Annual Reports

  • 20-F (Mar 7, 2017)
  • 20-F (Mar 24, 2016)
  • 20-F (Apr 16, 2015)
  • 20-F (Jul 29, 2014)
  • 20-F (Apr 10, 2014)
  • 20-F (Apr 29, 2013)

 
Other

Perion Network Ltd. 20-F 2016
zk1618233.htm



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 20-F

¨
REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR 12(g) OF THE SECURITIES EXCHANGE ACT OF 1934
 
OR
 
x
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the fiscal year ended December 31, 2015
 
OR
 
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
OR
 
¨
SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
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)

N/A
(Translation of Registrant's name into English)

Israel
(Jurisdiction of incorporation or organization)

26 HaRokmim Street
Holon, Israel 5885849
(Address of principal executive offices)
 
Yacov Kaufman, CFO
Tel: +972-73-3981582; Fax: +972-3-644-5502
26 HaRokmim Street
Holon, Israel 5885849
 (Name, Telephone, E-mail and /or Facsimile Number and Address of Company Contact Person)

Securities registered or to be registered pursuant to Section 12(b) of the Act.

Title of Each Class
Name of Each Exchange on which Registered
Ordinary shares, par value ILS 0.01 per share
NASDAQ Global Select Market
 
Securities registered or to be registered pursuant to Section 12(g) of the Act.
 
 None
(Title of Class)
 
Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act.
 
None
(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, 2015, the Registrant had outstanding 75,811,487 ordinary shares, par value ILS 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 T   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 T
Non-accelerated filer £
 
Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements included in this filing:

U.S. GAAP T
International Financial Reporting Standards as issued by
the International Accounting Standards Board  o
Other  o

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
 
 
 

 
 
PRELIMINARY NOTES
 
Terms
 
As used herein, and unless the context suggest otherwise, the terms "Perion," "Company," "we," "us" or "ours" refer to Perion Network Ltd. and subsidiaries. References to "dollar" and "$" are to U.S. dollars, the lawful currency of the United States, and references to "ILS" are to New Israeli Shekels, the lawful currency of the State of Israel. This annual report contains translations of certain ILS amounts into U.S. dollars at specified rates solely for your convenience. These translations should not be construed as representations by us that the ILS amounts actually represent such U.S. dollar amounts or could, at this time, be converted into U.S. dollars at the rate indicated. Unless otherwise indicated, we have translated ILS amounts into U.S. dollars at an exchange rate of ILS 3.9020 to $1.00, the representative exchange rate reported by the Bank of Israel on December 31, 2015.
 
Forward-Looking Statements
 
This annual report on Form 20-F 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, 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 from our expectations or projections include certain risks, including but not limited to the risks and uncertainties relating to our; business, intellectual property, industry and operations in Israel, as described in this annual report under Item 3.D. – "Key Information – Risk Factors."  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. 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.
 
 
1

 
 
TABLE OF CONTENTS
     
    Page
PART I
   
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42
42
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71
74
74
76
90
91
     
PART II
   
92
92
92
93
93
93
93
93
94
94
95
     
PART III
   
96
96
97

 
2

 
PART I
 
ITEM 1.                  IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS
 
Not applicable.
 
ITEM 2.                  OFFER STATISTICS AND EXPECTED TIMETABLE
 
Not applicable.
 
ITEM 3.                  KEY INFORMATION
 
A. 
SELECTED FINANCIAL DATA
 
On January 2, 2014, we purchased all of the outstanding shares of ClientConnect Ltd. ("ClientConnect"), which received the ClientConnect business of Conduit Ltd. ("Conduit") on December 31, 2013, in a stock-for-stock transaction (the "ClientConnect Acquisition"). Immediately following the closing, approximately 81% of our shares were owned by the former ClientConnect shareholders and option holders, and 19% by our pre-closing shareholders and option holders, on a fully diluted basis (as determined pursuant to the purchase agreement). Accordingly, since 2014, the ClientConnect Acquisition has been reflected in our financial statements as a reverse acquisition of all of our outstanding shares and options by ClientConnect in accordance with Accounting Standards Codification Topic 805, "Business Combinations" ("ASC 805"), using the acquisition method of accounting whereby ClientConnect is the deemed accounting acquirer and Perion is the deemed accounting acquiree. In accordance with the ASC 805 presentation requirements, our financial statements include ClientConnect’s comparative numbers, but not Perion's comparative numbers, for the years preceding 2014.

We derived the selected operations data below for the years ended December 31, 2013, 2014 and 2015 and the selected balance sheet data as of December 31, 2014 and 2015 from our audited consolidated financial statements and the related notes to the financial statements included elsewhere herein (the "Financial Statements"). We derived the selected operations data below for the years ended December 31, 2011 and 2012 and the selected balance sheet data as of December 31, 2011, 2012 and 2013 from our audited consolidated financial statements not incorporated by reference in this report. Our consolidated financial statements are prepared and presented in U.S. dollars and in accordance with U.S. Generally Accepted Accounting Principles ("U.S. GAAP"). The following tables present selected financial data and should be read in conjunction with "Item 5 – Operating and Financial Review and Prospects" and our Financial Statements.

 
3

 
Statement of Operations Data:
                             
(in thousands, except share and per share data)
 
Year ended December 31
 
   
2011
   
2012
   
2013
   
2014
   
2015
 
Revenues:
                             
Search
  $ 469,293     $ 517,060     $ 277,275     $ 330,757     $ 172,277  
Advertising and other
    12,431       19,948       48,233       57,974       48,673  
Total Revenues
    481,724       537,008       325,508       388,731       220,950  
                                         
Costs and Expenses:
                                       
Cost of revenues
    4,167       5,513       6,104       27,817       16,195  
Customer acquisition and media buy costs
    113,358       119,555       185,355       174,575       91,217  
Research and development
    18,346       16,858       22,394       44,129       26,377  
Selling and marketing
    17,917       7,920       10,298       25,388       28,270  
General and administrative
    4,126       4,705       19,115       37,605       31,520  
Restructuring charges
    -       -       -       3,981       1,052  
Impairment, net of change in fair value of contingent consideration
    -       -       -       19,941       92,340  
Total Costs and Expenses
    157,914       154,551       243,266       333,436       286,971  
                                         
Income (Loss) from Operations
    323,810       382,457       82,242       55,295       (66,021 )
Financial income (expense), net
    (591 )     7,696       2,782       (2,888 )     (1,939 )
                                         
Income (Loss) before Taxes on Income
    323,219       390,153       85,024       52,407       (67,960 )
Taxes on income
    22,564       75,435       22,616       9,581       697  
                                         
Net Income (Loss) from Continuing Operations
    300,655       314,718       62,408       42,826       (68,657 )
Net loss from discontinued operations
    (14,248 )     (23,798 )     (33,795 )     0       -  
                                         
Net Income (Loss)
  $ 286,407     $ 290,920     $ 28,613     $ 42,826     $ (68,657 )
                                         
Net Earnings (Loss) per Share - Basic:
                                       
Continuing operations
  $ 6.12     $ 6.02     $ 1.16     $ 0.63     $ (0.96 )
Discontinued operations
  $ (0.29 )   $ (0.45 )   $ (0.63 )   $ -       -  
Net Income (Loss)
  $ 5.83     $ 5.57     $ 0.53     $ 0.63     $ (0.96 )
                                         
Net Earnings (Loss) per Share – Diluted:
                                       
Continuing operations
  $ 5.86     $ 5.91     $ 1.14     $ 0.58     $ (0.96 )
Discontinued operations
  $ (0.28 )   $ (0.45 )   $ (0.62 )   $ -       -  
Net Income (Loss)
  $ 5.58     $ 5.46     $ 0.52     $ 0.58       (0.96 )
                                         
Number of shares – Basic:
                                       
Continuing operations
    49,118,535       52,320,133       53,910,741       68,213,209       71,300,432  
Discontinued operations
    49,118,535       52,320,133       53,910,741       -       -  
                                         
Number of shares – Diluted:
                                       
Continuing operations
    51,309,654       53,264,743       54,837,307       70,327,411       71,300,432  
Discontinued operations
    51,309,654       53,264,743       54,837,307       -       -  
 
 
4

 
Balance Sheet Data (in thousands):
 
As of December 31,
 
    2011     2012     2013     2014     2015  
                                         
Cash and cash equivalents
  $ 41,239     $ 78,395     $ 949     $ 101,183     $ 17,519  
Working capital (*)
  $ 249,718     $ 208,793     $ (19,682 )   $ 91,255     $ 37,394  
Total assets (*)
  $ 334,734     $ 308,920     $ 31,058     $ 356,139     $ 442,297  
Total liabilities (*)
  $ 48,890     $ 64,899     $ 21,031     $ 110,142     $ 242,461  
Shareholders' equity
  $ 285,844     $ 244,021     $ 10,027     $ 245,997     $ 199,837  
 
*In November 2015, the Financial Accounting Standards Board, or the FASB, issued Accounting Standards Update No. 2015-17, Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes (ASU 2015-17), which simplifies the presentation of deferred income taxes by requiring deferred tax assets and liabilities to be classified as noncurrent on the balance sheet. We have early adopted this standard retrospectively, and reclassified all of our current deferred tax assets to noncurrent deferred tax assets which has resulted in a change to previously published amounts.
 
 
5

 
 
B. 
CAPITALIZATION AND INDEBTEDNESS
 
Not applicable.
 
C. 
REASONS FOR OFFER AND USE OF PROCEEDS
 
Not applicable.
 
D. 
RISK FACTORS
 
We are subject to various risks and uncertainties relating to or arising out of the nature of our business and general business, economic, financial, legal and other factors or conditions that may affect us. We believe that the occurrence of any one or some combination of the following factors could have a material adverse effect on our business, financial condition, cash flows and results of operations.
 
Risks Related to our Industry

As a considerable portion of our revenues are derived from online advertising, any reduction in spending for online advertising by advertisers could adversely impact our business and results of operations.
 
Spending by advertisers tends to be cyclical, reflecting overall economic conditions and budgeting and buying patterns, as well as levels of consumer confidence and discretionary spending. Adverse economic conditions can have a material negative impact on the demand for advertising and cause advertisers to reduce the amounts they spend on advertising, particularly online advertising, which could negatively impact our revenues.
 
In the past, adverse economic conditions have caused, and if such conditions were to recur in the future they could cause, a decrease and/or delay in advertising expenditures, which would reduce our revenues and adversely affect our business and results of operations.

Advertisers typically do not have long-term advertising commitments. A decrease in overall advertising may adversely affect our results of operations.
 
In addition, the cost-per-click (CPC) and cost-per-thousand impressions (CPM) basis are negotiated between us, the publishers and advertisers and depend on a number of factors over which we have no control. If the publishers we partner with decrease the rates charged to advertisers, this would decrease the advertising revenues they share with us. Conversely, if we are paid by the advertiser or agency, in the event advertisers reduce the CPM rates they are willing to pay, there could be no assurance that we would be able to adjust the fees that we pay to publishers in order to maintain the current levels of profitability.
 
The online advertising market is very concentrated, with Google and Facebook in particular playing a substantial role in that market, limiting our flexibility to operate in this market.
 
In 2015, online advertising continued to grow globally and particularly in the United States. Advertising through search accounted for the largest portion of online advertising and in the United States accounted for approximately 45% (based on eMarketer) of all money spent on online advertising. Google as an advertising publisher accounted for most U.S. online search-generated revenues, and Microsoft and Yahoo accounted for substantially all of the rest of search generated revenues. In addition, a small number of social network companies, and Facebook in particular are seizing a growing portion of the advertising market. This high market concentration causes us to be subject to unilateral changes set by Google and some of the other large participants, with limited ability to respond to and adjust for those changes. Although we utilize other methods of advertising and partnering with other companies, these are currently not as lucrative as search advertising in general and affiliation with Google in particular. Continued unilateral changes could adversely affect our revenues and performance.

 
6

 
 
 
The digital advertising market is highly concentrated, and our inability to replace customers if necessary could have a material adverse impact on our business and results of operations.

While our largest advertiser and ad agency customers and the amounts of their advertising expenditures vary from year-to-year, the annual revenues of our Undertone business have historically been concentrated among a limited number of agencies and advertisers. Additionally, due to the dominance of Google and Facebook in the digital advertising market, our ability to engage new customers is limited. If, in any given year, the business from one or more of our customers decreases and we are unable to secure replacement customers to offset such decrease, it could have a material adverse impact our business and results of operations.

Additionally, the advertising industry has experienced substantial consolidation in recent years and we expect this consolidation to continue. This consolidation could adversely affect our business in a number of ways, including:

 
·
our customers or vendors could acquire or be acquired by our competitors and terminate their relationship with us;
 
·
our customers or vendors could merge with each other, which could reduce our ability to negotiate favorable terms; and
 
·
competitors could improve their competitive position through strategic acquisitions.

Further, the growing trend of consolidation of Internet advertising networks, web portals, search engines and web publishers, and increasing industry presence of a small number of large companies, such as Google, Facebook, and Apple could harm our business. We are currently able to serve, track and manage advertisements for our customers on a variety of networks and websites. Concentration of advertising networks could substantially impair our ability to serve advertisements if these networks or websites decide not to permit us to serve, track or manage advertisements on their websites, if they develop ad placement systems that are incompatible with our ad serving systems or if they use their market power to force their customers to use certain vendors on their networks or websites.
 
Our business is significantly reliant on the North American market. Any material adverse change in that market could have a material adverse effect on our results of operations.
 
Our revenues have historically been concentrated within the North American market, accounting for approximately 78% of our revenues for 2015. With the recent acquisition of Undertone, we expect the concentration to be even higher. A significant reduction in the revenues generated by such market, whether as a result of a recession that causes a reduction in advertising expenditures generally or otherwise, which causes a decrease in our North American revenues could have a material adverse effect on our results of operations.
 
The browser extension is susceptible to obsolescence with the continued advent of alternative Internet-based innovations which may become more attractive to users.
 
The development of new products and services in response to the evolving trends and technologies of the Internet, as well as the identification of new business opportunities in this dynamic environment, requires significant time and resources. We may not be able to adapt quickly enough (and/or in a cost-effective manner) to these changes, appropriately time the introduction to the market of new applications and features for our platform or for other products and services or identify new business opportunities in a timely manner. Also, these changes could require us to modify related infrastructures and the failure to do so could render our, or those of our partners, existing websites, applications, services and proprietary technologies obsolete. The failure to respond to any of these changes appropriately (and/or in a cost effective manner) could adversely affect us, our financial condition and our results of operations.
 
In the case of certain of the applications available via our platform, third parties have introduced (and continue to introduce) new or updated technologies, applications and policies that may interfere with the ability of our publishers or end users to access or utilize these applications generally or otherwise make publishers or users less likely to use our services (such as through the introduction of features and/or processes that disproportionately and adversely impact the ability of publishers or end users to access and use these applications relative to those of competitors). For example, third parties continue to introduce technologies and applications (including new and enhanced web browsers and operating systems) that may limit or prevent certain types of applications from being installed and/or have features and policies that significantly lower the likelihood that end users will install the applications generated from the platform or that previously-installed applications will remain in active use. In addition, there are technologies and applications that interfere with the functionality of (or settings changes made by) toolbar and/or platform applications. For example, there are technologies and applications that interfere with search boxes embedded within our toolbars and the maintenance of home page and web browser search settings previously selected by end users of the toolbar or some of our other products. These technologies, applications and policies adversely impact the ability of users to generate search queries through our applications, which in turn adversely impacts revenues. Technologies have also been introduced that can block the display of advertisements on web pages and that provide users with the ability to opt out of our advertising products. Our failure to successfully modify our toolbars and related applications in a cost-effective manner in response to the introduction and adoption of these new technologies and applications could adversely affect our business, financial condition and our results of operations.

 
7

 

New advertisement blocking technologies could limit or block the delivery or display of advertisements by our solutions, which could undermine the viability of our business.

Advertisement blocking technologies, such as mobile apps that limit or block the delivery or display of advertisements, are currently available for Internet users and are continuing to be developed for desktop and mobile use.  Further, new browsers and operating systems or updates to current browsers or operating systems offer users the ability to block ads.  If these technologies become widespread, the commercial viability of the current Internet ad-supported model may be undermined, thereby adversely affecting our business, financial condition, and results of operations.
 
We rely heavily on the ability to offer our search properties to our publishers and, as a result of such action, to obtain and retain the search properties of their users. Should this method of distribution be blocked, constrained, limited, materially changed, based on a change of guidelines, technology, or otherwise (which has happened in the past), or made redundant by any of our search engine providers, particularly Microsoft, our ability to generate revenues from our users' search activity could be significantly reduced.
 
The search distribution agreements with Microsoft and other search partners require that we comply with certain guidelines promulgated by them for the use of their brands and services, including the manner in which their paid listings are displayed within search results, and that we establish guidelines to govern certain activities of third parties to whom we syndicate the search services, including the manner in which those parties drive search traffic to their websites and display paid listings. Subject to certain limitations, any one of our search partners may unilaterally update its policies and guidelines, which could, in turn, require modifications to, or prohibit and/or render obsolete certain of our products, services and/or practices, which could be costly to address or otherwise have an adverse effect on our business, our financial condition and results of operations. Noncompliance with our search partners' guidelines, particularly Microsoft’s, by us or by third parties to which we syndicate paid listings or by the publishers through whom we secure distribution arrangements for our products could, if not cured, result in such companies' suspension of some or all of their services to us, or to the websites of our third party publishers, the imposition of additional restrictions on our ability to syndicate paid listings or distribute our products or the termination of the search distribution agreement by our search partners.
 
These guidelines, with respect to method of distribution, homepage resets,  and default search resets to search engine services, were changed by both Microsoft and Google numerous times in the past, having negative revenue implications. Since then, both companies have continued instituting other changes to the policies governing their relationship with search partners.

As a result, fewer and fewer substantial publishing partners are compliant with these requirements, increasing the concentration of revenues generated through each of our partners. In 2015, revenues generated through our largest partnership accounted for 25% of our revenues and the five most substantial partnerships accounted for 51% of our revenues. Should any of our large partnerships be deemed non-compliant, blocked or partner with another provider, it could be difficult to replace the revenues generated by that partnership and we would experience a material reduction in our revenues and, in turn, our business, financial condition and results of operations would be adversely affected.

 
8

 

Should the providers of the underlying platforms, particularly browsers, further block, constrain, limit, materially change their guidelines, technology, or the way they operate, our ability to generate revenues from our users' search activity could be significantly reduced.
 
As we provide our services through the Internet, we are reliant on our ability to work with the different Internet browsers. The Internet browser market is extremely concentrated with Google’s Chrome, Microsoft’s Internet Explorer and Mozilla’s Firefox accounting for over 89% of the desktop browser market in January 2016, and Google’s Chrome accounting for over 57% on its own, based on StatCounter reports. In June 2014, Google restricted the ability to install multi-purpose extensions onto its Chrome Internet browser. As most of our products and services offered such multi-purpose extensions at that time, this policy shift adversely affected our business. Since then, Google continued to further change and update its policies and technology in general, and specifically those relating to Chrome. Each such change further limits and constrains our ability to offer or change search properties. The operating system market is very concentrated as well, with Microsoft Windows dominating over 75% of the market as of January 2016, and Apple operating systems accounting for over 14% of that market, based on StatCounter reports. Recently, Microsoft announced changes to its browser modifier detection criteria and issued a new operating system (Windows 10), which includes a new default internet browser (Edge). Some of these changes may limit our ability to maintain our users' browser settings. If we are unable to effectively adapt to these changes, or if Microsoft, Google, Apple or other companies that provide Internet browsers, operating systems or other underlying platforms, effectively further restrict, discourage or otherwise hamper companies, like us, from offering or changing the search properties, this would continue to cause a material adverse effect on our revenue and our financial results.
  
Our software or provision of search services or advertising is occasionally blocked by software or utilities designed to protect users' computers, thereby causing our business to suffer.
 
Some of our products and offerings are viewed by some third parties, such as anti-virus software providers, as promoting or constituting "malware" or "spamming," or unjustly changing the user’s computer settings. As a result, our software, provision of search services or advertising is occasionally blocked by software or utilities designed to detect such practices. If this phenomenon increases or if we are unable to detect and effectively deal with such categorization of our products, we may lose both existing and potential new users and our ability to generate revenues will be negatively impacted.
 
The digital advertising business is subject to fierce competition. If we cannot compete effectively in this market, our revenues are likely to decline.

There are a large number of digital media companies and advertising technology companies that offer services similar to ours and that compete for a finite advertiser and agency budget, as well as limited inventory from publishers. Given that the barriers to entering the Internet advertising market are relatively low, the number of competitors may increase even further. There are also a large number of niche companies that are competitive with us, as they provide a subset of the services that we provide (e.g., mobile in-app ad networks). Further, companies that do not currently compete with us in this space may change their services to be competitive if there is a revenue opportunity. If we are unable to compete with such companies, our revenue may decline.

Competition for mobile advertising budgets is intense, as is competition for broader advertising solutions such as data management platforms. Our mobile marketing business operates in a dynamic market that is subject to rapid development and introduction of product and service offerings, changing branding objectives and evolving customer demands, all of which affect the ability to remain competitive. We expect competition to increase as the barriers to enter this market are low and consolidation of ad networks and ad exchanges is increasing. The introduction of new revenue acquisition management solutions by our competitors, the market acceptance of solutions based on new or alternative technologies, or the emergence of new industry standards could render our platform obsolete. Our platform is a centralized computerized media buying across multiple traffic sources bringing order to our customer's mobile marketing efforts. Advertisers struggle with inefficient and disorganized practices of media buying, campaign measurement and optimization. Our platform was created to resolve these mobile advertising challenges. In addition, the growth of in-house marketing and user acquisition teams within companies otherwise dependent on our services would minimize the need for our services.
 
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Competitors for our solutions include other companies that offer similar services and data management platforms that allow advertisers to purchase inventory directly from advertising exchanges or other third parties and manage and analyze their own consumer data and third party data.  As our platform evolves and we introduce new technologies and functionality, we may face competition from new sources or technology that allow developers to generate revenue from their apps without our assistance. Changes in standards in the advertising world could also cause us to incur additional development costs and any failure to quickly adapt to such changes could adversely affect the profitability of our mobile marketing business.
 
Our Undertone business is susceptible to seasonality which could affect our business, results of operations and our ability to repay indebtedness when due.

Historically, our Undertone business experienced the lowest sales in the first quarter and the highest sales in the fourth quarter, with the second quarter being slightly stronger than the third quarter. Fourth quarter sales tend to be the highest due to increased customer advertising volumes for the holiday selling season. In addition, product and service revenues are influenced by political advertising, which generally occurs every two years. Further, in any single period, product and service revenues and delivery costs are subject to significant variation based on changes in the volume and mix of deliveries performed during such period. In addition, revenues are subject to the changes of brand marketing efforts, i.e., when and where brands choose to spend their money in a given year.

In addition, customers retain the right to supplement, extend, or cancel existing advertising orders at any time prior to their completion, and have no control over the timing or magnitude of these revenue changes.  Relative complexity of individual advertising formats will also influence revenue timing, as the time between sale and initial revenue will be longer for more complicated formats.  Revenue delays may also arise based on the number of creative design iterations and any delays in obtaining final creative approvals.

As a result, our profit from these operations is even more seasonal, with the fourth quarter accounting for as much as 40% of our profits and the first quarter possibly resulting in a loss.

Moreover, due to the long receivable cycle and shorter payable cycle, this seasonality puts strains on our cash flow through the first and second quarter of every year.

These factors could adversely impact our cash flow, our ability to meet our financial debt covenants and even the ability to repay indebtedness when due.
 
Currently more individuals are using mobile devices to access the Internet, while most of our search revenue generation and services are currently not usable on mobile platforms. Also, web-based software and similar solutions are impacting the attractiveness of downloadable software products.
 
The market related to personal computers ("PCs"), has accounted for substantially all our search revenues.  As Internet usage continues to shift from PCs to mobile devices, we can expect downward pressure on revenues in general and in our search business in particular. Recently, the number of individuals who access the Internet through devices other than PCs, such as mobile phones, tablets, etc., has increased dramatically. While we have begun developing other models and solutions for mobile platforms and we have acquired Grow Mobile, Inc. ("Grow Mobile"), Make Me Reach SAS ("Make Me Reach") and Interactive Holding Corp. and its subsidiaries (collectively referred to as "Undertone"), most of our search and application services are not yet compatible with these alternative platforms and devices and substantially most of our search revenue to date has come from PCs. If this trend towards using the Internet on non-PC devices accelerates, some of our services will become less relevant and may fail to attract advertisers and web traffic. In addition, even if consumers do use our services, our revenue growth will still be adversely affected if we do not successfully implement revenue-generating models for our mobile applications.
 
Web (or "cloud") based software and similar solutions do not require the user to download software, and thus provides a very portable and accessible alternative for PCs, as compared to downloadable software. 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 software. Should this trend accelerate faster than our partners’ ability to provide differentiating advantages in their downloadable solutions, this could result in fewer downloads of their products and lower search revenues generated through the download of these products. See "Item 4.B Business Overview — Competition" for additional discussion of our competitive market.

 
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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 subject to the laws and regulations that apply to e-commerce and online businesses around the world. These laws and regulations are becoming more prevalent in the United States, Europe, Israel and elsewhere and may impede the growth of the Internet and consequently our services. These regulations and laws may cover user privacy, data collection and protection, location of data storage and processing, content, use of "cookies," access changes, "net neutrality," pricing, advertising, distribution of "spam," intellectual property, distribution of products, protection of minors, consumer protection, taxation and online payment services.
 
Many areas of the law affecting the Internet remain largely unsettled, even in areas where there has been some legislative action. This uncertainty can be compounded when services hosted in one jurisdiction are directed at users in another jurisdiction. For instance, European data protection rules may apply to companies which are not established in the European Union. The anticipated General Data Protection Regulation (expected to go take effect in or by 2018) will likely have an even wider territorial scope and more stringent user consent requirements. Further, it will include stringent operational requirements for companies that process personal data and will contain significant penalties for non-compliance. Also in other relevant subject matters such as cyber security, e-commerce, copyright and cookies, new European initiatives have been announced by the European regulators. To further complicate matters in Europe, member States have some flexibility when implementing European Directives, which can lead to diverging national rules.  Similarly, there have been laws and regulations adopted in Israel and throughout the United States that would impose new obligations in areas such as privacy, in particular protection of personally identifiable information, and liability for copyright infringement by third parties. Therefore, it is difficult to determine whether and how existing laws, such as those governing intellectual property, privacy, data collection and protection, libel, marketing, data security and taxation, apply to the Internet and our business.
 
Due to rapid changes in technology and the inconsistent interpretations of privacy and data protection laws, we may be required to 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. In addition, we use cloud based computing, which is not without substantial risk, particularly at a time when businesses of almost every kind are finding themselves subject to an ever expanding range of state and federal data security and privacy laws, document retention requirements, and other standards of accountability. Compliance with such existing and proposed laws and regulations can be costly and can delay, or impede the development of new products, result in negative publicity, increase our operating costs, require significant management time and attention and subject us to inquiries or investigations, claims or other remedies, including fines or demands that we modify or cease existing business practices.
 
For more information regarding government regulations to which we are subject, see "Item 4.B Business Overview — Government Regulation" for additional discussion of applicable regulations affecting our business.
 
If one or more states or countries determine that we are required to collect sales, use, or other taxes on the services that we sell, this may result in liability to pay sales, use, and other taxes (plus interest and penalties) on prior sales and a decrease in our future sales revenue.

In general, the digital advertising business has not traditionally paid sales tax.  However, a successful assertion by one or more cities, states or countries that digital advertising services should be subject to such taxes or that we are not providing digital advertising services, but other services and should collect sales, use, or other taxes on the sale of our services, or that we have failed to do so where required in the past, could result in a decrease in future sales and/or substantial tax liabilities for past sales.  Each state and country has different rules and regulations governing sales, use, and other taxes, and these rules and regulations are subject to varying interpretations that may change over time.

 
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Some states are also pursuing legislative expansion of the scope of goods and services that are subject to sales and similar taxes as well as the circumstances in which a vendor of goods and services must collect such taxes.  Furthermore, legislative proposals have been introduced in Congress that would provide states with additional authority to impose such taxes.  Accordingly, it is possible that either federal or state legislative changes may require us to collect additional sales and similar taxes from our clients in the future which could impact our future sales, and therefore result in a material adverse effect on our revenue.
 
Risks related to our Partners and Customers
 
Our search business depends heavily upon revenues generated from arrangements with search providers, particularly Microsoft, and any adverse change in those relationships could adversely affect our business or its financial condition and results of operations.
 
We are highly dependent on our search services agreement with Microsoft Online Inc. ("Microsoft"), which covers all of our search business with Microsoft and has a term from January 1, 2015 until December 31, 2017. In 2015, our search services agreement with Microsoft accounted for 81% of our revenues.
 
If our agreement with Microsoft, is terminated, substantially amended, or not renewed on favorable terms, we could experience a material decrease in our search-generated revenues or the profits it generates and we could be forced to seek alternative search providers. There are very few companies in the market that provide Internet search and advertising services similar to those provided by Microsoft, Google and Yahoo. These three companies are the dominant players in this market, and competitors do not offer as much coverage through sponsored links or searches. Although, we have agreements with both Google and Yahoo, we do not have a significant amount of revenue generated from either of them. 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 currently provided and utilized, or if the alternative arrangements will not attract the same traffic as the traffic attracted by Microsoft, or if the termination by Microsoft affects our ability to contract with 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 search revenue businessis highly reliant upon a small number of publishers, who account for the substantial majority of pay-outs to publishers and generate most of our revenues. If we were to lose all or a significant portion of those publishers as customers, our revenues and results of operations would be materially adversely affected.>
 
In 2015, the top ten publishers distributing our search properties accounted for approximately 62% of our revenues, of which the top five publishers represented approximately 51% of our revenue (each representing 25%, 13%, and the additional three: 4% of our revenues, each). There can be no assurance that these existing publishers will continue to distribute our search properties or continue utilizing the revenue-generating monetization services at the levels they did in the past or at all. The loss of all or a substantial portion of our relationships with these publishers, or a substantial reduction in their level of activity, could cause a material decline in our revenues and profitability.
 
The marketing of our search services partly relies on our ability to advertise and distribute our products together with the distribution of free software from other companies. Should Microsoft, Google or other search partners institute additional material changes in our ability to partner with distribution partners, it would be more difficult to acquire new customers and would adversely affect our revenues>.
 
We rely on advertising for acquiring new customers in conjunction with other companies distributing other free software products. These distribution partnerships are regulated by our search partners, including Microsoft and Google. While abiding by search providers’ policies and guidelines, we seek to optimize the installation process in order to increase users’ selection of search services. In particular, we have adopted an "opt out" approach to the installation process in the United States and Canada, pursuant to which, when users install a product containing a search engine, the option to have the search engine serve as their primary search provider is presented as the default option. Users are required to unselect each feature of the product’s search services if they do not wish to install the search functions of the product on their computers. This method of distribution has been very effective for us in the past and has significantly contributed to our growth. Should our search partners continue to implement changes to their guidelines, including the further restriction of the "opt out" feature, or restrict us from working with other distribution partners, our ability to market our products and search services would be limited, and our results of operations could be materially adversely affected.

 
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If our campaigns are not able to reach certain performance goals or measure certain metrics, this could have a material adverse effect on our business.

Our advertiser and ad agency customers expect and often demand that our advertising campaigns achieve certain performance levels based on metrics such as user engagement, clicks, or conversions, to validate the value proposition. We may have difficulty achieving these performance levels for a variety of reasons. Additionally, customers may request measurement of campaign metrics that are difficult or impossible to measure. For example, it is often difficult to track viewability on our proprietary high-impact ad units, either directly or through a third-party vendor. Accordingly, we may not be able to reach customer requested performance levels or measure certain metrics, which could cause customers to cancel campaigns, not provide repeat business, or request make-goods or refunds.
 
Our platform for managing ad campaigns on behalf of application developers, enabling to effectively acquire users and subsequently maintain their engagement, depends on our ability to collect and use data to distribute and target ads and measure performance, and any limitation on the collection and use of this data could significantly diminish the value of our solutions and cause us to lose clients and revenue.
 
When we deliver an ad, we are often able to collect information about the content and placement of the ad and the interaction of the user with the ad, such as whether the user clicked on the ad or watched a video. We may also be able to collect information about the user's location. As we collect and aggregate this data provided by billions of ad impressions, we analyze the data in order to optimize the targeting, placement, and scheduling of ads across the advertising inventory provided to us.
 
Our clients might decide not to allow us to collect some or all of this data or might limit our use of this data. For example, advertisers of mobile applications may not agree to provide us with the data generated by interactions with the content on their apps, or device users may not consent to having information about their device usage provided to the advertiser or to us through the advertiser. Additionally, our ability to either collect or use location-based data could be restricted by a number of factors, including new laws or regulations, technology, operating system restrictions or consumer choice. Any limitation on our ability to collect data about user behavior and interaction with mobile device content could make it more difficult for us to deliver an effective advertising platform that meets the demands of our advertisers.
 
Although our contracts generally permit us to collect data from campaigns, parties might nonetheless request that we discontinue using certain data.  It would be difficult, if not impossible, to comply with these requests, if the data had already been aggregated with other campaign data, and responding to these kinds of requests could also cause us to spend significant amounts of resources. Additionally, new browsers or operating systems or updates to browsers and operating systems may allow consumers to limit data collection and use. Interruptions, failures or defects in our data collection, mining, analysis and storage systems, as well as privacy concerns and regulatory restrictions regarding the collection of data, could also limit our ability to aggregate and analyze data from our advertisers' advertising campaigns. If that happens, we may not be able to optimize ad placement for the benefit of our advertisers, which could render our solutions less valuable, and, potentially result in loss of clients and a decline in revenues. Additional details are provided above under "--Risks Related to our Industry”.
 
 
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Our mobile marketing business incurs upfront costs associated with onboarding advertisers to its platform and may not recoup our investment if we do not maintain the advertiser relationship over time. We do not have long-term agreements with advertisers of mobile applications, and may be unable to retain key advertisers, attract new advertisers or replace departing advertisers with advertisers that can provide comparable revenue to us.
 
When adding new advertisers of mobile applications, we incur upfront costs that generally include expenses associated with entering such advertisers' data into our systems and other implementation-related costs. Our operating results may be negatively affected if we are unable to recoup our upfront costs for adding new advertisers of mobile applications to our platform. Because our advertisers are billed over the term of the insertion order, if new advertisers sign insertion orders with short initial terms and do not renew them, or otherwise do not continue to use our services to a level that generates revenues in excess of our upfront expenses, our operating results could be negatively impacted.
 
Our agreements with advertisers of mobile applications do not generally include long-term obligations requiring them to purchase our services and are cancelable upon short notice and without penalty. As a result, we may have limited visibility as to our future advertising revenue streams. We cannot assure that our advertisers of mobile applications will continue to use our services or that we will be able to replace, in a timely or effective manner. Most of our platform revenue is derived from advertisers that based their campaigns on performance and are subject to fluctuation and competitive pressures. Such advertisers, which seek to drive app downloads, "clicks," or other specific actions by viewers, are less consistent with respect to their spending volume on our platform, and may decide to substantially increase or decrease their use of our services based on seasonality or popularity of a particular app. Advertisers of mobile applications may shift their business to a competitor because of new or more compelling offerings, strategic relationships, technological developments, pricing and other financial considerations, or a variety of other reasons. Any nonrenewal, renegotiation, cancellation or deferral of large advertisers of mobile applications, or a number of insertion orders that in the aggregate account for a significant amount of revenue, could cause an immediate and significant decline in revenue and harm our business.
 
Sales efforts with advertising and ad agency customers require significant time and expense.
 
Contracting with new advertising and ad agency customers requires substantial time and expense, and we may not be successful in establishing new relationships or in maintaining current relationships. We may spend substantial time and effort educating customers about our unique high impact offerings, including providing demonstrations and comparisons against other available solutions. It is often difficult to identify, engage and market to potential advertisers of mobile applications who do not currently spend on mobile advertising or are unfamiliar with our current services. Furthermore, many of our advertisers of mobile applications purchasing and design decisions generally require input from multiple internal parties of these customers. As a result, we must identify those involved in the purchasing decision and devote a sufficient amount of time to presenting our services to each of those decision-making individuals.
 
The novelty of our products, services and business model often requires us to spend substantial time and effort educating potential advertisers of mobile applications about our offerings, including providing demonstrations and comparisons against other available services. This process can be costly and time-consuming. If we are not successful in streamlining the sales processes with such advertisers, our ability to grow our business may be adversely affected.
 
We are highly dependent on publishers, supply-side platforms, and advertising exchanges to provide advertising inventory in order for us to deliver advertising campaigns in a cost-effective manner.

We depend on direct publishers to provide us with quality high impact advertising inventory, and we rely on direct publishers, supply-side platforms and advertising exchanges to provide us with quality standard unit advertising inventory (collectively “Supply Sources”). The Supply Sources that supply their advertising inventory to us typically do so on a non-exclusive basis and are not required to provide any minimum amounts of advertising inventory to us or to provide us with a consistent supply of advertising inventory.  Supply Sources often maintain relationships with various sources of demand that compete with us, and it is easy for Supply Sources to quickly shift their advertising inventory among these demand sources, or to shift inventory to new demand sources, without notice or accountability.  Supply Sources may also seek to change the terms at which they offer inventory to us, or allocate their advertising inventory to our competitors who offer advertisements to them on more favorable economic terms or whose offerings are considered more beneficial. Publishers may also elect to sell all, or a portion, of their advertising inventory directly to advertisers and agencies. In addition, significant digital media properties in the industry may enter into exclusivity arrangements with our competitors, which could limit our access to a meaningful supply of quality advertising inventory. As a result of all of these factors, Supply Sources may not supply sufficient quality advertising inventory to us to meet our demand for serving certain proprietary and non-proprietary ad formats to audiences that our advertisers require us to target.

 
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Our supply of advertising inventory may be constrained as a result of a number of other factors, including, but not limited to:

 
·
Publishers sometimes place significant restrictions on the sale of their advertising inventory. These restrictions may include frequency caps, prohibitions on advertisements from specific advertisers or specific industries, or restrictions on the use of specified creative content or advertising format thereby restraining our supply of available inventory.

 
·
Online content and mobile applications may shift from an advertising-based monetization method to a pay for content/services model, thereby reducing available inventory.

 
·
Social media platforms may be successful in keeping users within their sites via products such as Facebook's Instant Articles.  If, as a result, users are not on the open web, advertising inventory on the open web (including our publisher’s sites) will be reduced.

 
·
Publishers may be reluctant to adopt certain of our proprietary ad formats for a variety of reasons (e.g. user preferences change making such ad formats less desirable) resulting in limited advertising inventory supply for such formats and inhibiting our ability to scale such formats.

In summary, if publishers decide not to make quality advertising inventory available to us, decide to increase the price of inventory, place significant restrictions on the sale of their advertising inventory, or if supply side platforms or exchanges terminate our access to them, we may not be able to replace this with inventory from other sellers that satisfies our requirements in a timely and cost-effective manner. If any of this happens, our revenue could decline or our cost of acquiring inventory could increase, lowering our operating margins.
 
If we do not continue to innovate and provide high quality solutions and services, we may not remain competitive, and our business and results of operations could be materially adversely affected.

                Our success depends on providing high quality solutions and services that foster consumer engagement. Our competitors, as well as the publishers themselves, are continuously developing innovations in online advertising, including new ad formats and video ads. Therefore, if we do not continue to innovate, our offering could become less desirable. As a result, we must continue to invest significant resources in research and development in order to enhance our technology and our existing solutions and services and introduce new high-quality solutions and services. If we are unable to predict user preferences or industry changes, or if we are unable to modify our solutions and services on a timely basis, and as a result are unable to provide quality solutions and services that run without complication or service interruptions, our customers may become dissatisfied and we may lose customers to our competitors and our reputation in the industry may suffer, making it difficult to attract new customers. Our operating results will also suffer if our innovations are not responsive to the needs of our customers, are not appropriately timed with market opportunity or are not effectively brought to market. As online advertising technologies continue to develop, our competitors may be able to offer solutions that are, or that are perceived to be, substantially similar or better than those offered by us. Customers will not continue to do business with us if our solutions do not deliver advertisements in an appropriate and effective manner and if the advertiser's investment in advertising does not generate the desired results. If we are unable to meet these challenges, our business and results of operations could be materially adversely affected.  
 
If the demand for high impact digital advertising does not develop or customers do not embrace our solutions, this could have a material adverse effect on our business.

We have made significant investments in high impact advertising through internal development efforts and acquisitions. There is, however, the chance that the overall market for these ads does not develop, or that it does not develop in a specific medium, such as mobile. Additionally, even if the market for these solutions develops, customers might not embrace our offerings.  For example, competitive offerings may be offered at lower prices or be perceived as having better features and functionality.  Further, even if the market for these solutions develops, we may not be able to scale our creative and technical production of high impact ad units.

 
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The generation of revenues from search activity through large publishers is subject to competition. If we cannot compete effectively in this market, our revenues are likely to decline.

We obtain a significant portion of our revenues through designating the Company as the default search provider during the download of our publishers’ product, and the use of our search services and the subsequent searches performed by the users thereof. We therefore are constantly looking for ways to convince potential users to accept our offering, designate the Company as its default search provider and accept the other search properties offered. To achieve these goals, we rely heavily on third-party publishers to distribute our search syndication services as a value-added component of their own offerings. There are other companies that generate revenue from searches, some of them with a more significant presence than ours and with greater capability to offer substantially more content. The large search engine companies, including Google, Microsoft and others, have become increasingly aggressive in their own search service offerings. In addition, we need to continually maintain the technological advantage of our platform, products and other services in order to attract partners to our offering.  If the search engine companies engage more direct relationships with publishers or we are unable to maintain the technological advantage to service our partners, we may lose both existing and potential new partner publishers and our ability to generate revenues will be negatively impacted.
 
Our mobile marketing business depends on ad networks and exchanges for mobile advertising opportunities to deliver our developer clients' advertising campaigns, and any decline in the advertising opportunities these venues provide could hurt our business.
 
We depend on ad networks and exchanges to provide us with advertising space on which we deliver ads. The future growth of our mobile marketing business will depend, in part, on our ability to enter into successful relationships with ad networks and exchanges. Identifying these venues and negotiating and documenting relationships with them requires significant time and resources. If we are unsuccessful in establishing or maintaining our relationships with these networks and exchanges on commercially reasonable terms, or if these relationships are not profitable for us, our ability to compete in the marketplace or to grow our revenues from our mobile marketing business could be impaired.

The contracts governing these relationships are typically nonexclusive and do not prohibit the relevant network or exchange from working with our competitors or from offering competing services. The tools that we provide to advertisers of mobile applications allow them to make decisions as to how to allocate advertising inventory among advertising networks. Ad networks and exchanges may change the price at which they offer advertising opportunities to us.  In addition, ad networks and exchanges may place significant restrictions on the advertising presented on their offerings. These restrictions may prohibit ads from specific advertisers or specific industries, or they could restrict the use of specified creative content or format. If ad networks and exchanges decide not to make advertising available to us for any of these reasons, decide to increase the price of their advertising space, or place significant restrictions on such, the revenue from our mobile marketing business could decline or our cost of acquiring inventory could increase.
 
In order to receive advertisement-generated revenues from our search partners, we depend, in part, on factors outside of our control.
 
The amount of revenue we receive from each of our search partners depends upon a number of factors outside of our control, including the amount these search providers charge for advertisements, the efficiency of the search provider’s system in attracting advertisers and syndicating paid listings in response to search queries and parameters established by it regarding the number and placement of paid listings displayed in response to search queries. In addition, each of the search partners makes judgments about the relative attractiveness (to the advertiser) of clicks on paid listings from searches performed on our search assets, and these judgments factor into the amount of revenue we receive. Changes to search partners' paid listings network efficiency, its judgment about the relative attractiveness of clicks on paid listings or the parameters applicable to the display of paid listings could have an adverse effect on our business, financial condition and our results of operations. Such changes could come about for a number of reasons, including general market conditions, competition or policy and operating decisions made by Microsoft or Google or other of our search partners.

 
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Commoditization in digital advertising could have a material adverse effect on our business.

There has been commoditization resulting in margin pressure in display and video advertising.  If such commoditization occurs in areas such as high impact and mobile, this could have a material adverse effect on our business.
 
 
Some of our products and those of our partners currently run or are based on Microsoft Windows operating systems. Recently Android and Apple have gained popularity and market share, particularly in the mobile market.  A decline in market acceptance of Microsoft technologies or the increased acceptance of other operating systems without products that work on these competing operating systems in a timely fashion could have a material adverse effect on our ability to market our products. Consumers are adopting these alternative technologies in increasing numbers and are migrating 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. Microsoft could introduce new features that would make it more difficult to install our search services. We cannot always maintain such compatibility and we cannot assure you that we will not incur significant expenses or losses of income in connection therewith.

Risks related to our Financial Status and Operating Environment

If we fail to comply with the terms and covenants of our debt obligations, our financial position may be adversely affected.
 
As of December 31, 2015, we had convertible bonds outstanding having an aggregate principal amount of approximately ILS 143.5 million (then equivalent to approximately $36.8 million). In the event that we fail to comply with the terms and/or covenants of our convertible bonds or our $19.9 million loan agreement with Bank Leumi, and cannot obtain a waiver of noncompliance, we may be required to immediately repay all of our outstanding indebtedness and the bond trustee and the bank may be entitled to exercise the remedies available under the convertible bonds and applicable law.

In addition, pursuant to the Undertone merger agreement, we are required to pay deferred consideration in the amount of $20 million, bearing interest, in November 2020. In the event that we fail to comply with certain provisions of the merger agreement, or if Undertone fails to comply with the terms and/or covenants of its $60 million secured loan agreement and the loan is accelerated, we may be required to immediately pay the $20 million deferred consideration under the merger agreement and Undertone may be required to immediately repay all of its outstanding indebtedness under the loan agreement. 
 
There is no assurance that we will be able to generate the cash necessary to fund the scheduled payments from operations or from additional equity or debt financing or other funding sources or that our operating results will enable us to meet our covenants and financial ratios as of the end of each fiscal quarter.  Our inability to comply with the repayment schedules, covenants or financial ratios under our debt instruments could result in a material adverse effect on us.
 
The terms of our credit facilities contain restrictive covenants that limit our business, financing, and investing activities.

The terms of our credit facilities include customary covenants that impose restrictions on our business, financing, and investing activities, subject to certain exceptions or the consent of our lenders including, among other things, limits on our ability to incur additional debt, create liens, enter into merger, acquisition and divestiture transactions, pay dividends, and engage in transactions with affiliates. The credit facilities also contain certain customary affirmative covenants and events of default. Our ability to comply with the covenants may be adversely affected by events beyond our control, including but not limited to, economic, financial and industry conditions. A breach of any credit facility covenant that is not cured or waived may result in an event of default. This may allow our lenders to terminate the commitments under the credit facilities, declare all amounts outstanding under the credit facilities, together with accrued interest, to be immediately due and payable, and to exercise other rights and remedies. If this occurs, we may not be able to refinance the accelerated indebtedness on acceptable terms, or at all, or otherwise repay the accelerated indebtedness which could have a material adverse effect on us.

 
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In addition, certain covenants also limit our flexibility in planning for, or reacting to, changes in our business and our industry. Complying with these covenants may impair our ability to finance our future operations or acquisitions or capital needs or to engage in other favorable business activities.

We have acquired and intend to continue to acquire other businesses. These acquisitions divert a substantial part of our resources and management attention and have in the past and could in the future, cause further dilution to our shareholders and adversely affect our financial results.
 
We acquired Smilebox in August 2011, SweetIM in November 2012, ClientConnect in January 2014, Grow Mobile in July 2014, Make Me Reach in February 2015, and Undertone in November 2015, and we intend to continue to acquire complementary products, technologies or businesses. Seeking and negotiating potential acquisitions to a certain extent diverts our management’s attention from other business concerns, and 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, we might lose key employees and vendors while integrating new organizations and may not effectively integrate the acquired products, technologies or businesses, or achieve the anticipated revenues or cost benefits or might harm our relationships with our future or current technology suppliers. Future acquisitions could result in customer dissatisfaction or vendor dissatisfaction or performance problems with an acquired product, technology or company. Paying the purchase price for acquisitions in the form of cash, debt or equity securities could weaken our cash position, increase our leverage or dilute our existing shareholders, as the case may be. Furthermore, a substantial portion of the price paid for these acquisitions is typically 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. Moreover, not all acquisitions result in better results of the acquiring company. All acquisitions may end up in losses, unwanted results and waste of valuable resources, time and money. If any of these or similar risks relating to acquiring products, technologies or businesses should occur in the future on a scale that is greater than the positive effects of the acquisition described above, our business could be materially harmed.
 
Our financial performance may be materially adversely affected by information technology, insufficient cyber security and other business disruptions.
 
Our business is constantly challenged and 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 and overloading our servers and systems with communications and data. Unidentified groups have hacked numerous Internet websites and servers, including our own, for various reasons, political, commercial and other. Given the unpredictability of the timing, nature and scope of such disruptions, we could potentially be subject to substantial 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 and results of operations. Although these attacks cause certain difficulties, they have not had a material effect on our business, financial condition or results of operations. However, there can be no assurance that such attacks can be prevented or that any such incidents will not have a material adverse effect on us in the future.

 
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Class action litigation due to share price volatility or other factors could cause us to incur substantial costs and divert our management’s attention and resources.
 
Historically, public companies that experience periods of volatility in the market price of their securities and/or engage in substantial transactions, are sometimes met with class action litigation. Companies in the Internet and software industry, such as ours, are particularly vulnerable to this kind of litigation as a result of the volatility of their stock prices and their regular involvement in transactional activities. In the past, we were named as a defendant in this type of litigation in connection with our acquisition of ClientConnect, and although this lawsuit was dismissed, in the future litigation of this sort could result in considerable costs and a diversion of management’s attention and resources.
 
If we are deemed to be non-compliant with applicable data protection laws, or are even thought to be so, our operating results could be materially affected.

We collect, use, and maintain certain data about our customers, partners, employees and consumers. Such collection and maintenance of information is subject to data protection laws and regulations. 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. Moreover, concerns about our collection, use, sharing or handling of such data or other privacy related matters, even if unfounded, could harm our reputation and 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, use, 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 adverse effect on our business. See "Item 4.B Business Overview — Government Regulation" for additional discussion of applicable regulations.
 
Our products operate in a variety of computer and device configurations and could contain undetected errors or defects that could result in product failures, lost revenues and loss of market share.
 
Our software and advertising products may contain undetected errors, failures or defects, especially when the products are first introduced or when new versions are released. Our customers’ computer and other device 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. As a result, there could be errors or failures in our products. In addition, despite testing by us and beta testing by some of our 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 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, makegoods, refunds, 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 resources and could cause interruptions.
 
We depend on third party Internet and telecommunication providers to operate our websites and web-based services. Temporary failure of these services, including catastrophic or technological interruptions, would materially reduce our revenues and damage our reputation, and securing alternate sources for these services could significantly increase our expenses and be difficult to obtain.
 
Each of our third party Internet and telecommunication providers may not continue to provide services to us without disruptions at the current cost or at all. Moreover, as traffic to our websites and applications increases and the number of new (and presumably more complex) products and services that we introduce continues to rise, we will need to upgrade our systems, infrastructures and technologies generally to facilitate this growth. Although there is certain overlap between the companies that provide such services, such a disruption in services by any one of them, even if temporary, would reduce our revenues from product sales and possibly even from search, depending on the extent of disruption. We also rent the services of approximately 530 servers located around the world, mainly through Amazon Web Services. While we believe that there are many alternative providers of hosting and other communication services available to us, 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. Such processes could be both expensive and time consuming and could result in lost business both during the transition period and after.
 
 
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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 deterioration in performance or interruption in these systems, delays, and loss of critical data and 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, hacking, 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 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.
 
Due to our evolving business model and rapid changes in the Internet and the nature of services, particularly mobile advertising platforms, we may not be able to accurately predict our future performance or increase revenue or profitability.
 
As a result of the volatile and declining nature of our search revenues and display advertising, we have decided to develop and focus future growth efforts on mobile advertising and mobile platforms. We do not have an extensive history of ongoing operations from which to predict our future performance, and making such predictions is very complex and challenging, particularly with regard to aggressively increasing the distribution and profitability of these platforms as well as maintaining our existing business. The future viability of our business will greatly depend on our ability to offer a robust, stable and efficient platform for our partners in the mobile advertising market, as well as adapting and creating new platforms and products in this market. If we are unsuccessful in doing so in a timely fashion, we may not be able to achieve revenue growth or increase our profitability.
 
A loss of the services of our senior management, other key personnel and technology vendors 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 expertise necessary for us to execute our business strategy and thereby adversely affect our business. 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, as well as third party technology vendors. Competition for well-qualified employees in our industry is intense and our continued ability to compete effectively depends, in part, upon our ability to retain existing key employees and to attract new skilled employees as well. 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. Although we have established programs to attract new employees and provide incentives to retain existing employees, particularly senior management, we cannot be assured that we will be able to retain the services of senior management or other key employees as we continue to integrate the Undertone business or that we will be able to attract new employees in the future who are capable of making significant contributions. See "Item 6 Directors, Senior Management and Employees."

 
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Should some of our vendors terminate their relationship with us, our ability to continue the development of some of our products could be adversely affected, until such time that we find adequate replacement for these vendors, or until such time that we can continue the development on our own.
 
Under current Israeli, U.S., U.K., French and German law, we may not be able to enforce non-competition and non-solicitation covenants and, therefore, we may be unable to prevent our competitors from benefiting from the expertise of some of our former employees and/or vendors, whether current or former.
 
We have entered into non-competition and non-solicitation agreements with many of our employees and vendors. These agreements prohibit our employees and vendors, if they terminate their relationship with us, from competing directly with us, working for our competitors, or soliciting current employees away from us for a limited period. Under current Israeli, U.S., U.K., French and German 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.
 
Exchange rate fluctuations may harm our earnings and asset base if we are not able to hedge our currency exchange risks effectively.
 
A significant portion of our costs, primarily personnel expenses, are incurred in ILS. Inflation in Israel may have the effect of increasing the U.S. dollar cost of our operations in Israel. Further, whenever the U.S. dollar declines in value in relation to the ILS, it will become more expensive for us to fund our operations in Israel. A revaluation of one percent of the ILS as compared to the U.S. dollar could impact our income before taxes by approximately $0.4 million. The exchange rate of the U.S. dollar to the ILS has been very volatile in the past three fiscal years, decreasing by approximately 7% in 2013, increasing by approximately 12% in 2014, and decreasing by less than 1% in 2015. As of December 31, 2015, we had a foreign currency net liability of approximately $39.5 million (which number includes approximately $35.5 million in long-term ILS denominated convertible bonds that we issued in Israel in September 2014), and our total foreign exchange gain was approximately $0.6 million for the year ended December 31, 2015. To assist us in assessing whether or not, and how to, hedge risks associated with fluctuations in currency exchange rates, we have contracted a consulting firm proficient in this area, and are generally implementing their proposals. However, due to market conditions, volatility and other factors, we do not always implement our consultant’s proposals in full and 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.
 
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.
 
A large portion of our operations are performed from outside the United States. In addition, we derive and expect to continue to derive a portion of our revenues from users outside the United States. Our international operations and sales are subject to a number of inherent risks, including risks with respect to:
 
 
·
potential loss of proprietary information due to piracy, misappropriation or laws that may be less protective of our intellectual property rights than those of the United States;
 
 
·
costs and delays associated with translating and supporting our products in multiple languages;
 
 
·
foreign exchange rate fluctuations and economic instability, such as higher interest rates and inflation, which could make our products more expensive in those countries;
 
 
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·
costs of compliance with a variety of laws and regulations;
 
 
·
restrictive governmental actions such as trade restrictions;
 
 
·
limitations on the transfer and repatriation of funds and foreign currency exchange restrictions;
 
 
·
compliance with different consumer and data protection laws and restrictions on pricing or discounts;
 
 
·
lower levels of adoption or use of the Internet and other technologies vital to our business and the lack of appropriate infrastructure to support widespread Internet usage;
 
 
·
lower levels of consumer spending on a per capita basis and fewer opportunities for growth in certain foreign market segments compared to the United States;
 
 
·
lower levels of credit card usage and increased payment risk;
 
 
·
changes in domestic and international tax regulations; and
 
 
·
geopolitical events, including war and terrorism.
 
Risks related to our Technological Environment
 
If we fail to detect non-human traffic or other invalid traffic or engagement with our ads, we could lose the confidence of our advertisers, damage our reputation, and be responsible for makegoods or refunds, which would cause our business to suffer.
 
Our business relies on delivering positive results to our advertisers. We are exposed to the risk of fraudulent impressions, clicks, or conversions that advertisers may perceive as undesirable.  Such fraudulent activities may occur when a software program, known as a bot, spider, or crawler, intentionally simulates user activity causing impressions, ad engagements or clicks to be counted as real users. Such malicious software programs can run on single machines or on tens of thousands of machines, making them difficult to detect and filter.

If fraudulent or other malicious activity is perpetrated by others, and we are unable to detect and prevent it, the affected advertisers may experience or perceive a reduced return on their investment. High levels of invalid or fraudulent activity could lead to dissatisfaction with our advertising services, refusals to pay, refund or make good demands, or withdrawal of future business. Any of these occurrences could damage our brand and lead to a loss of our revenue.
 
We may not be able to enhance our platform to keep pace with technological and market developments in our evolving industry.
 
To keep pace with technological developments, satisfy increasing developer requirements, maintain the attractiveness and competitiveness of our mobile advertising solutions and ensure compatibility with evolving industry standards, we will need to regularly enhance our platform and develop and introduce new services on a timely basis. We also must update our software to reflect changes in advertising networks' application programming interfaces ("APIs"), technological integration and terms of use. The success of any enhancement or new solution depends on several factors, including timely completion, adequate quality testing, appropriate introduction and market acceptance. Our inability, for technological, business or other reasons, to timely enhance, develop, introduce and deliver compelling mobile advertising services in response to changing market conditions and technologies or evolving expectations of advertisers of mobile applications or mobile device users could hurt our ability to grow our mobile marketing business.
 
If advertisers continue to shift toward computerized transacting, it could lead to a loss in revenue.

There has been a recent shift to computerized transacting (also known as transacting programmatically) in display advertising.  If this shift occurs in other areas of advertising, such as high impact, and users are unwilling to work with our method of delivering high impact programmatically, it may negatively affect our revenue.

 
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We provide a platform for application developers to advertise and effectively distribute their application. The mobile advertising market is relatively new and may develop or evolve not as currently expected, which could harm our mobile marketing business.
 
The market for mobile advertising management solutions such as ours is relatively new, and the solutions offered or being developed may not achieve or sustain high levels of demand and market acceptance. Advertisers of mobile applications have historically spent a smaller portion of their advertising budgets on mobile media as compared to traditional advertising methods, such as television, newspapers, radio and billboards, or online advertising over the Internet, such as through banner ads on websites. Many advertisers of mobile applications still have limited experience with mobile advertising and their utilization of this newer platform may evolve in a different fashion than currently expected. In addition, our current and potential advertisers may ultimately find mobile advertising to be less effective than traditional advertising media or marketing methods or other technologies for promoting their products and services, and may even reduce spending on mobile advertising from current levels as a result. If the market for mobile advertising deteriorates, or develops in a different fashion than currently expected, we may not be able to increase our revenues.
 
The growth of our mobile marketing business will be impaired if mobile devices, their operating systems or content distribution channels develop in ways that prevent our mobile marketing business's advertising campaigns from being delivered to their users.
 
Our mobile marketing future business is dependent on the need of mobile application advertisers for assistance in managing their advertising campaigns, including assistance in connecting such advertisers of mobile applications with advertising networks. If advertising networks significantly open their platforms and make more data available to their advertisers, the importance of our ability to manage an ad campaign and provide analytics would be diminished, potentially harming its revenues.
 
We do not control consumer infrastructure.  If consumer infrastructure fails, we may be unable to deliver our services and could suffer a material adverse effect.

Consumer infrastructure could fail for a variety of reasons, including new technology incompatibility, the degradation of network performance under the strain of too many consumers using the network, a general failure from natural disaster, or a political or regulatory shut-down. Individuals and groups who develop and deploy viruses, worms and other malicious software programs could also attack consumer infrastructure and the devices that run on those networks. Any such occurrences could impact our ability to serve ads and lead to a loss of revenue.
 
The introduction of new browsers and other popular software products may materially adversely affect user engagement with our search services.
 
Users typically install new software and update their existing software as new or updated software is introduced online by third-party developers. In addition, when a user purchases a new computing device or installs a new Internet browser, it generally uses the Internet search services that are typically pre-installed on the new device or Internet browser. Our products are distributed online and are usually not pre-installed on computing devices. Further, as many software vendors that distribute their solutions online also offer search services alongside their primary software product, users often replace our search services with those provided by these vendors in the course of installing new software or updating existing software. After users have installed search solutions offered by us, any event that results in a significant number of our users changing or upgrading their Internet browsers could result in the failure to generate the revenues that we anticipate from our users and result in a decline in our user base. Finally, although we constantly monitor the compatibility of our Internet search services and related solutions with such new versions and upgrades, we may not be able to make the required adjustments to ensure constant availability and compatibility of such solutions.

 
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Risks related to our Solutions’ Reputation and Perception
 
Our business depends on a strong brand reputation, and if we are not able to maintain and enhance our brand, our business and results of operations could be materially adversely affected.

Maintaining and enhancing our Undertone brand is an important aspect of our efforts to attract and expand our agency, advertiser and publisher base. Maintaining and enhancing our Undertone brand will depend largely on our ability to provide high-quality, innovative products and services, and there are no assurances that we will be able to continue to do so successfully. We have spent, and expect to continue spending, money and other resources on the establishment, building and maintenance of our Undertone brand, as well as on enhancing customer awareness of it. Our Undertone brand, however, may be negatively impacted by a number of factors, including but not limited to, fraud on publisher sites on which we serve ads, service outages, product malfunctions, data protection and security issues, and exploitation of our trademarks by others without our permission.  If we are unable to maintain or enhance our Undertone brand in a cost-effective manner, our business and operating results could be materially adversely affected.
 
We may be unable to deliver advertising in a brand safe environment, which could harm our reputation and cause our business to suffer.

It is important to brand advertisers that advertisements are not placed in or near content that is unlawful or would be deemed offensive or inappropriate by their customers. Unlike advertising in other mediums, we cannot guarantee that online advertisements will not appear in such an environment. If we are not successful in delivering ads in such an environment, our reputation could suffer and our ability to attract potential advertisers and retain and expand business with existing advertisers could be harmed, or our customers may seek to avoid payment or demand refunds, any of which could harm our business and operating results.
 
We have experienced a decline in business, and market perception of our search business has not been favorable. As a result, we may have difficulty achieving revenue growth and entering new markets.
 
Over the past several quarters, we have experienced a decline in revenues and an increasingly negative market bias regarding a major source of revenues, search-generated revenues. The combination of these factors presents challenges in:
 
 
·
recruiting and retaining highly qualified personnel for our current business and the new business we are developing;
 
 
·
attracting and acquiring customers and partners to support and expand our business; and
 
 
·
raising funds or utilizing our equity to facilitate acquisitions.

If we cannot maintain the commitment of our employees, recruit new employees and make the acquisitions required to enhance our organic activity, we may not return to revenue growth and our financial results will suffer.

Our reputation has been and may continue to be negatively impacted by a number of factors, including the negative reputation associated with search assets, search setting take over, toolbars, product and service quality concerns, complaints by publishers or end users or actions brought by them or by governmental or regulatory authorities and related media coverage and data protection and security breaches. Moreover, the inability to develop and introduce monetization products and services that resonate with consumers and/or the inability to adapt quickly enough (and/or in a cost effective manner) to evolving changes to the Internet and related technologies, applications and devices, could adversely impact our reputation, and, in turn, our business, financial condition and our results of operations.

 Risks Related to our Intellectual Property>

Our intellectual property may not be adequately protected and thus our technology may be unlawfully copied by other third parties.
 
The technology we use and is incorporated into our offering may not be protected by patents.
 
 
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There is no assurance that any existing or future patents will afford adequate protection against competitors and similar technologies. We regard the protection of our intellectual property as critical to our success.  We strive to protect our intellectual property rights by relying on contractual restrictions, common law rights, as well as federal and international intellectual property registrations and the laws on which these registrations are based. 

We generally enter into confidentiality and invention assignment agreements with our employees and contractors, and confidentiality agreements with parties with whom we conduct business, in order to limit access to, and the disclosure and use of, our proprietary information.  However, we may not be successful in executing these agreements with every party who has access to our confidential information or contributes to the development of our intellectual property.  In addition, those agreements that we do execute may be breached, and we may not have adequate remedies for any such breach.  Further, these contractual arrangements and the other steps we have taken to protect our intellectual property may not prevent the misappropriation of our intellectual property, or deter independent development of similar intellectual property by others. 
 
Third party claims of infringement or other claims against us could require us to redesign our products, seek licenses, or engage in costly intellectual property litigation which could adversely affect our financial position and our ability to execute our business strategy.
 
Given the competitive nature of our industry, companies often design similar products and services.  At times, this can cause claims of intellectual property infringement and potentially litigation. Further, the appeal of some 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 some of 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 such as these 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.
 
On December 22, 2015, Adtile Technologies Inc. filed a lawsuit against Perion and Undertone alleging, inter alia, that Undertone’s UMotion advertising format, “hand phone” image, and use of the full tilt library infringes on its intellectual property. On February 3, 2016, Adtile Technologies Inc. filed a motion for preliminary injunction to, inter alia, prevent Undertone from creating or selling motion-activated advertisements. If we do not prevail in this case, we may incur monetary damages and/or be prohibited from using certain intellectual property.

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 any of our brands name infringe(s) their trademark rights. In addition, names we choose for our products may be alleged 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.
 
We use certain "open source" software tools that may be subject to intellectual property infringement claims or that may subject our derivative works or products to unintended consequences, possibly impairing our product development plans, interfering with our ability to support our clients or requiring us to allow access to the source code of our products or necessitating that we pay licensing fees.
 
Certain of our products contain open source code and we may use more open source code in the future. In addition, certain third party software that we embed in our products contains open source code. Open source code is code that is covered by a license agreement that permits the user to liberally use, copy, modify and distribute the software without cost, provided that users and modifiers abide by certain licensing requirements. The original developers of the open source code provide no warranties on such code.
 
 
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As a result of the use of open source software, we could be subject to suits by parties claiming ownership of what they believe to be their proprietary code or we may incur expenses in defending claims alleging non-compliance with certain open source code license terms. In addition, third party licensors do not provide intellectual property protection with respect to the open source components of their products, and we may be unable to be indemnified by such third party licensors in the event that we or our customers are held liable in respect of the open source software contained in such third party software. If we are not successful in defending against any such claims that may arise, we may be subject to injunctions and/or monetary damages or be required to remove the open source code from our products. Such events could disrupt our operations and the sales of our products, which would negatively impact our revenues and cash flow.
 
Moreover, under certain conditions, the use of open source code to create derivative code may obligate us to make the resulting derivative code available to others at no cost. The circumstances under which our use of open source code would compel us to offer derivative code at no cost are subject to varying interpretations. If we are required to publicly disclose the source code for such derivative products or to license our derivative products that use an open source license, our previously proprietary software products may be available to others without charge. If this happens, our customers and our competitors may have access to our products without cost to them which could harm our business. Certain open source licenses require as a condition to use, modification and/or distribution of such open source that proprietary software incorporated into, derived from or distributed with such open source be disclosed or distributed in source code form, be licensed for the purpose of making derivative works, or be redistributable at no charge. The foregoing may under certain conditions be interpreted to apply to our software, depending upon the use of the open source and the interpretation of the applicable open source licenses.

We monitor our use of open source code to avoid subjecting our products to conditions we do not intend. The use of open source code, however, may ultimately subject some of our products to unintended conditions so that we are required to take remedial action that may divert resources away from our development efforts.

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, Hamas (an Islamist militia and political group in the Gaza Strip) and Hezbollah (an Islamist militia and political group in Lebanon). Recent political uprisings, social unrest and violence in various countries in the Middle East and North Africa, including Israel’s neighbors Egypt and Syria, are affecting the political stability of those countries. This instability may lead to deterioration of the political relationships that exist between Israel and these countries and have raised concerns regarding security in the region and the potential for armed conflict. In addition, Iran has threatened to attack Israel and is believed to be developing nuclear weapons. Iran is also believed to have a strong influence among the Syrian government, Hamas and Hezbollah. 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, such as the Gaza conflict in the summer of 2014, have in the past negatively affected business conditions in Israel. Any hostilities involving Israel could have a material adverse effect on our business, operating results and financial condition. Although 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. Since our headquarters 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 in the region would likely negatively affect business conditions, harm our results of operations and make it more difficult for us to raise capital.

 
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Several countries, principally in the Middle East, restrict doing business with Israel and Israeli companies, and additional countries may impose restrictions on doing business with Israel and Israeli companies whether as a result of hostilities in the region or otherwise. In addition, there have been increased efforts by activists to cause companies and consumers to boycott Israeli companies based on Israeli government policies. Such actions, particularly if they become more widespread, may adversely impact our business and results of operations.
 
Our operations may be disrupted by the obligations of our Israeli personnel to perform military service.
 
As of December 31, 2015, approximately 48% of our workforce is located in Israel and could be obliged 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, including in the summer of 2014, 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 or our directors or asserting U.S. securities laws claims in Israel.

We are incorporated under the laws of the State of Israel. Service of process on us, our Israeli subsidiaries, our directors and officers and the Israeli experts, if any, named in this annual report, substantially all of whom reside outside of the United States, may be difficult to obtain within the United States.
 
Furthermore, because the majority of our assets and investments, and substantially all of our directors, officers and Israeli external experts are located outside the United States, any judgment obtained in the United States against us or any of them may be difficult to collect within the United States.
 
We have been informed by our legal counsel in Israel that it may also be difficult to assert U.S. securities laws claims in original actions instituted in Israel. Israeli courts may refuse to hear a claim based on an alleged violation of U.S. securities laws reasoning that Israel is not the most appropriate forum to bring such a claim. In addition, even if an Israeli court agrees to hear a claim, it may determine that Israeli law and not U.S. law is applicable to the claim. There is little binding case law in Israel addressing these matters. If U.S. law is found to be applicable, the content of applicable U.S. law must be proved as a fact, which can be a time-consuming and costly process. Certain matters of procedure will also be governed by Israeli law.

Subject to specified time limitations and legal procedures, under the rules of private international law currently prevailing in Israel, Israeli courts may enforce a U.S. judgment in a civil matter, including a judgment based upon the civil liability provisions of the U.S. securities laws, as well as a monetary or compensatory judgment in a non-civil matter, provided that the following key conditions are met:
 
 
·
subject to limited exceptions, the judgment is final and non-appealable;
 
 
·
the judgment was given by a court competent under the laws of the state of the court and is otherwise enforceable in such state;
 
 
·
the judgment was rendered by a court competent under the rules of private international law applicable in Israel;
 
 
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·
the laws of the state in which the judgment was given provide for the enforcement of judgments of Israeli courts;
 
 
·
adequate service of process has been effected and the defendant has had a reasonable opportunity to present his arguments and evidence;
 
 
·
the judgment and its enforcement are not contrary to the law, public policy, security or sovereignty of the State of Israel;
 
 
·
the judgment was not obtained by fraud and does not conflict with any other valid judgment in the same matter between the same parties; and
 
 
·
an action between the same parties in the same matter was not pending in any Israeli court at the time the lawsuit was instituted in the U.S. court.
 
The tax benefits available to us for activities in Israel require us to meet several conditions and may be terminated or reduced in the future, which would increase our costs and taxes.
 
We have benefited and currently benefit from a variety of Israeli government programs and tax benefits with regards to our operations in Israel, that generally carry conditions that we must meet in order to be eligible to obtain any benefit. Our tax expenses and the resulting effective tax rate reflected in our financial statements may increase over time as a result of changes in corporate income tax rates, other changes in the tax laws of the countries in which we operate, non-deductible expenses, loss and timing differences, or changes in the mix of countries, where we generate profit.
 
If we fail to meet the conditions upon which certain favorable tax treatment is based, we would not be able to claim future tax benefits and could be required to refund tax benefits already received. Any of the following could have a material effect on our overall effective tax rate:
 
 
·
we may be unable to meet the requirements for continuing to qualify for some programs;
 
 
·
these programs and tax benefits may be unavailable at their current levels; or
 
 
·
we may be required to refund previously recognized tax benefits if we are found to be in violation of the stipulated conditions.
 
Additional details are provided in "Item 5 – Operating and Financial Review and Products" under the caption "Taxes on income," in "Item 10 – Additional Information" under the caption "Israeli taxation, foreign exchange regulation and investment programs" and in note 10 to our Financial Statements.
 
If we are characterized as a passive foreign investment company, our U.S. shareholders may suffer adverse tax consequences.>
 
Non-U.S. corporations generally may be characterized as a passive foreign investment company ("PFIC") for any taxable year, if, after applying certain look through rules, either (1) 75% or more of such company’s gross income is passive income, or (2) at least 50% of the average value of all such company’s assets (determined on a quarterly basis) are held for the production of, or produce, passive income.

If we are characterized as a PFIC, our U.S. shareholders may suffer adverse tax consequences, including having gains realized on the sale of our ordinary shares taxed at ordinary income rates, rather than capital gain rates. Similar rules apply to distributions that are "excess distributions." In addition, both gains upon disposition and amounts received as excess distributions could be subject to an additional interest charge. A determination that we are a PFIC could also have an adverse effect on the price and marketability of our ordinary shares.
 
We believe that in 2015 we were not a PFIC. Whether we are a PFIC is based upon certain factual matters such as the valuation of our assets. In calculating the value of our assets, we value our total assets, in part, based on our total market capitalization. We believe this valuation approach is reasonable. There is no assurance whether the IRS will challenge our valuations. If the IRS were to successfully challenge such valuations, we may potentially be classified as a PFIC for the 2015 taxable year or prior taxable years. Furthermore, there can be no assurance that we will not become a PFIC in the future. See a discussion of our PFIC status in Item 10.E under "U.S. Federal Income Tax Considerations – Passive Foreign Investment Company Considerations."

 
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Risks Related to our Ordinary Shares

Future sales of our ordinary shares could reduce our stock price.
 
At the closing of the ClientConnect Acquisition on January 2, 2014, we issued 54.75 million of our ordinary shares to ClientConnect’s shareholders. The ordinary shares were issued pursuant to an exception from registration under the Securities Act and are not subject to any resale restrictions under U.S. law, except for the volume limitations under Rule 144 applicable to our affiliates. Since January 2, 2016, the resale of such ordinary shares is no longer subject to any contractual lock-up restrictions.
 
As of March 1, 2016, there were outstanding an aggregate of 9,687,029 RSUs and options to purchase our ordinary shares.  As these securities vest, the holders thereof could sell the underlying shares without restrictions, except for the volume limitations under Rule 144 applicable to our affiliates.
 
As part of the consideration for the acquisition of Grow Mobile, we issued 600,100 ordinary shares in 2014, and 342,329 ordinary shares in 2015, to the security holders of Grow Mobile. Such shares generally will become freely tradable under U.S. law six months following their respective issuance. Additional share issuances due to the aforesaid acquisition are expected during 2016.
 
On February 10, 2015, as part of the consideration for the acquisition of Make Me Reach, we issued 1,437,510 ordinary shares to the security holders of Make Me Reach and additional 18,998 ordinary shares to certain employees. In the subsequent 12 months, we issued to certain former Make Me Reach security holders and to certain employees an additional 288,478 in ordinary shares. Such shares are generally not subject to any resale restrictions under U.S. law.

Pursuant to a registration rights undertaking described in Item 10.C "Material Contracts— J.P. Morgan Registration Rights Agreement," we expect to complete, in the upcoming months, the registration with the Securities and Exchange Commission of 4,436,898 of our ordinary shares, which may be resold by the holders thereof from time to time.
 
Finally, our Series L Bonds are convertible into an aggregate of approximately 4.3 million ordinary shares, at a conversion price of ILS 33.605 per share (approximately $8.61 per share as of December 31, 2015). These shares were issued pursuant to an exception from registration under the Securities Act and will not be subject to any resale restrictions under U.S. law, except for the volume limitations under Rule 144 applicable to our affiliates.
 
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. 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.
 
We do not intend to pay cash dividends.
 
Although we have paid cash dividends in the past, our current policy is to retain future earnings, if any, for funding growth. If we do not pay dividends, long term holders of our stock will generate a return on their investment only if our stock price appreciates between the date of purchase and the date of sale of our shares.
 
See "Item 8.A Consolidated Statements and Other Financial Information — Policy on Dividend Distribution" for additional information regarding the payment of dividends.
 
Several shareholders may be able to control us.

As a result of the ClientConnect Acquisition, several shareholders of Conduit became significant shareholders of Perion, including three shareholders that each beneficially own more than 10% of our outstanding shares. One of these shareholders is currently a member of our board of directors. See Item 7.A for more information. To our knowledge, these shareholders are not party to a voting agreement with respect to our shares. However, should they decide to act together, they may have the power to control the outcome of matters submitted for the vote of shareholders. In addition, such share ownership may make certain transactions more difficult and result in delaying or preventing a change in control of us unless approved by them.

 
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We are subject to ongoing costs and risks associated with complying with extensive corporate governance and disclosure requirements.
 
As an Israeli 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 and public disclosure requirements, including requirements under the Sarbanes-Oxley Act of 2002, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, the Listing Rules of the NASDAQ Stock Market, regulations of the SEC, 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 5759-1999 (the "Companies Law") that apply to us. For example, as a public company, we have created additional board committees and are required to have at least two external directors, pursuant to the 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. Section 404 of the Sarbanes-Oxley Act requires an annual assessment by our management of our internal control over financial reporting of the effectiveness of these controls as of year-end. In connection with our efforts to comply with Section 404 and the other applicable provisions of the Sarbanes-Oxley Act, our management and other personnel devote a substantial amount of time, and we have hired, and may need to hire, additional accounting and financial staff to assure that we comply with these requirements. The additional management attention and costs relating to compliance with the foregoing requirements could materially and adversely affect our financial results. 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 not considered a foreign private issuer status under U.S. federal securities laws, we would incur additional expenses associated with compliance with the U.S. securities laws applicable to U.S. domestic issuers.
 
We are a foreign private issuer, as such term is defined under U.S. federal securities laws, and, therefore, we are not required to comply with all of the periodic disclosure and current reporting requirements applicable to U.S. domestic issuers. If we did not have this status, we would be required to comply with the reporting and other requirements applicable to U.S. domestic issuers, which are more detailed and extensive than the requirements for foreign private issuers. The regulatory and compliance costs to us under U.S. securities laws, if we are required to comply with the reporting requirements applicable to a U.S. 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, 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 particular, a shareholder of an Israeli company has a duty to act in good faith in exercising his or her rights and fulfilling his or her obligations toward the company and other shareholders and to refrain from abusing his or her power in the company, including, among other things, in voting at the general meeting of shareholders on certain matters. Israeli law provides that these duties are applicable in shareholder votes at the general meeting with respect to, among other things, amendments to a company’s articles of association, increases in a company’s authorized share capital, mergers and actions and transactions involving interests of officers, directors or other interested parties which require shareholders’ approval. There is little case law available to assist in understanding the implications of these provisions that govern shareholder behavior.

 
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As a foreign private issuer whose shares are listed on NASDAQ, we follow certain home country corporate governance practices instead of certain NASDAQ requirements.
 
As a foreign private issuer whose shares are listed on NASDAQ, we are permitted to follow certain home country corporate governance practices instead of certain requirements contained in the NASDAQ listing rules. We follow the requirements of the Companies Law in Israel, rather than comply with the NASDAQ requirements, in certain matters, including with respect to the quorum for shareholder meetings, sending annual reports to shareholders, and shareholder approval with respect to certain issuances of securities. See "Item 16.G – Corporate Governance" in this Annual Report for a more complete discussion of the NASDAQ Listing Rules and the home country practices we follow. As a foreign private issuer listed on NASDAQ, we may also elect in the future to follow home country practice with regard to other matters as well. Accordingly, our shareholders may not be afforded the same protection as provided under NASDAQ’s corporate governance rules to shareholders of U.S. domestic companies.
 
Provisions of our articles of association and Israeli law may delay, prevent or make an acquisition of our Company difficult, 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 staggered 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.
 
Our share price has fluctuated significantly and could continue to fluctuate significantly.
 
            The market price for our ordinary shares, as well as the prices of shares of other Internet companies, has been volatile. Between February 2014 and March 2016, our share price has fluctuated from a high of $14.33 to a low of $1.98. The following factors may cause significant fluctuations in the market price of our ordinary shares:
 
 
·
fluctuations in our quarterly revenues and earnings or those of our competitors;
 
 
·
pending sales into the market due to  the release of contractual and tax lock ups;
 
 
·
shortfalls in our operating results compared to levels forecast by us or securities analysts;
 
 
·
changes in regulations or in policies of search engine companies or other industry conditions;
 
 
·
mergers and acquisitions by us or our competitors;
 
 
·
technological innovations;
 
 
·
the introduction of new products;
 
 
·
the conditions of the securities markets, particularly in the Internet and Israeli sectors; and
 
 
·
political, economic and other developments in Israel and worldwide.

In addition, share prices of many technology companies fluctuate significantly for reasons that may be unrelated or disproportionate to operating results.  The factors discussed above may depress or cause volatility of our share price, regardless of our actual operating results.

 
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Our ordinary shares are traded on more than one market and this may result in price variations.
 
Our ordinary shares are traded on the NASDAQ Global Select Market and on the TASE. Trading in our ordinary shares on these markets is effected in different currencies (U.S. dollars on NASDAQ and ILS on the TASE) and at different times (resulting from different time zones, different trading days and different public holidays in the United States and Israel). Consequently, the trading prices of our ordinary shares on these two markets often differ, resulting from the factors described above as well as differences in exchange rates and from political events and economic conditions in the United States and Israel. Any decrease in the trading price of our ordinary shares on one of these markets could cause a decrease in the trading price of our ordinary shares on the other market.
 
ITEM 4.                  INFORMATION ON THE COMPANY
 
A. 
HISTORY AND DEVELOPMENT OF THE COMPANY
 
Our History
 
We were incorporated in the State of Israel in November 1999 under the name Verticon Ltd., changed our name to IncrediMail Ltd. in November 2000 and in November 2011 changed our name to Perion Network Ltd.. We operate under the laws of the State of Israel. Our headquarters are located at 26 HaRokmim Street, Holon 5885849, Israel. Our phone number is 972-73-3981000. Our website address is www.perion.com. The information on our website does not constitute a part of this annual report. Our agent for service in the United States is Intercept Interactive Inc. d/b/a Undertone, which is located at 340 Madison Avenue, 8th Floor, New York, NY 10173-0899.
 
We completed the initial public offering of our ordinary shares in the United States on February 3, 2006.
 
Since November 20, 2007, our 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.
 
On November 30, 2012, we completed the purchase of SweetIM Ltd., a Belize company that wholly owns SweetIM Technologies Ltd., an Israeli company. Both companies were dissolved during 2015.
 
On January 2, 2014, we completed the purchase of ClientConnect Ltd., an Israeli company that wholly owns ClientConnect Inc., a Delaware corporation, and ClientConnect B.V., a Netherlands company.
 
On July 15, 2014, we completed the purchase of Grow Mobile, Inc., a Delaware corporation.
 
On February 10, 2015, we completed the purchase of Make Me Reach SAS, a French company.
 
On November 30, 2015, we completed the purchase of Interactive Holding Corp., a Delaware corporation, and its subsidiaries (collectively referred to as "Undertone"). See "Recent Developments".
 
Principal Capital Expenditures
 
In 2013, capital expenditures consisted of $1.9 million for investments mainly in computer hardware, software and furnishings. In 2014, capital expenditures consisted of $10.9 million for leasehold improvements and furnishing related to our new headquarters office in Holon, as well as investments in computer hardware and software. In 2015, capital expenditures consisted of $2.0 million, mainly from the acquisition of computer systems and software applications.
 
In 2016, we expect to continue our growth strategy of 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 of which are expected to be financed by our existing resources. We currently expect that outside of possible acquisitions of products and companies, our capital expenditures will be approximately at the same level in 2016. To date, we have financed our general capital expenditures with cash generated from operations and debt and equity financings.  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, or issuances of equity or debt securities.
 
 
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Recent Developments
 
Undertone Acquisition
 
On November 30, 2015 (“Closing date”), we completed the purchase of Interactive Holding Corp., a Delaware corporation, and its subsidiaries (collectively referred to as "Undertone") for a purchase price of $133.1 million, comprised of $89.1 million paid in cash, $16.0 million was retained as a holdback to cover potential claims until May 2017, for which a liability of $14.4 million was recorded at fair value.  $3.0 million will be paid in installments over the period ending September 2017, for which a liability of $2.8 million was recorded at fair value. $20.0 million, deferred consideration payment, bearing 10% annual interest, to be paid in November 2020, for which a liability of $22.0 million was recorded at fair value. As part of the purchase price, an amount of $1.2 million was paid on January 2016, and an amount of $2.1 million will be paid during 2016. In addition, an amount of approximately $1.5 million is expected to be paid as a working capital adjustment in cash. Concurrently with the closing, Undertone entered into a new secured credit agreement with its existing lenders for $50.0 million, due in quarterly installments from March 2016 to November 2019. On March 4, 2016, Undertone entered into an amendment to the secured credit agreement. The amendment to the credit agreement adds a $10.0 million revolving loan facility (which includes a $3.0 million swing line loan commitment and $3.0 million letter of credit commitment). Additionally, the amendment postpones the commencement date of a few of Undertone’s undertaking and covenants, and increases Undertone’s ability to invest in some of its subsidiaries.
 
The credit agreement is not guaranteed by Perion, but it is secured by a pledge on Perion's indemnification rights under the Undertone acquisition agreement. In connection with the acquisition, we granted options to purchase 3,289,000 ordinary shares to employees of Undertone and a warrant to purchase 200,000 ordinary shares to a third-party vendor that provides development services to Undertone.
 
Following the closing of the Undertone acquisition, Corey Ferengul, CEO of Undertone, joined Perion's executive management team. In addition, Robert Schwartz, the Vice President of Business Development of Undertone, became our Chief Strategy Officer, in place of Michael Waxman-Lenz, who became the Chief Financial Officer of Undertone.
 
Private Placement
 
On December 3, 2015, we completed a private placement of 4,436,898 ordinary shares for gross proceeds of $10.125 million pursuant to a securities purchase agreement with J.P. Morgan Investment Management Inc., as investment advisor to the National Council for Social Security Fund and 522 Fifth Avenue Fund L.P. (collectively referred to as the "Investors"). The purchase price per share was $2.282, which was the average closing price of an ordinary share on the Nasdaq Global Select Market for the 30 trading days ending on December 1, 2015. In the event that on September 1, 2016 the 15-trading day weighted average price of an ordinary share is less than $2.624, the per share purchase price will be adjusted downward 1% for each whole 1% that it is lower than such price, up to a maximum adjustment of 15%, and we will issue to the Investors such number of additional ordinary shares as is necessary so that each of the Investors will receive such number of ordinary shares in total that it would have purchased at the closing of the private placement at such lower price.

In connection with the private placement, we entered into a registration rights agreement with the Investors pursuant to which we granted to the Investors certain registration rights related to the ordinary shares issued in the private placement. We were required to file this registration statement on Form F-3 for the resale of the ordinary shares within 30 days following the closing of the private placement (such Form F-3 was filed on December 29, 2015) and to use our reasonable efforts to cause such registration statement to be declared effective within 120 days following the closing of the private placement. We expect to complete, in the upcoming months, the registration of said shares. We may incur liquidated damages if we do not meet our registration obligations. We also agreed to other customary obligations regarding registration, including indemnification and maintenance of the applicable registration statement.

    Bank Leumi credit facility

On November 22, 2015, we borrowed $19.9 million under a new credit facility from LeumiTech, the technology banking arm of Bank Leumi le-Israel B.M. The credit facility is secured by a lien on the accounts receivable of ClientConnect Ltd., an Israeli subsidiary, from its current and future business clients and is guaranteed by Perion. The credit facility matures in November 2016. As of December 31, 2015, the unpaid balance of the credit facility was $13.0 million.
 
 
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Make Me Reach Acquisition
 
On February 10, 2015, we consummated the acquisition of 100% of the shares of Make Me Reach SAS, a private French Company headquartered in Paris, France ("MMR"). The Purchase price was $6.4 million in cash and $4.4 million in the form of 1,437,510 ordinary shares. In the subsequent 12 months, we were required to pay additional $0.4 million in cash and issue an additional $0.4 million in ordinary shares to the founder of MMR, subject to retention conditions, which were paid in full in February 2016. In addition, certain key employees of MMR were entitled to retention payments of which $144,397 in cash and $62,883 in the form of 18,998 ordinary shares which were paid upon closing. An additional, $266,394 in cash and $208,169 in the form of 92,348 ordinary shares that were subject to retention conditions, were paid to such key employees in February 2016. Make Me Reach has become part of Perion’s focus on mobile marketing which was created to address the advertising needs of mobile app developers, and enables Perion to provide a more omprehensive technical and platform solution for app developers. Make Me Reach is a Facebook Marketing Partner, Instagram partner and Twitter Official Partner (TOP).
 
B. 
BUSINESS OVERVIEW
 
General

Perion is a global technology company that delivers high-quality advertising solutions to brands and publishers. Perion is committed to providing outstanding execution, from high-impact ad formats to branded search and a unified social and mobile programmatic platform.
 
Overview

While in 2015, we generated most of our revenues from search-based monetization solutions, we expect to devote most of our future growth efforts towards the advertising market.  Our Undertone business is an advertising technology business focused on delivering standout brand experiences. We do so by developing digital advertising creatively designed to capture consumer attention and drive engagement, delivering these ads across a hand-picked portfolio of websites and mobile applications. With the Undertone acquisition, we are now able to deliver standard and proprietary display, mobile, video, and high impact ad formats, leveraging proprietary technology to ensure that ads are delivered to the right audience, at the right time, and across the right websites and mobile applications.

Our ad creation platform allows us to bring sophisticated high impact formats to market quickly and to streamline production of client campaigns. By using HTML5 and a responsive design, we can deliver a seamless creative experience across screens. This combination of creative capabilities and proprietary high impact cross-screen and mobile-only advertising formats enables us to differentiate our offering in the market.  Customers can transact with us using traditional insertion order methods or programmatically (through computerized solutions). Our computerized capabilities enable customers to increase automation and efficiency while maintaining access to all of our formats. Our customers receive dedicated support throughout the full campaign cycle, including planning, client solutions, campaign management, performance and insights. We have longstanding relationships with major brands and advertising agencies across the United States and Europe.

Our proprietary social and mobile marketing platform offers a single dashboard for marketers that makes mobile media buying more efficient across ad networks, exchanges and direct publishers. Advertising networks, agencies and mobile application developers looking to promote their applications often struggle with inefficient and disorganized practices of media buying, campaign measurement and optimization. Our advertising platform simplifies the complexity of mobile app advertising, enabling companies to rapidly acquire new customers, increase user engagement and maximize revenue. It streamlines the process of buying ads across multiple channels, with an integrated solution suite that delivers sophisticated reports for quick results analysis, performance optimization and an increased return on investment.
 
 
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Our social and mobile marketing platform was created to resolve the mobile advertising challenges by offering centralized, programmatic media buying across multiple traffic sources and bringing order to mobile marketing efforts. With our mobile marketing platform, customers can acquire users from the industry’s top-performing traffic sources including Google, Facebook, Twitter and Instagram, and can access their performance data and revenue information in one place, enabling them to make better, quicker and more intelligent decisions and helping mobile application advertisers improve user acquisition, maximize their return on investment and ultimately meet their business goals.. The platform allows advertisers to control their marketing spends, planning and strategy in-house and utilize the technical tool to create better operational marketing efficiencies. The platform provides a mobile marketing distribution technology which is integrated into over 40 ad networks, exchanges and direct publishers and offers full reporting analytics that present data on results from the advertisers' budget spend and post campaign metrics. Following our acquisition of Make Me Reach, this platform includes social capabilities and the ability to serve ads on Facebook, Instagram and Twitter, as well. We offer our customers the opportunity to easily and efficiently increase spend, reduce churn and improve retention through engagement campaigns. Customers also receive ongoing analysis and optimization of their campaigns for increased return on investment and scaling of their key performance indicator goals.

Despite our focus on the advertising market, we still expect to generate significant revenues by providing search-based monetization solutions for our publishers with enhanced analytics capabilities to track and monitor their business performance. From the end user perspective, we enable users to configure their browser settings through the search setting dialogue so they are powered by our search-engine partners. Publishers can choose to implement our solution into or with their products and services (mobile and desktop) and to monetize their users’ search assets.
 
Our search related products enable end users to, among other things, replace their search asset(s) with ours, where users may conduct searches or follow links to advertisements that advertisers may display. They also allow publishers the ability to set up syndicated searches on their individual websites and to monetize their users’ other search assets. In addition, we are still generating a small portion of our revenues through our toolbar platform, which allows publishers to create, implement and distribute web browser toolbars, as well as through our consumer products; IncrediMail a unified messaging application that enables consumers to manage multiple email accounts in one place with an easy-to-use interface and extensive personalization features and Smilebox a leading photo sharing and social expression product.
 
In the past, Perion developed and acquired a number of downloadable consumer software products.  Currently these products account for only 8% of our revenues and are profitable. Our consumer products are currently available in seven languages in addition to English. Prices and license fees for our premium products range between $5 and $50, varying based on market, length of license period and whether the products are offered together. Our legacy product line crosses several vertical markets and consists of a few products, all of which may be downloaded over the Internet. We previously announced the beta launch of Violet, a do-it-yourself wedding design tool, yet the development of this product was abandoned during the fourth quarter of 2015.
 
Markets

In general, we work with advertising agencies, advertisers, publishers and search partners. While we work with some advertisers directly, our primary advertising customers are advertising agencies, who are paid by brand advertisers to develop their media plans. We work with these advertisers and agencies to plan, design, deliver, manage, and measure their digital advertising campaigns.

We contract for digital media with publishers, including software developers that own online media content such as mobile apps or web pages, as well as aggregators of such media. We focus on publishers and digital businesses, providing effective distribution, monetization, and optimization solutions. These developers and digital businesses, in turn, target consumers. Our experience and success as developers allow us to best understand the needs of publishers and to enable other developers to succeed. Honed through our own products, our technology-based solutions platform provides us with the opportunity to allow publishers to focus on what they do best, creating great digital content and applications or providing consumer content. Our team brings decades of experience, operating and investing in diversified digitally-enabled businesses, and we continue to innovate and create value for publishers. We keep the publishers’ end users focused and on-site for longer through targeted search results while building the perfect native ad experience.

We generally do not enter into long term contracts with advertising customers. We charge customers varied rates, based on ad format, campaign complexity, and creative requirements. We then engage in a consultative sales process to determine the best plan for that customer. Our customers purchase our products based on impressions served for each ad type, either using traditional insertion orders, or alternatively, programmatically, with options for managed service or self-service. Programmatic customers have access to the same ad formats as traditional customers but can leverage programmatic direct delivery in order to increase automation and efficiency. All our advertising customers receive support throughout the campaign cycle, with service and support teams including planning, client solutions, campaign management, performance, and insights.

 
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Our analytics platform enables app developers to manage their distribution and monetization activities and better optimize their offerings. Most app developers are small businesses without analytical capabilities or the required funds to improve customer “funnel” conversion, create the necessary systems for tracking revenue per user, or implement traffic acquisition with positive return on investment. Through our analytics platform, we provide our clients with real-time analytics, custom reports, and advanced optimization and editing tools, which together act as a springboard to higher conversions and increased return on investment.

We have generated the majority of our revenues from services agreements with our search partners. Search-generated revenues accounted for 85%, 85% and 78% of our revenues in 2013, 2014 and 2015, respectively. Through our search technology, including syndication, we offer end users the ability to search the Internet via easily embedded search boxes powered by premium search companies, including Microsoft, Google and Yahoo, and depending on the search partner powering the search and the location in which the search was initiated, we receive either a fixed price, pay-per-search fee or portion of the revenues generated by these companies through the search process.

We are currently one of the largest redistributors of search monetization in the United States and have agreements with all the major search engine companies. Our agreement with Microsoft, our largest search engine partner, is for a three-year term, from January 1, 2015 through December 31, 2017, and upon mutual agreement, the agreement may be renewed for an additional 12-month period, until the end of 2018. In the past, the fees payable by Microsoft under the Microsoft Agreement were payable based on either a fixed price, pay-per-search basis that is tied to the number of searches conducted by end users, or in certain instances on a share of the revenue generated as a result of searches conducted by end users who utilize the search engine that appears on toolbars created by publishers through our platform or through other search related products. The fees payable by Microsoft had varied annually over the term of the agreement, decreasing significantly in 2013 and 2014, as compared to 2011 and 2012. As of 2015, the fees payable by Microsoft under the Microsoft 2015 Agreement are payable based on a share of the revenue generated as a result of searches conducted by end users who utilize the search engine that appears on our product, the publisher’s product, search assets and websites.

While most of our search-generated revenues are based on our Microsoft relationship, nonetheless, in line with our strategy for diversification, we were successful in engaging and maintaining positive relationships with other search providers as well. We entered into an agreement with Google, effective as of July 1, 2015 and which will expire on April 30, 2017.  We also have an agreement with Yahoo, which is in effect until July 18, 2017. In addition, on April 29, 2013, we signed a three-year agreement with Ask. This agreement was amended on several occasions during 2014, and is in effect until March 31, 2016.
 
We also offer advertisers the ability to monetize their web properties with display advertising through our ad network. This offering is predominantly to our search revenue affiliate network and reliant on the acceptance of our resetting the home page of the users of their products.  These revenues are therefore highly correlated with our revenues from search.
 
Strategy

 
Our goal through our advertising high quality offering is to be the leader in advertising solutions that cut through the digital clutter and deliver messages that stand out to consumers, through innovative “high impact” ad units. We define high impact as advertising that has a great effect on consumers, such as non-standard rich media ad units. To address all of our customers’ digital advertising needs with a comprehensive solution, in addition to high impact ad units, we also offer standard and non-standard ad formats in display, video, and mobile.
 
We view our advertising offering to be complementary with our long standing search monetization offerings which yield steady revenues, providing high profitability and healthy cash flow.

 
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The key components to our advertising offering are:
 
Cross-Screen Ad Units
 
High impact advertising requires creative ad units that capture consumer attention, as well as functionality that drives consumer engagement. We have an in-house creative team, PIXL Studios, which works with clients to design, build, and execute custom high impact ad units. We currently offer 12 different high impact formats, each with a suite of interactive functionality, that can be deployed across desktop, mobile and tablet (“cross-screen”).  Eight of these are our proprietary formats.  We use HTML5 and responsive design to detect device type and screen size in order to deliver a seamless advertising experience across screens. Other proprietary formats, such as UMotion and Tapestry, leverage mobile-native functionality such as tap, swipe, shake, and tilt in order to deliver an engaging consumer experience.
 
Quality Media
 
In order to be effective, advertisements must be delivered in media environments that reach the right audiences. We hand-picked a broad portfolio of premium media properties, that we rigorously vetted using quantitative and qualitative criteria. Qualified publishers are then put through a certification process to ensure proper delivery of our high impact formats. Approved publishers are then placed on Undertone’s “Green List” and are subsequently continuously monitored for inappropriate content and non-human traffic.
 
Proprietary Technology
 
Our proprietary technology supports our mission of delivering standout brand experiences for advertisers:
 
 
·
Our HTML5-based ad creation platform allows for the rapid creation of high impact creative ads and the development of new high impact ad formats.
 
 
·
Our computerized platform allows our clients to increase efficiency and campaign flexibility by leveraging programmatic buying and selling.
 
 
·
Our Undertone Data Management System (UDMS) utilizes data-driven analysis and insights in order to deliver relevant ads to consumers.  UDMS is integrated with over 70 different data providers and integrate with first-party and third party targeting data.
 
Service and Support
 
We provide our clients with service and support before, during, and after the campaign cycle.  Our sales, client solutions, and planning teams utilize a consultative, solutions-driven approach in order to develop the appropriate campaign strategy for each individual client. Our campaign management and performance teams oversee all aspects of client campaigns in order to ensure that they meet the clients’ objectives.  Finally, our research and insights team provides clients with campaign results, key performance metrics, and critical analysis in order to provide useful feedback to clients.
 
Innovation
 
To maintain our edge and unique offering, we must continue to develop new solutions and services that foster consumer engagement.  To accomplish this, we have in-house research and development team, known as Future Proof Labs. Future Proof Labs researches, prototypes, and tests emerging technology in order to determine how best to reach and influence consumers. The team also conducts consumer research studies to determine the potential effectiveness of innovations.
 
Future Proof Labs focuses on three types of innovations:
 
 
·
Near-term innovations, which may be brought to market in less than a year and typically represent advances to existing capabilities,
 
 
·
Mid-term innovations, which may be brought to market in one to two years and typically represent new concepts, and
 
 
·
Long-term innovations, which have an uncertain time horizon, but that we believe may have a material impact on advertising.
 
 
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With the solutions we provide to our publisher partners, in the turbulent marketplace we currently act in, we intend to differentiate ourselves by providing solutions with three major advantages:
 
 
·
provide a user friendly monetization solution, that enables them to engage users, by providing quality software, while creating monetization through, user friendly, non-intrusive and transparent means;
 
 
·
deliver superior analytics and optimization tools enabling the software developer to extend its reach and increase monetization with a positive return on investment; and
 
 
·
offer creative and flexible monetization models with scalable risk and reward, suited to their business.

Publishers face increasing challenges monetizing their offerings. This is partly because most consumers find that the free version of a given software product or content adequately meets their needs. Accordingly, most app developers or web content publishers do not earn sufficient revenue to sustain a standalone business.
 
We provide a broad spectrum of solutions for our clients' monetization challenges. Through a sophisticated, data driven recommendation engine, we assist publishers to create new revenue streams and advertisers to hit targeted audiences- all while increasing site performance. We offer clients the ability to easily incorporate targeted ads into the download and installation process of their products as well as tailored and engaging advertising solutions for web content publishers, thereby further increasing monetization opportunities. The engine allows for funnel monetization opportunities on post-install and uninstall pages, as well. Altogether, the engine provides end users with more relevant offers, enhancing their experience by delivering relevant content and optimizing conversion for both advertisers and publishers, ultimately increasing end user satisfaction and monetization.
 
Through our search agreements with the world's leading search providers we enable our clients to monetize their search assets. Publishers and developers may incorporate a search box, generic or tailored to the publisher’s offering that is powered by our search providers, who in turn pay us fees for searches emanating from such search boxes. Depending on the payment model adopted, we pay our clients a fee on a pay-per-search or revenue sharing basis for search activity emanating from the incorporated search boxes.
 
Products under Development
 
Our research and development activities are primarily conducted internally, focusing on the development of new high impact ad formats and platform-based solutions that will offer developers (i) stand out brand experience (ii) effective distribution tools, (iii) increased monetization capabilities through content, and (iv) enhanced optimization via powerful, reliable, and easy-to-use analytics. Additionally, we focus our research and development efforts on developing new products and improving existing products through software updates and upgraded features. Our Research & Development department is divided into groups based on scientific disciplines and types of applications and products.
 
 
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Breakdown of Revenues
 
Our search monetization solutions, advertising platforms and other, are distributed and sold throughout the world in more than 100 countries. The following table shows the revenues, presented in our statement of operations, generated by territory in the years ended December 31, 2013, 2014 and 2015. As explained in Item 5.A, as a result of the ClientConnect Acquisition, which closed on January 2, 2014, our 2014 and 2015 financial statements include ClientConnect's comparative numbers for 2013.
 
   
2013
   
2014
   
2015
 
   
Search Revenue
   
Advertising and Other
   
Search Revenue
   
Advertising and Other
   
Search Revenue
   
Advertising and Other
 
Tier 1 – North America
    70 %     78 %     78 %     73 %     78 %     80 %
Tier 2 – Europe
    23 %     20 %     17 %     18 %     19 %     17 %
Tier 3 - Other
    7 %     2 %     5 %     9 %     3 %     3 %
Total
    100 %     100 %     100 %     100 %     100 %     100 %
 
Prior to the ClientConnect Acquisition, we divided our revenue categories or sales regions somewhat differently.  According to that method, in 2013, legacy search-generated including related advertising revenues and legacy product revenues in North America represented 35% and 86% of revenues, respectively, in Europe represented 47% and 10% of revenues, respectively, and in the rest of the world represented 18% and 4% of revenues, respectively.
 
Intellectual Property
 
Although we have a number of patents, copyrights, trademarks and trade secrets and confidentiality and invention assignment agreements to protect our intellectual property rights, we believe that our competitive advantage depends primarily on our marketing, business development, applications, know-how and ongoing research and development efforts. Accordingly, we believe that the expiration of any of our patents or patent licenses, or the failure of any of our patent applications to result in issued patents, would not be material to our business or financial position.
 
Part 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 the components we have licensed are not material to the overall performance of our software and may be replaced without significant difficulty.
 
We have six issued patents in the United States and one in Israel, as well as several patent applications pending in the United States, Israel and the European Union.
 
We enter into licensing arrangements with third parties for the use of software components, graphic, sound and multimedia content integrated into our products.
 
We have registered: (i) "Perion" as a trademark in the United States, Israel and the European Community (a community trademark); (ii) "IncrediMail" as a trademark in the United States, the European Community (a community trademark), China and Israel; (iii) "PhotoJoy" as a trademark in the United States, the European Community (a community trademark) and China; (iv) "Smilebox Teeth Design" in the United States; (v) "Smilebox" in Australia, Canada, China, France, Germany, Korea, United Kingdom and the United States; (vi) "SWEETPACKS" and "SWEETIM" in the United States; (vii) “CodeFuel” in the United States; (viii) "Perion Lightspeed" registered in the European Community (a community trademark); and (IX) "MakeMeReach" as a trademark in the European Community (a community trademark). Trademark applications for GROWMOBILE were filed in the United States and in the European Community (a community trademark).
 
With the acquisition of Undertone, we also have registered: (1) “Undertone” as a trademark in the United States, the European Union (an international registration), China and Russia; (2) “Intercept Interactive” as a trademark in the United States and the European Union (an international registration); (3) “PageGrabber” as a trademark in the United States and the European Union (an international registration); (4) “PageWrap” as a trademark in the United States and the European Community (a community trademark); (5) “TimeBlock” as a trademark in the United States; (6) “ScreenShift” as a trademark in the United States and the European Community (a community trademark); (7) “Undertone Impact Accelerator” as a trademark in the United States; (8) “PageGrabber X” as a trademark in the United States; (9) “Pixl Studios” as a trademark in the United States; (10) “GreenList” as a trademark in the United States; and (11) Undertone’s stylized square logo as a trademark in the United States.
 
 
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All employees and consultants are required to execute confidentiality covenants in connection with their employment and consulting relationships with us. These agreements (excluding those with our German and U.K. employees) also contain assignment and waiver provisions relating to the employee's or consultant’s rights in respect of inventions. However, there can be no assurance that these arrangements will provide us with adequate protection.
 
Competition
 
The markets in which we are active are subject to intense competition. We compete with many other companies offering solutions for online publishers and developers, including search services and other software in conjunction with changing a user’s default search settings.
 
The advertising technology industry is highly competitive. There are a large number of digital media companies and advertising technology companies that offer services similar to those of our Undertone business and that compete for finite advertiser/agency budgets and publisher inventory. There are also a large number of niche companies that are competitive with our Undertone business because they provide a subset of the services that we provide (e.g., mobile in-app ad networks). Some of these companies are larger and have more financial resources than we have, including, AOL, Google, and Facebook.  New entrants and companies that do not currently compete with our Undertone business may compete in the future given the relatively low barriers to entry in the industry.
 
As a major part of our revenues stem from our offering of search properties, we compete with search engine providers themselves such as Google, Microsoft, Yahoo, Ask and others. We also compete with many other companies offering consumer software, albeit totally different software, utilizing the same strategy, to offer their search properties, such as Interactive Corporation, AOL, Blucora and others.
 
Many of our current and potential competitors have significantly greater financial, research and development, back-end analytical systems, manufacturing, and sales and marketing resources than we have. These competitors could use their greater financial resources to acquire other companies to gain even further enhanced name recognition and market share, as well as to develop new technologies, enhanced systems and analytical capabilities, products or features that could effectively compete with our existing solutions, products and search services. Demand for our solutions, products and search services could be diminished by solutions, products, services and technologies offered by competitors, whether or not their solutions, products, services and technologies are equivalent or superior.
 
Finally, our ability to attract developers is largely dependent on our ability to pay higher rates to our publishers and developers, our success in creating strong commercial relationships with developers that have successful software, websites or distribution channels, and our ability to differentiate our distribution, monetization, and optimization tools from those of our competitors.
 
Government Regulation
 
We are subject to a number of U.S. federal and state and foreign laws and regulations that affect companies conducting business on the Internet. The manner in which existing laws and regulations will be applied to the Internet in general, and how they will relate to our business in particular is unclear. Accordingly, we cannot be certain how existing laws will be interpreted or how they will evolve in areas such as user privacy, data protection, content, use of "cookies," access changes, "net neutrality," pricing, advertising, distribution of "spam," intellectual property, distribution, protection of minors, consumer protection, taxation and online payment services.
 
For example, we are subject to U.S. federal and state laws regarding copyright infringement, privacy and protection of user data, many of which are subject to regulation by the Federal Trade Commission. These laws include the Digital Millennium Copyright Act, which aims to reduce the liability of online service providers for listing or linking to third-party websites that include materials that infringe copyrights or the rights of others, and other federal laws that restrict online service providers’ collection of user information on minors as well as distribution of materials deemed harmful to minors. Many U.S. states, such as California, are adopting statutes that require online service providers to report certain security breaches of personal data and to report to consumers when personal data will be disclosed to direct marketers. There are also a number of legislative proposals pending before the U.S. Congress and various state legislative bodies concerning data protection which could affect us.
 
 
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Foreign data protection, privacy and other laws and regulations may affect our business, and such laws can be more restrictive than those in the United States. For example, in Israel, privacy laws require that any request for information for use or retention in a database be accompanied by a notice that indicates: whether a person is legally required to disclose such information or that such disclosure is subject to such person’s consent; the purpose for which the information is requested; and to whom the information is to be delivered. A breach of privacy under such laws is considered a civil wrong and subject to a significant fines and civil damages. Certain violations of the law are considered criminal offences punishable by imprisonment. In the European Union, similar data protection rules exist and privacy legislation has tightened the restrictions relating to the use of cookies and similar technologies. Subject to some limited exceptions, 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 informed consent.  Further, the new General Data Protection Regulation, which is expected to take effect in or by 2018, will likely have an even wider territorial in scope and more stringent user consent requirements. Further, it will include stringent operational requirements for companies that process personal data and will contain significant penalties for non-compliance. Also in other relevant subject matters such as cyber security, e-commerce, copyright and cookies new European initiatives have been announced by the European regulators. To further complicate matters in Europe, Member States have some flexibility when implementing European Directives which can lead to diverging national rules.
 
These regulations result in significant compliance costs and could result in restricting the growth and profitability of our business.
 
C. 
ORGANIZATIONAL STRUCTURE
 
ClientConnect Ltd., our wholly owned Israeli subsidiary, owns all of the outstanding shares of common stock of ClientConnect, Inc., a Delaware corporation, and all of the outstanding ordinary shares of ClientConnect B.V., a Netherlands company.
 
IncrediMail, Inc., our wholly-owned Delaware subsidiary, owns all of the outstanding shares of common stock of Smilebox Inc., a Washington corporation, all of the outstanding equity of Grow Mobile LLC., a Delaware corporation and all of the outstanding shares of common stock of IncrediTone Inc., our wholly-owned Delaware subsidiary.  IncrediTone Inc. owns all of the outstanding shares of common stock of Interactive Holding Corp., a Delaware corporation, which was acquired, together with its subsidiaries, in November 2015.
 
Make Me Reach SAS, our wholly owned French subsidiary, was acquired in February 2015.
 
D. 
PROPERTY, PLANTS AND EQUIPMENT
 
Our headquarters are located in Holon, Israel. We lease approximately 101,500 square feet, out of which we sublease approximately 33,820 square feet. The lease expires in 2024, with an option to extend for two additional two-year periods. Annual cost is approximately $1.7 million.
 
We lease approximately 81,850 square feet in various locations in the United States. Our primary locations, and their principal terms, are as follows:
 
   
Square feet
   
Annual Base Rent for 2016 in US$ in millions
   
Lease expires on (not including extension options)
 
New York, New York
    51,182     $ 2,511       2021  
San Francisco, California
    10,674       856       2022  
Redmond, Washington
    8,300     $ 193       2021  
Chicago, Illinois
    7,943     $ 148       2018  
 
Outside of Israel and the United States, we lease offices in various locations throughout Europe. Our primary locations, and their principal terms, are as follows:

   
Square feet
   
Annual Base Rent for 2016 in US$ in millions
   
Lease expires on (not including extension options)
 
London, England
    4,252     $ 252       2019  
Paris, France
    5,000     $ 183       2017  

 
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We believe that our current facilities are more than adequate to meet our current needs, and we believe that suitable additional space will be available as needed to accommodate ongoing operations and any such growth.
 
We own approximately 900 servers located in Israel, Europe and the United States. We also rent the services of approximately 520 additional servers located around the world, approximately 390 of which are rented mainly through Amazon Web Services and approximately 130 of which are rented through Rackspace Hosting located in the United States.  Our servers include mainly web servers, application servers, data collection servers, data storage servers, data processing servers, mail servers and database servers. Bezeq and Cellcom Israel Ltd. provide our Internet and related telecommunications services in Israel, including hosting and co-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 incumbent national telecommunications provider. In the United States CenturyLink, and in Europe Evoswitch, are our co-location providers. Our Internet Service Providers ("ISPs") are CenturyLink, NTT Communication, Level3 Communication and Colt. Bezeq and Cellcom are the two largest providers of such services in Israel. All other ISPs are tier-1 worldwide providers in this area. For our Undertone business, (1) Rackspace Hosting provides our Internet and related telecommunications services in Dallas, Texas and Virginia data centers in the United States, and (2) Internap provides Internet and related telecommunication services to our co-located data centers in Europe and the United States which are needed to operate our websites. Rackspace Hosting, Amazon Web Services and Internap are some of the largest providers of such services in the United States.  All co-location and telecommunication services are provided 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.
 
UNRESOLVED STAFF COMMENTS
 
None.
 
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. 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 Exchange Act, 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
 
General

Perion is a global technology company that delivers high-quality advertising solutions to brands and publishers. Perion is committed to providing outstanding execution, from high-impact ad formats to branded search and a unified social and mobile programmatic platform.

Our headquarters and primary research and development facilities are located in Israel, and we have several other offices located in the United States and Europe.

Our Codefuel monetization product served 480 million average monthly queries in 2015, with 225 million being generated in United States. This level of activity makes us one of the larger search service providers in the U.S. market.

 
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However, this number of queries has declined from the high of 830 million average monthly queries in 2014 primarily as a result of our significantly reducing the investment in acquiring new customers and forming partnerships with software developers since the second half of 2014.  We reduced this investment as a result of two strategic decisions. The first was to become more selective in the companies we are willing to partner with, focusing on those that promote a more positive user experience, in line with our strategy, and those that can and do comply with the standards and policies introduced by the search engine companies, Google and Bing. The second strategic decision, in order to reduce our financial risk, was to discontinue up-front, payment-per-install relationships, a method contingent on our ability to estimate the future revenues and that suffered from the lack of visibility inherent in an ever changing environment. In its stead, we instituted relationships based on sharing the revenue generated by the end users as the revenue is generated. While this new method did reduce our profit margins somewhat, it resolved the risk of paying up-front marketing costs that may not have a positive return.

As a result of the increasing trend away from desktop downloadable software and towards mobile platforms, which inherently have very much reduced opportunities for monetization through the redistribution of search services, we are experiencing difficulties in growing our desktop monetization business.  We therefore have been focusing our growth efforts in developing a mobile advertising platform for app developers and we acquired Undertone.

The Undertone business is an advertising technology business focused on delivering standout brand experiences. We do so by developing digital advertising creatively designed to capture consumer attention and drive engagement, delivering these ads across a hand-picked portfolio of websites and mobile applications. With the Undertone acquisition, we are now able to deliver standard and proprietary display, mobile, video, and high impact ad formats, leveraging proprietary technology to ensure that ads are delivered to the right audience, at the right time, and across the right websites and mobile applications. Our ad creation platform allows us to bring sophisticated high impact formats to market quickly and to streamline production of client campaigns. By using HTML5 and a responsive design, we can deliver a seamless creative experience across screens. This combination of creative capabilities and proprietary high impact cross-screen and mobile-only advertising formats enables us to differentiate our offering in the market.

The Grow Mobile and Make Me Reach businesses, coupled with our organic development efforts, empower effective advertising campaigns for mobile app developers seeking to achieve distribution through advertising. By aggregating hundreds of advertising networks and exchanges in real-time through a single insertion order, our mobile marketing platform enables mobile applications developers to increase their customer acquisition, retention and monetization. Our proprietary platform, which has been released in Beta version, offers mobile application developers an efficient interface, containing on a single dashboard, a data room with all advertising networks> and campaigns together, with easy and understandable graphs and tables, enabling immediate analysis and effective action. Our platform includes social capabilities and the ability to serve ads on Facebook, Instagram and Twitter, as well. In addition, utilizing its proprietary bidding algorithm, it enables sophisticated retargeting of high quality users and integrates with top mobile advertising exchanges. Finally, by providing easy access to these tools and simplifying the administration of the advertising process, mobile application developers are free to focus on improving their mobile media buying strategy.
 
On March 17, 2016, we decided to discontinue the operations of the engagement product of Growmobile business and to redeploy certain parts of the mobile marketing platform so that it will no longer function as an independent business. We intend to strengthen the social platform, both as an independent service provider and servicing the Undertone high-impact offering with social distribution.

We are also developing other platforms and software, to enable mobile app developers improved optimization and monetization of their existing user base.

Recent Acquisitions
 
On November 30, 2015, we completed the purchase of Interactive Holding Corp., a Delaware corporation, and its subsidiaries (collectively referred to as "Undertone") for a purchase price of $133.1 million, comprised of $89.1 million paid in cash, $16.0 million were retained as a holdback to cover potential claims until May 2017, for which a liability of $14.4 million was recorded at fair value.  $3.0 million will be paid in installments over the period ending September 2017, for which a liability of $2.8 million was recorded at fair value. Deferred compensation in the amount of $20.0 million, bearing 10% annual interest, is required to be paid in November 2020, for which a liability of $22.0 million was recorded at fair value. As part of the purchase price, an amount of $1.2 million was paid on January 2016, and an amount of $2.1 million will be paid during 2016. In addition, an amount of approximately $1.5 million is expected to be paid as a working capital adjustment in cash. Concurrently with the closing, Undertone entered into a new secured credit agreement with its existing lenders for $50.0 million (which was amended on March 4, 2016, to increase the total credit amount to $60.0 million), due in quarterly installments from March 2016 to November 2019. In connection with the acquisition, we granted options to purchase 3,289,000 ordinary shares to employees of Undertone and a warrant to purchase 200,000 ordinary shares to a third-party vendor that provides development services to Undertone. The Undertone acquisition enables us to provide high quality advertising solutions to brands and agencies.  By creating and delivering proprietary high impact ads, as well as display, mobile, and video impressions, we can connect brands with their target audiences seamlessly across screens.
 
 
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On February 10, 2015, we consummated the acquisition of 100% of the shares of Make Me Reach SAS, a private French Company headquartered in Paris, France ("MMR"). The Purchase price was $6.4 million in cash and $4.4 million in the form of 1,437,510 ordinary shares. In the subsequent 12 months, we were required to pay additional $0.4 million in cash and issue an additional $0.4 million in ordinary shares to the founder of MMR, subject to retention conditions, which were paid in full in February 2016. In addition, certain key employees of MMR were entitled to retention payments of which $144,397 in cash and $62,883 in the form of 18,998 ordinary shares which were paid upon closing. An additional, $266,394 in cash and $208,169 in the form of 92,348 ordinary shares that were subject to retention conditions, were paid to such key employees in February 2016. Make Me Reach has become part of Perion’s focus on mobile marketing which was created to address the advertising needs of mobile app developers, and enables Perion to provide a more omprehensive technical and platform solution for app developers. Make Me Reach is a Facebook Marketing Partner, Instagram partner and Twitter Official Partner (TOP).
 
On July 15, 2014, we completed the acquisition of 100% of the shares of Grow Mobile LLC, a Delaware corporation.  Grow Mobile provides an innovative platform for mobile advertising that enables developers to buy, track, optimize and scale user acquisition campaigns from a single dashboard. For the acquisition of Grow Mobile, the Company paid total consideration of $17 million in cash and in shares, and the sellers were entitled to an additional milestones-based contingent payment of up to $25 million in cash and in shares.
 
On July 8, 2015, we entered into an amendment to the Grow Mobile acquisition agreement.  Under the amendment, the contingent payment was cancelled and in exchange, we agreed to pay $2.5 million of which $1.5 million was paid in cash and $1.0 million was in the form of 315,263 ordinary shares. In addition, we agreed to accelerate the release of the $1.5 million escrow deposit, which was originally scheduled to be released on September 30, 2016. Under the amendment, $1.0 million of the escrow deposit was released immediately and the remaining balance of $0.5 million was released on December 31, 2015.
 
Grow Mobile provides an innovative platform for mobile advertising that enables advertisers of mobile applications to buy, track, optimize, and scale user acquisition campaigns from a single dashboard. Grow Mobile has become part of Perion’s mobile marketing business, which was created to address the needs of advertisers of mobile applications, and will enable Perion to provide a more comprehensive technical and platform solution for app developers.
 
On January 2, 2014, we completed the purchase of all of the outstanding shares of ClientConnect. On December 31, 2013, pursuant to a Split Agreement, Conduit transferred to ClientConnect the entire activities and operations, and related assets and liabilities, of its ClientConnect business on a cash-free and debt-free basis and the Conduit shareholders became the shareholders of ClientConnect in proportion to their ownership of Conduit. Upon the consummation of the ClientConnect Acquisition, each ClientConnect ordinary share was exchanged for approximately 0.2387 of our ordinary shares, as a result of which ClientConnect became a wholly owned subsidiary of ours. In addition, we granted options to purchase our ordinary shares to ClientConnect employees in exchange for their options to purchase ClientConnect shares that were issued to them upon the consummation of the Conduit Split as a roll-over of their then existing options to purchase ordinary shares of Conduit. Accordingly, we issued 54.75 million of our ordinary shares to the ClientConnect shareholders and granted options to purchase 2.82 million of our ordinary shares to the ClientConnect employees. Immediately, following the closing, we were owned approximately 81% by the former ClientConnect shareholders and option holders and 19% by our pre-closing shareholders and option holders, on a fully diluted basis (as determined by the treasury stock method, together with an adjustment for an assumed issuance of our ordinary shares at a reference price of $10.49 per share based on the Black Scholes values of out-of-the-money Perion options and ClientConnect options). ClientConnect provides distribution, monetization and analytical services to software developers, distributors and publishers.
 
 
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In accordance with Accounting Standards Codification Topic 805, "Business Combinations" ("ASC 805"), using the acquisition method of accounting, ClientConnect is deemed the accounting acquirer and Perion is deemed the accounting acquiree. In accordance with the ASC 805 presentation requirements, following the acquisition, our financial statements include ClientConnect’s comparative numbers, namely, consolidated balance sheets as of December 31, 2013, and the related consolidated statements of income, comprehensive income, changes in shareholders' equity and cash flows for each of the two years in the period ended December 31, 2013.
 
Revenues

We generate our revenues primarily from two major sources: (i) search-generated revenues; and (ii) advertising and other. The following table shows our revenues by category (in thousands of U.S. dollars):

   
Year Ended December 31,
 
   
2013
   
2014
   
2015
 
                   
Search
  $ 277,275     $ 330,757     $ 172,277  
Advertising and other
    48,233       57,974       48,673  
                         
Total Revenues
  $ 325,508     $ 388,731     $ 220,950  
 
In 2014, revenues increased by 19% compared to 2013 due to organic growth, as well as the acquisition of Perion’s search activity. In 2015, revenues decreased by 43%, primarily as a result of our decision to dramatically reduce customer acquisition costs starting from the third quarter of 2014.  This decision reduced the tail of revenues going into 2015, as compared to 2014, and reduced ongoing revenues from our new revenue share model.

Advertising and other revenues increased in 2014, primarily as a result of acquiring Perion's activity, including display advertising and sales of the proprietary products Smilebox and IncrediMail. In 2015, advertising and other revenues decreased as well, primarily as these revenues were a side product of our search revenue monetization model and declined together with search as we decided to reduce our investment in customer acquisition. This decrease was partially offset by the revenues recorded from one month of Undertone’s activity, as the acquisition closed on November 30, 2015.

Cost of Revenues

Cost of revenues consists primarily of salaries and related expenses, license fees, amortization of acquired technology and payments for content and server maintenance. Cost of revenues as a percentage of revenues increased with the Perion acquisition in 2014, where cost of revenues was higher relating to the product revenues.  In 2015, cost of revenues increased primarily due to the costs associated with Undertone’s activity in December of 2015.  There were no employees included in cost of revenues in 2013, while at the end of 2014 and 2015 there were 22 and 20, respectively.

Customer Acquisition and Media Buy Costs

Our customer acquisition costs consist primarily of payments to publishers and developers who distribute our search properties together with their products, as well as the cost of distributing our own products. Media buy costs consist mainly of the costs of advertising inventory incurred to deliver ads. Customer acquisition costs are primarily based on fixed fee arrangements and on revenue share agreements with our traffic sources. We increased customer acquisition costs dramatically in 2013, with the aim to increase the number of product downloads, users, search queries generated by those downloading our software or that of our partners, and subsequently, revenue from search, premium subscriptions and advertising, in an effort to offset the decreasing revenue levels under our search agreement with Microsoft. As a result of changes in the marketplace, and our being more selective regarding the partners we work with, in the third quarter of 2014 we reduced our investment in customer acquisition by nearly half and have maintained a similar level of expenditure since. In order to mitigate some of the risk inherent in the lack of visibility regarding the generation of future revenues by the users of our partners' software, since the beginning of  2015 we have sought to work with our partners on revenue share agreements instead of fixed fee arrangements. This reduction was partially offset by an increase in media buy costs coming from the one month of activity included from Undertone since its acquisition. Customer acquisition and media buy costs were $185.4 million, $174.6 million and $91.2 million in 2013, 2014 and 2015, respectively.  We continue to work exclusively by the sharing of future revenues, rather than pay an up-front fixed fee to our partner software developers. Therefore, with the trailing off of revenues coming from the old model of prepaying for installs, revenues that were without expense in subsequent periods, the percentage of revenues invested in and generated through customer acquisition will increase in 2016. This is in addition to the media buy costs paid by Undertone to its publishers, increasing this cost dramatically in 2016. However, since this cost is relatively lower as a percentage of revenue in the Undertone business, we expect this expense in total as a percentage of revenues to decline in 2016.

 
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Research and Development Expenses

Our research and development expenses consist primarily of salaries and other personnel-related expenses for employees primarily engaged in research and development activities, allocated facilities costs, subcontractors and consulting fees. Our research and development expenditures in 2015 decreased compared to the prior year, primarily as a result of the restructuring of our search monetization business in November 2014, including a head count reduction as well as other cost saving measures, such as the consolidation of our Israeli offices. In addition, in 2015, we capitalized expenses, representing mainly compensation expenses for employees engaged in the development of our Growmobile platforms. The decrease was partially offset by Undertone’s one month of expenses as a result of the acquisition.

We continue to invest development effort in our high impact search-based formats in our desktop monetization offering, adapting and maintaining compatibility with the ever-changing software landscape in which we operate. This is in addition to the ongoing development effort in our high impact ad formats and technologies with the acquisitions of Make Me Reach and Undertone. As a result, we expect a nominal increase in research and development expense in 2016, which, coupled with a decrease in revenues, would cause this expense to increase as a percentage of revenues, as well.

The number of employees in research and development were 173, 217 and 221 at the end of 2013, 2014 and 2015, respectively.

Selling and Marketing Expenses

Our selling and marketing expenses consist primarily of salaries and other personnel-related expenses for employees primarily engaged in marketing activities, allocated facilities costs, as well as other outsourced marketing activity. This expenditure and the number of employees involved in this activity has increased and is expected to continue to increase as the Company and its various activities shift and the increasing emphasis on selling and marketing its products to grow the business, as well as a result of the Undertone acquisition. The number of employees in sales and marketing was 66, 115 and 227 at the end of 2013, 2014 and 2015, respectively.

General and Administrative Expenses ("G&A")

Our general and administrative expenses consist primarily of salaries and other personnel-related expenses for executive and administrative personnel, allocated facilities costs, professional fees and other general corporate expenses. G&A expenses in 2013 are those of ClientConnect prior to the acquisition of Perion and reflect the G&A expenses of a private company, acting as a division of a larger one, focused on organic growth. G&A expenses since 2014 are reflective of an independent public company, with all of its requisite costs, managing organic activity as well as being an active acquire of other businesses. In 2015, this number increased further, primarily as result of the substantial Undertone acquisition and the costs associated with it.  The number of G&A employees was 55, 98 and 128 at the end of 2013, 2014 and 2015, respectively.
 
Restructuring Charges

In 2014, we incurred restructuring charges of $4.0 million due to the restructuring of our search monetization business, including a head count reduction as well as other cost saving measures, such as the consolidation of our Israeli offices from three floors to two in order to sublease the third floor.

 
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In 2015, we incurred restructuring charges of $1.1 million in connection with the restructuring plan of one of our consumer app development project, mainly to reduce workforce, close certain facilities, as well as other cost saving measures.

Impairment, net of change in fair value of contingent consideration

We determined that certain indicators of potential impairment that required an interim goodwill impairment analysis for our reporting units existed in 2015. These indicators included a decrease in our share price and lower than expected sales and cash flow, as well as managerial decisions to abandon certain R&D projects. Based on our goodwill assessment for the search monetization reporting unit and Growmobile unit, we determined that the carrying amount of the reporting units exceeds its fair value resulting in an impairment of $70.9 million and $16.2 million, respectively. We will continue to monitor our reporting units to determine whether events and changes in circumstances, such as significant adverse changes in business climate or operating results, further significant decline in our market capitalization, changes in management's business strategy or changes of management's cash flows projections, warrant further impairment testing. In addition, we performed an impairment review of several intangible assets that were recognized in connection with the acquisition of Grow Mobile, its capitalized software costs and the Perion acquisition, which resulted in an impairment of $11.9 million. The impairment charges were measured as the difference between the carrying amounts of those intangible assets and their fair values.

We recorded a net gain of $6.6 million, comprised of the change in fair value of the previously accrued contingent payment, related to the Grow Mobile acquisition, in the amount of $9.1 million, net of the $2.5 million accrual of the payments we made in connection with amendment to the acquisition agreement in July 2015.

Income Tax Expense

A significant portion of our income is taxed in Israel. The standard corporate tax rate in Israel was 26.5% in 2015 and 2014 and 25.0% in 2013. In 2016 and thereafter, the rate will be 25.0%. For our Israeli operations we have elected to implement a tax incentive program pursuant to a 2011 Israeli tax reform, referred to as a "Preferred Enterprise," according to which a reduced tax rate of 16% is applied to our preferred income in 2015. With the Undertone acquisition we expect to have taxable income in the U.S. and to utilize cumulated losses we have from prior US acquisitions.

Critical Accounting Policies and Estimates

The discussion and analysis of our financial condition and results of operation are based on our financial statements, which have been prepared in conformity with U.S. GAAP. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We evaluate these estimates on an on-going basis. We base our estimates on our historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying amount values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. Under U.S. GAAP, when more than one accounting method or policy or its application is generally accepted, our management selects the accounting method or policy that it believes to be most appropriate in the specific circumstances. Our management considers some of these accounting policies to be critical.

A critical accounting policy is an accounting policy that management believes is both most important to the portrayal of our financial condition and results and requires management’s most difficult subjective or complex judgment, often as a result of the need to make accounting estimates about the effect of matters that are inherently uncertain. While our significant accounting policies are discussed in Note 2 of the Financial Statements, we believe the following accounting policies to be critical:

Stock-Based Compensation

We account 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, stock-based compensation expense and our results of operations would be impacted. Expense is recognized for the value of the awards, which have graded vesting based on service conditions, using the straight line method, over the requisite service period of each of the awards, net of estimated forfeitures. Estimated forfeitures are based on actual historical pre-vesting forfeitures. For performance-based stock units, expense is recognized for the value of such awards, if and when we conclude that it is probable that a performance condition will be achieved. We are required to reassess the probability of the vesting at each reporting period for awards with performance conditions and adjust compensation cost based on its probability assessment.

 
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We account for changes in award terms as a modification in accordance with ASC 718. A modification to the terms of an award should be treated as an exchange of the original award for a new award with total compensation cost equal to the grant-date fair value of the original award plus the incremental value measured at the same date. Under ASC 718, the calculation of the incremental value is based on the excess of the fair value of the new (modified) award based on current circumstances over the fair value of the original award measured immediately before its terms are modified based on current circumstances.

Total stock-based compensation expense recorded during 2015 was $7.4 million, of which $0.2 million was included in cost of revenues, $1.0 million was included in research and development costs, $1.9 million in selling and marketing expenses, $4.3 million in general and administrative expenses.

As of December 31, 2015, the maximum total compensation cost related to options and restricted stock units ("RSUs"), granted to employees and directors not yet recognized amounted to $8.9 million. This cost is expected to be recognized over a weighted average period of 1.25 years.

We estimate the fair value of standard stock options granted using the Binomial method option-pricing model. The option-pricing model requires a number of assumptions, of which the most significant is expected stock price volatility. Expected volatility was calculated based upon actual historical stock price movements of our stock. The risk-free interest rate is based on the yield from U.S. Treasury zero-coupon bonds with an equivalent term. The fair value of RSUs is based on the market value of the underlying shares at the date of grant.


We are subject to income taxes in Israel and the United States. 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. 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, 2015 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 13 of the 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.

 
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Business Combinations

We allocate the fair value of purchase consideration to the tangible assets acquired, liabilities assumed and intangible assets acquired based on their estimated fair values. The excess of the fair value of purchase consideration over the fair values of these identifiable assets and liabilities is recorded as goodwill. When determining the fair values of assets acquired and liabilities assumed, management makes significant estimates and assumptions, especially with respect to intangible assets.

Critical estimates in valuing certain intangible assets include but are not limited to future expected cash flows from customer relationships and acquired patents and developed technology; and discount rates. Management’s estimates of fair value are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable and, as a result, actual results may differ from estimates.

Other estimates associated with the accounting for acquisitions may change as additional information becomes available regarding the assets acquired and liabilities assumed, as more fully discussed in Note 3 of the Financial Statements.

Goodwill

Goodwill is allocated to reporting units expected to benefit from the business combination. We test goodwill for impairment at the reporting unit level at least annually, or more frequently if events or changes in circumstances occur that would more likely than not reduce the fair value of a reporting unit below its carrying value. Goodwill impairment tests require judgment, including the identification of reporting units, assignment of assets and liabilities to reporting units, assignment of goodwill to reporting units, and determination of the fair value of each reporting unit. In 2015, we incurred impairment charges of $87.0 million, related to goodwill associated with the monetization and Growmobile reporting units.

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 and 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 these estimates 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. In 2014, we incurred impairment charges of $19.9 million related to intangible assets associated with desktop technologies acquired in the acquisition of Perion that were determined during the process of integration with Perion to be redundant to the technology of ClientConnect. This impairment was also a result of our shifting future growth strategy towards mobile platforms and discontinuing some of the consumer products developed. In 2015, we incurred impairment charges of $11.9 million related to intangible assets and capitalized software costs associated with our Growmobile and monetization reporting units.

In addition, in connection with the restructuring plans in 2014 and 2015, we recorded an impairment of $0.6 million and $0.1 million of property and equipment.

 
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Derivative and Hedge Accounting
 
During fiscal 2015 and 2014, approximately 18% and 15% of our operating expenses, respectively, were denominated in new Israeli shekels (“ILS”). In order to mitigate the potential adverse impact on cash flows resulting from fluctuations in the exchange rate of the ILS, we started to hedge portions of our forecasted expenses with options contracts. The effective portion of the gain or loss on the derivative is reported as a component of other comprehensive income and reclassified into earnings in the same period, or periods, during which the hedged transaction affects earnings. The ineffective portion of a derivative’s change in fair value, if any, is recognized in earnings, as well as gains and losses from a derivative’s change in fair value that are not designated as hedges are recognized in earnings immediately. We have also entered into a cross currency interest rate SWAP agreement in order to transform cash flow in ILS into USD of interest payments and principal as derived from our convertible debt conditions (see note 9). The SWAP contracts were not designated as hedging instruments and therefore gains or losses resulting from the change of their fair value are recognized in "financial income, net". We estimate the fair value of such derivative contracts by reference to spot rates quoted in active markets.

Establishing and accounting for foreign exchange contracts involve judgments, such as determining the fair value of the contracts, determining the nature of the exposure, assessing its amount and timing, and evaluating the effectiveness of the hedging arrangement.

Although we believe that our estimates are accurate and meet the requirement of hedge accounting, if actual results differ from these estimates, such difference could cause fluctuation of our recorded revenue and expenses.

Recent Accounting Standards
 
In February 2016, the FASB issued ASU 2016-02, Leases. ASU 2016-02 requires that long-term lease arrangements be recognized on the balance sheet. The standard is effective for interim and annual periods beginning after December 15, 2018, and early adoption is permitted. The Company is currently evaluating the impact of adoption on its consolidated financial statements.
 
In September 2015, the FASB issued ASU 2015-16, Simplifying the Accounting for Measurement-Period Adjustments (Topic 805): Business Combinations, which requires that an acquirer recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined. The standard is effective for fiscal years beginning after December 15, 2015, including interim periods within those fiscal years. The guidance is to be applied prospectively to adjustments to provisional amounts that occur after the effective date of the standard, with earlier application permitted for financial statements that have not been issued. The Company does not expect that the adoption of this ASU will have a significant impact its consolidated financial statements.

In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update No. 2014-09 (ASU 2014-09) "Revenue from Contracts with Customers." ASU 2014-09 supersedes the revenue recognition requirements in “Revenue Recognition (Topic 605)”, and requires entities to recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled to in exchange for those goods or services. As currently issued and amended, ASU 2014-09 is effective for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period, though early adoption is permitted for annual reporting periods beginning after December 15, 2016. We are currently in the process of evaluating the impact of the adoption of ASU 2014-09 on our consolidated financial statements.
 
Adoption of New Accounting Standard

In November 2015, the FASB issued Accounting Standards Update No. 2015-17 (ASU 2015-17) “Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes”.  ASU 2015-17 simplifies the presentation of deferred income taxes by eliminating the separate classification of deferred income tax liabilities and assets into current and noncurrent amounts in the consolidated balance sheet statement of financial position. The amendments in the update require that all deferred tax liabilities and assets be classified as noncurrent in the consolidated balance sheet. The amendments in this update are effective for annual periods beginning after December 15, 2016, and interim periods therein and may be applied either prospectively or retrospectively to all periods presented. Early adoption is permitted. We have early adopted this standard in the fourth quarter of 2015 on a retrospective basis. Prior periods have been retrospectively adjusted.
 
As a result of the adoption of ASU 2015-17, we made the following adjustments to the 2014 balance sheet: a $3,000 decrease to current deferred tax assets, a $3,000 increase to noncurrent deferred tax asset, there was no change in noncurrent deferred tax liability.

In April 2015, the FASB issued guidance on debt issuance costs. The guidance requires entities to present debt issuance costs related to a recognized debt liability as a direct deduction from the carrying amount of that debt in the balance sheet. This guidance does not contain guidance for debt issuance costs related to line-of-credit arrangements. Consequently, in August 2015, the FASB issued additional guidance to add paragraphs indicating that the SEC staff would not object to an entity deferring and presenting debt issuance costs related to line-of-credit arrangements as an asset and subsequently amortizing the deferred debt issuance costs ratably over the term of the line-of-credit arrangement, regardless of whether there are any outstanding borrowings on the line-of-credit arrangement. The guidance is effective for the interim and annual periods beginning on or after December 15, 2015. We have early adopted the guidance for debt outstanding, as of December 31, 2015. There was no effect on prior year's presentation.
 
 
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Results of Operations

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):
 
   
Year Ended December 31,
 
   
2013
   
2014
   
2015
 
Revenues:
                 
Search
    85 %     85 %     78 %
Advertising and Other
    15       15       22  
Total revenues
    100 %     100 %     100 %
                         
Costs and expenses:
                       
Cost of revenues
    2 %     7 %     7 %
Customer acquisition and media buy costs
    57       45       41  
Research and development
    7       11       12  
Selling and marketing
    3       7       13  
General and administrative
    6       10       14  
Restructuring charges
    -       1       -(* )
Impairment, net of change in fair value of contingent consideration
    -       5       42  
Total costs and expenses
    75       86       130  
                         
Operating income (loss)
    25       14       (30 )
Financial income (expense), net
    1       (1 )     (1 )
Income (loss) before taxes on income
    26       13       (31 )
Income tax expense
    7       2       -(* )
Income (loss) from continuing operations
    19       11       (31 )
Loss from discontinuing operations, net
    (10 )     -       -  
Net income
    9 %     11 %     (31 )%

(*) less than 1

Year Ended December 31, 2015 Compared to Year Ended December 31, 2014
 
Revenues. Revenues decreased by 43%, from $388.7 million in 2014, to $221.0 million in 2015.
 
Search revenues. Search revenues decreased by 48% in 2015, from $330.8 million in 2014, to $172.3 million in 2015. This decrease was primarily a result of our decision to dramatically reduce customer acquisition costs starting from the third quarter of 2014.  This decision reduced the tail of revenues going into 2015, as compared to 2014, and also reduced ongoing revenues from our new revenue share model.  Our search revenues have substantially been stable since the second quarter of 2015, albeit at a lower level than previously, and as a result, we expect them to continue and contribute a substantial part of our revenues in 2016.

 
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Advertising and other revenues. Advertising and other revenues decreased by 16% in 2015, from $58.0 million in 2014 to $48.7 million in 2015. This decrease is primarily attributable to these revenues being substantially a side product of our search revenue monetization model and declined together with search as we decided to reduce our investment in customer acquisition. This decrease was partially offset by the revenues recorded from one month of Undertone’s activity, as the acquisition closed on November 30, 2015.  As a result of this acquisition, we expect advertising revenues to increase dramatically in 2016 as compared to 2015, greatly diversifying our revenue sources.

The following table shows costs and expenses by category (in thousands of U.S. dollar):

   
Year ended December 31
 
   
2013
   
2014
   
2015
 
                   
Cost of revenues
  $ 6,104     $ 27,817     $ 16,195  
Customer acquisition and media buy costs
    185,355       174,575       91,217  
Research and development
    22,394       44,129       26,377  
Selling and marketing
    10,298       25,388       28,270  
General and administrative
    19,115       37,605       31,520  
Restructuring charges
    -       3,981       1,052  
Impairment, net of change in fair value of contingent consideration
    -       19,941       92,340  
                         
Total Costs and Expenses
  $ 243,266     $ 333,436     $ 286,971  

Cost of revenues. Cost of revenues decreased by $11.6 million, or 42%, from $27.8 million in 2014, to $16.2 million in 2015. The decrease was primarily attributable to an $8.5 million decrease in amortization of intangible assets, as a result of an impairment of certain intangible assets in the fourth quarter of 2014 and to lesser extent in 2015. In addition, our hosting expenses decreased by approximately $2.7 million due to the reduction in our search revenue volume.

Customer acquisition costs (“CAC”) and media buy costs. Decreased by $83.4 million, or 48%, from $174.6 million in 2014, compared to $91.2 million in 2015. This decrease was a result of our decision to be more selective regarding our partners, coupled with the transition of our agreements from a prepayment per install method in 2014 to paying our partners a portion of the revenues generated as they are generated. In addition, $16.7 million of CAC associated to search revenues presented on net basis, was deducted directly from revenues in 2015. This reduction was partially offset by the increase in media buy costs of Undertone for the one month since the acquisition.  As a result of our stabilizing our CAC in the search business and the acquisition of Undertone and consolidating its media buying costs in the latter part of 2015, we expect this expenditure to increase in 2016, while it may not increase as a percentage of revenues as these costs are a lower percentage at Undertone.
 
Research and development expenses ("R&D"). R&D decreased by $17.8 million in 2015, or 40%, from $44.1 million in 2014, to $26.4 million in 2015. The decrease is primarily attributable to the restructuring of our search monetization business in November 2014, including a head count reduction as well as other cost saving measures, such as the consolidation of our Israeli offices. In addition, in 2015, $4.0 million was capitalized, representing mainly compensation expenses for employees engaged in the development of our mobile advertising platform with an emphasis on the self-service offering and a platform for optimizing and increasing the retention and subsequent monetization from the users of our partners' mobile apps. These costs were in addition to the ongoing development effort required in our desktop monetization offering; to adapt to and maintain compatibility with the ever-changing software landscape in which we operate. With the acquisition of Undertone in the latter part of 2015, we expect R&D to increase for the full year of 2016, but we do not expect it will increase as a percentage of revenues.

Selling and marketing expenses ("S&M"). Selling and marketing expenses increased by $2.9 million, or 11%, from $25.4 million in 2014 to $28.3 million in 2015. This increase was primarily attributable to expenses related to the acquisitions of Grow Mobile, Make Me Reach and Undertone in July 2014, February 2015 and November 2015, respectively, offset by a decrease in expenses resulting from the restructuring of our search monetization business in November 2014. S&M expenses are substantial at Undertone, and as a result on a consolidated basis, we expect this expenditure to increase both nominally and as a percentage of revenues in 2016.

General and administrative expenses ("G&A"). G&A decreased by $6.1 million, or 16%, from $37.6 million in 2014, to $31.5 million in 2015. The decrease was primarily attributable to decreases of $5.0 million in share based compensation and to the restructuring taken place in November 2014, including a head count reduction as well as other cost saving measures. The decrease is partially offset by the G&A costs of Undertone as a result of the acquisition. We expect G&A expense in 2016 to increase nominally, but to remain stable as a percentage of sales.

 
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Impairment, net of change in fair value of contingent consideration. We recorded a net gain of $6.6 million, comprised of the change in fair value of the previously accrued contingent payment, associated with the Grow Mobile acquisition, in the amount of $9.1 million, net of the $2.5 million accrual of the Release Payment.

We determined that certain indicators of potential impairment that required an interim goodwill impairment analysis for our reporting units existed in 2015. These indicators included a decrease in our share price and lower than expected sales and cash flow, as well as managerial decisions to abandon certain R&D projects. Based on our goodwill assessment for the search monetization reporting unit, we determined that the carrying amount of the reporting unit exceeds its fair value amount, as a result an impairment of $87.0 million was recorded. This impairment is included in impairment, change in fair value of contingent consideration, in the statement of income for 2015. We will continue to monitor our reporting units to determine whether events and changes in circumstances, such as significant adverse changes in business climate or operating results, further significant decline in our market capitalization, changes in management's business strategy or changes of management's cash flows projections, warrant further impairment testing. In addition, we performed an impairment review of several intangible assets that were recognized in connection with the acquisitions of Grow Mobile and Perion in addition to software capitalized costs in regards to our Growmobile platforms, which resulted in an impairment of $11.9 million. The impairment charges were measured as the difference between the carrying amounts of those intangible assets and their fair values.

Taxes on income. Taxes on income decreased by $8.9 million from $9.6 million in 2014 to $0.7 million in 2015. The decrease in the tax expenses is linked to the decrease in our income before tax as a result of the decrease in revenues as aforementioned. In addition, we have recorded a tax benefit of $7.1 million as a result of reversal of a valuation allowance in respect of net operating losses which after the acquisition of Undertone, it is more likely than not they will be utilized in future periods.

Net income (loss). Net income decreased by $111.5 million from net income of $42.8 million in 2014, to net loss of $68.9 million in 2015. The decrease resulted primarily from increase in impairment costs in the amount of $79.0 million in 2015, the decrease in our revenues, net of CAC and media buying, in the amount of $84.4 million, partially offset by a change in fair value of contingent consideration in the amount of $6.6 million, a decrease in the amortization of intangible assets of $9.9 million, a decrease in our share based compensation expenses of $7.5 million, decrease in tax expenses of $8.9 million, decrease in restructuring costs of $2.9 million and other significant cost saving measures, mostly attributable to the restructuring of our search monetization business in November 2014 and the consolidation of our Israeli offices.
 
 
 
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Year Ended December 31, 2014 Compared to Year Ended December 31, 2013

Revenues. Revenues increased by 19%, from $325.5 million in 2013, to $388.7 million in 2014. This increase was a result of increases in each of our revenue streams, as discussed below:

Search revenues. Search revenues increased by 19% in 2014, from $277.3 million in 2013, to $330.8 million in 2014. This increase was due to an increase in the number of downloads and consequently the number of users using our search service. This increase is attributable to organic growth, as well as the acquisition of Perion’s activity, which too was based on search-generated revenues. In 2013, Perion’s search revenues were $59.0 million. The year over year growth occurred entirely in the first half of 2014, when we recorded search-generated revenues of $189.3 million, increasing 38% over the first half of 2013. In the second half of 2014, with the reduced level of visibility regarding the future revenues from newly acquire users, we drew back on our customer acquisition costs and revenues declined, with search-generated revenues totaling $68.1 million in the fourth quarter of 2014, reflecting a 4% decrease as compared to the fourth quarter of 2013. We expect to maintain this lower level of customer acquisition costs and therefore expect a continued decline in revenues going into 2016.

Advertising and other revenues. Advertising and other revenues increased by 20% in 2014, from $48.2 million in 2013 to $58.0 million in 2014. This increase is primarily attributable to the acquisition of Perion’s activity, its products and advertising revenues. In 2013, Perion’s product and other revenues were $28.1 million. In addition the increase was due to display advertising revenues that are to a great extent dependent on the distribution being done for search-generated revenues. This increase was partially offset by a decrease resulting from certain policy changes associated with the distribution of toolbars, causing us to discontinue one of our toolbar marketing venues. As with search generated revenues, the increase in these other revenues was attributable to the first half of the year, when such revenues totaled $35.0 million, an increase of 51% over the first half of 2013, while in the second half of 2014, with the decrease in customer acquisition costs, such revenues decreased as well, with a 23% decrease in the fourth quarter of 2014, from $13 million in the fourth quarter of 2013 to $10.0 million, in the fourth quarter of 2014.

The following table shows costs and expenses by category (in thousands of U.S. dollars):

   
Year ended December 31,
 
   
2013
   
2014
 
             
Cost of revenues
  $ 6,104     $ 27,817  
Customer acquisition costs
    185,355       174,575  
Research and development
    22,394       44,129  
Selling and marketing
    10,298       25,388  
General and administrative
    19,115       37,605  
Impairment and restructuring charges
    -       23,922  
                 
Total costs and expenses
  $ 243,266     $ 333,436  

Cost of revenues. Cost of revenues in 2014 was $27.8 million, as compared to $6.1 million in 2013, representing an increase of 356 %. The increase is primarily attributable to amortization of intangible assets of $15.7 million due to acquisitions, as well as the cost of revenues for Perion’s legacy business recorded in 2014 and not included in 2013. In 2013, Perion’s cost of revenues were $11.4 million. The increase in amortization expenses caused the gross profit margin to decrease from 98% in 2013 to 93% in 2014.

Customer acquisition costs (“CAC”). CAC amounted to $174.6 million in 2014, compared to $185.4 million in 2013, representing a decrease of 6%. This decrease was entirely in the second half of 2014, when CAC amounted to $59.0 million, reflecting a 43% decrease compared to the second half of 2013. Our reduced level of investment was in light of our not having sufficient visibility to ensure a positive return on this investment, and as a result, our decision to engage higher margin software developing partners.

 
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Research and development expenses ("R&D"). R&D increased by $21.7 million in 2014, from $22.4 million in 2013, or 7% of revenues, to $44.1 million, or 11% of revenues, in 2014. The increase was primarily attributable to maintaining the technological edge of our desktop technologies and their ability to adapt to changing Internet platforms, as well as to investing in mobile advertising platforms, primarily in our advertising marketing platform, and to developing tools and platforms to enhance our ability to increase advertising revenues, independent of our search offering.

Selling and marketing expenses ("S&M"). Selling and marketing expenses increased 147%, from $10.3 million in 2013 to $25.4 million in 2014. This increase was primarily attributable to the Perion acquisition. In 2013, Perion's S&M expenses amounted to $11.1 million.

General and administrative expenses ("G&A"). G&A increased 97%, from $19.1 million in 2013 to $37.6 million in 2014. The increase reflects primarily the fact that 2013 does not include Perion’s activity and G&A in that year are those of ClientConnect prior to the acquisition, reflecting the G&A expenses of a private company, acting as a division of a larger one, focused on organic growth. G&A expenses in 2014 are reflective of an independent public company, with all of its requisite costs, managing organic activity as well as being an active acquirer of other businesses. In 2013, Perion’s G&A expenses were in the amount of $15.1 million.

Impairment and restructuring charges. Impairment charges of $19.9 million related to intangible assets associated with desktop technologies acquired in the Perion acquisition that during the integration process were determined to be redundant to the technology of ClientConnect. This impairment was also a result of our shifting future growth strategy towards mobile platforms and discontinuing some of the desktop products and technologies that we had developed or acquired.

On November 6, 2014, we announced a restructuring of our search monetization business, which included a head count reduction as well as other cost saving measures, such as consolidating of our Israeli offices from three floors to two in order to sublease the third floor. The cost of $4.0 million recorded reflects expenses accrued, resulting from this restructuring.

Taxes on income. Income tax in 2014 was $9.6 million, compared to $22.6 million in 2013. In 2013, taxes on income includes tax expenses of $11.8 million in respect of release of ClientConnect trapped earnings. Excluding such $11.8 million, the effective tax rate in 2013 was 13%, increasing to 18% in 2014, primarily as a result of the significant increase in expenses not deductible for tax purposes in 2014, including $3.2 million of acquisition-related costs and $4.7 million in employee stock-based compensation.

Net income. Net income in 2014 was $42.8 million, compared to $28.6 million in 2013. This increase was primarily a result of net loss of $33.8 million from discontinued operations in 2013, partially offset by an impairment costs to intangible assets in the amount of $19.9 million, net of deferred tax benefit of $3.2 million that did not contribute to the current operations.
 
B. 
LIQUIDITY AND CAPITAL RESOURCES

As of December 31, 2015, we had $60.0 million in cash, cash equivalents and short-term deposits, compared to $116.2 million at December 31, 2014. The $56.2 million decrease is primarily the result of cash paid, net of cash acquired, for the acquisition of Make Me Reach and Undertone in the amounts of $5.3 million and $81.7 million, respectfully, partially offset by $17.5 million cash provided by operating activities, $10.0 million from the issuance of shares in a private placement.

For 2013, 2014 and 2015, our cash flows were as follows (in thousands of U.S. dollars):

   
Year ended December 31
 
   
2013
   
2014
   
2015
 
                   
Net cash provided by operating activities
  $ 61,352     $ 72,042     $ 17,569  
Net cash used in investing activities
    (76,975 )     (6,984 )     (120,446 )
Net cash provided by (used in) continuing financing activities
    (64,159 )     35,176       19,199  
Effect of exchange rate changes on cash and cash equivalents
    -       -       14  
                         
    $ (79,782 )   $ 100,234     $ (83,664 )

 
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Net cash provided by operating activities

In 2015, our operating activities provided cash in the amount of $17.6 million, primarily as a result of net loss in the amount of $68.9 million, decreased by non-cash depreciation and amortization of $12.0 million, impairment expenses of $98.9 million, non-cash share-based compensation expenses of $7.4 million, offset by a decrease of $5.6 million in the payment obligation related to an acquisition and by net changes of $26.5 million in operating assets and liabilities.

In 2014, our operating activities provided cash in the amount of $72.0 million, primarily due to net income of $42.8 million, increased by non-cash depreciation, amortization and impairment expenses of $42.0 million, non-cash stock-based compensation expenses of $15.1 million, other non-cash expenses of $3.5 million and an increase in accounts payable and accrued expenses of $12.0 million, offset by a net increase of $13.9 million in deferred tax assets, an increase in accounts receivable of $23.6 million and changes of $5.9 million in other operating assets and liabilities.

In 2013, our continuing operating activities provided cash in the amount of $85.3 million primarily due to net income from continuing operations of $62.4 million, increased by non-cash depreciation and amortization of $2.1 million, non-cash stock-based compensation expenses of $10.4 million, other non-cash expenses of $1.2, a decrease in accounts receivables of $18.0 million and an increase in accounts payable of $8.7 million, offset by a decrease in deferred revenues of $6.2 million and changes in other operating assets and liabilities of $11.3 million.

Net cash used in investing activities

In 2015, our investing activities used cash in the amount of $120.4 million, primarily due to $27.4 million invested in short-term bank deposits, $5.3 million in cash used for the acquisition of Make Me Reach, $81.7 million in cash used for the acquisition of Undertone, $2.0 million invested in the purchase of property and equipment and $4.0 million invested in development costs that were capitalized.

In 2014, our investing activities used cash in the amount of $7.0 million, primarily due to $10.9 million invested in the purchase of property and equipment, $4.3 million in cash used for the acquisition of Grow Mobile and a deposit of $15.0 million in short term bank deposits, partially offset by cash acquired through the acquisition of Perion in the amount of $23.4 million.

In 2013, our continuing investing activities used cash in the amount of $77.9 million, primarily due to investments in short term investments, net of proceeds, of $76.0 million and purchase of property and equipment of $1.9 million.

Net cash provided by (used in) financing activities

In 2015, our financing activities provided cash in the amount of $19.2 million, primarily due to the $13.0 million proceeds from a short-term loan and proceeds from issuance of shares in the amount of $10.0 million, partially offset by $1.5 million of payment made in connection with prior acquisition and $2.3 million repayment of long-term bank loans

In 2014, our financing activities provided cash in the amount of $35.2 million, primarily from $37.9 million raised from the Israeli public in long-term, convertible debt, $1.6 million from the exercise of stock options and $0.5 million contribution by shareholders, offset by $2.5 million payment made in connection with an acquisition and $2.3 million repayment of long-term bank loans.

In 2013, our continuing financing activities used cash in the amount of $64.2 million, primarily due to the $65 million of payment of dividend made upon consummation of the spin-off of ClientConnect from Conduit, partially offset by proceeds from exercise of stock options in the amount of $0.8 million.

 
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Credit Facilities

In September 2011, we entered into a loan agreement with each of Bank Leumi Le-Israel B.M. ("Leumi") and First International Bank of Israel ("FIBI"), to secure a credit facility of up to a total of $20 million of financing. During the second quarter of 2012, we amended both agreements, and in addition reduced the amount of the credit facility to $10 million, $6.0 million provided by Leumi, and $4.0 million by FIBI. In December 2014 we executed a cross-currency and interest SWAP transaction with Leumi in order to mitigate the potential impact of the fluctuations in the ILS/$ exchange rate in regards to the future interest and principal payments of our convertible bonds (described below), which are all denominated in ILS. In April 1, 2015, we amended the agreement with Leumi in regards to the financial covenants to secure the fulfillment of all the obligations, liabilities and indebtedness to Leumi effective December 31, 2014. The repayment of the debt is structured over four and five years from the respective draw dates, and we have an option under each agreement for early repayment. As of December 31, 2015, the outstanding balance of these loans is in the amount of $2.0 million to be paid over the next one to two years, out of which $1.6 million is classified as long term debt and $0.4 million as current maturities. In order to secure our obligations to the banks, we originally granted to the banks a first priority floating charge on all of our assets and a first priority fixed charge on certain other immaterial assets, which were removed in 2014 due to the lower outstanding amounts under the credit facilities. We do have in place negative pledges for the benefit of the banks and liens over other deposits deposited with the banks from time to time.

On November 22, 2015, we borrowed $19.9 million under a new credit facility from Leumi. The credit facility is secured by a lien on the accounts receivable of ClientConnect, from its current and future business clients and is guaranteed by Perion. The credit facility matures in November 2016. As of December 31, 2015, the unpaid balance of the credit facility was $13.0 million bearing interest of Libor + 1.2%.

On November 30, 2015, concurrently with the closing of the Undertone acquisition, Undertone entered into a new secured credit agreement with SunTrust Bank, Silicon Valley Bank and Comerica Bank for $50 million, due in quarterly installments from March 2016 to November 2019. The installments start in the amount of $0.6 million, increase to $1.25 million in March 2018 and require a final payment upon maturity in the amount of $35 million. The outstanding principal amount bears interest at LIBOR plus 5.5% per year and is secured by substantially all the assets of the companies in the Undertone group and by guarantees of such companies. The loan is required to be prepaid by Undertone in certain circumstances, such as from proceeds of asset sales or casualty insurance policies, debt or equity offerings, or from excess cash flow in the event that Undertone's total leverage ratio exceeds specified targets, and a pro rata portion of indemnification payments (or offset of the holdback amount) under our merger agreement with Undertone.

Under the Undertone credit facility, Undertone is required to maintain with the following financial covenants as of the end of each fiscal quarter:

 
·
minimum total leverage ratio starting at 2.5 and declining gradually to 1.15; and
 
·
fixed coverage ratio of at least 2.0.

The Undertone credit facility contains customary restrictive covenants, including those regarding indebtedness and preferred equity, liens, fundamental changes, investments, loans, restricted payments, asset sales, transactions with affiliates, restrictive agreements and sale and leaseback transactions. It also contains customary events of default, including a "change in control", which is defined to include, among other things, the acquisition of record or beneficial ownership by any person or group of 35% or more of Perion's outstanding ordinary shares or the failure of continuing directors to constitute a majority of Perion's board of directors for a period of 24 consecutive months. As of December 31, 2015, the balance of the loan, net of fees, is in the amount of $48.6 million to be paid over the next one to four years, out of which $46.5 million classified as long term debt and $2.1 million as current maturities.

As of December 31, 2015, we had bank loans outstanding in the amount of $63.6 million to be paid over the next one to four years, including $46.9 million classified as long-term debt and $16.7 million as current maturities.

 
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Series L Convertible Bonds

On September 23, 2014, we completed a public offering in Israel of Series L Convertible Bonds (the "Bonds"). The Bonds have an aggregate principal amount of approximately ILS 143.5 million (approximately 36.8$ million as of December 31, 2015) at a price of ILS 965 per unit of ILS 1,000 par value. The Bonds, which are listed on the Tel Aviv Stock Exchange, are convertible into an aggregate of approximately 4.27 million ordinary shares, at a conversion price of ILS 33.605 per share (approximately $8.6 per share as of December 31, 2015). The principal of the Bonds are repayable in five equal annual installments commencing on March 31, 2016, with a final maturity date of March 31, 2020. The Bonds bear interest at the rate of 5% per year, subject to increase to up to 6% in the event of downgrades of our debt rating. The interest is payable semi-annually on March 31 and September 30 of each of the years 2015 through 2019, as well as a final payment on March 31, 2020.

Under the terms of our Bonds, our ability to make distributions is subject to various limitations. In addition, we are required to maintain and comply with the following financial covenants:

 
·
shareholders' equity of at least $120 million at the end of each quarter;
 
·
ratio of net financial indebtedness to twelve-month EBITDA of not more than 2.5 at the end of each quarter;
 
·
twelve-month EBITDA at the end of each quarter of not less than 40% of original aggregate principal amount of the bonds; and
 
·
cash and cash equivalents of at least $10 million (and, six months prior to each principal payment date, a sufficient amount to repay the principal and interest then due).

As of December 31, 2015, we were in compliance with all of the foregoing covenants.

Private placement

On December 3, 2015, we completed a private placement of 4,436,898 ordinary shares for gross proceeds of $10.1 million ($10.0 million net of legal fees) pursuant to a securities purchase agreement with J.P. Morgan Investment Management Inc., as investment advisor to the National Council for Social Security Fund and 522 Fifth Avenue Fund L.P. (collectively referred to as the "Investors"). The purchase price per share was $2.282 per share, which was the average closing price of an ordinary share on the Nasdaq Global Select Market for the 30 trading days ending on December 1, 2015. In the event that on September 1, 2016 the 15-trading day weighted average price of an ordinary share is less than $2.624, the per share purchase price will be adjusted downward 1% for each whole 1% that it is lower than such price, up to a maximum adjustment of 15%, and we will issue to the Investors such number of additional ordinary shares as is necessary so that each of the Investors will receive such number of ordinary shares in total that it would have purchased at the closing of the private placement at such lower price.
 
C. 
RESEARCH, DEVELOPMENT, PATENTS AND LICENSES, ETC.
 
Our research and development activities are conducted internally by a 221 person research and development staff. Research and development expenses were $22.4 million, $44.1 million and $26.4 million in the years ended December 31, 2013, 2014 and 2015, respectively. In 2015, our efforts were focused on maintaining our software products to adapt with changes to operating systems, browsers or other underlying platforms. Additionally, we continued to focus our research and development efforts on developing the new mobile advertising platform-based solutions that will offer developers (i) effective distribution tools, (ii) increased monetization capabilities, and (iii) enhanced optimization via powerful, reliable, and easy-to-use analytics.
 
For a discussion of our intellectual property and how we protect it, see "Business Overview—Intellectual Property" under Item 4.B above.
 
D. 
TREND INFORMATION
 
Industry trends expected to affect our revenues, income from continuing operations, profitability and liquidity or capital resources:
 
 
1.
The digital advertising environment is becoming increasingly crowded and consumers suffer from over exposure to advertising promotions.  This in turn has brought on a certain level of blindness to advertising, decreasing their effectiveness and value to advertisers.  We are therefore concentrating on unique stand-out ad formats that grab the attention of consumers in the crowded advertising environment, increasing the effectiveness of the ad and ultimately the value to advertisers.
 
 
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2.
The digital advertising environment is becoming increasingly complex and fragmented.  As a result it is increasingly difficult for advertisers, including brands and agencies, as well as investors, to discern the difference between the offerings, and requires that they maintain an excessive number of “small” relationships in order to understand and receive a comprehensive solution.  We are attempting to address this need in our various revenue streams by providing robust and differentiated products. For mobile app developers, our Growmobile platform offers a holistic solution for acquiring and subsequently enhancing the engagement of app consumers. With our Undertone solution, we offer a full suite of services for the advertising brand and agency, including the entire advertising process from creative through analytic data collection and processing. In our PC monetization revenue stream, we provide the publisher a solution for, on the one hand, creating new advertising inventory, and on the other, assisting in optimizing the multiple monetization streams deployed by the web publisher.
 
 
3.
Our search monetization revenue stream is predicated by a vibrant PC desktop environment, encouraging the development of downloadable software and advertising on the desktop.  The transition of consumer consumption of utility and content towards mobile platforms has accelerated and, as a result, an increasing share of advertising campaigns are channeled towards mobile platforms and fewer consumer software downloadable products are being developed.  To address this trend, we have shifted the growth focus of all parts of our business away from downloadable PC software. On the desktop we are focusing on monetization tools for content publishers that could also be cross-platform, accommodating mobile platforms as well.  In addition, we are leveraging our data analytic capabilities and investing heavily in developing and marketing a platform that will simplify and organize the advertising process for mobile app developers.
 
 
4.
In recent years the browser companies, particularly Google, as well as others, have been instituting policy changes and regulations making it increasingly difficult to change a browser’s settings, including the ability to change a browser’s default search settings. Changing such settings has been a major part of the Company’s monetization model and until now we have been successful in overcoming these measures; however, it is becoming increasingly difficult to do so. In connection with these efforts by the browser companies, they are also making an effort to reset the applicable browser’s settings back to its default setting, causing us to have to recapture our users on a more frequent basis. These activities have shortened the average lifetime we see from users utilizing our search settings. This has reduced the return on investment from our marketing and distribution efforts. Moreover, the increased frequency of changes has limited our visibility and therefore our ability to invest in customer acquisition. However, we continue to believe, as supported by the level of revenues over the last few quarters, that as the market consolidates around accepted marketing practices, there remains sufficient business.  While the profit margins continued to compress, we believe they will settle at a level sufficient to generate significant revenues and profits.
 
 
5.
New regulations governing the ability to download software from the major software depositories, such as the Google Store, have limited our ability to bundle search products, including toolbars and other services with other software.  In the past we were successful in working around these restrictions, but this has negatively affected our distribution to some degree and caused us to find work-arounds and ways for us and our software developer partners to offer and download software from alternative sites. However, due to this environment, there are fewer and fewer software developing companies that are able to comply with these restrictions.  We are therefore changing our marketing effort, more towards web content publishers and less on downloadable software.
 
For more information on uncertainties, demands, commitments or events that are reasonably likely to have a material effect on our business, see Item 3 "Key Information—Risk Factors."
 
For additional trend information, see the discussion in "Item 5.A Operating and Financial Review and Prospects – Operating Results."
 
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.
 
 
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F. 
TABULAR DISCLOSURE OF CONTRACTUAL OBLIGATIONS
 
The following table summarizes our contractual commitments as of December 31, 2015 and the effect those commitments are expected to have on our liquidity and cash flow in future periods.
 
   
Payments Due by Period
(U.S. dollars in thousands) (****)
 
Contractual Commitments as of December 31, 2015
 
Total
   
Less than
1 year
   
1-3 Years
   
3-5 Years
   
More than
5 Years
 
Long-term debt, including current portion (*)
  $ 64,950     $ 17,050     $ 9,150     $ 38,750     $ -  
Accrued severance pay (**)
    1,491       -       -       -       1,491  
Convertible debt (*)
    36,772       7,354       14,709       14,709       -  
Payment obligation related to acquisitions(***)
    48,970       11,970       17,000       20,000       -  
Operating leases
    38,632       5,953       11,784       11,782       9,114  
Total
  $ 190,816     $ 42,327     $ 52,643     $ 85,241321     $ 10,605  
_____________
                                       
(*)
Long-term debt and convertible debt obligations represent maximum repayment of principal and do not include interest payments due thereunder.
(**)
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 are for the most part covered by ongoing payments to funds to cover such obligations. Of this amount, only $ 1,166 is unfunded.
 (***)
Payment obligation related to acquisitions, represents the maximum cash payments we will be obligated to make under consideration arrangements with former owners of certain entities we acquired. As of December 31, 2015 we have cash payment obligations related to acquisitions in the amount of $49,124 included on our balance sheet.
(****)
The total amount of unrecognized tax benefits for uncertain tax positions was $2,367 in thousands as of December 31, 2015. Payment of these obligations would result from settlements with taxing authorities. Due to the difficulty in determining the timing of resolution of audits, these obligations are not included in the table.
 
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 March 1, 2016:
 
Name
 
Age
 
Position
Alan Gelman*(1)(2)
 
60
 
Chairman of the Board
Josef Mandelbaum
 
49
 
Chief Executive Officer
Dror Erez 
 
47
 
Director
Roy Gen(1)
 
44
 
Director
David Jutkowitz*(1)(3)(4)
 
65
 
External Director
Avichay Nissenbaum*(2)(3)(4)
 
49
 
External Director
Osnat Ronen*(4)
 
53
 
Director
Michael Vorhaus*(2)(3)
 
58
 
Director
Corey Ferengul
 
44
 
CEO, Undertone Business Unit
Limor Gershoni Levy