Perion Network Ltd. 20-F 2012
Documents found in this filing:
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
For the fiscal year ended December 31, 2011
Date of event requiring this shell company report………………………………….
For the transition period from ____ to _____
Commission File No. 000-51694
Perion Network Ltd.
(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, 2011, the Registrant had outstanding 9,916,194 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
Yes £ No T
If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.
Yes £ No T
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes T No £
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 £ No £
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):
Large accelerated filer £ Accelerated filer £ Non-accelerated filer T
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.
Item 17 £ Item 18 £
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):
Yes £ No T
In November 2011, the Company changed its name from IncrediMail Ltd. to Perion Network Ltd.
As used herein, and unless the context suggest otherwise, the terms "Perion", "Company", "we", "us" or "ours" refer to Perion Network Ltd. References to “U.S. dollars,” “U.S.$” and “$” are to the lawful currency of the United States of America, and references to “NIS” are to New Israeli Shekels, the lawful currency of the State of Israel.
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:
· our dependence on the web browsing environment and ability to adapt to its continuing evolution;
· our ability to manage our growth, including the integration of acquired companies;
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 consolidated financial statements and related notes appearing elsewhere in this annual report. We derived the selected operations data below for the years ended December 31, 2009, 2010 and 2011 and the selected balance sheet data as of December 31, 2010 and 2011 from our audited consolidated financial statements included elsewhere in this report. We derived the selected operations data below for the years ended December 31, 2007 and 2008 and the selected balance sheet data as of December 31, 2007, 2008 and 2009 from our audited consolidated financial statements not included in this report. Our consolidated financial statements are prepared and presented in U.S. dollars and in accordance with United States Generally Accepted Accounting Principles ("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 67% of our revenues for the year ended December 31, 2011 from this partnership. While this percentage has been decreasing recently, we expect this venue to continue to generate a major portion of our revenues in the foreseeable future.
In December 2010 we signed an agreement with Google effective January 1, 2011 and expiring January 1, 2013. As in past agreements, this too enables termination by either side after one year with 90 days notice (to date, neither party has exercised such right), and in addition, Google is able to amend the agreement, change its policies and guidelines, 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 competitors do not offer as much coverage through 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 affects our ability to contract other providers, we would experience a material reduction in our revenues and, in turn, our business, financial condition and results of operations would be adversely affected. Our failure to retain existing users, or attract new users, as well as generate traffic to our search properties, could adversely affect our business, financial condition and results of operations.
We rely heavily 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.
Approximately 72% of our revenues for the year ended December 31, 2011 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, while others may cause difficulties in resetting the 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, this had negative revenue implications, offset by some positive changes made in the 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 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 Perion’s home page, and retaining existing users, could suffer, preventing or delaying us in increasing our revenues, or even cause them to decrease.
Social related software and Facebook in particular, is becoming an increasingly dominant method of communication over the internet. If Facebook increases its dominance over other forms of communication, or changes the way people share content and we are not able to adapt our products to this new environment, the users of our products could decrease and negatively affect our revenues.
A significant portion of our revenues stems from the usage of our IncrediMail email client. If the usage of Facebook or other social related software as a method of communication replaces email, this would decrease the usage of our email client and subsequently have a negative effect on our revenues.
In addition, our IncrediMail email client and other products, interface with Facebook, which we believe contributes to the usage by our users of our products. If Facebook were to change the guidelines and policies governing their cooperation with companies, these changes could negatively impact the use of our products.
Finally, a significant portion of the users of our Smilebox photo-sharing product uses Facebook to share their creations. We could be impacted by changes that Facebook makes in how our users are able to post content into Facebook. These changes could negatively impact the use of Smilebox to post to Facebook which would adversely affect our service usage and revenues.
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 creative photo sharing 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, annual 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, our photo sharing product 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. The growing popularity of web based mail and its increased functionality and mobility negatively affect the potential market demand for our primarily PC based email client. Our photo sharing product has benefited from the social trend of sharing digital photos, while the increasing popularity for taking and viewing photos on mobile devices are a challenge for our primarily desktop oriented user experience. The rate of adoption and acceptance of our products may be affected adversely by changing consumer preferences, product obsolescence, technological change, market competition 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 and for the most part their discretionary purchase habits. The current overall lack of growth in the U.S. and European economies following on a few years of weak performance have resulted in continued negative pressure on consumer spending in general, and discretionary spending in particular, and have impacted consumers in our market territories in ways that could negatively affect our business. In the event that the United States or Europe experiences an economic downturn, or the current economic climate worsens, our current and potential software license subscribers may be unable or unwilling to purchase our products or use our service. This would also have a negative impact on consumer internet spending and search generated revenues. A reduction in the purchasing of our products or use our 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 to a great extent on "viral growth" to increase our user base, and although the pace of viral growth has declined, it is of relatively low cost and remains an important part of our growth strategy going forward. Other marketing methods, while effective, are far more costly. As users of our products stop, reduce, or limit their usage, our viral growth will diminish because these users will no longer forward links to our site via their emails, and as a result our market share and revenues decrease. Our historical experience with usage of our products indicates that usage of products declines rapidly, although some continue to use them for as long as 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.
One of our major products competes 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, which does not require the user to download software, and thus provides a very mobile and accessible email tool. Some of these competitors provide (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.
We rely significantly on our ability to advertise through the Google Adwords network for marketing and acquiring new users for our products. Should Google make substantial changes to this network or if it becomes substantially more expensive, it would be more difficult and expensive to acquire new customers and would negatively affect our revenues.
As the ability to market our products via "viral growth" methods declines, we are becoming increasingly reliant on advertising for acquiring new customers. One of the main venues for advertising our products is Google’s Adwords network. Google sets the standards for using this network as well as being the market-maker for establishing the pricing in its network. Although there are alternative networks and markets for advertising, none are currently as popular as Google. Should Google change the rules for using this network and the way distributers of downloadable software products interact with it, or the cost of advertising our products increases dramatically, our ability to distribute our products would be limited which would negatively affect our revenues.
We have and intend to continue and use a substantial portion of our invested resources to acquire unspecified businesses. These acquisitions divert a substantial part of our resources and management attention, could cause dilution to our shareholders and adversely affect our financial results.
We recently used a substantial portion of our invested resources to acquire Smilebox Inc. and intend to continue to acquire complementary products, technologies or businesses. Prior to this acquisition our management had no experience together as a team in making acquisitions or integrating acquired businesses. Although we believe we have been successful in this acquisition so far, the continued integration of this newly-acquired business, as well as negotiating potential additional acquisitions to a certain extent diverts our management’s attention from other business concerns, is expensive and time-consuming. New acquisitions could expose our business to unforeseen liabilities or risks associated with the business or assets acquired or with entering new markets. In addition, while this has not been the case so far with Smilebox, we might lose key employees while integrating new organizations and we might not effectively integrate any other acquired products, technologies or businesses. With regard to the Smilebox acquisition, less than a year has passed since the acquisition, and we might yet lose key employees and not effectively complete full integration, nor achieve anticipated revenues or cost benefits, from this acquisition and similar risks exist for other acquisitions which may occur in the future. Future acquisitions could result in customer dissatisfaction, performance problems with an acquired product, technology or company, the incurrence of debt or issuances of equity securities that cause dilution to our existing shareholders. Furthermore, a substantial portion of the cost of these acquisitions is for intangible assets. We may incur contingent liabilities, amortization expenses related to intangible assets, 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.
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, the European Union 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 evolving global standards regarding privacy, and inform our customers of our business practices prior to any installations of our product and use of our services, it is possible that these laws may be interpreted and applied in a manner that is inconsistent with our data collection and preservation practices, or that it may be argued that our practices do not comply with other countries' privacy and data protection laws and regulations. In addition to the possibility of fines, such a situation could result in the issuance of an order requiring that we change our data collection or retention 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 users or third parties express privacy or security concerns regarding our collection, use and handling of personal information, we could incur substantial expenses.
Although we strive to comply with strict privacy data security requirements and take all reasonable steps to ensure 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 websites. 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 websites. 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 full 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 accurately 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 and making such predictions is very complex and challenging, particularly with regard to new products and initiatives and scaling existing business. 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 organic growth of our operations has slowed in recent years. To accelerate growth we have invested heavily in advertising and the acquisition of new businesses and products. This strategy for emphasizing accelerated growth is required in order to achieve our business objectives, and is 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>.
Most of our products and virtualy all of our revenues currently run or are based on Microsoft Windows operating systems. Recently the Linux and Apple operating systems have gained populartity and market share, although still accounting for only a small part of the market. A decline in market acceptance of 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. 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 most of our products and 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, tablets, etc., has increased dramatically. Our products for the most part are not yet compatable with these alternative platforms 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 products will become less relevant and may fail to attract advertisers and web traffic.
If the ubiquity of Adobe’s flash technology decreases, the use of our Smilebox photo sharing product could be negatively affected and as a result our revenues could decline.
Our Smilebox photo sharing product for the desktop uses Adobe Flash technology as part of its core underlying file format and relies on the fact that recipients in general have Flash and are able to playback Smilebox creations without requiring an additional file download. We could be adversely impacted by a reduction in the marketing of Flash by Adobe and a related decline in the ubiquity of Flash as a platform.
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, a significant portion of our sales is in currencies other than the U.S. dollar, of which a large portion is in, or originates in, Euros. In 2011, approximately 16% of our revenue was received directly in these currencies and approximately an additional 69% 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. In addition, a substantial part of our costs, mainly personnel expenses, are incurred in NIS. Inflation in Israel may have the effect of increasing the U.S. dollar cost of our operations in Israel. Whenever 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 approximately $0.1 million. The exchange rate of the U.S. dollar to the New Israeli Shekel has been very volatile in the past years, increasing on average through the year, by approximately 10% in 2009, decreasing by 5% in 2010 and decreasing by approximately 4% in 2011. As of December 31, 2011, we had a foreign currency net asset of approximately $6 million and our total foreign exchange income was approximately $102 thousand for the year ended December 31, 2011. In addition, in market 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 consulting firm proficient in this area, and are generally implementing their proposals. Based on the advice received from this firm, 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 the amounts of these revenues are not material. However, due to the market conditions, volatility and other factors, we do not always implement our consultant’s 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, together with 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 non-competition covenants 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 most 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 users 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 the users of our products and services, 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", “Smilebox”, etc.) 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 damage to our reputation and loss of 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 effectively detect and terminate this misrepresentation activity of others or the way that 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 into 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. We have experienced such claims in the past 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 in the process of diversifying our product portfolio, currently our email product, IncrediMail, generates approximately 88% of our revenues. In addition, 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, have slowed the growth of the email market and 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.
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 20% 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, our revenues from product sales and services would decrease further.
Our financial performance may be adversely affected by information technology, insufficient cyber-security and Other Business Disruptions
Our business may be impacted by disruptions, including information technology attacks or failures. Cybersecurity attacks, in particular, are evolving and include, but are not limited to, malicious software, attempts to gain unauthorized access to data, and other electronic security breaches that could lead to disruptions in systems, unauthorized release of confidential or otherwise protected information and corruption of data. Unidentified groups recently hacked numerous Israel-based internet websites in what many have perceived as politically motivated attacks and as an Israeli Corporation we could similarly be at risk for attacks targeting Israeli entities in particular. We are not aware of material cybersecurity attacks directed at us in the past, but may experience them in the future, potentially with more frequency. We believe that we have adopted appropriate measures to mitigate potential risks to our technology and our operations from these information technology-related and other potential disruptions, and are also seeking to obtain appropriate levels of insurance coverage with respect to such incidents. However, given the unpredictability of the timing, nature and scope of such disruptions, we could potentially be subject to system downtimes, operational delays, other detrimental impacts on our operations or ability to provide products and services to our customers, the compromising of confidential or otherwise protected information, destruction or corruption of data, security breaches, other manipulation or improper use of our systems and networks, financial losses from remedial actions, loss of business or potential liability, and/or damage to our reputation, any of which could have a material adverse effect on our cash flows, competitive position, financial condition or results of operations.
New laws and regulations applicable to e-commerce, Internet advertising, privacy and data collection and protection, 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, Europe, 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 collection and protection, pricing, content, copyrights, electronic contracts and other communications, Internet advertising (including monitoring and tracking consumer behavior), consumer protection, the provision of online payment services, broadband residential Internet access, and the characteristics and quality of products and services.
There is currently also uncertainty in relation to the passing of relatively recent online laws. For example, legislation has been enacted to regulate the use of "cookie" technology. In Europe there is a patchwork of implementation and limit guidance as to what good practice looks like. Further, some Member States are yet to implement the relevant Directive and bring their laws into compliance. 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.
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 data 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. Since February 2011, Egypt has experienced political turbulence, following the resignation of Hosni Mubarak as president, including protests throughout Egypt, and the appointment of a military regime in his stead followed by the election to the Egyptian parliament of certain political parties which advocate breaking ties with Israel, which may damage the current peaceful and diplomatic relations between Israel and Egypt, and which could affect the region as a whole. Similar civil unrest and political turbulence has occurred in other countries in the region and is affecting the political stability of those countries. Syria, which borders Israel, has experienced months of violence and some have expressed concern that the unrest could spill into Israel or lead to incidents on what has been a relatively quiet border in recent years. This instability may lead to deterioration of the political and economic relationships that exist between the State of Israel and some of these countries. In addition, Iran has threatened to attack Israel and is widely believed to be developing nuclear weapons. Iran is also believed to have a strong influence among extremist groups in the region, such as Hamas in Gaza and Hezbollah in Lebanon. These situations may potentially escalate in the future to more violent events which may affect Israel and us. These situations, 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 have a material adverse effect on our business, operating results and financial condition. While such hostilities did not in the past have a material adverse impact on our business, we cannot guarantee that hostilities will not be renewed and have such an effect in the future. 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. The political and security situation in Israel may result in parties with whom we have contracts claiming that they are not obligated to perform their commitments under those agreements pursuant to force majeure provisions. These or other Israeli political or economic factors could harm our operations and product development and cause our sales to decrease. Any hostilities involving Israel or the interruption or curtailment of trade between Israel and its present trading partners could adversely affect our operations and could make it more difficult for us to raise capital. 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. Since many of our facilities are located in Israel, we could experience serious disruptions if acts associated with this conflict result in any serious damage to our facilities. Our business interruption insurance may not adequately compensate us for losses that may occur and any losses or damages incurred by us could have a material adverse effect on our business. Any future armed conflicts or political instability in the region would likely negatively affect business conditions and harm our results of operations.
Our operations may be disrupted by the obligations of our personnel to perform military service.
All non-exempt male adult citizens and permanent residents of Israel under the age of 40, or older for reserves officers or citizens with certain occupations, as well as certain female adult citizens and permanent residents of Israel, are obligated to perform military reserve duty and may be called to active duty under emergency circumstances. In recent years, there have been significant call-ups of military reservists, and it is possible that there will be additional call-ups in the future. 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 the relevant age of discharge from army service and, in the event of a military conflict, could be called to active duty. While we have operated effectively despite these conditions in the past, we cannot assess what impact these conditions may have in the future, particularly if emergency circumstances arise. 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 executive officers or key employees. Any disruption in our operations would harm our business.
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 most 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, most 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. However, subject to certain time limitations, Israeli courts may enforce U.S. final executory judgments for liquidated amounts in civil matters obtained after due trial before a court of competent jurisdiction (according to the rules of private international law currently prevailing in Israel) which enforces similar Israeli judgments, provided that the requisite procedural and legal requirements are adhered to. If a foreign judgment is enforced by an Israeli court, it generally will be payable in NIS, which can then be converted into foreign currency at the rate of exchange of such foreign currency on the date of payment. Pending collection, the amount of the judgment of an Israeli court stated in NIS (without any linkage to a foreign currency) ordinarily will be linked to the Israeli consumer price index plus interest at the annual statutory rate prevailing at such time. Judgment creditors bear the risk of unfavorable exchange rates.
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, during the period in the past when we distributed dividends, 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. This pertains in particular to establishing that revenues are generated and based on technology developed in Israel. 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 as we are contemplating, we increase our activities outside of Israel, for example, by additional future acquisitions or otherwise not based on technology based in Israel, 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 since the beginning of 2011 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 announced, our current policy is not to distribute 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 located outside of Israel) 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.
If we were to lose our foreign private issuer status under US federal securities laws, we would incur additional expenses associated with compliance with the US securities laws applicable to US domestic issuers.
We are a foreign private issuer, as such term is defined under US federal securities laws, and, therefore, we are not required to comply with all of the periodic disclosure and current reporting requirements applicable to US domestic issuers. If we lost this status, we would be required to comply with the reporting and other requirements applicable to US domestic issuers, which are more detailed and extensive than the requirements for foreign private issuers. The regulatory and compliance costs to us under US securities laws, if we are required to comply with the reporting requirements applicable to a US domestic issuer, may be significantly higher than the cost we currently incur as a foreign private issuer.
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. In addition, as a foreign private issuer, we are permitted by the listing requirements of the NASDAQ to rely on home country governance requirements and certain exemptions thereunder rather than relying on the corporate governance requirements of the NASDAQ. 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. Israeli law does not currently describe the substance of this duty of fairness, but provides that laws applicable to a breach of contract, adjusted according to the circumstances shall apply to a breach of such duties. See "Item 10.B Memorandum and Articles of Association — Approval of Related Party Transactions" for additional information concerning this and other duties of a shareholder under Israeli law. Because Israeli corporate law has undergone extensive revision in recent years, there is relatively little case law available to assist in understanding the implications of these provisions that govern shareholder behavior.
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, although our executive officers and directors have certain limitations regarding how and when they may trade our securities, neither they or relatively large shareholders are subject to contractual restrictions on the sale by them of shares, resulting in a substantial number of shares held by them 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.
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, and in November 2011 to Perion Network Ltd., to better reflect the diverse 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 website address is www.perion.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.
On August 31, 2011 we completed the purchase of Smilebox Inc., a Washington corporation, through our Delaware subsidiary. See “Recent Developments” below.
Principal Capital Expenditures
We had capital expenditures of $31.8 million in 2011, $0.7 million in 2010 and $0.5 million in 2009. We currently expect that outside of possible acquisition of products and companies, our capital expenditures will be approximately $1.5 million in 2012. To date, we have financed our general capital expenditures with cash generated from operations.
Our capital expenditures during 2009 and 2010 consisted primarily of; leasehold improvements and furnishings, as well as investments in computer hardware and software, in Israel. In 2011, capital expenditures consisted of $31.5 million for the acquisition of Smilebox, including approximately $7 million to be paid in 2012, and $0.3 million for investment in computer hardware and software, leasehold improvements and furnishings.
In 2012, we expect to continue our growth strategy for acquiring products and businesses, in addition to organic capital investments. Our organic investments are expected to consist primarily of acquiring computer hardware, software, peripheral equipment and installation, all which are expected to be financed by the Company’s resources. To the extent we acquire new products and businesses these acquisitions may be financed by any of, or a combination of, cash generated from operations, the credit facility currently available to the Company from Israeli banks, in an amount up to $20 million, and\or issuances of securities or debt.
On August 1, 2011 we signed a definitive agreement to acquire (via our Delaware Subsidiary) Smilebox Inc., a U.S. consumer focused photo sharing and social expression company.
Smilebox is an Internet photo sharing service available for the desktop and smart-phone, with an easy-to-use, downloadable desktop application that allows consumers to use personal photos and videos to construct unique creations, including: greeting cards, invitations, slideshows, scrapbooks and photo albums. On the desktop, Smilebox can be used both on the PC and the Mac, in order to create digital creations from personal photos using a range of digital designs including Invitations, Greetings, Collages, Scrapbooks, Photo Albums and slideshows. These creations can then be shared free of charge via email, Facebook, Twitter, Print, DVD or Photo Frames. Revenues are generated from subscriptions for premium content and features, advertising from creations that are shared for free, printing revenues from creations that are printed to store or printed and shipped to home and search revenues for consumers that elect to have Smilebox provide their default search results.
Smilebox is also available for the iPhone making easy to personalize and share photos in the moment directly from the device. Personalization options include captions, stickers and frames and sharing options include email, Facebook or SMS. Revenues are generated via subscriptions for premium content
The acquisition added another major product to the Perion portfolio of products, significantly diversifying its revenue mix. Under the terms of the agreement, Perion paid $25 million substantially in cash at closing which occurred on August 31, 2011, with additional payments of up to $15 million, if certain milestones and performance based conditions are met, payable in two installments on the seven and fourteen months anniversary from closing. Approximately 10% of the acquisition consideration is being held in escrow until 18 months after closing.
Smilebox continues to operate from its Redmond, Washington, based offices, which employs approximately 50 people, as of the date of this annual report.
B. BUSINESS OVERVIEW
We are a digital media company that provides products and services to consumers to help make their everyday life simpler and more enjoyable. Focusing on an underserved market of second wave adopters who value their time online, Perion offers a growing portfolio of easy-to-use products. The Company's products include:
Since we began operations in 2000, our products have been downloaded in more than 100 countries, and in the last quarter of 2011 we recorded an average of approximately 2.1 million registered downloads each month. As of December 31, 2011, we had an installed base of approximately 12.3 million, and in the last quarter of 2011 more than 369 million IncrediMail® emails and our Smilebox users shared 2.3 million photo creations. Our users typically use our products for as long as six years. However, the length of use varies dramatically based on the product, whether it’s the free version or paid for, when the product was downloaded and other factors.
In 2011 we sold 402,000 products and content licenses worldwide to our registered users. We believe that 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."
In the past we relied primarily on "viral growth" to grow our user base. Since the middle of 2011, while viral growth still contributes a substantial portion of our growth, we are investing increasing sums in advertising to accelerate our growth as the effectiveness of our viral growth declines. Our "viral growth" has resulted from recipients of our users’ emails clicking on the link at the bottom of emails sent with IncrediMail® Xe, or receiving digital photo creations from friends and relatives, created by our Smilebox software, and then downloading our products and also from word of mouth. Our revenues were $27.2 million in 2009, $29.5 million in 2010 and $35.5 million in 2011. Our operations have been profitable since 2002, with a gross profit margin of at least 90%.
When we use the term "registered user" in this annual report, we mean a user who has downloaded at least one of our products and completed the registration process. Registrations are not necessarily indicative of the number of individuals using our products or services, as a user may register more than one time and a particular product or service may be resident on their computer but not actually being used. 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 applicable measurement date.
In the past we emphasized the graphic content provided in our products 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 users’ email experience. Consistent with this strategy, we developed our Magentic and HiYo products, both of which are also rich in graphic content. However, neither of these products has been successful in generating substantial revenues.
Based on our recent consumer research, we have learned 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 of “second wave adopters”, software that is simple, safe and useful, assisting them in better utilizing their time.
Our user. Our products ideally service “second wave adopters”, characterized by typically being above 40 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 learned that, approximately 94% of our users are 35 years or older and approximately 79% 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, photo sharing software and recently begun with our PC optimization software. 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 products Smilebox and PhotoJoy have 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, safety and security in the POC environment, personal productivity, wellness, and other areas.
Our objective is to become the market leader and a reliable provider of consumer software for second wave adopters 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 recently developed and still being improved, the Company has increased 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 continue to enrich and expand our product suite.
However, in order to grow our business beyond organic growth, the Company intends to invest in acquiring other products and extend the business as we have done with the acquisition of Smilebox Inc. in 2011. This will enable us to further diversify our revenue base, better serve the needs of our users and reduce the time required to bring these new products to market.
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;
Search generated revenues
We offer our users the ability to search by collaborating with premium search companies, currently almost exclusively Google Inc., and to 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, effective January 1, 2011 and expiring January 31, 2013, 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, the results produced by this new agreement are materially similar to those of the prior agreement. Google’s coverage and service offering is the one most suited to our global distribution and provides the best monetization opportunity for our products. Nonetheless, we will continue to explore opportunities to work with the other search providers.
Other advertising and other revenues
Finally, we utilize the distribution of our products and their presence in the user’s desktop to generate other advertising revenues from methods such as display ads and banners, as well for generating revenues by collaborating with other companies to offer their products to those that download our products.
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 $5 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:
Digital photo vertical:
Security and Safety vertical:
Products under Development
Our research and development activities are conducted internally by our Chief Technology Officer and a 69 person research and development staff. Our research and development efforts are focused on the development of upgraded software, new features and the enhancement, and enabling new platforms for our existing product suite.
In 2011 we increased our development investment effort, and refocused this effort so as to enhance our product pipeline. The initial results of this effort are apparent by the products and features released during the past year. We intend to continue this effort in 2012 by introducing additional products and focusing on adapting our existing products for use on mobile platforms, including the iPhone, iPad and possibly Android based platforms as well.
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 users, search generated revenues and products sold by territory in 2011: (*)
(*) 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 supplemented the viral marketing with customer acquisition efforts aimed at accelerating our growth, increasing the number of registered users, and as a result increasing revenues. We plan to continue this effort, and increase it somewhat, in 2012
We have typically experienced stronger product 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 especially so regarding our Smilebox photo-sharing software. This is in addition to the general seasonality of the Internet as well as e-commerce being more active in the winter months. Since 2007 and up until the first half of 2011, as search generated revenues accounted for a growing and more dominant portion of our revenues, the seasonality of our revenues has decreased; however, with the acquisition of Smilebox and the increased growth in product sales, we can again expect higher seasonality towards those months.
As of December 31, 2011 we had 32 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 from third parties. Except for our agreements regarding anti-spam software and some of our content licenses, most 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 July 2006 a patent was awarded to the Company in the in the United States entitled “System and Method for visual feedback of command execution in electronic mail systems”.
In 2011 the Israeli Patent office concluded the examination and has notified the Company that it is willing to allow a patent of said application in Israel. A correspondent application is still pending in the EPO.
In 2007 an international application was filed for an invention entitled "Interactive Message Editing System and Method". This application was filed as part of 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: (i) IncrediMail, and PhotoJoy as trademarks in the United States, the European Community (a community Trademark) and China; (ii) “Smilebox Teeth Design” in the United States; and (iii) “Smilebox” in Australia, Canada, China, France, Germany, Japan, Korea, United Kingdom and the United States.
We have pending trademark applications of “Perion” in Israel, United States the European Community (a community Trademark).
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.
The vertical markets we are active in are subject to intense competition. Our products compete in the specialized market for email software products, digital photo services and PC safety and security, aiming to offer simple, safe and useful applications.
Perion was among the first companies to offer to the consumer email market a solution that combines an easy to use and intuitive email product with a 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 2000. 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.
In the digital photo sharing space, our Smilebox product is unique in that it is the only service that enables consumers to create a complete range of digital creations that can be shared electronically via email, Facebook or Twitter complete with music, interactivity and animation or physically via print, DVD or photo frame. Smilebox is unique in personalizing the photo sharing experience on smart-phones, by easily enabling the user to personalize their photos with content, and which can then be shared in a way that is personal via email, SMS or Facebook.
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:
With respect to our communication products, 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 each offer 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 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. 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.
With respect to our Smilebox photo sharing product, Smilebox competes broadly within the photo services category. Competition includes America Greetings and Hallmark from the greetings category, Shutterfly, Kodak and Snapfish from the photo products category and services like Flikr, Facebook and Instagram in the social photo sharing category.
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. In some instances, in the EU particularly, those that have been implemented are dating rapidly as online practice (and particular social commerce and extent of online interaction and communication) evolves. 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 (and associated guidance) 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 connection with this, some of the countries in which we operate have increased their enforcement of local laws and therefore the potential impact of failing to comply with local and international legislative requirements has increased significantly.
In this regard, there are still 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, mandatory consents or affirmations 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 (the “Privacy Law”). Maintaining a database other than in compliance with the Privacy 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 21, 2004.
In addition to the registration obligations under the Privacy Law, the Privacy Law also determines that any request for information should be accompanied by a notice that indicates: whether a person is legally required to expose such information, or that such exposure is subject to such person’s own will and consent; 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. The Privacy Law stipulates that an infringement of privacy is a civil wrong action, and authorizes the court to set compensation of NIS 50,000 (approximately US$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 Copyrights Law of 2007 (the “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 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 27,000).
On December 1, 2008, Amendment No. 40 to the Israeli Communications Law (Transmissions and Broadcasting) 5742-1982 (the “Israeli Anti-Spam Law”) came into effect. The Israeli Anti-Spam Law prohibits dissemination of commercial e-mail advertisements, as well as other forms of electronic advertisements, without the recipient’s prior express consent. The Israeli Anti-Spam Law applies equally to entities themselves offering goods or services, and entities distributing electronic advertisements on their behalf. Consent may be obtained in writing, by electronic message or recorded conversation. Advertisers may make a single contact with business recipients in order to solicit such consent; such initial contact will not be considered a violation of the Israeli Anti-Spam Law. Recipients may revoke their consent at any time, either in writing or in the same medium used to transmit the advertisement. It is permitted to distribute commercial promotional electronic advertisements without prior recipient consent where all of the following conditions are met: (i) the recipient provided his contact information to the advertiser in the course of purchasing goods or services or negotiations for the purchase of goods or services, and the advertiser provided notice that the details so provided would be used for purposes of disseminating such advertisements; (ii) the advertiser provided the recipient the opportunity to refuse to receive such advertisements, either generally or of a particular type, and the recipient did not do so; and (iii) the advertisement relates to goods or services similar to those described in (i) above. In addition to the consent requirements described above, the Israeli Anti-Spam Law requires that all electronic advertisements include a clear, conspicuous notice containing (i) identification of the message as an advertisement (for email communications, the word “advertisement” must appear in the email subject line; in all other electronic advertisements, such identification must appear in the beginning of the advertisement; (ii) the advertiser’s identity and contact information; and (iii) notification of the recipient’s right to opt out of receiving such advertisements and means for opting out (including an email address for email advertisements). Violations of the Israeli Anti-Spam Law may carry criminal and civil penalties. Advertisers who disseminate advertisements in violation of the law are subject to a fine of approximately NIS 202,000 (approximately US $54,000). Failure to comply with the mandatory notice provisions carries a fine of approximately NIS 67,300 (approximately US $18,000). Managers and individuals working for the advertiser who are responsible for marketing or promotions and who do not take sufficient measures to ensure compliance with the law may be personally liable for violations of the law and may be subject to a fine of approximately NIS 67,300 (approximately US $18,000). There is a statutory presumption that any illegal spam that was sent, was sent knowingly, unless proven otherwise. This statutory presumption of knowingly delivering illegal spam cannot even be challenged under certain instances (such as repeat offenses or distribution to a randomly selected list of addresses). The Israeli Anti-Spam Law also creates a private right of action for violations; in addition to other compensation to which recipients may be entitled, the court is authorized to award recipients statutory damages of approximately NIS 1,000 (approximately US $ 300) per email received in knowing violation of the law. There are also provisions for punitive damages as well as civil tort liabilities. In addition, the Israeli Anti-Spam Law provides for certifying claims against advertisers who violate the Israeli Anti-Spam Law as class-action lawsuits. In light of the fact that we are headquartered out of Israel and have Israeli customers, we are challenged by these rules with respect to our email campaigns, and non-compliance would expose us to potential fines and sanction, civil tort claims, as well as potential reputational damage.
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 (“COPPA”), 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 September of 2011, the Federal Trade Commission proposed significant regulations under COPPA. Among other changes, the proposal provided for updated requirements for parental notice, expanded definitions of “personal information” and “collection”. The rules could regulate tracking cookies, device serial numbers and IP addresses of children under 13. Because of the nature of our business includes, among other things, the placement of cartoon “emoticons” in emails, we anticipate that our services could attract a significant number of users who would fall into the regulated class. Accordingly, depending on the exact regulations adopted, our business could be affected by the new rules. 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. Because our services enable users to upload photographs to the internet and share them with others, we could be subject to liability unless our procedures adequately identify and report such violations of the law. 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. For example, 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. The Massachusetts Office of Consumer Affairs and Business Regulation established data security regulations (201 CMR 17.00 et seq.) which became effective on March 1, 2010. They require any company which possesses the personal information of a Massachusetts resident to adopt and implement a comprehensive written information security program. The program must include technical, physical, and administrative safeguards for the protection of personal information owned, licensed, received, stored, maintained, processed, or otherwise accessed by the company. State legislation could require us to modify our business practices and could potentially subject us to liability.
United Kingdom and European Union
The U.K. Data Protection Act and similar European Member State implementations of the European Union Data Protection Directive establish a core framework of rights and duties which are designed to safeguard personal data processed within the EU. There are other ancillary and related laws and regulations across the EU which combine to create an extensive regulatory regime. The core data privacy framework is underpinned by a set of eight straightforward principles which we must apply to safeguard personal data. Any failure to ensure that personal information is processed in accordance with these principles could result in criminal or civil penalties as well as potentially damage our customers. 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 and the associated compliance practices implemented under such legislation may impose significant additional costs or restrictions on our business or subject us to additional liabilities.
"the storing of information or the gaining of access to information already stored in the terminal equipment of a subscriber or user is only allowed on condition that the subscriber or user concerned has given his or her consent."
Some local legislation is now implemented by Member States but others, missing the prescribed deadline for such implementation of May 2011, have not resolved and published their approach to the required changes to legislation. Much about how this new directive may affect our operations in the European Union remains unknown until member states pass their own implementing legislation. Valuable associated regulatory guidance on best practice in those Member States that have implemented the rules is only slowly being issued leaving additional uncertainty around the changes which may be required of our business. As others in the online market, we are observing the changes in online practice made by our peers and recognize a likely need to amend our practices.
Notably, and as mentioned above, Article 66 of the ePrivacy Directive requires both transparency about cookie use and that a provider obtain a user’s consent before a cookie is placed 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 these technologies have not yet emerged and as a consequence it is likely that some form of affirmative step is to be necessary to enable a user to opt in before or at the time the cookie is placed. As clarity around these new rules and associated guidance emerges 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. Inevitably the solution required may also have a negative impact on consumer adoption and the types of services and revenue we can drive from cookie use and the information such use can derive.
In the UK at least, the government is taking a phased approach to the implementation of the ePrivacy Directive and, until May 2012, the regulator (ICO) are therefore taking the approach that if they receive a complaint about a website then they will expect to receive a response from an organization setting out how they have considered the new requirements and to demonstrate that the organization has a realistic plan to achieve compliance.
Similar to CAN-SPAM Act of 2003, the EU has equally tough legal regime as a result of the Privacy and Electronic Communications Directive (2002/58/EC), which specifically applies to the sending of unsolicited commercial email. All EU Member States now have implementations within their own national legislation which implement these rules (though not always on the same basis which complicates our compliance). As a consequence direct marketing email messages may be sent only to subscribers who have given their prior consent ("opt-in") although certain exemptions apply where there has been a prior course of dealing with the consumer in question and these can provide our business with more flexibility. We are challenged by these (and associated rules) when mounting EU email campaigns and non-compliance would expose us to potential fines and regulatory investigation and sanction on a country to country basis as well as potentially reputational damage.
C. ORGANIZATIONAL STRUCTURE
During 2006, we formed a wholly-owned subsidiary in Delaware, for marketing and other activities (the “Delaware Subsidiary”), and formed another wholly owned subsidiary in Israel to acquire the business of our transaction processing provider, operating primarily out of Israel (the “Israeli Subsidiary”). In 2009 we refocused the transaction processing activity to deal exclusively with internally generated activity and currently the Israeli Subsidiary is inactive. In August 2011 we acquired, through our Delaware Subsidiary, all the outstanding shares of Smilebox Inc., a Washington corporation operating out of Redmond Washington. See “Recent Developments”. Except for such subsidiaries, we do not currently have other subsidiaries.
D. PROPERTY, PLANTS AND EQUIPMENT
We lease two facilities, one located in Tel Aviv, Israel and the second in Redmond Washington. The lease in Tel Aviv for a total area of 18,300 square feet was extended in 2011 to expire in 2015, with annual rent of approximately $18 per square foot. The lease in Redmond for a total area of 8,300 square feet was extended in 2010 to expire in 2015, with an option to extend for another 2-5 years, with annual rent of approximately $19 per square foot.
Perion owns servers that are located in Israel and Smilebox owns additional servers located in Seattle Washington for a total of 60 servers. We also rent the services of approximately 100 additional servers located around the world. Our servers include mainly web servers, application servers, ad servers, mail servers and database servers. Bezeq International Ltd. which we refer herein as "Bezeq", provides our Internet and related telecommunications services in Israel, including hosting and location facilities, needed to operate our websites. 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, software for sharing digital photo creations, a photo discovery tool and PC optimization software. We believe we are unique in addressing our demographic market of second wave adopters. We believe that the user experience we have created has been successful in attracting a unique underserved demographic, seeking software application that make their life a little simpler and more enjoyable.
In the last quarter of 2011, we recorded an average of approximately 2.1 million registered downloads each month. As of December 31, 2011, we had an installed base of approximately 12.3 million, and 402,000 users of our premium products. In the last quarter of 2011, our email users sent over 369 million IncrediMail® emails and our Smilebox users shared 2.3 million creations each month. Included in our “installed base” are users who have our software installed on their computer on 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). However, the length of use varies dramatically based on the product, whether it’s the free version or paid for, when the product was downloaded and other factors. 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 $5 to about $60. These prices are subject to market conditions and can vary in currencies, other than the US dollar. Because a significant portion of our revenues come through other aggregators, it is difficult for us to know whether and to what extent inflation or a fluctuation in foreign currency exchange rates have had a material effect on our revenues and therefore there is little we can do to address these issues.
We generate our revenues primarily from three major sources: (i) search generated revenues and other services, (ii) sale of premium software products and solutions, and (iii) advertising and other. The following table shows our revenues by category (in thousands of US Dollars):
Cost of Revenues
Cost of revenues consists primarily of salaries and related expenses, license fees, amortization of acquired technology, amortization of capitalized research and development costs and payments for content and server maintenance, all related to our product revenues and communicating with our users. The direct cost relating to search and advertising revenues are immaterial.
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 in 2011 increased compared to last year, primarily due to the acquisition of Smilebox Inc. and its product development effort, although decreasing as percentage of sales, to continue and increase at a moderate rate, while decreasing as a percentage of sales. The nominal increase will enable us to continue to enrich our product pipeline going forward.
Our selling and marketing expenses consist of customer acquisition cost, 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. As part of our strategy to accelerate growth, in 2011 we increased customer acquisition costs dramatically, particularly in the second half of the year, and expect to increase the pace of investment even further in 2012. This investment is in order to increase the number of product downloads, users and subsequently revenue generated. Customer acquisition costs were; $1.9 million, $1.8 million and $8.1 million in 2009, 2010 and 2011, respectively. Credit card commissions include nominal transaction costs and percentage commission costs, both of which vary based on the service provider, currency, geographic location and other variables.
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. These investments had their full impact and started showing their results in 2011. As a result, G&A expenses increased in 2010 and continued to increase in 2011. Having completed most of the ramping up needed in this area, we currently expect that absent of acquisitions, G&A expenses to increase nominally to accommodate the Company’s growth, while decreasing as a percentage of sales in 2012.
Income Tax Expense
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 did in 2009 and 2010, the distributed sum would benefit only partially from this program. The Company has elected to implement the recent tax reform to its 2011 preferred income. According to which, reduced tax rate of 15% is applied to the Company's preferred income. A distribution from a Preferred Enterprise out of the “Preferred Income” would be subject to 15% withholding tax for Israeli-resident individuals and non-Israeli residents (subject to applicable treaty rates).
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 3 to our financial statements, we believe the following accounting policies to be critical:
Search generated and other 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 currently offer one year licenses for The Gold Gallery content database for a one-time, upfront payment. These licenses constituted less than 5% of our revenues in 2011. In the past we offered lifetime licenses as well. 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. We intend in the future to turn this service into a product which expires after one year, without providing ongoing service or updates during the license period and as a result, recognize revenues upon purchase of the license.
Revenues from our JunkFilter Plus / Protection Center solution and Smilebox service are recognized over the term of the license.
Our deferred revenue consists of the unamortized balance of the license fees, which totaled $5.4 million as of December 31, 2011, of which $4.3 million was classified as short-term deferred revenues and the balance as long-term deferred revenue on our balance sheets.
The Company accounts for share-based payment awards made to employees and directors in accordance with ASC 718, "Compensation – Stock Compensation", which requires the measurement and recognition of compensation expense based on estimated fair values. Determining the fair value of stock-based awards at the grant date requires the exercise of judgment, as well as the determination of the amount of stock-based awards that are expected to be forfeited. If actual forfeitures differ from our estimates, equity-based compensation expense and our results of operations would be impacted.
Total equity-based compensation expense recorded during 2011 was $1.2 million, of which $1.0 million was included in general and administrative expenses and the rest in research and development costs and selling and marketing expenses.
As of December 31, 2011, the maximum total compensation cost, related to options granted to employees, not yet recognized, amounted to $1.5 million. This cost is expected to be recognized over a weighted average period of 2 years.
The Company estimates the fair value of standard stock options granted using the Binomial method option-pricing model and options with exercise that is subject to a stock price target, using the Monte Carlo simulations. The option-pricing models require a number of assumptions, of which the most significant are; expected stock price volatility and the expected option term. In 2009 and 2010, expected volatility was calculated based upon an average between historical volatilities of the Company, similar entities and industry sector index similar to the Company's characteristics, since it did not have sufficient company specific data. In 2011, expected volatility was calculated based upon actual historical stock price movements. The expected option term was calculated based on the Company’s assumptions of early exercise multiples which were calculated based on comparable companies and termination exit rate which was calculated based on actual historical data. The expected option term represents the period that the Company’s stock options are expected to be outstanding. The risk-free interest rate is based on the yield from U.S. Treasury zero-coupon bonds with an equivalent term.
In November 2010 the Company's Board decided to change its dividend policy so that beginning with earnings of 2011 and beyond, the Company does not intend to distribute any dividends to the holders of its ordinary shares, as result the Company has no foreseeable plans to pay dividends.
Taxes on Income
We are subject to income taxes in Israel and the U.S. Significant judgment is required in evaluating our uncertain tax positions and determining our provision for income taxes. Based on the guidance in ASC 740 “Income Taxes”, we use a two-step approach to recognizing and measuring uncertain tax positions. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount that is more than 50% likely of being realized upon settlement.
Although we believe we have adequately reserved for our uncertain tax positions, no assurance can be given that the final tax outcome of these matters will not be different. We adjust these reserves in light of changing facts and circumstances, such as the closing of a tax audit, the refinement of an estimate or changes in tax laws. To the extent that the final tax outcome of these matters is different than the amounts recorded, such differences will impact the provision for income taxes in the period in which such determination is made. The provision for income taxes includes the impact of reserve provisions and changes to reserves that are considered appropriate, as well as the related interest. Starting 2011, interest is recorded within finance income, net.
Accounting for tax positions requires judgments, including estimating reserves for potential uncertainties. We also assess our ability to utilize tax attributes, including those in the form of carry forwards for which the benefits have already been reflected in the financial statements. We record valuation allowances for deferred tax assets that we believe are not more likely than not to be realized in future periods. While we believe the resulting tax balances as of December 31, 2011 and 2010 are appropriately accounted for, the ultimate outcome of such matters could result in favorable or unfavorable adjustments to our consolidated financial statements and such adjustments could be material. See Note 10 to our Consolidated Financial Statements for further information regarding income taxes. We have filed or are in the process of filing local and foreign tax returns that are subject to audit by the respective tax authorities. The amount of income tax we pay is subject to ongoing audits by the tax authorities, which often result in proposed assessments. We believe that we adequately provided for any reasonably foreseeable outcomes related to tax audits and settlement. However, our future results may include favorable or unfavorable adjustments to our estimated tax liabilities in the period the assessments are made or resolved, audits are closed or when statutes of limitation on potential assessments expire.
We account for business combinations following ASC 805 “Business Combinations”, which requires that we allocate the purchase price of acquired companies to the tangible and intangible assets acquired and liabilities assumed, based on their estimated fair values. In addition, we expense acquisition-related expenses as they are incurred. We engage third-party appraisal firm to assist management in determining the fair values of certain assets acquired and liabilities assumed. Such valuations require management to make significant estimates and assumptions, especially with respect to intangible assets.
Management makes estimates of fair value based upon assumptions it believes to be reasonable. These estimates are based on historical experience and information obtained from the management of the acquired companies and relevant market and industry data and are, inherently, uncertain. Critical estimates made in valuing certain of the intangible assets include, but are not limited to, the following: (i) future expected cash flows from license sales, maintenance agreements, customer contracts and acquired developed technologies and patents; (ii) the acquired company’s brand and market position as well as assumptions about the period of time the acquired brand will continue to be used in the combined company’s product portfolio; and (iii) discount rates. Unanticipated events and circumstances may occur which may affect the accuracy or validity of such assumptions, estimates or actual results. Changes to these estimates, relating to circumstances that existed at the acquisition date, are recorded as an adjustment to goodwill during the purchase price allocation period (generally within one year of the acquisition date) and as operating expenses, if otherwise.
In connection with purchase price allocations, we estimate the fair value of the support obligations assumed in connection with acquisitions. The estimated fair value of the support obligations is determined utilizing a cost build-up approach. The cost build-up approach determines fair value by estimating the costs related to fulfilling the obligations plus a normal profit margin. The sum of the costs and operating profit approximates, in theory, the amount that we would be required to pay a third party to assume the support obligation. See Note 2 to our consolidated financial statements for additional information on accounting for our recent acquisition.
Goodwill is measured as the excess of the cost of acquisition over the sum of the amounts assigned to tangible and identifiable intangible assets acquired less liabilities assumed. We review goodwill for impairment annually in October each year, and whenever events or changes in circumstances indicate its carrying value may not be recoverable in accordance with ASC 350 “Intangibles – Goodwill and other”. Goodwill impairment is deemed to exist if the carrying value of a reporting unit exceeds its fair value. If the carrying value of a reporting unit’s goodwill exceeds its implied fair value, then we would record an impairment loss equal to the difference.
We operate in one operating segment, and this segment comprises our only reporting unit. In calculating the fair value of the reporting unit, we used our market equity capitalization.
If the carrying value of a reporting unit exceeds its fair value, we then calculate the goodwill’s implied fair value by performing a hypothetical allocation of the reporting unit’s fair value to the underlying assets and liabilities, with the residual being the implied fair value of goodwill. This allocation process involves using significant estimates; include estimates of future cash flows, future short-term and long-term growth rates, weighted average cost of capital and assumptions about the future deployment of the long-lived assets of the reporting unit. Other factors we consider are the brand awareness and the market position of the reporting unit and assumptions about the period of time we will continue to use the brand in our product portfolio. If these estimates or their related assumptions change in the future, we may be required to record impairment charges for our goodwill.
Our most recent annual goodwill impairment analysis, which was performed during in 2011, did not result in impairment. As of December 31, 2011, the market capitalization of the Company was significantly higher than the equity book value.
Impairment of Long-Lived Assets.
We are required to assess the impairment of tangible and intangible long-lived assets subject to amortization, 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 from the use of the asset or asset group to the carrying amount of the asset, an impairment charge is recorded for the excess of carrying amount over the fair value. We measure fair value using discounted projected future cash flows. We base our fair value estimates on assumptions we believe to be reasonable but that are unpredictable and inherently uncertain. If these estimates or their related assumptions change in the future, we may be required to record impairment charges for our tangible and intangible long-lived assets subject to amortization. No impairment charges were recognized during 2009, 2010 and 2011.
Research and Development Expenses, Net.>
Research and development costs incurred in the process of software development before establishment of technological feasibility are charged to expenses as incurred. Costs of the production of a detailed program design, incurred subsequent to the establishment of technological feasibility are capitalized. Based on our product development process, technological feasibility is established upon completion of a detailed program design.
Capitalized software development costs are amortized commencing with general product release by the straight-line method over the estimated useful life of the software product.
At each balance sheet date, we assess the recoverability of this intangible asset by comparing the unamortized capitalized software costs to the net realizable value on a product by product basis. Should the amount of the unamortized capitalized costs of a computer software product exceed the net realizable value, these products will be written down by the excess amount.
Recently issued accounting pronouncements.
See Item 18. Financial Statements. Note 3(w).
The following table sets forth, for the periods indicated, our statements of operations 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 generally 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 until the second half of 2011 relied primarily on viral marketing. Starting the second half of 2011, we increased our investment in customer acquisition costs dramatically to fuel future growth. These expenses increased from $1.8 million in 2010 to $8.1 million in 2011. This was the primary reason for selling and marketing expenses increasing in 2011, both nominally and as a percentage of sales, resulting in lower operating and net income margins in 2011. We expect to further increase our customer acquisition costs in 2012, increasing our sales and marketing expenses, and having a negative effect on the operating margin in 2012. However, as a result of the increased expenditure in 2011 and the subsequent increase in revenues in 2012, we expect operating margins to improve in 2012.
Year Ended December 31, 2011 Compared to Year Ended December 31, 2010>
Search revenues. These revenues increased by 12%, from $22.8 million in 2010, to $25.5 million in 2011. This increase was due to an increase in the number of downloads and subsequently the number of users using our search service. As the number of downloads of our IncrediMail products increased, while the number of downloads of our Magentic and HiYo products decreased, search generated revenues through our partnership with Google accounted for more than 94% of these revenues, with the remaining revenues coming from other search providers. Our current agreement with Google continues until January 31, 2013 and we therefore expect them to continue to account for virtually all the search generated revenues. We have begun to implement our search generating revenue model with our PhotoJoy and Smilebox products. While these products did not contribute significantly to search revenues in 2011, we expect them, particularly Smilebox, to generate growing search revenues in 2012, through our partnership with Google and our ability to apply this technology and the back systems required to support and track these revenues.
Products revenues. These revenues grew by over 33% in 2011, from $5.4 million in 2010 to $7.2 million in 2011. This increase was primarily attributable to our recent acquisition of Smilebox Inc. whose products sales were $2.2 million, partially offset by a $0.4 million decrease of organic products sales. We believe that in 2012 we will see increasing revenues from the Smilebox product as a result off; (i) consolidating these product sales for a full year, as compared to only 4 months in 2011, (ii) a result of the accounting rules regarding acquired deferred revenues, deferred revenues from Smilebox product prior to the closing are adjusted downward to their fair value as of the acquisition and the resulting reduction in revenues will decrease as we complete a year post acquisition, and (iii) continued organic growth in sales of this product. In addition, we expect to record increasing sales of our IncrediMail products and recently introduced Fixie product in 2012.
Other revenues. These revenues more than doubled in 2011, from $1.3 million in 2010 to $2.8 million in 2011. This increase is attributable to collaboration with other vendors for the sale of their product to our users and an increase in other advertising revenues through a toolbar, on our homepage and other. We believe we will be able to maintain a similar nominal level of these sales in 2012. However, we currently have no plans for increasing our investment to grow these sales beyond that.
Cost of revenues. Cost of revenues in 2011 was $2.8 million, as compared to $1.6 million in 2010. This increase was primarily due to the acquisition of Smilebox who’s associated direct costs of approximately $0.6 million, included amortization of intangible assets and direct content costs. Smilebox content costs were based on usage, and as a result included in the cost of revenues. Since the acquisition, the Company has been working to transition these relationships to a model where the Company acquires the full rights to the content regardless of usage, paying for what is expected to be a much lower sum in advance. However, this positive effect will be more than offset by the fact that the Company will be consolidating a full year of Smilebox’s activity in 2012 as compared to only 4 months in 2011. As a result, we expect that although gross profits will increase, the gross profit margin will decline somewhat in 2012. In addition, direct cost in 2011 also included approximately $0.3 million payments to third-party search partners.
Research and development expenses, net ("R&D"). R&D increased by $0.9 million, from $6.6 million in 2010 to $7.5 million in 2011, decreasing as a percentage from sales from 23% in 2010 to 21% in 2011. The increase was as a result of our investing in enriching our product pipeline in 2011, with the Fixie product already selling in the fourth quarter of 2011, the mobile version of our Smilebox product announced shortly after the acquisition, and the recently announced PhotoJoy product for iPad and iPhone platforms. In 2012, we expect this expenditure to further increase nominally, although generally remain stable as a percentage of sales as we continue to organically enrich our product pipeline.
Selling and marketing expenses. Selling and marketing expenses more than doubled from $5.2 million in 2010 to $13.0 million in 2011. This increase was primarily attributable to the increased investment in customer acquisition costs, which increased from $1.8 million in 2010 to $8.1 million in 2011. In addition, marketing expenses increased due to personnel costs incurred by our increasing the size of our marketing department to enable us to make these investments and subsequently track the return generated. Finally, the increase was also due to the marketing expenses incurred by the acquisition of Smilebox and the marketing expenses needed to support that product. As we look to 2012, we expect to continue to increase customer acquisition costs significantly, possibly even double, in order to further accelerate the growth in revenues. That being said, we continue to condition this investment on a positive return on investment (“RoI”) within one year, and to the extent we cannot ramp up and maintain a positive RoI, we may draw back on this expenditure.
General and administrative expenses ("G&A"). G&A increased from $4.7 million in 2010 to $7.6 in 2011. This increase was primarily due to our building a management team, primarily in the latter part of 2010, capable of scaling the business model and taking the Company to the next level, both organically and through acquisitions. As a result, in 2011 G&A on average was at a level similar to that off the last quarter of 2010. In addition, the Company recorded over $1.0 million in expenses related to the acquisition of Smilebox Inc., which in according to US GAAP is accounted for as an expense when incurred. . With exception to costs that could be incurred by future acquisitions, we expect G&A to increase nominally, primarily as a result of consolidating Smilebox for a full year, as compared to only four months in 2011, although decrease as a percentage of sales.
Taxes on Income. Income tax in 2011 was $0.2 million, compared to $3.2 million in 2010. The decrease in income tax was a result of a number of tax credits received with respect to past years, tax refund due to settlement of tax audit with the Israeli tax authorities and the discontinuation of our dividend distribution policy. Assuming a similar tax environment in 2012, we expect an effective tax rate less than 20% for our activity in Israel and the effective tax rate for our activity in Washington will be dependent on our ability to utilize accumulated losses from prior periods.
Net Income. Net income in 2011 was $5.7 million, compared to $8.4 million, in 2010. As described above, this decrease was primarily a result of the $6.2 million increase in customer acquisition costs, amortization of intangibles resulting from Smilebox acquisition, partially offset by increased profits from the increase in revenues and capitalization of research and development costs.
Year Ended December 31, 2010 Compared to Year Ended December 31, 2009>
Search generated revenues. These revenues increased by 14%, from $20.0 million in 2009, to $22.8 million in 2010. 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 10% 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.
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.
Advertising and other revenues. These revenues more than tripled in 2010, from $0.5 million in 2009 to $1.3 million in 2010. This increase is attributable to collaboration with other vendors for the sale of their product to our users and an increase in other advertising revenues through a toolbar, on our homepage and other. We expect to be able to continue and grow these revenues, albeit they still are not expected to contribute a significant portion of our revenues in 2011.
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, net ("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 an 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.
B. LIQUIDITY AND CAPITAL RESOURCES
As of December 31, 2011, working capital was $0.0 million, consisting of approximately $21.0 current assets and $21.0 current liabilities.. As of December 31, 2010, we had working capital of $28.1 million and our primary source of liquidity was $31 million in cash and cash equivalents and marketable securities, partially offset by accrued and othe short-term liabilities of $6.2 million. The decrease in working capital, cash, cash equivalents and marketable securities, as well as the increase in other short term liabilities and expenses, was entirely due to the acquisition of Smilebox Inc. in the second half of 2011. Under the terms of the acquisition agreement, the Company paid approximately $25 million, substantially in cash at closing and additional payments of up to $15 million are payable if certain milestones and performance based conditions are met, payable in two installments on the seven and fourteen months anniversary from closing. The first installment, in the amount of approximately $7 million, is expected to be paid on the seven months anniversary of closing.
The decrease in cash and cash equivalents by $19.8 million was due to cash paid upon closing the acquisition, partially offset by cash generated from our ongoing activities in 2011.
As of December 31, 2011, we had a credit facility comprised of $12 million provided by Bank Leumi Le-Israel and $8 million provided by First International Bank of Israel. The repayment of the debt under this credit facility is structured over three to five years respectively, and we have an option for early repayment. We have not utilized this credit facility as of yet.
We believe that our cash balances and cash generated from operations will be more than sufficient to meet our anticipated cash requirements for operations, at least for the next 12 months.
Net Cash Provided By Operating Activities. Net cash provided by operating activities was $10.7 million, $9.8 million and $7.0 million for 2009, 2010 and 2011, respectively. The decrease in cash provided by operating activities in 2011 was primarily a result of the $2.7 million decrease in net income as the changes in the adjustment of revenues to cash revenues and expenses to cash expenses offsetting each other.
Net Cash Provided By (Used In) Investing Activities. Net cash provided by (used in) investing activities was $13.5 million, ($10.2) million and ($8) million in 2009, 2010 and 2011, respectively. While in 2009 and 2010, the net cash provided by or used in investment activities was a result of selling or investing in marketable securities, in 2011 the cash used in investing activities was primarily a result of investing $21.7 million in cash for the acquisition of Smilebox, partially offset by the $14.8 million in proceeds from the net sale of marketable securities. In addition, in 2011 the Company invested in equipment and capitalized content and software costs $1.1 million.
Net Cash Used In Financing Activities. Net cash used in financing activities was $7.6 million, $7.9 million and $3.9 million in 2009, 2010 and 2011, respectively. In all these years the cash was used primarily for the payment of dividends to shareholders, a policy that has been discontinued.
C. RESEARCH, DEVELOPMENT, PATENTS AND LICENSES, ETC.
Our research and development activities are conducted internally by our Chief Technology Officer and a 69 person research and development staff.
Research and development expenses, net were $6.3 million, $6.6 million and $7.5 million in the years ended December 31, 2009, 2010 and 2011, respectively. In 2011 our efforts were focused on developing the back-end systems required for tracking the usage of our products and their monetization, developing new products such as our PC optimization tool Fixie that was released in the fourth quarter of 2011 and the iPad and iPhone versions of our photo discovery tool PhotoJoy. In addition, we continued to invest in the mobile version of our photo sharing product Smilebox. In 2012 we plan on increasing our investment in the mobile space, developing a new version of our IncrediMail email client for tablet, as well as further organically enriching our product suite with new products adopted and planned for our demographic of “second wave adopters”. On a whole, we expect in 2012 this investment will increase nominally, although it will likely decrease as a percentage of sales relative to 2011.
D. TREND INFORMATION
Sales. The increase in sales in 2011 compared to 2010 was due to the consolidation of Smilebox activities starting September 2011, as well as a continued increase in search generated revenues and other advertising revenues, partially offset by a decrease in IncrediMail product sales. Together, these increases contributed to the 20% year over year growth in revenues. We expect these same factors to continue and contribute to even accelerate growth in 2012, particularly, the consolidation of Smilebox revenues for a full year, renewed growth in premium product sales both from our Smilebox product and IncrediMail and finally moderate growth in search generated revenues.
Until the acquisition of Smilebox in the second half of 2011, the percentage of sales attributable to search grew from 74% in 2009 to 77% in 2010 and in the first half of 2011 was 78%. With the acquisition of Smilebox and resulting rapid growth in premium product sales, search generate revenues accounted for 66% of total revenues in the second half of 2011, bringing the average for the year to 72%. As a result of the continued rapid growth in premium product sales, while search generated revenues are expected to grow, we expect they will account for an even smaller portion of total revenues in 2012.
Gross Profit. While gross profits continue to grow as a result of the growth in revenues, we expect the gross profit margin to decrease somewhat, as it did in the second half of 2011, since the acquisition of Smilebox. This small decrease is a result of Smilebox’s cost structure which includes direct costs related to the payment for the use of premium content by users in sharing their Smilebox creations. We nonetheless anticipate relatively strong profit margins.
R&D. R&D expenses increased nominally in 2011. However, as a percentage of sales they decreased as they did in 2010. We expect this trend, of nominal increases while decreasing as a percentage of sales, to continue into 2012.
Sales and marketing expenses. Our sales and marketing expenses increased by $7.7 million, from $5.2 million in 2010 to $13 million in 2011. This increase was primarily due to the increase in customer acquisition cost which increased from $1.8 million in 2010 to $8 in 2011. This increase reflects a ramping up of these expenses within 2011, reaching $3.1 million in the fourth quarter of 2011. This investment is to fuel future accelerated growth and we expect to further increase this investment in 2012 fueling growth in 2012 and 2013. In addition to the increased investment in customer acquisition costs, sales and marketing expenses have increased since the acquisition of Smilebox. We expect these expenses to grow only nominally from the level established in the last quarter of 2011.
General and administrative expenses. G&A expenses increased as well in 2011. This increase is attributable to three main factors; (i) 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 in the latter part of 2010 and had full financial effect in 2011, (ii) the acquisition of Smilebox in the middle of 2011, together with required overhead to manage that business, and (iii) approximately $1.0 million in one-time transaction costs associated with the Smilebox acquisition.
With exception to possible transaction costs associated with a new acquisition, we expect G&A expenses in 2012 to continue at their current level.
Taxes on Income. In 2011 we benefited from significant non-recurring tax credits and tax settlements with the Israeli Tax Authorities, as we look towards 2012, we do not currently expect such tax credits and expect an effective tax rate of approximately 20% on our activity in Israel. As to our activity in Redmond, Washington, this will depend on our ability to utilize losses carried forward from previous periods and other factors.
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, 2011 and the effect those commitments are expected to have on our liquidity and cash flow in future periods:
(*) Uncertain income tax positions are due upon settlement and we are unable to reasonably estimate the ultimate amount or timing of settlement. See Note 10(i) of our Consolidated Financial Statements for further information.
(**) Severance pay obligations to our Israeli employees, as required under Israeli labor law and as set forth in employment agreements, are payable only upon termination, retirement or death of the respective employee and there is no obligation for benefits accrued prior to February 2008, if the employee voluntarily resigns. Of this amount, $462 is unfunded.
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 29, 2012:
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.
Iris Beck was elected as director in November 2011. Ms. Beck has been the Chief Executive Officer of McCann Erickson Israel since 2009. Between 2002 and 2008 she served as the Chief Marketing Officer of Partner Communications, and between 2001-2002 she served as the Chief Executive Officer of Unilever Israel. Ms. Beck holds a B.A (with distinction) in Economic Science from Haifa University and an MBA (with distinction) from Bar Ilan University, and attended Management courses at INSEAD
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 co-founded SupersonicAds in 2008, a leading social media monetization platform focused on European advertisers, and serves as its Chief Operation Officer. He co-founded Metacafe Inc., one of the world’s largest privately held video sites, with 50 million monthly visitors and was its Chief Executive Officer between 2003-2007. Before becoming an entrepreneur, Arik spent 10 years in the Israeli Air Force, and participated in the Talpiot R&D officers project. Arik has a BA in mathematics, physics and computer sciences, and an MBA in finance and banking.
Alan Gelman was elected director in August 2011. Mr. Gelman has been the Chief Financial Officer and Deputy CEO of Bezeq Group, Israel’s largest and leading telecommunications group since 2008, and between 2006 and 2008 Mr. Gelman was the Chief Financial Officer and Deputy CEO of Delek Group. Between 2001 and 2006 Mr. Gelman was the Chief Financial Officer of Partner Communications Company Ltd., and prior to that the Chief Financial Officer of Barak ITC. Mr Gelman holds a Bachelor’s degree in Accounting from Queens College in New York and an MBA from Hofstra University in New York. Mr. Gelman is licensed as a Certified Public Accountant in the USA and in Israel.
Limor Gershoni Levy joined us in January 2011 and serves as Vice President, General Counsel and Corporate Secretary. Prior to joining the Company Ms. Gershoni-Levy was General Legal Counsel for seven years at Veraz Networks (NASDAQ: VRAZ), a leading provider of band-with optimization and next generation switching products. In 2010 Veraz merged with Dialogic (NASDAQ: DLGC). Before that, Ms. Gershoni-Levy was General Counsel at Medigate Ltd. a company 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., Albaad Ltd., Carasso Motors 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.
Ron Harari joined the Company as Vice President of Products in May 2011 and was recently appointed General Manager of the Communications Business division. Before joining the Company, Ron worked at ICQ/AOL for almost ten years, and was a member of the management team from 2005. During those years, Ron acted as Vice President of Web R&D, Vice President Operations and Vice President Products and Operations. Prior to working at ICQ, Ron served in a range of positions at Walla Communications (Israel's leading portal) and for the Government of Israel. Ron also currently serves as an Advisory Board Member at Treezer, a startup company specializing in ad conversions. Ron has a certificate in multimedia from New York University.
Rajiv Jain joined the Company as Chief Technology and Innovation Officer in April 2011. Previously Rajiv was Executive Vice President of Corbis.com and Chief Technology & Innovation Officer at Corbis Inc., where he was responsible for the company’s technology as well as its online consumer business. Prior to Corbis, Rajiv’s experience includes Chief Technology Officer of American Greetings Interactive (AGI), senior and executive management positions at AT&T Wireless, as General Manager of their e-commerce business; Portal Software Inc. (now Oracle); IBM; Taligent, a joint venture between Apple, Inc, HP and IBM Corporation; and prior to that, Autodesk. Rajiv received a M.S. from the University of Rochester and a B.S. from the Indian Institute of Technology. He also holds eleven software and process patents under his name and currently sits on the Founding Board of University of Washington Information School.
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, and of King Engine Bearings Ltd. a manufacturer of engine bearings. 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.
Avichay Nissenbaum was elected to serve a three year term as an "external director" in July 2009. Mr. Nissenbaum is a general partner and cofounder of Lool Ventures. Prior to founding Lool, Avichay Nissenbaum was the CEO & Co-founder of Yedda, an AOL company and AOL Israel Country Manager. As co-founder and CEO of Yedda, Inc. Avichay led the company to become a prominent player in the Internet social search space which led to the acquisition by AOL (A Time Warner company Nasdaq:TWX). Prior to Yedda Avichay co-founded SmarTeam (Acquired by Dassault Systemes, Nasdaq: DASTY), a market leader in the PLM domain (Product Lifecycle Management). With over 20 years of experience in the software industry, through leadership positions in management, sales, business development, marketing, and operations, Avichay serves as a board member for Winbuyer Ltd., ComSleep Ltd. and advises and helps several startups and entrepreneurs. Avichay holds a B.Sc degree in Computer Science and a B.A in Economics.
Tomer Pascal joined us in July 2009 and currently serves as General Manager of the Utility Tools division. Prior this appointment Tomer was the Company Vice President of Marketing. Prior to joining the Company, Tomer was co-founder of PlaySpex, a company operating in the fantasy sports field that raised a seed investment from Gemini Ventures and LightSpeed. Tomer has worked for several companies in the field of online gaming such as 888 Holdings and Ujamu.com as a Product Manager and SEO Specialist. Prior to that, Tomer worked for the Government of Israel as a systems specialist.
Andrew Wright joined the Company as General Manger of our Photo division, with the acquisition of Smilebox Inc. in August 2011. Mr. Wright founded Smilebox Inc. in 2005, currently a wholly owned subsidiary of Perion. Prior to Smilebox, Andrew was the Vice President of Games at RealNetworks, where he founded and built the RealArcade games business. Andrew was previously a Product Unit Manager at Microsoft Corporation, where he managed the consumer imaging and publishing business, including Picture It!, Home Publishing, and the Greetings product lines.
The aggregate direct compensation we paid to our officers as a group (8 persons) for the year ended December 31, 2011, was approximately $3.0 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 2011.
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, 2011 was approximately $256 thousand. Directors are also reimbursed for expenses incurred in order to attend board or committee meetings.
As of February 29, 2012, there were outstanding options to purchase 1,090,000 ordinary shares granted to 14 of our directors and officers, at a weighted average exercise price of $5.57 per share. These options were granted under our 2003 Israeli Share Option Plan, as amended, (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 external directors is $25,000, and $500 (plus value added tax (“V.A.T.”), if applicable) per meeting, while other directors, who are not officers, receive annual gross compensation of $35,000, with no payment 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 the Company in 2003 and our standard option agreement executed by each director and by the Company 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 and our standard option agreement. In accordance with this resolution, all directors who are not officers were granted 10,000 options on January 6, 2011 and on October 27, 2011, after the 2010 and 2011 annual general meetings.
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 and the Company's standard option agreement. See "Item 6.E Share Ownership — Employee Benefit Plans — The 2003 Plan" below.
On July 9, 2009, 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 or an Annual Grant have a vesting period of three years (instead of four years) from the date of 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 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. At our 2011 annual general meeting held in October 2011, the term of the third class, consisting of Arik Ramot, expired, he did not stand for reelection and Iris Beck 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 July 9, 2009, Avichay Nissenbaum was elected as an external director for a three-year term and 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, and Josef Mandelbaum was elected for a three year term as director. In August 2011 the Board of Directors appointed Alan Gelman, to fill the vacancy occurring after the resignation of Ofer Adler for personal reasons, which took effect on August 7th 2011. Mr. Gelman was appointed to complete Mr. Adler’s term until the annual meeting of shareholders of the Company to be held in the year 2013 and the due election of his successor.
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. However, as described below, external directors may serve one term of three years, and subject to certain conditions, an additional two terms of three years each, under specific conditions as prescribed by law.
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 the Company.
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. Subject to the provisions of the Israeli Companies Law 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 directors 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. 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 at the annual shareholders meeting held on December 27, 2007 and reappointed at the annual shareholders meeting held 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.
In accordance with the Companies Law, and the provisions of a recent amendment which was enacted and went into effect during 2011, 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 he is a relative of a person controlling the Company, or if at the date of his or her appointment or within the prior two years, that person, or his or her relatives, partners, employers, to whom he reports directly or indirectly or entities under his or her control, are subject to, have or had any affiliation with us, to any entity or person controlling us or to a relative of any entity or person controlling us, at the time of appointment or to another entity, and in a company where there is no person or entity controlling it or a shareholder with a control block of at least 25% of the votes in a shareholders meeting, there is also no affiliation to anyone whom, on the date of appointment, is the chairperson of the board of directors of the company, chief executive officer, a major shareholder who holds at least 5% of the issued and outstanding shares of the company or 5% of the votes at a shareholders meeting, or the most senior executive officer in the finance department of the company. 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 general manager, chief business manager, deputy general manager, vice general manager, or any manager assuming the responsibilities of any of these positions regardless of that person’s title, as well as a director, or a manager directly subordinate to the general manager.
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. Additionally, no person may serve as an external director if the person, the person’s relative, spouse, employer or any entity controlling or controlled by the person, has a business or professional relationship with someone with whom affiliation is prohibited, even if such relationship is not maintained on a regular basis, excepting negligible relationships, or if such person received from the company any compensation as an external director in excess of what is permitted by the Israeli Companies Law. 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 two additional three-year terms. 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, and is otherwise prohibited from receiving any other compensation, directly or indirectly, in connection with service provided as an external director. 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 Listing 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 Listing 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 Listing 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, investment committee and a nominating and governance committee.
Our audit committee is comprised of David Jutkowitz, Avichay Nissenbaum (both of which are external directors) and Alan Gelman and operates pursuant to a written charter. David Jutkowitz serves as the chairperson of the audit committee.
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 Listing 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, and the majority of its members must be independent directors. The audit committee may not include the chairman of the board, any director employed by the company or employed by a person or entity controlling the company or by an entity in control of such a controlling person or entity, director who provides services on an ongoing basis to the company, a person or entity controlling the company as well as a director who derives most of his earnings from a controlling entity. The chairperson of the audit committee must be an external director, the required quorum for audit committee meetings and decisions is a majority of the committee members, of which the majority of members present must be independent and external directors, and any person who is not eligible to serve on the audit committee is further restricted from participating in its meetings and votes, unless the chairman of the audit committee determines that such person’s presence is necessary in order to present a certain matter, provided however, that company employees who are not controlling shareholders or relatives of such shareholders may be present in the meetings but not for the actual votes, and likewise, company counsel and secretary who are not controlling shareholders or relatives of such shareholders may be present in the meetings and for the decisions if such presence is requested by the audit committee.
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 Israeli Companies regulations with respect to the procedure in which financial statements should be approved by companies. Such regulations state, among other things, 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 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 issuers, 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 (in lieu of the audit committee, subject to meeting certain prerequisites) followed by the approval of the board of directors.
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 on a yearly basis, to recommend the terms of compensation for officers who are not directors, and to approve the issuance of employee share options under our 2003 Plan and benefit plans and approve incentive compensation for our other employees.
Our investment committee is comprised of Tamar Gottlieb, David Jutkowitz, Avichay Nissenbaum and Josef Mandelbaum. The Investment Committee is responsible for formulating the overall investment policies of the Company, and establishing investment guidelines in furtherance of those policies. The Committee monitors the management of the portfolio for compliance with the investment policies and guidelines and for meeting performance objectives over time as well as assist the board of directors in fulfilling its oversight responsibility for the investment of assets of the company.
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 substantial shareholder 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. The accounting firm of Yardeni-Gelfand provides us with internal auditor services.
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 Mr. Mandlebaum 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 Mr. Mandlebaum 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 Mr. Mandlebaum resigns without giving the required notice period, we may deduct from the money that we owe Mr. Mandlebaum 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, 2011 we had 139 employees. The breakdown of our employees by department and fiscal period is as follows:
As of December 31, 2011, 93 of our employees were located in Israel, and 46 employees located in the US. In Israel we are subject to certain labor statutes and national labor court precedent rulings, as well as to 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. These provisions of collective bargaining agreements apply to our Israeli employees by virtue of extension orders issued in accordance with relevant labor laws by the Israeli Ministry of Industry, Trade and Labor, and which apply such agreement provisions to our employees even though they are not directly part of a union that has signed a collective bargaining agreement. The laws and labor court rulings that apply to our employees principally concern minimum wage laws, procedures for dismissing employees, determination of severance pay, leaves of absence (such as annual vacation or maternity leave), sick pay and other conditions for employment. The expansion orders which apply to our employees principally concern the requirement for the length of the workday and the work-week, annual recuperation pay and commuting expenses, compensation for working on the day before and after a holiday and payments to pension funds and other conditions for employment. 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 upon termination of employment by the employer or, in certain circumstances, by the employee. 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, 2011, our net accrued unfunded severance obligations totaled $0.5 million.
Furthermore, Israeli employees and employers are required to pay predetermined sums to the National Insurance Institute, which covers, amongst other benefits, payments for state retirement benefits and survivor benefits, (similar to the United States Social Security Administration) as well as state unemployment benefits. These amounts also include payments for national health insurance. The payments to the National Insurance Institute can equal up to approximately 17.9% of wages subject to a cap if an employee’s monthly wages exceed a specified amount, of which the employee contributes approximately 12% and the employer contributes approximately 5.9%.
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 29, 2012 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 9,917,046 ordinary shares outstanding on February 29, 2012.
* 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 11 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 January 2011, as of December 31, 2011 a total of 2,421,403 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.
The board of directors of the Company has determined that it is in the interests of the Company to allow our employees in the United States to participate in our stock option plans for employees. According to the laws in the United States (particularly the U.S. Internal Revenue Code of 1986, as amended) in order for a grant of options to qualify as an “incentive stock option” it must, amongst other requirements, be granted pursuant to a plan which is approved by the stockholders of the granting corporation within 12 months before or after the date such plan is adopted. Therefore, the board of directors has resolved to seek shareholder approval for the adoption of an amendment for U.S. taxpayers to the 2003 Plan (the "U.S. Appendix"), for the award of options to purchase Shares under the 2003 Plan, all of which may be issued under the U.S. Appendix pursuant to "incentive stock options" within the meaning of the U.S. Internal Revenue Code of 1986, as amended. In the annual shareholders meeting of the Company, held on October 27th, 2011, the 2003 Plan has been amended, in order to adopt the US Appendix for U.S taxpayers.
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. 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 December 2011, the Company's board of directors adopted a compensation policy according to which the eligibility of 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 29, 2012 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 Perion Network Ltd., 4 HaNechoshet Street, Tel Aviv 69710, Israel.
Beneficial ownership of shares is determined in accordance with the Securities Exchange Act of 1934 and the rules promulgated thereunder, 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 9,917,046 ordinary shares outstanding on February 29, 2012. Our major shareholders do not have different voting rights than our other shareholders.
To our knowledge, as of February 29, 2012, we had 14 stockholders of record of which 7 (including the Depository Trust Company) were registered with addresses in the United States. These United States holders were, as of such date, the holders of record of approximately 92% of our outstanding shares, including shares held through 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.
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, 2011 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
In November 2010 we announced that as we are focusing on growth and intend to utilize our cash and investments to achieve that growth, we 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 a 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", and since November 10, 2011 under the symbol “PERI”. 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" and since November 16, 2011 under the Hebrew letters which read “PERION”.
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.