your investment will only occur if our stock price appreciates. See "Item 8.A Consolidated Statements and Other Financial Information — Policy on Dividend Distribution" for additional information regarding the payment of dividends.
We incur significant costs as a result of being a public company.
As a public company, we incur significant legal, accounting and other expenses. We incur costs associated with our public company reporting requirements as well as costs associated with corporate governance requirements, including requirements under the Sarbanes-Oxley Act of 2002, the rules of the Nasdaq Stock Market, the provisions of the Israeli Securities Law that apply to dual listed companies (companies that are listed on the Tel Aviv Stock Exchange ("TASE") and another recognized stock exchange) and the provisions of the Israeli Companies Law that apply to public companies. For example, as a public company, we have created additional board committees and are required to have two external directors, pursuant to the Israeli Companies Law. We have also contracted an internal auditor and a consultant for implementation of and compliance with the requirements under the Sarbanes-Oxley Act. See "Item 5 Operating and Financial Review and Prospects — Overview — General and Administrative Expenses" for a discussion of our increased expenses as a result of being a public company.
A small number of existing shareholders hold a significant percentage of our outstanding ordinary shares and can exercise significant influence over our actions.
As of February 28 2011, the two founding shareholders held approximately 16.7% of our outstanding ordinary shares in the aggregate. The interests of these shareholders may differ from your interests. These shareholders, acting together, could exercise significant influence over our operations and business strategy and will have sufficient voting power to influence all matters requiring approval by our shareholders, including the ability to elect or remove directors, to approve or reject mergers or other business combination transactions, the raising of future capital and the amendment of our articles of association, which govern the rights attached to our ordinary shares. In addition, this concentration of ownership may delay, prevent or deter a change in control, or deprive you of a possible premium for your ordinary shares as part of a sale of our Company.
The rights and responsibilities of our shareholders are governed by Israeli law and differ in some respects from the rights and responsibilities of shareholders under U.S. law.
We are incorporated under Israeli law. The rights and responsibilities of holders of our ordinary shares are governed by our memorandum of association, our articles of association and by Israeli law. These rights and responsibilities differ in some respects from the rights and responsibilities of shareholders in typical U.S. corporations. See "Item 16.G Corporate Governance." In particular, a shareholder of an Israeli company has a duty to act in good faith toward the company and other shareholders and to refrain from abusing his power in the company, including, among other things, in voting at the general meeting of shareholders on certain matters. See "Item 10.B Memorandum and Articles of Association — Approval of Related Party Transactions" for additional information concerning this duty. Our shareholders generally may find it difficult to comply with the provisions of Israeli law.
Provisions of our articles of association and Israeli law may delay, prevent or make difficult an acquisition of our Company, which could prevent a change of control and, therefore, depress the price of our shares.
Israeli corporate law regulates mergers, requires tender offers for acquisitions of shares above specified thresholds, requires special approvals for transactions involving directors, officers or significant shareholders and regulates other matters that may be relevant to these types of transactions. In addition, our articles of association contain provisions that may make it more difficult to acquire our Company, such as provisions establishing a classified board. Furthermore, Israeli tax considerations may make potential transactions unappealing to us or to some of our shareholders. See "Item 10.B Memorandum and Articles of Association — Approval of Related Party Transactions" and "Item 10.E – Taxation — Israeli Taxation" for additional discussion about some anti-takeover effects of Israeli law.
These provisions of Israeli law may delay, prevent or make difficult an acquisition of our Company, which could prevent a change of control and therefore depress the price of our shares.
Future sales of our ordinary shares could reduce our stock price.
Sales by shareholders of substantial amounts of our ordinary shares, or the perception that these sales may occur in the future, could materially and adversely affect the market price of our ordinary shares. In addition, our executive officers, directors and certain large shareholders are no longer subject to contractual restrictions on the sale by them of shares, resulting in a substantial number of shares held by them or issuable upon exercise of options currently eligible for sale in the public market. Furthermore, the market price of our ordinary shares could drop significantly if our executive officers, directors, or certain large shareholders sell their shares, or are perceived by the market as intending to sell them.
U.S. investors in our Company could suffer adverse tax consequences if we are characterized as a passive foreign investment company.
If, for any taxable year, our passive income or our assets that produce passive income exceed levels provided by law, we may be characterized as a passive foreign investment company, or PFIC, for U.S. federal income tax purposes. This characterization could result in adverse U.S. tax consequences to our shareholders. If we were classified as a passive foreign investment company, a U.S. holder of our ordinary shares could be subject to increased tax liability upon the sale or other disposition of ordinary shares or upon the receipt of amounts treated as "excess distributions." Under these rules, the excess distribution and any gain would be allocated ratably over the U.S. holder’s holding period for the ordinary shares, and the amount allocated to the current taxable year and any taxable year prior to the first taxable year in which we were a passive foreign investment company would be taxed as ordinary income. The amount allocated to each of the other taxable years would be subject to tax at the highest marginal rate in effect for the applicable class of taxpayer for that year, and an interest charge for the deemed deferral benefit would be imposed on the resulting tax allocated to such other taxable years. The tax liability with respect to the amount allocated to years prior to the year of the disposition, or "excess distribution," cannot be offset by any net operating losses. In addition, holders of shares in a passive foreign investment company may not receive a "step-up" in basis on shares acquired from a decedent. U.S. shareholders should consult with their own U.S. tax advisors with respect to the U.S. tax consequences of investing in our ordinary shares, as well as the specific application of the "excess distribution" and other rules discussed in this paragraph. For a discussion of how we might be characterized as a PFIC and related tax consequences, please see "Item 10.E Taxation — United States Federal Income Tax Considerations — Passive Foreign Investment Company Considerations."
ITEM 4. INFORMATION ON THE COMPANY
A. HISTORY AND DEVELOPMENT OF THE COMPANY
We were incorporated in the State of Israel in November 1999 under the name Verticon Ltd. We changed our name to IncrediMail Ltd. in November 2000 to better reflect the nature of our business. We operate under the laws of the State of Israel. Our headquarters are located at 4 HaNechoshet Street, Tel-Aviv 69710, Israel. Our phone number is (972-3) 769-6100. Our agent for service of process in the United States is Puglisi & Associates, located at 850 Library Avenue, Suite 204, Newark, Delaware 19715. Our website addresses are www.incredimail-corp.com and www.incredimail.com. The information on our websites does not constitute a part of this annual report.
We completed the initial public offering of our ordinary shares in the United States on February 3, 2006, whereby we became a "limited liability public company" under the Israeli Companies Law. The registration statement on Form F-1 relating to our initial public offering became effective on January 30, 2006.
Since November 20, 2007 the Company’s ordinary shares are also traded on the Tel Aviv Stock Exchange.
Principal Capital Expenditures
We had capital expenditures of $0.7 million in 2010, $0.5 million in 2009 and $0.6 million in 2008. We currently expect that our capital expenditures will be approximately $0.7 million in 2011. We have financed our capital expenditures with cash generated from operations.
Our capital expenditures during 2008, 2009 and 2010 consisted primarily of; leasehold improvements and furnishings, as well as investments in computer hardware and software, in Israel. In 2011, we expect these investments to consist primarily of acquiring computer hardware, software, peripheral equipment and installation, all which are expected to be financed by the Company’s resources.
In 2011 the Company intends to embark on a strategy for acquiring other activities and businesses. To the extent that the current balance of cash and investments, in addition to the cash generated from operating activities is not sufficient, the Company will look into the alternatives available for increasing its liquidity.
As previously disclosed, in January 2011 one of the founders of the Company and its director, Mr. Ofer Adler, sold 1,020,000 shares of the Company's ordinary shares to institutional and accredited investors. The Company did not receive any proceeds from the offering, and no new shares were issued as a result thereof. Because the shares sold have certain trading restrictions and are not freely transferable, the Company agreed to register the shares sold for resale with the applicable regulatory authorities following the closing of the sale, which occurred in February 2011. In addition, also in January 2011, the Company registered an additional 1,000,000 Ordinary Shares, which are reserved for offer and sale under the 2003 Israeli Share Option Plan.
B. BUSINESS OVERVIEW
We are an Internet content and media company, whose products we believe bring a new level of fun, personality and convenience to email, desktops and screen savers, and have been downloaded more than eighty million times. Having secured a large active email user base, IncrediMail is now branching out into Instant Messaging, using its unique content and approach to enhance the user experience.
Since we began operations in 2000, our products have been downloaded in more than 100 countries, and in 2010 we recorded on average approximately 1.5 million registered downloads each month. As of December 31, 2010, we had approximately 10.7 million active users, and currently, more than 280 million IncrediMail® emails are sent by our users each month, to an even larger number of recipients. Our users typically use our products for as long as six years. Through December 31, 2010, we have sold more than 2 million products and content licenses worldwide to our registered users. We believe our historical track record of converting registered users to purchasing customers represents a convincing validation of our business strategy.
We generate revenue primarily by:
For a breakdown of total revenues by category of activity, see "Item 5.A Operating Results — Revenues."
To date, we have relied primarily on "viral growth" to grow our user base. Our "viral growth" has resulted from recipients of our users’ emails clicking on the link at the bottom of emails sent with IncrediMail® Xe and then downloading our products and also from word of mouth. Our viral growth, with regard to our instant messaging add-on HiYo has resulted from recipients of our users’ instant messages, enhanced with graphic content provided by our software clicking on an invitation to view the graphic content sent together with the message. Our revenues were $21.9 million in 2008, and $27.2 million in 2009 and $29.5 million in 2010. Our operations have been profitable since 2002, with a gross profit margin currently of 95%.
When we use the term "registered user" in this annual report, we mean a user who has downloaded one of our products and completed the registration process. Registrations are not necessarily indicative of the number of individual users as a user may register more than one time. In addition, the term "active user" as used in this annual report means a registered user whose computer the Company can communicate with in order to verify if any of its products are resident on such computer, in the 30 days prior to the measurement date.
In the past the Company emphasized the graphic content provided in its product and looked to develop and market products rich in graphic content. This perception was created by the success of our email client IncrediMail Xe, which was rich in graphic content and provided the ability to personalize your email experience. Consistent with this strategy, we developed our Magentic and HiYo products, both of which are rich in graphic content. However, neither of these products has been successful in generating substantial revenues.
Based on our recent consumer research, we have learnt that while the graphic content was critical in attracting the user to the product, the use of the product was based on our ability to provide our consumer segment a tool that is simple, safe and useful, assisting them in better utilizing their time.
Our user. Our email software has introduced us to a unique demographic segment, people above 35 years in age, looking for computer applications that assist them in effectively utilizing their time and that are simple, safe and useful. Based on our internal statistics and in-depth consumer research contracted by the Company, we have learnt that, on average 95% of our users are 35 years or older, and on average 78% are 45 or older. In addition, our users do tend to adopt technology later in its life cycle, rather than earlier.
Our Opportunity. We believe we are one of the few hi-tech companies that target this unique demographic segment, rather than offering the latest technology to younger audiences. Our opportunity is to offer this demographic software that is simple safe and useful, enabling them to better utilize their time, as we have done successfully with our email client. We believe this is a substantial and underserved market.
Productivity tools. We are actively seeking to enrich our product suite to include other consumer products that bear similar characteristics appealing to our unique demographic segment. We believe our digital photo product PhotoJoy has these characteristics and will appeal similarly to our user base. Based on our consumer research, we will seek to offer our users, in addition to these products, other tools in the areas, personal productivity, language, PC optimization tools, and other areas.
Our objective is to become the market leader and a reliable provider of consumer software for people aged 35 and above seeking computer products that are simple, safe and easy to use. To achieve this we intend to enhance our existing business and extend it beyond that by way of acquisitions.
To enhance the existing business we intend to;
By investing in consumer research, we will be able to better identify the specific needs of our targeted demographic. In addition, until recently, the Company had predominantly relied on the viral nature of its applications, investing in customer acquisition only as a tool of initial market penetration for its products. The growth of our user base has been tapering off as a result of us relying on this method of marketing. Based on the back-end systems currently being developed, the Company intends to increase significantly the amount invested in customer acquisition, in order to accelerate the growth in its user base. Finally, in order to reduce the Company’s dependency on a limited number of products and to better serve our users and their needs, we intend to enrich our product suite.
However, in order to grow our business, beyond the organic growth, the Company intends to invest in acquiring other products and extend the business. This will enable us to diversify our revenue base, better serve the needs of our users and reduce the time required to offer these new products.
By focusing on our consumer, enhancing and extending our business, we believe we will be able to further grow the basic metrics that support our growth, by;
Advertising and search generated revenues
Advertising revenues consist almost entirely of revenues generated through search. We offer our users the ability to search by collaborating with premium search companies, currently primarily Google Inc., as well as a small portion with InfoSpace Inc, and receive a portion of the revenues generated by these companies through the search process.
On December 27, 2010 we signed a new search distribution agreement with Google for two years, effective January 1, 2011, which replaced the previous agreement we had with Google. We are unable to disclose many of the terms of this contract. However, while there are several changes in this new agreement when compared to the one previously in place, we believe that the result produced by this new agreement and its terms will be similar to those of the prior agreement. We continue to work with InfoSpace Inc. as well. However, both IncrediMail and InfoSpace are able to terminate the relationship immediately. That being said, we expect to continue and power at least 10% of our business by search providers other than Google.
For a breakdown of total revenues by category of activity, see "Item 5.A Operating Results — Revenues."
Our products are currently available in ten languages in addition to English. Prices and license fees for our premium products range between $10 and $60, varying based on market, length of license period and whether the products are offered together. We offer the following products, all of which may be downloaded over the Internet through a personal computer running on a Microsoft Windows operating system:
IncrediMail® Xe is our flagship product that is available over the Internet free of charge. It offers a variety of features that the user can apply to email messages including:
In August 2009, we released a substantially new version of this product; IncrediMail 2. In addition to providing all of the above features with a fresh look and current graphics, the new version has greatly enhanced search capabilities as well as other enhanced functions.
IncrediMail® Premium is an enhanced version of IncrediMail® Xe. Users who upgrade their free version of IncrediMail® Xe through the purchase of IncrediMail® Premium benefit from the following features:
The advanced account access system allows a user to download a specific email from an account without necessarily downloading all emails that have been delivered to the account. In addition, it allows a user to preview the email details residing on the server and delete email messages from the account without first having to download them. This software feature is built into IncrediMail® Premium and does not require the user to download or install any additional software. Users are therefore able to remove undesirable emails that they suspect may be infected with viruses or that may otherwise compromise their computers without downloading them.
IncrediMail® Letter Creator is an application that enables IncrediMail® Xe and IncrediMail® Premium users to design and create their own personalized email letters and ecards. Such users can create their own letterheads, customize their emails with 3D effects, font styles, images and pictures and add personalized backgrounds. Emoticon Super Pack, launched in the first quarter of 2005, is a special package of emoticons sold separately.
The Gold Gallery is a license-based content product. It offers additional IncrediMail® content files in the form of email backgrounds, animations, sounds, graphics and email notifiers.
JunkFilter Plus is an advanced anti-spam product, based on the Recurrent Pattern Detection Technology (RPD™) that we license from Commtouch Ltd. JunkFilter Plus offers a filtering technique to manage unwanted email, including offensive content, viruses, hoax emails and identity theft scams. This anti-spam product is designed to automatically identify and block undesirable mail from the user’s inbox and protect against fraudulent and malicious emails. It detects and blocks spam in the first few minutes of an outbreak, unlike other anti-spam approaches.
Magentic enhances and enriches the computer desktop by adding enhanced graphics enabling users to easily personalize the working environment. Magentic offers hundreds of high quality wallpapers and screensavers. In 2008 we suspended further development and marketing of this product, however, it continues to generate search related revenues, and we continue to support it and may renew marketing efforts in the future. In addition, the Company has developed PhotoJoy a product entirely focused on providing brand-new graphically enriched ways to view and enjoy personal photos. PhotoJoy provides 3D Photo Screensavers enriched with a variety of styles and designs, fun desktop widgets that display photos in the most creative and playful ways (named "PhotoToys"), and Collage Wallpapers presenting photos within various themes, sceneries, and illustrations.
HiYo, launched in May 2008, is a graphic enhancement tool for enriching instant messaging products, by adding enhanced graphics and enabling users to personalize their messages. Such users can customize their messages with 3D effects, font styles, images and pictures and add personalized backgrounds content. HiYo is available for instant messaging users of; Windows Live Messenger® Yahoo! Messenger and AOL Instant Messaging ("AIM"). HiYo is bringing new users and demographics into the IncrediMail® experience.
PhotoJoy soon to be marketed, is designed to reveal on a user's desktop all chosen photos saved on a user’s personal computer. In addition, the software allows users to take photos from photo hosting web sites (such as Flickr and Picasa) and continue viewing new photos once uploaded to these sites directly in PhotoJoy as well, thereby enabling the user to enjoy photos on the computer desktop.
Products under Development
Our research and development activities are conducted internally by our Chief Technology Officer and a 54 person research and development staff. Our research and development efforts are focused on the development of upgraded software, new features and the enhancement of our existing product suite.
After restricting our development effort to our core products over the past couple of years, in 2011 we plan to refocus this effort in order to enhance our product pipeline in the coming years.
Sales, Marketing and Distribution
Our products are distributed and sold throughout the world in more than 100 countries. The following table shows the estimated distribution of our registered email users, search generated revenues and products sold by territory in 2010: (*)
(*) Tier 1: United States, Canada, United Kingdom & Australia; Tier 2: France, Germany, Netherlands, Italy, Belgium, Switzerland; Tier 3: Other
To date, we have relied mainly on "viral growth," arising from recipients of our users’ emails clicking on the link at the bottom of emails sent with IncrediMail® Xe and then downloading our products and from word-of-mouth. In addition, during 2008 we employed traditional marketing strategies, consisting primarily of online advertising, which efforts were met to our satisfaction. These efforts were employed to assist in the initial market penetration of our HiYo product in the latter part of 2008. Having achieved the objectives originally set out, and in light of the new market conditions and our focus on profitability in 2009, we scaled back our marketing efforts and remained at a similar level in 2010. In 2011 we intend to supplement the viral marketing with customer acquisition efforts aimed at accelerating our growth, increasing the number of registered users, and as a result increase revenues.
We have typically experienced stronger sales in the first and fourth quarters, principally because our products are purchased in holiday sales in December or in the after-holiday sales in January. This is in addition to the general seasonality of the Internet as well as e-commerce being more active in the winter months. However, as search generated revenues account for a growing and now dominant portion of our revenues, the seasonality of our revenues has decreased.
As of December 31, 2010 we had 18 employees in our sales and marketing department.
We rely on a combination of patent, copyright, trademark and trade secret laws and confidentiality and invention assignment agreements to protect our intellectual property rights. However, we do not currently believe that they provide a significant competitive advantage.
Most of the components of our software products were developed solely by us. We have licensed certain components of our software, such as a speller function, from third parties. Except for our agreement with Commtouch Ltd. (described below), all of these licenses entailed a one-time fee or are freeware. We believe that these components are not material to the overall performance of our software and may be replaced without significant difficulty.
In 2001, we submitted patent applications in the United States, Europe and Israel for the following two inventions:
In July 2006, a patent was awarded in the US for the first invention; the second US patent application was abandoned in 2009.
In 2007 an international application was filed for the invention "interactive message editing system and method". This application was filed in the National Phase in the USA, Europe and China.
We enter into licensing arrangements with third parties for the use of graphic, sound and multimedia content integrated into our products.
We have registered IncrediMail and PhotoJoy as trademarks in the United States, the European Community and China. All other trademarks, trade names and service marks appearing in this annual report are the property of their respective owners.
All professional employees and technical consultants are required to execute confidentiality covenants in connection with their employment and consulting relationships with us. We also require them to agree to disclose and assign to us all inventions conceived in connection with their services to us. However, there can be no assurance that these arrangements will be enforceable or that they will provide us with adequate protection.
JunkFilter Plus was developed using an anti-spam software development kit developed by Commtouch Ltd. Under our agreement with Commtouch from 2004, Commtouch granted us a nonexclusive right and license to copy the software development kit and related software and documentation for purposes of further development or modification in connection with the design, development and sale of products that integrate the spam identification and classification services of Commtouch’s Detection Center, and to sell products incorporating such software and documentation. Under the agreement, we pay Commtouch an annual fee for each customer who purchases JunkFilter Plus based on the number of purchasers. The agreement was last extended for another year ending July 2011. Commtouch will continue to provide customers with accessibility to its software and our integrated products following termination of the agreement, and the licenses granted to our customers will also survive such termination.
Our industry is subject to intense competition. Our products compete in the specialized market for email software products and services that aim to offer a simple, safe and useful application, providing a personalized and entertaining email experience for consumers. IncrediMail was among the first companies to offer to the consumer email market a solution that combines an email product with an online gallery of creative content. Providing this kind of solution and compiling content is a lengthy process and based on a prolonged relationship with our users, and we have been doing it since 1999. We believe we have established ourselves with our unique demographic segment, as a provider of solutions answering to these needs, and we believe that we have as such an advantage over many of our competitors.
Our ability to compete effectively depends upon our ability to distinguish our Company and our products from our competitors and their products, and includes the following factors:
Our main competition is with web-based email software products, such as Google's Gmail™, Yahoo! Mail™ and Microsoft's Hotmail™. The web based email market is characterized with significant competition, changing technologies and evolving products and services enhancements.
Google, Yahoo! and Microsoft are each offering a web-based e-mail service in addition to the many other services they provide, such as desktop search, local search, instant messaging, photos, maps, video sharing, mobile applications, and so on. We expect these competitors to increasingly use their financial and engineering resources to compete with our client-based e-mail service, and if we are unable to successfully compete with them, our results of operations may be adversely affected.
In addition, there is some competition in the area of downloadable email clients, such as: WikMail, Arcsoft Multimedia Email™ 3 and Mind Spark Products™. In addition, our products also face competition from general email software programs offered to the private market by large Internet and software companies, such as AOL9 by America Online, Inc., Eudora® by QUALCOMM Incorporated (Nasdaq: QCOM), Thunderbird® by Mozilla Corporation and Outlook Express by Microsoft Corporation (Nasdaq: MSFT), some of which may also incorporate certain special features that provide a personalized email experience, some of them offering creative graphic backgrounds, such as Yahoo! Mail™. Many of the large Internet and software companies offer their email software programs free of charge. Our Magentic and PhotoJoy products’ main competitors, in area of providers of wallpapers, screensaver and digital photo management offer the following products: Picasa, webshots.com and screensavers.com, which offer wallpapers and screensavers both free and premium products for a fee. Our HiYo product's main competitors, in the area of creative instant messenger tools, are SweetIM, Bandoo, Imminent and SmileyCentral by IAC/InterActiveCorp. Competition with these products, reliance on viral marketing and technical difficulties have resulted in a reduction of the number of downloads, market share, prices and margins.
Many of our competitors have more established brands, products and customer relationships than we do, which could inhibit our market penetration efforts even if they may not offer a solution that is as simple to use, or that provides a customized and entertaining email experience similar to IncrediMail®. For example, consumers may choose to receive an extensive package of Internet and email services from a more dominant and recognized company, such as Microsoft Corporation (Outlook Express) or America Online, Inc. (AOL®). If we are unable to achieve continued market penetration, we will be unable to compete effectively.
In addition, as a major part of our revenues stem from our offering search properties by means of offering consumer downloadable software, other companies with consumer downloadable software, albeit with totally different software, are competing by utilizing the same strategy, to offer their search properties.
Finally, many of our other current and potential competitors have significantly greater financial, research and development, manufacturing, and sales and marketing resources than we have. These competitors could use their greater financial resources to acquire other companies to gain enhanced name recognition and market share, as well as to develop new technologies, products or features that could effectively compete with our existing product lines. Demand for our products could be diminished by products and technologies offered by competitors, whether or not their products and technologies are equivalent or superior.
U.S., U.K., the European Union, Israeli and other jurisdictions have adopted laws that could have an impact on our business, including the ones described in this section.
There are still relatively few laws or regulations specifically addressing the Internet,. As a result, the manner in which existing laws and regulations should be applied to the Internet in general, and how they relate to our business in particular, is unclear in many cases and varies from county to country. Such uncertainty arises under existing laws regulating matters, including user privacy, defamation, access changes, “net-neutrality” pricing, advertising, taxation, gambling, sweepstakes, promotions, content regulation, quality of products and services, and intellectual property ownership and infringement.
To resolve some of the current legal uncertainty, it is possible that new laws and regulations will be adopted that will be directly applicable to our activities. Any existing or new laws, regulations or legislation applicable to us could expose us to potential liability, including significant expenses necessary to comply with such laws and regulations, and could dampen the growth in use of the Internet in general.
In this regard, there are a large number of legislative proposals before the European Union, as well as before the United States Congress and various state legislative bodies, regarding privacy and other issues related to our business. Other jurisdictions could also adopt laws and regulations that could adversely impact our company and business. It is not possible to predict whether or when such laws, regulations and legislation may be adopted, and certain proposals, if adopted, could harm our business through a decrease in user registrations and revenues. These decreases could be caused by, among other possible provisions, the required use of disclaimers or other requirements before users can utilize our services.
Our database, which includes a database of registered users, falls within the definition of a database that requires registration under the Israeli Protection of Privacy Law 1981. Maintaining a database other than in compliance with this law may subject the owner, holder, manager and operator to criminal liability and civil liability. We registered our database with the Data Base Registrar on June 20, 2004.
In addition to the registration obligations under the Israeli Protection of Privacy Law – 1981, the Israeli Protection of Privacy Law also determines that any request for information should be accompanied by a notice that indicates: whether the delivery of information depends on the user consent (or is it mandate); the purpose for which the information is requested; and to whom the information is to be delivered and for what purpose. The law also determines that any person is entitled to inspect any information about him which is kept in a certain data base. It should be stated that violating such requirements can result in imprisonment liability. The law stipulates that an infringement of privacy is a civil wrong action, and authorizes the court to set compensation of NIS 50,000 (approximately USD 14,000) without proof of injury. The database registrar has been granted with wide authorities in event of violation of the provisions of the law, such as canceling the registration of a certain database.
The new Israeli Copyright Act of 2007 had commenced on May 25, 2008, replacing the old copyright law. The Israeli Copyrights Law protects, among others, artistic works, as well as sound recordings and computer programs, foreign work and moral rights (the right of paternity and the right of integrity). The Israeli Copyrights Law set forth the amount for compensation that a court may award to a claimant without proof of injury, for each copyright or moral right infringement to NIS 100,000, (approximately USD 28,000).
The CAN-SPAM Act of 2003 is intended to regulate spam and create criminal penalties for unmarked and unsolicited email advertisements, sexually-oriented material and emails containing fraudulent headers. The USA Patriot Act is intended to give the government greater ability to conduct surveillance on the Internet by allowing it in certain cases to intercept communications regarding terrorism and compromises to national security. The Digital Millennium Copyright Act ("DMCA") is intended to reduce or shield the liability of online service providers for displaying content posted and created by third parties that contain copyright infringing materials, if the provider complies with certain policies, registers a DMCA agent with the U.S Copyright Office and adopts a "take-down" policy that is enforced. We do not presently offer such online provider services. The Children’s Online Protection Act, the Children’s Online Privacy Protection Act, and the Prosecutorial Remedies and Other Tools to End Exploitation of Children Today Act of 2003, are intended to restrict the distribution of certain materials deemed harmful to children and impose additional restrictions on the ability of online services to collect user information from minors without verifiable parental or guardianship consent. In addition, the Protection of Children from Sexual Predators Act of 1998 requires electronic communication service and remote computing service providers to report to law enforcement agencies any knowledge of facts or circumstances from which a violation of specified offenses involving child pornography is apparent. Almost all the states in the United States have data security breach laws that impose various requirements on service providers to report to state attorneys general and send notices to affected consumers in the event of a breach of security of network and computer systems that compromise a user’s personal financial and other information, such as social security numbers and financial information. A national data breach notification bill is pending before the U.S. Congress, which if enacted into law, would likely supersede the numerous state notification laws.
In addition, some state laws govern internet activity generally, including the California Online Privacy Protection Act which applies to any Internet website which can be accessed by California residents and regulates information collected about users.
United Kingdom and European Union
Under the U.K. Data Protection Act and the European Union Data Protection Directive, a failure to ensure that personal information is accurate could result in criminal or civil penalties. . EU data protection legislation further prohibits the transfer of personal data to non-EEA countries that do not meet the European “adequacy” standard for privacy protection. The European Union privacy legislation requires, among other things, the creation of government data protection agencies, registration of processing with those agencies, and in some instances prior approval before personal data processing may begin. Such legislation may impose significant additional costs on our business or subject us to additional liabilities.
On November 25, 2009, EU Directive 2009/136/EC was enacted, which amended certain prior directives affecting online service providers respecting the processing of personal data and the protection of privacy in the electronic communications sector; how this new directive may affect our operations in the European Union remains unknown until member states pass their own implementing legislation. Notably, Article 66 of the Directive requires a user’s consent before a third party is permitted to place a cookie on the user’s computer. While a user’s choice in browser settings to allow cookies has been deemed to suffice in several European jurisdictions, some member states are considering legislation which would actively require a user to opt in at the time the cookie is placed. If such provisions were to be enacted, we might be required to incur costs to ensure compliance and consider solutions or limitation of access to our services, and we might become subject to additional liability.
C. ORGANIZATIONAL STRUCTURE
During 2006, we formed a wholly-owned subsidiary in Delaware, operating out of New York, for marketing and other activities, and formed another wholly owned subsidiary in Israel to acquire the business of our transaction processing provider, operating primarily out of Israel. In 2009 we refocused the transaction processing activity to deal exclusively with internally generated activity. The current activity in these subsidiaries is minimal. Except for such subsidiaries, we do not have other subsidiaries.
D. PROPERTY, PLANTS AND EQUIPMENT
We lease our facility, located in Tel Aviv, Israel, pursuant to a lease that was entered into during 2006 and expires in 2011, with an option to extend the lease for 2 more years. The lease is for a total area of 1,700 square meters, at a monthly rent of approximately $20 per square meter.
We own 33 servers that are hosted in a server farm by Bezeq International Ltd., which we refer to herein as "Bezeq". Our servers include mainly web servers, application servers, ad servers, mail servers and database servers. Bezeq provides the Internet and related telecommunications services, including hosting and location facilities, needed to operate our website. Bezeq is Israel’s largest provider of such services and is a member of Bezeq Group, Israel’s national telecommunications provider. Bezeq provides these services through standard purchase orders and invoices. We add servers and expand our systems located at their facilities as our operations require. We believe there are many alternative providers of these services both within and outside of Israel.
ITEM 4.A UNRESOLVED STAFF COMMENTS
ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS
The following discussion of our financial condition and results of operations should be read in conjunction with our financial statements and the related notes to the financial statements included elsewhere in this annual report. In addition to historical financial information, the following discussion and analysis contains forward looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, including, without limitation, statements regarding the Company’s expectations, beliefs, intentions, or future strategies that are signified by the words "expects," "anticipates," "intends," "believes," or similar language. These forward looking statements involve risks, uncertainties and assumptions. Our actual results and timing of selected events may differ materially from those anticipated in these forward looking statements as a result of many factors, including those discussed under "Item 3.D Risk Factors" and elsewhere in this annual report.
A. OPERATING RESULTS
We design and market a suite of downloadable consumer products that are simple safe and useful. These include, customized and entertaining email software products, a graphic add-on to instant messaging software, wallpaper and screensaver software, and software for presenting digital personal photos. We believe we are unique in addressing our demographic market of not early adopters, and particularly regarding our email client, a global technology leader in enriching email interactions by offering users the ability to design highly personalized email presentations. We believe that the user experience we have created has been successful in attracting a unique underserved demographic, seeking software applications that make their life a little simpler and time effective.
Since we began operations in 2000, we have recorded over 146 million registered downloads of our free products in more than 100 countries, and in 2010, we recorded an average of approximately 1.5 million registered downloads each month. As of December 31, 2010, we had approximately 10.7 million active users, and currently, our email users send over 280 million IncrediMail® emails each month. We define an "active" user as any user who has performed any activity using any IncrediMail® product or service, including opening or sending emails using IncrediMail®, sending a message utilizing our HiYo tool, downloading content or updating the product, in the 30 days prior to the measurement date. Our users use our products for as long as six years, based on current statistics (this estimate has been adjusted upwards over the past three years). Through December 31, 2010, we have sold more than 2 million products and content licenses worldwide to our registered users. We believe our historical track record of our users accepting and utilizing the search properties we offer, as well as converting registered users to purchasing customers, represents a convincing validation of our business strategy.
Prices and license fees for our products vary based on market, length of license period and whether the products are offered together. Our prices and fees range from less than $10 to about $60. These prices are subject to market conditions and can vary in currencies, other than the US dollar. We are not aware of inflation or a fluctuation in foreign currency exchange rates having a material effect on our revenues.
We generate our revenues primarily from two major sources: (i) advertising, primarily through search generated revenues and other services, and (ii) software products and solutions, licensing our IncrediMail® Premium, email software, other add-on subscriptions and licenses and our anti-spam solution. In addition, we generate revenues from advertising in our email client, our content database and on our website. The following table shows our revenues by category (in thousands of US Dollars):
Cost of Revenues
Our cost of revenues consists primarily of salaries and related expenses, license fees and payments for content and server maintenance, all related to our product revenues and communicating with our users. Our revenues relating to advertising, primarily search, do not have direct cost associated with them.
Our research and development expenses consist primarily of salaries and other personnel-related expenses for employees primarily engaged in research and development activities. We expect our research and development expenditures, which have increased nominally compared to last year, although decreasing as percentage of sales in 2010, to continue and increase at a moderate rate, while decreasing as a percentage of sales. The nominal increase will enable us to enrich our product pipeline going forward.
Our selling and marketing expenses consist of customer acquisition expenses, salaries and other personnel-related expenses for employees primarily engaged in marketing activities, credit card commissions and fees to our payment gateway providers that provide secure Internet payment processes. Credit card commissions vary between 1.9% and 5.6% based on the credit card, currency of payment and location of clearing agency. Having completed the initial market penetration of HiYo, our instant messaging add-on, in 2008, we reduced the level of expenditure for customer acquisition at the onset of 2009, remaining at that level in 2010. As part of our growth strategy for 2011, we intend to significantly increase customer acquisition costs in 2011, both nominally and as a percentage of sales, in order to increase the number of downloads, users and revenue generated.
General and Administrative Expenses (“G&A”)
Our general and administrative expenses consist primarily of salaries and other personnel-related expenses for executive, accounting and administrative personnel, professional fees and other general corporate expenses. In order to facilitate our strategy for accelerated organic and non-organic growth in 2011 and beyond, the Company has enhanced its management team with experienced professionals, capable of taking the Company to the next level. In the latter half of 2010, the Company engaged a new experienced CEO, created a Corporate Development department and hired a VP of Corporate Development and enhanced the other administrative functions with experienced personnel. As a result, G&A expenses have increased in 2010, compared to 2009, particularly in the second half of the year. We expect to complete this effort in the first half of 2011 and thereafter expect G&A expenses to increase only moderately to accommodate the Company’s growth.
Income Tax Expense (Benefit)
In 2001 and 2003, we were granted the status of "Approved Enterprise" and in 2008 we received approval for continued "Beneficiary Enterprise" status, all with respect to three separate investment programs, entitling us to a tax exemption for a period of two years 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 our Company). The "Approved Enterprise" status and the "Beneficiary Enterprise" status under these tax benefits programs allow for 0% corporate tax for a limited period of time on undistributed profits generated from operations, and preferential taxation of the distributed portion, requiring regular Israeli corporate tax on income generated from other sources. To the extent the Company distributes dividends from profits generated under this program, as it has in 2009 and 2010, the distributed sum would benefit only partially from this program. Nevertheless, it should be mentioned that commencing 2011, the Investment Law provides that new benefitted programs will enjoy reduced tax rates (for “Preferred Enterprises”) with no possibility for 0% corporate tax. See " Item 10.E Taxation — Israeli Taxation—Law for the Encouragement of Capital Investments, 1959" and Item 8. Financial Information A. Consolidated Statements and Other Financial Information - Policy on Dividend Distribution, for more information about these programs and the Company’s dividend policy.
Critical Accounting Policies and Estimates
The discussion and analysis of our financial condition and results of operation are based on our financial statements, which have been prepared in conformity with U.S. GAAP. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We evaluate these estimates on an on-going basis. We base our estimates on our historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying amount values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. Under U.S. GAAP, when more than one accounting method or policy or its application is generally accepted, our management selects the accounting method or policy that it believes to be most appropriate in the specific circumstances. Our management considers some of these accounting policies to be critical.
A critical accounting policy is an accounting policy that management believes is both most important to the portrayal of our financial condition and results and requires management’s most difficult subjective or complex judgment, often as a result of the need to make accounting estimates about the effect of matters that are inherently uncertain. While our significant accounting policies are discussed in Note 2 to our financial statements, we believe the following accounting policies to be critical:
Revenues from advertising, whether from keyword search, advertising on our website or in our email client, are recognized when we are entitled to receive the fee. Advertisers are charged and pay monthly, based on the number of clicks generated by users clicking on these ads.
In accordance with ASC 605-50, "Customer Payments and Incentives" the Company accounts for cash consideration given to customers, for which it does not receive a separately identifiable benefit or cannot reasonably estimate fair value, as a reduction of revenue rather than as an expense.
Revenues from email software license sales are recognized when all criteria outlined in ASC 985-605, "Software – Revenue Recognition",, are met. Revenues from software license are recognized when persuasive evidence of an agreement exists, delivery of the product has occurred, the fee is fixed or determinable and collectability is probable.
For substantially all of our software arrangements, we evaluate each of these criteria as follows:
Evidence of an arrangement: We consider a clicking on "acceptance" of the agreement terms to be evidence of an arrangement.
Delivery: Delivery is considered to occur when the license key is sent via email to the customer or alternatively the customer is given access to download the licensed key.
Fixed or determinable fee: Fees are determinable at the time of sale. Customers are charged immediately through credit cards. In addition, the fees are subject to a refund policy period, currently up to 30 days.
Collection is probable: We are subject to a minimal amount of collection risk related to software sold to our customers as these are obtained through credit card sales.
Revenues from licensing The Gold Gallery content database are recognized over the term of the licensing period. We offer one year, two year and lifetime licenses for The Gold Gallery content database for a one-time, upfront payment. The different term licenses constituted less than 5% of our revenues in 2010. Our estimation of the lifetime usage of The Gold Gallery is six years and is based on historical data collected. We continually track usage patterns, and as we gather more user information, we may update this estimated useful life. If the lifetime usage of The Gold Gallery is demonstrated to be shorter or longer than the current estimate, we would recognize revenues earlier or later. Based on our current revenue streams, such an adjustment would not have a significant effect on our revenues.
Revenues from our JunkFilter Plus solution are recognized over the one year term of the license.
Our deferred revenue consists of the unamortized balance of The Gold Gallery and the JunkFilter Plus license fees, which totaled $3.8 million as of December 31, 2010, of which $2.2 million was classified as short-term deferred revenues and the balance as long-term deferred revenue on our balance sheet.
With regard to arrangements involving multiple elements, our revenues are allocated to the different elements in the arrangement under the "relative fair value method" when Vendor Specific Objective Evidence ("VSOE") of fair value exists for all elements. Under the relative fair value method, we recognize and defer revenue proportionally based on the fair value of its delivered and undelivered elements, when the basic criteria in ASC 985-605 have been met. Any discount in the arrangement is allocated pro rata to the different elements in the arrangements.
Collaboration arrangements are established with other websites who use our brand name Incredi and to whom we refer users. Under the agreement the collaborators provide their products and services and manage, host and maintain the websites that provide games or matchmaking services to Internet users, using our Incredi brand for the domain names IncrediGames.com and IncrediMailPersonals.com and our website’s graphical external envelop. We promote these websites, among other things, through promotions on our website and email client. In consideration for our brand and promotional activity, we are entitled to share the net or gross revenues, (as provided in each agreement), generated from these websites, including subscription and advertising fees. Revenues from these collaboration arrangements are recognized when earned and based on reports received from the collaborating party.
On January 1, 2006, we adopted ASC 718, "Compensation – Stock Compensation", which requires the measurement and recognition of compensation expense based on estimated fair values for all share-based payment awards made to employees and directors. As of December 31, 2010, the total compensation cost, related to options granted to employees, not yet recognized, amounted to $1.2 million. This cost is expected to be recognized over a weighted average period of 2.2 years. Our stock-based compensation to employees was allocated as follows (in thousands):
Determining the appropriate fair value model and calculating the fair value of stock-based awards, which includes estimating stock price volatility, forfeiture rates, expected lives and dividend yield, requires judgment and could materially impact our operating results.
Taxes on Income
We record income taxes using the asset and liability approach. Management judgment is required in determining our provision for income taxes. The provision for income tax is calculated based on our assumptions as to our entitlement to various benefits under the applicable tax laws. The entitlement to such benefits depends upon our compliance with the terms and conditions set out in these laws. Although we believe that our estimates are reasonable and that we have considered future taxable income and ongoing prudent and feasible tax strategies in estimating our tax outcome, there is no assurance that the final tax outcome will not be different than those which are reflected in our historical income tax provisions and accruals. Such differences could have a material effect on our income tax provision, net income and cash balances in the period in which such determination is made.
On January 1, 2007, we adopted ASC 740 with respect to uncertain tax positions which contains a two-step approach to recognizing and measuring uncertain tax positions accounted for in accordance with ASC 740, "Income Taxes". The first step is to evaluate the tax position taken or expected to be taken in a tax return by determining if the weight of available evidence indicates that it is more likely than not that, on an evaluation of the technical merits, the tax position will be sustained on audit, including resolution of any related appeals or litigation processes. The second step is to measure the tax benefit as the largest amount that is more than 50% likely to be realized upon ultimate settlement.
Impairment of investments in marketable securities.
On April 1, 2009, we adopted a new guidance that changed the impairment and presentation model for our available for sale debt securities. Under the amended impairment model, an other-than-temporary impairment (OTTI) loss is recognized in earnings if the entity has the intent to sell the debt security, or if it is more likely than not that it will be required to sell the debt security before recovery of its amortized cost basis. However, if an entity does not expect to sell a debt security, it still needs to evaluate expected cash flows to be received and determine if a credit loss exists. In the event of a credit loss, only the amount of impairment associated with the credit loss is recognized currently in earnings. Amounts relating to factors other than credit losses are recorded in other comprehensive income.
Upon adoption of the new guidance, we reclassified a non-credit related amount of $210 thousand net of tax for OTTI losses recognized in earnings prior to April 1, 2009, as a cumulative effect adjustment that increased retained earnings and decreased other comprehensive income (OCI) at April 1, 2009.
Prior to April 1, 2009, we reviewed various factors in determining whether we should recognize an impairment charge for our marketable securities, including our intent and ability to hold the investment for a period of time sufficient to allow for any anticipated recovery in market value, the length of time and extent to which the fair value has been less than our cost basis, the credit ratings of the securities and the financial condition and near-term prospects of the issuers.
Impairment of Long-Lived Assets.
Our long-lived assets include property and equipment and other intangible assets. In assessing the recoverability of our property and equipment and other intangible assets, we make judgments regarding whether impairment indicators exist based on legal factors, market conditions and operating performances of our business and products. Future events could cause us to conclude that impairment indicators exist and that the carrying values of the intangible assets are impaired. Any resulting impairment loss could have a material adverse impact on our financial position and results of operations.
We are required to assess the impairment of long-lived assets, tangible and intangible, other than goodwill, under ASC 360, "Property Plant and Equipment" on a periodic basis, when events or changes in circumstances indicate that the carrying value may not be recoverable. Impairment indicators include any significant changes in the manner of our use of the assets or the strategy of our overall business, significant negative industry or economic trends and significant decline in our share price for a sustained period.
Upon determination that the carrying value of a long-lived asset may not be recoverable based upon a comparison of aggregate undiscounted projected future cash flows to the carrying amount of the asset, an impairment charge is recorded for the excess of fair value over the carrying amount. We measure fair value using discounted projected future cash flows.
Recently issued accounting pronouncements.
See Item 18. Financial Statements. Note 2(u).
The following table sets forth, for the periods indicated, our statements of income expressed as a percentage of total revenues (the percentages may not equal 100% because of the effects of rounding):
As shown in the above table, our operations are characterized by high margins, which are attributable mainly to two factors: (i) we do not have manufacturing costs for our products, and (ii) we sell our products online and rely primarily on viral marketing. Our operating margins decreased in 2010, in comparison to 2009 primarily as a result of our enhancing our management capabilities and hiring of experienced professionals capable of scaling our profitable model and growing the business organically and non-organically. We expect to increase our customer acquisition costs dramatically in 2011, increasing our sales and marketing expenses, and reducing operating margin in 2011. While increasing our customer acquisition costs is a long-term strategy, as we ramp up this expense, we expect it to have a more negative effect in 2011, and less so in future years, and we expect the operating margins to improve in 2012 and beyond, compared to 2011.
Year Ended December 31, 2010 Compared to Year Ended December 31, 2009>
Revenues from advertising, primarily search, and other services. These revenues increased by 17%, from $20.5 million in 2009, to $24.0 million in 2010. The increase in revenues was due to a $2.8 million increase in search generated revenues and a $0.8 million increase in other advertising and other revenues. In 2010 we continued to collaborate with two search providers; with approximately 90% of search generated revenues being provided by our partnership with Google and the remaining 9% coming from other search providers, primarily InfoSpace. The continued increase in search generated revenues reflects the success of our strategy to leverage our large user base, primarily those using our free products. In 2011, as we implement our strategy for growth and invest in customer acquisition, we expect to accelerate the growth coming from these revenues. In 2010, we were not successful in increasing HiYo registrations and revenues, and this product while still generating revenues, no longer constitutes a product that we are focused on. As to PhotoJoy, while we now have completed a marketable product, we expect that through our customer acquisition strategy, this product will start attracting a significant number of downloads, and subsequently generate revenues in the latter part of 2011. We expect to be able to continue and grow other revenues, albeit they still are not expected to contribute a significant portion of our revenues in 2011.
Revenues from products. These revenues continued to decrease from $6.7 million in 2009 to $5.4 million in 2010. We believe this decrease is attributable to our continued focus on search generated revenues, as well as the decreasing popularity in purchasing downloadable software and the effect of the economic downturn in 2009 had on discretionary purchases. In the latter part of 2010, we saw this trend level out, with new product sales increasing. As we increase our marketing efforts in this area in 2011, we can expect cash sales from products to increase. However, the increase in accounting revenues recorded according to US GAAP, will be delayed as these revenues are for the most part deferred over the period of their subscriptions.
Cost of revenues. Cost of revenues from products in 2010 was $1.6 million, as compared to $1.5 million in 2009. This increase was primarily due to our allocating increasing communication and other infrastructure costs to maintain and servicing our existing user base, as opposed to marketing to new users in the past. Despite this nominal increase, as a result of the increasing portion of revenues attributable to search, the gross profit margin in 2010 increased to 95%, as compared to 94% in 2009. As search generated revenues continue to account for a growing portion of our revenues, we expect the gross profit margin to remain at its current level.
Research and development expenses ("R&D"). R&D increased by $0.3 million, from $6.3 million in 2009 to $6.6 million in 2010, decreasing as a percentage from sales from 24% in 2009 to 22% in 2010. This decrease was a result of us maintaining the existing product suite without enriching the product pipeline for future years. Looking at 2011, we expect this expenditure to increase, although generally remain stable as a percentage of sales. The increase in expenditure in 2011 is planned for contributing to a richer product pipeline to fuel future growth.
Selling and marketing expenses. Selling and marketing expenses, increased by $0.6 million, or 14%, from $4.6 million in 2009 to $5.2 million in 2010. This increase was primarily attributable to the consumer research contracted in the fourth quarter as well as the marketing and sales consultants hired. Marketing expenses included approximately $1.8 million in customer acquisition costs in 2010, similar to the level in 2009. In 2011, as we implement our strategy for growth, we intend to increase this expense more than three-fold, with most of the increase being in the latter part of 2011. As a result, we can expect operating margins to be lower during that part of 2011, due to the fact that a substantial part of the return on that investment is only expected in 2012.
General and administrative expenses ("G&A"). G&A increased from $3.3 million in 2009 to $4.7 in 2010. This increase was primarily due to our building a management team capable of scaling the business model and taking the Company to the next level, both organically and through acquisitions. In the third quarter we engaged a new experienced CEO (while still retaining the prior CEO through the end of the year), created a corporate and business development department, hired a new VP of Corporate Development and started staffing that department. We expect to further invest in enhancing our management team in 2012, however, we do not expect this expenditure to increase as a percentage of revenues.
Financial income, net. We recorded $0.3 million, net, in financial income in 2010, compared to $0.1 million in 2009. We continue to maintain a stringent investment policy so that a majority of our investments are in US treasury or US government backed securities, with the balance in debentures of a limited sum and relatively short-term maturity, rated at A and higher and dollar denominated or linked. As a result, the returns on our portfolio have been minimal. Assuming interest rates and the financial environment do not change drastically we expect the current rate of return to continue going forward.
Taxes on Income. Income tax in 2010 was $3.2 million, with an effective tax rate of 28%, compared to $3.5 million, with the same effective tax rate of 31% in 2009. This rate reflects our decision to institute a dividend distribution policy, distributing at least 50% of net income as a dividend, in 2009 and 2010. We distributed dividends of $8.5 million in each of the years, 2009 and 2010. As a result of our policy to distribute dividends, we are not able to take full advantage of the tax reduced tax rates afforded to Approved and Beneficiary Enterprises. As we announced in November 2010, we have changed our dividend distribution policy and do not intend to distribute dividends from earnings in 2011 or beyond. As a result, and assuming a similar tax environment in 2011, we expect to have a substantially lower effective tax rate in 2011.
Net Income. The Net Income in 2010 was $8.4 million, compared to $8.0 million, in 2009. As described above, this was a result of our increase in revenues being offset by a higher level of expenditure.
Year Ended December 31, 2009 Compared to Year Ended December 31, 2008>
Revenues from advertising, primarily search, and other services. These revenues increased by 61%, from $12.7 million in 2008, to $20.5 million in 2009. The increase in revenues was due to an $8.2 million increase in search generated revenues, partially offset by a $0.5 million decrease in other advertising and other revenues. In 2009 we continued to collaborate with two search providers; with approximately 88% of search generated revenues being provided by our partnership with Google and the remaining 12% coming from other search providers, primarily InfoSpace. The continued increase in search generated revenues reflects the success of our strategy to leverage our large user base, primarily those using our free products. In 2010 we expected to further increase these revenues, while diversifying, our search generated revenues through our continued market penetration of HiYo, adding our PhotoJoy user base and additional search assets. In addition, we intended to invest in increasing other advertising based revenues from affiliates other than companies powering search.
Revenues from products. These revenues decreased from $9.2 million in 2008 to $6.7 million in 2009. We believe this decrease is attributable to the decreasing popularity in purchasing downloadable software and the effect of the economic downturn in 2009 had on discretionary purchases. We believed that in 2010 we would be able to reverse this trend and see some growth in product sales, as a result of increased marketing efforts and an improvement in the economic environment.
Cost of revenues. Cost of revenues from products in 2009 was $1.5 million, as compared to $1.7 million in 2008. This decrease was primarily a result of a reduction in compensation expenses, as well as the aforementioned decrease in product sales and their associated costs. As a result of the increasing portion of revenues attributable to search and the decrease in direct costs, the gross profit margin in 2009 increased to 94%, as compared to 92% in 2008. As search generated revenues continue to account for a growing portion of our revenues, we expected the gross profit margin to remain at its current level.
Research and development expenses ("R&D"). R&D decreased by $1.5 million, from $7.8 million in 2008 to $6.3 million in 2009. This was a result of our refocusing our activities on our core competencies discontinuing some projects and freezing others. After releasing PhotoJoy in 2008, in 2009 we suspended most of the development and marketing costs related to this product, until the viral marketing aspects were achieved. In addition, in August 2009 we released a substantially new version of our back-bone email client product IncrediMail®, enabling us to further reduce some of our development costs. As a result of the above, as a percentage of revenues, R&D decreased from 36% in 2008 to 23% in 2009. We expected our research and development expenditures to remain as a percentage of sales, at the general current level of the last couple of quarters, increasing only to enable us to pursue our current strategy for increasing downloads, reducing churn and continue enhancing our existing suite of products.
Selling and marketing expenses. Selling and marketing expenses, decreased by $2.6 million, or 36%, from $7.2 million in 2008 to $4.6 million in 2009. This decrease was primarily attributable to a $2 million decrease in customer acquisition expenses, from $3.8 million in 2008 to $1.8 million in 2009, as well as a $0.7 million decrease in other marketing expenses as we refocused our activities. The reduction in customer acquisition expenses was a result of having achieved the market penetration objectives for HiYo by the end of 2008 and a reduced level of other customer acquisition costs reflecting the economic environment and our focusing on profitability.
General and administrative expenses ("G&A"). G&A decreased from $3.8 million in 2008 to $3.3 in 2009. As a percentage of sales, G&A decreased from to 17% in 2008 to 12% in 2009, and we expected to be able to maintain a similar level of G&A expenditure as a percentage of sales in 2010.
Goodwill impairment and other charges. In 2008 the Company realigned its strategy and decided to focus on its core competencies. As a result it reorganized and suspended certain activities. These expenses included $0.5 million compensation expenses, $0.1 million goodwill impairment and $0.5 million of other expenses related to activities suspended. As this effort was completed, there were no similar expenses in 2009.
Financial income, net. We recorded $0.1 million, net, in financial income in 2009, compared to $4.5 million in 2008. The sum in 2008 was primarily due to receiving in the last quarter of 2008 the proceeds from the sale of an Auction Rate Security, which had been written-off in the fourth quarter of 2007, and recorded as a gain upon receipt in 2008. In light of the economic situation in general and the financial markets in particular, we have further tightened our investment policy so that a majority of our investments are in US treasury or US government backed securities, with the balance in debentures of a limited sum and relatively short-term maturity, rated at A and higher and dollar denominated or linked. As a result, the returns on our portfolio have been minimal. Assuming interest rates and the financial environment do not change drastically we expected the current rate of return to continue going forward.
Income before Tax. The income before tax in 2009 was $11.6 million, compared to income before tax in 2008 of $4.7 million. While the income before tax in 2009 was attributable to profit from operations, in 2008 this income was primarily attributable to the aforementioned $4.5 million financial income.
Taxes on Income. Income tax in 2009 was $3.6 million compared to $0.3 million in 2008. Our effective tax rate in 2009 was 31%, reflecting our decision to institute a dividend distribution policy, distributing at least 50% of net income as a dividend, starting 2009. In 2009 we distributed a dividend totaling $8.5 million, of which $3.8 million was on account of net income on 2009. As a result of the distribution of dividends and our accounting for this policy, we are not able to take full advantage of the tax reduced tax rates afforded Approved Enterprises. We expected to continue to distribute dividends and therefore the effective tax rate to remain at a similar level in 2010. The low taxes on income and effective tax rate in 2008 was due to the fact that the income before tax in 2008 was primarily due to the proceeds from selling an Auction Rate Security at cost, for which no tax was incurred.
Net Income. The Net Income in 2009 was $8 million compared to Net Income of $4.4 million, in 2008. As described above, while the net income was attributable to profit from operations, offset by a higher effective tax rate, net income in 2008 was primarily attributable to financial income recognized from the sale of the Auction Rate Security.
B. LIQUIDITY AND CAPITAL RESOURCES
From inception until consummation of our initial public offering we funded our operations principally from private placements of ordinary and preferred shares that resulted in aggregate net proceeds of approximately $3.3 million and cash flow from operations. We received net proceeds of $16.8 million from our initial public offering, consummated in February 2006.
As of December 31, 2010, we had working capital of $28.1 million and our primary source of liquidity was $31.0 million in cash, cash equivalents and marketable securities. As of December 31, 2009, we had working capital of $26.8 million and our primary source of liquidity was $29.6 million in cash, cash equivalents and marketable securities. The increase in working capital and cash, cash equivalents and marketable securities was primarily due to the $9.8 million from operating activities, less $8.5 million distributed as dividends in 2010.
We believe that our cash balances and cash generated from operations will be more than sufficient to meet our anticipated cash requirements for at least the next 12 months.
Net Cash Provided By Operating Activities. Net cash provided by operating activities was $0.9 million, $10.7 million and $9.8 million for 2008, 2009 and 2010, respectively. The change in net cash provided by operating activities reflects primarily net income of $8.4 million, $1.1 million non-cash expenses, net and $0.3 million non-cash increase in working capital.
Net Cash Provided By (Used In) Investing Activities. Net cash provided by (used in) investing activities was $3.0 million, $13.5 million and ($10.2) million in 2008, 2009 and 2010, respectively. In 2009, net cash provided by investing activities consisted primarily of the net proceeds from the sale of marketable securities and short term deposits of $13.8 million, net of $0.5 million investment in property and equipment. While in 2010, we used cash primarily for net investments in marketable securities of $9.8 million, in addition to investing $0.4 million in property, equipment and content purchased.
Net Cash (Used In) Financing Activities. Net cash (used in) financing activities was ($0.7) million used in 2008, primarily for the repurchase of the Company’s shares, ($7.6) million used in 2009, primarily $8.5 million distributed as a dividend, net of $1.0 million received from the exercise of options, and ($7.9) million in 2010, primarily, $8.5 million distributed as a dividend, net of $0.4 million received from the exercise of options.
C. RESEARCH, DEVELOPMENT, PATENTS AND LICENSES, ETC.
Our research and development activities are conducted internally by our Chief Technology Officer and a 54 person research and development staff. Our research and development efforts are currently focused on upgrading the software and new features for IncrediMail and HiYo products. In 2009 we released the full version of IncrediMail, which improves the graphics and numerous user- friendly functions, bringing a much more graphically advanced user interface. In addition, we released new versions of our HiYo product supporting the Yahoo! Messenger and AIM platforms.
Our research and development expenditures were $7.8 million, $6.3 million and $6.6 million in the years ended December 31, 2008, 2009 and 2010, respectively. We intend to continue our investment in product development at a level similar to that of 2010, increasing nominally, in order to enrich our product pipe line.
D. TREND INFORMATION
Sales. The increase in sales in 2010 compared to 2009 was due to the continued increase in search generated revenues, partially offset by a decrease in product sales. The rate of growth in 2010 tapered off to 8.5% and was derived entirely from our email product, more than offsetting the decline in revenues from our HiYo and Magentic products. We have therefore reduced our investment in promoting HiYo and Magentic and expect to increase our marketing efforts for IncrediMail as well as to begin generating revenues from PhotoJoy. We signed a new two-year agreement with Google for powering the search offered to IncrediMail and HiYo users. Although there are several changes in the terms and conditions in the new agreement, we expect that the new agreement will provide results similar to those of the previous agreement. In 2010 our dependence on search generated revenues and revenues generated by our email product increased. In 2011 we intend to invest in diversifying our revenue base, reducing our reliance on search generated revenues and the dependence on revenues from our flagship email product. We expect to achieve this by introducing and generating revenues from new products, such as PhotoJoy which we expect to initiate marketing efforts in the second quarter of 2011, as well as other products to be developed or acquired in 2011. We have recently completed extensive consumer research the findings of which we expect to implement during the coming months and as a result we hope to increase product sales. Although we will be making these investments in 2011, we expect these efforts will not provide for a significant increase in sales until 2012.
R&D. R&D expenses increased nominally in 2010 after decreasing significantly in 2009. In 2011 we expect these expenses to increase moderately as a result of our implementing the findings of our consumer research and investing in increasing our product pipeline so as to diversify our product suite in future years.
Sales and marketing expenses. Our sales and marketing expenses increased in 2010, after decreasing significantly in 2009. This resulted from our engaging in depth consumer research and hiring marketing and sales consultants in order to better appreciate what our consumers need and how best to service these needs. In 2011 we will continue to engage these consultants, although less so. In 2010 we relied predominantly on the viral nature of our products and our expenditure on customer acquisition costs was $1.8 million, similar to the level of expenditure in 2009. However, in 2011 we intend to increase this expenditure more than three-fold, in an effort to increase significantly the number of downloads and users of our software and search services, as part of our strategy to accelerate revenue growth.
General and administrative expenses. G&A expenses increased as well in 2010. This increase was a result of our enhancing management with new and experienced professionals capable of taking the Company to the next level by implementing organic and non-organic growth strategies. This effort began with hiring a new CEO with extensive corporate and internet related experience, continued with creating a Corporate Development department, hiring an experienced VP to manage this department and staffing it, and other investments. We intend to continue this effort in 2011, enabling us to implement our growth strategy. However, we do not expect G&A expenses to increase significantly beyond the level established in the latter part of 2010.
Industry trends expected to affect our revenues, income from continuing operations, profitability and liquidity or capital resources:
E. OFF-BALANCE SHEET ARRANGEMENTS
We do not have off-balance sheet arrangements (as such term is defined by applicable SEC regulations) that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial conditions, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to investors.
F. TABULAR DISCLOSURE OF CONTRACTUAL OBLIGATIONS
The following table summarizes our contractual commitments as of December 31, 2010 and the effect those commitments are expected to have on our liquidity and cash flow in future periods:
ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES
A. DIRECTORS AND SENIOR MANAGEMENT
The following table sets forth information regarding our executive officers and directors as of February 28, 2011:
* "Independent" for Nasdaq Stock Market purposes.
David Jutkowitz and Avichay Nissenbaum were elected to serve as our external directors by our shareholders as required by Israeli law. No shareholder has special voting rights with respect to the election of directors or otherwise.
Josef Mandelbaum joined the Company as a Chief Executive Officer on July 7, 2010 and was elected as a Director in January 2011. Before joining the Company, Mr. Mandelbaum worked at American Greetings as Chief Executive Officer of the AG Intellectual Properties group, since 2000 and as Senior Vice President of the Sales and Business Development AG Interactive group from1998 until 2000. Mr. Mandelbaum holds a BA in economics from Yeshiva University and an MBA from the Weatherhead School of Management at Case Western Reserve University.
Ofer Adler co-founded IncrediMail and has been a director since our incorporation, most recently reelected in January 2011, for another three year term. Mr. Adler served as the Company's Chief Executive Officer since February 5, 2008 up until being replaced by Mr. Josef Mandelbaum on August 5, 2010 and Chief Product Officer until November 2, 2011 Before co-founding the Company, Mr. Adler worked as a trader and portfolio manager at Clal Insurance from 1997 to 1999, and as a trader and technical analysis expert at Batucha, Israel’s largest private brokerage firm, from 1994 to 1997.
Li Carmel joined us in November 2009 and serves as Vice President of Human Resources. Li brings with her more than ten years of experience in Human Resources management positions in the Hi-Tech industry. She served as VP of Human Resources at Surf Communications Ltd., as Human Resources Manager at Radware Ltd., and held HR positions at Nice Systems Ltd. and Orbotech Ltd. Li holds a B.A in Psychology and Philosophy, and an M.B.A. from Tel-Aviv University.
Arik Czerniak was elected director in December 2009. Arik is a veteran internet entrepreneur and a founder of several consumer focused internet startups. He spent 4 years as founding CEO of Metacafe Inc., one of the world’s largest privately held video sites, with 50 million monthly visitors. Before becoming an entrepreneur, Arik spent 10 years in the Israeli Air Force - first studying for a BA in mathematics, physics and computer sciences at the Talpiot R&D officers project, and later serving as a fighter pilot. Arik also holds an MBA in finance and banking.
Limor Gershoni Levy joined us in January 2011 and serves as Vice President, General Counsel and Corporate Secretary. Prior to joining IncrediMail Ms. Gershoni-Levy was General Legal Counsel for 7 years at Veraz Networks (NASDAQ: VRAZ), a leading provider of band-with optimization and next generation switching products. Veraz recently merged with Dialogic (NASDAQ: DLGC). Before that, Ms. Gershoni-Levy was General Counsel at Medigate Ltd. a start-up that developed management software. Ms. Gershoni-Levy has an L.L.M from University Tel Aviv Law School and a L.L.B in Law from Essex University, England.
Tamar Gottlieb has served as our director since 2001 and became Chair of the Board of Directors on February 3, 2006, the closing date of our initial public offering. She is a Managing Director of Harvest Capital Markets Ltd., an investment banking and financial consulting firm that she founded in January 2001. Prior to 2001, Ms. Gottlieb held Managing Director or Senior Manager positions in several investment banking institutions, including Investec Clali – Management & Underwriting Ltd. (from July 1997 to January 2001), Oscar Gruss (1996) Ltd. (from February 1996 to May 1997) and Leumi & Co. Investment Bankers Ltd. (from 1980 to 1991). From August 1991 to June 1994, Ms. Gottlieb served as the Founding Managing Director of Maalot – The Israeli Securities Rating Company Ltd., Israel’s first credit rating agency. She currently serves as a board member of several Israeli public and private companies, including Emilia Development Ltd., Leumi Mortgage Bank Ltd., N.R. Spuntech Industries Ltd. and Reit 1 Ltd. In the past she has also served as a director of, among others, El Al Israeli Airlines Ltd. and "Dan" the Company for Public Transport Ltd. Ms. Gottlieb has a B.A. in international relations from the Hebrew University of Jerusalem and an M.A. in economics from Indiana University.
Yuval Hamudot is our Chief Operating Officer (COO) and Chief Technology Officer (CTO) Yuval was appointed COO in March 2010 and has been CTO since March 2007. As CTO, Yuval is responsible for the technological design and development of our products and online system. In that capacity he manages our research and development team as well as our quality assurance and information technology departments. As COO, Yuval is also responsible for business intelligence and customer support. Yuval joined us in 2000, and since 2003, and until his recent appointment, was Vice President – Research and Development. Prior to joining us, Mr. Hamudot worked for two years in the research and development at Commonsense Ltd., a software company that outsourced hi-end technology solutions. Mr. Hamudot served in the IDF computer unit ("Mamram") and has a B.Sc. in Computer Science from Tel Aviv University and an M.B.A. from Bar-Ilan University.
David Jutkowitz was reelected to serve another three year term as an "external director" in January, 2011. Mr. Jutkowitz serves as a director of Extal Ltd a producer of aluminum profiles and systems. Mr. Jutkowitz served as a director of Arad Investment and Industrial Development from 2006 till 2010, and from 2001 until October 2007, Mr. Jutkowitz has served as an external director of Carmel Investment Group Ltd., and was a member of the audit, investment and portfolio committees of Carmel Investment Group Ltd. Between 2000 and 2003, Mr. Jutkowitz held the position of CEO at BXS Ltd., where his responsibilities included managing all stages in development of the business, including the raising of funds from investors and building a local and international distribution. From 1995 until 2002, Mr. Jutkowitz held the position of CEO at E.L. Advanced Science Ltd., where his responsibilities included identifying and acquiring appropriate companies and taking an active part in the management of such companies. From 1976 to 2001, Mr. Jutkowitz held the position of CFO at Etz Lavud Ltd.
Yacov Kaufman was engaged to serve as our Chief Financial Officer in 2005. From 1996 to November 2005, Mr. Kaufman was the Chief Financial Officer of Acorn Energy Inc. (formerly Data Systems & Software Inc., NASDAQ: ACFN) that, through its subsidiaries, provides software consulting and development services and serves as an authorized dealer and a value-added-reseller of computer hardware. At Acorn, Mr. Kaufman established and subsequently managed the accounting and financial departments of the company and its subsidiaries. His responsibilities included financial analysis and implementation of procedures for internal control over financial reporting. Mr. Kaufman also served as the comptroller of dsIT Technologies Ltd., a subsidiary of Acorn since 1986, and as its Chief Financial Officer since 1990. From 1993 to 1999, Mr. Kaufman served as a director of Tower Semiconductor Ltd. (Nasdaq: TSEM), an integrated circuits manufacturer and then subsidiary of Acorn. Mr. Kaufman is an Israeli Certified Public Accountant and has a B.A. in accounting and economics from the Hebrew University of Jerusalem and an M.B.A. in business finance from Bar-Ilan University.
Mr. Arik Ramot was elected as a director at our annual meeting of shareholders held on December 24, 2008. Mr. Ramot is the founder and has been the CEO of Ramot & Co, Investment House since 1996. From 1988 to 1996, Mr. Ramot served as legal advisor and manager at Kaszierer International, working in more than 20 countries. Prior to that, Mr. Ramot practiced law in Israel. Mr. Ramot is also the founder of Hayoman Ltd., an Israeli internet company. Mr. Ramot holds LLB and LLM degrees from Tel Aviv University.
Mark Ziering joined IncrediMail as VP of Corporate Development in August of 2010. Mark has over 17 years experience in the biotech, Internet and enterprise software technologies. Prior to joining IncrediMail, Mark was a partner at Genesis Partners, a leading Israeli venture capital fund where he was investing in software since 1999. At Genesis he was involved in over 30 investments and 5 successful exits. Before that Mark was an analyst at Chemical Bank (predecessor to JP Morgan Chase) and The Federal Reserve Bank of NY. Mark has a B.A. From Yeshiva University and an M.B.A from Yale University.
The aggregate direct compensation we paid to our officers as a group (6 persons) for the year ended December 31, 2010, was approximately $2.2 million, which included approximately $0.4 million that was set aside or accrued to provide for pension, retirement, severance or similar benefits. This amount does not include expenses we incurred for other payments, including dues for professional and business associations, business travel and other expenses, and other benefits commonly reimbursed or paid by companies in Israel. We did not pay our officers who also serve as directors any separate compensation for their directorship during 2010.
The aggregate direct compensation we paid to our directors who are not officers for their services as directors as a group for the year ended December 31, 2010 was approximately $221 thousand. Directors are also reimbursed for expenses incurred in order to attend board or committee meetings.
As of February 28, 2011, there were outstanding options to purchase 200,828 ordinary shares granted to 12 of our directors and officers, at a weighted average exercise price of $5.44 per share. These options were granted under our 2003 employees share option plan (the "2003 Plan").
The compensation of our directors who are not officers of our Company, including our external directors, was approved by the Company’s governing bodies, as required under the Israeli law In accordance with these resolutions, (i) annual gross compensation for independent directors is $25,000, and $500 per meeting, while other directors, who are not officers, receive $18,000, and $500 per meeting (plus V.A.T, if applicable) to be paid in four equal quarterly installments; (ii) a grant of options to purchase 10,000 of our ordinary shares, with the following terms: (a) each option shall be exercisable for one ordinary share at an exercise equal to the closing price on the date of grant of the options, as reported by the Nasdaq Capital Market; (b) the options shall vest in three equal parts; and (c) any and all other terms and conditions pertaining to the grant of the options shall be in accordance with, and subject to, the "2003 Plan" adopted by IncrediMail in 2003 and our standard option agreement executed by each director and by IncrediMail promptly after the date of grant.
In accordance with the shareholders approval of December 27, 2007 each of the directors who is not an employee of the Company, receives for each year of service by such person as a director of the Company, an option to purchase 10,000 ordinary shares of the Company (in this subsection - the "Annual Grant"), under the following terms: (a) the Annual Grant shall be made immediately following the annual general meeting of the shareholders of the Company in the relevant year, commencing with the shareholders meeting held on December 27, 2007; (b) each option shall be exercisable for one ordinary share at an exercise price equal to the closing price of an ordinary share on the date of the annual general meeting of the shareholders of the Company upon which such option was granted, as reported by the Nasdaq Global Market; and (c) the options shall vest in four equal portions on each anniversary of the Annual Grant, commencing with the first anniversary. Any and all other terms and conditions pertaining to the grant of the options shall be in accordance with, and subject to, the 2003 Plan adopted by IncrediMail in 2003 and our standard option agreement. In accordance with this resolution, all directors that are not officers were granted 10,000 options on December 31, 2009 and January 6, 2011, after the 2009 and 2010 annual general meetings.
On December 27, 2007, and following approval by our audit committee and board of directors, our shareholders approved a grant to Mr. Ofer Adler of options to purchase 50,000 ordinary shares of the Company, under the following terms: (a) each option shall be exercisable for one Ordinary Share at an exercise price equal to the closing price of an ordinary share on December 27, 2007, as reported by the Nasdaq Global Market; and (b) the options shall vest in four equal portions on each anniversary of the date of approval of the grant, commencing with the first anniversary. Any and all other terms and conditions pertaining to the grant of the options hereunder shall be in accordance with, and subject to, the 2003 Plan adopted by the Company in 2003 and the Company's standard option agreement. See "Item 6.E Share Ownership - Employee Benefit Plans - The 2003 Plan" below.
On July 17, 2008, and following approval by our audit committee and board of directors, our shareholders approved a grant to Ms. Tamar Gottlieb of options to purchase 10,000 ordinary shares of the Company, under the following terms: (a) each option shall be exercisable for one ordinary share at an exercise price equal to the closing price of an ordinary share on July 17, 2008, as reported by the Nasdaq Global Market; and (b) the options shall vest in three equal portions on each anniversary of the date of approval of the grant, commencing with the first anniversary. Any and all other terms and conditions pertaining to the grant of the options hereunder shall be in accordance with, and subject to, the 2003 Plan adopted by the Company in 2003 and the Company's standard option agreement. See "Item 6.E Share Ownership — Employee Benefit Plans — The 2003 Plan" below.
On July 9, 2009, and following approval by our audit committee and board of directors, our shareholders amended the terms of options granted to the external directors and the directors of the Company. In accordance with the amendment, our directors' recurring annual stock option grants now have a vesting period of three years (instead of four years) from the date of their annual stock option grant. Also, upon termination or expiration of the applicable director's service with the Company, provided that the termination or expiration is not "for Cause" and not resulting from the director's resignation, the stock options granted to such director shall retain their original termination dates, and shall not terminate 90 days after the applicable termination date, and the next upcoming tranche of stock options, of each grant, that are scheduled to vest immediately subsequent to the termination date, if any, shall automatically vest and become exercisable immediately prior to the termination date. In addition, to avoid a possible conflict of interest while discussing a Change of Control of the Company (which may result in the termination of the director’s term of office), all unvested options held by the director shall automatically vest and become exercisable upon such "Change of Control" event. "Change of Control" is defined for these purposes as: (i) merger, acquisition or reorganization of the Company with one or more other entities in which the Company is not the surviving entity, (ii) a sale of all or substantially all of the assets of the Company; (iii) a transaction or a series of related transactions as a result of which more than 50% of the outstanding shares or the voting rights of the Company are held by any party (whether directly or indirectly).
C. BOARD PRACTICES
Board of Directors and Executive Officers
We are deemed a "limited liability public company" under the Israeli Companies Law. As a limited liability public company, we are managed by a board of directors and by our executive officers. Under the Israeli Companies Law and our articles of association, the board of directors is responsible, among other things, for:
Our board of directors also appoints and may remove our chief executive officer and may appoint or remove other executive officers, subject to any rights that the executive officers may have under employment agreements.
Upon the closing of our initial public offering (meaning, January 30, 2006), all previously existing special rights to appoint or serve as directors had terminated and our articles of association were amended to remove these special rights.
Our board of directors generally consists of seven directors, two of whom qualify as "external directors" for Israeli law purposes and have been determined by our board of directors to qualify as "independent" for Nasdaq Stock Market Purposes as well. Other than external directors, who are subject to special election requirements under Israeli law, our directors are elected in three staggered classes by the vote of a majority of the ordinary shares present and entitled to vote at meetings of our shareholders at which directors are elected. The members of only one staggered class will be elected at each annual meeting for a three-year term, so that the regular term of only one class of directors expires annually. At our annual general meeting held in 2008, the term of the third class, consisting of Gittit Guberman, expired, she did not stand for reelection and Arik Ramot was elected in her place for a three-year term. At our annual general meeting on December 31, 2009, the term of the first class, consisting of Tamar Gottlieb and Yaron Adler, expired, Tamar Gottlieb was reelected, Yaron Adler was not and Arik Czerniak was elected in his place for a three-year term. The external directors will not be assigned a class and will serve in accordance with Israeli law. On March 30, 2009 the term of one of our external directors, Mr. James H. Lee, expired and at the extraordinary shareholder meeting on July 9, 2009, Avichay Nissenbaum was elected as an external director for a three-year term. At our 2010 annual shareholder meeting held on January 6, 2011, David Jutkowitz was reelected for another three year term as an external director of the Company, Ofer Adler was reelected for a three year term as director, Josef Mandelbaum was elected for a three year term as director, and the term of service of Yair M. Zadik's term as a member of the Company's board of directors expired.
If the number of directors constituting the board is changed, any increase or decrease shall be apportioned among the classes so as to maintain the number of directors in each class as nearly equal as possible, but in no case will a decrease in the number of directors constituting the board shorten the term of any incumbent director.
The board may appoint any other person as a director, whether to fill a vacancy or as an addition to the then current number of directors, provided that the total number of directors shall not at any time exceed seven directors. Any director so appointed shall hold office until the annual general meeting of our shareholders at which the term of his or her class expires, unless otherwise stated in the appointing resolution.
There is no limitation on the number of terms that a director may serve. As described below, external directors may serve two terms of three years each and, subject to certain conditions, an unlimited number of subsequent three-year terms.
Nominations for the election of directors may be made by our board of directors in view of the recommendation of the nominating and governance committee or, subject to the Companies Law, by any of our shareholders. However, any shareholder or shareholders holding at least 5% of the voting rights in our issued share capital may nominate one or more persons for election as directors at a general meeting only if a written notice of such shareholder’s intent to make such nomination or nominations has been given to our secretary and each such notice sets forth all the details and information as required to be provided under our articles of association.
Shareholders may remove a director who is not an external director from office only by a resolution approved by shareholders holding more than two-thirds of the voting power of the issued and outstanding share capital of IncrediMail.
The board of directors appoints its chairperson from among its members in accordance with our articles of association and subject to the provisions of the Companies Law. Pursuant and subject to our articles of association, the chairperson convenes and presides over the meetings of the board. The quorum required for meetings of the board is a majority of the members of the board who are lawfully entitled to participate and vote at the meeting, and resolutions are approved by a vote of the majority of the members present. If the board of directors meeting is adjourned for failure to obtain a quorum and at the adjourned meeting a quorum is not present, then the quorum shall be constituted by the presence of two directors then in office who are lawfully entitled to participate and vote at that meeting. A director may appoint an alternate director to attend a meeting in his or her place, but an alternate director so appointed must be approved by the board prior to the relevant meeting.
Pursuant to the requirements of the Israeli Companies Law, our board has determined that at least one of our directors must have accounting and financial expertise (in addition to the external director that must have accounting and finance expertise). In determining such number of directors, the board considered, among other things, the business of our Company, our size and the scope and complexity of our operations. Such determination also took into account our total number of directors as set forth in the articles of association in accordance with the Israeli Companies Law.
Each of our executive officers serves at the discretion of our board of directors and holds office until his or her successor is elected or his or her earlier resignation or removal.
Under the Israeli Companies Law, Israeli companies whose shares have been offered to the public in or outside of Israel are required to appoint at least two external directors to serve on their board of directors for a three year term. Mr. James H. Lee was appointed as an external director on March 30, 2006 and his term expired on March 30, 2009. At the extraordinary shareholder meeting held on July 9, 2009, Mr. Avichay Nissenbaum was appointed as an external director. In addition Mr. David Jutkowitz was appointed as an external director on December 27, 2007 and reappointed on January 6, 2011.
Each committee of the board of directors entitled to exercise any powers of the board is required to include at least one external director. The audit committee must include all the external directors.
An amendment to the Israeli Companies Law in January 2006 provides that a person may be appointed as an external director if he or she has professional qualifications or if he or she has accounting and financial expertise. In addition, at least one of the external directors must have accounting and financial expertise. A person may not serve as an external director if at the date of his or her appointment or within the prior two years, that person, or his or her relatives, partners, employers or entities under his or her control, are subject to, have or had any affiliation with us or any entity or person controlling us at the time of appointment or an entity that is controlled, at the time of appointment or the prior two years, by us or by the person or entity controlling us. Under the Companies Law, "affiliation" is defined in this context to include an employment relationship, a business or professional relationship maintained on a regular basis, control or service as an office holder. However, the service of a director who was appointed for the purpose of being an external director in a company that intends to first offer its shares to the public is not considered a prohibited affiliation. An office holder is defined in the Companies Law as any director, general manager, chief business manager, deputy general manager, vice general manager, other manager directly subordinate to the general manager or any other person assuming the responsibilities of any of these positions regardless of that person’s title.
A person may not serve as an external director if that person’s position or other activities create, or may create, a conflict of interest with the person’s service as a director or may otherwise interfere with the person’s ability to serve as a director. If at the time any external director is appointed, all members of the board are the same gender, then the external director to be appointed must be of the other gender.
External directors are elected by a majority vote at a shareholders’ meeting, as long as either:
The Israeli Companies Law provides for an initial three-year term for an external director, which may be extended for one additional three-year term. Thereafter (with respect to companies whose securities are listed on certain designated stock exchange, including the Nasdaq Global Market), he or she may be reelected by our shareholders for additional periods of up to three years each, in each case provided that the audit committee and the board of directors confirm that, in light of the external director’s expertise and special contribution to the work of the board of directors and its committees, the reelection for such additional period(s) is beneficial to the company. External directors may be removed only:
In the event of a vacancy created by an external director, our board of directors is required under the Companies Law to call a shareholders’ meeting to appoint a new external director as soon as practicable.
External directors may be compensated only in accordance with regulations adopted under the Israeli Companies Law. The regulations provide three alternatives for cash compensation to external directors: a fixed amount determined by the regulations, an amount within a range set in the regulations, or an amount that shall not be lower than the compensation received by another director nor higher than the average compensation to other directors. "Another" or "other" directors are defined in the applicable regulations as directors of the company that are not external directors and who are not (1) controlling shareholders of the company or (2) employees or service providers of the company on a regular basis or (3) serving at, or providing services on a regular basis, to a company that controls the company or to a company that is under common control with the company or (4) directors who do not receive compensation from the company. A company also may issue shares or options to an external director at an amount not lower than that received by another director (as defined in the applicable regulations) nor higher than the average amount granted to other directors (as defined in the applicable regulations). Cash compensation at the fixed amount determined by the regulations does not require shareholder approval. Compensation determined in any other manner requires the approval of the company’s audit committee, board of directors and shareholders, in that order. Compensation of external directors must be determined prior to their consent to serve as external directors.
Nasdaq Market Governance Requirements for Foreign Private Issuers
Assuming that we maintain our status as a foreign private issuer, under the Nasdaq Market Rules, a foreign private issuer may generally follow its home country rules of corporate governance except for certain matters such as composition of the audit committee (as discussed below). Nasdaq Marketplace Rules specify that the board of directors must contain a majority of independent directors and that the independent directors must have regularly scheduled meetings at which only independent directors are present. Our board contains two independent directors in accordance with the provisions contained in Sections 239-249 of the Israeli Companies Law – 1999 and Rule 10A-3 of the general rules and regulations promulgated under the Securities Act of 1933, rather than a majority of independent directors. Israeli law does not require, nor do our independent directors conduct, regularly scheduled meetings at which only they are present. See "Item 10.B Memorandum and Articles of Association — Nasdaq Marketplace Rules and Home Country Practices" and "Item 16G – Corporate Governance" for a summary of the significant ways in which our corporate governance practices follow the requirements of Israeli law rather than Nasdaq governance requirements for domestic companies. Investors are cautioned that there are other Nasdaq governance requirements with which, as a foreign private issuer, we may elect not to comply. If we so elect, we will provide disclosure of any Nasdaq governance requirements we elect not to comply with in accordance with Nasdaq's disclosure requirements, as may be in effect from time to time.
Committees of the Board of Directors
Our board of directors has established an audit committee, a compensation committee and a nominating and governance committee.
Our audit committee is comprised of David Jutkowitz, Avichay Nissenbaum (both of which are external directors) and Arik Ramot and operates pursuant to a written charter.
Under the listing requirements of the Nasdaq Stock Market, a foreign private issuer is required to maintain an audit committee that has certain responsibilities and authority (such as being directly responsible for the appointment, compensation, retention and oversight of the work of the issuer’s public accountants). In addition, applicable Nasdaq Marketplace Rules require that a foreign private issuer can maintain an audit committee that meets the requirements of Rule 10A-3(b)(subject to the exemptions provided in Rule 10A-3(c)) under the Exchange Act, instead of an audit committee composed solely of independent directors. We currently maintain a board of audit in accordance with Israeli home country regulations, meeting these requirements of Rule 10A-3, in that our audit committee complies with the requirements under Israeli law.
Israeli Companies Law Requirements
Under the Israeli Companies Law, the board of directors of a public company must establish an audit committee. The audit committee must consist of at least three directors and must include all of the external directors. The audit committee may not include the chairman of the board, any director employed by the company or providing services to the company on an ongoing basis, a controlling shareholder or any of the controlling shareholder’s relatives.
The audit committee provides assistance to the board of directors in fulfilling its legal and fiduciary obligations in matters involving our accounting, auditing, financial reporting, internal control and legal compliance functions by approving the services performed by our independent accountants and reviewing their reports regarding our accounting practices and systems of internal accounting controls. The audit committee also oversees the audit efforts of our independent accountants and takes those actions as it deems necessary to satisfy itself that the accountants are independent of management. Under the Israeli Companies Law, the audit committee is also required to monitor and approve remedial actions with respect to deficiencies in the administration of the company, including by consulting with the internal auditor and recommend remedial actions with respect to such deficiencies, and to review and approve related party transactions.
On December 20, 2010 our Audit committee had been authorized by the Company's board of directors to act as the financial statements review committee in accordance with the new Israeli Companies regulations with respect to the procedure in which financial statements should be approved by companies. Such regulations require, among others, that a financial statements review committee shall discuss and prepare recommendations to the board of directors about matters related to the financial statements such as: estimations, internal control procedures, accounting policies, etc. The said regulations permit that the audit committee shall act as the financial statements review committee, provided that the audit committee meets the requirements set forth in the regulations.
As a foreign private issuer, we comply with our home country regulations with respect to the compensation committee. Unlike the Nasdaq Marketplace Rules, applicable to domestic issuer, which require that the determination of the compensation of an executive officer be made by a majority of the independent directors on the board or a compensation committee comprised solely of independent directors, under the Israeli Companies Law and the Company's article of association, the compensation of an executive officer, who does not serve on our board, can be approved by the compensation committee, provided that such compensation is not considered as an Extraordinary Transaction, in which case the approval of the audit committee followed by the approval of the board are required.
Under the Israeli Companies Law, "Extraordinary Transaction" - means a transaction not in a company’s ordinary course of business, a transaction that is not undertaken in market conditions or a transaction that is likely substantially to influence the profitability of a company, its property or liabilities.
Our compensation committee is comprised of Tamar Gottlieb, Avichay Nissenbaum and David Jutkowitz, and operates pursuant to a written charter. The compensation committee is authorized to approve on a yearly basis, the terms of compensation for officers who are not directors, the issuance of employee share options under our share option and benefit plans and approve incentive compensation for our other employees.
Nominating and Governance Committee
Our nominating and governance committee is comprised of Tamar Gottlieb and David Jutkowitz, and operates pursuant to a written charter. It is responsible for making recommendations to the board of directors regarding candidates for directorships and the size and composition of the board. In addition, the committee is responsible for overseeing our corporate governance guidelines and reporting and making recommendations to the board concerning corporate governance matters. Under Israeli Companies Law, the nominations for director are generally made by our directors but may be made by one or more of our shareholders. However, any shareholder or shareholders holding at least 5% of the voting rights in our issued share capital may nominate one or more persons for election as directors at a general meeting only if a written notice of such shareholder’s intent to make such nomination or nominations has been given to our secretary and each such notice sets forth all the details and information as required to be provided under our articles of association.
Under the Israeli Companies Law, the board of directors of a public company must appoint an internal auditor nominated in accordance with the audit committee’s recommendation. The role of the internal auditor is to examine whether a company’s actions comply with the law and proper business procedure. The internal auditor may be an employee of the company employed specifically to perform internal audit functions but may not be an interested party or office holder, or a relative of any interested party or office holder, and may not be a member of the company’s independent accounting firm or its representative. The Israeli Companies Law defines an interested party as a holder of 5% or more of the shares or voting rights of a company, any person or entity that has the right to nominate or appoint at least one director or the general manager of the company or any person who serves as a director or as the general manager of a company. The internal auditor’s term of office shall not be terminated without his or her consent, nor shall he or she be suspended from such position unless the board of directors has so resolved after hearing the opinion of the audit committee and after giving him or her a reasonable opportunity to present his or her position to the board and to the audit committee. In August 2006 the Board of Directors approved the appointment of the firm of Yardeni-Gelfand as internal auditor of the Company, and they have been acting as such since.
Certain Employment Agreements with Directors
We have entered into employment agreements, effective July 6, 2010, with Josef Mandelbaum to retain his services as Chief Executive Officer. The employment agreement does not provide for a specified term and may be terminated by either party upon 180 days prior notice. The employment agreement includes the grant of options, the terms of which are as is customary in the Company. However, a portion of the options are also subject to the Company’s share reaching a strike price higher than market at the time. Upon termination by us of the employment of the executive other than for "cause" (as set forth in the agreement), we are required to continue to pay the terminated executive his salary, benefits and bonus until the end of the 180 day notice period. However, we will have the option to pay the terminated executive a lump sum equal to all amounts due as of the notice date. As required by Israeli law, we will also remit severance payment to the terminated executive in an amount equal to one month’s salary for each year of employment with us following the first year of employment (and a pro rata portion of such monthly salary for each portion of a year of employment following the first year of employment). Such amount of severance payment will be remitted to the executive even if he voluntarily terminates his employment with us. In the event that we terminate the employment of Mr. Mandelbaum for "cause," we will not be required to give prior notice and/or to pay the executive severance payment, except for payment required by Israeli law. In the event that the executive resigns without giving the required notice period, we may deduct from the money that we owe the executive an amount equal to the wages to which he would have been entitled had he worked during the notice period. With regard to the options granted, in the event that Mr. Mandelbaum resigns: (1) the period during which his vested options will be exercisable shall be one (1) year from termination date (as such term is define in the 2003 plan); and (2) a number of unvested options equal to the pro rata options (as such term is defined in his option agreement) shall become vested. In the event that the employment is terminated by the Company without “cause” (as defined in the 2003 Plan): the period during which vested options will be exercisable shall be the period ending on the expiration date (as set forth in his option agreement) and (2) a number of unvested options equal to the pro rata options (as such term is defined in his option agreement) shall become vested.
Josef Mandelbaum has agreed not to compete with us during the term of the agreement and for a period of 180 days thereafter. The agreement also contains customary confidentiality and intellectual property assignment provisions.
We also have existing employment agreements with our other executive officers. These agreements do not contain any change of control provisions and otherwise contain salary, benefit and non-competition provisions that we believe to be customary in our industry.
As of December 31, 2010 we had 107 employees all of which are based in Israel. The breakdown of our employees by department and fiscal period is as follows:
Some provisions of the collective bargaining agreement between the Histadrut, which is the General Federation of Labor in Israel, and the Coordination Bureau of Economic Organizations, including the Industrialist’s Association of Israel, apply to our Israeli employees by virtue of extension orders of the Israeli Ministry of Industry, Trade and Labor. These provisions concern the length of the workday and the work-week, recuperation pay and commuting expenses, compensation for working on the day before and after a holiday and payments to pension funds. Furthermore, these provisions provide that the wages of most of our employees are adjusted automatically. The amount and frequency of these adjustments are modified from time to time. Additionally, we are required to insure all of our employees by a comprehensive pension plan or a senior employees' insurance according to the terms and the rates detailed in the order. In addition, Israeli law determines minimum wages for workers, minimum paid leave or vacation, sick leave, working hours and days of rest, insurance for work-related accidents, determination of severance pay, the duty to give notice of dismissal or resignation and other conditions of employment. In addition, certain laws prohibit or limit the employer’s ability to dismiss its employees in special circumstances. We have never experienced a work stoppage, and we believe our relations with our employees are good.
Israeli law generally requires the payment of severance by employers upon the retirement or death of an employee or termination of employment. The Company’s agreements with employees in Israel, joining the Company since February 2, 2008, are in accordance with section 14 of the Severance Pay Law -1963, whereas, the Company’s contributions for severance pay shall be instead of its severance liability. Upon contribution of the full amount of the employee’s monthly salary, and release of the policy to the employee, no additional calculations shall be conducted between the parties regarding the matter of severance pay and no additional payments shall be made by the Company to the employee. Further, the related obligation and amounts deposits on behalf of such obligation are not stated on the balance sheet, as they are legally released from obligation to employees once the deposit amounts have been paid.
We currently fund most of our ongoing severance obligations through insurance policies. As of December 31, 2010, our net accrued unfunded severance obligations totaled $0.3 million.
Furthermore, Israeli employees and employers are required to pay predetermined sums to the National Insurance Institute. These amounts also include payments for national health insurance. The payments to the National Insurance Institute can equal up to approximately 16.0% of wages, of which the employee contributes approximately 10.0% and the employer contributes approximately 6.0%.
E. SHARE OWNERSHIP
Security Ownership of Directors and Executive Officers
The following table sets forth information regarding the beneficial ownership of our ordinary shares as of February 28, 2011 by:
Beneficial ownership of shares is determined in accordance with the rules of the SEC and generally includes any shares over which a person exercises sole or shared voting or investment power. Ordinary shares that are subject to warrants or stock options that are presently exercisable or exercisable within 60 days of a specified date are deemed to be outstanding and beneficially owned by the person holding the stock options for the purpose of computing the percentage ownership of that person, but are not treated as outstanding for the purpose of computing the percentage of any other person.
Except as indicated in the footnotes to this table, each shareholder in the table has sole voting and investment power for the shares shown as beneficially owned by them. Percentage ownership is based on 9,713,092 ordinary shares outstanding on February 28, 2011.
* Represents less than one percent
Employee Benefit Plans
Our current equity incentive plan was adopted in 2003 under Section 102 of the Israeli Income Tax Ordinance, providing certain tax benefits in connection with share-based compensation. Please also see Note 10 of our financial statements included in this annual report for information on the options issued under our plan.
Under the 2003 Plan, we may grant to our directors, officers, employees, service providers and controlling shareholders options to purchase our ordinary shares. Following an increase in the number of shares available for grant approved by our board of directors and shareholders in December 2007 and November 2010, as of December 31, 2010 a total of 1,717,309 ordinary shares are subject to the 2003 Plan. Any expired or cancelled options are available for reissuance under the 2003 Plan. Our employees, officers and directors may only be granted options under Section 102 of the Israeli Income Tax Ordinance (the "Tax Ordinance>"), which provides for a beneficial tax treatment, and our non-employees (such as service providers) and controlling shareholders may only be granted options under another section of the Tax Ordinance, which does not provide for similar tax benefits. To be eligible for tax benefits under Section 102, options or ordinary shares must be issued through a trustee, and if held by the trustee for the minimum required period, the employees and directors are entitled to defer any taxable event with respect to the options until the earlier of (i) the transfer of the options or underlying shares from the trustee to the employee or director or (ii) the sale of the options or underlying shares to any other third party. Based on elections made by us, our employees and directors will only be subject to capital gains tax of 25% on the sale of the options or the underlying shares, provided the trustee holds their options or, upon their exercise, the underlying shares for the lesser of (i) 30 months, or (ii) 24 months following the re-pricing of any options and for options without re-pricing for 24 months following the end of the calendar year in which the options were granted, and if granted after January 1, 2006, for only 24 months. We may not deduct expenses pertaining to the options for tax purposes.
The tax treatment with respect to options granted to employees and directors under the 2003 Plan is the result of our election of the capital gains tax track under Section 102 of the Tax Ordinance. Section 102 also provides for an income tax track, under which, among other things, the benefit to the employees will be taxed as income, the issuer will be allowed to recognize expenses for tax purposes, and the minimum holding period for the trustee will be 12 months from the date upon which such options are granted. We are able to change our election with respect to future grants under the 2003 Plan as of the close of 2004.
Our board of directors has the authority to administer the 2003 Plan and to grant options under the plan. However, the compensation committee appointed by the board provides recommendations to the board with respect to the administration of the plan and also has full power, among other things, to alter any restrictions and conditions of the options, accelerate the rights of an optionee to exercise options and determine the exercise price of the options.
Options granted to date under the 2003 Plan in the past generally vest in three equal parts annually. One of the grants to the directors vested in four equal parts annually. Options under the 2003 Plan prior our initial public offering were generally granted at an exercise price of $1.72 per share. Since the Company’s initial public offering all options are granted with an exercise price equal to the closing market price, on the day the grant is approved. However, on February 21, 2008 the board of directors of the Company approved the re-pricing of all the existing options, granted to employees under the 2003 Plan and with an exercise price greater than $3.00, to $3.00, which was confirmed by the Israeli Tax Authorities on July 3, 2008. See Note 10 to the Company's Consolidated Financial Statements. These changes did not apply to the options held by our directors. See "Item 6.B Compensation" for a description of options granted under the 2003 Plan to our directors.
The 2003 Plan does not provide for any other acceleration of the vesting period upon the occurrence of certain corporate transactions. However, the board or compensation committee may provide in individual option agreements that if the options are not substituted or exchanged by a successor company, then the vesting of the options shall accelerate.
Adjustments to the number of options or exercise price shall not be made in the event of rights offering on outstanding shares.
In November 2010, the Company's board of directors adopted a compensation policy according to which the eligibility of managerial level employees for option grants under the 2003 Plan was established. The compensation policy also sets forth guidelines regarding employee salaries and bonuses.
ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS
A. MAJOR SHAREHOLDERS
The following table sets forth information regarding the beneficial ownership of our ordinary shares as of February 28, 2011 by each person or group of affiliated persons that we know beneficially owns more than 5% of our outstanding ordinary shares. Other than with respect to our directors and officers, we have relied on public filings with the SEC. Unless otherwise stated herein, each shareholder’s address is c/o IncrediMail Ltd., 4 HaNechoshet Street, Tel Aviv 69710, Israel.
Beneficial ownership of shares is determined in accordance with the rules of the SEC and generally includes any shares over which a person exercises sole or shared voting or investment power. Ordinary shares that are subject to warrants or stock options that are presently exercisable or exercisable within 60 days of a specified date are deemed to be outstanding and beneficially owned by the person holding the stock options or warrants for the purpose of computing the percentage ownership of that person, but are not treated as outstanding for the purpose of computing the percentage of any other person.
Except as indicated in the footnotes to this table, each shareholder in the table has sole voting and investment power for the shares shown as beneficially owned by such shareholder. Percentage ownership is based 9,713,092 ordinary shares outstanding on February 28, 2011 . Our major shareholders do not have different voting rights than our other shareholders.
To our knowledge, as of February 28, 2011 , we had 8 stockholders of record of which 2* were registered with addresses in the United States. These United States holders were, as of such date, the holders of record of approximately 83%* of our outstanding shares.
* Includes the Depository Trust Company
B. RELATED PARTY TRANSACTIONS
It is our policy that transactions with office holders or transactions in which an office holder has a personal interest ("Affiliated Transactions") will be on terms that, on the whole, are no less favorable to us than could be obtained from independent parties.
Generally, Affiliated Transactions which are "extraordinary transactions" (as such term is defined in the Companies Law), must be approved by a majority of our disinterested directors; nevertheless under Israeli law, under certain circumstances, such transactions (i) must first be approved by the audit committee and then by the board of directors and, in certain circumstances must also be approved by the shareholders; or (ii) may be approved by a simple majority of the board (and by a simple majority of the audit committee and interested directors may participate in the deliberations and the voting with respect to such transactions if the majority of the members of the board (or the audit committee) have a personal interest in the approval of the transaction; provided that in such circumstances the approval of such Affiliated Transaction shall also require the approval of the shareholders.
See "Item 10.B Memorandum and Articles of Association — Approval of Related Party Transactions" for a discussion of the requirements of Israeli law regarding special approvals for transactions involving directors, officers or controlling shareholders.
On July 17, 2008, and following approval by our audit committee and board of directors, our shareholders approved a grant to Ms. Tamar Gottlieb of options to purchase 10,000 ordinary shares of the Company, under the following terms: (a) each option shall be exercisable for one ordinary share at an exercise price equal to the closing price of an ordinary share on July 17, 2008, as reported by the Nasdaq Global Market; and (b) the options shall vest in four equal portions on each anniversary of the date of approval of the grant, commencing with the first anniversary. Any and all other terms and conditions pertaining to the grant of the options hereunder shall be in accordance with, and subject to, the 2003 Plan adopted by the Company in 2003 and the Company's standard option agreement. See "Item 6.E Share Ownership — Employee Benefit Plans — The 2003 Plan" below.
Also on July 17, 2008, following approval by our audit committee and board of directors, our shareholders approved a re-pricing of options to purchase Ordinary Shares, previously granted to Mr. Yaron Adler, at the time, the Company’s President and a member of the board of directors of the Company, such that the exercise price of any previously granted options that exceeded $3.00 per Ordinary Share were reduced to $3.00 per share. The Company undertook to re-price Mr. Adler’s options as part of the terms of service of Mr. Yaron Adler as the Company’s President, which terms were approved at the shareholders meeting of the Company held on April 9, 2008.
On July 9, 2009, at an extraordinary general meeting the shareholders approved a proposal to amend the terms of options granted to the directors of the Company. It was resolved that; (a) the recurring annual stock option grants to the directors, for board service, will have a vesting period applicable to one term of office of a director, which under the Company's articles of association is a term of three (3) years (instead of a vesting period of four (4) years as was formerly approved by the shareholders) from the date of grant; (b) the stock options granted to a director shall retain their original expiration dates specified upon the date of grant, and shall not terminate 90 days after the Termination Date as set forth in the directors' option agreements, provided that the termination or expiration is not "for Cause" and not resulting from the director's resignation; and (c) the next upcoming tranche of stock options, of each grant, that are scheduled to vest immediately subsequent to the Termination Date, if any, shall automatically vest and become exercisable immediately prior to that Termination Date. In addition, to avoid a possible conflict of interest with respect to a potential Change of Control of the Company (which may result in the termination of the director’s term of office), all unvested options held by a director, shall automatically vest and become exercisable upon a "Change of Control" event. "Change of Control" was defined for these purposes as: (i) merger, acquisition or reorganization of the Company with one or more other entities in which the Company is not the surviving entity, (ii) a sale of all or substantially all of the assets of the Company; (iii) a transaction or a series of related transactions as a result of which more than 50% of the outstanding shares or the voting rights of the Company are held by any party (whether directly or indirectly).
C. INTERESTS OF EXPERTS AND COUNSEL
ITEM 8. FINANCIAL INFORMATION
A. CONSOLIDATED STATEMENTS AND OTHER FINANCIAL INFORMATION
Our audited consolidated financial statements for the year ended December 31, 2010 are included in this annual report pursuant to Item 18.
We are not aware of any legal proceedings the outcome of which would have a significant impact on the Company's financial condition.
Policy on Dividend Distribution
On November 4, 2010 we announced that as we are focusing on growth and intend to utilize our cash and investments to achieve that growth, we have decided to change our dividend policy so that beginning with earnings of 2011 and beyond, we do not intend to distribute any dividends to the holders of our ordinary shares.
All of the ordinary shares of the Company are entitled to an equal share in any dividends declared and paid.
On January 23, 2008 the Company announced that its Board of Directors had resolved to adopt a share buyback plan, and on March 25, 2009, the Company announced that it had elected to continue with the second phase of this plan that authorizes the purchase of up to an additional $1 million of its ordinary shares. Up to March 5, 2009, the Company repurchased 346,019 ordinary shares in open market transactions.
The distribution of dividends and the buy-back plan is subject to limitations under Israeli law, including permitting the distribution of dividends (and purchasing the company’s own shares) only out of profits. See "Item 10.B Memorandum and Articles of Association — Dividend and Liquidation Rights." In addition, the payment of dividends is subject to Israeli withholding taxes. See "Item 10.E Taxation — Israeli Taxation —Taxation of our Shareholders—Taxation of Non-Israeli Shareholders on Receipt of Dividends."
B. SIGNIFICANT CHANGES
Since the date of our audited financial statements included elsewhere in this report, there have not been any significant changes other than as set forth in this report under Item 4.A. – "Recent Developments".
ITEM 9. THE OFFER AND LISTING
A. OFFER AND LISTING DETAILS
Our ordinary shares have been listed on the Nasdaq Capital Market since January 31, 2006 and since June 27, 2007 on the NASDAQ Global Market ("NASDAQ"), under the symbol "MAIL". Our ordinary shares commenced trading as a dual listed company on the Tel Aviv Stock Exchange ("TASE") on December 4, 2007 under the Hebrew letters which read "EMAIL".
The following table shows, for the periods indicated, the high and low closing sale prices of our ordinary shares as reported on the NASDAQ and the TASE:
The closing prices of our ordinary shares, as reported on the Nasdaq Global Market and on the Tel Aviv Stock Exchange on March 8, 2011 , which are the last full trading days before filing of this annual report, were $7.45 and NIS 26.47, (equal to $7.39 based on the Bank of Israel representative exchange rate as of such date), respectively.
* Since our listing on the Tel Aviv Stock Exchange on December 4, 2007.
B. PLAN OF DISTRIBUTION
Our ordinary shares are quoted on the Nasdaq Global Market under the symbol "MAIL", and on the Tel Aviv Stock Exchange under the Hebrew letters which read "EMAIL".
D. SELLING SHAREHOLDERS
F. EXPENSES OF THE ISSUE
ITEM 10. ADDITIONAL INFORMATION
A. SHARE CAPITAL
At our 2010 annual shareholder meeting held on January 6, 2011, the shareholders resolved to increase the authorized share capital of the Company by NIS 250,000 divided into 25,000,000 ordinary shares, par value NIS0.01 each, and to amend the Company’s Articles of Association to reflect such increase of share capital, so that following such increase, the authorized share capital of the Company is NIS 400,000, consisting of 40,000,000 ordinary shares with a nominal value of NIS 0.01 each.
B. MEMORANDUM AND ARTICLES OF ASSOCIATION
Registration Number and Purposes
Our registration number with the Israeli Companies Registrar is 51-284949-8. Pursuant to Section 3 of our articles of association, our objectives are the development, manufacture and marketing of software and any other objective as determined by our board of directors.
Dividend and Liquidation Rights
The holders of the ordinary shares are entitled to their proportionate share of any cash dividend, share dividend or dividend in kind declared with respect to our ordinary shares on or after the date of this annual report. We may declare dividends out of profits legally available for distribution. Under the Israeli Companies Law, a company may distribute a dividend only if the distribution does not create a reasonable risk that the company will be unable to meet its existing and anticipated obligations as they become due. A company may only distribute a dividend out of the company’s profits, as defined under the Israeli Companies Law. If the company does not meet the profit requirement, a court may allow it to distribute a dividend, as long as the court is convinced that there is no reasonable risk that such distribution might prevent the company from being able to meet its existing and anticipated obligations as they become due.
Under the Israeli Companies Law, the declaration of a dividend does not require the approval of the shareholders of a company unless the company’s articles of association provide otherwise. Our articles of association provide that the board of directors may declare and distribute dividends without the approval of the shareholders. In the event of our liquidation, holders of our ordinary shares have the right to share ratably in any assets remaining after payment of liabilities, in proportion to the paid-up par value of their respective holdings.
These rights may be affected by the grant of preferential liquidation or dividend rights to the holders of a class of shares that may be authorized in the future.
Voting, Shareholder Meetings and Resolutions
Holders of ordinary shares have one vote for each ordinary share held on all matters submitted to a vote of shareholders. This right may be changed if shares with special voting rights are authorized in the future.
Our articles of association and the laws of the State of Israel do not restrict the ownership or voting of ordinary shares by non-residents of Israel, except with respect to citizens of countries that are in a state of war with Israel.
Under the Israeli Companies Law, an annual general meeting of our shareholders should be held once every calendar year, but no later than 15 months from the date of the previous annual general meeting. The quorum required for a general meeting of shareholders consists of at least two shareholders present in person or by proxy holding in the aggregate at least 33 1/3% of the voting power. A meeting adjourned for lack of a quorum generally is adjourned to the same day in the following week at the same time and place or any time and place as the chairperson of the board of directors designates in a notice to the shareholders with the consent of the holders of the majority voting power represented at the meeting voting on the question of adjournment. In the event of a lack of quorum in a meeting convened upon the request of shareholders, the meeting shall be dissolved. At the reconvened meeting, the required quorum consists of any number of shareholders present in person or by proxy.
Our board of directors may, in its discretion, convene additional meetings as "special general meetings." In addition, the board must convene a special general meeting upon the demand of two of the directors, one fourth of the nominated directors, one or more shareholders having at least 5% of outstanding share capital and at least 1% of the voting power in the company, or one or more shareholders having at least 5% of the voting power in the company. The chairperson of the board of directors presides at each of our general meetings. The chairperson of the board of directors is not entitled to a vote at a general meeting in his capacity as chairperson.
Most shareholders’ resolutions, including resolutions to:
Under the Israeli Companies Law, shareholders’ meetings generally require prior notice of at least 21 days, or 35 days if the meeting is adjourned for the purpose of voting on any of the following matters:
Modification of Class Rights
The Israeli Companies Law provides that, unless otherwise provided by the articles of association, the rights of a particular class of shares may not be adversely modified without the vote of a majority of the affected class at a separate class meeting.
Election of Directors
Our ordinary shares do not have cumulative voting rights in the election of directors. Therefore, the holders of ordinary shares representing more than 50% of the voting power at the general meeting of the shareholders, in person or by proxy, have the power to elect all of the directors whose positions are being filled at that meeting, to the exclusion of the remaining shareholders. External directors are elected by a majority vote at a shareholders’ meeting, provided that either:
See "Item 6.C Board Practices" regarding our staggered board.
Transfer Agent and Registrar
American Stock Transfer and Trust Company is the transfer agent and registrar for our ordinary shares.
Approval of Related Party Transactions
The Israeli Companies Law codifies the fiduciary duties that office holders owe to a company. An office holder is defined in the Israeli Companies Law as any director, general manager, chief business manager, deputy general manager, vice general manager, other manager directly subordinate to the general manager or any other person assuming the responsibilities of any of these positions regardless of that person’s title. Each person listed in the table under "Management — Executive Officers and Directors" is an office holder under the Israeli Companies Law.
Fiduciary duties. An office holder’s fiduciary duties consist of a duty of loyalty and a duty of care. The duty of loyalty requires the office holder to act in good faith and to the benefit of the company, to avoid any conflict of interest between the office holder’s position in the company and any other of his or her positions or personal affairs, and to avoid any competition with the company or the exploitation of any business opportunity of the company in order to receive personal advantage for himself or others. This duty also requires him or her to reveal to the company any information or documents relating to the company’s affairs that the office holder has received due to his or her position as an office holder. The duty of care requires an office holder to act with a level of care that a reasonable office holder in the same position would employ under the same circumstances. This includes the duty to use reasonable means to obtain information regarding the advisability of a given action submitted for his or her approval or performed by virtue of his or her position and all other relevant information pertaining to these actions.
Compensation. Under the Israeli Companies Law, all compensation arrangements for office holders who are not directors require approval of the board of directors, unless the articles of association provide otherwise and provided that such arrangements is not considered to be an "Extraordinary Transaction" (see definition below), in which case the approval of the audit committee will be required as well, prior to the approval of the board. Under our articles of association, our compensation committee has the authority to approve the compensation of all office holders. Arrangements regarding the compensation of directors (including officers who are also directors) require audit committee, board and shareholder approval, in such order.
Disclosure of personal interest. The Israeli Companies Law requires that an office holder promptly disclose to the company any personal interest that he or she may have and all related material information known to him or her, in connection with any existing or proposed transaction by the company. "Personal interest", as defined by the Israeli Companies Law, includes a personal interest of any person in an act or transaction of the company, including a personal interest of his relative or of a corporate body in which that person or a relative of that person is a 5% or greater shareholder, a holder of 5% or more of a company’s outstanding shares or voting rights, a director or general manager, or in which he or she has the right to appoint at least one director or the general manager. "Personal interest" does not apply to a personal interest stemming merely from the fact that the office holder is also a shareholder in the company.
The office holder must make the disclosure of his personal interest without delay and no later than the first meeting of the company’s board of directors that discusses the particular transaction. This duty does not apply to the personal interest of a relative of the office holder in a transaction unless it is an "Extraordinary Transaction". The Israeli Companies Law defines an Extraordinary Transaction as a transaction not in the ordinary course of business, not on market terms or that is likely to have a material impact on the company’s profitability, assets or liabilities, and defines a relative as a spouse, sibling, parent, grandparent, descendent, spouse’s descendant and the spouse of any of the foregoing.
Approvals. The Israeli Companies Law provides that a transaction with an office holder or a transaction in which an office holder has a personal interest may not be approved if it is adverse to the company’s interest. In addition, such a transaction generally requires board approval, unless the transaction is an extraordinary transaction or the articles of association provide otherwise. If the transaction is an extraordinary transaction, or if it concerns exculpation, indemnification or insurance of an office holder, then in addition to any approval stipulated by the articles of association, approvals of the company’s audit committee and the board of directors is required. Exculpation, indemnification, insurance or compensation of a director also would require shareholder approval. A director who has a personal interest in a matter that is considered at a meeting of the board of directors or the audit committee may not attend that meeting or vote on that matter, unless a majority of the board of directors or the audit committee also has a personal interest in the matter. If a majority of the board of directors or the audit committee has a personal interest in the transaction, shareholder approval is also required.
The Israeli Companies Law imposes the same disclosure requirements, as described above, on a controlling shareholder of a public company that it imposes on an office holder. For these purposes, a controlling shareholder is any shareholder that has the ability to direct the company’s actions, including any shareholder holding 25% or more of the voting rights if no other shareholder owns more than 50% of the voting rights in the company. Two or more shareholders with a personal interest in the approval of the same transaction are deemed to be one shareholder.
Approval of the audit committee, the board of directors and our shareholders is required for:
The shareholder approval must include the majority of shares voted at the meeting. In addition, either:
Under the Israeli Companies Law, a shareholder has a duty to act in good faith towards the company and other shareholders and to refrain from abusing his or her power in the company including, among other things, when voting in a general meeting of shareholders or in a class meeting on the following matters:
A shareholder has a general duty to refrain from depriving any other shareholder of their rights as a shareholder. In addition, any controlling shareholder, any shareholder who knows that it possesses the power to determine the outcome of a shareholder or class vote and any shareholder who, pursuant to the company’s articles of association has the power to appoint or prevent the appointment of an office holder in the company, is under a duty to act with fairness towards the company. The Companies Law does not describe the substance of this duty of fairness.
Anti-Takeover Provisions; Mergers and Acquisitions
Merger. The Israeli Companies Law permits merger transactions with the approval of each party’s board of directors and shareholders, except that when the merger involves one of the following companies, the approval of the shareholders of these companies is not required:
At the general meeting of a merging company which shares are held by the other party to the merger or by any person holding at least 25% of any control measures of the other party to the merger, a merger shall not be deemed approved if the shareholders holding the majority of the voting power present at the meeting object to the merger. In calculating this majority, (i) the abstaining shareholders and (ii) shareholders that are part of the other party to the merger or hold 25% or more of any control measures of the other party to the merger are excluded. Shares held by relatives or companies controlled by a person are deemed held by that person. The term "control measures" of a company includes, among other things, voting power or means of appointing the board of directors.
Under the Israeli Companies Law, a merging company must inform its creditors of the proposed merger. Any creditor of a party to the merger may seek a court order to delay or block the merger, if there is a reasonable concern that the surviving company will not be able to satisfy all of the obligations of the parties to the merger. Moreover, a merger may not be completed until all of the required approvals have been filed by both merging companies with the Israeli Registrar of Companies and (i) 30 days have passed from the time both companies’ shareholders resolved to approve the merger, and (ii) at least 50 days have passed from the time that the merger proposal was filed with the Israeli Registrar of Companies.
Tender Offer. The Israeli Companies Law requires a purchaser to conduct a tender offer in order to purchase shares in publicly held companies, if as a result of the purchase the purchaser would hold more than 25% of the voting rights of a company in which no other shareholder holds more than 25% of the voting rights, or the purchaser would hold more than 45% of the voting rights of a company in which no other shareholder holds more than 45% of the voting rights. The requirement to conduct a tender offer shall not apply to (i) the purchase of shares in a private placement, provided that such purchase was approved by the company’s shareholders as a private placement that is intended to provide the purchaser with more than 25% of the voting rights of a company in which no other shareholder holds more than 25% of the voting rights, or with more than 45% of the voting rights of a company in which no other shareholder holds more than 45% of the voting rights; (ii) a purchase from a holder of more than 25% of the voting rights of a company that results in a person becoming a holder of more than 25% of the voting rights of a company, and (iii) a purchase from the holder of more than 45% of the voting rights of a company that results in a person becoming a holder of more than 45% of the voting rights of a company.
Under the Israeli Companies Law, a person may not purchase shares of a public company if, following the purchase of shares, the purchaser would hold more than 90% of the company’s shares or of any class of shares unless the purchaser makes a tender offer to purchase all of the target company’s shares or all the shares of the particular class, as applicable. If, as a result of the tender offer, the purchaser would hold more than 95% of the company’s shares or a particular class of shares, the ownership of the remaining shares will be transferred to the purchaser. However, if the purchaser is unable to purchase 95% or more of the company’s shares or class of shares, the purchaser may not own more than 90% of the shares or class of shares of the target company.
Tax Law. Israeli tax law treats some acquisitions, such as a stock-for-stock swap between an Israeli company and a foreign company, less favorably than U.S. tax law. For example, Israeli tax law may subject a shareholder who exchanges his ordinary shares for shares in a foreign corporation to immediate taxation. Please see "Item 10.E Taxation — Israeli Taxation."
Exculpation, Indemnification and Insurance of Directors and Officers
Our articles of association allow us to indemnify, exculpate and insure our office holders, which includes our directors, to the fullest extent permitted by the Israeli Companies Law, provided that procuring this insurance or providing this indemnification or exculpation is approved by the audit committee and the board of directors, as well as by the shareholders if the office holder is a director. Our articles of association also allow us to insure or indemnify any person who is not an office holder, including any employee, agent, consultant or contractor who is not an office holder.
Under the Israeli Companies Law, a company may indemnify an office holder in respect of some liabilities, either in advance of an event or following an event. If a company undertakes to indemnify an office holder in advance against monetary liability incurred in his or her capacity as an office holder whether imposed in favor of another person pursuant to a judgment, a settlement or an arbitrator’s award approved by a court, the indemnification must be limited to foreseeable events in light of the company’s actual activities at the time of the indemnification undertaking and to a specific sum or a reasonable criterion under such circumstances, as determined by the board of directors.
Under the Israeli Companies Law, only if and to the extent provided by its articles of association, a company may indemnify an office holder against the following liabilities or expenses incurred in his or her capacity as an office holder:
Under the Israeli Companies Law, a company may obtain insurance for an office holder against liabilities incurred in his or her capacity as an office holder, if and to the extent provided for in its articles of association. These liabilities include a breach of duty of care to the company or a third-party, a breach of duty of loyalty and any monetary liability imposed on the office holder in favor of a third-party.
A company may, in advance only, exculpate an office holder for a breach of the duty of care. However, a company may not so exculpate an office holder for a breach of the duty of care in connection with a distribution of dividends or a repurchase of the company’s securities. A company may not exculpate an office holder from a breach of the duty of loyalty towards the company.
Under the Israeli Companies Law, however, an Israeli company may only indemnify or insure an office holder against a breach of duty of loyalty to the extent that the office holder acted in good faith and had reasonable grounds to assume that the action would not prejudice the company. In addition, an Israeli company may not indemnify, insure or exculpate an office holder against a breach of duty of care if committed intentionally or recklessly, or an action committed with the intent to derive an unlawful personal gain, or for a fine or forfeit levied against the office holder.
Our board of directors and shareholders have resolved to indemnify our directors and our Chief Financial Officer to the extent permitted by law and by our articles of association for liabilities not covered by insurance and that are of certain enumerated events, subject to an aggregate sum equal to 50.0% of the shareholders equity as set forth in the financial report of the preceding year to which a claim for indemnification is made.
Nasdaq Marketplace Rules and Home Country Practices
In accordance with Israeli law and practice and subject to the exemption set forth in Rule 4350(a)(1) of the NASDAQ Marketplace Rules, we follow the provisions of the Israeli Companies Law – 1999, rather than the requirements of Marketplace Rule 4350 with respect to the following requirements: