UNITED STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549




FORM
20–F




o
            REGISTRATION
      STATEMENT PURSUANT TO SECTION 12(b) OR (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,
2009




OR




o
            TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934




OR




o
            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 number 000–26495




COMMTOUCH
SOFTWARE LTD.


(Exact
name of Registrant as specified in its charter and


translation
of Registrant’s name into English)




Israel


(Jurisdiction
of incorporation or organization)




4A
Hazoran Street


Poleg
Industrial Park,


P.O.
Box 8511


Netanya
42504, Israel


011–972–9–863–6888


(Address
of principal executive offices)




Ron
Ela, CFO, Fax: 011-972-9-8636863. Same address as above.


(Name,
Telephone, Email 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
      registeredOrdinary
      Shares, par value NIS 0.15 per share
                
                NASDAQ
      Capital Market




Securities
registered or to be registered pursuant to Section 12(g) of the Act:
None




Securities
for which there is a reporting obligation pursuant to Section 15(d) of the
Act.




None




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 (December 31,
2009).




Ordinary
Shares, par value NIS 0.15 23,958,761




Indicate by check mark if the
registrant is a well-known seasoned issuer, as defined in Rule 405 of the
Securities Act.  Yes oNo x




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 oNo x




Note:
Checking the above box will not relieve any registrant required to file reports
pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 from
their obligations under those Sections.




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 xNo o




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      ̈ No1




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 filero
                Accelerated
      filero
                Non-accelerated
      filerx
 Indicate by check mark which basis of
accounting the registrant has used to prepare the financial statements included
in this filing.


U.S.
      GAAPx
              International
      Financial Reporting Standards as issued by the International Accounting
      Standards Boardo
              Othero


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 o Item 18
o
  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 oNo x







1 Boxes to
remain unchecked.







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.




Unless
otherwise indicated, all references in this document to “Commtouch,” “the
Company,” “we,” “us” or “our” are to Commtouch Software Ltd. or its wholly–owned
subsidiary, Commtouch Inc., as relating to consolidated financial information
contained herein.




The
selected consolidated statements of operations data for the years ended December
31, 2007, 2008 and 2009 and the selected consolidated balance sheet data as of
December 31, 2008 and 2009 have been derived from the Consolidated Financial
Statements of Commtouch included elsewhere in this report. The selected
consolidated statements of operations data for the years ended December 31, 2005
and 2006 and the selected consolidated balance sheet data as of December 31,
2005, 2006 and 2007 have been derived from the Consolidated Financial Statements
of Commtouch not included elsewhere in this report. Our historical results are
not necessarily indicative of results to be expected for any future period. The
data set forth below should be read in conjunction with “Item 5. Operating and
Financial Review and Prospects” and the Consolidated Financial Statements and
the Notes thereto included elsewhere herein:




Year Ended December 31,2005
                
                
                2006
                
                
                2007
                
                
                2008
                
                
                2009(USD
      in thousands, except per share data)Selected
      Data:Revenues
                
                $
                3,925
                
                
                $
                7,234
                
                
                $
                11,250
                
                
                $
                14,092
                
                
                $
                15,189Operating
      profit (loss)
                
                $
                (2,656
                )
                
                $
                (415
                )
                
                $
                1,610
                
                
                $
                1,931
                
                
                $
                2,696Net
      income (loss) attributable to ordinary and equivalently participating
      shareholders
                
                $
                (2,690
                )
                
                $
                (190
                )
                
                $
                2,109
                
                
                $
                2,270
                
                
                $
                5,160Basic
      net earnings (loss) per share
                
                $
                (0.28
                )
                
                $
                (0.01
                )
                
                $
                0.08
                
                
                $
                0.09
                
                
                $
                0.21Diluted
      net earnings (loss) per share
                
                $
                (0.28
                )
                
                $
                (0.01
                )
                
                $
                0.08
                
                
                $
                0.08
                
                
                $
                0.20Weighted
      average number of shares used in computing basic net earnings (loss) per
      share
                
                
                15,802
                
                
                
                22,113
                
                
                
                24,847
                
                
                
                25,619
                
                
                
                24,532Weighted
      average number of shares used in computing diluted net earnings (loss) per
      share
                
                
                15,802
                
                
                
                22,113
                
                
                
                27,591
                
                
                
                26,929
                
                
                
                25,292Total
      Assets
                
                $
                7,995
                
                
                $
                11,999
                
                
                $
                18,210
                
                
                $
                20,709
                
                
                
                25,190




FORWARD
LOOKING STATEMENTS




Except
for the historical information contained in this Annual Report, the statements
contained in this Annual Report are “forward-looking statements” within the
meaning of the Private Securities Litigation Reform Act of 1995, as amended, and
other federal securities laws with respect to our business, financial condition
and results of operations.  Such forward-looking statements reflect
our current view with respect to future events and financial
results.




We
urge you to consider that statements which use the terms “anticipate,”
“believe,” “expect,” “plan,” “intend,” “estimate and similar expressions are
intended to identify forward-looking statements.  We remind readers
that forward-looking statements are merely predictions and therefore inherently
subject to uncertainties and other factors and involve known and unknown risks
that could cause the actual results, performance, levels of activity, or our
achievements, or industry results, to be materially different from any future
results, performance, levels of activity, or our achievements, or industry
results, expressed or implied by such forward-looking statements. Such
forward-looking statements appear in Item 4 – “Information on the Company” and
Item 5 – “Operating and Financial Review and Prospects,” as well as elsewhere in
this Annual Report.Readers are cautioned
not to place undue reliance on these forward-looking statements, which speak
only as of the date hereof.  Except as required by applicable law,
including the securities laws of the United States, we undertake no obligation
to update or revise any forward-looking statements to reflect new information,
future events or circumstances, or otherwise after the date
hereof.  We have attempted to identify significant uncertainties and
other factors affecting forward-looking statements in the Risk Factors section
that appears below.









RISK
FACTORS




You
should carefully consider the following risk factors before you decide to buy
our Ordinary Shares. You should also consider the other information in this
report. If any of the following risks actually occur, our business, financial
condition, operating results or cash flows could be materially adversely
affected. This could cause the trading price of our Ordinary Shares to decline,
and you could lose part or all of your investment. The risks described below are
not the only ones facing us. Additional risks not presently known to us, or that
we currently deem immaterial, may also impair our business
operations.




Business
Risks




If the market does not continue to
respond favorably to our current messaging and Web security solutions, including
our anti-spam, email anti-virus and  Uniform Resource Locator or URL
filtering solutions, or our future solutions do not gain acceptance, we will
fail to generate sufficient revenues.




Our
success depends on the continued acceptance and use of our messaging and Web
security solutions by current and new enterprise, Original Equipment
Manufacturer or OEM, and Service Provider customers. We have been selling our
anti-spam products for over six years, Zero-HourTM virus outbreak detection
product for approximately five years, our GlobalViewTM Mail Reputation perimeter
defense solution for approximately four years and our URL filtering solutions
for over one year.




As the
markets for messaging and Web security products continue to mature and
consolidate, we are seeing increasing competitive pressures and demands for even
higher quality products at lower prices.   This increasing demand
comes at a time when email and Web-based threats are more varied and intensive,
challenging even the top end solutions to keep their performance at an industry
acceptable high level of accuracy. If our solutions do not continue to evolve to
meet market demand, or newer products on the market prove more effective, our
business could fail.  Also, if growth in the markets for messaging and
Web-based security solutions begins to slow, our business will suffer
dramatically.




Continuing unfavorable national and
global economic conditions could have a material adverse effect on our business,
operating results and financial condition




It is not
yet clear if the recent crisis in the financial and credit markets in the United
States, Europe and Asia, that led to a global economic slowdown, has passed
completely. If the economies of countries in which our customers and potential
customers are located continue to be weak or weaken further, our customers may
reduce or postpone their spending significantly. This could result in reductions
in sales of our services and longer sales cycles, slower adoption of new
technologies and increased price competition. In addition, weakness in the
end-user market could negatively affect the cash flow of our OEM partners,
distributors and resellers who could, in turn, delay paying their obligations to
us. This would increase our credit risk exposure and cause delays in our
recognition of revenues on future sales to these customers. While our OEM
business remained strong during 2009, we did see instances of financial weakness
with a few non-key OEM partners during 2009.   Specific economic
trends, such as declines in the demand for PCs, servers, and other computing
devices, or weakness in corporate information technology spending, could have a
more direct impact on our business. Any of these events would likely harm our
business, operating results and financial condition.




If global
economic and market conditions, or economic conditions in the United States or
other key markets do not continue to improve, or revert to a recessionary state,
our business, operating results and financial condition may be adversely
impacted in a material way.




2




Tighter
governmental enforcement of regulations could decrease the distribution of
unsolicited bulk (spam) email and malicious software and decrease demand for our
solutions, or increase our cost of doing business.




The
Controlling the Assault of Non-Solicited Pornography and Marketing Act of 2003
(CAN-SPAM Act) established a framework of administrative, civil, and criminal
tools to combat spam. The law establishes both civil and criminal prohibitions
to assist in deterring the most offensive forms of spam, including unmarked
sexually-oriented messages and emails containing fraudulent headers. Under the
law, senders of email are required to honor a request by a consumer not to
receive any further unsolicited messages. While past high profile prosecutions
of direct marketers seemingly have not had much of a deterrent effect on
marketers of unsolicited email, it is not known whether or not future
enforcement actions will prove effective.




In
addition, various state legislatures have enacted laws aimed at regulating the
distribution of unsolicited email.




These and
similar legal measures may have the effect of reducing the amount of unsolicited
email and malicious software that is distributed and hence diminish the need for
our email defense solutions. Any such developments would have an adverse impact
on our revenues.




We
depend upon OEM partners and resellers and we have a limited concentration of
products.




We expect
to continue to be dependent upon resellers and OEM partners for a significant
portion of our revenues, which will be derived from sales of our messaging and
Web security solutions. Our operating results and financial condition may be
materially adversely affected if:




•
              Our limited product suite fails to remain attractive to current or
      prospective partners;




•
              Anticipated orders or payments from these resellers and OEM partners fail
      to materialize;




•
              We are unable to locate and or sign additional OEM partners (given the
      limited pool of available candidates for   our technology);
      or




•
              Some of the key resellers or OEM partners cease the promotion of our
      business or begin to promote additional solutions in a layered approach to
      email defense and URL filtering
management.




•
              Some of our key OEM partners’ businesses fail as a result of a deepening
      global economic crisis.




Our
            quarterly
      operating results may fluctuate, which could adversely affect the value of
      your investment.




A number
of factors, many of which are enumerated in this “Risk Factors” section, are
likely to cause fluctuations in our operating results or cause our share price
to decline. These factors include:




•
            Our
      ability to successfully market our messaging and Web security solutions in
      new markets, both domestic and
international;




•
            Our
      ability to successfully develop and market new, modified or upgraded
      solutions, as may be needed;




•
            The
      continued acceptance of our solutions by our current customer
      base;




•
            Our
      ability to expand our workforce with qualified personnel, as may be
      needed;




•
            Unanticipated
      bugs or other problems affecting the delivery of our solutions to
      customers;




•
            The
      success of our resellers’ and OEM partners’ sales efforts to potential
      customers;




•
            The
      solvency of our resellers and OEM partners and their ability to allocate
      sufficient resources towards the marketing of our solutions to potential
      customers;




•
            Our
      OEM partners’ ability to effectively integrate our solutions into their
      product offerings;




•
            The
      substantial decrease in information technology
  spending;




•
            The
      pricing of our solutions;




•
            Our
      ability to timely collect fees owed by resellers and OEM
      partners;




•
            A
      renewed global slowdown;




3




•
            Sudden,
      dramatic fluctuations in exchange rates of currencies covering the fees we
      collect from our foreign customers versus the currencies utilized in our
      business (namely, the New Israeli Shekel, U.S. Dollar and
      EURO);




•
            Our
      ability to add cost-effective space and equipment to our current detection
      centers in a timely and effective manner to match the rate of growth in
      our business, plus our ability to build new, cost-effective detection
      centers as worldwide demand for our products may require;
    and




•
            The
      effectiveness of our customer support, whether provided by our resellers
      and OEM partners, or directly by
Commtouch.




Our
products and services have changed many times since we commenced operations in
1991.  For example, in late 2006, we announced the availability of our
IP reputation service, now known as GlobalView Mail Reputation and in late 2008,
we released the initial version of our URL filtering, or Web security,
solutions. Future changes  in our product offerings may require that
we adjust our business processes and workforce, which can cause fluctuations in
our results from operations.




We
have many established competitors who are offering a multitude of solutions to
the problems of spam/virus distribution and Web-related security
threats.




The
market for messaging security products remains intensely competitive. This has
resulted in pricing pressures and lower operating margins, which has been a
cause in the slowing of our business’ rate of growth.




In the
market for messaging security solutions, there are fewer providers offering
somewhat ineffectual “content filtering” solutions (solutions focusing solely on
the content of potential spam email) than in the past, and more sophisticated
offerings that compete with our solutions. Messaging security providers offering
forms of software (gateway), multi-functional appliances and managed service
solutions and which may be viewed as both competitors and potential customers to
Commtouch include Symantec (Brightmail), TrendMicro, McAfee (including products
of the previously acquired Secure Computing) and Cisco
(IronPort).  Messaging security providers offering solutions on an OEM
basis similar to Commtouch’s business model, and which may be viewed as direct
competitors, include Cloudmark, Mailshell and Mail-Filters.  As this
market continues to develop, it is likely that companies will attempt to either
enter or increase their presence in this market, or expand into ancillary
markets, by acquiring or forming strategic alliances with our competitors or
business partners. Some examples of this are the acquisitions of IronPort by
Cisco, Secure Computing by McAfee, CipherTrust by Secure Computing, Brightmail
by Symantec Corp., Microsoft of both Frontbridge Technologies and Sybari
Software and, more recently, Bizanga by Cloudmark.




In the
market for Web security solutions, there are fewer providers offering somewhat
ineffectual “content filtering” solutions (solutions focusing solely on “Black
& White” lists) than in the past, and more advanced offerings that compete
with our URL filtering solutions. Web security providers offering forms of
software (gateway), multi-functional appliances and managed service solutions
and which may be viewed as both competitors and potential customers to Commtouch
include McAfee (Secure Computing), WebSense and IBM (ISS/Cobion).  Web
security providers offering solutions on an OEM basis similar to Commtouch’s
business model, and which may be viewed as direct competitors, include
BrightCloud, eSoft, RuleSpace and Puresight.  As this market continues to
develop, it is likely that companies with greater resources than ours will
attempt to either enter or increase their presence in this market by acquiring
or forming strategic alliances with our competitors or business partners. Some
examples of this are the acquisitions of Fastdata by Cisco, SurfControl by
WebSense and Secure Computing by McAfee.




Also,
there are companies that develop and maintain in-house email defense and web
security solutions, such as Google and Yahoo. These and other companies could
potentially leverage their existing capabilities and relationships to enter the
messaging and/or Web security markets.




Competitors
could introduce products with superior features, scalability and functionality
at lower prices than our products and could also bundle existing or new products
with other more established products that discourage users from purchasing our
products. Our market’s level of competition has increased as current competitors
have improved the sophistication and effectiveness of their offerings and as new
participants have entered the market. Some of our current and potential
competitors have longer operating histories, larger customer bases, greater
brand recognition and greater financial, technical, sales, marketing and other
resources than we do and may enter into strategic or commercial relationships on
more favorable terms. New technologies and the expansion of existing
technologies may increase competitive pressures on us, and we may not be able to
compete successfully against current and future competitors.




4




Our
ability to continue to increase our revenues will depend on our ability to
successfully execute our sales and business development plan.




The
complexity of the underlying technological base of messaging and Web security
solutions, and the current landscape of the markets, require highly trained
sales and business development personnel to educate prospective resellers, OEM
partners and customers regarding the use and benefits of our solutions.
Recently, we have added new vice presidents of business development for our U.S.
and international operations.  It may take time for our current and
future employees to convey to potential, as well as current, OEM partners and
resellers how to most effectively market and utilize our solutions. As a result,
our sales and business development personnel may not be able to compete
successfully against larger, more heavily financed and more experienced sales
and business development departments of our competitors.




The
loss of our key employees would adversely affect our ability to manage our
business, therefore causing our operating results to suffer and the value of
your investment to decline.




Our
success depends on the skills, experience and performance of our senior
management and other key personnel. The loss of the services of any of our
senior management or other key personnel could materially and adversely affect
our business. The loss of our software developers or senior operations personnel
may also adversely affect the continued development and support of our messaging
and Web security solutions, thereby causing our operating results to suffer and
the value of your investment to decline.




We do not
have employment agreements inclusive of set periods of employment with any of
our key personnel. We cannot prevent them from leaving at any time. We do not
maintain key-person life insurance policies, listing us as a beneficiary, on any
of our employees.




Our
business and operating results could suffer if we do not successfully address
potential risks inherent in doing business overseas.




As of
December 31, 2009, we had sales offices in Israel and the United States. We also
are marketing our messaging and Web security solutions in international markets
by utilizing appropriate distribution channels. However, we may not be able to
compete effectively in international markets due to various risks inherent in
conducting business internationally, such as:




•
            Differing
      technology standards;




•
            Inability
      of distribution channels to successfully market our
    solutions;




•
            Export
      restrictions;




•
            Difficulties
      in collecting accounts receivable and longer collection
      periods;




•
            Unexpected
      changes in regulatory requirements;




•
            Political
      and economic instability;




•
            Potentially
      adverse tax consequences;




•
            The
      adoption of new legislation-backed penalties, which may discourage the
      distribution of unsolicited email messages and Web security threats;
      and




•
            Limited
      enforcement mechanisms for protecting intellectual property
      rights.




Any of
these factors could adversely affect the Company’s prospective international
sales and, consequently, business and operating results.




Our
Web security solution may be adversely affected if we are not able to receive
sufficient components from third party suppliers.




Our Web
security solution relies in part on certain components supplied by third parties
pursuant to contractual relationships.  If these third parties breach
their agreements with us, we may have difficulty in securing alternative sources
for these components in a timely manner and thus our Web security solution may
not perform at the level we expect.  If this were to occur, the
effectiveness of this solution would drop, it would become less attractive to
customers/potential customers and anticipated revenues could
decline.




5




Technology
Risks




We
have recently entered a new market with our URL filtering solutions, and may not
fully appreciate the needs of customers and risks inherent in this new
market




Historically,
Commtouch has focused its products solely on email based messaging security
solutions.  The recent move into the Web security industry in late
2008 represents our first effort at expansion into a totally new
market.  While we have expended resources in educating ourselves about
this new market, and we showed tangible traction in this new market during 2009,
nevertheless we cannot be totally certain that we have anticipated all possible
issues that might arise with our “in the cloud” technology infrastructure and
trends affecting Web-based threats.  Should unanticipated issues
arise, sales of our URL filtering solutions likely will slow and our business
will suffer.




We
may not have the resources or skills required to adapt to the changing
technological requirements and shifting preferences of our customers and their
users.




Both the
messaging and Web security industries are characterized by difficult
technological challenges, sophisticated distributors of email and Web threats,
multiple-variant viruses, unique phishing scams and constantly evolving
malevolent software distribution practices and targets that could render our
solutions and proprietary technology ineffective. Our success depends, in part,
on our ability to continually enhance our existing messaging and Web security
solutions and to develop new solutions, functions and technology that address
the potential needs of prospective and current customers and their users. The
development of proprietary technology and necessary enhancements entails
significant technical and business risks and requires substantial expenditures
and lead-time. We may not be able to keep pace with the latest technological
developments. We may not be able to use new technologies effectively or adapt to
OEM, customer or end user requirements or emerging industry standards. Also, we
must be able to act more quickly than our competition, and may not be able to do
so.




Our
solutions may be adversely affected by defects or denial of service attacks,
which could cause our OEM partners, customers or end users to stop using our
solutions.




Our
messaging and Web security solutions are based in part upon new and complex
software and highly advanced computer systems. Complex software and computer
systems can contain defects, particularly when first introduced or when new
versions are released, and are possible targets for denial of service attacks
instigated by “hackers”. Although we conduct extensive testing and implement
Internet security processes, we may not discover defects to or vulnerabilities
in our software or systems that affect our new or current solutions or
enhancements until after they are delivered. Although we have not experienced
any material defects or vulnerabilities to date in our messaging and Web
security offerings, it is possible that, despite testing by us, defects or
vulnerabilities may exist in the solutions we provide. These defects or
vulnerabilities could cause or lead to interruptions for customers of our
solutions, resulting in damage to our reputation, legal risks, loss of revenue,
delays in market acceptance and diversion of our development resources, any of
which could cause our business to suffer.




Our
solutions may be adversely affected if we are not able to receive a sufficient
sampling of Internet traffic or deliver our services to customers.




Our
messaging and Web security solutions are dependent, in part, on the ability of
our Detection Centers to analyze, in an automated fashion, live feeds of
Internet and Web related traffic received through our services to customers and
other contractual arrangements.  If we were to suffer an
unanticipated, substantial decrease in such traffic or our Detection Centers
become unavailable for any significant period, the effectiveness of our
technologies would drop, our product offerings would become less attractive to
customers/potential customers and revenues could decline.




Our
Web security solution may be adversely affected if we are not able to receive
sufficient components from third party suppliers.




Our Web
security solution relies in part on certain components supplied by third parties
pursuant to contractual relationships.  If these third parties breach
their agreements with us, we may have difficulty in securing alternative sources
for these components in a timely manner and thus our Web security solution may
not perform at the level we expect.  If this were to occur, the
effectiveness of this solution would drop, it would become less attractive to
customers/potential customers and anticipated revenues could
decline.




6




Investment
Risks




If
we will be in need of additional capital, we may not be able to secure
additional funds on acceptable terms, or at all, and the Company could
fail.




We have
invested heavily in technology development. We expect to continue to spend
financial and other resources on developing and introducing new offerings and
maintaining our corporate organizations and strategic relationships. We also
expect to invest resources in research and development projects to further
enhance our URL categorization and blocking, anti-spam and anti-virus
solutions.




Notwithstanding
the Company’s current, solid financial condition and the fact that recently the
Office of the Chief Scientist for the State of Israel, or the OCS, has approved
the allocation of research and development funding for the Company, should
additional funding become necessary we may be unable to secure capital on
acceptable terms, or at all, due to, among other things, difficulties in the
capital and credit markets.  In such case, the Company’s business
could suffer.




Our
directors, executive officers and principal shareholders will be able to exert
significant influence over matters requiring shareholder approval and could
delay or prevent a change of control.




Our
directors and affiliates of our directors, our executive officers and our
shareholders who currently individually beneficially own over five percent of
the voting power in the Company (together known as “affiliated entities”),
beneficially own, in the aggregate, approximately 36.3% of our outstanding
Ordinary Shares as of December 31, 2009. Included in the calculation of voting
power are warrants and options exercisable by the affiliated entities within 60
days thereof (the exercise price of some of which was more than the price of our
shares as of December 31, 2009). If they vote together (especially if they were
to convert all beneficial holdings into shares entitled to voting rights in the
Company), these shareholders will be able to exercise significant influence over
all matters requiring shareholder approval, including the election of directors
and approval of significant corporate transactions. This concentration of
ownership could also delay or prevent a change in control of Commtouch. In
addition, conflicts of interest may arise as a consequence of the significant
shareholders control relationship with us, including:




•
            Conflicts
      between significant shareholders, and our other shareholders whose
      interests may differ with respect to, among other things, our strategic
      direction or significant corporate
transactions;




•
            Conflicts
      related to corporate opportunities that could be pursued by us, on the one
      hand, or by these shareholders, on the other hand;
  or




•
            Conflicts
      related to existing or new contractual relationships between us, on the
      one hand, and these shareholders, on the other
  hand.




Our ordinary
shares are traded on more than one market and this may result in price
variations.




Our
ordinary shares are traded primarily on the NASDAQ Capital Market and also on
the Tel Aviv Stock Exchange.  Trading in our ordinary shares on these
markets is made in different currencies (U.S. dollars on the NASDAQ Capital
Market, and New Israeli Shekels, or NIS, on the Tel Aviv Stock Exchange), 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.  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.




7




Intellectual
Property Risks




If
we fail to adequately protect our intellectual property rights or face a claim
of intellectual property infringement by a third party, we could lose our
intellectual property rights or be liable for significant damages.




We regard
our patented and patent pending technology, copyrights, service marks,
trademarks, trade secrets and similar intellectual property as critical to our
success, and rely on patent, trademark and copyright law, trade secret
protection and confidentiality or license agreements with our employees and
customers to protect our proprietary rights.




During
2004, we purchased a United States patent, U.S. Patent No. 6,330,590. During
2005, we filed in the United States an anti-spam related patent application,
claiming priority for a prior period based on the filing of U.S. Provisional
Patent Application. This application remains outstanding. During 2006, we filed
in the United States a patent application relating to the prevention of spam in
streaming systems or, in other words, unwanted conversational media sessions
(i.e. voice and video related).  This provisional application was
converted to a formal patent application, which we continue to prosecute with
the United States Patent and Trademark Office.  During 2008, we filed
a U.S. Provisional Patent Application for anti-malware data center aggregate,
the subject of which remains unpublished and thus confidential. During 2009, it
too converted into a formal patent application.  We may seek to patent
certain additional software or other technology in the future. Any such patent
applications might not result in patents issued within the scope of the claims
we seek, or at all.




Despite
our precautions, unauthorized third parties may copy certain portions of our
technology, reverse engineer or obtain and use information that we regard as
proprietary or otherwise infringe or misappropriate our patent or our patent
pending technology, trade secrets, copyrights, trademarks and similar
proprietary rights.  We may not have the proper resources in order to
adequately protect our intellectual property. In addition, the laws of some
foreign countries do not protect proprietary rights to the same extent as do the
laws of the United States. Our means of protecting our proprietary rights in the
United States or abroad may not be adequate and competitors may independently
develop similar technology.




We cannot
be certain that our messaging and Web security solutions do not infringe issued
patents in certain parts of the world. In addition, because patent applications
in the United States are not publicly disclosed until eighteen months after the
application is filed, applications previously may have been filed which relate
to our solutions.  Therefore, other parties, whether in the United
States or elsewhere, may assert infringement claims against us. We may also be
subject to legal proceedings and claims from time to time in the ordinary course
of our business, including claims of alleged infringement of copyrights,
trademarks and other intellectual property rights of third parties by ourselves
and our customers. Our customer agreements typically include indemnity
provisions, so we may be obligated to defend against third party intellectual
property rights infringement claims on behalf of our
customers.   Such claims, even if not meritorious, could result
in the expenditure of significant financial and managerial
resources.  We may not have the proper resources in order to
adequately defend against such claims.




Risks
Relating to Operations in Israel




We
have important facilities and resources located in Israel, which has
historically experienced military and political unrest.




We are
incorporated under the laws of the State of Israel. Our principal research and
development facilities are located in Israel. Although the majority of our past
sales were made to customers outside Israel, we are nonetheless directly
influenced by the political, economic and military conditions affecting Israel.
Any major hostilities involving Israel, or the interruption or curtailment of
trade between Israel and its present trading partners, could significantly harm
our business, operating results and financial condition.




Since the
State of Israel was established in 1948, a number of armed conflicts have
occurred between Israel and its Arab neighbors.  Since
October 2000, terrorist violence in Israel has increased
significantly.  Recently, there has been an escalation in violence
among Israel, Hamas, the Palestinian Authority and other groups, as well as
extensive hostilities in December 2008 and January 2009 along Israel's border
with the Gaza Strip, which resulted in missiles being fired from the Gaza Strip
into Southern Israel.   There were also extensive hostilities along
Israel's northern border with Lebanon in the summer of 2006. Ongoing and revived
hostilities or other Israeli political or economic factors could harm our
operations and cause our revenues to decrease.




8




In
addition, Israel and some companies doing business with Israel have been the
subject of an economic boycott by Arab countries and their close allies since
Israel’s establishment. These restrictive laws and policies may have an adverse
impact on our operating results, financial condition and expansion of our
business.




Our
results of operations may be negatively affected by the obligation of key
personnel to perform military service.




Certain
of our officers and employees are currently obligated to perform annual reserve
duty in the Israel Defense Forces and are subject to being called for active
military duty at any time in the event of a national emergency, such as in
connection with the hostilities along Israel's border with the Gaza Strip in
December 2008 and January 2009. Although Commtouch has operated effectively
under these requirements since its inception, we cannot predict the effect of
these obligations on Commtouch in the future. Our operations could be disrupted
by the absence for a significant period of one or more of our officers or key
employees due to military service. Any disruption in our operations would harm
our business.




Because
a substantial portion of our revenues historically have been generated in U.S.
dollars and the Euro, and a portion of our expenses have been incurred in New
Israeli Shekels, our results of operations may be adversely affected by currency
fluctuations.




We have
generated a substantial portion of our revenues in U.S. dollars and Euro, and
incurred a portion of our expenses, principally salaries and related personnel
expenses in Israel, in New Israeli Shekels, or NIS. We anticipate that a
significant portion of our expenses will continue to be denominated in Israeli
shekels.  As a result, we are exposed to risk to the extent that the
value of the U.S. dollar decreases against the NIS and the Euro.  In
that event, the U.S. dollar cost of our operations will increase and our U.S.
dollar-measured results of operations will be adversely affected, as occurred
during portions of 2006 - 2008, when the NIS and the Euro appreciated against
the U.S. dollar, which resulted in a significant increase in the U.S. dollar
cost of our operational expenses and revenues. We cannot predict the trend for
future years. Our operations also could be adversely affected if we are unable
to guard against currency fluctuations in the future. To date, we have not
engaged in hedging transactions.  In the future, we may enter into
currency hedging transactions to decrease the risk of financial exposure from
fluctuations in the exchange rate of the dollar against the NIS. These measures,
however, may not adequately protect us from material adverse effects if
inflation in Israel accelerates.




The
government programs and benefits which we previously received require us to meet
several conditions and may be terminated or reduced in the future.




Prior
to 1998, we received grants from the Government of Israel, through the OCS, for
the financing of a significant portion of our research and development
expenditures in Israel. These grants totaled $0.6 million.  In 2001,
we received $0.6 million and in 2002 we received $0.2 million. We did not submit
an application for funding during the period 2004 - 2008.  In 2009,
our application for funding was approved in an amount of approximately $0.5
million. We currently intend to apply for an additional grant during
2010.  In the past, the OCS budget has been subject to reductions
which may affect the availability of funds for possible future grants.
Therefore, we cannot be certain that we will be able to receive future grants in
similar amounts, or at all. In addition, the terms of any future OCS grants may
be less favorable than our past grants.




In order
to meet specified conditions in connection with the grants and programs of the
OCS, we have made representations to the Israel government about our Israeli
operations.  From time to time the conduct of our Israeli operations
has deviated from our forecasts.  If we fail to meet the conditions of
the grants, including the maintenance of a material presence in Israel, or if
there is any material deviation from the representations made by us to the
Israeli government, we could be required to refund the grants previously
received (together with an adjustment based on the Israeli consumer price index
and an interest factor) and would likely be ineligible to receive OCS grants in
the future.




Under the
Law for the Encouragement of Industrial Research and Development, 5744-1984 and
the related regulations, the discretionary approval of an OCS committee is
required for any transfer of technology developed with OCS funding or for the
transfer of manufacturing rights outside of Israel.  OCS approval is
not required for the export of any products resulting from the research and
development. There is no assurance that we will receive the required approvals
for any proposed future transfer.  Such approvals, if granted, may be
subject to the following additional restrictions:




·
            a
      requirement to pay the OCS a portion of the consideration we receive upon
      any sale of such technology to an entity that is not
      Israeli.  The scope of the support received, the royalties that
      were paid by us, the amount of time that elapsed between the date on which
      the know-how was transferred and the date on which the grants were
      received, as well as the sale price, will be taken into account in order
      to calculate the amount of the payment;
and




9




·
            the
      transfer of manufacturing rights could be conditioned upon an increase in
      the royalty rate and payment of increased aggregate royalties (up to 300%
      of the amount of the grant plus interest, depending on the percentage of
      the manufacturing that is foreign).




These
restrictions may impair our ability to sell certain of our older technology
assets outside of Israel.  The restrictions will continue to apply
even after we repay the full amount of royalties payable for the
grants.




You
may have difficulties enforcing a U.S. judgment against us and our executive
officers and directors or asserting U.S. securities laws claims in
Israel.





We are
organized under the laws of Israel, and we maintain significant operations in
Israel. In addition, the majority of our directors and executive officers are
not residents of the United States and most of their assets and our assets are
located outside the United States.  Service of process upon our
non-U.S. resident directors or executive officers and enforcement of judgments
obtained in the United States against us and our directors and executive
officers may be difficult to obtain within the United States.  It may
be difficult to assert U.S. securities law claims in original actions instituted
in Israel.  Israeli courts may refuse to hear a claim based on a
violation of U.S. securities laws because Israel is not the most appropriate
forum in which 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.  If U.S. law is found to be applicable,
the substance of the 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.  Furthermore, there is little
binding case law in Israel addressing these matters.





Israeli
courts might not enforce judgments rendered outside Israel which may make it
difficult to collect on judgments rendered against us. Subject to certain time
limitations, an Israeli court may declare a foreign civil judgment enforceable
only if it finds that (a) the judgment was rendered by a court which was,
according to the laws of the state of the court, competent to render the
judgment; (b) the judgment may no longer be appealed; (c) the obligation imposed
by the judgment is enforceable according to the rules relating to the
enforceability of judgments in Israel and the substance of the judgment is not
contrary to public policy; and (d) the judgment is executory in the state in
which it was given.





Even if
these conditions are satisfied, an Israeli court will not enforce a foreign
judgment if it was given in a state whose laws do not provide for the
enforcement of judgments of Israeli courts (subject to exceptional cases) or if
its enforcement is likely to prejudice the sovereignty or security of the State
of Israel.  An Israeli court also will not declare a foreign judgment
enforceable if (i) the judgment was obtained by fraud; (ii) there is a finding
of lack of due process; (iii) the judgment was rendered by a court not competent
to render it according to the laws of private international law in Israel; (iv)
the judgment is at variance with another judgment that was given in the same
matter between the same parties and that is still valid; or (v) at the time the
action was brought in the foreign court, a suit in the same matter and between
the same parties was pending before a court or tribunal in Israel.





Provisions
of Israeli law may delay, prevent or make difficult an acquisition of Commtouch,
which could prevent a change of control and therefore depress the price of our
shares.




Israeli
corporate law regulates mergers and acquisitions of shares through tender
offers, requires special approvals for transactions involving significant
shareholders and regulates other matters that may be relevant to these types of
transactions. Furthermore, Israeli tax law treats stock-for-stock acquisitions
between an Israeli company and a foreign company less favorably than does U.S.
tax law. For example, Israeli tax law may subject a shareholder who exchanges
his Ordinary Shares for shares in a foreign corporation to immediate taxation or
to taxation before his investment in the foreign corporation becomes liquid.
These provisions may adversely affect the price of our shares.




10





As
a foreign private issuer whose shares are listed on the NASDAQ Capital Market,
we may follow certain home country corporate governance practices instead of
certain NASDAQ requirements.





As a
foreign private issuer whose shares are listed on the NASDAQ Capital Market, we
are permitted to follow certain home country corporate governance practices
instead of certain requirements of the NASDAQ Listing Rules.





Among
other things, we may follow home country practice with regard to composition of
the board of directors and quorum at shareholders' meetings.  In
addition, we may follow our home country law, instead of the NASDAQ Listing
Rules, which require that we obtain shareholder approval for certain dilutive
events, such as for the establishment or amendment of certain equity based
compensation plans, an issuance that will result in a change of control of the
Company, certain transactions other than a public offering involving issuances
of a 20% or more interest in the Company and certain acquisitions of the stock
or assets of another company.





A foreign
private issuer that elects to follow a home country practice instead of NASDAQ
requirements, must submit to NASDAQ in advance a written statement from an
independent counsel in such issuer's home country certifying that the issuer's
practices are not prohibited by the home country's laws.  In addition,
a foreign private issuer must disclose in its annual reports filed with the
Securities and Exchange Commission or on its website each such requirement that
it does not follow and describe the home country practice followed by the issuer
instead of any such requirement.  Accordingly, our shareholders may
not be afforded the same protection as provided under NASDAQ's corporate
governance rules.




Item
4. Information on the Company.




Overview




The legal
name of the Company is Commtouch Software Ltd., and its principal executive
offices are located at 4A Hazoran Street, Poleg Industrial Park, P.O.Box 8511,
Netanya 42504, Israel, where our telephone number is 011–972–9–863–6888. The
Company was incorporated under the laws of the State of Israel on February 5,
1991 and its legal form is a company limited by shares. Its Articles of
Association are on file in Israel with the office of the Israeli Registrar of
Companies and available for public inspection at that office. The Company’s
wholly owned subsidiary, Commtouch Inc., is located at 292 Gibraltar Drive,
Suite 107, Sunnyvale, California 94089, where our telephone number is (650)
864–2000.




We are a
provider of messaging and Web security solutions to a wide array of customers
and OEM distribution partners, including real-time anti-spam, Zero-Hour virus
outbreak protection and Global View Mail Reputation services, as well as a
GlobalView URL Filtering solution. The Company offers its solutions to network
and security vendors offering content security gateways, unified threat
management solutions, network routers and appliances, anti-virus solutions and
to service providers such as Software-as-a-Service vendors, Web hosting
providers and Internet Service Providers.  At the core of Commtouch’s
messaging security offerings is Commtouch’s proprietary Recurrent Pattern
Detection (RPD)TM technology which, in general terms, analyzes messages
associated with mass email outbreaks and directs the blocking of such emails,
without the need to analyze individual messages.  At the core of
Commtouch’s URL filtering solutions is its “in the cloud” infrastructure, which
analyzes various feeds from worldwide sources pertaining to URLs, and provides a
ranking of the URLs tailored to the needs of each customer.




Additional
Detail on Commtouch Offerings




We offer
a Software Development Kit or SDK comprised of multiple components, which is
built on our proprietary Recurrent Pattern DetectionTM technology; each different
component enables third-party vendors to integrate a Company offering. Two
components, known as ctasd and ctengine, represent alternative methods of
enabling third-party vendors to integrate the Commtouch anti-spam solution into
their existing offerings. Both ctengine and ctasd provide these manufacturers or
service providers with full spam identification and spam classification services
from the Commtouch Detection Centers (described below). The SDK communicates
fully with a remote Detection Center, receiving results to queries about
suspicious messages and acting according to set policies on the customer side.
These same two components also enable integration of the Company’s Zero-HourTM
virus outbreak protection. This solution provides customers with the ability to
block malevolent software (or as known in the industry "malware"), including
email borne viruses, in real time, at the moment the initial attack occurs.
During the initial attack phase, traditional anti-virus vendors are typically
analyzing messages to determine whether they are indeed infected with a virus.
It is this critical lag in response time by traditional anti-virus vendors that
the Zero-Hour solution has been developed to remedy.




11




A third
component of the SDK, known as ctipd, enables integration of the Company’s
GlobalView Mail Reputation Service. This service is typically integrated into a
device that sits at the perimeter of the organization, deciding which email
traffic to allow to enter the organization, and which to block. It accomplishes
this by receiving classification data from a Commtouch Detection Center about
the sender of each email message.




Products
that may benefit from integration of the SDK solution include:




•
            Anti-virus
      applications;




•
            Content
      filtering solutions;




•
            Firewall
      systems;




•
            Security
      servers; and




•
            Other
      network appliances




In
relation to the three components noted above, Commtouch has also developed
plug-ins, milters and a connector to enable hosting and service providers to
access these Commtouch services in connection with their existing messaging
products.  Commtouch’s support of the hosting and service provider
industry encompasses a wide range of third party technologies: integration with
Parallels Plesk, H-Sphere and cPanel; plug-ins for common open source email
filtering packages such as SpamAssassin; a connector for Microsoft Exchange; and
a Milter for Sendmail and Postfix.




We also
offer an enterprise anti-spam and Zero-Hour virus outbreak detection solution,
consisting of both a software element, or the “Enterprise Gateway”, and a
service component, or a Commtouch “Detection Center”, which is typically sold
through reseller channels.  At the Enterprise Gateway, messages are
filtered at the customer organization’s entry point, before being distributed to
recipients, with added user-level controls and a top level of secure spam and
virus detection services from the Detection Center, all allowing for real-time
reaction to worldwide attacks. At the heart of the solution, however, is the
Detection Center, which detects new spam and virus attacks as soon as they are
launched and distributed over the Internet, and communicates the detection
results to the Enterprise Gateways to enable real-time protection.





During
late 2008, the Company released its Globalview URL filtering solution – a Web
security solution representing the Company’s first foray into a non-email
centric market. The services associated with this solution analyze and
categorize for customers of our OEM partners the website being accessed by such
customers, mainly in order to prevent a) the possibility of malware attacks
being propogated by malicious URLs, b) access to non-business related websites
by employees and c) access by children to inappropriate
websites.




Competitive
Landscape




The
markets in which Commtouch competes are intensely competitive and rapidly
changing. However, we believe there is no single competitor that offers the
complete package of anti–spam, anti-virus, IP reputation and Web defense
protections that Commtouch provides.




The
principal competitive factors in our industry include price, product
functionality, product integration, platform coverage and ability to scale,
worldwide sales infrastructure and global technical support. Some of our
competitors have greater financial, technical, sales, marketing and other
resources than we do, as well as greater name recognition and a larger installed
customer base. Additionally, some of these competitors have research and
development capabilities that may allow them to develop new or improved products
that may compete with product lines we market and distribute, possibly at a
lower cost.  Our success will depend on our ability to adapt to these
competing forces, to develop more advanced products more rapidly and less
expensively than our competitors, and to educate potential customers as to the
benefits of using our products rather than developing their own
products.




In the
market for messaging security solutions, there are fewer providers offering
somewhat ineffectual “content filtering” solutions (solutions focusing solely on
the content of potential spam email) than in the past, and more sophisticated
offerings that compete with our solutions. Email defense providers offering
forms of software (gateway), multi-functional appliances and managed service
solutions and which may be viewed as both competitors and potential customers to
Commtouch include Symantec (Brightmail), TrendMicro, McAfee (including products
of the previously acquired Secure Computing) and Cisco
(IronPort).  Email defense providers offering solutions on an OEM
basis similar to Commtouch’s business model, and which may be viewed as direct
competitors, include Cloudmark, Mailshell and Mail-Filters.




12




Commtouch’s
GlobalView Mail Reputation Service competes in an evolving market. This market
includes some established vendors, including TrendMicro, that are offering
reputation-based solutions. In some cases, while the product positioning may be
new, the underlying solutions may be mature – for example, Spamhaus
repositioning its RBL, or “Real-time Block List”, service as a commercial
reputation service. In addition, there are several startups competing in this
space, such as Karmasphere.




The
market for real-time virus protection products is also constantly evolving, as
those promoting the proliferation of viruses continually seek new distribution
techniques. Commtouch’s offering differs from traditional anti-virus solutions
in that we are offering an additional, complementary solution to signature and
heuristic-based anti-virus engines. For this reason, our Zero-Hour virus
outbreak protection engine has been employed by several anti-virus
companies, including F-Secure and VirusBuster.  If virus distribution
methods continue to migrate from email to other formats, there may be less of a
demand for our Zero-Hour solution and more of a demand for a Web security
product, such as our GlobalView URL filtering solution.




In the
market for Web security solutions, there are fewer providers offering somewhat
ineffectual “content filtering” solutions (solutions focusing solely on “Black
& White” lists) than in the past, and more advanced offerings that compete
with our GlobalView URL filtering solution. Web security providers offering
forms of software (gateway), multi-functional appliances and managed service
solutions and which may be viewed as both competitors and potential customers to
Commtouch include McAfee (Secure Computing), WebSense and IBM
(ISS/Cobion).  Web security providers offering solutions on an OEM basis
similar to Commtouch’s business model, and which may be viewed as direct
competitors, include BrightCloud, RuleSpace and Puresight.




We expect
that the markets for messaging and Web security solutions will continue to
become more consolidated, with companies increasing their presence in this
market or entering ancillary markets by acquiring or forming strategic alliances
with our competitors or business partners. Some examples of this in the
messaging security field are the acquisitions of IronPort by Cisco, CipherTrust
by Secure Computing, Brightmail by Symantec Corp., Microsoft of both Frontbridge
and Sybari Software and, more recently, Cloudmark of Bizanga.  Some
examples of this in the web defense field are the acquisitions of Fastdata by
Cisco, SurfControl by WebSense and Secure Computing by McAfee.




See also
disclosure under “Item 3. Key Information– RISK FACTORS—Business Risks—We have
many established competitors who are offering a multitude of solutions to the
problems of spam/virus distribution and Web-related security
threats.”




Sales
and Marketing




We
utilize third party distribution channels to sell our
products.  Generally, our software is provided to OEM customers, who
in turn integrate the software into their product or service offerings for sale
of our services to their customers.  We are paid service fees under a
variety of fee structures, including fixed fee and fee sharing
arrangements.




Our
enterprise anti-spam and Zero-Hour anti-virus gateway product is sold through
resellers, who pay us pre-negotiated fees from each sale closed with a
reseller’s customer.




All
Company sales are managed by the Company’s and its U.S. subsidiary’s business
development departments, each of which consists of a department head and a
relatively small number of business development professionals.  The
Company’s marketing efforts are aimed mainly at potential OEM
customers.  The marketing department is concentrated in the Company’s
Israel office, though our personnel travel internationally in furtherance of the
Company’s marketing goals.




13




Intellectual
Property




We regard
our patented and patent pending anti–spam and anti-virus technology, copyrights,
service marks, trademarks, trade secrets and similar intellectual property as
critical to our success, and rely on patent, trademark and copyright law, trade
secret protection and confidentiality and/or license agreements with our
employees, customers, partners and others to protect our proprietary rights.
During 2004, we purchased a United States patent, Patent No. 6,330,590, which we
believe to be an integral part of our patent strategy aimed at protecting our
proprietary anti-spam technology.  During 2005, we filed in the United
States an anti-spam related patent application, claiming priority for a prior
period based on the filing of U.S. Provisional Patent Application. This
application remains outstanding. During 2006, we filed in the United States a
patent application relating to the prevention of spam in streaming systems or,
in other words, unwanted conversational media sessions (i.e. voice and video
related).  This provisional application was converted to a formal
patent application, which we continue to prosecute with the United States Patent
and Trademark Office.  During 2008, we filed a U.S. Provisional Patent
Application for anti-malware data center aggregate, the subject of which remains
unpublished and thus confidential. During 2009, it too converted into a formal
patent application.  We may seek to patent certain additional software
or other technology in the future. We are only actively maintaining our
registered trademark for "COMMTOUCH", which is registered in the U.S., Canada,
Israel, European Union, China, Taiwan and South Korea. A previous registration
of "PRONTO" in Canada is still in force, but we are not maintaining this
registration and it will lapse. Since at least September 2003, we have claimed
trademark rights in “RPD” and “Recurrent Pattern Detection”, as applicable to
our messaging security solutions.  We have also been claiming
trademark rights in Zero-Hour in relation to our virus outbreak detection
product (and more recently one of our web security products) and GlobalView in
relation to our IP reputation and Web security products.




It may be
possible for unauthorized third parties to copy or reverse engineer certain
portions of our products or obtain and use information that we regard as
proprietary. In addition, the laws of some foreign countries do not protect
proprietary rights to the same extent as do the laws of the United States. There
can be no assurance that our means of protecting our proprietary rights in the
United States or abroad will be adequate or that competing companies will not
independently develop similar technology.




Other
parties may assert infringement claims against us. We may also be subject to
legal proceedings and claims from time to time in the ordinary course of our
business, including claims of alleged infringement by us and/or our customers of
the trademarks and other intellectual property rights of third
parties.  Our customer agreements typically include indemnity
provisions, so we may be obligated to defend against third party intellectual
property rights infringement claims on behalf of our customers.  Such
claims, even if not meritorious, could result in the expenditure of significant
financial and managerial resources.




Government
Regulation




Laws
aimed at curtailing the spread of spam have been adopted by the United States
federal government, i.e. CAN-SPAM Act, and some individual U.S. states, with the
CAN-SPAM Act superseding some state laws or certain elements
thereof.  See also disclosure under “Item 3. Key Information– RISK
FACTORS—Business Risks— “Tighter governmental enforcement of regulations could
decrease the distribution of unsolicited bulk (spam) email and malicious
software and decrease demand for our solutions, or increase our cost of doing
business.”  Despite this
legislation, we have not seen abatement in the amount of spam traffic on the
Internet; rather, a continuing increase in large numbers that is being
distributed in more sophisticated ways.  The continuing growth and
development of the spam market may prompt calls for even more stringent Internet
user protection laws that would limit the ability of companies and individuals
promoting or delivering spam online, and thus potentially negatively affect our
business.




The
propagation of email viruses, whether through email or Web sites, which are
aimed at destroying or stealing third party data, is illegal under standard
state and federal law outlawing theft, misappropriation, conversion, etc.,
without the need for special legislation prohibiting such activities on the
Internet.  Despite the existence of these laws, sources for Internet
viruses continue to spread multi-variant viruses seemingly without much fear of
recrimination.  New laws providing for more stringent penalties could
be adopted in various jurisdictions, but it is unclear what, if any, affect
these would have on the anti-virus industry in general and our Zero-Hour Virus
Outbreak Detection and GlobalView URL filtering solutions in
particular.




Employees




As of
December 31, 2009, 2008 and 2007, we had 72, 69 and 60 employees, respectively.
None of our U.S. employees are covered by a collective bargaining agreement. As
of December 31, 2009, our employees were categorized as follows:




LOCATION
                                                    
                                                    General &
                                                      Administrative
                                                    
                                                    Sales &
                                                      Marketing
                                                    
                                                    Research &
                                                      Development
                                                    
                                                    Hosting
                                                      (Operations)
                                                    
                                                    TOTAL:ISRAEL
      OFFICE
                                                    
                                                    7
                                                    
                                                    13
                                                    
                                                    37
                                                    
                                                    -
                                                    
                                                    57U.S.
      OFFICE
                                                    
                                                    4
                                                    
                                                    5
                                                    
                                                    -
                                                    
                                                    6
                                                    
                                                    15





14




We
believe that our relations with our employees are good.




Israeli
law and certain provisions of the nationwide collective bargaining agreements
between the Histadrut (General Federation of Labor in Israel) and the
Coordinating Bureau of Economic Organizations (the Israeli federation of
employers’ organizations) apply to Commtouch’s Israeli employees. These
provisions principally concern the maximum length of the workday and workweek,
minimum wages, contributions to a pension fund, insurance for work–related
accidents, procedures for dismissing employees, determination of severance pay
and other conditions of employment. Furthermore, pursuant to such provisions,
the wages of most of Commtouch’s Israeli employees are subject to cost of living
adjustments, based on changes in the Israeli Consumer Price Index. The amounts
and frequency of such adjustments are modified from time to
time.  Also, all Israeli employees employed for at least a year
commencing in 2009 are entitled to the funding of pension benefits by preset
monthly contributions of the employee and the employer.
Israeli law generally requires the payment of severance pay upon the retirement
or death of an employee or upon termination of employment by the employer or, in
certain circumstances, by the employee. We currently fund our ongoing severance
obligations by making monthly payments for insurance policies and by an accrual.
A general practice in Israel followed by Commtouch, although not legally
required, is the contribution of funds on behalf of certain employees to an
individual insurance policy known as “Managers’ Insurance.” This policy provides
a combination of savings plan, insurance and severance pay benefits to the
insured employee. It provides for payments to the employee upon retirement or
death and secures a substantial portion of the severance pay, if any, to which
the employee is legally entitled upon termination of employment. Each
participating employee contributes an amount equal to 5% of such employee’s base
salary, and the employer contributes between 13.3% and 15.8% of the employee’s
base salary. Full–time employees who are not insured in this way are entitled to
a savings account, to which each of the employee and the employer makes a
monthly contribution of 5% of the employee’s base salary. We also provide
certain Israeli employees with an Education Fund, to which each participating
employee contributes an amount equal to 2.5% of such employee’s base salary, and
the employer contributes an amount equal to 7.5% of the employee’s base salary,
up to a certain maximum base salary set by law.




Description
of Property




All of
our facilities are leased. Our headquarters, in Netanya, Israel, is
approximately 1,057.4 square meters, and it houses senior management, research
and development, sales, marketing and administrative personnel.  Our
subsidiary’s Sunnyvale, California office, which is approximately 4, 527 square
feet in size, houses administrative, sales and hosting (operations)
personnel.




Geographic InformationThe
Company conducts its business on the basis of one reportable segment (see also
Note 1 of  Notes to the Financial Statements for a brief description
of the Company’s business) in accordance with ASC 280, "Segment
Reporting".




Revenues
for Last Three Financial Years




See Item
5. Operating and Financial Review and Prospects - “Revenue Sources” and the
financial statements included elsewhere in this annual report. Below is a
breakdown of our revenues by location (in thousands):




Year December 31,2007
                  
                  
                  2008
                  
                  
                  2009Israel
                  
                  $
                  742
                  
                  
                  $
                  1,080
                  
                  
                  $
                  1,544North
      America
                  
                  
                  6,424
                  
                  
                  
                  8,018
                  
                  
                  
                  8,032Europe
                  
                  
                  2,735
                  
                  
                  
                  3,160
                  
                  
                  
                  3,776Asia
                  
                  
                  1,038
                  
                  
                  
                  1,497
                  
                  
                  
                  1,508Other
                  
                  
                  311
                  
                  
                  
                  337
                  
                  
                  
                  329$
                  11,250
                  
                  
                  $
                  14,092
                  
                  
                  
                  15,189





15




We have
had only negligible capital expenditures and divestitures in the last three
financial years.




Item
4A.  Unresolved Staff Comments.




Not
applicable




Item
5. Operating and Financial Review and Prospects.




Overview




From 2003
through 2008, the sole focus of our business had been the development and
selling, through reseller and OEM distribution channels, of anti-spam, Zero-Hour
virus outbreak detection and IP reputation solutions to a wide array of
customers. During late 2008, we expanded our focus by way of the release of our
first URL filtering solutions for the web security market.




Critical
Accounting Policies and Estimates




Operating
and Financial Review and Prospects are based upon the Company’s consolidated
financial statements, which have been prepared in accordance with United States
generally accepted accounting principles. The preparation of these financial
statements requires management to make estimates and judgments that affect the
reported amounts of assets, liabilities, revenues and expenses and related
disclosure of contingent assets and liabilities. Management believes the
critical accounting policies and areas that require the most significant
judgments and estimates to be used in the preparation of the consolidated
financial statements are accounting for stock-based compensation, revenue
recognition, commitments and contingencies, valuation of investments and
accounting for income taxes .




Accounting
for Stock–Based Compensation:





ASC 718
requires companies to estimate the fair value of equity-based payment awards on
the date of grant using an option-pricing model. The value of the portion of the
award that is ultimately expected to vest is recognized as an expense over the
requisite service periods in the Company's consolidated income
statements.





The
Company applies ASC 718, and ASC 505-50, "Equity Based Payments to
Non-Employees" ("ASC 505-50"), with respect to options and warrants issued to
non-employees. ASC 718 requires the use of an option valuation model to measure
the fair value of the options and warrants at the measurement date as defined in
ASC 505-50.





The
Company recognizes compensation expense for the value of its awards on a
straight line basis over the requisite service period of each of the awards, net
of estimated forfeitures. Estimated forfeitures are based on actual historical
pre-vesting forfeitures. ASC 718 requires forfeitures to be estimated at the
time of grant and revised, if necessary, in subsequent periods if actual
forfeitures differ from those estimates.





The
Company estimates the fair value of stock options granted using the
Black-Scholes option-pricing model. The option-pricing model requires a number
of assumptions, of which the most significant are the expected stock price
volatility and the expected option term. Expected volatility was calculated
based upon actual historical stock price movements. The expected term of options
granted represents the period of time that options granted are expected to be
outstanding. The risk-free interest rate is based on the yield from U.S.
treasury bonds with an equivalent term. The Company has historically not paid
dividends and has no foreseeable plans to pay dividends.




Revenue recognition




The
Company derives revenues from Anti-Spam, Zero-HourTM Virus Outbreak Protection,
GlobalView Mail Reputation and GlobalView URL filtering Services. The service
component of the Company's solutions is considered essential to the
functionality of the software components. Furthermore, the software components
cannot be effectively used on a standalone basis, or with a third party's
service. The customer has no ability to effectively run the software or the
Software Development Kit ("SDK") on its own hardware. As the software portion of
the product cannot effectively stand on its own, the Company considers each sale
as a service arrangement.




16





Therefore,
revenues from such services are recognized over the service term, which
generally includes a term period of one to three years.





Revenue
is recognized in accordance with ASC 605, "Revenue Recognition", when the
earnings process is complete, as evidenced by an agreement between the customer
and the Company, when delivery has occurred or services have been rendered, when
the fee is fixed or determinable and when collectability is
probable.




We
generally use customer purchase orders and contracts to determine the existence
of an arrangement. We assess whether the sales price is fixed or determinable
based on the payment terms associated with the transaction and whether the price
is subject to refund or adjustment. We assess collectability based primarily on
the creditworthiness of the customer as determined by credit checks and
analysis, as well as the customer’s payment history.





Deferred
revenues include unearned amounts received from customers, but not yet
recognized as revenues.




Commitments
and Contingencies




Commtouch
periodically records the estimated impacts of various conditions, situations or
circumstances involving uncertain outcomes. These events are called
“contingencies”, and Commtouch’s accounting for such events is prescribed by ASC
450 “Contingencies” ("ASC 450 "). ASC 450 defines a contingency as “an existing
condition, situation, or set of circumstances involving uncertainty as to
possible gain or loss to an enterprise that will ultimately be resolved when one
or more future events occur or fail to occur.”




ASC 450
does not permit the accrual of gain contingencies under any circumstances. For
loss contingencies, the loss must be accrued if (1) information is available
that indicates it is probable that the loss has been incurred, given the
likelihood of the uncertain future events; and (2) that the amount of the loss
can be reasonably estimated.




The
accrual of a contingency involves considerable judgment on the part of
management. Commtouch uses its internal expertise, and outside experts (such as
lawyers, tax specialists and engineers), as necessary, to help estimate the
probability that a loss has been incurred and the amount (or range) of the loss.
The Company has recorded contingencies in situations where management determined
it was probable a loss had been incurred and the amount could be reasonably
estimated.




Valuation
of investments




In 2008,
the Company classified its marketable securities in accordance with ASC 320,
"Investments-Debt and Equity Securities" ("ASC 320"), as available-for-sale. The
marketable securities that were held for the short-term and available for
immediate sale were stated at quoted market prices at balance sheet date. The
Company's marketable securities consisted of highly-rated auction rate (AAA)
securities ("ARS") which were federal backed student loan securities.
Available-for-sale securities were carried at fair value, with the unrealized
gains and losses, reported in "accumulated other comprehensive income (loss)" in
shareholders' equity.





Commencing
February 2008, all of the Company's ARSs (comprised of five securities) suffered
from failed auctions. On January 5, 2009, all of the Company's marketable
securities were purchased by the bank at full par value amounting to a total of
$2 million and by agreeing to the settlement with the bank, the Company
essentially stated that it no longer had the intent of holding the ARSs until
recovery, as it would recover any unrealized loss through the settlement offer
and, accordingly, the ARSs were classified as trading securities as of December
31, 2008.




Accounting
for income taxes




The
Company accounts for income taxes in accordance with FASB ASC Topic 740, "Income
Taxes" ("ASC 740"). ASC 740  prescribes the use of the liability
method whereby deferred tax asset and liability account balances are determined
based on differences between financial reporting and tax bases of assets and
liabilities and are measured using the enacted tax rates and laws that will be
in effect when the differences are expected to reverse. The Company provides a
valuation allowance, if necessary, to reduce deferred tax assets to amounts more
likely than not to be realized.




17





In 2009,
a deferred tax asset in the amount of $2.4 million in respect of loss carry
forwards and other temporary differences was created in respect of forecasted
taxable income that is more likely than not to be realized in the foreseeable
future, based on our established pattern of profitability in the last few
years.





Deferred
tax assets are classified as current or non-current based on the classification
of the related asset or liability for financial reporting, or according to the
expected reversal dates of the specific temporary differences if not related to
an asset or liability for financial reporting.





ASC 740
addresses the determination of whether tax benefits claimed or expected to be
claimed on a tax return should be recorded in the financial statements. ASC 740
contains a two-step approach to recognizing and measuring uncertain tax
positions. The first step is to evaluate the tax position taken or expected to
be taken in a tax return by determining if the weight of available evidence
indicates that it is more likely than not that, on an evaluation of the
technical merits, the tax position will be sustained on audit, including
resolution of any related appeals or litigation processes. The second step is to
measure the tax benefit as the largest amount that is more than 50% likely to be
realized upon ultimate settlement. No liability for unrecognized tax benefits
was recorded as a result of the implementation of ASC 740.





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 do not record valuation
allowances for deferred tax assets that we believe are more likely than not to
be realized in future periods. While we believe the resulting tax balances as of
December 31, 2009 and 2008 are appropriately accounted for, the ultimate
outcome of such matters could result in favorable or unfavorable adjustments to
our consolidated financial statements.




Revenue
Sources




We
recognize revenues from anti-spam, Zero-Hour virus outbreak detection,
GlobalView Reputation and URL filtering/Web security services. Revenues from
these services are recognized when persuasive evidence of an arrangement exists,
services are provided, the fee is fixed or determinable and collectability is
probable. Revenues derived from these services are recognized ratably over the
life of the service period.




Results
of Operations




The
following table sets forth financial data for the years ended December 31, 2007,
2008 and 2009 (in thousands):




2007
                              
                              
                              2008
                              
                              
                              2009Revenues
                              
                              $
                              11,250
                              
                              
                              $
                              14,092
                              
                              
                              $
                              15,189Cost
      of revenues
                              
                              
                              1,411
                              
                              
                              
                              1,828
                              
                              
                              
                              2,260Gross
      profit
                              
                              
                              9,839
                              
                              
                              
                              12,264
                              
                              
                              
                              12,929Operating
      expenses:Research
      and development, net
                              
                              
                              2,187
                              
                              
                              
                              3,152
                              
                              
                              
                              2,958Sales
      and marketing
                              
                              
                              3,453
                              
                              
                              
                              3,992
                              
                              
                              
                              4,212General
      and administrative
                              
                              
                              2,589
                              
                              
                              
                              3,189
                              
                              
                              
                              3,063Total
      operating expenses
                              
                              
                              8,229
                              
                              
                              
                              10,333
                              
                              
                              
                              10,233Operating
      income
                              
                              
                              1,610
                              
                              
                              
                              1,931
                              
                              
                              
                              2,696Financial
      income (expenses), net
                              
                              
                              527
                              
                              
                              
                              346
                              
                              
                              
                              60Net
      income before taxes on income (tax benefit)
                              
                              
                              2,137
                              
                              
                              
                              2,277
                              
                              
                              
                              2,756Taxes
      on income (tax benefit)
                              
                              
                              28
                              
                              
                              
                              7
                              
                              
                              
                              (2,404
                              )Net
      income attributable to ordinary and equivalently participating
      shareholders
                              
                              $
                              2,109
                              
                              
                              $
                              2,270
                              
                              
                              $
                              5,160




18




Comparison
of Years Ended December 31, 2009 and 2008




Revenues. Revenues increased
by $1.1 million from $14.1 million in 2008 to $15.2 million in
2009.  The increase is mainly due to a growth in market share,
especially in the international (non-U.S.) markets and due to sales derived from
our Web security product launched in the fourth quarter of 2008. The number of
parties we signed OEM agreements with increased by 29 in 2009 and amounted to
135 as of December 31, 2009, 18 of which are in respect of our Web security
products.




Cost of Revenues. Cost of
revenues increased by $0.5 million from $1.8 million in 2008 to $2.3 million in
2009. The increase in 2009 is mainly due to higher facility costs and hosting
expenses following the opening of a fifth data center in the
U.S.  aimed to serve the increasing number of customers. Cost of
revenues increased in 2009 to a greater extent than the sales in 2009 due to
economies of scale, i.e., most costs of revenues are fixed and are not affected
by increases or decreases in revenues.




Research and Development,
net. Research and development expenses decreased by 6% and amounted to
$3.0 million in 2009 compared to $3.2 million in 2008. The decrease is mainly
due to approval of a $0.5 million OCS grant, which reduced our payroll cost in
$0.3 million during 2009; however, this decrease was offset by an increase due
to recruitment of additional employees to support the company’s efforts to
develop new products. Research and development expenses include $0.3 million of
expenses in connection with ASC 718.




Sales and Marketing. Sales
and marketing expenses increased by 6% and amounted to $4.2 million compared to
$4.0 million in 2008. The increase is mainly due to recruitment of employees and
increased selling and marketing activity. In 2009, sales and marketing expenses
included $0.3 million expenses in connection with ASC 718.




General and Administrative.
General and administrative expenses decreased by 4% from $3.2 million in 2008 to
$3.1 million in 2009. The decrease is mainly due to a decrease in expenses
related to ASC 718. In 2009, general and administrative expenses included $0.7
million expenses in connection with ASC 718.




Financial Income (Expenses),
Net. Financial income (expenses), net, decreased by 83% from income of
$0.3 million in 2008 to income of $60,000 in 2009.  The decrease is
primarily due to less interest income derived from declining interest rates
throughout 2009 earned on the company's cash deposits.




Taxes on income (tax benefit).In 2009, a deferred tax asset in the amount of $2.4 million in respect of
loss carry forwards and other temporarydifferences was created
in respect of forecasted taxable income that is more likely than not to be
realized in the foreseeable future, based on our established pattern of
profitability in the last few years.




Comparison
of Years Ended December 31, 2008 and 2007




Revenues. Revenues increased
by $2.8 million from $11.3 million in 2007 to $14.1 million in
2008.  The increase is mainly due to a growth in market share,
especially in the international market. The number of OEMs increased by 32 in
2008 and amounted to 116 as of December 31, 2008.




Cost of Revenues. Cost of
revenues increased by $0.4 million from $1.4 million in 2007 to $1.8 million in
2008. The increase in 2008 is mainly due to higher facility costs and hosting
expenses following the open of a fourth data center in Japan aiming to serve the
increasing number of customers. Cost of revenues did not increase in the same
proportion as sales in 2008 due to economies of scale. Most costs of revenues
are fixed and are not affected by increases or decreases in
revenues.




Research and Development,net.
Research and development expenses increased by 44% and amounted to $3.2 million
in 2008 compared to $2.2 million in 2007. The increase is due to recruitment of
more employees as part of the Company’s decision to develop new products.
Research and development expenses include $319,000 of expenses in connection
with ASC 718.




Sales and Marketing. Sales
and marketing expenses increased by 16% and amounted to $4.0 million compared to
$3.5 million in 2007. The increase is mainly due to recruitment of employees and
increased selling and marketing activity. In 2008, sales and marketing expenses
included $298,000 expenses in connection with ASC 718.




General and Administrative.
General and administrative expenses increased by 23% from $2.6 million in 2007
to $3.2 million in 2008. The increase is mainly due to the recruitment of two
new employees. In 2008, general and administrative expenses included $833,000
expenses in connection with ASC 718.




19




Financial Income (Expenses),
Net. Financial income (expenses), net, decreased by 34% from income of
$527,000 in 2007 to income of $346,000 in 2008.  The decrease is
primarily due to less interest income derived from declining interest rates
throughout 2008, earned on the company's cash deposits.




Quarterly
Results of Operations (Unaudited)




The
following table sets forth certain unaudited quarterly statements of operations
data for the eight quarters ended December 31, 2009. This information has been
derived from the Company’s consolidated unaudited financial statements, which,
in management’s opinion, have been prepared on the same basis as the audited
consolidated financial statements, and include all adjustments, consisting only
of normal recurring adjustments, necessary for a fair presentation of the
information for the quarters presented. This information should be read in
conjunction with our audited consolidated financial statements and the notes
thereto included elsewhere in this report. The operating results for any quarter
are not necessarily indicative of the operating results for any future
period.




Three
      Months EndedMar.31,
                
                
                Jun.30,
                
                
                Sept.30,
                
                
                Dec.31,
                
                
                Mar.31,
                
                
                Jun30,
                
                
                Sept.30,
                
                
                Dec.31,2008
                
                
                2008
                
                
                2008
                
                
                2008
                
                
                2009
                
                
                2009
                
                
                2009
                
                
                2009(in
      thousands)(unaudited)Revenues
                
                $
                3,401
                
                
                $
                3,568
                
                
                $
                3,622
                
                
                $
                3,501
                
                
                $
                3.543
                
                
                $
                3.733
                
                
                $
                3,899
                
                
                $
                4,014Cost
      of revenues
                
                
                449
                
                
                
                459
                
                
                
                466
                
                
                
                454
                
                
                
                513
                
                
                
                516
                
                
                
                596
                
                
                
                635Gross
      profit
                
                
                2,952
                
                
                
                3,109
                
                
                
                3,156
                
                
                
                3,047
                
                
                
                3,030
                
                
                
                3,217
                
                
                
                3,303
                
                
                
                3,379Operating
      expenses:Research
      and development, net
                
                
                781
                
                
                
                792
                
                
                
                780
                
                
                
                799
                
                
                
                786
                
                
                
                765
                
                
                
                806
                
                
                
                601Sales
      and marketing
                
                
                1,015
                
                
                
                967
                
                
                
                1,043
                
                
                
                967
                
                
                
                998
                
                
                
                1,022
                
                
                
                1,025
                
                
                
                1,167General
      and administrative
                
                
                869
                
                
                
                839
                
                
                
                797
                
                
                
                684
                
                
                
                732
                
                
                
                746
                
                
                
                772
                
                
                
                813Total
      operating expenses
                
                
                2,665
                
                
                
                2,598
                
                
                
                2,620
                
                
                
                2,450
                
                
                
                2,516
                
                
                
                2,533
                
                
                
                2,603
                
                
                
                2,581Operating
      income
                
                
                287
                
                
                
                511
                
                
                
                536
                
                
                
                597
                
                
                
                514
                
                
                
                684
                
                
                
                700
                
                
                
                798Financial
      income (expenses), net
                
                
                120
                
                
                
                71
                
                
                
                108
                
                
                
                47
                
                
                
                (78
                )
                
                
                12
                
                
                
                149
                
                
                
                (23
                )Net
      income
                
                
                407
                
                
                
                582
                
                
                
                644
                
                
                
                644
                
                
                
                436
                
                
                
                696
                
                
                
                849
                
                
                
                775Taxes
      on income (tax benefit)
                
                
                7
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                (2,404
                )Net
      income attributable to ordinary and equivalently participating
      shareholders
                
                $
                400
                
                
                $
                582
                
                
                $
                644
                
                
                $
                644
                
                
                $
                436
                
                
                $
                696
                
                
                $
                849
                
                
                $
                3,179BasicNet
      income per share
                
                $
                0.02
                
                
                $
                0.02
                
                
                $
                0.02
                
                
                $
                0.03
                
                
                $
                0.02
                
                
                $
                0.03
                
                
                $
                0.03
                
                
                $
                0.13Diluted
      net income per share
                
                $
                0.01
                
                
                $
                0.02
                
                
                $
                0.02
                
                
                $
                0.02
                
                
                $
                0.02
                
                
                $
                0.03
                
                
                $
                0.03
                
                
                $
                0.13





New
Accounting Pronouncements





In June
2009, the FASB issued ASC 105, "Generally Accepted Accounting Principles" ("ASC
105"). ASC 105 establishes the FASB Accounting Standards Codification, which
will become the source of authoritative U.S. GAAP recognized by the FASB.
Following this statement, the FASB will issue new standards in the form of
Accounting Standards Updates ("ASUs"). ASC 105 is effective for financial
statements issued for interim and annual periods ending after September 15,
2009. The adoption of ASC 105 did not have any impact on the Company's financial
statements, as it does not modify GAAP, except for the specific references to
GAAP literature in the notes to the Company's consolidated financial
statements.




20





In
October 2009, the FASB issued an update to ASC 985-605, "Software-Revenue
Recognition" (originally issued as EITF 09-3). In accordance with the update to
the ASC, tangible products containing software components and non-software
components that function together to deliver the tangible product’s essential
functionality are excluded from the scope of the software revenue recognition
guidance. In addition, hardware components of a tangible product containing
software component are always excluded from the software revenue guidance. The
mandatory adoption of this update is effective on January 1, 2011. The Company
may elect to adopt the update prospectively, to new or materially modified
arrangements beginning on the adoption date, or retrospectively, for all periods
presented. In such case the Company must also early adopt the amendment to ASC
605-25 with respect to multiple-elements arrangements. The Company does not
expect the adoption of the update to have a material impact on its financial
condition or results of operations.





In
October 2009, the FASB issued an update to ASC 605-25, "Revenue recognition –
Multiple-Element Arrangements", which amended the criteria for separating
consideration in multiple-deliverable arrangements to:





-
            Provide
      updated guidance on whether multiple deliverables exist, how the
      deliverables in an arrangement should be separated and how the
      consideration should be allocated;





-
            Require
      an entity to allocate revenue in an arrangement using estimated selling
      prices (“ESP”) of deliverables if a vendor does not have vendor-specific
      objective evidence of selling price (“VSOE”) or third-party evidence of
      selling price (“TPE”);





-
            Eliminate
      the use of the residual method and require an entity to allocate revenue
      using the relative selling price method;
and





-
            Require
      expanded disclosures of qualitative and quantitative information regarding
      application of the multiple-deliverable revenue arrangement
      guidance.





The
Company may elect to adopt the update prospectively, to new or materially
modified arrangements beginning on the adoption date, or retrospectively, for
all periods presented. The Company is currently evaluating the impact on its
consolidated results of operations and financial condition.




Liquidity
and Capital Resources




We have
financed our operations from positive operating cash flows, the issuance of
equity securities and, to a lesser extent, from private loans and research and
development grants from the Israeli government.




As of
December 31, 2008 and December 31, 2009, we had approximately $16.4 million and
$17.3 million of cash and cash equivalents and marketable securities,
respectively. The increase was mainly due to positive operating cash flow of
$5.1 million  and receipt of proceeds from the exercise of warrants
and options in the amount of $0.2 million, less $3.5 million expended in our
Ordinary Share buyback plan (see discussion under Item 16E. “Purchases of Equity
Securities by the Issuer and Affiliated Purchasers”).




In 2009,
net cash provided by operating activities was approximately $5.1 million. The
increase in operating cash flow was mainly due to our net income in 2009. Net
cash used in financing activities in 2009 was approximately $3.3 million, net of
the share buyback activity. Net cash provided by investing activities in 2009
was $1.9 million and consisted primarily of a sale of marketable securities of
$2.0 million, investment of $0.5 million in Mirapoint Software, Inc. – one of
our OEM customers, a decrease in short term cash deposits of $0.7 million, and
purchase of property and equipment in the amount of $0.4 million. As of December
31, 2008 and December 31, 2009, we had working capital of $14.8 million and
$16.9 million, respectively.




As of
December 31, 2008, marketable securities of the Company represented short-term
municipal ARS, which were purchased at par (100) and were valued at par (100).
They were all invested in triple A rated securities. Such investments in the
United States may be in excess of insured limits and are not insured in other
jurisdictions. Commencing February 2008, the ARS (comprised of five securities)
suffered from failed auctions. On January 5, 2009, the Company’s entire ARS
portfolio was purchased by the issuing bank at full par value, amounting to a
total of $2 million. Therefore, there was no effect on the statement of
operations in 2008 and 2009 from such securities.




21




Based on
the cash balance at December 31, 2009, current projections of revenues and
related expenses, the Company believes it has sufficient cash to continue
operations at least through March 2011.




Contractual
obligations




The
following table summarizes our outstanding contractual obligations as of
December 31, 2009 (in thousands):




Contractual Obligation
                            
                            Payments due by period
                              (USD in thousands)Total
                            
                            
                            Less than 1
                              year
                            
                            
                            1-3 years
                            
                            
                            3-5 years
                            
                            
                            More than 5
                              yearsOperating
      lease obligation
                            
                            $
                            612
                            
                            
                            $
                            478
                            
                            
                            $
                            134
                            
                            
                            $
                            -
                            
                            
                            $
                            -Other
      Long-term liabilities reflected on the Company’s Balance Sheet - Accrued
      severance pay
                            
                            
                            1,050
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            1,050Other
      Long-term asset reflected on the Company’s Balance Sheet - severance pay
      fund
                            
                            
                            (945
                            ))
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            (945
                            )Net
      - severance pay liability
                            
                            
                            105
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            105Total
                            
                            $
                            717
                            
                            
                            $
                            478
                            
                            
                            $
                            134
                            
                            
                            $
                            -
                            
                            
                            $
                            105




Effective
Corporate Tax Rates





The Company is subject to company tax
on its taxable income. The applicable rate was 29% in 2007, 27% in 2008 and 26%
in 2009, is 25% in 2010, and is scheduled to decline to 24% in 2011, 23% in
2012, 22% in 2013, 21% in 2014, 20% in 2015 and 18% in 2016 and
thereafter.





As of
December 31, 2009, the Company's net operating loss carryforwards for tax
purposes amounted to approximately $ 76,000, which may be carried forward
and offset against taxable income in the future, for an indefinite
period.





As of
December 31, 2009, for federal income tax purposes, the U.S. subsidiary had net
operating loss carry-forwards of approximately $ 92,000. These losses may
offset any future U.S. taxable income of the U.S. subsidiary and will expire in
the years 2011 through 2025.





Utilization
of U.S. net operating losses may be subject to substantial annual limitation due
to a "change in ownership" under provisions of the Internal Revenue Code of 1986
and similar state provisions.  Such limitation might result in the
loss of some or all of our U.S. net operating losses.




22




Impact
of Inflation and Currency Fluctuations




Most of
our sales are in U.S. dollars, and the rest are mainly in Euros. However, a
portion of our costs relate to our operations in Israel. A substantial portion
of our operating expenses in Israel, primarily our research and development
expenses are denominated in NIS. Costs and revenues not denominated in U.S.
dollars are re-measured to U.S. dollars, when recorded, at prevailing rates of
exchange. This is done for the purposes of our financial statements and
reporting. As a result, we are exposed to risk to the extent that the value of
the U.S. dollar decreases against the NIS.  In that event, the U.S.
dollar cost of our operations will increase and our U.S. dollar-measured results
of operations will be adversely affected, as occurred in the first half of 2008,
when the NIS appreciated against the U.S. dollar, which resulted in a
significant increase in the U.S. dollar cost of our operations.  Also,
in the event that the U.S. dollar appreciates against the Euro, our revenues
will decrease. Consequently, we are and will be affected by changes in the
prevailing NIS/U.S. dollar and Euro/ U.S. dollar exchange rates.




The
annual rate of inflation in Israel was 3.9% in 2009, 3.8% in 2008 and 3.4% in
2007 The NIS appreciated against the U.S. dollar by approximately (0.7%) in 2009
and (1.1%) in 2008 and (8.9%) in 2007. The representative dollar exchange rate
for converting the NIS to U.S. dollars, as reported by the Bank of Israel, was
NIS 3.775 for one U.S. dollar on December 31, 2009. The representative dollar
exchange rate was NIS 3.722 at March 16, 2010. Because exchange rates between
the NIS and the dollar fluctuate continuously, exchange rate fluctuations and
especially larger periodic devaluations will have an impact on our operating
results and period–to–period comparisons of our results. The effects of foreign
currency re–measurements are reported in the consolidated financial statements
for relevant periods in the statement of operations.




Item
6. Directors, Senior Management and Employees




The
following table presents information with respect to our directors’ beneficial
ownership of our Ordinary Shares as of December 31, 2009.  Beneficial
ownership is determined in accordance with the rules of the SEC and includes
voting or investment power, with respect to shares. To our knowledge, except
under applicable community property laws or as otherwise indicated, the persons
named in the table have sole voting and sole investment control and rights to
receive economic benefits with respect to all shares beneficially owned. The
applicable percentage of ownership for each director is based on 23,958,761
Ordinary Shares outstanding as of December 31, 2009. Ordinary Shares issuable
upon exercise of options and other rights held and exercisable on or within
sixty days of December 31, 2009 are deemed outstanding for the purpose of
computing the percentage ownership of the director holding those options and
other rights.




Name and
                                      Position
                                    
                                    Age
                                    
                                    Ordinary
                                      Share
                                      Beneficial
                                      Ownership
                                      >1%
                                    
                                    Number of
                                      Ordinary Shares
                                      Beneficially Owned
                                    
                                    Number of Options and Warrants included
                                      in Beneficial OwnershipAmir
      Lev,Director,President andCTO
                                    
                                    49
                                    
                                    3.3%
                                    
                                    811,157
                                    
                                    650,006
      options, at exercise prices ranging from $0.36 to $6.60 per Ordinary
      Share.  Expiration dates range from 12/30/11 to
      8/4/15Aviv
      Raiz,Director (1)(4)
                                    
                                    51
                                    
                                    22.8%
                                    
                                    5,562,740
                                    
                                    76,871
      options, at exercise prices ranging from $1.58 to $6.60 per Ordinary
      Share.  Expiration dates range from 12/30/11 to 10/26/15. Also,
      333,333 warrants, with an exercise price of $1.95, expiring in early
      October 2010Gideon
      Mantel,Director, Chairman of theBoard and
    CEO(4)
                                    
                                    50
                                    
                                    5.5%
                                    
                                    1,365,643
                                    
                                    962,617
      options, at exercise prices ranging from $0.0375 to
      $6.60.  Expiration dates range from 8/15/11 to
      8/4/15


23





Hila
      Karah,
                              Director(1)(3)
                            
                            41
                            
                            <1%
                            
                            <1%Lloyd
      E. Shefsky,
                              Director(2)(3)(5)
                            
                            69
                            
                            1.5%
                            
                            365,485
                            
                            135,205
      options, at exercise prices ranging from $1.17 to $6.60. Expiration dates
      range from 12/30/11 to 10/26/15Yair
      Shamir,
                              Director
                              (Outside
                              Director)
                              (2)(3)(4)(6)
                            
                            65
                            
                            4.7%
                            
                            1,200,241
                            
                            27,913
      options, at exercise prices ranging from $1.58 to
      $4.10.  Expiration dates range from 3/31/14 to
      10/26/15Yair
      Bar-Touv,
                              Director
                              (Outside
                              Director)
      (1)(2)
                            
                            49
                            
                            <1%
                            
                            <1%


(1)
              Member
      of the Compensation Committee




(2)
                Member
      of the Audit Committee




(3)
              Member
      of the Nominating Committee




(4)
              Member
      of the Investment Committee




(5)
              Mr.
      Shefsky’s ownership information includes his individual holdings and
      holdings of LENE L.P. (134,265 Ordinary Shares), in which Mr. Shefsky
      currently holds a relatively nominal, limited partnership
      interest.




(6)
              Mr.
      Shamir’s ownership interest includes 1,089,783 Ordinary Shares purchased
      by Catalyst Private Equity Partners II, for which Mr. Shamir acts as
      Chairman and Managing Partner.  Mr. Shamir’s options, as noted
      in the table above, are also held on behalf of
  Catalyst.




Other
Senior Management Employees:




The
following table sets forth the names and positions of our senior management
employees, with ownership data being as of December 31, 2009:




Name
                          
                          Age
                          
                          Ownership >1%
                          
                          PositionGideon
      Mantel
                          
                          50
                          
                          See
      table above
                          
                          CEO
      and Chairman of the BoardAmir
      Lev
                          
                          49
                          
                          See
      table above
                          
                          President
      and Chief Technical OfficerRon
      Ela
                          
                          39
                          
                          (1)
                          
                          Chief
      Financial OfficerIdo
      Hadari
                          
                          36
                          
                          (1)
                          
                          Chief
      Operating OfficerGary
      Davis
                          
                          48
                          
                          (1)
                          
                          Vice
      President, General Counsel and Corporate SecretaryRonen
      Rosenblatt
                          
                          44
                          
                          (1)
                          
                          Vice
      President, Research and Development Commtouch Software
  Ltd.Francois
      Depayras
                          
                          37
                          
                          (1)
                          
                          Vice
      President, Americas Sales and Business Development, Commtouch
      Inc.Ofer
      Tal
                          
                          39
                          
                          (1)
                          
                          Vice
      President, International Sales and Business Development, Commtouch
      Software Ltd.Yossi
      Maslaton
                          
                          43
                          
                          (1)
                          
                          Vice
      President, Network Operations & Customer Services, Commtouch
      Inc.Asaf
      Greiner
                          
                          36
                          
                          (1)
                          
                          Vice
      President, Products, Commtouch Software Ltd.Rebecca
      Herson
                          
                          40
                          
                          (1)
                          
                          Vice
      President, Marketing, Commtouch Software Ltd.Gabriel
      Mizrahi
                          
                          36
                          
                          (1)
                          
                          Vice
      President, Technologies, Commtouch Software
Ltd.


(1)    
less than 1%


24


Amir Lev
is a co–founder of Commtouch and has served as its Chief Technology Officer and
as a Director since its inception in 1991. Mr. Lev was also the General Manager
of Commtouch from January 1997 through April 2000, and in May 2000 became
President. Mr. Lev received a B.A. in Computer Science and Economics from Hebrew
University, Jerusalem.




Aviv
Raizhas served as
a Director since December 2005.  He is the founder and President of
Eurotrust Ltd.  Mr. Raiz has been active in the foreign exchange
markets for the past twenty years, and has been a private equity investor in
several high-tech, bio-tech and Internet companies for the past ten years.He holds an M.B.A. from
Tel Aviv University.




Gideon
Mantel is a co–founder of Commtouch and served as its Chief Financial Officer
from its inception in February 1991 until October 1995, when he became
Commtouch’s Chief Operating Officer. In November 1997, he became Commtouch’s
Chief Executive Officer, and in December 2006, he was confirmed as Chairman of
the Board. He has also served as a Director of Commtouch since inception. Mr.
Mantel received a B.A. in Political Science and an M.B.A. from Tel Aviv
University.




Hila
Karah joined the Board of Directors in March 2008. Ms. Karah has been the CIO of
Eurotrust Ltd. since 2006, and has been a private and public equity investor in
several high-tech, bio-tech and Internet companies since 2000. Prior to her
joining Eurotrust, she served as a partner financial analyst at Perceptive Life
Sciences Ltd., a New York-based hedge fund. Prior to her position at Perceptive,
Ms. Karah was a research analyst at Oracle Partners Ltd., a health care-focused
hedge fund based in Connecticut. Ms. Karah holds a BA in Molecular and Cell
Biology from the University of California, Berkeley, and has studied at the
UCB-UCSF JMP.




Lloyd E.
Shefskyhas served as
a Director of Commtouch since October 2003.  He is a Clinical
Professor of Entrepreneurship and Co-Director of the Center for Family
Enterprises at the Kellogg School of Management and has taught in several
countries. In 1970, he founded the Chicago law firm, Shefsky & Froelich
Ltd., where has been Of Counsel since 1996. Since 1981 he has represented the
Government of Israel throughout the Midwestern U.S. For nearly forty years he
has represented hundreds of entrepreneurs and their companies, and during the
past twenty-five years, such representation has included numerous Israeli
companies with U.S. operations.  Mr. Shefsky authored Entrepreneurs Are Made Not
Born, which was translated into five foreign languages. He received his
J.D. from the University of Chicago Law School, a B.S.C. from De Paul University
(accounting), is a member of the Illinois and Florida Bars, and has a CPA
certificate in Illinois.




Yair
Shamir joined the Board of Directors as an Outside Director under the Israel
Companies Law in March 2008.  Mr. Shamir is the Chairman and Managing
Partner of Catalyst Investments and the Chairman of IAI, Israeli Aerospace
Industries.  From 2004 to 2005, Mr. Shamir was Chairman of El Al,
Israeli Airlines and lead the privatization process of the firm.  From
1997 to 2005, Mr. Shamir served as Chairman and CEO of VCON Telecommunications
Ltd.  From 1995 to 1997, Mr. Shamir served as executive vice president
of the Challenge Fund-Etgar L.P.  From 1994 to 1995, he served as
Chief Executive Officer of Elite Food Industries, Ltd.  From 1988 to
1993, Mr. Shamir served as Executive Vice President and General Manager of
Scitex Corporation, Ltd. Mr. Shamir served in the Israeli Air Force as a pilot
and commander from 1963 to 1988. During his term in the Air Force, Mr. Shamir
attained the rank of colonel and served as head of the electronics department,
the highest professional electronics position within the Air
Force.  He currently serves as a director of DSP Group Corporation and
also serves as director of other private hi-tech companies.  Mr.
Shamir holds a B.Sc. Electronics Engineering from the Technion, Israel Institute
of Technology.




25




Yair
Bar-Touv joined the Board of Directors as an Outside Director under the Israel
Companies Law in March 2008.  Mr. Bar-Touv is formerly the CIO of a
leading government enterprise specializing in analytic software solutions for
knowledge discovery (text and data mining) of large volumes of data, with a
focus on changing the ways enterprise organizations make decisions with regards
to primary business processes.  Mr. Bar-Touv is also the former CEO of
Elron Telesoft  and co-CEO of NCC, a leading Systems Integrator
operating in Israel and the USA, which was acquired in 1997 by Elron
Electronics.  Mr. Bar-Touv holds an M.Sc in Computer Engineering from
the Technion Institute of Technology (1987) and a B.Sc in Electronic Engineering
from Ben-Gurion University (1981).





Ron Ela
joined Commtouch in July 2006 as its Chief Financial Officer. A Certified Public
Accountant, Mr. Ela formerly held management positions at two Israeli-based
NASDAQ listed companies, and most recently held the role of Controller at Verint
Systems Ltd., a wholly–owned subsidiary of Verint Systems Inc. During the five
years prior to that time, Mr. Ela served as Deputy Controller and subsequently
Controller for Partner Communication Ltd. Also, Mr. Ela spent 3 years in public
accounting with Kesselman & Kesselman, a member of PricewaterhouseCoopers in
Israel. Mr. Ela has a B.A. in business administration majoring in accounting
from the College of Management Academic Studies.




Ido
Hadari joined Commtouch in 2008, as Vice President, International Sales and
Business Development and since November 2009 is serving as Chief Operating
Officer. Mr. Hadari has over a decade of business management and sales
experience, most recently at Interwise, an enterprise voice and web conferencing
provider that was acquired by AT&T. At Interwise, where he worked for eight
years, he held various senior business development and channel management
positions with responsibilities for regional sales in Europe and Asia, and
global strategic alliances. He holds a BA magna cum laude in Business
Administration and Economics from Hebrew University, Jerusalem.




Gary
Davis joined Commtouch in September 1999 and serves as Vice President, General
Counsel and Corporate Secretary. Mr. Davis has over 20 years of legal experience
in both private law firm and corporate practices. Mr. Davis is certified to
practice law in both the State of Israel and California. Prior to September
1999, Mr. Davis was in–house counsel to Israel Military Industries and Elta
Electronics Industries. He received a B.A. in Political Economy of Industrial
Societies from U.C. Berkeley and a J.D. in law from Golden Gate
University.




Ronen
Rosenblatt rejoined Commtouch in January 2009 and serves as Vice President,
Engineering. For the past 18 years, he has held executive positions in the
Israeli hi-tech industry ranging from start–ups to publically traded companies.
Mr. Rosenblatt served as VP of research and development at Commtouch in its
early stages until 2000 and most recently, he served as Vice President of
research and development at NiceVision, a division of Nice Systems. Previously,
Mr. Rosenblatt served in technology and business executive roles in several
startup companies, including Xacct, a provider of industry-leading mediation
software for telecom service providers that was acquired by Amdocs, Savantis,
and Gigaspaces. He earned a Bachelor of Science degree from Tel-Aviv University
and an Executive MBA from the Recanati School of Business.




Francois
Depayras re-joined Commtouch in 2010 as Vice President, Americas Sales and
Business Development. Mr. Depayras has over a decade of experience in the
messaging market, from leadership roles at Critical Path and Ensim as well as
his prior affiliation with Commtouch. At Critical Path, Mr. Depayras served as
Senior Product Manager, responsible for the development of a hosted email
solution targeting large enterprises. He then served as Vice President of Sales
and Alliances at Ensim, where he was responsible for managing worldwide sales of
user provisioning software solutions targeting both service providers and
enterprises, and managed relationships with strategic partners. Prior to these
positions, Mr. Depayras worked at Commtouch for four years in a variety of
roles, his last post being Director of Business Development. He holds an MBA
from San Francisco State University.




Ofer Tal
joined Commtouch in 2009 as Vice President, International Sales & Business
Development. Mr. Tal is an experienced business development & sales
executive with nearly a decade of global experience in technology solutions
across EMEA. Most recently prior to Commtouch, he served as Senior Director of
Channel Sales and then Director of Sales, SEMEA at GigaSpaces Technologies.
Prior to GigaSpaces, he held various senior business development and sales
positions at Interwise, an enterprise voice and web conferencing provider that
was acquired by AT&T.  He holds an LL.B from the University of Tel
Aviv School of Law.




Yossi
Maslaton joined Commtouch in 1998 and has served as Vice President of Network
Operations and Customer Services since early 2005.  Before 2005 he was
Director of Service Operations.  With over 20 years of experience in the
fields of Information Technology and Networking, Mr. Maslaton
is responsible for the operations of Commtouch's data centers and
customer services, servicing tens of millions of users daily with the
highest standards of uptime.  From 1991 to 1998 Mr. Maslaton was Manager of
Information Systems and labs for RND Networks, a group of hi-tech startups in
the network-routing field.  Prior to that, Mr. Maslaton managed the
technical field-operations of a large project for the Israel Defense Forces in
the areas of distributed computing systems and radio
communications.




26




Asaf
Greiner joined Commtouch in 2008 and serves as Vice President, Products. Mr.
Greiner has over a decade of experience in executive and entrepreneurial roles,
previously serving as Director of Business Innovation at Aladdin Knowledge
Systems, a company specializing in software and Internet security. Previously he
co-founded and acted as general manager of beeFENCE, a network security company,
and Aduva, a Linux lifecycle management company that was acquired by SUN
Microsystems. He holds an MBA summa cum laude from The Interdisciplinary Center,
Herzliya and a BA in Business and Economics from Hebrew University,
Jerusalem.




Rebecca
Steinberg Herson joined Commtouch in April 2006 as Director of Marketing.
Currently, she serves as Vice President, Marketing, orchestrating the company's
global marketing strategy and activities. Prior to joining Commtouch, Ms. Herson
served as Vice President of Marketing at Redmatch, a software start-up.
Previously, she led marketing initiatives at Whale Communications (acquired in
2006 by Microsoft), Orckit Communications (NASDAQ: ORCT) and at various
not-for-profit organizations. As the head of marketing for six years at Whale,
an Internet security company, she was responsible for launching numerous
hardware/software products and held a key role in establishing the company as a
market leader in the secure remote access field. Ms. Herson holds a BA magna cum
laude from Yale University, and an MS in Management from Boston
University.




Gabriel
Mizrahi joined Commtouch in 2008 and serves as Vice President,Technologies.
Prior to Commtouch, Mr. Mizrahi co-founded and served as CTO of PineApp, a
global messaging and Web security company that utilizes Commtouch’s technology.
Prior to PineApp, Mr. Mizrahi was a Project Manager in a large integration
company, where he led Unix and Linux projects in the field of Internet Security
& Networking. He has extensive technical knowledge and experience in
tailor-made solutions and complex technology integration, and received a
prestigious award from the Chief of Electronics and Computers of the Israel
Defense Force for designing, developing and implementing a logistics and
technical management system. Mr. Mizrahi holds a technical degree in electronics
from Ort College.




Election
of Directors




Directors
(other than outside directors, as explained below) are elected by shareholders
at the annual general meeting of the shareholders and hold office until the next
annual general meeting following the general meeting at which such director is
elected and until a successor is elected, or until the director is removed. An
annual general meeting must be held at least once in every calendar year, but
not more than fifteen months after the preceding annual general meeting.
Directors may be removed and other directors may be elected in their place or to
fill vacancies in the Board of Directors at any time by the holders of a
majority of the voting power at a general meeting of the shareholders. Until a
vacancy is filled by the shareholders, the Board of Directors may appoint new
directors temporarily to fill vacancies on the Board of Directors. The Amended
and Restated Articles of Association of Commtouch authorize the shareholders to
determine, from time to time, the number of directors. The maximum number of
directors is currently fixed at ten directors, though only seven directors are
currently serving on the Board of Directors. There are no family relationships
among any of the directors, officers or key employees of Commtouch.




Alternate
Directors




The
Amended and Restated Articles of Association of Commtouch provide that any
director may appoint another person to serve as an alternate director and may
remove such alternate. Any alternate director possesses all the rights and
obligations of the director who appointed him, except that the alternate has no
standing at any meeting while the appointing director is present, the alternate
may not in turn appoint an alternate for himself (unless the instrument
appointing him otherwise expressly provides) and the alternate is not entitled
to remuneration. A person who is not qualified to be appointed as a director may
not be appointed as an alternate director. Unless the appointing director limits
the time or scope of the appointment, the appointment is effective for all
purposes until the appointing director ceases to be a director or terminates the
appointment. The appointment of an alternate director does not in itself
diminish the responsibility of the appointing director as a
director.




27




Independent
and Outside Directors




The
Israel Companies Law requires Israeli companies with shares that have been
offered to the public in or outside of Israel to appoint at least two outside
directors. No person may be appointed as an outside director if the person or
the person’s relative, partner, employer or any entity under the person’s
control has or had, on or within the two years preceding the date of the
person’s appointment to serve as outside director, any affiliation with the
company or any entity controlling, controlled by or under common control with
the company. The term affiliation includes:




•
            an
      employment relationship;




•
            a
      business or professional relationship maintained on a regular
      basis;




•
            control;
      and




•
            service
      as an office holder.




No person
may serve as an outside director if the person’s position or other business
activities create, or may create, a conflict of interest with the person’s
responsibilities as an outside director or may otherwise interfere with the
person’s ability to serve as an outside director. If, at the time outside
directors are to be appointed, all current members of the Board of Directors are
of the same gender, then at least one outside director must be of the other
gender.  At least one of the outside directors is required to have
"financial and accounting expertise," unless another member of the audit
committee, who is an independent director under the NASDAQ Listing Rules, has
"financial and accounting expertise," and the other outside director or
directors are required to have "professional expertise," all as defined under
the Israel Companies Law.




Outside
directors are to be elected by a majority vote at a shareholders’ meeting,
provided that either:




•
            such
      majority includes at least one–third of the shares held by non–controlling
      shareholders who are present and voting at the meeting;
  or




•
            the
      total number of shares held by non–controlling shareholders voting against
      the election of the director at the meeting does not exceed one percent of
      the aggregate voting rights in the
company.




The
initial term of an outside director is three years and may be extended for an
additional period of three years. Outside directors may be removed only by the
same percentage of shareholders as is required for their election, or by a
court, and then only if the outside director ceases to meet the statutory
qualifications for their appointment or if they violate their fiduciary duty to
the company. Each committee of a company’s Board of Directors must include at
least one outside director and the audit committee (the existence of which is
required under the Israel Companies Law) must include all outside directors. An
outside director is entitled to compensation as provided in the regulations
adopted under the Israel Companies Law and is otherwise prohibited from
receiving any other compensation, directly or indirectly, in connection with
service provided as an outside director.




Mr.
Shamir and Mr. Bar-Touv currently serve as the Company’s outside
directors.




In
addition, the NASDAQ Listing Rules currently require Commtouch to have at least
a majority of independent directors, as defined under Listing Rule 5605(a)(2),
on the Board of Directors and to maintain an audit committee of at least three
members, each of whom must:




(i)
            be
      independent as defined under Listing Rule
  5605(a)(2);




(ii)
            meet
      the criteria for independence set forth in Rule 10A-3(b)(1) under the
      Securities Exchange Act of 1934, as amended, or “Exchange Act”, as set
      forth below (subject to the exemptions provided in Exchange Act Rule
      10A-3(c));




(iii)
            not
      have participated in the preparation of the financial statements of the
      Company or any current subsidiary of the Company at any time during the
      past three years; and




(iv)
            be
      able to read and understand fundamental financial statements, including a
      company’s balance sheet, income statement and cash flow
      statement.




Under
limited circumstances, the Company may have one audit committee member not
independent in accordance with the above, but such a member would only be able
to serve for a maximum of two years.




28




Exchange
Act Rule 10A-3(b)(1) requires that members of the audit committee meet that
rule’s definition of independence, which requires that an audit committee member
may not, except in his or her capacity as a director or committee member, (i)
accept directly or indirectly any consulting, advisory, or other compensatory
fee from the Company or any of its subsidiaries (except for fixed amounts of
compensation under a retirement plan for prior service with the Company,
provided that such compensation is not contingent in any way on continued
service), and (ii) be an “affiliated person” of the Company or any of its
subsidiaries.





NASDAQ
rules also require that the Company certify that it has, and will continue to
have, at least one member of the audit committee who has past employment
experience in finance or accounting, requisite professional certification in
accounting, or any other comparable experience or background which results in
the individual’s financial sophistication, including being or having been a
chief executive officer, chief financial officer or other senior officer with
financial oversight  responsibilities.  Also, the Company is
required to disclose whether or not it has an “audit committee financial expert”
on its audit committee, as defined under Item 16A to Form 20-F.




The three
directors who serve on our audit committee, Mr. Shamir, Mr. Bar-Touv and Mr.
Shefsky, qualify as independent directors under NASDAQ Listing Rules (including
Exchange Act Rule 10A-3). Furthermore, Mr. Shamir and Mr. Bar-Touv meet the
qualification requirements for outside directors, as required under the Israel
Companies Law.




The
Company has identified the following Board members as “Independent directors”
pursuant to NASDAQ Listing Rule 5605(a)(2):





a.
            Yair
      Bar-Touv


b.
            Yair
      Shamir


c.
            Aviv
      Raiz


d.
            Hila
      Karah


e.
            Lloyd
      Shefsky




Pursuant
to the Israeli Companies Law, an Israeli company, whose shares are publicly
traded, may elect to adopt a provision in its articles of association pursuant
to which a majority of its board of directors will constitute individuals
complying with certain independence criteria prescribed by the Israel Companies
Law.  We have not included such a provision in our articles of
association since our board of directors complies with the independence
requirements of the NASDAQ and Securities and Exchange Commission regulations
described above.




Audit
Committee




As noted
above in the discussion under “Independent and Outside
Directors”, the Israel Companies Law requires public companies to appoint
an audit committee. The responsibilities of the audit committee include
identifying irregularities in the management of the Company’s business,
approving management compensation and approving related party transactions as
required by law. An audit committee must consist of at least three directors
meeting the independence standards under the NASDAQ Listing Rules and must
include all outside directors under the Israel Companies Law, all as described
above. Furthermore, the Israel Companies Law specifically prohibits the chairman
of the Board of Directors, any director employed by or otherwise providing
services to a company and a controlling shareholder or any relative of a
controlling shareholder from being a member of the audit committee. Our Audit
Committee is in compliance with the noted requirements.




Compensation
Committee




The
Compensation Committee is responsible for determining salaries, incentives and
other forms of compensation for Commtouch’s directors and its executive
officers.  The Compensation Committee is also responsible for
administering the various stock option plans, including the issuance of grants
of options to employees of the Company and its subsidiary.




Nominating
Committee




The
committee’s responsibilities include identifying individuals qualified to
become board members and recommending director nominees to the
board.




29




Investment
Committee




The
committee’s responsibilities include identifying appropriate investment vehicles
for the cash reserves of the Company and recommending to the board appropriate
investment policy from time to time.




Internal
Auditor




Under the
Israel Companies Law, the Board of Directors must appoint an internal auditor,
nominated by the audit committee. The role of the internal auditor is to
examine, among other matters, whether a company’s actions comply with relevant
law and orderly business procedure. Under the Companies Law, the internal
auditor may be an employee of the company but not an interested party or office
holder, or a relative of an interested party or office holder, and he or she may
not be the company’s independent accountant or its representative




Approval
of Certain Transactions; Obligations of Directors, Officers and
Shareholders




The
Israel Companies Law codifies the fiduciary duties that office holders,
including directors and executive officers, owe to a company. An office holder’s
fiduciary duties consist of a duty of care and a duty of loyalty. Each person
listed in the first table that appears above at the beginning of this Item 6 is
an office holder.




The duty
of loyalty requires an office holder to act in good faith and for the benefit of
the company, including to avoid any conflict of interest between the office
holder’s position in the company and such person’s personal affairs, avoiding
any competition with the company, avoiding exploiting any corporate opportunity
of the company in order to receive personal advantage for such person or others,
and revealing to the company any information or documents relating to the
company’s affairs which the office holder has received due to his or her
position as an office holder. A company may approve any of the acts mentioned
above provided that all the following conditions apply: the office holder acted
in good faith and neither the act nor the approval of the act prejudices the
good of the company, and the office holder disclosed the essence of his personal
interest in the act, including any substantial fact or document, a reasonable
time before the date for discussion of the approval.





The duty
of care requires an office holder to act with a level of care that a reasonable
office holder in the same position would employ under the same
circumstances.  This includes the duty to use reasonable means to
obtain information regarding the advisability of a given action submitted for
his or her approval or performed by virtue of his or her position and all other
relevant information material to these actions.





Under the
Israel Companies Law, all arrangements as to compensation of office holders who
are not directors require approval of the Board of Directors unless the Articles
of Association provide otherwise. Arrangements regarding the compensation of
directors also require audit committee and shareholder approval.




The
Israel Companies Law requires that an office holder promptly disclose any
personal interest that he or she may have and all related material information
known to him or her, in connection with any existing or proposed transaction by
the company. "Personal interest," as defined by the Companies Law, includes a
personal interest of any person in an act or transaction of the company,
including a personal interest of his relative or of a corporation in which that
person or a relative of that person is a 5% or greater shareholder, a holder of
5% or more of the voting rights, a director or general manager, or in which he
or she has the right to appoint at least one director or the general
manager.  "Personal interest" does not apply to a personal interest
stemming merely from holding shares in the company.




The
office holder must make the disclosure of his personal interest no later than
the first meeting of the company's board of directors that discusses the
particular transaction.  This duty does not apply to the personal
interest of a relative of the office holder in a transaction unless it is an
"extraordinary transaction."  An “extraordinary transaction” is
defined as a transaction not in the ordinary course of business, a transaction
that is not on market terms, or a transaction that is likely to have a material
impact on the company’s profitability, assets or liabilities, and a "relative"
as a spouse, siblings, parents, grandparents, descendants, spouse’s descendants
and the spouses of any of the foregoing.




30




In the
case of a transaction that is not an extraordinary transaction, after the office
holder complies with the above disclosure requirement, only Board approval is
required unless the Articles of Association of the company provide
otherwise.  Our Amended and Restated Articles of Association do not
provide otherwise.  Such approval must determine that the transaction
is not adverse to the company’s interest. If the transaction is an extraordinary
transaction, then in addition to any approval required by the Articles of
Association, it also must be approved by the audit committee and by the Board
and, under specified circumstances, by a meeting of the shareholders. An Israeli
company whose shares are publicly traded shall not be entitled to approve such a
transaction unless, at the time the approval was granted, two members of the
audit committee were outside directors and at least one of them was present at
the meeting at which the audit committee decided to grant the approval. An
office holder who has a personal interest in a matter that is considered at a
meeting of the Board of Directors or the audit committee generally may not be
present at this meeting or vote on this matter unless a majority of the board of
directors or the audit committee has a personal interest in the
matter.  If a majority of the board of directors or the audit
committee has a personal interest in the transaction, shareholder approval also
would be required.




The
Israel Companies Law applies the same disclosure requirements to a controlling
shareholder of a public company, which includes a shareholder that holds 25% or
more of the voting rights if no other shareholder owns more than 50% of the
voting rights in the company. Extraordinary transactions, including a private
placement, with a controlling shareholder or in which a controlling shareholder
has a personal interest, and the terms of compensation of a controlling
shareholder who is an office holder, require the approval of the audit
committee, the Board of Directors and the shareholders of the company. The
shareholder approval must either include at least one–third of the disinterested
shareholders who are present, in person or by proxy, at the meeting or,
alternatively, the total shareholdings of the disinterested shareholders who
vote against the transaction must not represent more than one percent of the
voting rights in the company.




Under the
Israel Companies Law, a shareholder has a duty to act in good faith towards the
company and other shareholders and refrain from abusing his or her power in the
company, including, among other things, in respect to his or her voting at the
general meeting of shareholders on the following matters:




•
            any
      amendment to the Articles of
Association;




•
            an
      increase of the company’s authorized share
  capital;




•
            a
      merger; or




•
            approval
      of interested party transactions that require shareholder
      approval.




In
addition, any controlling shareholder, any shareholder who can determine the
outcome of a shareholder vote and any shareholder who, under the company’s
Articles of Association, can appoint or prevent the appointment of an office
holder, is under a duty to act with fairness towards the company. The Israel
Companies Law provides that a breach of the duty of fairness will be governed by
the laws governing breach of contract. The Israel Companies Law does not
describe the substance of this duty.




Insurance,
Indemnification and Exculpation of Directors and Officers; Limitations on
Liability




The
Israel Companies Law permits a company to insure an office holder in respect of
liabilities incurred by him or her as a result of the breach of his or her duty
of care to the company or to another person, or as a result of the breach of his
or her duty of loyalty to the company, to the extent that he or she acted in
good faith and had reasonable cause to believe that the act would not prejudice
the company. A company can also insure an office holder for monetary liabilities
as a result of an act or omission that he or she committed in connection with
his or her serving as an office holder. Moreover, a company can indemnify an
office holder for (a) any monetary liability imposed upon such a office holder
for the benefit of a third party pursuant to a court judgment, including a
settlement or an arbitrator’s decision, confirmed by a court, (b) reasonable
legal costs, including attorney’s fees, expended by a office holder as a result
of an investigation or proceeding instituted against the office holder by a
competent authority, provided that such investigation or proceeding concludes
without the filing of an indictment against the office holder and either i) no
financial liability was imposed on the office holder in lieu of criminal
proceedings  or ii) financial liability was imposed on the office
holder in lieu of criminal proceedings but the alleged criminal offense does not
require proof of criminal intent, and (c) reasonable litigation expenses,
including legal fees, actually incurred by such a office holder or imposed upon
the office holder by a court order, in a proceeding brought against the office
holder by or on behalf of the company or by others, or in a criminal action in
which he was acquitted, or in a criminal action which does not require proof of
criminal intent in which he was convicted.  The Companies Law further
provides that the indemnification provision in a company’s articles of
association (i) may be an obligation to indemnify in advance, provided that,
other than litigation expenses, it is limited to events the board of directors
can foresee in light of the company’s actual activities when providing the
obligation and that it is limited to a sum or standards the board of directors
determines is reasonable in the circumstances, and (ii) may permit the company
to indemnify an officer or a director after the fact.




31




Furthermore,
a company can, with one limited exception, exculpate an office holder in
advance, in whole or in part, from liability for damages sustained by a breach
of duty of care to the company.




All of
these provisions are specifically limited in their scope by the Companies Law,
which provides that a company may not indemnify or exculpate an officer or
director nor enter into an insurance contract that would provide coverage for
any monetary liability incurred as a result of (i) a breach by the officer or
director of the duty of loyalty, unless the officer or director acted in good
faith and had a reasonable basis to believe that the act would not prejudice the
company, in which case the company is permitted to indemnify and provide
insurance to but not to exculpate; (ii) an intentional or reckless breach by the
officer or director of the duty of care, other than if solely done in
negligence; (iii) any act or omission done with the intent to derive an illegal
personal benefit; or (iv) any fine levied or forfeit against the director or
officer.




Our
Amended and Restated Articles of Association allow us to insure, exculpate and
indemnify office holders to the fullest extent permitted by law provided such
insurance, exculpation or indemnification is approved in accordance with the
Israel Companies Law. We have acquired directors’ and officers’ liability
insurance covering the officers and directors of Commtouch and its subsidiary
for certain claims. At the annual meeting of shareholders held on November 18,
2002, the shareholders approved a form of indemnification, exculpation and
insurance agreement that is applicable to all our directors.  The form
of this agreement, as well as related provisions in our Amended and Restated
Articles of Association, were amended at the annual meeting of shareholders held
on December 30, 2005.




Compensation
of Directors and Executive Officers




The
directors of Commtouch can be remunerated by Commtouch for their services as
directors to the extent such remuneration is approved by Commtouch’s audit
committee, Board of Directors and shareholders. Through 2008, directors did not
receive cash compensation for their services.  However, at the annual
meeting in December 2008, shareholders approved the payment of cash
compensation, in addition to equity compensation (options), according to the
following:




a.
            NIS
      31,700 base annually per director, as linked to the applicable Israeli
      consumer price index, payable in four equal installments at the beginning
      of each calendar quarter; and


b.
            NIS
      1,590 per director per face to face Board or committee meeting or NIS954
      (60% of NIS 1590) in case of telephonic participation at such meeting,
      payable at the beginning of each calendar quarter following the quarter
      during which a Board member participated in a meeting. No separate per
      meeting compensation will be paid for committee meetings that are held on
      the same day immediately prior or subsequent to a Board
      meeting.  In that event, a Board and committee meeting will be
      considered one meeting.


c.
            For
      non-Israeli based directors, the amounts set forth will be paid in United
      States dollars, according to the representative rate of exchange published
      by the Bank of Israel on the date of
payment.




Directors
also are reimbursed for their expenses for each Board of Directors meeting
attended. See in this item 6., “Amended and Restated 1999 Non-employee Directors
Stock Option Plan” for a discussion of director compensation in the form of
option grants. During 2009, options to purchase 427,000 Ordinary Shares were
granted to directors and executive officers under the Company’s stock option
plans at a weighted average exercise price of $ 3.19 per share. The aggregate
direct remuneration paid by Commtouch to all directors and executive officers (9
persons) in 2009 was approximately $850 thousand. During the same period
Commtouch accrued or set aside approximately $90 thousand for the same group to
provide pension, retirement or similar benefits. As of December 31, 2009,
directors and executive officers of Commtouch (9 persons) held an aggregate of
3,024,033 stock options to purchase a like number of Ordinary Shares, with
2,025,286 of those options being vested and exercisable within sixty days of
said date.




Options
to Purchase Securities from Registrant or Subsidiaries




As of
December 31, 2009, options to purchase 4,428,365Ordinary Shares were outstanding
and held by 45 persons made up of then existing employees, consultants,
executive officers and non–employee directors under the Company’s stock option
plans, and there were 845,200 shares available for grant under all plans. Of the
number of options outstanding, 2,757,251 were vested and
exercisable.  Additionally, these outstanding options had exercise
prices ranging from $0.0375 to $6.60 per share, a weighted average per share
exercise price of approximately $2.46 and termination dates ranging from
February 2011 to December 2015.




32




Employee
Stock Option Plans




Employees,
including executive officers and other management employees, participate in the
Company’s employee option plans. The Commtouch Software Ltd. 2006 U.S. Stock
Option Plan, primarily covering the granting of options to employees and
consultants based in the United States, was adopted on December 15, 2006 and has
a term of ten years.  The Commtouch Software Ltd. Amended and Restated
Israeli Share Options Plan, primarily covering the granting of options to
employees, consultants and directors based in Israel, was adopted on June 22,
2003 and has a term of ten years.   While Israeli based directors
receive their grants under the Israeli plan, the principal terms of their grants
are identical to those of non-Israeli based directors receiving their grants
under the non-employee director plan (discussed below).




Some
previous employee option plans have either terminated or were amended and
restated, though options remain outstanding and exercisable under those
plans.  Such plans include the Amended and Restated 1996 CSI Stock
Option Plan which expired on January 1, 2006 and theAmended and Restated 1999
3(i) Share Option Plan, which was replaced by the above described Israeli Share
Option Plan.





All
employee stock option plans are administered by the Compensation Committee.
Subject to the provisions of the employee stock plans and applicable law, the
Compensation Committee has the authority to determine, among other things, to
whom options may be granted; the number of Ordinary Shares to which an option
may relate; the exercise price for each share; the vesting period of the option
and the terms, conditions and restrictions thereof, including accelerated
vesting on change of control provisions; to amend provisions relating to such
plans; and to make all other determinations deemed necessary or advisable for
the administration of such plans.




Amended
and Restated 1999 Non–Employee Directors Stock Option Plan




New
non-employee directors are currently entitled to an initial grant of 50,000
options. Non-employee directors who are re-elected at the annual meeting of
shareholders are entitled to additional grants of 16,667 options, though at the
annual meeting held October 26, 2009 shareholders approved a one-time increase
in the grants to re-elected directors to 30,000 options.




The
Company’s Non–Employee Directors Plan was extended by an additional ten years at
the annual meeting of shareholders held on December 15, 2008. Under this plan,
each option becomes exercisable at a rate of 1/16th of the option shares every
three months, and has an exercise price equal to the fair market value of the
Ordinary Shares on the grant date of such option. Up through 2004, each option
granted had a maximum term of ten years, but would terminate earlier if the
optionee ceased to be a member of the Board of Directors. Options granted to
directors during 2005 - 2009 have a maximum term of six years.  At the
annual meeting of shareholders of December 30, 2005, shareholders approved an
amendment to the Non-Employee Directors Plan to allow for the acceleration of
unvested options for any director who has served the Company for at least three
years, unless the director resigned voluntarily or was removed from the Board of
Directors due to a failure to perform any of his/her duties to the
Company.




Employees




See Item
4: Employees




Item
7. Major Shareholders and Related Party Transactions.




The
following table presents information with respect to beneficial ownership of our
Ordinary Shares as of December 31, 2009, including:




•
            each
      person or entity known to Commtouch to own beneficially more than five
      percent of Commtouch’s Ordinary Shares,
and




•
            all
      executive officers and directors as a
group.




Beneficial
ownership is determined in accordance with the rules of the SEC and includes
voting or investment power, with respect to shares. To our knowledge, except
under applicable community property laws or as otherwise indicated, the persons
named in the table have sole voting and sole investment control and rights to
receive economic benefits with respect to all shares beneficially owned. The
applicable percentage of ownership for each shareholder is based on 23,958,761
Ordinary Shares outstanding as of December 31, 2009. Ordinary Shares issuable
upon exercise of options and other rights held and exercisable on or within
sixty days of December 31, 2009 are deemed outstanding for the purpose of
computing the percentage ownership of the person holding those options and other
rights and for all directors and officers as a group, but are not deemed
outstanding for computing the percentage ownership of any other
person.  Major shareholders in the Company have the same voting rights
as all other shareholders.




33




MAJOR
      SHAREHOLDERS OF ORDINARY SHARES
                      
                      Amount
                      
                      
                      Percent
      ofOwned
                      
                      
                      ClassAviv
      Raiz*
                      
                      
                      5,562,740
                      **
                      
                      
                      22.8
                      %Gideon
      Mantel*
                      
                      
                      1,365,643
                      ***
                      
                      
                      5.5
                      %Catalyst
      Private Equity Partners II LP
                      
                      
                      1,200,241
                      ****
                      
                      
                      5
                      %All
      directors and executive officers as a group at 12/31/09 (9
      persons)
                      
                      
                      9,564,605
                      *****
                      
                      
                      36.3
                      %




*These
shareholders of record reside in Israel.  With respect to Catalyst
Private Equity Partners II LP, the Chairman and Managing Partner of this limited
partnership, Mr. Yair Shamir – a director in the Company - resides in
Israel.


**Includes
76,871 options and 333,333 warrants, exercisable into a like number of Ordinary
Shares.


***Includes
962,617 options exercisable into a like number of Ordinary Shares.


****Includes
27,913 options exercisable into a like number of Ordinary Shares.


*****Includes
2,025,286 options exercisable into a like number of Ordinary
Shares.  Also, this number includes 134,265 shares held by LENE L.P.,
in which Mr. Lloyd Shefsky holds a relatively small limited partner interest,
without any control over partnership management.





Based on
a review of the information provided to us by our transfer agent, as
of December 31, 2009, there were79 holders of
record of our Ordinary Shares, including 52 holders of record residing in
the United States holding 22,493,527 Ordinary Shares, or approximately
94% of the aggregate 23,958,761 Ordinary Shares outstanding as of such
date.  These numbers are not representative of the number of
beneficial holders of our shares nor is it representative of where such
beneficial holders reside since many of these ordinary shares were held of
record by brokers or other nominees (including one U.S. nominee company, CEDE
& Co., which held approximately 87% of our outstanding Ordinary Shares
as of such date on behalf of approximately 91 brokers and banks).




Significant
Changes in Percentage Ownership During the Past Three Years




Since
December 2006, Catalyst Private Equity Partners II LP has acquired through
purchases on the open market a total of 1,172,328 Ordinary Shares, which as of
the filing of this annual report represents slightly less than 5% ownership in
the Company.




Interest
of Management and their Family Members in Certain Transactions




There
were no related party transactions during 2009 or through the date of filing of
this Form 20-F.




Item
8. Financial Information.




See Item
18: Financial Statements.  If the Company decides to distribute a cash
dividend out of income that has been tax exempt due to an “approved enterprise”
status under the Law for the Encouragement of Capital Investments, 5719-1959,
the amount of cash dividend will be subject to corporate tax at the rate then in
effect under Israeli law. The Company has never declared or paid cash dividends
on its Ordinary Shares.  However, the Company has not adopted a policy
not to pay cash dividends and therefore may declare a dividend in the future.
The Company’s current plans are to retain future earnings primarily to finance
the development of its business and for other corporate purposes.




We are
not a party to any litigation, and we are not aware of any threatened litigation
which, in the aggregate, would be material to the business of the
Company.




34





Except as
otherwise disclosed in this Annual Report, there has been no material change in
our financial position since December 31, 2009.




Item
9. The Offer and Listing.




The
Company’s Ordinary Shares have been traded publicly on NASDAQ as
follows:




a.
            From
      July 13, 1999 through June 29, 2004, under the symbol “CTCH” (up to June
      7, 2002 on the National Market, and subsequently on the Small Cap Market,
      which during 2005 was renamed the “Capital
  Market”);




b.
            From
      June 30, 2004 through June 26, 2005, under the symbol
    “CTCHC”;




c.
            From
      June 27, 2005 through January 1, 2008, under the symbol
      “CTCH”;




d.
            From
      January 2, 2008 through January 29, 2008, under the symbol “CTCHD”;
      and




e.
            From
      January 30, 2008, under the symbol
CTCH.




Since
December 16, 2009, the Company’s Ordinary Shares have also been traded on the
Tel Aviv Stock Exchange, or “TASE”, under the symbol CTCH.




The
following table lists the high and low closing sales prices for the Company’s
Ordinary Shares on the NASDAQ Capital Market, for the periods
indicated:




High
                                        
                                        
                                        Low2005:
                                        
                                        $
                                        3.90
                                        
                                        
                                        $
                                        1.352006:
                                        
                                        $
                                        4.08
                                        
                                        
                                        $
                                        2.102007:
                                        
                                        $
                                        7.44
                                        
                                        
                                        $
                                        3.692008:
                                        
                                        $
                                        6.22
                                        
                                        
                                        $
                                        1.502009:
                                        
                                        $
                                        4.30
                                        
                                        
                                        $
                                        1.572008:First
      Quarter
                                        
                                        $
                                        6.22
                                        
                                        
                                        $
                                        3.68Second
      Quarter
                                        
                                        $
                                        4.40
                                        
                                        
                                        $
                                        2.77Third
      Quarter
                                        
                                        $
                                        3.45
                                        
                                        
                                        $
                                        2.15Fourth
      Quarter
                                        
                                        $
                                        2.50
                                        
                                        
                                        $
                                        1.502009:First
      Quarter
                                        
                                        $
                                        2.12
                                        
                                        
                                        $
                                        1.57Second
      Quarter
                                        
                                        $
                                        2.04
                                        
                                        
                                        $
                                        1.71Third
      Quarter
                                        
                                        $
                                        3.73
                                        
                                        
                                        $
                                        2.63Fourth
      Quarter
                                        
                                        $
                                        4.30
                                        
                                        
                                        $
                                        3.39Most
      Recent Six Months:September
      2009
                                        
                                        $
                                        3.21
                                        
                                        
                                        $
                                        2.63October
      2009
                                        
                                        $
                                        3.73
                                        
                                        
                                        $
                                        3.11November
      2009
                                        
                                        $
                                        3.42
                                        
                                        
                                        $
                                        3.03December
      2009
                                        
                                        $
                                        3.88
                                        
                                        
                                        $
                                        3.39January
      2010
                                        
                                        $
                                        4.30
                                        
                                        
                                        $
                                        3.84February
      2010
                                        
                                        $
                                        4.00
                                        
                                        
                                        $
                                        3.82
  35




Given the
limited trading history on the TASE, the Company is providing the high and low
prices only for the period December 16, 2009 through February 28,
2010.  Share prices on the TASE are quoted in New Israeli Shekels
(NIS):




High
                        
                        LowDecember
      2009(since December 16, 2009)
                        
                        NIS
      15.1
                        
                        NIS14.6January
      2010
                        
                        NIS
      16.6
                        
                        NIS15.9February
      2010
                        
                        NIS
      15.7
                        
                        NIS15.2




Item
10. Additional Information.




We are
registered under the Israel Companies Law as a public company with registration
number 52-004418-1.  The objective stated in our memorandum of
association is to engage in any lawful activity.




DESCRIPTION
OF SHARES




Set forth
below is a summary of the material provisions governing our share capital. This
summary is not complete and should be read together with our Memorandum of
Association and Amended and Restated Articles of Association, copies of which
are filed with this report or have been filed as exhibits to certain of our
prior filings with the SEC.




As of
December 31, 2009, our authorized share capital consisted of 55,353,340 Ordinary
Shares, NIS 0.15 par value. As of December 31, 2009, there were
23,958,761Ordinary Shares issued and outstanding.




DESCRIPTION
OF ORDINARY SHARES




All
issued and outstanding Ordinary Shares of Commtouch are duly authorized and
validly issued, fully paid and nonassessable.




The
Ordinary Shares do not have preemptive rights. Our Memorandum of Association,
Amended and Restated Articles of Association and the laws of the State of Israel
do not restrict in any way the ownership or voting of Ordinary Shares by
non–residents of Israel, except with respect to subjects of countries which are
in a state of war with Israel.




DIVIDEND
AND LIQUIDATION RIGHTS




The
Ordinary Shares are entitled to their full proportion of any cash or share
dividend declared.




Subject
to the rights of the holders of shares with preferential or other special rights
that may be authorized, the holders of Ordinary Shares are entitled to receive
dividends in proportion to the sums paid up or credited as paid up on account of
the nominal value of their respective holdings of the shares in respect of which
the dividend is being paid (without taking into account the premium paid up on
the shares) out of assets legally available therefor and, in the event of our
winding up, to share ratably in all assets remaining after payment of
liabilities in proportion to the nominal value of their respective holdings of
the shares in respect of which such distribution is being made, subject to
applicable law. Declaration of a dividend requires Board of Directors
approval.




Under
current Israeli regulations, any dividends or other distributions paid in
respect of Ordinary Shares purchased by non–residents of Israel with certain
non–Israeli currencies (including U.S. dollars) will be freely repatriable in
such non–Israeli currencies at the rate of exchange prevailing at the time of
conversion, provided that Israeli income tax has been paid on, or withheld from,
such payments.




36




MODIFICATION
OF CLASS RIGHTS




If at any
time the share capital is divided into different classes of shares, then, unless
the conditions of allotment of such class provide otherwise, the rights,
additional rights, advantages, restrictions and conditions attached or not
attached to any class, at any given time, may be modified, enhanced, added or
abrogated by resolution at a meeting of the holders of the shares of such
class.




Pursuant
to Israel’s securities laws, a company registering its shares for trade on the
Tel Aviv Stock Exchange may not have more than one class of shares for a period
of one year following registration, after which it is permitted to issue
preferred shares, if the preference of those shares is limited to a preference
in the distribution of dividends and these preferred shares have no voting
rights.




SPECIAL
PROVISIONS IN AMENDED AND RESTATED ARTICLES OF ASSOCIATION RELATING TO
DIRECTORS




The
discussion regarding approval of director compensation and transactions with the
Company under “Item 6. Directors, Senior Management and Employees - Approval of
Certain Transactions; Obligations of Directors, Officers and Shareholders” is
incorporated herein by reference.




VOTING,
SHAREHOLDER MEETINGS AND RESOLUTIONS




Holders
of Ordinary Shares have one vote for each share held on all matters submitted to
a vote of shareholders.




An annual
general meeting must be held once every calendar year at such time (not more
than 15 months after the last preceding annual general meeting) and at such
place, either within or outside the State of Israel, as may be determined by the
Board of Directors. The quorum required for a general meeting of shareholders
consists of at least two shareholders present in person or by proxy and holding
at least one–third of the voting rights of the issued share capital. A meeting
adjourned for lack of a quorum may be adjourned to the same day in the next week
at the same time and place, or to such time and place as the Board of Directors
may determine in a notice to shareholders. At such reconvened meeting any two
shareholders entitled to vote and present in person or by proxy will constitute
a quorum.  Rule 5620(c) to Nasdaq Listing Rules requires that an
issuer listed on Nasdaq should have a quorum requirement that in no case be less
than 33 1/3% of the outstanding shares of the company’s common voting stock.
However, as mentioned above, our articles of association, consistent with the
Companies Law, provides for a lower quorum requirement at an adjourned
meeting.




Generally,
shareholder resolutions will be deemed adopted if approved by the holders of a
majority of the voting power represented at the meeting, in person or by proxy,
and voting thereon.  For certain matters as described under the Israel
Companies law, there is a requirement that the majority include the
affirmative vote of at least one-third of the votes cast by shareholders who are
not controlling shareholders of the Company or interested parties in the matter
to be voted upon (or their representatives) or, alternatively, the total
shareholdings of the votes cast against the proposal (other than by the
Company’s controlling shareholders or interested parties in the matter to be
voted upon) must not represent more than one percent of the voting rights in the
Company.




ANTI–TAKEOVER
PROVISIONS UNDER ISRAELI LAW




Under the
Companies Law, a merger is generally required to be approved by the shareholders
and board of directors of each of the merging companies. If the share capital of
the company that will not be the surviving company is divided into different
classes of shares, the approval of each class is also required. In addition, a
merger can be completed only after 30 days have passed from the shareholders’
approval of each of the merging companies, all approvals have been submitted to
the Israeli Registrar of Companies and at least fifty days have passed from the
time that a proposal for approval of the merger was filed with the
Registrar.




The
Companies Law provides that an acquisition of shares in a public company must be
made by means of a tender offer if as a result of the acquisition the purchaser
would hold 25% or more of the voting rights in  the company, unless
there is already another 25% shareholder of the company. Similarly, the
Companies Law provides that an acquisition of shares in a public company must be
made by means of tender offer if as a result of the acquisition the purchaser
would hold more than 45% of the voting rights in the company, unless someone
else already holds 45% of the voting power of the company.




37




Finally,
Israeli tax law treats specified acquisitions, including a stock–for–stock swap
between an Israeli company and a foreign company, less favorably than does U.S.
tax law. For example, Israeli tax law may subject a shareholder who exchanges
his Ordinary Shares for shares in a foreign corporation to taxation before it
would become taxable in the United States, even though the investment has not
become liquid, although in the case of shares of a foreign corporation that
are traded on a stock exchange, the tax may be postponed subject to certain
conditions.




TRANSFER
OF SHARES AND NOTICES




Fully
paid Ordinary Shares that are issued and not subject to any legal restrictions
on transference may be transferred freely. Each shareholder of record is
entitled to receive at least twenty-one days' prior notice (and for certain
matters, thirty-five days’ prior notice) before the date of a shareholder
meeting and at least five days notice before the record date for the meeting.
For purposes of determining the shareholders entitled to notice and to vote at
such meeting, the Board of Directors may fix a record date not exceeding 40 days
prior to the date of any shareholder meeting.




CHANGES
IN OUR CAPITAL




Changes
in our capital are subject to the approval of the shareholders by a majority of
the votes of shareholders present by person or by proxy and voting at the
shareholders meeting.




ACCESS
TO INFORMATION




We file
reports with the Israeli Registrar of Companies regarding our registered
address, our registered capital, our shareholders of record and the number of
shares held by each, the identity of the directors and details regarding
security interests on our assets. In addition, Commtouch must file with the
Israeli Registrar of Companies its Amended and Restated Articles of Association
and any further amendments thereto. The information filed with the Registrar of
Companies is available to the public. In addition to the information available
to the public, our shareholders are entitled, upon request, to review and
receive copies of all minutes of meetings of our shareholders.




We are
subject to certain of the information reporting requirements of the Exchange
Act.  As a “foreign private issuer,” we are exempt from the rules and
regulations under the Exchange Act prescribing the furnishing and content of
proxy statements, and our officers, directors and principal shareholders are
exempt from the reporting and “short-swing” profit recovery provisions contained
in Section 16 of the Exchange Act, with respect to their purchase and sale of
the ordinary shares.  In addition, we are not required to file reports
and financial statements with the SEC as frequently or as promptly as U.S.
companies whose securities are registered under the Exchange
Act.  However, we file with the SEC an Annual Report on Form 20-F
containing financial statements audited by an independent registered public
accounting firm.  We also furnish quarterly reports on Form 6-K
containing unaudited financial information after the end of each quarter and
other reports on Form 6-K from time to time.  We post our Annual
Report on Form 20-F on our Website (www.commtouch.com)
promptly following the filing of our Annual Report with the Securities and
Exchange Commission. The information on our website is not incorporated by
reference into this Annual Report.





This
report and other information filed or to be filed by us can be inspected and
copied at the public reference facilities maintained by the SEC at:





100 F
Street, NE


Public
Reference Room


Washington,
D.C. 20549





The SEC
maintains a Web site at www.sec.gov that contains reports, proxy and information
statements, and other information regarding registrants that make electronic
filings with the SEC using its EDGAR system.




38




In
addition, since we are also listed on the Tel Aviv Stock Exchange we submit
copies of all our filings with the Securities and Exchange Commission to the
Israeli Securities Authority and the Tel Aviv Stock Exchange. Such copies can be
retrieved electronically through the Tel Aviv Stock Exchange’s internet
messaging system (www.maya.tase.co.il) and through the MAGNA distribution
site of the Israeli Securities Authority
(www.magna.isa.gov.il).




MATERIAL
CONTRACTS DURING PAST TWO YEARS




Equity Investments. Commtouch
made a $750,000 investment in Mirapoint Software, Inc., a secure messaging
vendor and an OEM licensee, as part of Mirapoint's larger financing round in the
fourth quarter of 2007.  In connection therewith, Commtouch received a
minority ownership interest in Mirapoint of approximately 8%.  During
early 2009, Commtouch made an additional investment in Mirapoint, as part of a
larger financing round, in the amount of $477,000. In total, Commtouch
investments in Mirapoint as of December 31, 2009 amounted to
$1,227,000.




Amended
and Restated Articles of Association




See the
discussion under Item 4 “Information on the Company- Overview” for instructions
on how to locate the Company’s Amended and Restated Articles of Association. In
addition, the Articles are incorporated by reference to this Form 20-F under
Exhibit 1.2 below.




EXCHANGE
CONTROLS




Non-residents
of Israel who own our ordinary shares may freely convert all amounts received in
Israeli currency in respect of such ordinary shares, whether as a dividend,
liquidation distribution or as proceeds from the sale of the ordinary shares,
into freely-repatriable non-Israeli currencies at the rate of exchange
prevailing at the time of conversion (provided in each case that the applicable
Israeli income tax, if any, is paid or withheld).





Until May
1998, Israel imposed extensive restrictions on transactions in foreign
currency.  These restrictions were largely lifted in May
1998.  Since January 1, 2003, all exchange control restrictions have
been eliminated although there are still reporting requirements for foreign
currency transactions.  Legislation remains in effect, however,
pursuant to which currency controls can be imposed by administrative action at
any time.





The State
of Israel does not restrict in any way the ownership or voting of our ordinary
shares by non-residents of Israel, except with respect to subjects of countries
that are in a state of war with Israel.




ISRAELI
TAXATION




The
following is a summary of the principal tax laws applicable to companies in
Israel, including special reference to their effect on us, and Israeli
government programs benefiting us. This section also contains a discussion of
the material Israeli tax consequences to you if you acquire Ordinary Shares of
our company. This summary does not discuss all the acts of Israeli tax law that
may be relevant to you in light of your personal investment circumstances or if
you are subject to special treatment under Israeli law. To the extent that the
discussion is based on new tax legislation which has not been subject to
judicial or administrative interpretation, we cannot assure you that the views
expressed in this discussion will be accepted by the tax authorities. The
discussion should not be understood as legal or professional tax advice and is
not exhaustive of all possible tax considerations.




General
Corporate Tax Structure




Generally,
Israeli companies are subject to “Corporate Tax” on their taxable income. The
applicable rate was 29% in 2007, 27% in 2008, 26% in 2009, is 25% in 2010 and is
scheduled to decline to 24% in 2011, 23% in 2012, 22% in 2013, 21% in 2014, 20%
in 2015 and 18% in 2016 and thereafter.




39




Tax
Benefits under the Law for the Encouragement of Industry (Taxes),
1969





The Law
for the Encouragement of Industry (Taxes), 1969, generally referred to as the
Industry Encouragement Law, provides several tax benefits for industrial
companies. An industrial company is defined as a company resident in Israel, at
least 90% of the income of which in a given tax year exclusive of income from
specified government loans, capital gains, interest and dividends, is derived
from an industrial enterprise owned by it. An industrial enterprise is defined
as an enterprise whose major activity in a given tax year is industrial
production activity.





Under the
Industry Encouragement Law, industrial companies are entitled to a number of
corporate tax benefits, including:




·
            deduction
      of purchase of know-how and patents and/or right to use
      a patent over an eight-year period;


·
            the
      right to elect, under specified conditions, to file a consolidated tax
      return with additional related Israeli industrial companies and an
      industrial holding company;


·
            accelerated
      depreciation rates on equipment and
buildings.


·
            Expenses
      related to a public offering on TA stock exchange and as of 1.1.2003 on
      recognized stock markets outside of Israel, are deductible in equal
      amounts over three years.





Under
some tax laws and regulations, an industrial enterprise may be eligible for
special depreciation rates for machinery, equipment and buildings. These rates
differ based on various factors, including the date the operations begin and the
number of work shifts. An industrial company owning an approved enterprise may
choose between these special depreciation rates and the depreciation rates
available to the approved enterprise.





Eligibility
for benefits under the Industry Encouragement Law is not subject to receipt of
prior approval from any governmental authority.





We
believe that we currently qualify as an industrial company within the definition
of the Industry Encouragement Law. We cannot assure you that the Israeli tax
authorities will agree that we qualify, or, if we qualify, that we will continue
to qualify as an industrial company or that the benefits described above will be
available to us in the future.




Special
Provisions Relating to Measurement of Taxable Income





Our
company is
taxed until tax year 2007 (including) under the Income Tax Law (Inflationary
Adjustments), 1985, generally referred to as the Inflationary Adjustments Law.
The Inflationary Adjustments Law is highly complex and represents an attempt to
overcome the problems presented to a traditional tax system by an economy
undergoing rapid inflation. Its features, which are material to us, are
summarized as follows:




·
            Where
      a company’s equity, as calculated under the Inflationary Adjustments Law,
      exceeds the depreciated cost of its fixed assets (as defined in the
      Inflationary Adjustments Law), a deduction from taxable income is
      permitted equal to the excess multiplied by the applicable annual rate of
      inflation. The maximum deduction permitted in any single tax year is 70%
      of taxable income, with the unused portion permitted to be carried
      forward, linked to the Israeli consumer price index. The unused portion
      that was carried forward may be deductible in full in the following
      year.




·
            Where
      a company’s depreciated cost of fixed assets exceeds its equity, then the
      excess multiplied by the applicable annual rate of inflation is added to
      taxable income. (hereinafter: “inflation supplement”).
      Note, the inflation supplement will only be added to the corporate income
      but not to other incomes such as capital
gains.




40




·
            Subject
      to specified limitations, depreciation deductions on fixed assets and
      losses carried forward are adjusted for inflation based on the change in
      the consumer price index.





In
February 2008, the Inflationary Adjustments Law was repealed.




Capital
Gains Tax on Sales of Our Ordinary Shares




Israeli
law generally imposes a capital gains tax on the sale of any capital assets by
residents of Israel, as defined for Israeli tax purposes, and on the sale of
assets located in Israel, including shares in Israeli companies, by both
residents and non-residents of Israel, unless a specific exemption is available
or unless a tax treaty between Israel and the shareholder’s country of residence
provides otherwise. The law distinguishes between real gain and inflationary
surplus. The inflationary surplus is a portion of the total capital gain which
is equivalent to the increase of the relevant asset’s purchase price which is
attributable to the increase in the Israeli consumer price index or, in certain
circumstances, a foreign currency exchange rate, between the date of purchase
and the date of sale. The real gain is the excess of the total capital gain over
the inflationary surplus.




As of
January 1, 2006, the tax rate applicable to capital gains derived from the sale
of shares, whether listed on a stock market or not, is 20% for Israeli
individuals, unless such shareholder claims a deduction for financing expenses
in connection with such shares, in which case the gain will generally be taxed
at a rate of 25%. Additionally, if such shareholder is considered a “material
shareholder” at any time during the 12-month period preceding such sale, i.e.,
such shareholder holds directly or indirectly, including with others, at least
10% of any means of control in the company, the tax rate shall be 25%. Israeli
companies are subject to the Corporate Tax rate on capital gains derived from
the sale of shares, unless such companies were not subject to the Adjustments
Law (or certain regulations) at the time of publication of the aforementioned
amendment to the Tax Ordinance that came into effect on January 1, 2006, in
which case the applicable tax rate is 25%. However, the foregoing tax rates do
not apply to: (i) dealers in securities; and (ii) shareholders who acquired
their shares prior to an initial public offering (that may be subject to a
different tax arrangement).




Non-Israeli
residents are exempt from Israeli capital gains tax on any gains derived from
the sale of shares of Israeli companies publicly traded on a recognized stock
exchange or regulated market outside of Israel, provided however that such
capital gains are not derived from a permanent establishment in Israel, such
shareholders are not subject to the Adjustments Law, and such shareholders did
not acquire their shares prior to an initial public offering. However,
non-Israeli corporations will not be entitled to such exemption if an Israeli
resident (i) has a controlling interest of 25% or more in such non-Israeli
corporation, or (ii) is the beneficiary or is entitled to 25% or more of the
revenues or profits of such non-Israeli corporation, whether directly or
indirectly.




In some
instances where our shareholders may be liable to Israeli tax on the sale of
their ordinary shares, the payment of the consideration may be subject to the
withholding of Israeli tax at the source.




Pursuant
to the Convention Between the government of the United States of America and the
government of Israel with Respect to Taxes on Income, as amended (the
“U.S.-Israel Tax Treaty”), the sale, exchange or disposition of ordinary shares
by a person who (i) holds the ordinary shares as a capital asset, (ii) qualifies
as a resident of the United States within the meaning of the U.S.-Israel Tax
Treaty and (iii) is entitled to claim the benefits afforded to such person by
the U.S.-Israel Tax Treaty, generally, will not be subject to the Israeli
capital gains tax. Such exemption will not apply if (i) such Treaty U.S.
Resident holds, directly or indirectly, shares representing 10% or more of our
voting power during any part of the 12-month period preceding such sale,
exchange or disposition, subject to certain conditions, or (ii) the capital
gains from such sale, exchange or disposition can be allocated to a permanent
establishment in Israel. In such case, the sale, exchange or disposition of
ordinary shares would be subject to Israeli tax, to the extent applicable;
however, under the U.S.-Israel Tax Treaty, such Treaty U.S. Resident would be
permitted to claim a credit for such taxes against the U.S. federal income tax
imposed with respect to such sale, exchange or disposition, subject to the
limitations in U.S. laws applicable to foreign tax credits. The U.S.-Israel Tax
Treaty does not relate to U.S. state or local taxes.




41




Taxation
of Non-Resident Holders of Shares




Non-residents
of Israel are subject to income tax on income accrued or derived from sources in
Israel. Such sources of income include passive income such as dividends,
royalties and interest, as well as non-passive income from services rendered in
Israel. On distributions of dividends other than bonus shares, or stock
dividends, income tax is withheld at the source at the following rates: for
dividends distributed on or after January 1, 2006 - 20%, or 25% for a
shareholder that is considered a “material shareholder” at any time during the
12-month period preceding such distribution, unless a different rate is provided
in a treaty between Israel and the shareholder’s country of residence. Under the
U.S.-Israel Tax Treaty, the maximum tax on dividends paid to a holder of
ordinary shares who is a Treaty U.S. Resident is 25%. Furthermore, dividends not
generated by an Approved Enterprise (or Benefited Enterprise) paid to a U.S.
corporation holding at least 10% of our issued voting power during the part of
the tax year which precedes the date of payment of the dividend and during the
whole of its prior tax year, are generally taxed at a rate of
12.5%.





For
information with respect to the applicability of Israeli capital gains taxes on
the sale of ordinary shares by United States residents, see above “— Capital
Gains Tax on Sales of Our Ordinary Shares.”





UNITED
STATES FEDERAL INCOME TAX CONSEQUENCES





THE
FOLLOWING SUMMARY IS INCLUDED HEREIN FOR GENERAL INFORMATION AND IS NOT INTENDED
TO BE, AND SHOULD NOT BE CONSIDERED TO BE, LEGAL OR TAX ADVICE. EACH U.S. HOLDER
SHOULD CONSULT WITH HIS OR HER OWN TAX ADVISOR AS TO THE PARTICULAR U.S. FEDERAL
INCOME TAX CONSEQUENCES OF THE PURCHASE, OWNERSHIP AND SALE OF ORDINARY SHARES,
INCLUDING THE EFFECTS OF APPLICABLE STATE, LOCAL, FOREIGN OR OTHER TAX LAWS AND
POSSIBLE CHANGES IN THE TAX LAWS.





U.S.
Federal Income Taxation





Subject
to the limitations described in the next paragraph, the following discussion
summarizes the material U.S. federal income tax consequences to a “U.S. Holder”
arising from the purchase, ownership and sale of the Ordinary Shares. For this
purpose, a “U.S. Holder” is a holder of Ordinary Shares that is: (1) an
individual citizen or resident of the United States, including an alien
individual who is a lawful permanent resident of the United States or meets the
substantial presence residency test under U.S. federal income tax laws; (2) a
corporation (or entity treated as a corporation for U.S. federal tax purposes)
or a partnership (other than a partnership that is not treated as a U.S. person
under any applicable U.S. Treasury Regulations) created or organized under the
laws of the United States or the District of Columbia or any political
subdivision thereof; (3) an estate, the income of which is includable in gross
income for U.S. federal income tax purposes regardless of source; (4) a trust if
a court within the United States is able to exercise primary supervision over
the administration of the trust and one or more U.S. persons have authority to
control all substantial decisions of the trust; (5) a trust that has a valid
election in effect to be treated as a U.S. person to the extent provided in U.S.
Treasury regulations, or (6) any person otherwise subject to U.S. federal income
tax on a net income basis in respect of the Ordinary Shares, if such status as a
U.S. Holder is not overridden pursuant to the provisions of an applicable tax
treaty.





This
summary is for general information purposes only and does not purport to be a
comprehensive description of all of the U.S. federal income tax considerations
that may be relevant to a decision to purchase our Ordinary Shares. This summary
generally considers only U.S. Holders that will own our Ordinary Shares as
capital assets. Except to the limited extent discussed below, this summary does
not consider the U.S. federal tax consequences to a person that is not a U.S.
Holder, not does it describe the rules applicable to determine a taxpayer’s
status as a U.S. Holder. This summary is based on the provisions of the Internal
Revenue Code of 1986, as amended, or the Code, final, temporary and proposed
U.S. Treasury Regulations promulgated thereunder,administrative and
judicial interpretations thereof, and the U.S./Israel Income Tax Treaty, all as
in effect as of the date hereof and all of which are subject to change, possibly
on a retroactive basis, and all of which are open to differing
interpretations.  Commtouch will not seek a ruling from the U.S.
Internal Revenue Service, or the IRS, with regard to the U.S. federal income tax
treatment of an investment in our Ordinary Shares by U.S. Holders and,
therefore, can provide no assurances that the IRS will agree with the
conclusions set forth below.




42





This
discussion does not address all of the aspects of U.S. federal income taxation
that may be relevant to a particular shareholder based on such shareholder’s
particular circumstances and in particular does not discuss any estate, gift,
generation-skipping, transfer, state, local or foreign tax considerations. In
addition, this discussion does not address the U.S. federal income tax treatment
of a U.S. Holder who is: (1) a bank, life insurance company, regulated
investment company, or other financial institution or “financial services
entity”; (2) a broker or dealer in securities or foreign currency; (3) a person
who acquired our Ordinary Shares in connection with employment or other
performance of services; (4) a U.S. Holder that is subject to the U.S.
alternative minimum tax; (5) a U.S. Holder that holds our Ordinary Shares as a
hedge or as part of a hedging, straddle, conversion or constructive sale
transaction or other risk-reduction transaction for U.S. federal income tax
purposes; (6) a tax-exempt entity; (7) real estate investment trusts; (8) a U.S.
Holder that expatriates out of the United States or a former long-term resident
of the United States; or (9) a person having a functional currency other then
the U.S. dollar. This discussion does not address the U.S. federal income tax
treatment of a U.S. Holder that owns, directly or constructively, at any time,
Ordinary Shares representing 10% or more of our voting power. Additionally, the
U.S. federal income tax treatment of persons who hold Ordinary Shares through a
partnership or other pass-through entity are not considered.





Each
prospective investor is advised to consult such person’s own tax advisor with
respect to the specific U.S. federal and state income tax consequences to such
person of purchasing, holding or disposing of the Ordinary Shares, including the
effects of applicable state, local, foreign or other tax laws and possible
changes in the tax laws.





Distributions
on Ordinary Shares





Subject
to the discussion under the heading “Passive Foreign Investment Companies”
below, a U.S. Holder will be required to include in gross income as ordinary
income the amount of any distribution paid on Ordinary Shares (including the
amount of any Israeli tax withheld on the date of the distribution), to the
extent that such distribution does not exceed our current and accumulated
earnings and profits, as determined for U.S. federal income tax purposes. The
amount of a distribution which exceeds our earnings and profits will be treated
first as a non-taxable return of capital, reducing the U.S. Holder’s tax basis
for the Ordinary Shares to the extent thereof, and then capital gain. Corporate
holders generally will not be allowed a deduction for dividends received. In
general, preferential tax rates not exceeding 15% for “qualified dividend
income” and long-term capital gains are applicable for U.S. Holders that are
individuals, estates or trusts (these preferential rates are scheduled to expire
for taxable years beginning after December 31, 2010, after which time dividends
are scheduled to be taxed at ordinary income rates and long-term capital gains
are scheduled to be taxed at rates not exceeding 20%). For this purpose,
“qualified dividend income” means, inter alia, dividends
received from a “qualified foreign corporation.” A “qualified foreign
corporation” is a corporation that is entitled to the benefits of a
comprehensive tax treaty with the United States which includes an exchange of
information program. The IRS has stated that the Israel/U.S. Tax Treaty
satisfies this requirement and we believe we are eligible for the benefits of
that treaty.





In
addition, our dividends will be qualified dividend income if our Ordinary
Sharesare readily
tradable on NASDAQ or another established securities market in the United
States. Dividends will not qualify for the preferential rate if we are treated,
in the year the dividend is paid or in the prior year, as a passive foreign
investment company, or PFIC. A U.S. Holder will not be entitled to the
preferential rate: (i) if the U.S. Holder has not held our Ordinary Shares or
ADRs for at least 61 days of the 121 day period beginning on the date which is
60 days before the ex-dividend date, or (ii) to the extent the U.S. Holder is
under an obligation to make related payments on substantially similar property.
Any days during which the U.S. Holder has diminished its risk of loss on our
Ordinary Shares are not counted towards meeting the 61-day holding period.
Finally, U.S. Holders who elect to treat the dividend income as “investment
income” pursuant to Code section 163(d)(4) will not be eligible for the
preferential rate of taxation.




43





The
amount of a distribution with respect to our Ordinary Shares will be measured by
the amount of the fair market value of any property distributed, and for U.S.
federal income tax purposes, the amount of any Israeli taxes withheld therefrom.
(See discussion above under “Taxation of Non-Resident Holders of Shares.”) Cash
distributions paid by us in NIS will be included in the income of U.S. Holders
at a U.S. dollar amount based upon the spot rate of exchange in effect on the
date the dividend is includible in the income of the U.S. Holder, and U.S.
Holders will have a tax basis in such NIS for U.S. federal income tax purposes
equal to such U.S. dollar value. If the U.S. Holder subsequently converts the
NIS, any subsequent gain or loss in respect of suchNIS arising from
exchange rate fluctuations will be U.S. source ordinary exchange gain or
loss.





Distributions
paid by us will generally be foreign source income for U.S. foreign tax credit
purposes. Subject to the limitations set forth in the Code, U.S. Holders may
elect to claim a foreign tax credit against their U.S. income tax liability for
Israeli income tax withheld from distributions received in respect of the
Ordinary Shares. In general, these rules limit the amount allowable as a foreign
tax credit in any year to the amount of regular U.S. tax for the year
attributable to foreign source taxable income. This limitation on the use of
foreign tax credits generally will not apply to an electing individual U.S.
Holder whose creditable foreign taxes during the year do not exceed $300, or
$600 for joint filers, if such individual’s gross income for the taxable year
from non-U.S. sources consists solely of certain passive income. A U.S. Holder
will be denied a foreign tax credit with respect to Israeli income tax withheld
from dividends received with respect to the Ordinary Shares if such U.S. Holder
has not held the Ordinary Shares for at least 16 days out of the 31-day period
beginning on the date that is 15 days before the ex-dividend date or to the
extent that such U.S. Holder is under an obligation to make certain related
payments with respect to substantially similar or related property. Any day
during which a U.S. Holder has substantially diminished his or her risk of loss
with respect to the Ordinary Shares will not count toward meeting the 16-day
holding period. A U.S. Holder will also be denied a foreign tax credit if the
U.S. Holder holds the Ordinary Shares in an arrangement in which the U.S.
Holder’s reasonably expected economic profit is insubstantial compared to the
foreign taxes expected to be paid or accrued. The rules relating to the
determination of the U.S. foreign tax credit are complex, and U.S. Holders
should consult with their own tax advisors to determine whether, and to what
extent, they are entitled to such credit. U.S. Holders that do not elect to
claim a foreign tax credit may instead claim a deduction for Israeli income
taxes withheld, provided such U.S. Holders itemize their
deductions.





Disposition
of Shares





Except as
provided under the PFIC rules described below, upon the sale, exchange or other
disposition of our Ordinary Shares, a U.S. Holder will recognize capital gain or
loss in an amount equal to the difference between such U.S. Holder’s tax basis
for the Ordinary Shares and the amount realized on the disposition (or its U.S.
dollar equivalent determined by reference to the spot rate of exchange on the
date of disposition, if the amount realized is denominated in a foreign
currency). The gain or loss realized on the sale or exchange or other
disposition of Ordinary Shares will be long-term capital gain or loss if the
U.S. Holder has a holding period of more than one year at the time of the
disposition.




44





In general, gain realized by a U.S.
Holder on a sale, exchange or other disposition of Ordinary Shares will
generally be treated as U.S. source income for U.S. foreign tax credit purposes.
A loss realized by a U.S. Holder on the sale, exchange or other disposition of
Ordinary Shares is generally allocated to U.S. source income. However, U.S.
Treasury Regulations require such loss to be allocated to foreign source income
to the extent certain dividends were received by the taxpayer within the
24-month period preceding the date on which the taxpayer recognized the loss.
The deductibility of a loss realized on the sale, exchange or other disposition
of Ordinary Shares is subject to limitations.





Passive
Foreign Investment Companies





Special
U.S. federal income tax laws apply to a U.S. Holder who owns shares of a
corporation that was (at any time during the U.S. Holder’s holding period)
PFIC.  We would be treated as a PFIC for U.S. federal income tax
purposes for any tax year if, in such tax year, either:





75%
      or more of our gross income (including our pro rata share of gross
      income for any company, U.S. or foreign, in which we are considered to own
      25% or more of the shares by value), in a taxable year is passive (the
      “Income Test”); or




At
      least 50% of our assets, averaged over the year and generally determined
      based upon value (including our pro rata share of the
      assets of any company in which we are considered to own 25% or more of the
      shares by value), in a taxable year are held for the production of, or
      produce, passive income (the “Asset
Test”).




For this
purpose, passive income generally consists of dividends, interest, rents,
royalties, annuities and income from certain commodities transactions and from
notional principal contracts. Cash is treated as generating passive
income.





If we are
or become a PFIC, each U.S. Holder who has not elected to treat us as a
qualified electing fund by making a “QEF election”, or who has not elected to
mark the shares to market (as discussed below), would, upon receipt of certain
distributions by us and upon disposition of our Ordinary Shares at a gain, be
liable to pay U.S. federal income tax at the then prevailing highest tax rates
on ordinary income plus interest on such tax, as if the distribution or gain had
been recognized ratably over the taxpayer’s holding period for the Ordinary
Shares. In addition, when shares of a PFIC are acquired by reason of death from
a decedent that was a U.S. Holder, the tax basis of such shares would not
receive a step-up to fair market value as of the date of the decedent’s death,
but instead would be equal to the decedent’s basis if lower, unless all gain
were recognized by the decedent. Indirect investments in a PFIC may also be
subject to special U.S. federal income tax rules.





The PFIC
rules would not apply to a U.S. Holder who makes a QEF election for all taxable
years that such U.S. Holder has held the Ordinary Shares while we are a PFIC,
provided that we comply with certain reporting requirements. Instead, each U.S.
Holder who has made such a QEF election is required for each taxable year that
we are a PFIC to include in income such U.S. Holder’s pro rata share of our
ordinary earnings as ordinary income and such U.S. Holder’s pro rata share of our net
capital gains as long-term capital gain, regardless of whether we make any
distributions of such earnings or gain. In general, a QEF election is effective
only if we make available certain required information. The QEF election is made
on a shareholder-by-shareholder basis and generally may be revoked only with the
consent of the IRS. Although we have no obligation to do so, we intend to comply
with the applicable information reporting requirements for U.S. Holders to make
a QEF election.





A U.S.
Holder of PFIC shares which are traded on certain public markets, including the
NASDAQ, can elect to mark the shares to market annually, recognizing as ordinary
income or loss each year an amount equal to the difference as of the close of
the taxable year between the fair market value of the PFIC shares and the U.S.
Holder’s adjusted tax basis in the PFIC shares. Losses are allowed only to the
extent of net mark-to-market gain previously included income by the U.S. Holder
under the election for prior taxable years.




45





In light
of the complexity of PFIC rules, we cannot assure you that we have not been or
are not a PFIC or will avoid becoming a PFIC in the future. U.S. Holders who
hold Ordinary Shares during a period when we are a PFIC will be subject to the
foregoing rules, even if we cease to be a PFIC, subject to certain exceptions
for U.S. Holders who made a QEF or mark-to-market election. U.S. Holders are
strongly urged to consult their tax advisors about the PFIC rules, including the
eligibility, manner, and consequences to them of making a QEF or mark-to-market
election with respect to our Ordinary Shares in the event we that qualify as a
PFIC. For those U.S. Holders who determine that we were a PFIC in any of our
taxable years and notify us in writing of their request for the information
required in order to effectuate the QEF election described above, we will
promptly make such information available to them.





Information
Reporting and Withholding





A U.S.
Holder may be subject to backup withholding (currently at a rate of 28%, but
scheduled to increase to 31% for taxable years beginning after December 31,
2010) with respect to cash dividends and proceed from a disposition of Ordinary
Shares. In general, back-up withholding will apply only if a U.S. Holder fails
to comply with certain identification procedures. Backup withholding will not
apply with respect to payments made to certain exempt recipients, such as
corporations and tax-exempt organizations. Backup withholding is not an
additional tax and may be claimed as a credit against the U.S. federal income
tax liability of a U.S. Holder, provided that the required information is timely
furnished to the IRS.





Non-U.S.
Holders of Ordinary Shares





Except as provided below, an
individual, corporation, estate or trust that is not a U.S. Holder generally
will not be subject to U.S. federal income or withholding tax on the payment of
dividends on, and the proceeds from the disposition of, our Ordinary
Shares.





A non-U.S. Holder may be subject to
U.S. federal income or withholding tax on a dividend paid on our Ordinary Shares
or the proceeds from the disposition of our Ordinary Shares if: (i) such item is
effectively connected with the conduct by the non-U.S. Holder of a trade or
business in the United States or, in the case of a non-U.S. Holder that is a
resident of a country which has an income tax treaty with the United States,
such item is attributable to a permanent establishment or, in the case of gain
realized by an individual non-U.S. Holder, a fixed place of business in the
U.S.; (ii) in the case of a disposition of our Ordinary Shares, the individual
non-U.S. Holder is present in the U.S. for 183 days or more in the taxable year
of the sale and certain other conditions are met; (iii) the non-U.S. Holder is
subject to U.S. federal income tax pursuant to the provisions of the U.S. tax
law applicable to U.S. expatriates.





In general, non-U.S. Holders will not
be subject to backup withholding with respect to the payment of dividends on our
Ordinary Shares if payment is made through a paying agent, or office of a
foreign broker outside the United States. However, if payment is made in the
United States or by a U.S. related person, non-U.S. Holders may be subject to
backup withholding, unless the non-U.S. Holder provides on an applicable Form
W-8 (or a substantially similar form) a taxpayer identification number,
certifies to its foreign status, or otherwise establishes an exemption. A U.S.
related person for these purposes is a person with one or more current
relationships with the United States.





The amount of any backup withholding
from a payment to a non-U.S. Holder will be allowed as a credit against such
holder’s U.S. federal income tax liability and may entitle such holder to a
refund, provided that the required information is timely furnished to the
IRS.




46




Item
11. Qualitative and Quantitative Disclosure about Market Risk.




We
develop our technology in Israel and seek to provide our services worldwide. As
a result, our foreign currency exposures give rise to market risk associated
with exchange rate movements of the U.S. dollar, our functional and reporting
currency, against the NIS and Euro. We are exposed to the risk of fluctuation in
the U.S. dollar/NIS and the U.S. dollar/Euro exchange rate. Our
shekel-denominated expenses consist principally of salaries and related
personnel expenses, as well as vehicle lease payments. Although the majority of
our revenues are in US dollars, a substantial portion of our sales are derived
from the Euro currency. Neither a ten percent increase nor decrease in current
exchange rates would have a material effect on our consolidated financial
statements in the next six months.





Due to
the fact that we do not have any material debt, we have concluded that there is
currently no material interest market risk exposure.




Therefore,
no quantitative tabular disclosures are provided.




Item
12. Description of Securities Other than Equity Securities.




The
Company does not have any outstanding American Depositary Shares or American
Depositary Receipts.




PART
II




Item
13. Defaults, Dividend Arrearages and Delinquencies.




None.




Item
14. Material Modifications to the Rights of Security Holders and Use of
Proceeds.




None.




Item
15T. Controls and Procedures.




(a) As of
December 31, 2009, we performed an evaluation under the supervision and with the
participation of our management, including our Chief Executive Officer and Chief
Financial Officer, of the effectiveness of the design and operation of our
disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e)
of the Exchange Act). Our management recognizes that any controls and
procedures, no matter how well designed and operated, can provide only
reasonable assurance of achieving their objectives and our management
necessarily applies its judgment in evaluating the cost-benefit relationship of
possible controls and procedures. Based on this evaluation, our Chief Executive
Officer and Chief Financial Officer concluded that our disclosure controls and
procedures are effective as of December 31, 2009, to provide reasonable
assurance that the information required to be disclosed in filings and
submissions under the Exchange Act, is recorded, processed, summarized, and
reported within the time periods specified by the SEC’s rules and forms, and
that such information related to us and our consolidated subsidiary is
accumulated and communicated to management, including the Chief Executive
Officer and Chief Financial Officer, as appropriate to allow timely decisions
about required disclosure.




(b) and
(c) Our management is responsible for establishing and maintaining adequate
internal control over our financial reporting, as such term is defined in Rule
13a-15(f) under the Security Exchange Act. Our internal control over financial
reporting system was designed to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial statements
for external purposes in accordance with generally accepted accounting
principles.




Because
of its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements and even when determined to be effective can
only provide reasonable assurance with respect to financial statements. Also
projections of any evaluation of effectiveness to future periods are subject to
the risk that controls may become inadequate because of changes in conditions,
or that the degree of compliance with the policies or procedures may
deteriorate.




47




Our
management assessed our internal control over financial reporting as of December
31, 2009. Our management based its assessment on criteria established in
Internal Control- Integrated Framework issued by the Committee of Sponsoring
Organization of the Treadway Commission. Based on this assessment, our
management has concluded that, as of December 31, 2009, our internal control
over financial reporting is effective.




(d) Our
independent registered public accounting firm, Kost, Forer, Gabbay &
Kasierer, a member of Ernst & Young Global, independently assessed the
effectiveness of the Company's internal control over financial reporting. Kost,
Forer, Gabbay & Kasierer, a member of Ernst & Young Global, has issued
an attestation report in respect of our internal control over financial
reporting as of December 31, 2009, which is included under Item 18 on page F-3
of this annual report.  We note that this report is provided
voluntarily for 2009, as non-accelerated filers are not required to include it
in their Form 20-F filing.




(e)
During the period covered by this annual report on Form 20-F, there were
no  changes to our internal control over financial reporting that
occurred during the year ended December 31, 2009 that have materially affected,
or are reasonably likely to materially affect, our internal control over
financial reporting.




Item
16A. Audit Committee Financial Expert.




The Board
of Directors of the Company has determined that Mr. Yair Shamir, a member of the
Audit Committee, is an audit committee financial expert as that term is defined
in Item 16A of Form 20-F and is independent as that term is defined in NASDAQ
Listing Rule 5605(a)(2).




Item
16B. Code of Ethics.




The
Company, by way of Board of Directors resolution, has adopted a Code of Ethics
applicable to its senior financial officers, including its principal executive,
financial and accounting officers.  The Code of Ethics is posted on
the Company’s website at www.commtouch.com, under the
link to “investor relations”.




Item
16C. Principal Accountant Fees and Services.




Kost,
Forer, Gabbay & Kasierer, a member of Ernst & Young Global, has served
as our Independent Registered Public Accounting Firm for each of the fiscal
years in the three-year period ended December 31, 2009, for which audited
financial statements appear in this annual report on Form 20-F. The following
table presents the aggregate fees for professional and other services rendered
by Kost, Forer, Gabbay & Kasierer for 2009 and 2008:




Year ended December 31,2009
                                  
                                  
                                  2008Fees
                                  
                                  
                                  FeesAudit
      fees (1)
                                  
                                  $
                                  133,000
                                  
                                  
                                  $
                                  125,000Tax
      Fees (2)
                                  
                                  $
                                  18,000
                                  
                                  
                                  $
                                  21,000Total
                                  
                                  $
                                  151,000
                                  
                                  
                                  $
                                  146,000





(1) Audit
fees consist of fees billed for the annual audit services engagement and other
audit services, which are those services that only the Independent Registered
Public Accounting Firm can reasonably provide, and include the group audit
including  statutory audits; consents; attest services; and assistance
in connection with documents filed with the SEC. Thesefees
also include the attestation of our internal control over financial
reporting.





(2) Tax
fees include fees billed for tax compliance services, including the preparation
of original and amended tax returns and claims for refund; tax consultations,
such as assistance and representation in connection with tax audits and appeals,
transfer pricing, and requests for rulings or technical advice from taxing
authority; and tax planning services.




48





Audit
Committee Pre-approval Policies and Procedures





Below is
a summary of our current Policies and Procedures:




The main
role of the Company’s audit committee is to assist the Board of Directors in
fulfilling its responsibility for oversight of the quality and integrity of the
accounting, auditing and reporting practices of the Company. The Audit Committee
oversees the appointment, compensation, and oversight of the Company’s
independent registered public accounting firm engaged to prepare or issue an
audit report on the financial statements of the Company. The audit committee’s
specific responsibilities in carrying out its oversight role include the
approval of all audit and non-audit services to be provided by the external
auditor and the quarterly review of the firm’s non-audit services and related
fees. These services may include audit services, audit-related services, tax
services and other services, as described above. It is the policy of the audit
committee to approve in advance the particular services or categories of
services to be provided to the Company periodically. Additional services may be
pre-approved by the audit committee on an individual basis during the
year.  The audit committee did not avail itself of section
(c)(7)(i)(C) of Rule 2-01 of Regulation S-X during 2007, which allows for an
exemption from the pre-approval process under certain limited
circumstances.




Item 16D. Exemptions from the Listing Standards
for Audit Committees.





Not
applicable.





Item 16E. Purchases of Equity Securities by the
Issuer and Affiliated Purchasers.





In July
2008, the Company announced the commencement of an Ordinary Share buyback plan,
under which the Company purchased  almost $5 million worth of its
Ordinary Shares through the end of 2009.  The Company completed its
buyback plan in December 2009 and, in total, it expended $4,872,000 to
repurchase 2,163,826 Ordinary Shares at an average price of $2.25 per
share.  Repurchases during 2009 are summarized in the following
table:




ISSUER
PURCHASES OF SECURITIES





Period
                                              
                                              Total Number
                                                Of Shares
                                                Purchased
                                              
                                              
                                              Average Price
                                                Paid Per Share
                                                ($)
                                              
                                              
                                              Total Number
                                                Of Shares
                                                Purchased As
                                                Part of Publicly
                                                Announced
                                                Plan
                                              
                                              
                                              Maximum U.S.
                                                Dollar Value That
                                                May Yet Be
                                                Purchased Under
                                                ThePlanJanuary1-
                                                January
      31
                                              
                                              
                                              118,500
                                              
                                              
                                              
                                              2.02
                                              
                                              
                                              
                                              118,500
                                              
                                              
                                              
                                              3,427,369February
      1-
                                                February
      28
                                              
                                              
                                              79,700
                                              
                                              
                                              
                                              1.96
                                              
                                              
                                              
                                              79,700
                                              
                                              
                                              
                                              3,270,927March1-
                                                March
      31
                                              
                                              
                                              132,772
                                              
                                              
                                              
                                              1.84
                                              
                                              
                                              
                                              132,772
                                              
                                              
                                              
                                              3,027,229April
      1 –
                                                April
      30
                                              
                                              
                                              155,949
                                              
                                              
                                              
                                              1.85
                                              
                                              
                                              
                                              155,949
                                              
                                              
                                              
                                              2,739,110May
      1 –
                                                May
      31
                                              
                                              
                                              101,165
                                              
                                              
                                              
                                              1.93
                                              
                                              
                                              
                                              101,165
                                              
                                              
                                              
                                              2,544,065June
      1-
                                                June
      30
                                              
                                              
                                              169,000
                                              
                                              
                                              
                                              1.96
                                              
                                              
                                              
                                              169,000
                                              
                                              
                                              
                                              2,212,520July1
      –
                                                July
      31
                                              
                                              
                                              98,243
                                              
                                              
                                              
                                              2.35
                                              
                                              
                                              
                                              98,243
                                              
                                              
                                              
                                              1,981,397August
      1-
                                                August
      31
                                              
                                              
                                              124,530
                                              
                                              
                                              
                                              2.68
                                              
                                              
                                              
                                              124,530
                                              
                                              
                                              
                                              1,647,721September
      1 –
                                                September
      30
                                              
                                              
                                              124,978
                                              
                                              
                                              
                                              2.76
                                              
                                              
                                              
                                              124,978
                                              
                                              
                                              
                                              1,302,754October
      1 –
                                                October
      31
                                              
                                              
                                              119,472
                                              
                                              
                                              
                                              3.35
                                              
                                              
                                              
                                              119,472
                                              
                                              
                                              
                                              902,878November
      1 –
                                                November
      30
                                              
                                              
                                              155,290
                                              
                                              
                                              
                                              3.23
                                              
                                              
                                              
                                              155,290
                                              
                                              
                                              
                                              401,085December
      1 –
                                                December
      31
                                              
                                              
                                              78,149
                                              
                                              
                                              
                                              3.47
                                              
                                              
                                              
                                              78,149
                                              
                                              
                                              
                                              127,573Total
                                              
                                              
                                              1,457,748
                                              
                                              
                                              
                                              2.43
                                              
                                              
                                              
                                              1,457,748
                                              
                                              
                                              
                                              N/A





49




Subsequent
Event





On March
15, 2010, the Company announced that its board of directors had authorized an
additional plan for the repurchase of the Company's Ordinary Shares in the open
market or through privately negotiated transactions, in an amount in cash of up
to $5 million.  The Company has begun implementing the
plan.





Item
16F. Change in Registrant’s Certifying Accountant.





Not
applicable.





Item
16G. Corporate Governance.





Under
NASDAQ Listing Rule 5615(a)(3), foreign private issuers, such as our Company,
are permitted to follow certain home country corporate governance practices
instead of certain provisions of certain NASDAQ Listing
Rules.   We do not comply with the following requirements of the
NASDAQ Listing Rules, and instead follow Israeli law and practice with respect
to such corporate governance practices:




NASDAQ
Listing Rule 5250(d) requires that an annual report be delivered to shareholders
in accordance with three alternative delivery methods set forth in the
rule.  One of those delivery methods allows for the posting of the
annual report on the Company’s website.  However, that method also
requires that i) a prominent undertaking be posted on the website indicating
that, upon request, shareholders may receive a hard copy of the annual report
free of charge, and ii)simultaneous with this
posting, the Company issue a press release stating that its annual report has
been filed with the SEC (or other appropriate regulatory authority). This press
release must also state that the annual report is available on the Company's
website and include the website address and that shareholders may receive a hard
copy free of charge upon request.




While the
Company’s most current annual report on Form 20-F, inclusive of consolidated
financial statements, is available on its website at www.commtouch.com,
and the Company has indicated publicly that it will provide copies of that
report free of charge, upon shareholder request, nevertheless the Company is not
in strict compliance with the NASDAQ rule.  The Company does not
include a statement on its website in the form noted above and does not issue a
press release upon the posting of the annual report to its website; rather, the
Company is following its home country practice (in Israel, which, in addition to
the Company’s activities noted above, also enables shareholders to inspect the
Company’s annual consolidated financial statements in person at its principal
offices).




50




Rule
5620(c) to Nasdaq Listing Rules requires that an issuer listed on Nasdaq should
have a quorum requirement that in no case be less than 33 1/3% of the
outstanding shares of a company’s common voting stock.  However, the
Company’s articles of association, consistent with the Companies Law, provides
for a lower quorum in the event of a meeting adjourned for lack of a quorum, in
which case any two shareholders entitled to vote and present in person or by
proxy at such adjourned meeting shall constitute a quorum.  Our quorum
requirements for an adjourned meeting do not comply with the NASDAQ requirements
and we instead follow our home country practice.





As a
foreign private issuer listed on the NASDAQ Capital Market, we may also follow
home country practice with regard to, among other things, composition of the
board of directors, director nomination process and regularly scheduled meetings
at which only independent directors are present.  In addition, we may
follow our home country practice, instead of the NASDAQ Listing Rules, which
require that we obtain shareholder approval for certain dilutive events, such as
for the establishment or amendment of certain equity based compensation plans,
an issuance that will result in a change of control of the company, certain
transactions other than a public offering involving issuances of a 20% or more
interest in the company and certain acquisitions of the stock or assets of
another company. A foreign private issuer that elects to follow a home country
practice instead of NASDAQ requirements, must submit to NASDAQ in advance a
written statement from an independent counsel in such issuer’s home country
certifying that the issuer’s practices are not prohibited by the home country’s
laws. In addition, a foreign private issuer must disclose in its annual reports
filed with the Securities and Exchange Commission or on its website each such
requirement that it does not follow and describe the home country practice
followed by the issuer instead of any such requirement. Accordingly, our
shareholders may not be afforded the same protection as provided under NASDAQ’s
corporate governance rules.




PART
III




Item
17. Financial Statements.




The
Company has responded to Item 18




Item
18. Financial Statements.




See pages
F-1 to F-26.


51
  COMMTOUCH
SOFTWARE LTD. AND ITS SUBSIDIARY
 
 CONSOLIDATED
FINANCIAL STATEMENTS
 
 AS
OF DECEMBER 31, 2009
 
 U.S.
DOLLARS IN THOUSANDS
 
 INDEX
 
 PageReports
      of Independent Registered Public Accounting Firm
                  F-2
      - F-3Consolidated
      Balance Sheets
                  F-4
      - F-5Consolidated
      Statements of Operations
                  F-6Statements
      of Changes in Shareholders' Equity
                  F-7Consolidated
      Statements of Cash Flows
                  F-8
      - F-9Notes
      to Consolidated Financial Statements
                  F-10
      - F-26
 
 -
- - - - - - - - - - - - - - - - - - -
  
 
 
 
 REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
 To
the Board of Directors and Shareholders of
 
 COMMTOUCH
SOFTWARE LTD.
 
 We have
audited the accompanying consolidated balance sheets of Commtouch Software Ltd.
("the Company") and its subsidiary as of December 31, 2008 and 2009, and the
related consolidated statements of operations, changes in shareholders' equity
and cash flows for each of the three years in the period ended December 31,
2009. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
 
 We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
 
 In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the consolidated financial position of the Company and
its subsidiary as of December 31, 2008 and 2009, and the consolidated results of
their operations and their cash flows for each of the three years in the period
ended December 31, 2009, in conformity with U.S. generally accepted
accounting principles.
 
 We also
have audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the Company's internal control over financial
reporting as of December 31, 2009, based on criteria established in Internal
Control-Integrated Framework issued by the Committee of Sponsoring Organizations
of the Treadway Commission and our report dated March 26, 2010 expressed an
unqualified opinion thereon.
 
 /s/   Kost, Forer, Gabbay &
      KasiererTel-Aviv,
      Israel
                KOST
      FORER GABBAY & KASIERERMarch
      26, 2010
                A
      Member of Ernst & Young
Global
  F-2
  
 
 REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
 To
the Board of Directors and Shareholders of
 
 COMMTOUCH
SOFTWARE LTD.
 
 We have
audited Commtouch Software Ltd.'s ("Commtouch" or the "Company") internal
control over financial reporting as of December 31, 2009, based on criteria
established in Internal Control-Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission (the "COSO criteria").
Commtouch's management is responsible for maintaining effective internal control
over financial reporting and for its assessment of the effectiveness of internal
control over financial reporting. Our responsibility is to express an opinion on
the Company's internal control over financial reporting based on our
audit.
 
 We conducted our audit in accordance
with the standards of the Public Company Accounting Oversight Board (United
States). Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether effective internal control over financial
reporting was maintained in all material respects. Our audit included obtaining
an understanding of internal control over financial reporting, assessing the
risk that a material weakness exists, testing and evaluating the design and
operating effectiveness of internal control based on the assessed risk, and
performing such other procedures as we considered necessary in the
circumstances. We believe that our audit provides a reasonable basis for our
opinion.
 
 A company's internal control over
financial reporting is a process designed to provide reasonable assurance
regarding the reliability of financial reporting and the preparation of
financial statements for external purposes in accordance with generally accepted
accounting principles. A company's internal control over financial reporting
includes those policies and procedures that (1) pertain to the maintenance of
records that, in reasonable detail, accurately and fairly reflect the
transactions and dispositions of the assets of the company; (2) provide
reasonable assurance that transactions are recorded as necessary to permit
preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company's
assets that could have a material effect on the financial
statements.
 
 Because of its inherent limitations,
internal control over financial reporting may not prevent or detect
misstatements. Also, projections of any evaluation of effectiveness to future
periods are subject to the risk that controls may become inadequate because of
changes in conditions, or that the degree of compliance with the policies or
procedures may deteriorate.
 
 In our
opinion, Commtouch maintained in all material respects, effective internal
control over financial reporting as of December 31, 2009, based on the COSO
criteria.
 
 We also have audited, in accordance
with the standards of the Public Company Accounting Oversight Board (United
States), the consolidated balance sheets of Commtouch and its subsidiary as of
December 31, 2009 and 2008, and the related consolidated statements of
operations, changes in shareholders' equity and cash flows for each of the three
years in the period ended December 31, 2009 and our report dated March 26,
2010expressed an unqualified opinion thereon.
 
 /s/   Kost, Forer, Gabbay &
      KasiererTel-Aviv,
      Israel
                KOST
      FORER GABBAY & KASIERERMarch
      26, 2010
                A
      Member of Ernst & Young
Global
  F-3
  COMMTOUCH
SOFTWARE LTD. AND ITS SUBSIDIARY
  CONSOLIDATED
BALANCE SHEETS
 U.S.
dollars in thousands
 
 December 312008
                    
                    
                    2009ASSETSCURRENT
      ASSETS:Cash
      and cash equivalents
                    
                    $
                    13,661
                    
                    
                    $
                    17,275Short-term
      cash deposit
                    
                    
                    740
                    
                    
                    
                    -Marketable
      securities
                    
                    
                    2,000
                    
                    
                    
                    -Trade
      receivables
                    
                    
                    1,614
                    
                    
                    
                    1,932Deferred
      income taxes
                    
                    
                    -
                    
                    
                    
                    1,417Prepaid
      expenses
                    
                    
                    270
                    
                    
                    
                    233Other
      accounts receivable
                    
                    
                    119
                    
                    
                    
                    410Total
      current assets
                    
                    
                    18,404
                    
                    
                    
                    21,267LONG-TERM
      ASSETS:Long-term
      lease deposits
                    
                    
                    64
                    
                    
                    
                    63Investment
      in affiliate
                    
                    
                    750
                    
                    
                    
                    1,227Severance
      pay fund
                    
                    
                    720
                    
                    
                    
                    945Deferred
      income taxes
                    
                    
                    -
                    
                    
                    
                    987Property
      and equipment, net
                    
                    
                    771
                    
                    
                    
                    701Total
      long-term assets
                    
                    
                    2,305
                    
                    
                    
                    3,923Total
      assets
                    
                    $
                    20,709
                    
                    
                    $
                    25,190
 
 The
accompanying notes are an integral part of the consolidated financial
statements.
  F-4
  COMMTOUCH
SOFTWARE LTD. AND ITS SUBSIDIARY
  CONSOLIDATED
BALANCE SHEETS
 
 U.S.
dollars in thousands, except share and per share data
 
 December 312008
                  
                  
                  2009LIABILITIES
      AND SHAREHOLDERS' EQUITYCURRENT
      LIABILITIES:Accounts
      payable
                  
                  $
                  253
                  
                  
                  $
                  357Employees
      and payroll accruals
                  
                  
                  726
                  
                  
                  
                  996Accrued
      expenses and other liabilities
                  
                  
                  187
                  
                  
                  
                  210Government
      authorities
                  
                  
                  50
                  
                  
                  
                  18Deferred
      revenues
                  
                  
                  2,341
                  
                  
                  
                  2,834Total
      current liabilities
                  
                  
                  3,557
                  
                  
                  
                  4,415LONG-TERM
      LIABILITIES:Long-term
      deferred revenues
                  
                  
                  635
                  
                  
                  
                  848Accrued
      severance pay
                  
                  
                  857
                  
                  
                  
                  1,050Total
      long-term liabilities
                  
                  
                  1,492
                  
                  
                  
                  1,898COMMITMENTS
      AND CONTINGENCIESSHAREHOLDERS'
      EQUITY:Ordinary
      shares nominal value NIS 0.15 par value-Authorized:
      55,353,340 shares as of December 31, 2008 and 2009; Issued: 25,912,737 and
      26,122,587shares as of December 31, 2008 and 2009, respectively;
      Outstanding: 25,206,659 and 23,958,761 shares as of December 31, 2008
      and 2009, respectively
                  
                  
                  890
                  
                  
                  
                  842Additional
      paid-in capital
                  
                  
                  182,144
                  
                  
                  
                  183,731Treasury
      shares (706,078 and 2,163,826 Ordinary shares at December 31, 2008 and
      2009, respectively)
                  
                  
                  (1,306
                  )
                  
                  
                  (4,788
                  )Accumulated
      other comprehensive income
                  
                  
                  23
                  
                  
                  
                  23Accumulated
      deficit
                  
                  
                  (166,091
                  )
                  
                  
                  (160,931
                  )Total
      shareholders' equity
                  
                  
                  15,660
                  
                  
                  
                  18,877Total
      liabilities and shareholders' equity
                  
                  $
                  20,709
                  
                  
                  $
                  25,190
 
 The
accompanying notes are an integral part of the consolidated financial
statements.
  F-5
  COMMTOUCH
SOFTWARE LTD. AND ITS SUBSIDIARY
  CONSOLIDATED
STATEMENTS OF OPERATIONS
 
 U.S.dollars in thousands, except share
and per share data
 
 Year ended December 31,2007
                  
                  
                  2008
                  
                  
                  2009Revenues
                  
                  $
                  11,250
                  
                  
                  $
                  14,092
                  
                  
                  $
                  15,189Cost
      of revenues
                  
                  
                  1,411
                  
                  
                  
                  1,828
                  
                  
                  
                  2,260Gross
      profit
                  
                  
                  9,839
                  
                  
                  
                  12,264
                  
                  
                  
                  12,929Operating
      expenses:Research
      and development, net
                  
                  
                  2,187
                  
                  
                  
                  3,152
                  
                  
                  
                  2,958Sales
      and marketing
                  
                  
                  3,453
                  
                  
                  
                  3,992
                  
                  
                  
                  4,212General
      and administrative
                  
                  
                  2,589
                  
                  
                  
                  3,189
                  
                  
                  
                  3,063Total
      operating expenses
                  
                  
                  8,229
                  
                  
                  
                  10,333
                  
                  
                  
                  10,233Operating
      income
                  
                  
                  1,610
                  
                  
                  
                  1,931
                  
                  
                  
                  2,696Financial
      income, net
                  
                  
                  527
                  
                  
                  
                  346
                  
                  
                  
                  60Income
      before taxes on income (tax benefit)
                  
                  
                  2,137
                  
                  
                  
                  2,277
                  
                  
                  
                  2,756Taxes
      on income (tax benefit)
                  
                  
                  28
                  
                  
                  
                  7
                  
                  
                  
                  (2,404
                  )Net
      income
                  
                  $
                  2,109
                  
                  
                  $
                  2,270
                  
                  
                  $
                  5,160Basic
      net earnings per share
                  
                  $
                  0.08
                  
                  
                  $
                  0.09
                  
                  
                  $
                  0.21Diluted
      net earnings per share
                  
                  $
                  0.08
                  
                  
                  $
                  0.08
                  
                  
                  $
                  0.20Weighted
      average number of shares used in computing basic net earnings per
      share
                  
                  
                  24,846,690
                  
                  
                  
                  25,618,933
                  
                  
                  
                  24,531,810Weighted
      average numbers of shares used in computing diluted net earnings per
      share
                  
                  
                  27,591,498
                  
                  
                  
                  26,929,407
                  
                  
                  
                  25,291,517
 
 The
accompanying notes are an integral part of these consolidated financial
statements.
  F-6
  COMMTOUCH SOFTWARE LTD. AND ITS
SUBSIDIARY
  STATEMENTS
OF CHANGES IN SHAREHOLDERS' EQUITY
 U.S.
dollars in thousands, except share data
 
 Ordinary
                    shares
                  
                  
                  Ordinary
                    shares
                    amount
                  
                  
                  Additional
                    paid-in
                    capital
                  
                  
                  Treasury
                    stock
                  
                  
                  Accumulated
                    other
                    comprehensive
                    income *)
                  
                  
                  Accumulated
                    deficit
                  
                  
                  Total
                    comprehensive
                    income
                  
                  
                  TotalBalance
      as of January 1, 2007
                  
                  
                  24,011,155
                  
                  
                  $
                  845
                  
                  
                  $
                  177,095
                  
                  
                  $
                  -
                  
                  
                  $
                  23
                  
                  
                  $
                  (170,470
                  )
                  
                  
                  
                  
                  $
                  7,493Issuance
      of shares upon exercise of options and warrants
                  
                  
                  1,334,887
                  
                  
                  
                  48
                  
                  
                  
                  1,615
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  
                  
                  
                  1,663Stock-based
      compensation related to employees
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  1,015
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  
                  
                  
                  1,015Stock-based
      compensation related to options granted to non-employees
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  68
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  
                  
                  
                  68Net
      income
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  2,109
                  
                  
                  $
                  2,109
                  
                  
                  
                  2,109Total
      comprehensive income
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  $
                  2,109Balance
      as of December 31, 2007
                  
                  
                  25,346,042
                  
                  
                  
                  893
                  
                  
                  
                  179,793
                  
                  
                  
                  -
                  
                  
                  
                  23
                  
                  
                  
                  (168,361
                  )
                  
                  
                  
                  
                  
                  
                  12,348Purchase
      of treasury shares
                  
                  
                  (706,078
                  )
                  
                  
                  (28
                  )
                  
                  
                  -
                  
                  
                  
                  (1,306
                  )
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  
                  
                  
                  
                  (1,334
                  )Issuance
      of shares upon exercise of options and warrants
                  
                  
                  566,695
                  
                  
                  
                  25
                  
                  
                  
                  819
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  
                  
                  
                  
                  844Stock-based
      compensation related to employees
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  1,495
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  
                  
                  
                  
                  1,495Stock-based
      compensation related to options granted to non-employees
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  37
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  
                  
                  
                  
                  37Net
      income
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  2,270
                  
                  
                  $
                  2,270
                  
                  
                  
                  2,270Total
      comprehensive income
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  $
                  2,270Balance
      as of December 31, 2008
                  
                  
                  25,206,659
                  
                  
                  
                  890
                  
                  
                  
                  182,144
                  
                  
                  
                  (1,306
                  )
                  
                  
                  23
                  
                  
                  
                  (166,091
                  )
                  
                  
                  
                  
                  
                  
                  15,660Purchase
      of treasury shares
                  
                  
                  (1,457,748
                  )
                  
                  
                  (56
                  )
                  
                  
                  -
                  
                  
                  
                  (3,482
                  )
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  
                  
                  
                  
                  (3,538
                  )Issuance
      of shares upon exercise of options
                  
                  
                  209,850
                  
                  
                  
                  8
                  
                  
                  
                  210
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  
                  
                  
                  
                  218Stock-based
      compensation related to employees
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  1,345
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  
                  
                  
                  
                  1,345Stock-based
      compensation related to options granted to non-employees
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  32
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  
                  
                  
                  
                  32Net
      income
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  5,160
                  
                  
                  $
                  5,160
                  
                  
                  
                  5,160Total
      comprehensive income
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  $
                  5,160Balance
      as of December 31, 2009
                  
                  
                  23,958,761
                  
                  
                  $
                  842
                  
                  
                  $
                  183,731
                  
                  
                  $
                  (4,788
                  )
                  
                  $
                  23
                  
                  
                  $
                  (160,931
                  )
                  
                  
                  
                  
                  
                  $
                  18,877
 
 *)
              Relates
      to foreign currency translation
adjustments
 
 The
accompanying notes are an integral part of the consolidated financial
statements.
  F-7
  COMMTOUCH
SOFTWARE LTD. AND ITS SUBSIDIARY
 CONSOLIDATED
STATEMENTS OF CASH FLOWS
 U.S.
dollars in thousands
 
 Year ended December 31,2007
                  
                  
                  2008
                  
                  
                  2009Cash
      flows from operating activities:Net
      income
                  
                  $
                  2,109
                  
                  
                  $
                  2,270
                  
                  
                  $
                  5,160Adjustments
      to reconcile net income to net cash provided by operating
      activities:Depreciation
                  
                  
                  397
                  
                  
                  
                  466
                  
                  
                  
                  491Compensation
      related to options granted to employees and non-employees
                  
                  
                  1,083
                  
                  
                  
                  1,532
                  
                  
                  
                  1,377Increase
      in deferred income taxes
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (2,404
                  )Changes
      in assets and liabilities:Increase
      in trade receivables
                  
                  
                  (540
                  )
                  
                  
                  (504
                  )
                  
                  
                  (318
                  )Increase
      in prepaid expenses and other accounts receivable
                  
                  
                  (107
                  )
                  
                  
                  (46
                  )
                  
                  
                  (271
                  )Increase
      (decrease)in accounts payable
                  
                  
                  24
                  
                  
                  
                  (69
                  )
                  
                  
                  112Increase
      (decrease) in employees and payroll accruals, accrued expenses and other
      liabilities and government authorities
                  
                  
                  279
                  
                  
                  
                  (198
                  )
                  
                  
                  261Increase
      (decrease) in deferred revenues
                  
                  
                  861
                  
                  
                  
                  (459
                  )
                  
                  
                  706Increase
      (decrease) in accrued severance pay, net
                  
                  
                  11
                  
                  
                  
                  27
                  
                  
                  
                  (32
                  )Other
                  
                  
                  (2
                  )
                  
                  
                  -
                  
                  
                  
                  -Net
      cash provided by operating activities
                  
                  
                  4,115
                  
                  
                  
                  3,019
                  
                  
                  
                  5,082Cash
      flows from investing activities:Change
      in short-term cash deposit
                  
                  
                  (1,600
                  )
                  
                  
                  860
                  
                  
                  
                  740Decrease
      (increase) in long-term lease deposits
                  
                  
                  (20
                  )
                  
                  
                  (31
                  )
                  
                  
                  1Sale
      of marketable securities
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  2,000Investment
      in affiliate
                  
                  
                  (750
                  )
                  
                  
                  -
                  
                  
                  
                  (477
                  )Purchase
      of property and equipment
                  
                  
                  (605
                  )
                  
                  
                  (504
                  )
                  
                  
                  (412
                  )Net
      cash provided by (used in) investing activities
                  
                  
                  (2,975
                  )
                  
                  
                  325
                  
                  
                  
                  1,852Cash
      flows from financing activities:Purchase
      of treasury shares at cost
                  
                  
                  -
                  
                  
                  
                  (1,334
                  )
                  
                  
                  (3,538
                  )Proceeds
      from options and warrants exercised
                  
                  
                  1,663
                  
                  
                  
                  844
                  
                  
                  
                  218Net
      cash provided by (used in) financing activities
                  
                  
                  1,663
                  
                  
                  
                  (490
                  )
                  
                  
                  (3,320
                  )Increase
      in cash and cash equivalents
                  
                  
                  2,803
                  
                  
                  
                  2,854
                  
                  
                  
                  3,614Cash
      and cash equivalents at the beginning of the year
                  
                  
                  8,004
                  
                  
                  
                  10,807
                  
                  
                  
                  13,661Cash
      and cash equivalents at the end of the year
                  
                  $
                  10,807
                  
                  
                  $
                  13,661
                  
                  
                  $
                  17,275
 
 The
accompanying notes are an integral part of the consolidated financial
statements.
  F-8
  COMMTOUCH
SOFTWARE LTD. AND ITS SUBSIDIARY
 CONSOLIDATED
STATEMENTS OF CASH FLOWS
 U.S.
dollars in thousands
 
 Year ended December 31,2007
                    
                    
                    2008
                    
                    
                    2009(a)
                    Non-cash
      transactions:Purchase
      of property and equipment - trade payables
                    
                    $
                    (33
                    )
                    
                    $
                    (13
                    )
                    
                    $
                    (9
                    )Supplemental
      cash flow activities:Cash
      paid during the year for:Income
      taxes
                    
                    $
                    20
                    
                    
                    $
                    -
                    
                    
                    $
                    -
 
 The
accompanying notes are an integral part of the consolidated financial
statements.
  F-9
  COMMTOUCH
SOFTWARE LTD. AND ITS SUBSIDIARY
  NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 U.S.
dollars in thousands, except share and per share data
 
 NOTE
      1:
                  GENERAL
 
 a.
                Commtouch
      Software Ltd. ("Commtouch" or the Company") was incorporated under the
      laws of Israel in 1991. The Company and its subsidiary (Commtouch Inc.)
      develop and provide messaging and Web security solutions to OEM partners
      and enterprises. The Company's business is to develop and sell, through a
      variety of third party distribution channels, these solutions to various
      customers. The Company's messaging solutions are comprised of anti-spam,
      Zero-Hour anti-virus and GlobalView Mail Reputation solutions, and its Web
      security solution is known as GlobalView URL
  filtering.
 
 b.
                The
      Company expects that it will continue to be dependent upon third-party
      distribution channels for a significant portion of its revenues, which are
      expected to be derived from sales of the Company's anti-spam, anti-virus,
      IP reputation and URL filtering
solutions.
 
 NOTE
      2:
              SIGNIFICANT
      ACCOUNTING POLICIES
 
 The
consolidated financial statements have been prepared in accordance with
accounting principles generally accepted in the United States ("U.S.
GAAP").
 
 a.
                Use
      of estimates:
 
 The
preparation of consolidated financial statements in conformity with U.S.
generally accepted accounting principles requires management to make estimates
and assumptions that affect the amounts reported in the consolidated financial
statements and accompanying notes. Actual results could differ from those
estimates.
 
 b.
                Financial
      statements in U. S. dollars:
 
 A
majority of the revenues of the Company and its subsidiary is generated in
United States dollars ("dollars"). In addition, a substantial portion of their
costs is incurred or denominated in dollars. The Company's management believes
that the dollar is the currency of the primary economic environment in which the
Company and its subsidiary operate. Thus, the dollar is their functional and
reporting currency. Accordingly, monetary accounts maintained in currencies
other than the dollar are remeasured into U.S. dollars, in accordance with ASC
Topic 830, "Foreign Currency Matters".  All transaction gains and
losses of the remeasured monetary balance sheet items are reflected in the
statements of operations as financial income or expenses, as
appropriate.
 
 c.
                Principles
      of consolidation:
 
 The
consolidated financial statements include the accounts of the Company and its
wholly-owned subsidiary. All inter-company balances and transactions have been
eliminated upon consolidation.
 
 d.
                Cash
      equivalents:
 
 Cash
equivalents are short-term highly liquid investments that are readily
convertible to cash with original maturities of three months or less when
purchased.
  F-10
  COMMTOUCH
SOFTWARE LTD. AND ITS SUBSIDIARY
  NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 U.S.
dollars in thousands, except share and per share data
 
 NOTE
      2:-
              SIGNIFICANT
      ACCOUNTING POLICIES (Cont.)
 
 e.
                Short-term
      bank deposits:
 
 Bank
deposits with maturities of more than three months but less than one year are
included in short-term bank deposits. Such short-term bank deposits are stated
at cost.
 
 f.
                Marketable
      securities:
 
 In 2008,
the Company classified its marketable securities in accordance with ASC 320,
"Investments-Debt and Equity Securities" ("ASC 320"), as available-for-sale. The
marketable securities that are held for the short-term and available for
immediate sale were stated at quoted market prices at balance sheet date. The
Company's marketable securities consisted of highly-rated auction rate (AAA)
securities ("ARS") which were federal backed student loan securities.
Available-for-sale securities were carried at fair value, with the unrealized
gains and losses, reported in "accumulated other comprehensive income (loss)" in
shareholders' equity.
 
 Commencing
February 2008, all of the Company's ARSs (comprised of five securities) suffered
from failed auctions. On January 5, 2009, all of the Company's marketable
securities were purchased by the bank at full par value amounting to a total of
$ 2,000 and by agreeing to the settlement with the bank, the Company essentially
stated that it no longer had the intent of holding the ARSs until recovery, as
it would recover any unrealized loss through the settlement offer and,
accordingly, the ARSs were classified as trading securities as of December 31,
2008.
 
 g.
                Investment
      in affiliate:
 
 For the
purposes of these financial statements, an affiliated company is a company held
to the extent of 20% or more, or a company less than 20% held, in which the
Company can exercise significant influence over operating and financial policy
of the affiliate. For the year ended December 31, 2007, the investment in an
affiliated company (Imatrix) is accounted for under the equity method in
accordance with ASC 323 "Investments—Equity Method". Profits on inter-company
sales not realized outside the group were eliminated.
 
 As of
December 31, 2007, the Company lacks the ability to exercise significant
influence over operating and financial policies of Imatrix and, accordingly, the
investment is accounted for on a cost basis.
 
 In
November 2007 and April 2009, the Company made a $ 750 and $ 477, respectively,
cash investment in Mirapoint Inc. ("Mirapoint"), a secure messaging vendor and
an OEM licensee. The investment in an affiliated company is accounted for under
the cost method since the Company cannot exercise significant influence over the
operating and financial policies of Mirapoint.
 
 The
Company's investments are reviewed for impairment whenever events or changes in
circumstances indicate that the carrying amount of an investment may not be
recoverable. As of December 31, 2009, no impairment losses have been
identified.
  F-11
  COMMTOUCH
SOFTWARE LTD. AND ITS SUBSIDIARY
  NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 U.S.
dollars in thousands, except share and per share data
 
 NOTE
      2:-
              SIGNIFICANT
      ACCOUNTING POLICIES (Cont.)
 
 h.
                Property
      and equipment:
 
 Property
and equipment are stated at cost, net of accumulated depreciation. Depreciation
is calculated using the straight line method over the estimated useful lives of
the assets at the following annual rates:
 
 %Computers
      and peripheral equipment
                                      
                                      33.33Office
      furniture and equipment
                                      
                                      7 –
      20Motor
      vehicles
                                      
                                      15Leasehold
      improvements
                                      
                                      Over the shorter of the term of the
                                        lease or the life of the assets
 
 i.
                Impairment
      of long-lived assets:
 
 The
Company and its subsidiary's long-lived assets are reviewed for impairment
inaccordance with
ASC 360 "Property, Plant and Equipment", whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable. Recoverability of assets to be held and used is measured by a
comparison of the carrying amount of an asset to the future undiscounted cash
flows expected to be generated by the assets. If such assets are considered to
be impaired, the impairment to be recognized is measured by the amount by which
the carrying amount of the assets exceeds the fair value of the assets. No
impairment losses were recorded in 2007 through 2009.
 
 j.
                Fair
      value measurements
 
 Concurrently
with the adoption of ASC 820, the Company adopted ASC Topic 825, "Financial
Instruments," ("ASC 825") which permits entities to elect, at specified election
dates, to measure eligible financial instruments at fair value. As of December
31, 2009, the Company did not elect the fair value option under ASC 825 for any
financial assets and liabilities that were not previously measured at fair
value.
 
 The
carrying amounts of cash and cash equivalents, marketable securities, trade
receivables, prepaid expenses, other accounts receivable and accounts payable,
approximate their fair values due to the short-term maturities of financial
instruments.
 
 k.
                Revenue
      recognition:
 
 The
Company derives revenues from Anti-Spam, Zero-HourTM Virus Outbreak Protection,
GlobalView Mail Reputation and GlobalView URL filtering Services. The service
component of the Company's solutions is considered essential to the
functionality of the software components. Furthermore, the software components
can not be effectively used on a standalone basis, or with a third party's
service. The customer has no ability to effectively run the software or the
Software Development Kit ("SDK") on its own hardware. As the software portion of
the product cannot effectively stand on its own, the Company considers each sale
as a service arrangement.
  F-12
  COMMTOUCH
SOFTWARE LTD. AND ITS SUBSIDIARY
  NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 U.S.
dollars in thousands, except share and per share data
 
 NOTE
      2:-
              SIGNIFICANT
      ACCOUNTING POLICIES (Cont.)
 
 Therefore,
revenues from such services are recognized over the service term, which
generally includes a term period of one to three years.
 
 Revenue
is recognized in accordance with ASC 605, "Revenue Recognition", when the
earnings process is complete, as evidenced by an agreement between the customer
and the Company, when delivery has occurred or services have been rendered, when
the fee is fixed or determinable and when collectability is
probable.
 
 Deferred
revenues include unearned amounts received from customers, but not yet
recognized as revenues.
 
 l.
                Research
      and development costs:
 
 ASC
985-20, "Costs of Software to be Sold, Leased or Marketed", requires
capitalization of certain software development costs subsequent to the
establishment of technological feasibility.
 
 Based on
the Company's product development process, technological feasibility is
established upon completion of a working model. Costs incurred by the Company
between completion of the working models and the point at which the products are
ready for general release, have been insignificant. Therefore, all research and
development costs have been expensed.
 
 m.
                Government
      grants:
 
 Royalty-bearing
grants from the Government of Israel for funding certain approved research and
development projects are recognized at the time the Company is entitled to such
grants, on the basis of the related costs incurred and recorded as a deduction
of research and development costs. Research and development grants from the
Government of Israel amounted to $ 263, $0 and $0 in 2009, 2008 and 2007,
respectively
 
 n.
                Concentrations
      of credit risk:
 
 The
Company and its subsidiary have no significant off-balance-sheet concentration
of credit risk.
 
 Financial
instruments that potentially subject the Company to concentrations of credit
risk consist principally of trade receivables and cash and cash equivalents. The
majority of the Company's short-term deposits and cash and cash equivalents are
invested in dollars and dollar linked investments and are deposited in major
banks in the United States and Israel. Such investments in the United States may
be in excess of insured limits and are not insured in other jurisdictions.
Management believes that the financial institutions that hold the Company's
investments are institutions with high credit standing, and accordingly, minimal
credit risk exists with respect to these investments.
 
 The trade
receivables of the Company are derived from transactions with companies located
primarily in North America, Europe, Israel and Asia. An allowance for doubtful
accounts is determined with respect to those amounts that the Company and its
subsidiary have determined to be doubtful of collection. The allowance for
doubtful accounts was $ 0 at December 31, 2008 and 2009. Bad debt expense for
each of the years ended December 31, 2007, 2008 and 2009 was
$ 0.
  F-13
  COMMTOUCH
SOFTWARE LTD. AND ITS SUBSIDIARY
  NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 U.S.
dollars in thousands, except share and per share data
 
 NOTE
      2:-
              SIGNIFICANT
      ACCOUNTING POLICIES (Cont.)
 
 o.
                Accounting
      for stock-based compensation:
 
 ASC 718
requires companies to estimate the fair value of equity-based payment awards on
the date of grant using an option-pricing model. The value of the portion of the
award that is ultimately expected to vest is recognized as an expense over the
requisite service periods in the Company's consolidated income
statements.
 
 The
Company applies ASC 718, and ASC 505-50, "Equity Based Payments to
Non-Employees" ("ASC 505-50"), with respect to options and warrants issued to
non-employees. ASC 718 requires the use of an option valuation model to measure
the fair value of the options and warrants at the measurement date as defined in
ASC 505-50.
 
 The
Company recognizes compensation expense for the value of its awards on a
straight line basis over the requisite service period of each of the awards, net
of estimated forfeitures. Estimated forfeitures are based on actual historical
pre-vesting forfeitures. ASC 718 requires forfeitures to be estimated at the
time of grant and revised, if necessary, in subsequent periods if actual
forfeitures differ from those estimates.
 
 The
Company estimates the fair value of stock options granted using the
Black-Scholes option-pricing model. The option-pricing model requires a number
of assumptions, of which the most significant are the expected stock price
volatility and the expected option term. Expected volatility was calculated
based upon actual historical stock price movements. The expected term of options
granted represents the period of time that options granted are expected to be
outstanding. The risk-free interest rate is based on the yield from U.S.
treasury bonds with an equivalent term. The Company has historically not paid
dividends and has no foreseeable plans to pay dividends.
 
 The fair value for options granted in 2007, 2008 and 2009 is estimated
at the date of grant using a Black-Scholes options pricing model with the
following weighted average assumptions:
 
 Year ended December 31,Employee stock options
                                                  
                                                  2007
                                                  
                                                  2008
                                                  
                                                  2009Volatility
                                                  
                                                  70%
                                                  
                                                  80%
                                                  
                                                  82%Risk-free
      interest rate
                                                  
                                                  3.76%-4.94%
                                                  
                                                  1.79%-2.79%
                                                  
                                                  1.34%-1.61%Dividend
      yield
                                                  
                                                  0%
                                                  
                                                  0%
                                                  
                                                  0%Expected
      life (years)
                                                  
                                                  4.08
                                                  
                                                  3.03
                                                  
                                                  3.35
 
 p.
                Basic
      and diluted net earnings per
share:
 
 Basic and
diluted net earnings per share are presented in accordance with ASC Topic 260,
"Earnings per Share", for all periods presented.
  F-14
  COMMTOUCH
SOFTWARE LTD. AND ITS SUBSIDIARY
  NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 U.S.
dollars in thousands, except share and per share data
 
 NOTE
      2:-
              SIGNIFICANT
      ACCOUNTING POLICIES (Cont.)
 
 Basic net
earnings per share have been computed using the weighted-average number of
Ordinary shares outstanding during the year. Diluted net earnings per share is
computed based on the weighted average number of Ordinary shares outstanding
during each year, plus the weighted average number of dilutive potential
Ordinary shares considered outstanding during the year.
 
 In 2007,
2008 and 2009, the difference between the denominator of basic and diluted net
earnings per share is due to the effect of dilutive securities for stock options
and warrants. In 2007, 2008 and 2009 363,133 ,1,563,038 and 2,584,732,
respectively, weighted average number of shares related to options and warrants
outstanding were excluded from calculation of the diluted earnings per share
since they would have an anti-dilutive effect.
 
 q.
                Severance
      pay:
 
 The
Company's liability for severance pay in Israel is calculated pursuant to
Israel's Severance Pay Law based on the most recent salary of the employees
multiplied by the number of years of employment as of the balance sheet date.
Employees are entitled to one month's salary for each year of employment or a
portion thereof. The Company's obligation for all of its Israeli employees is
fully provided by monthly deposits with severance pay funds and insurance
policies, and by an accrual. The value of those funds and policies is recorded
as an asset in the Company's balance sheet.
 
 The
deposited funds include profits and losses accumulated up to the balance sheet
date. The deposited funds may be withdrawn only upon the fulfillment of the
obligation pursuant to Israel's Severance Pay Law or labor agreements. The value
of the deposited funds is based on the cash surrendered value of these
policies.
 
 Severance
(income) expense for the years ended December 31, 2007, 2008 and 2009 was
approximately $ 11, $ 26 and $ (31), respectively.
 r.
                  Treasury
      shares:
 The
Company repurchases its Ordinary shares from time to time on the open market and
holds such shares as Treasury shares. The Company presents the cost to
repurchase Treasury shares as a reduction in shareholders' equity.
 
 s.
                Income
      taxes:
 
 The
Company accounts for income taxes in accordance with ASC Topic 740, "Income
Taxes" ("ASC 740"). ASC 740  prescribes the use of the liability
method whereby deferred tax asset and liability account balances are determined
based on differences between financial reporting and tax bases of assets and
liabilities and are measured using the enacted tax rates and laws that will be
in effect when the differences are expected to reverse. The Company provides a
valuation allowance, if necessary, to reduce deferred tax assets to amounts more
likely than not to be realized.
 
 Deferred
tax assets are classified as current or non-current based on the classification
of the related asset or liability for financial reporting, or according to the
expected reversal dates of the specific temporary differences if not related to
an asset or liability for financial reporting.
  F-15
  COMMTOUCH
SOFTWARE LTD. AND ITS SUBSIDIARY
  NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 U.S.
dollars in thousands, except share and per share data
 
 NOTE
      2:-
              SIGNIFICANT
      ACCOUNTING POLICIES (Cont.)
 
 ASC 740
contains a two-step approach to recognizing and measuring a liability for
uncertain tax positions. The first step is to evaluate the tax position taken or
expected to be taken in a tax return by determining if the weight of available
evidence indicates that it is more likely than not that, on an evaluation of the
technical merits, the tax position will be sustained on audit, including
resolution of any related appeals or litigation processes. The second step is to
measure the tax benefit as the largest amount that is more than 50% likely to be
realized upon ultimate settlement. No liability for unrecognized tax benefits
was recorded as a result of the implementation of ASC 740.
 
 t.
                Recently
      issued accounting
pronouncements:
 
 In June
2009, the FASB issued ASC 105, "Generally Accepted Accounting Principles" ("ASC
105"). ASC 105 establishes the FASB Accounting Standards Codification, which
will become the source of authoritative U.S. GAAP recognized by the FASB.
Following this statement, the FASB will issue new standards in the form of
Accounting Standards Updates ("ASUs"). ASC 105 is effective for financial
statements issued for interim and annual periods ending after September 15,
2009. The adoption of ASC 105did not have any impact on the Company's financial
statements, as it does not modify GAAP, except for the specific references to
GAAP literature in the notes to the Company's consolidated financial
statements.
 
 In
October 2009, the FASB issued an update to ASC 985-605, "Software-Revenue
Recognition" (originally issued as EITF 09-3). In accordance with the update to
the ASC, tangible products containing software components and non-software
components that function together to deliver the tangible product's essential
functionality are excluded from the scope of the software revenue recognition
guidance. In addition, hardware components of a tangible product containing
software component are always excluded from the software revenue guidance. The
mandatory adoption is on January 1, 2011. The Company may elect to adopt the
update prospectively, to new or materially modified arrangements beginning on
the adoption date, or retrospectively, for all periods presented. In such case
the Company must also early adopt the amendment to ASC 605-25 with respect to
multiple-elements arrangements. The Company does not expect the adoption of the
update to have a material impact on its consolidated financial condition or
results of operations.
 
 In
October 2009, the FASB issued an update to ASC 605-25, "Revenue recognition -
Multiple-Element Arrangements", that provides amendments to the criteria for
separating consideration in multiple-deliverable arrangements to:
 
 -
                Provide
      updated guidance on whether multiple deliverables exist, how the
      deliverables in an arrangement should be separated, and how the
      consideration should be
allocated;
 
 -
                Require
      an entity to allocate revenue in an arrangement using estimated selling
      prices ("ESP") of deliverables if a vendor does not have vendor-specific
      objective evidence of selling price ("VSOE") or third-party evidence of
      selling price ("TPE");
and
  F-16
  COMMTOUCH
SOFTWARE LTD. AND ITS SUBSIDIARY
  NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 U.S.
dollars in thousands, except share and per share data
 
 NOTE
      2:-
              SIGNIFICANT
      ACCOUNTING POLICIES (Cont.)
 
 -
                Eliminate
      the use of the residual method and require an entity to allocate revenue
      using the relative selling price
method.
 
 -
                Require
      expanded disclosures of qualitative and quantitative information regarding
      application of the multiple-deliverable revenue arrangement
      guidance.
 
 The
Company may elect to adopt the update prospectively, to new or materially
modified arrangements beginning on the adoption date, or retrospectively, for
all periods presented. The Company is currently evaluating the impact on its
consolidated results of operations and financial condition.
 
 NOTE
      3:
              PROPERTY
      AND EQUIPMENT
 
 December 312008
                        
                        
                        2009Cost:Computers
      and peripheral equipment
                        
                        $
                        2,846
                        
                        
                        $
                        3,224Office
      furniture and equipment
                        
                        
                        605
                        
                        
                        
                        614Motor
      vehicles
                        
                        
                        88
                        
                        
                        
                        88Leasehold
      improvements
                        
                        
                        1,157
                        
                        
                        
                        1,1914,696
                        
                        
                        
                        5,117Less
      accumulated depreciation
                        
                        
                        (3,925
                        )
                        
                        
                        (4,416
                        )Property
      and Equipment, net
                        
                        $
                        771
                        
                        
                        $
                        701
 
 Depreciation
expense amounted to approximately $ 397, $ 466 and $ 491 in 2007, 2008 and
2009, respectively.
 
 NOTE
      4:
              COMMITMENTS
      AND CONTINGENCIES
 
 a.
                Commtouch
      Software Ltd. which is incorporated in Israel, partially financed its
      research and development expenditures under programs sponsored by the
      Office of Chief Scientist ("OCS") for the support of certain research and
      development activities conducted in
Israel.
 
 In
connection with its research and development, the Company received and accrued
participation payments from the OCS in the aggregate amount of $ 263. In
return for the OCS's participation, the Company is committed to pay royalties at
a rate of 3% of sales of the developed product, up to 100% of the amount of
grants received (100% plus interest at LIBOR). The Company's total commitment
for royalties payable with respect to future sales, based on OCS participations
received or accrued, net of royalties paid or accrued, totaled approximately
$ 255 as of December 31, 2009. For the years ended December 31, 2009 and
2008, the amounts of $ 8 and $ 0, respectively, were recorded as cost
of revenues with respect to royalties due to the OCS.
  F-17
  COMMTOUCH
SOFTWARE LTD. AND ITS SUBSIDIARY
  NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 U.S.
dollars in thousands, except share and per share data
 
 NOTE
      4:
              COMMITMENTS
      AND CONTINGENCIES (Cont.)
 
 b.
                Operating
      leases:
 
 The
Company leases its facility in Israel under an operating lease agreement
expiring on December 31, 2010. The subsidiary leases its facility in the U.S.
under an operating lease agreement expiring on February 28,
2011.
 
 Facilities
rent expense for 2007, 2008 and 2009 was approximately $ 164, $ 202
and $ 259, respectively.
 
 Annual
minimum future lease payments due under the above agreements (and motor vehicle
leases, which expire in 2012), at the exchange rate in effect on December 31,
2009, are approximately as follows:
 
 2010
                          
                          $
                          4782011
                          
                          
                          1162012
                          
                          
                          18$
                          612
 
 NOTE
      6:
              SHAREHOLDERS'
      EQUITY
 
 a.
                General:
 
 The
Ordinary shares of the Company have been traded on the Nasdaq National
Market  (now known as the Nasdaq Global Market) and Nasdaq Capital
Market (formerly The NASDAQ SmallCap Market), since July 1999 and 2002,
respectively.
 
 On
December 16, 2009, the Company's Ordinary shares became listed for trading
publicly on the Tel Aviv Stock Exchange, or "TASE", thus becoming a "dual
listed" company.
 
 The
Ordinary shares confer upon their holders the right to receive notice to
participate and vote in general shareholder meetings of the Company and to
receive dividends, if declared. In January 2008, the Board of Directors and
shareholders approved a 3:1 reverse stock split of the Company's share capital.
As a result of this action, every three shares (including all authorized, issued
and outstanding shares and all outstanding warrants and options to purchase
shares) were combined into one share of the same respective class of shares
bearing a par value of NIS 0.15 each.
  F-18
  COMMTOUCH
SOFTWARE LTD. AND ITS SUBSIDIARY
  NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 U.S.
dollars in thousands, except share and per share data
 
 NOTE
      6:
              SHAREHOLDERS'
      EQUITY (Cont.)
 
 b.
                Warrants
      to investors:
 
 As of
December 31, 2009, the Company's outstanding warrants issued to various parties
were as follows:
 
 Issuance date
                      
                      Warrants
                        granted for
                        Ordinary
                        shares
                      
                      
                      Exercise
                        price per
                        share
                      
                      
                      Remaining
                        warrants
                        exercisable
                      
                      Exercisable throughOctober
      2005
                      
                      
                      500,000
                      
                      
                      $
                      1.95
                      
                      
                      
                      458,333
                      
                      October
      2010May
      2006
                      
                      
                      23,364
                      
                      
                      $
                      3.21
                      
                      
                      
                      23,364
                      
                      May
      2011Total
                      
                      
                      523,364
                      
                      
                      
                      
                      
                      
                      
                      481,697
 
 c.
                Employee
      stock options:
 
 In 1996,
the Company adopted the 1996 CSI Stock Option Plan for granting options to its
U.S. employees and consultants to purchase Ordinary shares of the Company, which
was replaced in 2006 by the 2006 U.S. Stock Option Plan. Until 1999, the Company
issued options to purchase Ordinary shares to its Israeli employees pursuant to
individual agreements. In 1999, the Company approved the 1999 Section 3(i) share
option plan for its Israeli employees and consultants, (which was amended in
2003 and renamed the "Amended and Restated IsraeliShare Option
Plan").As of
December 31, 2009, an aggregate of 845,200 Ordinary shares of the Company are
still available for future grant to employees and directors.
 
 Options
granted under such plans and agreements up to September 2005, expire generally
after ten years from the date of grant, with grants from September 2005 having
six-year terms from the date of grant. Options cease vesting upon termination of
the optionee's employment or other relationship with the Company. The options
generally vest over a period of four years. The exercise price of the options
granted under the individual agreements may not be less than the nominal value
of the shares into which such options are exercisable. Any options that are
canceled or not exercised within the option term become available for future
grant.
  F-19
  COMMTOUCH
SOFTWARE LTD. AND ITS SUBSIDIARY
  NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 U.S.
dollars in thousands, except share and per share data
 
 NOTE
      6:
              SHAREHOLDERS'
      EQUITY (Cont.)
 
 A summary
of the Company's employees share option activity under the plans is as
follows:
 
 Number of
                      shares
                    
                    
                    Weighted
                      average
                      exercise
                      price
                    
                    
                    Aggregate
                      intrinsic
                      value2009
                    
                    
                    2009
                    
                    
                    2009Outstanding
      at the beginning of the year
                    
                    
                    3,512,557
                    
                    
                    $
                    2.69
                    
                    
                    $
                    1,009Granted
                    
                    
                    682,167
                    
                    
                    $
                    2.57Exercised
                    
                    
                    (209,850
                    )
                    
                    $
                    1.04Expired
      and Forfeited
                    
                    
                    (245,006
                    )
                    
                    $
                    3.96Outstanding
      at the end of the year
                    
                    
                    3,739,868
                    
                    
                    $
                    2.67
                    
                    
                    $
                    *)4,966Options
      vested and expected to vest at the end of the year
                    
                    
                    3,601,244
                    
                    
                    $
                    2.65
                    
                    
                    $
                    4,852Exercisable
      options at the end of the year
                    
                    
                    2,413,521
                    
                    
                    $
                    2.35
                    
                    
                    $
                    3,771Weighted
      average fair value of options granted during the year
                    
                    
                    
                    
                    
                    $
                    1.54
 
 *)       885,822
options were out of the money as of December 31, 2009, and their intrinsic value
was $0.
 
 The
aggregate intrinsic value of the Company's options is the difference between the
Company's closing share price on the last trading day of the fiscal year 2009
and the exercise price, times the number of options.
 
 The
options outstanding as of December 31, 2009, have been separated into ranges of
exercise prices, as follows:
 
 Exercise
                          price per
                          share
                        
                        Options
                          outstanding
                        
                        
                        Weighted
                          average
                          remaining
                          contractual
                          life in years
                        
                        
                        Weighted
                          average
                          exercise price
                          per share
                        
                        
                        Options
                          exercisable
                        
                        
                        Weighted
                          average
                          exercise
                          priceper
                          share of
                          exercisable
                          options$
                        0.03-$0.27
                        
                        
                        111,606
                        
                        
                        
                        1.62
                        
                        
                        $
                        0.04
                        
                        
                        
                        111,606
                        
                        
                        $
                        0.04$
                        0.
      33-$0.60
                        
                        
                        500,000
                        
                        
                        
                        2.77
                        
                        
                        $
                        0.35
                        
                        
                        
                        500,000
                        
                        
                        $
                        0.35$
                        0.81-$0.84
                        
                        
                        38,667
                        
                        
                        
                        1.84
                        
                        
                        $
                        0.82
                        
                        
                        
                        38,667
                        
                        
                        $
                        0.82$
                        0.93-$1.89
                        
                        
                        624,549
                        
                        
                        
                        4.59
                        
                        
                        $
                        1.39
                        
                        
                        
                        430,561
                        
                        
                        $
                        1.31$
                        1.93-$2.91
                        
                        
                        712,488
                        
                        
                        
                        4.32
                        
                        
                        $
                        2.21
                        
                        
                        
                        257,139
                        
                        
                        $
                        2.56$
                        3.12-$4.35
                        
                        
                        1,262,279
                        
                        
                        
                        2.78
                        
                        
                        $
                        3.39
                        
                        
                        
                        822,930
                        
                        
                        $
                        3.24$
                        4.69-$6.60
                        
                        
                        490,279
                        
                        
                        
                        3.65
                        
                        
                        $
                        6.23
                        
                        
                        
                        252,618
                        
                        
                        $
                        6.213,739,868
                        
                        
                        
                        3.44
                        
                        
                        
                        2.67
                        
                        
                        
                        2,413,521
                        
                        
                        $
                        2.35
  F-20
  COMMTOUCH
SOFTWARE LTD. AND ITS SUBSIDIARY
  NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 U.S.
dollars in thousands, except share and per share data
 
 NOTE
      6:
              SHAREHOLDERS'
      EQUITY (Cont.)
 
 d.
                Non-employee
      directors stock option plan:
 
 In 1999,
the Company adopted the 1999 Non-Employee Directors Stock Option Plan, and in
2008 shareholders approved an extension of the term of this plan through July
13, 2019. The original allotment of shares to this plan was 1,263,333. On
December 15, 2006, the Company combined the remaining pool of options in the
employee stock option plans reserve with the amount of options remaining in the
Non-Employee Directors Stock Option Plan reserve.
 
 Since the
annual meeting of shareholders in 2003 and up until December 31, 2008, new
directors joining the Board areentitledto an option grant of
50,000 Ordinary shares.Directors
who are re-elected at the annual meeting of shareholders are entitled to
additional grants of 16,667 options, though at the annual meeting held October
26, 2009 shareholders approved a one-time increase in the grants to re-elected
directors to 30,000 options.
 
 Each
option granted under the Non-Employee Directors Stock Option Plan becomes
exercisable at a rate of 1/16th of the shares every three months. Each option
has an exercise price equal to the fair market value of the Ordinary shares on
the grant date of such option. Until September 2005, each option granted had a
maximum term of ten years, but since September 2005, the term of granted options
is six years. Options will terminate earlier if the optionee ceases to be a
member of the Board of Directors.
 
 During
2009, the Company granted 150,000 options to non-employee directors at a
weighted average exercise price of $ 3.29 per share. Weighted average fair value
of options granted during the year is $1.84. As of December 31, 2009, 286,440
options were vested and unexercised and 608,337 were outstanding under the
Non-Employee Directors Stock Option Plan.
 
 e.
                Options
      to non-employees:
 
 Issuance date
                      
                      Options granted
                        for Ordinary
                        Shares
                      
                      
                      Exercise price
                        per share
                      
                      
                      Options
                        exercisable
                      
                      Exercisable
                        throughMay
      2006-2008 (i)
                      
                      
                      83,334
                      
                      
                      
                      $3.21-$5.73
                      
                      
                      
                      60,414
                      
                      May
      2013Total
                      
                      
                      83,334
                      
                      
                      
                      
                      
                      
                      
                      60,414
 
 (i)
                As
      a consideration for consulting services, on May 7, 2006 the Company issued
      50,000 options to a service provider to purchase the Company's Ordinary
      shares at a price of $ 3.21 per option. On May 5, 2007, the Company
      issued an additional 16,667 options to the service provider to purchase
      the Company's Ordinary shares at a price of $ 5.73 per option. On May
      6, 2008, the Company issued an additional 16,667 options to purchase
      Ordinary shares to the service provider at a price of $ 3.85 per option.
      The options shall vest and become exercisable at a rate of 1/16 of the
      options every three months. The Company has accounted for this grant under
      the fair value method of ASC 505-50. The fair value for these options was
      estimated using a Black-Scholes option-pricing model. Compensation expense
      for 2007, 2008 and 2009 amounted to $ 70, $ 37 and $ 32,
      respectively.
 
 f.
                The
      total unrecognized estimated compensation cost related to non-vested stock
      options granted until December 31, 2009 was $ 2,797 which is expected
      to be recognized over a period of up to four
  years.
  F-21
  COMMTOUCH
SOFTWARE LTD. AND ITS SUBSIDIARY
  NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 U.S.
dollars in thousands, except share and per share data
 
 NOTE
      6:
              SHAREHOLDERS'
      EQUITY (Cont.)
 
 g.
              Total
      stock-based compensation expenses recognized in 2007, 2008 and
      2009:
 
 The total
stock-based compensation expense related to all of the Company's equity-based
awards, recognized for the year ended December 31, 2007, 2008 and 2009, was
comprised as follows:
 Year ended December 31,2007
                    
                    
                    2008
                    
                    
                    2009Cost
      of revenues
                    
                    $
                    31
                    
                    
                    $
                    45
                    
                    
                    $
                    40Research
      and development
                    
                    
                    246
                    
                    
                    
                    319
                    
                    
                    
                    302Selling
      and marketing
                    
                    
                    194
                    
                    
                    
                    298
                    
                    
                    
                    300General
      and administrative
                    
                    
                    612
                    
                    
                    
                    870
                    
                    
                    
                    735$
                    1,083
                    
                    
                    $
                    1,532
                    
                    
                    $
                    1,377
 
 NOTE
      7:
              INCOME
      TAXES
 
 a.
                Corporate
      tax structure:
 
 Israeli companies are generally subject
to company tax on their taxable income. The applicable rate is 29% in 2007, 27%
in 2008, 26% in 2009, 25% in 2010, and scheduled to decline to 24% in 2011, 23%
in 2012, 22% in 2013, 21% in 2014, 20% in 2015 and 18% in 2016 and
thereafter.
 
 b.
                Measurement
      of taxable income under the Income Tax (Inflationary Adjustments) Law,
      1985:
 
 Results
for tax purposes are measured in terms of earnings in NIS after certain
adjustments for increases in the Israeli Consumer Price Index ("CPI"). As
explained in Note 2b, the financial statements are measured in U.S. dollars. The
difference between the annual change in the Israeli CPI and in the NIS/dollar
exchange rate causes a further difference between taxable income and the income
before taxes shown in the financial statements. In accordance with paragraph
9(f) of ASC 740, the Company has not provided deferred income taxes on the
difference between the functional currency and the tax bases of assets and
liabilities. In February 2008, the inflationary adjustment law was
cancelled.
 
 c.
                Tax
      benefits under Israel's Law for the Encouragement of Industry (Taxation),
      1969:
 
 The
Company may currently qualify as an "industrial company" within the definition
of the Law for the Encouragement of Industry (Taxation), as such, it may be
eligible for certain tax benefits, including, inter alia, special depreciation
rates for machinery, equipment and buildings, amortization of patents, certain
other intangible property rights and deduction of share issuance
expenses.
  F-22
  COMMTOUCH
SOFTWARE LTD. AND ITS SUBSIDIARY
  NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 U.S.
dollars in thousands, except share and per share data
 
 NOTE
      7:
              INCOME
      TAXES (Cont.)
 
 d.
                Net
      operating loss carryforwards:
 
 As of
December 31, 2009, the Company's net operating loss carryforwards for tax
purposes amounted to approximately $ 76,000 which may be carried forward
and offset against taxable income in the future, for an indefinite
period.
 
 As of
December 31, 2009, for federal income tax purposes, the U.S. subsidiary had net
operating loss carry-forwards of approximately $ 92,000. These losses may
offset any future U.S. taxable income of the U.S. subsidiary and will expire in
the years 2011 through 2025.
 
 Utilization
of U.S. net operating losses may be subject to substantial annual limitation due
to the "change in ownership" provisions of the Internal Revenue Code of 1986 and
similar state provisions. The annual limitations may result in the expiration of
net operating losses before utilization.
 
 Management
currently believes that since the Company has history of losses it is more
likely than not that some of the deferred tax assets regarding the loss carry
forwards will not be utilized in the foreseeable future. Thus, a valuation
allowance was provided to reduce deferred tax assets to their realizable
value.
 
 e.
                Deferred
      income taxes:
 
 Deferred
taxes reflect the net tax effects of temporary differences between the carrying
amounts of assets and liabilities for financial reporting purposes and the
amounts used for income tax purposes. As of December 31, 2008 and 2009, the
Company's deferred taxes were in respect of the following:
 December 31,2008
                    
                    
                    2009Net
      operating loss carry-forwards
                    
                    $
                    54,522
                    
                    
                    $
                    53,213Reserves
      and allowances
                    
                    
                    226
                    
                    
                    
                    274Property
      and Equipment
                    
                    
                    50
                    
                    
                    
                    52Research
      and development costs
                    
                    
                    471
                    
                    
                    
                    642Deferred
      tax assets before valuation allowance
                    
                    
                    55,269
                    
                    
                    
                    54,181Valuation
      allowance
                    
                    
                    (55,269
                    )
                    
                    
                    (51,777
                    )Deferred
      tax asset
                    
                    $
                    -
                    
                    
                    $
                    2,404Domestic:Current
      deferred tax asset, net
                    
                    $
                    -
                    
                    
                    $
                    1,283Non-current
      deferred tax asset, net
                    
                    
                    -
                    
                    
                    
                    986-
                    
                    
                    
                    2,269Foreign:Current
      deferred tax asset, net
                    
                    
                    
                    
                    
                    
                    134Non-current
      deferred tax asset, net
                    
                    
                    -
                    
                    
                    
                    1-
                    
                    
                    
                    135$
                    -
                    
                    
                    $
                    2,404
 
 Current
deferred tax asset, net, is included within other current assets in the balance
sheets.
  F-23
  COMMTOUCH
SOFTWARE LTD. AND ITS SUBSIDIARY
  NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 U.S.
dollars in thousands, except share and per share data
 
 NOTE
      7:
              INCOME
      TAXES (Cont.)
 
 f.
                For
      the years ended December 31, 2007 and 2008, the main reconciling items
      between the statutory tax rate of the Company and the effective tax rate
      are the non-recognition of the benefits from accumulated net operating
      loss carry forward due to the uncertainty of the realization of such tax
      benefits. For the year ended December 31, 2009, the main reconciling items
      between the statutory tax rate of the Company and the effective tax rate
      are the non-recognition of the benefits from accumulated net operating
      loss carry forward due to the uncertainty of the realization of such tax
      benefits, as well as recognition of a deferred tax asset of $2,404 in
      respect of net operating loss carry forwards and temporary differences
      that are more likely than not to be realized in the foreseeable
      future.
 
 g.
                Income
      before taxes on income (tax benefit) consists of the
      following:
 
 Year ended December 31,2007
                    
                    
                    2008
                    
                    
                    2009Israel
                    
                    $
                    1,947
                    
                    
                    $
                    2,011
                    
                    
                    $
                    2,573U.S.
                    
                    
                    190
                    
                    
                    
                    266
                    
                    
                    
                    183$
                    2,137
                    
                    
                    $
                    2,277
                    
                    
                    $
                    2,756
 
 The
Company is required to calculate and account for income taxes in each
jurisdiction in which the Company or its subsidiary operate. Significant
judgment is required in determining its worldwide provision for income taxes and
recording the related assets and liabilities.
 
 h.
                Taxes
      on income (tax benefit) are comprised of the
  following:
  Year ended December 31,2007
                    
                    
                    2008
                    
                    
                    2009Current
      taxes:Foreign
                    
                    $
                    28
                    
                    
                    $
                    7
                    
                    
                    $
                    -$
                    28
                    
                    
                    $
                    7
                    
                    
                    $
                    -Deferred
      taxes:Foreign
                    
                    $
                    -
                    
                    
                    $
                    -
                    
                    
                    $
                    (135
                    )Domestic
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    (2,269
                    )$
                    -
                    
                    
                    $
                    -
                    
                    
                    $
                    (2,404
                    )
  F-24
  COMMTOUCH
SOFTWARE LTD. AND ITS SUBSIDIARY
  NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 U.S.
dollars in thousands, except share and per share data
 
 NOTE
      7:
              INCOME
      TAXES (Cont.)
 
 i.
                Tax
      assessments:
 
 The
Company has final tax assessments in Israel through 2003.
  NOTE
      8:
              GEOGRAPHIC
      INFORMATION
 
 The
Company conducts its business on the basis of one reportable segment. The
Company has adopted ASC 280, "Segment Reporting".
 
 a.
                Revenues
      from external customers:
 
 Year ended December 31,2007
                    
                    
                    2008
                    
                    
                    2009Israel
                    
                    $
                    742
                    
                    
                    $
                    1,080
                    
                    
                    $
                    1,544North
      America
                    
                    
                    6,424
                    
                    
                    
                    8,018
                    
                    
                    
                    8,032Europe
                    
                    
                    2,735
                    
                    
                    
                    3,160
                    
                    
                    
                    3,776Asia
                    
                    
                    1,038
                    
                    
                    
                    1,497
                    
                    
                    
                    1,508Other
                    
                    
                    311
                    
                    
                    
                    337
                    
                    
                    
                    329$
                    11,250
                    
                    
                    $
                    14,092
                    
                    
                    $
                    15,189
 
 For the
years ended December 31, 2007, 2008 and 2009, there are no major
customers.
 
 b.
                The
      Company's net amount of long-lived assets is as
  follows:
 
 December 312008
                    
                    
                    2009Israel
                    
                    $
                    175
                    
                    
                    $
                    198U.S.A.
                    
                    
                    596
                    
                    
                    
                    503$
                    771
                    
                    
                    $
                    701
  F-25
  COMMTOUCH
SOFTWARE LTD. AND ITS SUBSIDIARY
  NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 U.S.
dollars in thousands, except share and per share data
 
 NOTE
      9:-
              FINANCIAL
      INCOME, NET
 
 Year ended December 31,2007
                    
                    
                    2008
                    
                    
                    2009Income:Interest
      on cash and cash equivalents and short term deposit
                    
                    $
                    575
                    
                    
                    $
                    434
                    
                    
                    $
                    108Capital
      gain on sale of marketable securities
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    38Expenses:Foreign
      currency exchange differences
                    
                    
                    (46
                    )
                    
                    
                    (81
                    )
                    
                    
                    (74
                    )Other
                    
                    
                    (2
                    )
                    
                    
                    (7
                    )
                    
                    
                    (12
                    )$
                    527
                    
                    
                    $
                    346
                    
                    
                    $
                    60
 
 NOTE
      10:
              SUBSEQUENT
      EVENTS
 
 On March
15, 2010, the Company announced that its board ofdirectors
authorized an additional plan for the repurchase of the Company's ordinary
shares in the open market or through privately negotiated transactions, in an
amount in cash of up to $5,000. The plan will commence immediately, and the term
of the plan will be reviewed on a quarterly basis by the board of directors.
Under the repurchase program, share purchases may be made from time to time
depending on market conditions, share price, trading volume and other
factors.
 
 The
repurchase program does not require the Company to acquire a specific number of
shares and may be suspended from time to time or discontinued.
  - - - - - - - - - - - - - - - - - - -
-
  F-26




Item
19. Exhibits.




The list of exhibits required by this
Item is incorporated by reference to the Exhibit Index which precedes the
exhibits to this report.




SIGNATURES




The
registrant hereby certifies that it meets all of the requirements for filing on
Form 20–F and that it has duly caused and authorized the undersigned to sign
this annual report on its behalf.




COMMTOUCH
      SOFTWARE LTD.By:
                /s/ Ron ElaRon
      ElaChief
      Financial OfficerMarch
      26, 2010







Item
19. Exhibits




Exhibit Number
                                      
                                      Description of Document1.1
                                      
                                      Memorandum
      of Association of the Company.(1)1.2
                                      
                                      Amended
      and Restated Articles of Association of the Company, as amended on
      December 14, 2007.(2)4.1
                                      
                                      Commtouch
      Software Ltd. 2006 U.S. Stock Option Plan.(3)4.2
                                      
                                      Amended
      and Restated Commtouch Software Ltd. 1999 Non–Employee Directors Stock
      Option Plan.(4)4.3
                                      
                                      Extension
      of Amended and Restated Commtouch Software Ltd. 1999 Non-Employee
      Directors Stock Option Plan.(5)4.4
                                      
                                      Commtouch
      Software Ltd. Amended and Restated Israeli Share Option Plan [successor
      plan to 1999 Section 3(i) Share Option Plan].(6)4.5
                                      
                                      Commtouch
      Software Ltd. Amended and Restated 1996 CSI Stock Option
      Plan.(7)4.6
                                      
                                      Amended
      and Restated 1999 Section 3(i) Share Option Plan.(8)4.7
                                      
                                      Summary
      of Director Compensation.8
                                      
                                      List
      of Subsidiaries of the Company.12.1
                                      
                                      Certification
      of Company’s Principal Executive Officer Pursuant to Exchange Act Rule
      13a-14(a) or 15d-14(a).12.2
                                      
                                      Certification
      of Company’s Principal Financial Officer Pursuant to Exchange Act Rule
      13a-14(a) or 15d-14(a).13
                                      
                                      Certification
      of Company’s Principal Executive Officer and Principal Financial Officer
      Pursuant  to 18 U.S.C. 1350.15
                                      
                                      Consent
      of Kost, Forer, Gabbay & Kasierer, independent
    auditors.





(1)
            Incorporated
      by reference to exhibits in Amendment No. 1 to Registration Statement on
      Form F–1 of Commtouch Software Ltd., File No.
  333–78531.




(2)
            Incorporated
      by reference to Exhibit 1.2 to Annual Report on Form 20–F for the year
      ended December 31, 2007.




(3)
            Incorporated
      by reference to Exhibit 99.4 to Registration Statement on Form S–8 No.
      333–141177. [filed March 9, 2007]




(4)
            Incorporated
      by reference to Exhibit 99.1 to Registration Statement on Form S–8 No.
      333–141177. [filed March 9, 2007]




(5)
            Incorporated
      by reference to Exhibit 4.6 to Annual Report on form 20-F for the year
      ended December 31, 2008.




(6)
            Incorporated
      by reference to Exhibit 99.3 to Registration Statement on Form S–8 No.
      333–141177. [filed March 9, 2007]




(7)
            Incorporated
      by reference to Exhibit 99.2 to Registration Statement on Form S–8 No.
      333–141177. [filed March 9, 2007]




(8)
            Incorporated
      by reference to Exhibit 5 to Schedule TO, filed July 20,
    2001.