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

                                    FORM 20-F

  [ ] 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, 2001

                                       OR

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

      6 Hazoran Street Poleg Industrial Park, P.O. Box 8511 Netanya 42504,
                            Israel 011-972-9-863-6888
                    (Address of principal executive offices)

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

     Title of each class               Name of each exchange on which registered
     -------------------               -----------------------------------------
             N/A                                        None

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

                  Ordinary Shares, par value NIS 0.05 per share
                  ---------------------------------------------
                                (Title of Class)

        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, 2001).

    Ordinary Shares, par value NIS 0.05             17,496,819

    Indicate  by check mark  whether  the  registrant  (1) has filed all reports
required to be filed by Section 13 or 15(d) of the  Securities  Exchange  Act of
1934  during  the  preceding  12 months  (or for such  shorter  period  that the
registrant was required to file such reports),  and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]

     Indicate by check mark which  financial  statement  item the registrant has
elected to follow. Item 17 [ ] Item 18 [X]

<PAGE>
                                     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
subsidiaries,  Commtouch Inc., Commtouch (UK) Ltd, Commtouch Latin America Inc.,
Wingra, Inc. and its majority-owned subsidiary, Commtouch K.K. (Japan).

The selected  consolidated  statements  of  operations  data for the years ended
December 31, 1999,  2000 and 2001 and the selected  consolidated  balance  sheet
data as of December 31, 2000 and 2001 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,  1997  and 1998  and the  selected  consolidated  balance  sheet  data as of
December  31,  1997,  1998 and 1999  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:

<TABLE>
<CAPTION>
                                                                          Year Ended December 31,
                                                       --------------------------------------------------------
                                                          1997       1998        1999       2000         2001
                                                       ---------   --------    --------    --------    --------
                                                               (USD in thousands, except per share data)
<S>                                                    <C>         <C>         <C>         <C>         <C>
Consolidated Statements of Operations Data:
Revenues:
   Email services ..................................   $   --      $    389    $  4,251    $ 17,965    $ 14,697
   Software licenses, maintenance and services .....        899        --          --         1,150         621
                                                       ---------   --------    --------    --------    --------
     Total revenues ................................        899         389       4,251      19,115      15,318

   Cost of revenues:
   Email services ..................................       --           569       3,643      11,864      14,605
   Software licenses, maintenance and services .....        165        --          --          --          --
                                                       ---------   --------    --------    --------    --------
     Total cost of revenues ........................        165         569       3,643      11,864      14,605
                                                       ---------   --------    --------    --------    --------
   Gross profit (loss) .............................        734        (180)        608       7,251         713
                                                       ---------   --------    --------    --------    --------
 Operating expenses:
   Research and development, net ...................      1,108       1,149       2,942      10,357       7,278
   Sales and marketing .............................      2,202       2,001       7,722      26,585      13,496
   General and administrative ......................        829         604       4,328      13,621      11,236
   In-process research and development .............       --          --          --         1,280        --
   Amortization of prepaid marketing expenses ......       --          --         3,263       4,508        --
   Amortization of goodwill and other purchased
     intangibles ...................................       --          --          --          --         2,794
   Write-off of impaired goodwill and other
     intangible assets .............................       --          --          --          --        13,280
   Write-off of impaired property, equipment
     and other .....................................       --          --          --          --        10,166
   Amortization of stock-based employee deferred
     compensation ..................................       --            91       3,436       3,050       2,204
                                                       ---------   --------    --------    --------    --------
     Total operating expenses ......................      4,139       3,845      21,691      59,401      60,454
 Operating loss ....................................     (3,405)     (4,025)    (21,083)    (52,150)    (59,741)
 Interest and other income (expenses), net .........        (68)       (326)      1,232       2,870         449
 Write-off of impaired long-term investments .......       --          --          --        (5,000)     (2,000)
 Minority interest .................................       --          --          --            55         285
                                                       ---------   --------    --------    --------    --------
 Net loss ..........................................   $ (3,473)   $ (4,351)   $(19,851)   $(54,225)   $(61,007)
 Basic and diluted net loss per share ..............   $  (2.40)   $  (3.00)   $  (2.65)   $  (3.51)   $  (3.56)
 Weighted average number of shares used in
 Computing basic and diluted net loss per share ....      1,450       1,450       7,487      15,462      17,152
                                                       ---------   --------    --------    --------    --------
</TABLE>

                                       2
<PAGE>

<TABLE>
<CAPTION>
                                                                  December 31,
                                         ------------------------------------------------------------------
                                            1997        1998         1999           2000             2001
                                          --------    --------     ---------       -------         --------
                                                                  (in thousands)
<S>                                       <C>         <C>          <C>             <C>             <C>
Consolidated Balance Sheet Data:
 Cash and cash equivalents........        $   324     $   834      $  65,996       $20,831         $ 2,248
 Marketable securities............             --          --         18,050         8,607              --
 Working capital (deficit)........         (1,264)     (1,440)        88,053        23,768            (607)
 Total assets.....................          1,065       2,366        100,336        77,280           9,545
 Long-term liabilities............            366         530            497         1,825             940
 Shareholders' equity (deficit)...         (1,108)       (815)        95,312        61,728           4,059
</TABLE>

The following data is presented:

         o    On an actual basis and

         o    On a pro  forma as  adjusted  basis to give  effect to the sale of
              4,434,931   million  ordinary  shares  in  the  private  placement
              approved by the shareholders on April 8, 2002, at an assumed price
              of $0.292 per share.

                                         December 31,     December 31,
                                         ------------     ------------
                                            2001              2001
                                            ----              ----
                                                          Pro Forma As
                                                          ------------
                                           Actual           Adjusted
                                           ------           --------
                                       (in thousands)    (in thousands)
Consolidated Balance Sheet Data:
 Cash and cash equivalents........        $ 2,248           $ 3,543
 Working capital (deficit)........           (607)              688
 Total assets.....................          9,545            10,840
 Long-term liabilities............            940               940
 Shareholders' equity (deficit)...          4,059             5,354

                           FORWARD LOOKING STATEMENTS

This  report  contains   forward-looking   statements  that  involve  risks  and
uncertainties. These statements relate to our future plans, objectives, beliefs,
expectations  and intentions.  In some cases,  you can identify  forward-looking
statements  by our use of words such as  "expects,"  "anticipates,"  "believes,"
"intends," "plans," "seeks" and "estimates" and similar expressions.  Our actual
results,  levels of activity,  performance or achievements may differ materially
from those  expressed or implied by these  forward-looking  statements.  Factors
that could cause or contribute  to these  differences  include  those  discussed
below and elsewhere in this report.

                               RECENT DEVELOPMENTS

a. Private Placement

In February 27, 2002,  Commtouch entered into a private placement agreement with
a  few  of  its  founders  and  new  investors   whereby  Commtouch  will  issue
approximately   4.4  million   ordinary   shares   against  the   investment  of
approximately  $1.3  Million  in  a  private  placement  to  private  investors;
approximately  one-third  of the  shares  are  being  purchased  by  Commtouch's
founders,  who are currently Commtouch directors and/or executive officers.  The
purchasers  in the private  placement  will also receive  five-year  warrants to
purchase up to an additional 2.66 million ordinary shares

                                       3
<PAGE>
(approximately).  The exercise price for one-third of the warrants will be $0.37
per share,  the exercise price for an additional  one-third of the warrants will
be $1.00 per  share  and the  exercise  price  for the  final  one-third  of the
warrants  will  be  $2.00  per  share.   This  agreement  was  approved  by  the
shareholders  on April 8, 2002.  The Company  plans to use the  proceeds of this
placement  for general  corporate  working  capital.  The funds were received on
April 15, 2002.

b. Sale of Wingra

Commtouch  sold off its migration  service  business,  Wingra,  Inc. to Wingra's
senior  management at the end of February 2002. The terms include mutual release
of all liabilities, obligations and rights of the parties to the agreement. This
sale reduced the Company's net liabilities by approximately $0.7 million.

c. Sale of Hosted Exchange

In January 2002,  Commtouch sold its Hosted Exchange  business to Telecomputing,
Inc. Terms of the transaction include the transference of the Company's customer
base and  certain  equipment  to  Telecomputing,  in exchange  for certain  cash
payments and royalties.  Furthermore,  the Company assigned  equipment leases to
Telecomputing,  thereby  eliminating  the  Company's  obligation  to make  lease
payments thereunder.

d. Strategic Agreement with MailCentro

Within the framework of an agreement with MailCentro Inc.  ("MC"),  MC (a wholly
owned  subsidiary of CP Software  Group,  Inc.) assumed all aspects of servicing
most of the Company's consumer customers, including its free email service known
as Zap Zone  service.  According  to the  agreement  entered  into with MC,  the
Company  transferred  customers  to MC and is expected to realize  royalties  on
payments made by these former customers to MC (primarily in 2002). Additionally,
certain Commtouch trademarks, domain names, software licenses and equipment were
sold to MC.

e. As a part of the Company's cost containment  efforts,  it reached  settlement
agreements with a few of its vendors. Some of the settlement agreements included
issuance of shares or warrants  while others  included only cash  payments.  The
amount written off totaled  approximately $0.8 million,  which was deducted from
the relevant  categories  of operating  expenses,  and the Company also recorded
approximately $0.1 million  compensation  expenses regarding the warrants issued
and  agreed to pay a letter of credit  for  approximately  $1.0  million  it had
previously issued to its landlord.

f.  During  2001,  the  Company  announced  that it was  implementing  strategic
initiatives  intended to further reduce costs.  In connection with the strategic
initiatives,  the Company recorded  restructuring charges of approximately $11.2
million. The restructure included curtailing expenses and reducing the number of
employees.   The  cash  and  non-cash  elements  of  the  restructuring   charge
approximate  $2.0 million and $9.2 million,  respectively  (the non-cash  charge
represents property, equipment and other write-downs).

g. Repricing

On April 30, 2001 the Company's  Board of Directors  approved the "repricing" of
options  previously  granted  to  employees  according  to  certain  criteria's.
Accordingly,  the Company  filed a Tender Offer which  expired on September  14,
2001,  and  Commtouch  has accepted for exchange  options to purchase  1,273,513
Ordinary Shares.  Previously granted options were cancelled and new options were
issued with an exercise price equal to the par value of the shares.

As of December  31,  2001,  we had  approximately  $2.2  million of cash to fund
operations in 2002. In 2001 we utilized  $24.7 million of cash to fund operating
losses and $5.7 million from investing activities, mainly proceeds from sales of
marketable   securities.   Net  cash  provided  by  financing   activities   was
approximately  zero,  after  repayment  of  bank  loans  and  notes  payable  of
approximately  $1.0 million,  net of approximately $1.0 million of proceeds from
issuance  of  shares  and from  minority  interest  in 2001.  To limit  our cash
expenses in 2002, we have significantly reduced staff,  curtailed  discretionary
expenses and limited  capital  expenditures.  These  actions were taken due to a
decline in our revenue growth resulting from  competitive  factors and a slowing
economic environment. To enhance our overall financial

                                       4
<PAGE>
position,  we have  entered  into a private  investment  round,  sold our Wingra
subsidiary to its senior management,  entered into a strategic agreement with MC
(see item d, Recent  Developments) and sold the Hosted Exchange  business,  such
that we may  concentrate on providing  software  messaging  solutions to service
providers.

Based on the cash balance at December 31, 2001, current projections of revenues,
related expenses, the ability to further curtail certain discretionary expenses,
sale of the Wingra  subsidiary's  net  liabilities and completion of the private
investment  round (as  discussed  below under Item 5,  "Operating  and Financial
Review and Prospects - Liquidity and Capital  Resources"),  the Company believes
it has  sufficient  cash to  continue  operations  for at least the next  twelve
months.

                                  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 respond  favorably  to our new  messaging  solutions  and
related technologies, we will fail to generate revenues.

Our success  will depend on the  acceptance  and use of our  software  messaging
solutions by service providers to provide email services to their customers.  We
cannot estimate the size or growth rate of the potential market for our software
offerings.  If the market for email  software fails to grow or grows more slowly
than we currently  anticipate,  our business will suffer  dramatically.  Even if
that market grows, our solutions may not achieve broad market acceptance.  Since
we  have  only  recently  released  our  new  messaging   platform  for  general
distribution,  we do not have  experience  to evaluate  whether it will  achieve
broad market  acceptance.  Also,  because a preponderance  of our future revenue
will be derived directly or indirectly from our software messaging solutions, if
that market does not grow, our business will likely fail.

Our future revenues are  unpredictable  and our quarterly  operating results may
fluctuate which could adversely affect the value of your investment.

Because we have a limited  history with our new email  solutions  and because of
the  emerging  nature  of the  markets  in  which we  compete,  our  revenue  is
unpredictable.  Our current and future expense levels (although greatly reduced)
are to a large  extent  fixed.  We may be unable to adjust  spending  quickly to
compensate for any revenue  shortfall,  and any  significant  revenue  shortfall
would have an immediate  negative  effect on our results of operations and share
price.

A number  of  factors,  many of which  are  enumerated  in this  "Risk  Factors"
section,  are likely to cause fluctuations in our operating results and/or cause
our share  price to decline.  Other  factors  which may cause such  fluctuations
include:

         o    The market acceptance of our new software  messaging  platform and
              related solutions

         o    The size,  timing and  fulfillment  of orders for our new software
              messaging solutions;

         o    The success of our selling efforts to service providers;

         o    The  rate of  adoption  of new  software  messaging  solutions  by
              enterprise customers in the current economic environment;

         o    The threat of de-listing by the NASDAQ;

         o    The receipt or payment of  irregular or  nonrecurring  revenues or
              expenses;

                                       5
<PAGE>
         o    Our ability to successfully  develop and market new solutions,  as
              may be needed;

         o    Pricing of our solutions; and

         o    Effectiveness of our customer support.

Because  of  differing  operational  factors  and the  material  changes  to our
business model,  period-to-period comparisons of our operating results are not a
good  indication  of our future  performance.  It is likely  that our  operating
results in some quarters will be below market expectations. Because we are going
to market  with new  solutions  and have sold most of our hosted  email  service
businesses, it is difficult to evaluate our business and prospects.

We commenced  operations in 1991,  but we are only  beginning to try to sell our
new software  messaging  solutions after having sold outsourced  Web-based email
services  from 1998  through  2001,  which  itself was a change from our initial
focus on the  sale,  maintenance  and  servicing  of  stand-alone  email  client
software products for mainframe and personal  computers.  In late 2001 and early
2002, we sold  essentially  all of our hosted email service  businesses to focus
exclusively on developing and selling new software messaging technologies.  This
change  required  us  to  adjust  our  business  processes  and  to  restructure
Commtouch.  Therefore,  we have no  operating  history as a provider  of our new
email  technologies  upon which you may be able to  evaluate  our  business  and
prospects. It is too early to judge the success of this business.

We have many established competitors who are offering similar solutions

The market for messaging  technologies is intensely competitive and we expect it
to be increasingly  competitive.  Increased  competition could result in pricing
pressures,  low  operating  margins and the  realization  of little or no market
share, any of which could cause our business to suffer.

In the market for email and messaging  software  solutions,  we compete directly
with software solution  providers,  including Critical Path,  OpenWave,  iPlanet
(Sun Microsystems), Mirapoint, Sendmail and Rockcliff, as well as with companies
that develop and maintain  in-house email solutions,  such as Microsoft and IBM.
Furthermore,  certain  small-scale email software providers offer low-cost basic
solutions, but with limited scalability or value-added functionality.  These and
other  companies  could  potentially  leverage their existing  capabilities  and
relationships to enter the service provider email solutions industry.

Our market's level of  competition is likely to increase as current  competitors
increase the sophistication of their offerings and as new participants enter the
market.  In the future, as we expand our offerings,  we may encounter  increased
competition in the development and distribution of these solutions.  Many of our
current and  potential  competitors  have  longer  operating  histories,  larger
customer bases,  greater brand recognition and greater financial,  marketing and
other  resources  than  we  do  and  may  enter  into  strategic  or  commercial
relationships  on more favorable  terms. In addition,  new  technologies and the
expansion of existing  technologies may increase competitive pressures on us. We
may not be able to compete successfully against current and future competitors.

Our ability to increase our revenues will depend on our ability to  successfully
execute our sales and marketing plan.

The complexity of our software messaging solutions and the email software market
require  highly  trained  sales and marketing  personnel to educate  prospective
customers  regarding  the use and  benefits of our  solutions.  We have  limited
experience in selling software solutions to service provider customers.  It will
take time for our  current  and  future  employees  to learn  how to market  our
solutions.  Additionally,  we are unable to predict the success in selling newly
introduced solutions in which we have no experience marketing and are relying on
these solutions to produce a substantial  portion of our revenues in the future.
As a result of these factors,  our sales and marketing  organization  may not be
able to compete  successfully  against the bigger and more experienced sales and
marketing organizations of our competitors.

We have a history of losses and may never achieve profitability.

We incurred net losses of approximately  $19.9 million in 1999, $54.2 million in
2000 and $61.0 in 2001. As of December 31, 2001, we had an  accumulated  deficit
of  approximately  $146.8  million.  We have not achieved  profitability

                                       6
<PAGE>
in any period, and we might continue to incur net losses in the future. If we do
not achieve profitability, our share price may decline further.

Possible Need For Additional Funds

The Company is very thinly capitalized.  As such, we might become dependent upon
raising  additional funds to finance our business.  Our cash balance at December
31,  2001 was $2.2  million.  If we are unable to raise  additional  funds,  the
Company  could  fail.  There can be no  assurance  that we will be able to raise
necessary  funds or that we will be able to do so on terms  acceptable to us. If
needed,  our  inability to obtain  adequate  capital  would limit our ability to
continue our operations.  Any such additional  funding may result in significant
dilution to existing stockholders.

Risk of Recession

Some of our former customers  continue to operate in the dot-com market based on
internet-centric  business  models and are  experiencing a significant  economic
slowdown and an inability to raise additional capital.

These  former  customers  were  assigned to  MailCentro,  Inc.  (a wholly  owned
subsidiary of CP Software  Group,  Inc.) and  Telecomputing,  Inc. in connection
with  the  Company's  agreements  with  these  companies.   According  to  these
agreements entered with MailCentro, Inc. and Telecomputing, Inc., the Company is
expected to realize  royalties  on payments  made by these  former  customers to
MailCentro and Telecomputing  (primarily in 2002). The ability of MailCentro and
Telecomputing to collect  outstanding  receivables is significantly  impacted by
the liquidity issues of these customers, which may negatively impact our ability
to recognize future revenue based on the afore-stated royalties. As a result, we
may experience shortfalls in our future revenues.

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 further 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,  including  Gideon Mantel,  our Chief
Executive Officer and Amir Lev, our President and Chief Technical Officer, could
materially  and  adversely  affect  our  business.  The  loss  of  our  software
developers may also adversely affect our messaging  platform product,  therefore
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 these key personnel.  We cannot prevent them from leaving
at any time. We do not maintain key-person life insurance policies on any of our
employees.

Our recent head-count reduction from 210 employees to approximately 35 employees
is  significantly  straining our operational  resources.  We have  significantly
curtailed  sales and marketing  resources and this may compromise our ability to
enhance revenues.

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

At December 31, 2001 we had sales offices in Israel, United States and Japan. We
intend to continue to seek ways to market our  software  messaging  solutions in
international markets by utilizing appropriate distributorship channels, i.e. by
way  of  our  joint  strategic   relationship  with  Unisys  and  other  foreign
representatives.  We may not be able to  compete  effectively  in  international
markets due to various risks  inherent in conducting  business  internationally,
such as:

         o    differing technology standards;

         o    inability  of  distribution  channels to  successfully  market our
              software messaging solutions;

         o    export   restrictions,   including  export  controls  relating  to
              encryption technologies;

         o    difficulties   in  collecting   accounts   receivable  and  longer
              collection periods;

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<PAGE>
         o    unexpected changes in regulatory requirements;

         o    political and economic instability;

         o    potentially adverse tax consequences; and

         o    potentially reduced protection for intellectual property rights.

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

Terrorist  attacks such as the attacks that occurred in New York and Washington,
D.C. on September 11, 2001 and other attacks or acts of war may adversely affect
the markets on which our ordinary shares trade, our financial  condition and our
results of operations.

On September 11, 2001, the United States was the target of terrorist  attacks of
unprecedented scope. These attacks have caused major instability in the U.S. and
other financial markets.  There could be further acts of terrorism in the United
States or  elsewhere  that  could  have a similar  impact.  Leaders  of the U.S.
government  have announced  their intention to actively pursue and take military
and other  action  against  those behind the  September  11, 2001 attacks and to
initiate broader action against national and global terrorism. Armed hostilities
or further  acts of  terrorism  would cause  further  instability  in  financial
markets and could  directly  impact our  financial  condition and our results of
operations.

Technology Risks

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

The internet messaging industry is characterized by rapid technological  change,
changes in end user  requirements  and  preferences,  and the  emergence  of new
industry standards and practices that could render our solutions and proprietary
technology obsolete. Our success depends, in part, on our ability to continually
enhance our existing email and messaging solutions and to develop new solutions,
functions and technology that address the increasingly  sophisticated and varied
needs  of  our  prospective  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  customer or end user
requirements or emerging industry  standards.  Also, we must be able to act more
quickly than our competition.

Our  software  may be  adversely  affected  by  defects,  which  could cause our
customers or end users to stop using our solutions.

Our solutions are based upon new and complex  software.  Complex  software often
contains  defects,  particularly  when first introduced or when new versions are
released.  Although we conduct extensive  testing,  we may not discover software
defects  that affect our new or current  solutions or  enhancements  until after
they are  delivered.  Although we have not  experienced  any  material  software
defects to date in our service offering, it is possible that, despite testing by
us, defects may exist in the software we sell. These defects could cause service
interruptions  for our customers that could damage our reputation,  create legal
risks,  cause  us to  lose  revenue,  delay  market  acceptance  or  divert  our
development resources, any of which could cause our business to suffer.

Investment Risks

We may need additional capital.

                                       8
<PAGE>

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 develop
enhanced service provider messaging solutions.

Based on the cash balance at December 31, 2001, current projections of revenues,
related  expenses,  the sale of the  Wingra  subsidiary  and  completion  of the
private  investment  round (as  discussed  below  under Item 5,  "Operating  and
Financial Review and Prospects - Liquidity and Capital Resources"),  the Company
believes it has  sufficient  cash to continue  operations  for at least the next
twelve months.

We are  subject to a class  action  lawsuit  which may have a  material  adverse
effect on us.

Following  our  restatement  of revenues  for the first three  quarters of 2000,
several class action lawsuits were filed in the United States District Court for
the  Northern  District  of  California  against  the Company and certain of our
officers and a director,  alleging violations of the antifraud provisions of the
Securities Exchange Act of 1934 arising from the Company's financial statements.
These lawsuits were consolidated into one action in late 2001.  Thereafter,  the
Company filed a Motion to Dismiss, which has been granted, though the plaintiffs
have been granted leave to amend the  complaint,  which they are expected to do.
While we are unable to predict the ultimate outcome of the  consolidated  claim,
we believe that it is without merit and intend to continue to vigorously  defend
ourselves.

If we cannot  satisfy  Nasdaq's  maintenance  requirements,  it may  delist  our
ordinary  shares and we may not have an active  public  market for our  ordinary
shares, which would likely make our shares an illiquid investment.

Our ordinary shares are quoted on the Nasdaq National Market.  To continue to be
listed,  our shares must have a minimum bid price of $1.00 per share and we must
maintain a minimum market value of our publicly held shares of $5,000,000, among
other  requirements.  Our shares have a minimum bid price of less than $1.00 per
share and the minimum market value is under $5,000,000.  Consequently, we do not
satisfy the Nasdaq listing requirements and may not be able to so in the future.
Nasdaq has  recently  notified  us that our stock may be  delisted as of May 15,
2002.  If  this  occurs,   trading  in  the  shares  may  be  conducted  in  the
over-the-counter  market in the so-called  "pink  sheets" or, if available,  the
"OTC  Bulletin  Board  Service." As a result,  an investor  would likely find it
significantly more difficult to dispose of, or to obtain accurate  quotations as
to the value of, our shares.

Nasdaq also may delist our shares if it deems it necessary to protect  investors
and the public interest.

If our shares are delisted,  they may become  subject to the SEC's "penny stock"
rules and be more difficult to sell.

SEC rules  require  brokers to provide  information  to purchasers of securities
traded at less than $5.00 and not traded on a national  securities  exchange  or
quoted on the Nasdaq Stock  Market.  If our shares  become "penny stock" that is
not exempt  from these SEC rules,  these  disclosure  requirements  may have the
effect of reducing  trading  activity in our shares and making it more difficult
for  investors  to  sell.  The  rules  require  a  broker-dealer  to  deliver  a
standardized  risk  disclosure  document  prepared  by  the  SEC  that  provides
information  about  penny  stocks and the nature and level of risks in the penny
market.  The  broker  must also give bid and offer  quotations  and  broker  and
salesperson compensation information to the customer orally or in writing before
or with the confirmation.  The SEC rules also require a broker to make a special
written  determination  that the penny  stock is a suitable  investment  for the
purchaser  and receive the  purchaser's  written  agreement  to the  transaction
before a transaction in a penny stock.

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  own over five percent of our ordinary
shares,  beneficially  own,  in  the  aggregate,   approximately  18.5%  of  our
outstanding  ordinary shares. If they vote together,  these shareholders will be
able to exercise  significant  influence over all matters requiring  shareholder
approval,  including  the  election of  directors  and  approval of  significant
corporate  transactions.  This  concentration  of ownership  could also delay or
prevent a change in control of Commtouch.

                                       9
<PAGE>
Jan Eddy,  the President  and Chief  Executive  Officer of Wingra  Technologies,
beneficially owns approximately 5% of our outstanding  ordinary shares issued to
her in connection  with our  acquisition of Wingra  Technologies on November 24,
2000.

InfoSpace beneficially owns approximately 5% of our outstanding ordinary shares.
InfoSpace  merged with Go2Net in October 2000.  In  connection  with this merger
InfoSpace  assumed  Go2Net shares,  warrants and rights.  In 1999, in connection
with entering into an email services agreement, we issued to InfoSpace a warrant
to purchase  1,136,000 ordinary shares at an exercise price of $12.80 per share.
Concurrent with Commtouch Inc.  entering into the email services  agreement,  we
issued 896,057  ordinary  shares to InfoSpace and 448,029 in ordinary  shares to
Vulcan  Ventures in a private  placement  at $14.88 per share.  We believe  that
Vulcan Ventures divested itself of all of its shareholdings in the Company.  The
warrant is non-forfeitable,  fully vested and immediately exercisable,  and will
expire  in July  2004.  Assuming  exercise  of the  InfoSpace  warrant  on a net
issuance basis, the warrant currently has no impact on beneficial ownership,  as
the warrant is currently underwater.

These  significant  shareholders  will be able to  significantly  influence  and
possibly  exercise  control  over  most  matters   requiring   approval  by  our
shareholders,  including the election of directors  and approval of  significant
corporate transactions. This concentration of ownership may also have the effect
of delaying or  preventing  a change in  control.  InfoSpace  will also have the
right to name one director to our Board as long as it continues to hold at least
620,022  shares,  including  the shares  issuable upon exercise of the InfoSpace
warrant. It named Thomas Camp to the Board under this provision, who resigned on
August 22, 2001 and was not replaced by  Infospace.  In  addition,  conflicts of
interest may arise as a consequence of these  significant  shareholders  control
relationship with us, including:

         o    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;

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

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

Substantial sales of our ordinary shares could adversely affect our share price.

The sale, or  availability  for sale, of substantial  quantities of our ordinary
shares may have the  effect of further  depressing  its  market  price.  A large
number  of  our  ordinary  shares  which  were  previously   subject  to  resale
restrictions,  are  currently  eligible  for resale.  In addition a  significant
number of shares  will be  eligible  for resale at various  dates in the future,
should the  private  investment  round close (as  discussed  below under Item 5,
"Operating   and  Financial   Review  and  Prospects  -  Liquidity  and  Capital
Resources").

As previously  announced and as discussed under Item 5, "Operating and Financial
Review and  Prospects--Liquidity  and Capital Resources," we have entered into a
private  placement to issue shares and raise  approximately  $1.3  million.  The
shares we will issue under this round will dilute existing shareholders.

Risk of failure to obtain registration rights for the private placement

As previously  announced and as discussed under Item 5, "Operating and Financial
Review and  Prospects--Liquidity  and Capital Resources," we have entered into a
private  placement,  pursuant to which we are obligated to register with the SEC
the  shares to be issued  to  investors.  According  to the  agreement  with the
investors,  should the Company  fail to meet  certain  deadlines  for filing the
registration  statement  and achieving the  effectiveness  thereof,  the Company
risks having imposed on it liquidated damages as defined in the agreement.

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.

                                       10
<PAGE>
We regard our copyrights,  service marks, trademarks,  trade secrets and similar
intellectual  property as critical to our  success,  and rely on  trademark  and
copyright law, trade secret protection and confidentiality or license agreements
with our  employees  and  customers  to protect our  proprietary  rights.  Third
parties may infringe or  misappropriate  our copyrights,  trademarks and similar
proprietary rights.  Although we have not filed any patent applications,  we may
seek to patent  certain  software or other  technology  in the future.  Any such
future patent  applications  may not be issued within the scope of the claims we
seek, or at all. We cannot be certain that our software does not infringe issued
patents that may relate to our software  products.  In addition,  because patent
applications in the United States are not publicly disclosed until the patent is
issued, applications may have been filed which relate to our software products.

Despite our precautions, unauthorized third parties may copy certain portions of
our technology or reverse  engineer or obtain and use information that we regard
as proprietary.  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.

Governmental  regulation and legal  uncertainties could impair the growth of the
internet and decrease  demand for our software  messaging  solutions or increase
our cost of doing business.

There are currently few laws and regulations directly applicable to the internet
and  commercial  email  services.  However,  a number of laws have been proposed
involving  the  internet,  including  laws  addressing  user  privacy,  pricing,
content, copyright,  antitrust,  distribution and characteristics and quality of
products and services.  Further,  the growth and  development  of the market for
email may prompt  calls for more  stringent  consumer  protection  laws that may
impose additional burdens on companies conducting business online. Moreover, the
applicability  to  the  internet  of  existing  laws  in  various  jurisdictions
governing issues such as property  ownership,  sales and other taxes,  libel and
personal  privacy is  uncertain  and may take years to resolve.  The adoption of
additional  laws  or  regulations,  or  the  application  of  existing  laws  or
regulations to the internet, may impair the growth of the internet or commercial
online  services.  This could  decrease the demand for our software and increase
our  cost of doing  business,  or  otherwise  harm our  business  and  operating
results.

Risks Relating to Operations in Israel

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

We are  incorporated  under  the laws of the  State  of  Israel.  Our  principal
research   and   development   facilities   are  located  in  Israel.   Although
substantially  all of our 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.

Israel's economy has been subject to numerous destabilizing factors, including a
period of rampant  inflation in the early to  mid-1980's,  low foreign  exchange
reserves,  fluctuations in world commodity prices,  military conflicts and civil
unrest.  In addition,  Israel and some companies doing business with Israel have
been the  subject  of an  economic  boycott  by Arab  countries  since  Israel's
establishment. These restrictive laws and policies may have an adverse impact on
our operating results, financial condition or expansion of our business.

Since the establishment of the State of Israel in 1948, a state of hostility has
existed,  varying in degree and  intensity,  between  Israel  and  certain  Arab
countries.   Since  September  2000,  a  continuous   armed  conflict  with  the
Palestinian  Authority has been taking place.  Although  Israel has entered into
various  agreements with certain Arab countries and the  Palestinian  Authority,
and various  declarations have been signed in connection with efforts to resolve
some of the economic and political problems in the Middle East, Israel continues
to face  hostile  actions and threats from  various  elements in the region.  We
cannot predict whether or in what manner these problems will be resolved.

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

                                       11
<PAGE>
Certain of our officers and employees are currently  obligated to perform annual
reserve  duty in the Israel  Defense  Forces and are subject to being called for
active military duty at any time.  Although  Commtouch has operated  effectively
under these  requirements  since its inception,  we cannot predict the effect of
these obligations on Commtouch in the future.  Our operations could be disrupted
by the absence,  for a significant period, of one or more of our officers or key
employees due to military service.

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

We generate a  substantial  portion of our revenues in U.S.  dollars and incur a
portion of our expenses,  principally salaries and related personnel expenses in
Israel, in New Israeli Shekels, commonly referred to as NIS. As a result, we are
exposed to the risk that the rate of inflation in Israel will exceed the rate of
devaluation  of the NIS in  relation  to the  dollar  or that the  timing of any
devaluation may lag behind  inflation in Israel.  While in recent years the rate
of devaluation of the NIS against the dollar has generally  exceeded the rate of
inflation,  which is a reversal  from prior  years,  we cannot be sure that this
reversal  will  continue.  If the  dollar  cost  of  our  operations  in  Israel
increases, our dollar-measured results of operations will be adversely affected.
Our  operations  also  could be  adversely  affected  if we are  unable to guard
against  currency  fluctuations  in the future.  Accordingly,  we may enter into
currency  hedging  transactions to decrease the risk of financial  exposure from
fluctuations in the exchange rate of the dollar against the NIS. These measures,
however,  may not adequately protect us from material adverse effects due to the
impact of inflation in Israel.

The government  programs and benefits which we currently  receive  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.  In 2001 and 2002, we applied for additional  grants and
we may apply for additional  grants in the future.  In 1999 and 2000, we did not
receive any grants from the OCS. In 2001 we received  $0.6 million and we expect
the percentage of our research and  development  expenditures  financed from OCS
grants will  continue to remain  quite low.  The OCS budget has been  subject to
reductions  which may affect the  availability  of funds for these grants in the
future.  Therefore, we cannot be certain that we will continue to receive grants
at the same rate, or at all. In addition, the terms of any future OCS grants may
be less  favorable  than  our past  grants.  In  connection  with  research  and
development  grants  received  from the OCS, we must pay royalties to the OCS on
the  revenue  derived  from  the sale of  products,  technologies  and  services
developed with grants from the OCS.

The terms of the OCS  grants and the law  pursuant  to which the grants are made
restrict our ability to manufacture products or transfer technologies  developed
using OCS grants outside of Israel.  This  restriction  may limit our ability to
enter into agreements for those products or technologies,  without OCS approval.
We cannot be certain  that the  approvals  of the OCS will be  obtained on terms
that are acceptable to us, or at all. In connection with our grant applications,
we have made  representations and covenants to the OCS. The funding from the OCS
is subject to the accuracy of these  representations  and  covenants  and to our
compliance with the conditions and  restrictions  imposed by the OCS. If we fail
to comply with any of these conditions or restrictions,  we could be required to
repay any grants previously received,  together with interest and penalties, and
would likely be ineligible to receive OCS grants in the future.

The Company received grants from the Government of Israel,  through the OCS, for
the  financing  of  a  significant  portion  of  its  research  and  development
expenditures in Israel.  The related funded projects  ultimately  failed and the
relevant payments were made for the revenues generated from these projects.  The
Company will not be obligated to pay future  royalties for such projects through
2001, since no future revenue is expected from these projects.  Accordingly, the
Company decided to write down the $0.4 million accrual it recorded in past years
and determined that as of December 31, 2001 there are no contingent  liabilities
for  royalties  from these  projects.  In March 2002,  the Company  submitted an
application  for project  failure with regard to these  projects.  However,  the
ultimate  liability  is subject to the review of the  Israeli  government.  With
regard to the grant  received in 2001,  a  contingent  liability of $0.6 million
exists.

The tax benefits we are currently  entitled to from the Government of Israel may
be reduced or terminated in the future.

Pursuant to the Law for the Encouragement of Capital Investments, the Government
of Israel through the Investment Center has granted "approved enterprise" status
to a portion  of our  capital  investment  programs.  The  portion of our

                                       12
<PAGE>
income derived from our approved  enterprise program will be exempt from tax for
a  limited  period of two years  commencing  in the first  year in which we have
taxable income, and will be subject to a reduced tax for an additional period of
five to eight years  dependent on the  percentage of foreign  shareholders.  The
benefits   available  to  an  approved   enterprise  are  conditioned  upon  the
fulfillment  of conditions  regarding a required  amount of investments in fixed
assets and a portion of these investments being made with net proceeds of equity
capital  raised  by us as  stipulated  in  applicable  law  and in the  specific
certificates of approval.  If we fail to comply with these conditions,  in whole
or in part, we may be required to pay  additional  taxes for the period in which
we  benefited  from the tax  exemption  or reduced tax rates and would likely be
denied these benefits in the future. From time to time, the Government of Israel
has discussed  reducing or eliminating the benefits available under the approved
enterprise  program. It is possible that these tax benefits may not be continued
in the future at their current levels or at all.

Israeli  courts might not enforce  judgments  rendered  outside of Israel and it
might therefore be difficult for an investor to recover any judgment against any
of our officers or directors resident in Israel.

We  are  organized  under  the  laws  of  Israel,  and we  maintain  significant
operations in Israel. Certain of our officers and directors named in this report
reside outside of the United States. Therefore, you might not be able to enforce
any judgment  obtained in the U.S. against us or any of such persons.  You might
not be able to bring  civil  actions  under U.S.  securities  laws if you file a
lawsuit in Israel.  However,  we have been advised by our Israeli  counsel that,
subject to certain limitations, Israeli courts may enforce a final judgment of a
U.S. court for liquidated amounts in civil matters after a hearing in Israel. We
have appointed  Commtouch  Software Inc., our U.S.  subsidiary,  as our agent to
receive service of process in any action against us arising from this report. We
have not  given  our  consent  for our agent to accept  service  of  process  in
connection  with any  other  claim  and it may  therefore  be  difficult  for an
investor  to  effect  service  of  process  against  us or any  of our  non-U.S.
officers,  directors  and  experts  relating to any other  claims.  If a foreign
judgment is enforced by an Israeli court, it may be payable in Israeli currency.

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

Israeli corporate law regulates  mergers,  votes required to approve mergers and
acquisitions  of shares through tender offers,  requires  special  approvals for
transactions involving significant shareholders and regulates other matters that
may be  relevant  to  these  types  of  transactions.  Furthermore,  Israel  tax
considerations may make potential  transactions  unappealing to us or to some of
our shareholders.

Proposed tax reform in Israel may reduce our tax benefits, which might adversely
affect our profitability.

On May 4,  2000,  a  committee  chaired by the  former  Director  General of the
Israeli  Ministry of Finance issued a report  recommending a sweeping  reform in
the Israeli system of taxation.  The proposed reform would  significantly  alter
the  taxation of  individuals,  and would also  affect  corporate  taxation.  In
particular,  the  proposed  reform  would  reduce,  but not  eliminate,  the tax
benefits  available to approved  enterprises  such as ours. The Israeli  cabinet
approved the  recommendations  in principle,  but  implementation  of the reform
requires  legislation  by  Israel's  Knesset.  In the  interim  there  have been
significant political and economic changes. On February 26, 2002 the Minister of
Finance  appointed a new committee to recommend tax reforms,  and this committee
is expected  to submit a report  within 90 days.  The Company  cannot be certain
whether the  proposed  reform  will be adopted,  when it will be adopted or what
form any reform will ultimately take.

Item 4. Information on the Company.

Overview

We are a  provider  of email  services  and  software  for email  and  messaging
solutions  to service  providers  that  target  both  residential  and  business
subscriber users.

Our main  target  customers  include  companies  that  specialize  in  providing
communications  applications  to  enterprises,  such as, ASPs,  ISPs,  telecoms,
CLECs, wireless carriers, data centers, systems integrators, and IT consultants.

                                       13
<PAGE>
Email and  messaging is complex and  requires  focus to  implement,  deliver and
maintain.  Today's  solutions  include the ability to address both front-end and
back-end requirements,  anytime-anywhere access, and features such as anti-virus
protection, unified messaging,  calendaring, group scheduling, file sharing, and
collaboration.  Technologies  for the  future are  necessitating  that email and
messaging adapt and change with the new innovations. Our flexible technology and
economies of scale  enable us to provide  email  solutions  in a  cost-effective
manner,  intended to allow businesses to achieve desirable economic  advantages.
These technologies have been conceived, developed and refined over the course of
the past 11 years, during which we have provided both services and software to a
multitude of customers.

Commtouch Offerings

We offer software for email and messaging solutions to service providers, mainly
small and medium size enterprises (SME).  Service providers receive a license to
install and use our software and  technology  in order to provide  messaging and
email  services  from  their own data  center  facility.  Our  service  provider
solution  enables  service  providers to easily  manage the email and  messaging
features/services that they in turn provide to their end users.

We deliver a comprehensive software solution that -

         o    Enables  ISP  business  subscribers  to enjoy  advanced  messaging
              applications.

         o    Enables  service  providers to offer  packages of email  services.
              With  Commtouch  Classes of Service (CoS),  service  providers can
              create  different   packages  of  service  to  their   diversified
              subscribers and market each package separately.

         o    Enables service providers to simplify deployment and manageability
              of  a  highly-scalable  messaging  platform  for  residential  and
              business   subscribers,   and  to  achieve  high  performance  and
              maximized   utilization  at  a  competitive  low  cost  (i.e.  low
              hardware, bandwidth and administration costs).

Our solution provides:

         o    Access to accounts  from  standard  desktop  email  clients  (e.g.
              Microsoft Outlook and Qualcomm Eudora),  Web browsers and wireless
              devices, such as, WAP-enabled mobile phones.

         o    Message  notification on an advanced platform,  to pagers,  mobile
              phones, instant messengers and other email addresses.

         o    Integrated,  Web-based  applications,   including  calendar,  task
              manager,  contact center,  notes, short message service (SMS), and
              more.

         o    Customization  of the Web  email  client  interface  to  extend an
              organization's brand.

         o    Multiple language support for a multilingual user base.

Competitive Landscape

Discussed above under Item 3 - RISK FACTORS/Business Risks

                                       14
<PAGE>
Intellectual Property

We regard our copyrights,  service marks, trademarks,  trade secrets and similar
intellectual  property as critical to our  success,  and rely on  trademark  and
copyright  law,  trade secret  protection  and  confidentiality  and/or  license
agreements  with our  employees,  customers,  partners and others to protect our
proprietary  rights.  We have the  following  registered  trademarks:  COMMTOUCH
(registered in the U.S.,  Israel,  European Union,  China,  Mexico, New Zealand,
Norway, South Korea and Australia);  PRONTO (Canada and South Korea);  COMMTOUCH
SOFTWARE  (Australia  and New Zealand);  PRONTO FAMILY,  PRONTO SECURE  (Japan);
PRONTO  MAIL  (Japan  and New  Zealand);  We also  have  the  following  pending
trademark  applications:  COMMTOUCH (Taiwan,  Russian Federation,  Japan, India,
Canada and Brazil),  and PRONTO  (European  Community).  At the end of 2001,  we
assigned our ZAPZONE and ZZN trademarks to CP Software Group,  Inc.,  within the
framework of our transaction with MailCentro.

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 of the trademarks and other
Intellectual  property  rights of third parties by ourselves and our  licensees.
Such  claims,  even if not  meritorious,  could  result  in the  expenditure  of
significant financial and managerial resources.

We also continue to hold a perpetual  mail server  license which was utilized in
our hosted  service  offering  and is still being  utilized  to service  certain
customers,  and may continue to license SSL encryption  and other  technology as
the need arises.  We cannot be certain that, apart from the mail server license,
other  third-party  content  licenses  will be available  to us on  commercially
reasonable  terms  or  that  we will  be  able  to  successfully  integrate  the
technology  into our products.  These  third-party  in-licenses may expose us to
increased  risks,  including  risks  associated  with  the  assimilation  of new
technology,  the  diversion  of  resources  from  the  development  of  our  own
proprietary  technology,  and  our  inability  to  generate  revenues  from  new
technology  sufficient to offset associated  acquisition and maintenance  costs.
The inability to obtain any of these  licenses could result in delays in product
development  until  equivalent  technology  can  be  identified,   licensed  and
integrated.  Any such delays could cause our  business/financial  condition  and
operating results to suffer.

Government Regulation

Since the September 11, 2001 terrorist attacks on the United States, governments
worldwide are taking a closer look at various issues that may affect the privacy
of individuals.  In the U.S., the Federal Trade Commission  chairman announced a
broad privacy agenda and stricter enforcement of current privacy rules, relating
to both online and  offline  activities.  Further,  the U.S.  Congress  recently
passed the USA Patriot Act which, among other things, broadens the powers of law
enforcement officials to intercept electronic  communications in the name of the
fight against terrorism.  Other laws and regulations  directly applicable to the
internet and  commercial  email services  include the Electronic  Communications
Privacy Act, Children's Online Privacy Protection Act and related regulations in
the U.S.  and  restrictions  on the export of  personal  data from the  European
Community  (according  to the  European  Directive,  which has been  adopted  in
various forms by many European  Community member states).  It is possible that a
number of laws and  regulations may be adopted in the future with respect to the
internet or  commercial  email  services  covering  issues such as user privacy,
pricing,  content,  copyright,  distribution,  antitrust and characteristics and
quality of products and services.  Further,  the growth and  development  of the
market for online email may prompt calls for more stringent consumer  protection
laws that may impose additional burdens on companies conducting business online.
The  adoption of  additional  laws or  regulations  may impair the growth of the
internet or  commercial  online  services,  which could,  in turn,  decrease the
demand for our products and  increase our cost of doing  business,  or otherwise
have a material adverse effect on our business,  operating results and financial
condition.  Moreover,  the  applicability  to the  internet of existing  laws in
various  jurisdictions  governing issues such as property  ownership,  sales and
other  taxes,  libel and  personal  privacy is  uncertain  and may take years to
resolve.  Any such new  legislation or regulation,  the  application of laws and
regulations from jurisdictions whose laws do not currently apply to our business
or the application of existing laws and regulations to the internet could have a
material  adverse  effect  on our  business,  operating  results  and  financial
condition.

                                       15
<PAGE>
Employees

As of  December  31,  2001,  2000 and  1999,  we had 92,  486 and 214  full-time
employees,  respectively. We sold the Hosted exchange business and our migration
services  subsidiary  in early 2002,  and on March 1, 2002,  we had 35 full-time
employees.  None of our U.S.  employees  are covered by a collective  bargaining
agreement. We believe that our relations with our employees are good.

Israeli law and  certain  provisions  of the  nationwide  collective  bargaining
agreements between the Histadrut (General Federation of Labor in Israel) and the
Coordinating  Bureau  of  Economic  Organizations  (the  Israeli  federation  of
employers'   organizations)  apply  to  Commtouch's  Israeli  employees.   These
provisions  principally  concern the maximum length of the 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.  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.

Description of Property

Our  principal  executive  offices  are  located  at  6  Hazoran  Street,  Poleg
Industrial  Park,  Netanya  42504,   Israel,   where  our  telephone  number  is
011-972-9-863-6888,  and 2029 Stierlin Court,  Mountain View,  California 94043,
where our telephone number is (650) 864-2000.  All of our facilities are leased.
We were incorporated in Israel under the laws of Israel on February 5, 1991. Our
Articles  of  Association  are on file in Israel  with the office of the Israeli
Registrar of Companies and available for public inspection from the Registrar.

Item 5. Operating and Financial Review and Prospects.

The following  discussion  should be read in conjunction  with the  Consolidated
Financial  Statements and the Notes thereto  included  elsewhere in this report.
This  discussion   contains   forward-looking   statements  based  upon  current
expectations  that involve risks and  uncertainties.  Any  statements  contained
herein  that  are  not  statements  of  historical  fact  may  be  deemed  to be
forward-looking  statements.  For example,  the words "expects,"  "anticipates,"
"believes,"  "intends," "plans," "seeks" and "estimates" and similar expressions
are intended to identify forward-looking statements.  Commtouch's actual results
and the timing of certain events may differ  significantly  from those projected
in the  forward-looking  statements.  Factors that might cause future results to
differ  materially  from  those  projected  in  the  forward-looking  statements
include,   but  are  not  limited  to,  those  set  forth  under  "Item  3.  Key
Information."  and in the  Company's  other  filings  with  the  Securities  and
Exchange Commission.

Overview

During 2001,  our main business was providing  outsourced  integrated  Web-based
email and messaging solutions to businesses.  Our solutions are flexible, highly
customizable  and enable us to satisfy the unique email and  messaging  needs of
our customers worldwide.  Our customers are large and small businesses who offer
our Web-based  email  through  their  website to their end users and  employees.
Commtouch is currently the developer  and provider of  comprehensive  and highly
scalable messaging  solutions through its Commtouch Messaging Platform (CMP) for
service  providers  such as  ISPs,  ASPs,  Data  Centers,  telcos  and  Wireless
Operators.  The CMP offers service  providers an opportunity to increase revenue
from  their  business  and  residential  subscribers  utilizing  CMP's  advanced
messaging services, which can be deployed and managed easily and quickly.

                                       16
<PAGE>

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
accounting  principles  generally accepted in the United States. 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  revenue  recognition,   allowance  for
doubtful accounts, impairment and commitments and contingencies.

Revenue recognition

Revenue is recognized 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
collection is probable. The company's revenue recognition policy is discussed in
Note 2 of Notes to Consolidated Financial Statements. The recognition of revenue
in conformity with accounting principles generally accepted in the United States
requires the company to make estimates and assumptions  that affect the reported
amounts of revenue.  Estimates related to the recognition of revenue include the
accumulated  provision for revenues  subject to refund and other.  As additional
information becomes available, or actual amounts are determinable,  the recorded
estimates  are  revised.  Consequently,  operating  results  can be  affected by
revisions to prior accounting estimates.

Allowance for Doubtful Accounts

We maintain  allowances  for  doubtful  accounts for  estimated  losses from our
customers'  inability  to make  payments  they owe us. In order to estimate  the
appropriate level of this allowance,  we analyze historical bad debts,  customer
concentrations, current customer credit-worthiness,  current economic trends and
changes in our customer  payment  patterns.  If the  financial  condition of our
customers  were to  deteriorate  and to impair their ability to make payments to
us, additional allowances might be required in future periods.

Impairment

We assess the fair value and recoverability of our long-lived assets,  including
goodwill,  whenever events and  circumstances  indicate the carrying value of an
asset may not be recoverable from estimated future cash flows expected to result
from its use and  eventual  disposition.  In doing so, we make  assumptions  and
estimates   regarding   future  cash  flows  and  other   factors  to  make  our
determination. The fair value of our long-lived assets and goodwill is dependent
upon the forecasted performance of our business, changes in our industry and the
overall economic  environment.  When we determine that the carrying value of our
long-lived assets and goodwill may not be recoverable, we measure any impairment
based upon a forecasted  discounted cash flow method. If these forecasts are not
met,  we may  have  to  record  additional  impairment  charges  not  previously
recognized.

During 2001,  we performed an  assessment  of the goodwill and other  intangible
assets  related to our  acquisition of Wingra,  Inc.,  pursuant to SFAS No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be  Disposed  Of." In 2001,  a change in the  business  environment  resulted in
significantly  less demand for  Wingra's  migration  services  and the number of
potential customers seeking these services diminished greatly.  Consequently, we
revised our forecasted cash flows from the migration service and determined that
the decline in the market  conditions  was  material  and other than  temporary.
After using an undiscounted  cash flow model of the future cash flows forecasted
to be generated from sales of migration  services and discussions with potential
buyers for Wingra,  we determined  that there was an impairment  and the size of
the impairment. As a result, we recorded a charge of approximately $13.2 million
during 2001 to reduce goodwill and other intangible  assets  associated with the
purchase of Wingra to zero. During 2001, we recorded  approximately $2.8 million
of amortization of goodwill and other intangible assets relating to Wingra.

                                       17
<PAGE>
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  Statement  of  Financial   Accounting   Standards  No.  5,  "Accounting  for
Contingencies"  ("SFAS No. 5") SFAS No. 5 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."

SFAS  No.  5 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 it could be reasonably estimated.

Revenue Sources

Service Fees.  During 2001 and 2000, most of our email service revenues resulted
from  contracts  that  required  our  customers to pay us a monthly per emailbox
price  subject to a minimum  commitment  fee and fees for direct  marketing  and
communications  services. In addition, the Company recognized revenue from sales
of software licenses to end users.

Prior to 1999,  some of our contracts with customers  provided for email service
fees based solely on a share of banner advertising revenue, recognized only when
such revenues were earned by the customers, with no minimum annual commitment.

Direct  E-marketing.  E-commerce  vendors seek  channels  through which they can
market goods and services. Because of our installed user base and our agreements
with our customers,  we can assist  e-commerce  companies in distributing  their
services to our  customers' end users who have opted to receive offers by email.
We share with our customers the revenues from this direct e-marketing, which are
earned either on a per-message  basis, a referral  basis,  or as a commission on
products  sold.  In the  fourth  quarter  of 1998,  we  began  to  offer  direct
e-marketing  opportunities  to e-commerce  vendors on a test basis.  In 1999, we
recognized  11% of our total revenues from  MyPoints,  a permission  based email
service company. In 2001 and 2000, no direct e-marketing  customer provided more
then 10% of revenues.

Strategic Transaction with Go2Net (InfoSpace)

InfoSpace  merged with Go2Net in October 2000.  In  connection  with this merger
InfoSpace assumed Go2Net shares, warrants and rights.

In 1999,  concurrent with the sale of our shares in the initial public offering,
we entered  into a service  agreement  with  InfoSpace,  a network  of  branded,
technology- and community-driven websites focused on personal finance, commerce,
and  games.  InfoSpace  also  develops  Web-related  software.  Pursuant  to the
agreement we were offering  InfoSpace's end users a private label email service,
including  our  email,   calendaring  and  other  services.  The  services  were
customized  to the look  and feel of  InfoSpace's  websites.  The  terms of this
agreement were  substantially  the same as our commercial  agreements with other
customers except that we had agreed to share a materially greater portion of our
advertising  revenues  with  InfoSpace  than we are sharing  under other similar
agreements.  In  addition,  in  connection  with the  agreement,  we  issued  to
InfoSpace  a  warrant  to  purchase  1,136,000  ordinary  shares  at a per share
exercise price of $12.80, subject to adjustment as set forth in the warrant. The
warrant is fully vested and non-forfeitable. The warrant will expire on July 16,
2004, the fifth  anniversary of the initial public  offering.  The fair value of
the warrant,  estimated at $5.8  million,  was  amortized to operating  expenses
ratably  over  the  minimum  term of the  agreement  (one  year)  and was  fully
amortized at the end of 2000.  Simultaneously with the sale of the shares in the
initial  public  offering,  we issued a total of  1,344,086  ordinary  shares to
InfoSpace  and  Vulcan  Ventures  Incorporated  at $14.88 per share in a

                                       18
<PAGE>
private placement.  In the future, we may have to issue in-the-money warrants to
acquire our ordinary  shares to  marketing  channels who provide us with a large
base of potential end users.  We may also have to provide these  customers  with
more  favorable  commercial  terms  than  we  have  previously  provided  to our
customers. The issuance of in-the-money warrants and the grant of more favorable
terms to marketing  channels may further dilute our  shareholders,  increase our
operating  loss in the future and cause our stock price to fall.  Recently,  the
service agreement of 1999 was replaced by a new agreement, effective February 1,
2002 having a one year  duration,  but  InfoSpace has the right to terminate the
agreement at any time upon thirty (30) days written  notice.  InfoSpace also has
the right to terminate the  agreement if there are  technical  problems with the
products or services provided.  The performance  specifications set forth in the
agreement include the maintenance of certain levels of email system availability
and response  time.  Infospace is to pay a quarterly fee of $7,500 for use of up
to 10,000 mailboxes.  This agreement has been assigned to MailCentro,  Inc., the
party which  assumed the servicing of most of our consumer  business,  effective
March 1, 2002. Commtouch Inc. will continue to receive a portion of the revenues
from  this  agreement  for a maximum  period of one year from the above  date of
assignment.

Results of Operations

The following  table sets forth  financial data for the years ended December 31,
1999, 2000 and 2001 (in thousands):

<TABLE>
<CAPTION>
                                                            Year Ended December 31,
                                                       --------------------------------
                                                         1999        2000        2001
                                                       --------    --------    --------
<S>                                                    <C>         <C>         <C>
Revenues:

 Email services ....................................   $  4,251    $ 17,965    $ 14,697
 Software license revenues .........................       --         1,150         621
                                                       --------    --------    --------
 Total revenues ....................................      4,251      19,115      15,318
                                                       --------    --------    --------
Cost of revenues:
 Email services ....................................      3,643      11,864      14,605
 Software license revenues .........................       --          --          --
                                                       --------    --------    --------
 Total cost of revenues ............................      3,643      11,864      14,605
                                                       --------    --------    --------
 Gross profit ......................................        608       7,251         713
                                                       --------    --------    --------
Operating expenses:
 Research and development, net .....................      2,942      10,357       7,278
 Sales and marketing ...............................      7,722      26,585      13,496
 General and administrative ........................      4,328      13,621      11,236
 In-process research and development ...............       --         1,280        --
 Amortization of prepaid marketing expenses ........      3,263       4,508        --
 Amortization of stock-based employee deferred .....      3,436       3,050       2,204
 compensation
 Amortization of goodwill and other purchased ......       --          --         2,794
 intangibles
 Write-off of impaired goodwill and other intangible       --          --        13,280
 assets
 Write-off of impaired property, equipment and other       --          --        10,166
                                                       --------    --------    --------
 Total operating expenses ..........................     21,691      59,401      60,454
                                                       --------    --------    --------
Operating loss .....................................    (21,083)    (52,150)    (59,741)
 Interest and other income, net ....................      1,232       2,870         449
 Write-off impaired long-term investments ..........       --        (5,000)     (2,000)
 Minority interest .................................       --            55         285
                                                       --------    --------    --------
Net loss ...........................................   $(19,851)   $(54,225)   $(61,007)
                                                       ========    ========    ========
</TABLE>

Comparison of Years Ended December 31, 2001 and 2000

Revenues.  Email  service  revenues  decreased 18% from $18.0 million in 2000 to
$14.7 million in 2001.  We recognized  revenue of $0.6 million and $1.1 million,
from the sale of licenses in 2001 and 2000,  respectively.  In 2001 and 2000, no
customer accounted for more than 10% of revenues.

                                       19
<PAGE>
Cost of Revenues.  Cost of revenues  increased 23% from $11.9 million in 2000 to
$14.6 million in 2001, due to the increase in depreciation costs as we ramped up
during 2000. Cost of revenues  consisted  primarily of costs related to internet
data center  services from  third-party  providers,  depreciation  of equipment,
internet  access,  personnel  and  related  costs.  In 2000 we sized our hosting
infrastructure for substantial growth.  Recently, in light of the agreement with
MailCentro  and sale of the Hosted  Exchange  business,  we have  decreased  our
hosting infrastructure costs.

Research and Development,  Net. Research and development  expenses decreased 28%
from  $10.4  million  in 2000 to $7.3  million  in 2001 due to the  decrease  in
personnel and other related costs. In 2001, we received  royalty-bearing  grants
totaling  $0.6 million  from the Israeli  government,  which were  recorded as a
reduction of research and development  costs.  The Israeli  government  requires
beneficiaries of such grants to pay royalties to the Israeli government based on
the  revenues  derived  from the sale of  products,  technologies  and  services
developed with such grants.  We believe that we have no obligation for royalties
in 2001, related to the 2001 grants, since we had not started generating revenue
for the product  developed  with such grants,  but we may have  obligations  for
royalties  in 2002  and  future  years.  Moreover,  we  believe  that we have no
obligation  for  royalties in 2001 for the previous  years'  funded  projects as
these  projects  failed and we do not  generate  revenue  or expect to  generate
revenue from these projects.  Nevertheless, the ultimate liability is subject to
review by the OCS.

During 2001,  we reduced  research  and  development  personnel  by  eliminating
certain  projects,  while  only  maintaining  a core  project  aligned  with our
strategic  direction.  Based on these  eliminations,  we expect to maximize  the
benefits of this cost reduction during 2002.

Sales and  Marketing.  Sales and  marketing  expenses  decreased  49% from $26.6
million in 2000 to $13.4 million in 2001, due to decreased personnel and related
costs, public relations, other marketing expenses and direct sales costs in line
with reduced  expected  revenue  levels and the  Company's  channel  selling and
marketing focus in 2001.  Previously,  Company  personnel were focused on direct
sales  efforts.  We expect these costs to decrease in absolute terms in 2002 due
to the agreement with  MailCentro and sale of the Hosted Exchange  business,  as
well as the change in business strategy.

General and  Administrative.  General and administrative  expenses decreased 18%
from  $13.6  million  in 2000  to  $11.2  million  in  2001,  due  primarily  to
curtailment of costs.

Amortization  of  Prepaid  Marketing  Expenses.   Our  amortization  of  prepaid
marketing  expenses  related to the InfoSpace and Microsoft  warrants  decreased
from $4.5 million in 2000 to zero in 2001,  since it was fully  amortized at the
end of 2000. The prepaid marketing expense was amortized using the straight-line
method over the one-year minimum term of each of the commercial agreements.

Amortization  of Stock-Based  Employee  Deferred  Compensation.  Our stock-based
employee deferred compensation expenses decreased 28% from $3.1 million for 2000
to $2.2 million for 2001. The deferred compensation is being amortized using the
sum-of-digits   method  over  the  vesting   schedule,   generally  four  years.
Amortization  of these amounts will  conclude  during the third quarter of 2003.
Deferred  compensation  expenses  also  included  $0.3  million  related  to the
repricing of stock options  during 2001. The total  amortization  charge of $1.0
million  related to the  repricing  will be  amortized  using the  straight-line
method over a three year vesting schedule.

Write-off of Impaired Intangibles and Other Assets. Impairment and other charges
consist of costs  and/or  charges that are not  directly  associated  with other
expense classification or ongoing operations.  The Company periodically assesses
the  recoverability  of the carrying amount of intangible  assets,  property and
equipment  and  provides  for  any  possible  impairment  loss  based  upon  the
difference between the carrying amount and fair value of such assets. Impairment
and other  charges of $23.4  million  included  a $13.3  million  impairment  of
goodwill and other intangibles related to our acquisition of Wingra,  Inc., $4.4
million impairment of leasehold  improvements at unused leased facilities,  $3.6
million  impairment  of computer  hardware  which is idle and not being used, an
accrual of $1.0 million for costs related to early  termination  of these unused
facilities  and a $1.1 million  write-off of a customer  relationship  module (a
software tool for managing customer relations),  which portion will no longer be
utilized.

Interest and Other Income,  Net. Our interest and other income,  net,  decreased
from a net income of $2.9  million for 2000 to a net income of $0.4  million for
2001, due primarily to decreased  interest  income earned from cash  equivalents
and marketable securities, as the funds depleted in 2001.

                                       20
<PAGE>
Write-Off of Impaired Long-term Investments.  The Company invested $7 million in
the first nine months of 2000 in certain internet centric companies in which the
company believed it had a significant ongoing strategic interest.  However,  due
to the economic slowdown and the significant decline in capital available to and
in valuations of these privately funded internet centric companies,  the Company
believes that these  investments  are fully impaired.  Accordingly,  the Company
recorded  a  charge  of  $5  million  and  $2.0  million,   in  2000  and  2001,
respectively, to reflect impairment of these assets.

Minority Interest.  Minority interest  represents a stockholders'  proportionate
share of the equity of Commtouch,  K.K.  (Japan) or 29.4%.  At December 31, 2000
and 2001,  the Company owned 94.17% and 70.6%,  respectively,  of the equity and
voting rights of Commtouch, K.K. (Japan).

Income  Taxes.  As of December 31, 2001, we had  approximately  $38.0 million of
Israeli net operating loss  carry-forwards and $67.6 million of U.S. federal net
operating loss  carry-forwards  available to offset future taxable  income.  The
U.S. net operating  loss  carry-forwards  will expire in various  amounts in the
years 2008 to 2022.  The  Israeli  net  operating  loss  carry-forwards  have no
expiration date.

Comparison of Years Ended December 31, 2000 and 1999

Revenues.  Email service  revenues  increased  323% from $4.3 million in 1999 to
$18.0 million in 2000.  We  recognized  revenue of $1.1 million from the sale of
licenses in 2000.  Revenues  from  MyPoints,  a permission  based email  service
company,  represented  11% of total  revenues  during 1999. In 2000, no customer
accounted for more than 10% of revenues.

Cost of Revenues.  Cost of revenues  increased 226% from $3.6 million in 1999 to
$11.9 million in 2000, due to the increase in contracts  with  customers  during
2000 and the related service provided.  Cost of revenues consisted  primarily of
costs  related to internet  data center  services  from  third-party  providers,
depreciation of equipment, internet access, personnel and related costs. In 2000
we sized our hosting infrastructure for substantial growth.

Research and Development.  Research and development expenses increased 252% from
$2.9  million in 1999 to $10.4  million in 2000 due to an increase in  personnel
and other related costs. In previous years, we received  royalty-bearing  grants
from the Israeli government, recorded as a reduction of research and development
costs.  The  Israeli  government  requires  beneficiaries  of such grants to pay
royalties to the Israeli  government based on the revenues derived from the sale
of products,  technologies and services  developed with such grants.  We believe
that we have no obligation for royalties  since the programs  ultimately  failed
and we do not expect to generate  future  revenue from products  developed  with
such grants.  Nevertheless,  the ultimate  liability is subject to review by the
OCS.

Sales and  Marketing.  Sales and  marketing  expenses  increased  244% from $7.7
million in 1999 to $26.6 million in 2000, due to increased personnel and related
costs,  public  relations,  other  marketing  expenses and direct sales costs to
support the growth of our email service revenues.

General and Administrative.  General and administrative  expenses increased 215%
from  $4.3  million  in  1999  to  $13.6  million  in  2000,  due  primarily  to
substantially  higher personnel and related costs,  facility costs,  higher fees
for outside  professional  services and other costs to support the growth of our
email service revenues.

Amortization  of  Prepaid  Marketing  Expenses.   Our  amortization  of  prepaid
marketing expenses related to the InfoSpace and Microsoft warrants increased 38%
from $3.3  million  for 1999 to $4.5  million for 2000.  The  prepaid  marketing
expense is being  amortized  using the  straight-line  method over the  one-year
minimum term of each of the commercial agreements.

Amortization  of Stock-Based  Employee  Deferred  Compensation.  Our stock-based
employee deferred compensation expenses decreased 11% from $3.4 million for 1999
to $3.1 million for 2000. The deferred compensation is being amortized using the
sum-of-digits method over the vesting schedule, generally four years.

Interest and Other Income,  Net. Our interest and other income  (expense),  net,
increased  from a net  income of $1.2  million  for 1999 to a net income of $2.9
million for 2000,  due primarily to increased  interest  income earned from cash
equivalents and marketable securities.

                                       21
<PAGE>
Write-Off of Impaired Long-term Investments.  The Company invested $7 million in
the first nine months of 2000 in certain internet centric companies in which the
Company believed it had a significant ongoing strategic interest.  However,  due
to the economic slowdown and the significant decline in capital available to and
in valuations of these privately funded internet centric companies,  the Company
believes a portion of these investments are impaired.  Accordingly,  the Company
recorded a charge of $5 million to reflect  impairment  of this asset  below its
recorded cost.

Minority Interest.  Minority interest  represents a stockholders'  proportionate
share of the equity of Commtouch,  K.K.  (Japan) or 5.83%. At December 31, 2000,
the Company  owned  94.17% of the equity and voting  rights of  Commtouch,  K.K.
(Japan).

Income  Taxes.  As of December 31, 2000, we had  approximately  $38.0 million of
Israeli net operating loss  carry-forwards and $33.6 million of U.S. federal net
operating loss  carry-forwards  available to offset future taxable  income.  The
U.S. net operating  loss  carry-forwards  will expire in various  amounts in the
years 2008 to 2021.  The  Israeli  net  operating  loss  carry-forwards  have no
expiration date.

Quarterly Results of Operations (Unaudited)

The  following  table sets  forth  certain  unaudited  quarterly  statements  of
operations data for the eight quarters ended December 31, 2001. 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.

<TABLE>
<CAPTION>
                                                                        Three Months Ended
                                       --------------------------------------------------------------------------------------------
                                        Mar. 31,   Jun. 30,    Sept. 30,   Dec. 31,    Mar. 31,    Jun. 30,   Sept. 30,    Dec. 31,
                                         2000        2000        2000        2000        2001        2001        2001        2001
                                       --------    --------    --------    --------    --------    --------    --------    --------
                                                                                (in thousands)
                                                                                  (unaudited)
<S>                                    <C>         <C>         <C>         <C>         <C>         <C>         <C>         <C>
Email service revenues .............   $  3,597    $  5,009    $  4,747    $  4,612    $  4,009    $  3,974    $  3,923    $  2,791
Software license revenues ..........       --          --           500         650        --           383          67         171
                                       --------    --------    --------    --------    --------    --------    --------    --------
Total revenues .....................      3,597       5,009       5,247       5,262       4,009       4,357       3,990       2,962
                                       --------    --------    --------    --------    --------    --------    --------    --------
Cost of email service revenues .....      2,121       2,784       3,025       3,934       4,844       3,734       3,713       2,314
Cost of software license revenues ..       --          --          --          --          --          --          --          --
                                       --------    --------    --------    --------    --------    --------    --------    --------
Total cost of revenues .............      2,121       2,784       3,025       3,934       4,844       3,734       3,713       2,314
                                       --------    --------    --------    --------    --------    --------    --------    --------
Gross profit (loss) ................      1,476       2,225       2,222       1,328        (835)        623         277         648
                                       --------    --------    --------    --------    --------    --------    --------    --------
Operating expenses:
 Research and development, net .....      1,993       2,270       2,561       3,533       2,946       2,520       1,420         392
 Sales and marketing ...............      4,746       6,404       6,337       9,098       6,495       2,856       2,594       1,551
 General and administrative ........      2,107       2,576       3,185       5,755       5,752       2,886       2,170         428
 In-process research and development       --          --          --         1,280        --          --          --          --
 Amortization of prepaid
 marketing expenses ................      1,941       1,941         476         150        --          --          --          --
 Amortization of stock-based
 employee compensation .............        762         762         762         762         481         481         694         548
 Amortization of goodwill and
  Other purchased intangibles ......       --          --          --          --           909         891         890         104
</TABLE>

                                       22
<PAGE>

<TABLE>
<S>                                    <C>         <C>         <C>         <C>         <C>         <C>         <C>         <C>
Write-off of impaired
 goodwill and other intangible
  assets ...........................       --          --          --          --          --          --        12,077       1,203
Write-off of impaired
 property, equipment and other......       --          --          --          --          --          --         6,485       3,681
                                       --------    --------    --------    --------    --------    --------    --------    --------
 Total operating expenses ..........     11,549      13,953      13,321      20,578      16,583       9,634      26,330       7,907
                                       --------    --------    --------    --------    --------    --------    --------    --------
Operating loss .....................    (10,073)    (11,728)    (11,099)    (19,250)    (17,418)     (9,011)    (26,053)     (7,259)
Interest and other income
 (expenses), net ...................        938         931         883         118         265         464          70        (350)
Write-off of impaired long-term
  investments ......................       --          --          --        (5,000)       --          --        (2,000)       --
Minority interest ..................       --          --          --            55          22          21         137         105
                                       --------    --------    --------    --------    --------    --------    --------    --------
Net loss ...........................   $ (9,135)   $(10,797)   $(10,216)   $(24,077)   $(17,131)   $ (8,526)   $(27,846)   $ (7,504)
                                       ========    ========    ========    ========    ========    ========    ========    ========
</TABLE>
Fluctuations in Quarterly Results

We have incurred operating losses since inception, and we cannot be certain that
we will achieve  profitability on a quarterly or annual basis in the future. Our
results of operations  have  fluctuated  and are likely to continue to fluctuate
significantly from quarter to quarter as a result of a variety of factors,  many
of which are outside of our  control.  A relatively  large  expense in a quarter
could have a  negative  effect on our  financial  performance  in that  quarter.
Additionally,  as a strategic response to a changing competitive environment, we
may elect  from time to time to make  certain  pricing,  service,  marketing  or
acquisition  decisions  that  could  have a  negative  effect  on our  quarterly
financial performance. Other factors that may cause our future operating results
to fluctuate include, but are not limited to:

         o    continued growth of the internet and of email usage;

         o    demand for email and messaging solutions;

         o    our ability to attract and retain customers and maintain  customer
              satisfaction;

         o    our  ability to  upgrade,  develop  and  maintain  our systems and
              infrastructure;

         o    the amount and timing of operating costs and capital  expenditures
              relating to expansion of our business and infrastructure;

         o    the size,  timing  and  fulfillment  of  orders  for our email and
              messaging solutions;

         o    the receipt or payment of  irregular or  nonrecurring  revenues or
              expenses;

         o    technical difficulties or system outages;

         o    foreign exchange rate fluctuations;

         o    the  announcement or  introduction of new or enhanced  services by
              our competitors;

         o    our  ability  to  attract  and  retain  qualified  personnel  with
              internet  industry  expertise,  particularly  sales and  marketing
              personnel;

         o    the pricing policies of our competitors;

         o    failure to increase our sales; and

         o    governmental  regulation  relating to the  internet,  and email in
              particular.

In addition  to the  factors set forth  above,  our  operating  results  will be
impacted  by the  extent  to which we incur  non-cash  charges  associated  with
stock-based arrangements with employees and non-employees.

                                       23
<PAGE>
Liquidity and Capital Resources

We have  financed  our  operations  principally  from  the  issuance  of  equity
securities  and to a lesser extent from bank loans and research and  development
grants from the Israeli government.

As of December  31,  2001,  we had  approximately  $2.2  million of cash to fund
operations in 2002. In 2001 we utilized  $24.7 million of cash to fund operating
losses and $5.7 million from investing activities, mainly proceeds from sales of
marketable   securities.   Net  cash  provided  by  financing   activities   was
approximately  zero,  after  repayment  of  bank  loans  and  notes  payable  of
approximately  $1.0 million,  net of approximately $1.0 million of proceeds from
issuance  of  shares  and from  minority  interest  in 2001.  To limit  our cash
expenses in 2002 we have further  reduced  staff from 92 at December 31, 2001 to
approximately  35 at  March  1,  2002.  These  actions  were  possible  due to a
significant decline in our revenue growth due to competitive  factors, a slowing
economic  environment,  the sale of Hosted  Exchange and Wingra,  in early 2002.
Furthermore,  we were able to reduce our future  obligations  for  facility  and
equipment  leases by way of  settlements  with the  Mountain  View  landlord and
Compaq, which will result in cost reductions in 2002.

Recent developments

a. Sale of Wingra

Commtouch  sold off its migration  service  business,  Wingra,  Inc. to Wingra's
current senior  management at the end of February 2002. The terms include mutual
release  of all  liabilities,  obligations  and  rights  of the  parties  to the
agreement. This sale reduced the Company's net liabilities by approximately $0.7
million.

b. Private Placement

On February 27, 2002,  Commtouch  entered  into a private  placement  agreement,
whereby  Commtouch will issue  approximately 4.4 million ordinary shares against
the investment of approximately  $1.3 Million in a private  placement to private
investors;  approximately  one-third  of  the  shares  are  being  purchased  by
Commtouch's  founders,  who are currently  Commtouch  directors and/or executive
officers.  The purchasers in the private  placement will also receive  five-year
warrants  to  purchase  up  to  an  additional  2.66  million   ordinary  shares
(approximately).  The exercise price for one-third of the warrants will be $0.37
per share,  the exercise price for an additional  one-third of the warrants will
be $1.00 per  share  and the  exercise  price  for the  final  one-third  of the
warrants will be $2.00 per share. This agreement was approved by shareholders on
April 8, 2002.  The  Company  plans to use the  proceeds of this  placement  for
general corporate working capital. The funds were received on April 15, 2002.

c. Sale of Hosted Exchange

In  January  2002,   Commtouch  sold  its  Hosted  Exchange   business  unit  to
Telecomputing,  Inc. Terms of the  transaction  include the  transference of the
Company's customer base and certain equipment to Telecomputing,  in exchange for
certain cash payments and royalties. Furthermore, the Company assigned equipment
leases to Telecomputing,  thereby  eliminating the Company's  obligation to make
lease payments thereunder.

d. Strategic Agreement with MailCentro

Within the framework of an agreement with MailCentro Inc.  ("MC"),  MC (a wholly
owned  subsidiary of CP Software  Group,  Inc.) assumed all aspects of servicing
most of the Company's consumer customers, including its free email service known
as Zap Zone  service.  According  to the  agreement  entered  into with MC,  the
Company  transferred  customers  to MC and is expected to realize  royalties  on
payments made by these former customers to MC (primarily in 2002). Additionally,
certain Commtouch trademarks, domain names, software licenses and equipment were
sold to MC.

As of December 31, 2001, we had negative net working capital of $0.6 million.

                                       24
<PAGE>
Based on the cash balance at December 31, 2001, current projections of revenues,
related  expenses,  and the  completion  of the private  placement,  the Company
believes it has  sufficient  cash to continue  operations  for at least the next
twelve months.

Class Action Litigation

Following  our  restatement  of revenues  for the first three  quarters of 2000,
several class action lawsuits were filed in the United States District Court for
the  Northern  District  of  California  against  the Company and certain of our
officers and a director,  alleging violations of the antifraud provisions of the
Securities  Exchange Act of 1934 arising from the Company's  restatement  of the
financial  statements for the first three quarters of 2000.  These lawsuits were
consolidated  into one  action in late 2001.  Thereafter,  the  Company  filed a
Motion to Dismiss,  which was granted,  though the plaintiffs  have been granted
leave to amend the  complaint,  which  they have  done.  While we are  unable to
predict the ultimate  outcome of the  consolidated  claim, we believe that it is
without merit and intend to continue to vigorously defend ourselves.

Effective Corporate Tax Rates

Our tax  rate  will  reflect  a mix of the U.S.  statutory  tax rate on our U.S.
income and the  Israeli  tax rate  discussed  below.  We expect that most of our
taxable  income will be generated in Israel.  Israeli  companies  are  generally
subject to  corporate  tax at the rate of 36% of taxable  income.  A part of our
income,  however,  is derived from the Company's capital investment program with
Approved  Enterprise  status  under  the Law for the  Encouragement  of  Capital
Investments in three separate plans,  and is therefore  eligible for certain tax
benefits.  Pursuant to these  benefits,  we will enjoy a tax exemption on income
derived  during  the first  two years in which  such  investment  plans  produce
taxable income  (provided  that we do not distribute  such income as a dividend)
and a reduced tax rate of 10% to 25% for an  additional  period of five to eight
years  depending on the level of foreign  investment in Commtouch.  All of these
tax benefits are subject to various conditions and restrictions. There can be no
assurance  that we will  obtain  approval  for  additional  Approved  Enterprise
programs,  or  that  the  provisions  of the  law  will  not  change.  Moreover,
notwithstanding  these tax  benefits,  to the  extent  we  receive  income  from
countries  other than  Israel,  such income may be subject to  withholding  tax.
Since we have  incurred tax losses in every year through  2001,  we have not yet
used the tax benefits for which we are eligible.

Impact of Inflation and Currency Fluctuations

Most of our sales are in U.S. dollars.  However,  a portion of our costs relates
to our operations in Israel. A substantial  portion of our operating expenses in
Israel,  primarily our research and development expenses, is denominated in NIS.
Costs not  denominated  in U.S.  dollars are  translated to U.S.  dollars,  when
recorded, at prevailing rates of exchange.  This is done for the purposes of our
financial  statements and reporting.  Costs not denominated in U.S. dollars will
increase  if the rate of  inflation  in Israel  exceeds the  devaluation  of the
Israeli  currency  as  compared  to the U.S.  dollar  or if the  timing  of such
devaluation lags considerably behind inflation. Consequently, we are and will be
affected by changes in the prevailing  NIS/U.S.  dollar  exchange rate. We might
also be affected by the dollar  exchange  rate to the major  European  and Asian
currencies, due to the fact that we derive revenues from customers in Europe and
Asia.

The annual rate of inflation  in Israel was 1.013% in 2001,  0% in 2000 and 1.3%
in 1999. The NIS was devalued against the U.S. dollar by  approximately  9.3% in
2001, -2.7% in 2000 and 0.17% in 1999. The  representative  dollar exchange rate
for converting the NIS to U.S. dollars,  as reported by the Bank of Israel,  was
NIS 4.416 for one U.S. dollar on December 31, 2001. Note that the representative
dollar exchange rate was NIS 4.675 at March 1, 2002.

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 profitability 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

                                       25
<PAGE>
The  following  table sets forth  certain  information  regarding  our executive
officers and directors at March 1, 2002:
<TABLE>
<CAPTION>
                                      Beneficial
                                      Ownership
          Name                Age        >1%(3)                      Position
-----------------------     -------   ----------   -------------------------------------------------
<S>                           <C>          <C>      <C>
Amir Lev................      42           2.1%     President, Chief Technology Officer and Director
Carolyn Chin............      54            --      Chairman of the Board of Directors
Gideon Mantel(1)........      42           3.1%     Chief Executive Officer and Director
Nahum Sharfman(1)(2)....      54           2.2%     Director
Richard Sorkin..........      40            --      Director
Udi Netzer (2)..........      46            --      Director
Ofer Segev(1)(2)........      42            --      Director
Avner Amram.............      40            --      Chief Operating Officer
</TABLE>

---------------------
(1)  Member of the Compensation Committee

(2)  Member of the Audit Committee

(3)  For purposes of this table,  a person or group of persons is deemed to have
     beneficial  ownership  of shares of the  Company's  common stock which such
     person  or group  has the  right to  acquire  on or  within  60 days  after
     December 31, 2001. Unless otherwise  indicated,  to the Company's knowledge
     the  person  named has sole  voting and  investment  power and the right to
     receive  the  economic  benefits,  or share such power and rights with such
     person's spouse, with respect to all shares held by that person.

Other Management Employees:

The  following  table sets  forth the names and  positions  of other  management
employees:
<TABLE>
<CAPTION>
             Name                  Age                       Position
------------------------------   ------  ---------------------------------------------------
<S>                                <C>   <C>
Devyani Patel.................     41    Vice President, Finance
Brian Fox.....................     38    Vice President, Corporate and Business Development,
                                         Commtouch Inc.
Gary Davis....................     40    General Counsel and Corporate Secretary
Udi Trugman...................     31    Vice President, Research and Development Commtouch
                                         Software Ltd.
Michal Kofman ................     35    Vice President, Sales, Commtouch Software Ltd.
Haggai Carmon ................     43    Vice President, Marketing, Commtouch Software Ltd.
</TABLE>

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 has also been the
General  Manager  of  Commtouch  since  January  1997  and  in May  2000  became
President. Mr. Lev received a B.A. in Computer Science and Economics from Hebrew
University, Jerusalem.

Carolyn  Chin has served as the  Chairman  of the Board of  Directors  since May
2001. Ms. Chin has served as a Director of Commtouch since August 2000. Ms. Chin
has  30  years  of  experience  in  information  technology,  marketing,  media,
telecommunications,  retailing, health care, education and small business market
segments.  She has held a number of senior  executive  positions  including  at:
Reuters,  Market XT, IBM, Citibank,  AT&T, Macy's and in the US Government.  She
has served on over 30 boards and committees. Ms. Chin has also received numerous
honors  including  selection  as a White House  Fellow and the  Committee of 100
(prominent  Chinese-Americans).  She  graduated  with an MBA  from  the  Harvard
Business School and a BS in Management  Engineering from Rensselaer  Polytechnic
Institute.

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.  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.

                                       26
<PAGE>
Nahum Sharfman rejoined the Board in March 2000. Mr. Sharfman is a co-founder of
Commtouch  and served as its Chief  Executive  Officer and Chairman of the Board
from its inception in February 1991. In November 1997 Mr.  Sharfman  resigned as
Chief  Executive  Officer  to become a founder  of  Dealtime.com.  Mr.  Sharfman
remained  Chairman of the Board of Commtouch and a Director  until January 1999.
Prior to founding  Commtouch,  Mr.  Sharfman  spent eleven  years with  National
Semiconductor  Corporation  in various  development  and management  roles.  Mr.
Sharfman  received a Ph.D. in High Energy Nuclear  Physics from Carnegie  Mellon
University  and M.S.  and B.S.  degrees in  Physics  from the  Technion-  Israel
Institute of Technology, Haifa.

Richard Sorkin has served as a Director of Commtouch since July 1999. Since June
1998 Mr.  Sorkin  has  served as an  advisor  to  several  early-stage  internet
companies  and is a director  of several  private  companies.  From June 1998 to
April 1999 he was the Chairman of the Board of  Directors  of ZIP2,  an internet
media company which was sold to Compaq. From May 1996 to June 1998, he was Chief
Executive  Officer  of ZIP2 and from  May  1993 to  March  1996 he held  various
executive  positions  with  Creative  Technology,  Ltd.,  a leading  provider of
multi-media  hardware.  Mr. Sorkin received a B.A. with honors in Economics from
Yale University and an M.B.A. from Stanford University.

Udi Netzer has served as a Director of Commtouch since February 2002. Mr. Netzer
is also  currently  the active  Chairman of  Eyeblaster,  Inc.,  a rich media ad
management   system  that  allows   publishers,   agencies  and  advertisers  to
independently create and manage out-of-banner  advertising campaigns. Mr. Netzer
has  over 15  years'  experience  in  various  sales,  marketing  and  executive
positions  with  companies  such as 3Com,  Netmanage,  and VCON. As a partner in
Evergreen, Mr. Netzer was one of the first venture capitalists in Israel.

Ofer Segev has served as a Director of Commtouch  since February 2002. Mr. Segev
is also currently  Chief  Executive  Officer of  TeleKnowledge,  Inc., a leading
provider of advanced  content  monetization  software  solutions for  commercial
content  providers.  Mr.  Segev  has over 15 years of  experience  in  strategic
financial  management.  He most recently served as CFO for Tundo, a developer of
an IP-based  voice and media  services  platform Prior to his position at Tundo,
Mr. Segev was a partner in Ernst &  YoungIsrael,  where he spent 15 years.  From
1996 through 2000 Mr. Segev led the High Tech Industry  practice group for Ernst
& Young Israel. He has a BA in Economics and Accounting from Bar Ilan University
in Israel,  and has  studied at the Kellogg  Graduate  School of  Management  at
Northwestern University.

Avner Amram has served as Chief  Operating  Officer of Commtouch  since November
2001.  From April 1999 until  that  time,  he served as Senior  Vice  President,
Operations of Commtouch  Inc.. Mr. Amram was Director of Operations of Commtouch
Inc. from March 1998 to April 1999 and a Software Team Leader from March 1996 to
March 1998.  Mr. Amram  received a B.Sc. in Computer  Science from the Technion-
Israel Institute of Technology, Haifa.

Devyani  Patel joined  Commtouch in 1996 as a consultant  and became a full-time
employee in early 1999. She served as Corporate  Controller for Commtouch  until
November 2001 when she was appointed as the Vice President of Finance. Ms. Patel
has nearly 20 years of accounting and finance experience,  including  technology
industry   experience.   Ms.  Patel  graduated  from  the  University  of  Kent,
Canterbury, England in Accounting and Law.

Brian Fox has served as Vice  President,  Corporate and Business  Development of
Commtouch  since October  2001.  From the time he joined the Company in February
2000 until that time,  Mr. Fox served as Director of Corporate  Development  and
Senior Director of Corporate Development.  Prior to joining the Company, Mr. Fox
was President of Fox Advisory  Services,  a Manager in the  Consulting  Group at
Deloitte & Touche and a Senior Consultant at Price Waterhouse.  Mr. Fox earned a
B.A. in Economics  and Business  from UCLA (magna cum laude) and an MBA from the
Wharton School of the University of Pennsylvania.

Gary Davis joined  Commtouch in September 1999 and serves as General Counsel and
Corporate  Secretary.  Mr. Davis has over 16 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.

Udi Trugman  joined  Commtouch in December 1996 and serves as Vice  President of
Research and  Development.  Prior to 2002,  Mr.  Trugman was Senior  Director of
Systems in the R&D group. Mr. Trugman has over 15 years of software  development
and  management  experience.   Prior  to  working  at  Commtouch,   Mr.  Trugman
specialized in development of commercial applications.

                                       27
<PAGE>
Michal  Kofman  joined  Commtouch  in  2000  and  serves  as Vice  President  of
International  Sales.  Prior to 2002,  Ms.  Kofman  was a Director  of  Business
Development.  Prior to joining Commtouch,  Ms. Kofman was a Director of Sales at
TIS, a public software vendor for document  management and served as Director of
International  Sales at Hotel Guide, a Swiss company that advertises  hotels via
the internet.  Ms. Kofman has over 10 years of experience in international sales
and management.

Haggai Carmon joined  Commtouch in January 2002 and serves as Vice  President of
Marketing.  From  1998 to 2002,  Mr.  Carmon  was Vice  President  of  Corporate
Marketing and of Sales in  Asia-Pacific  for VCON  Telecommunications,  a public
vendor of corporate  videoconferencing  solutions,  and was also responsible for
international  pre-sales and technical support. Prior to that, Mr. Carmon was at
NetManage Ltd., a public software company of TCP/IP  applications for Windows, a
founder and CEO of Applico,  a Computer-aided  Design for  Architecture  service
firm and  managed  a  college  of Fine  Arts.  Mr.  Carmon  has over 15 years of
experience in technology and international management.

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 his  successor  is elected,  or until he 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  Articles  of  Association  of  Commtouch   authorize  the  shareholders  to
determine,  from time to time,  the  number of  directors.  The  number was most
recently fixed at nine directors. There are no family relationships among any of
the directors, officers or key employees of Commtouch.

Alternate Directors

The 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,  or a person who already
serves as a  director  or an  alternate  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.

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:

         o    an employment relationship;

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

         o    control; and

         o    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

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<PAGE>

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.

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

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

         o    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  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 must include both outside directors. An
outside  director  is entitled to  compensation  as provided in the  regulations
adopted under the Companies Law and is otherwise  prohibited  from receiving any
other compensation,  directly or indirectly, in connection with service provided
as an outside director.

In addition,  the Nasdaq National Market requires Commtouch to have at least two
independent  directors  on the  Board of  Directors  and to  establish  an audit
committee,  at least a majority of whose members are  independent of management.
We have appointed directors who qualify both as independent  directors under the
Nasdaq National Market requirements and as outside directors under the Companies
Law.

Audit Committee

The 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  and  approving   related  party
transactions  as required by law. An audit  committee  must  consist of at least
three  directors,  including all of the outside  directors.  The chairman of the
Board of Directors,  any director employed by or otherwise providing services to
the company,  and a  controlling  shareholder  or any relative of a  controlling
shareholder, may not be a member of the audit committee.

Internal Auditor

Under the  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 the company's actions comply with the
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.  The Company
appointed a qualified internal auditor during 2001.

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.  The duty of
loyalty  includes  avoiding 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. Each person listed in the first table that appears
above at the beginning of this Item 6 is an office holder.

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

                                       29
<PAGE>
known to him or her, in connection with any existing or proposed  transaction by
the company.  In addition,  if the transaction is an extraordinary  transaction,
the office  holder must also  disclose any personal  interest held by the office
holder's  spouse,  siblings,  parents,   grandparents,   descendants,   spouse's
descendants  and the spouses of any of the foregoing,  or by any  corporation in
which the office  holder is a five percent or greater  shareholder,  director or
general  manager  or in which he or she has the  right to  appoint  at least one
director or the general manager.  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.

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.  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.

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  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:

         o    any amendment to the Articles of Association;
         o    an increase of the company's authorized share capital;
         o    a merger; or
         o    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 does not describe the substance of this duty.

Compensation Committee Interlocks

The Compensation Committee,  which was established by the Board in January 1996,
is  responsible  for  determining  salaries,   incentives  and  other  forms  of
compensation  for  Commtouch's  directors,  officers and other employees and for
administering various incentive compensation and benefit plans. The Compensation
Committee consists of the Chief Executive Officer and two other Directors.  Ofer
Segev,  as an outside  director,  and Nahum Sharfman are currently the two other
directors on the Compensation Committee.

Indemnification of Directors and Officers; Limitations on Liability

Israeli  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 fiduciary duty 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

                                       30
<PAGE>
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)  monetary  liability  imposed  upon him or her in favor of other
persons  pursuant to a court  judgment,  including a  compromise  judgment or an
arbitrator's  decision  approved  by a  court,  and  (b)  reasonable  litigation
expenses,  including attorneys' fees, actually incurred by him or her or imposed
upon him or her by a court, in an action, suit or proceeding brought against him
or her by or on behalf of the company or other persons,  or in connection with a
criminal  action which does not require  criminal  intent in which he or she was
convicted,  in each case in connection  with his or her  activities as an office
holder.  Our Articles of  Association  allow us to insure and  indemnify  office
holders to the fullest  extent  permitted  by law  provided  such  insurance  or
indemnification  is approved in accordance  with the Israel  Companies  Law. The
Company has acquired  directors' and officers'  liability insurance covering the
officers and directors of the Company and its  subsidiaries  for certain claims.
In  addition,  the Company has entered  into an  undertaking  to  indemnify  the
directors of the Company subject to certain  limitations,  and this  undertaking
has been ratified by shareholders.

Compensation of Directors and 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.  Apart from Carolyn Chin and
Richard Sorkin,  directors  currently do not receive cash compensation for their
services as directors but are  reimbursed  for their  expenses for each Board of
Directors meeting  attended.  However,  see "Nonemployee  Directors Stock Option
Plan," below.

The  aggregate  direct  remuneration  paid by  Commtouch  to all  directors  and
executive officers (13 persons) in 2001 was approximately  $1.4 million.  During
the same period  Commtouch  accrued or set aside  approximately  $25,000 for the
same group to provide pension,  retirement or similar  benefits.  As of December
31, 2001,  directors and executive  officers of Commtouch (8 persons) held stock
options to purchase an aggregate of 825,080 ordinary shares.

Options to Purchase Securities from Registrant or Subsidiaries.

As of December  31, 2001,  stock  options to purchase  ordinary  shares had been
granted to employees, consultants, executive officers and non-employee directors
under the Company's stock option plans, net of cancelled options. Of that number
had not been exercised and had exercise  prices ranging from $0.01 to $35.56 per
share and a weighted average per share exercise price of $2.20, and were held by
61 persons;  these options have termination  dates ranging from February 2006 to
August 2011.  At December 31,  2001,  the persons  named in Item 6 as a group (8
persons) held options to acquire 298,538 ordinary shares. Reference is also made
to the information contained in Item 7 below.

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, 2001, including:

         o    each person or entity known to Commtouch to own beneficially  more
              than five percent of Commtouch's ordinary shares, and

         o    all executive officers and directors as a group.

Beneficial  ownership  is  determined  in  accordance  with  the  rules  of  the
Securities and Exchange  Commission and includes voting or investment  power, or
the right to receive the economic benefits of ownership, 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 17,496,819  ordinary  shares  outstanding as of December
31, 2001 (since the InfoSpace warrant of 1,136,000 shares is underwater based on
the market price of an ordinary share on December 31, 2001 and an exercise price
of $12.80 per share,  the warrants have no impact on the percentage of ownership

                                       31
<PAGE>
computation). Ordinary shares issuable upon exercise of options and other rights
held and  exercisable  on or within  sixty days of December  31, 2001 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.

                                                       Amount      Percent of
                                                        Owned        Class
                                                      ---------    ---------
InfoSpace                                               896,057       5.11%
Jan Eddy (President: Wingra Technologies, LLC.)         877,081       5.00%
All directors and officers as a group (8 persons)     1,462,298       8.36%

Interest of Management in Certain Transactions.

Relationship with InfoSpace

Concurrent with the closing of the initial public offering, our U.S. subsidiary,
Commtouch Inc., entered into a Customized Web-based Email Service Agreement with
InfoSpace. Under that agreement, we provided customer email services,  including
calendaring and other products and services, to end users of InfoSpace's various
properties,  which may have included cable subscribers of Charter Communications
and its affiliates, users of services offered by High Speed Access Corp. and any
browser, website, ISP or similar service that InfoSpace sponsored or to which it
provided  content.  This  agreement was replaced by a new  agreement,  effective
February  1, 2002 having a one year  duration,  but  InfoSpace  has the right to
terminate  the  agreement  at any time upon  thirty  (30) days  written  notice.
InfoSpace  also has the right to terminate  the agreement if there are technical
problems with the products or services provided. The performance  specifications
set forth in the agreement  include the  maintenance  of certain levels of email
system  availability  and response time.  Infospace is to pay a quarterly fee of
$7,500 for use of up to 10,000  mailboxes.  This  agreement has been assigned to
MailCentro,  Inc.,  the party to whom we sold our consumer  business,  effective
March 1, 2002. Commtouch Inc. will continue to receive a portion of the revenues
from  this  agreement  for a maximum  period of one year from the above  date of
assignment.

In connection  with  Commtouch  Inc.  entering into the original  email services
agreement,  we issued to  InfoSpace  a warrant to  purchase  1,136,000  ordinary
shares at an exercise price of $12.80 per share. The warrant is non-forfeitable,
fully vested and  immediately  exercisable,  and will expire five years from the
date of the original email service agreement.

Concurrent  with  Commtouch Inc.  entering into the email services  agreement in
1999, we issued 896,057 ordinary shares to InfoSpace and 448,029 ordinary shares
to Vulcan Ventures in a private  placement at $14.88 per share.  Pursuant to the
share purchase  agreement,  InfoSpace and Vulcan Ventures have the right to name
one  director to our board as long as they  continue to hold at least 25% of the
combined  number of shares  purchased by them in the private  placement  and the
shares issuable to InfoSpace upon exercise of the warrant.  Mr. Thomas Camp, who
was appointed to the board  pursuant to that  agreement,  resigned on August 22,
2001 and was not replaced by InfoSpace and Vulcan Ventures,  and we believe that
Vulcan Ventures divested itself of all of its  shareholdings in the Company.  In
connection with this transaction, we agreed to pay U.S. Bancorp Piper Jaffray an
advisory fee of $550,000 under the terms of an engagement letter agreement dated
as of July 5, 1999.

We agreed to register the shares and warrant  described above promptly after the
closing of the  initial  public  offering.  The  registration  statement  became
effective on January 7, 2000.

At  InfoSpace's  option,  the  warrant  is  exercisable  pursuant  to a cashless
exercise based on the average  closing price of the ordinary shares for the five
days  preceding  the  exercise.  The holder of the  warrant is required to avoid
becoming a 10% or greater shareholder of the Company as a result of any exercise
of the  warrant.  The holder of the warrant is given the  opportunity  to profit
from a rise in the market  price of the  ordinary  shares and the  warrant.  The
warrant  includes  provisions  which  adjust  the  exercise  and price  upon the
occurrence  of certain  events  which  might  otherwise  dilute the value of the
warrant.

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<PAGE>
Option Exercises and Purchases of Shares By Certain Officers

Gideon Mantel is the Chief  Executive  Officer and a Director of  Commtouch.  On
March  17,  1999,  Mr.  Mantel  exercised  certain  options  granted  to  him by
Commtouch.  In consideration  for the ordinary shares purchased  pursuant to the
exercise of the options,  he provided Commtouch with a full-recourse  promissory
note dated March 17, 1999 in the  original  principal  amount of  $341,272.  The
promissory note bears interest at 4.83% annually, with payments of interest only
due on March 17 of each year and with the  balance due and payable on the fourth
anniversary of the date of the promissory note. This loan was used by Mr. Mantel
to purchase  286,120 ordinary shares of Commtouch at a weighted average purchase
price of $1.19 per share. The promissory note is  collateralized  by a pledge of
the stock purchased.  The outstanding principal amount of the note as of January
31, 2002 is $341,272.

Item 8. Financial Information.

See Item 18: Financial Statements

Item 9. The Offer and Listing.

The Company's  Ordinary  Shares have traded  publicly on The Nasdaq Stock Market
under the symbol "CTCH" since July 13, 1999.

The  following  table  lists  the  high and low  closing  sales  prices  for the
Company's Ordinary Shares, for the periods indicated,  as reported by The Nasdaq
Stock Market:

                                                   High          Low
                                                 --------      -------
1999:
Third Quarter (beginning July 13, 1999)          $  22.62   $  11.0625
Fourth Quarter                                      49.12      14.3125

2000:
 First Quarter ........................          $  66.50   $  35.5625
 Second Quarter .......................             38.56      14.625
 Third Quarter                                      33.93      16.50
 Fourth Quarter .......................          $  19.25$      7.44

2001:
 First Quarter ........................          $   3.81   $   0.75
 Second Quarter .......................              1.19       0.28
 Third Quarter                                       0.67       0.20
Fourth Quarter ........................          $   0.46$      0.20

Most Recent Six Months:
September 2001 ........................          $   3.81   $   0.75
October 2001 ..........................              0.42       0.22
November 2001 .........................              0.46       0.20
December 2001 .........................              0.35       0.25
January 2002 ..........................              0.43       0.24
February 2002 .........................              0.36       0.25

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,  1959, the amount of cash dividend will be
subject to  corporate  tax at the rate that would  have been  applicable  to its
income had the Company not been tax. The Company has never declared or paid cash
dividends  on its  ordinary  shares  and does  not  anticipate  paying  any cash
dividends  in the  foreseeable  future.  The  Company  intends to retain  future
earnings to finance the development of its business.

                                       33
<PAGE>
Item 10. Additional Information.

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  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.

Neither the Articles of  Association of the Company nor the laws of the State of
Israel  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
at a state of war with Israel.

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 Articles of Association, copies of which have been
filed as exhibits  to our Annual  Report on Form 20-F,  as  amended,  subject to
amendment of our Articles of Association from time to time.

As of December 31, 2001,  our authorized  share capital  consisted of 40,000,000
ordinary  shares,  NIS 0.05 par  value.  As of  December  31,  2001,  there were
17,496,819 ordinary shares and no preferred 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.   Neither  our  Memorandum  of  Association,   Articles  of
Association  nor  the  laws  of the  State  of  Israel  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 Director approval.

VOTING, SHAREHOLDER MEETINGS AND RESOLUTIONS

Holders of  ordinary  shares have one vote for each  ordinary  share held on all
matters submitted to a vote of shareholders.  Such rights may be affected by the
future  grant of any special  voting  rights to the holders of a class of shares
with preferential rights. Once the creation of a class of shares with preference
rights has been  approved,  the Board of Directors may issue  preferred  shares,
unless the Board is limited  from doing so by the Articles of  Association  or a
contractual provision.

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, or representing,  more than one-quarter 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 present in person
or by proxy will  constitute a quorum.  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.

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<PAGE>
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 all  approvals  have been
submitted to the Israeli  Registrar of Companies  and at least seventy 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 become a 25%  shareholder  of the  company.  This rule does not
apply if 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 become a 45% shareholder of the company, unless someone else already holds
a majority of the voting power of the  company.  These rules do not apply if the
acquisition  is made  by way of a  merger.  Regulations  promulgated  under  the
Companies  Law provide  that these  tender  offer  requirements  do not apply to
companies whose shares are listed for trading outside of Israel if, according to
the law in the country in which the shares are traded,  including  the rules and
regulations of the stock exchange on which the shares are traded, either:

         o    there is a limitation  on  acquisition  of any level of control of
              the company; or

         o    the acquisition of any level of control  requires the purchaser to
              do so by means of a tender offer to the public.

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, and
even though the investment has not become liquid.

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 of
shareholder  meetings.  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.

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.

DESCRIPTION OF INVESTOR OPTIONS AND WARRANTS

INFOSPACE WARRANT

The  discussion  regarding  the Infospace  warrant  under Item 5.  Operating and
Financial Review and  Prospects--Strategic  Transaction with Go2Net  (InfoSpace)
and Item 7. "Major  Shareholders  and Related Party  Transactions--  Interest of
Management in Certain Transactions--Relationship with InfoSpace" is incorporated
herein by reference.

WINGRA WARRANTS AND OPTIONS

In connection with our acquisition of Wingra, we assumed warrants and options to
purchase 137,233 shares issued to the Wingra investors  (subsequently reduced to
121,329 due to expiration of certain  options),  and options to purchase 168,382
ordinary shares issued to Wingra employees  (subsequently reduced to 162,257 due

                                       35
<PAGE>
to expiration of options of terminating  employees).  Upon  effectiveness of the
merger, these warrants and options became immediately exercisable.

The assumed  investor  warrants and options were originally  issued by Wingra in
connection with loans to Wingra by banks and  shareholders.  The exercise prices
of those warrants and options range from $6.29 to $9.35 and the expiration dates
range from July 2002 through March 2004.

The employee stock options were originally granted to Wingra employees under the
Wingra  Technologies,  LLC 1998 Unit Option Plan.  The exercise  prices of those
options range from $0.2010 to $3.5010 and the expiration dates range from August
2008  through  July 2010.  At the time of the merger,  we assumed the rights and
obligations under that Option Plan.

EQUITY OFFICE PROPERTIES WARRANT

The  discussion  regarding the Equity Office  Properties  warrant under Item 19,
Note 13 to the Notes to Consolidated Financial Statements - Shareholders' Equity
is incorporated herein by reference.

COMPAQ WARRANT

The discussion  regarding the Compaq warrant under Item 19, Note 13 to the Notes
to  Consolidated  Financial  Statements -  Shareholders'  Equity is incorporated
herein by reference.

INVESTMENT ROUND WARRANTS

The discussion  regarding the February  investment  round warrant under Item 19,
Note 13 to the Notes to Consolidated Financial Statements - Shareholders' Equity
is incorporated herein by reference.

REGISTRATION RIGHTS

The holders of convertible  preferred shares which were converted into 7,109,800
ordinary shares (the "Registrable Securities") upon effectiveness of the initial
public  offering,  have  certain  rights  to  register  those  shares  under the
Securities  Act.  If  requested  by  holders of a  majority  of the  Registrable
Securities  after  the  second  anniversary  of the date of the  initial  public
offering,  Commtouch must file a registration statement under the Securities Act
covering all Registrable  Securities  requested to be included by all holders of
such Registrable Securities.  Commtouch may be required to effect up to two such
registrations.  Commtouch has the right to delay any such registration for up to
120 days under certain circumstances, but not more than once during any 12-month
period.

In addition,  if Commtouch proposes to register any of its ordinary shares under
the Securities Act other than in connection with a company employee benefit plan
or a corporate  reorganization pursuant to Rule 145 under the Securities Act, or
a registration on any registration  form that does not permit secondary sales or
does not include  substantially  the same information as would be required to be
included  in  a  registration   statement   covering  the  sale  of  Registrable
Securities,  the holders of  Registrable  Securities  may require  Commtouch  to
include  all or a portion of their  shares in such  registration,  although  the
managing underwriter of any such offering has certain rights to limit the number
of shares in such registration.

Further,  a  majority  of the  holders of  Registrable  Securities  may  require
Commtouch to register all or any portion of their Registrable Securities on Form
F-3,  subject to certain  conditions and limitations.  All expenses  incurred in
connection with all registrations  (other than fees,  expenses and disbursements
of counsel retained by the holders of the Registrable  Shares, and underwriters'
and brokers' discounts and commissions) will be borne by Commtouch.

The registration  rights described in the preceding three paragraphs expire five
years after the closing date of our initial public offering (July 16, 2004).

In  addition,  the Company  granted  registration  rights to  InfoSpace,  Vulcan
Ventures  and  Microsoft  pursuant  to  which  their  holdings  in  the  Company
(including the warrant issued to InfoSpace) were registered on January 7, 2000.

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<PAGE>
Also, under the terms of the Wingra acquisition  agreement,  we were required to
register the 1,568,869  shares  issuable to the Wingra  investors and employees,
including shares currently  issuable under options and warrants described above.
The  registration  statements were filed to fulfill this  requirement and became
effective, respectively, on September 6, 2001 and July 20, 2001.

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 Articles of  Association  and any 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.

TRANSFER AGENT AND REGISTRAR

The transfer  agent and  registrar  for our ordinary  shares is Wells Fargo Bank
Minnesota N.A.

Material Contracts.

Stock Purchase  Agreement between Commtouch Software Ltd. and Rideau Ltd., dated
June 1, 2001

This  agreement  relates  to the  purchase  by Rideau  Ltd.  of  315,789  of the
Company's ordinary shares at $0.95 per share, for an aggregate purchase price of
$300,000.

Wingra Technologies, LLC 1998 Unit Option Agreement

Commtouch  assumed the above unit option agreement as part of its acquisition of
Wingra.

Form of Wingra Technologies, LLC Investor Option Agreement

Commtouch assumed the above investor option agreement as part of its acquisition
of Wingra.  This  agreement  was entered into by Wingra  prior to the  Commtouch
acquisition in relation to certain loans provided by investors.

Form of Wingra Technologies, LLC Investor Warrant Agreement

Commtouch   assumed  the  above  investor  warrant  agreement  as  part  of  its
acquisition  of Wingra.  This  agreement was entered into by Wingra prior to the
Commtouch acquisition in relation to certain loans provided by investors.

Stock Purchase  Agreement  between  Commtouch  Software Ltd. And Hughes Holdings
L.L.C., dated June 5, 2001

Pursuant to the  agreement  with  Hughes,  Commtouch  intended  to sell  850,000
ordinary  shares in increments of at least $250,000 worth of ordinary shares per
week.  Hughes was also  granted an option to  purchase an  additional  1,400,000
ordinary shares, plus warrant coverage of 10%. With the price per ordinary share
having  fallen  below  $0.75,  Hughes  had the  right  and chose not to fund the
transactions. Despite the above, the agreement has not formally terminated.

Agreement of Commercial  Lease between Am-Ram Pituah Drom Netanya (South Netanya
Development) Ltd. As Lessor and Commtouch  Software Ltd. As Lessee dated June 3,
2000 for premises in Netanya, Israel.

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<PAGE>
This is the  facilities  lease  agreement  for the  Israel  office  which  binds
Commtouch for a minimum period of three years.

Conditional Lease Termination Agreement between  EOP-Shoreline  Technology Park,
L.L.C. and Commtouch Inc. dated December 21, 2001

Pursuant to the  agreement  with EOP,  Commtouch and EOP agreed to terminate the
then existing facilities lease agreement. Within the framework of this agreement
Commtouch  made  certain  payments  to EOP,  assigned  rights  to a  sub-tenancy
agreement , transferred  ownership to certain furniture and issued a warrant for
175,000  ordinary  shares,   and  EOP  released  Commtouch  from  the  remainder
(approximately five years) of the lease term under the original agreement.

Settlement between Compaq Financial Services  Corporation and Commtouch Inc. and
Commtouch Software Ltd. dated December 21, 2001

Pursuant to the agreement with Compaq, Commtouch and Compaq, agreed to terminate
four separate  equipment  lease  schedules  under a master lease  agreement.  In
relation  thereto,  Commtouch  made  certain  payments  and returned the related
equipment to Compaq,  and Compaq  released  Commtouch  from the remainder of the
lease term.

Settlement and Termination of Services Agreement between Exodus  Communications,
Inc. and Commtouch Inc. dated January 10, 2002

Pursuant to the agreement with Exodus, Commtouch and Exodus, agreed to terminate
the  services  agreement  and  settle  on  an  amount  that  was  paid  in  full
satisfaction of all service fees claimed by Exodus.

Amended and Restated 1996 CSI Stock Option Plans and form of agreement.

In 1996, the Company adopted the 1996 CI Stock Option Plan for granting  options
to its U.S.  employees to purchase  ordinary shares of the Company.  The options
generally vest ratably over a 4-year  period,  though  certain  repriced  shares
offered to employees in a Tender Offer  Statement of July 20, 2001,  as amended,
vest over a three year period.  The exercise price of the options  granted under
the  individual  agreements may not be less than the nominal value of the shares
into which such  options are  exercisable.  Any options that are canceled or not
exercised within the options period become available for future grant.

Amended and Restated 1999 Section 3(i) Share Option Plan

In 1999 the Company  approved  the 1999  Section  3(i) Share Option Plan for its
Israeli   employees,   which  was  amended  in  2001  to  include   Section  102
applicability  (the sections  relate to code sections under the Israel tax law).
The options generally vest ratably over a 4-year period, though certain repriced
shares  offered to employees in a Tender  Offer  Statement of July 20, 2001,  as
amended,  vest over a three  year  period.  The  exercise  price of the  options
granted under the  individual  agreements may not be less than the nominal value
of the shares into which such  options  are  exercisable.  Any options  that are
canceled or not exercised  within the options period become available for future
grant.

Amended 1999 Non-Employee Directors Stock Option Plan

The Company  adopted the 1999  Non-Employee  Directors  Stock Option  Plan.  The
original allotment of shares was in the amount of 180,000 ordinary shares,  with
an additional  allotment in 2000 bringing the plan's total  allotment to 500,000
shares and a further  allotment  in 2001  bringing  the plan's  total to 750,000
ordinary  shares.  During 1999,  each  individual  who first joined the Board of
Directors  as a  non-employee  director  on or after the  effective  date of the
initial public offering  received an option grant for 10,000 shares.  Subsequent
to July 2000,  individuals  who joined the board  received  an initial  grant of
30,000   options.   Directors  who  are  reelected  at  the  annual  meeting  of
shareholders  are  generally  entitled to  additional  grants of 10,000  shares,
though  those  directors  reelected  at the August 22,  2001  annual  meeting of
shareholders  were  entitled to a grant of 33,750 and those  directors in office
immediately after the extraordinary  general meeting of shareholders on February
25, 2002 were granted a one-time option grant of 150,000 ordinary shares.  Also,
in  addition to the grant of shares for her  reelection  as a director in August
2001,  Carolyn  Chin,  on behalf of her  activities  as  Chairman  of the Board,

                                       38
<PAGE>
received an additional  grant of 221,250  ordinary  shares.  Each option granted
under the Non-Employee  Directors Plan originally was to have become exercisable
with respect to one-fourth of the number of shares  covered by such option three
months after the date of grant and with  respect to  one-third of the  remaining
shares  subject to the option  every  three  months  thereafter;  however,  this
changed  pursuant to an amendment to the plan  approved by  shareholders  at the
August  10,  2000  annual  meeting of  shareholders,  such that  options  become
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.  However,  certain  options  outstanding  and
unexercised at the time of the effective  date of the Tender Offer  Statement of
July 20, 2001, as amended,  were  repriced in  accordance  with the terms of the
Tender Offer Statement, as amended. Each option has a maximum term of ten years,
but will terminate earlier if the optionee ceases to be a member of the Board of
Directors.

Agreement of Merger  between CP Software  Group Inc.,  Commtouch  Software  Ltd,
MailCentro, Inc. and CPSGNEWCO, Inc. dated November 16, 2001

Within the framework of an agreement with MailCentro Inc.  ("MC"),  MC (a wholly
owned  subsidiary of CP Software  Group,  Inc.) assumed all aspects of servicing
most of the Company's consumer customers, including its free email service known
as Zap Zone  service.  According  to the  agreement  entered  into with MC,  the
Company  transferred  customers  to MC and is expected to realize  royalties  on
payments made by these former customers to MC (primarily in 2002). Additionally,
certain Commtouch trademarks, domain names, software licenses and equipment were
sold to MC.

Business  Unit  Purchase  Agreement  by  and  between  Telecomputing,  Inc.  and
Commtouch Inc.

In  January  2002,   Commtouch  sold  its  Hosted  Exchange   business  unit  to
Telecomputing,  Inc. Terms of the  transaction  include the  transference of the
Company's customer base and certain equipment to Telecomputing,  in exchange for
certain cash payments and royalties. Furthermore, the Company assigned equipment
leases to Telecomputing,  thereby  eliminating the Company's  obligation to make
lease payments thereunder.

Sale and Purchase  Agreement by and between Commtouch  Software Ltd.,  Commtouch
Inc., Wingra,  Incorporated,  Wingra  Technologies,  L.L.C., Jan Eddy and Steven
Entine

Commtouch  sold  off the net  liabilities  of its  migration  service  business,
Wingra,  Inc. to Wingra's  senior  management at the end of February  2002.  The
terms include mutual release of all  liabilities,  obligations and rights of the
parties  to the  agreement.  This  sale is  expected  to  reduce  our  Company's
operating losses and its net liabilities by approximately $0.7 million.

See the discussion  under Item 4  "Information  on the  Company--Description  of
Property" for an indication of where the Company's  Articles of Association  may
be inspected.

                    ISRAELI TAXATION AND INVESTMENT PROGRAMS

The  following  discussion  summarizes  the  material  Israeli tax  consequences
relating to Commtouch,  its  shareholders  and ownership and  disposition of its
ordinary  shares.  This  summary does not discuss all aspects of Israeli tax law
that  may be  relevant  to a  particular  investor  in  light  of  his  personal
investment  circumstances  or to certain  types of investors  subject to special
treatment under Israeli law (for example,  traders in securities or persons that
own,  directly or  indirectly,  10% or more of  Commtouch's  outstanding  voting
shares).  The following also includes a discussion of certain Israeli government
programs benefiting various Israeli businesses such as Commtouch.  To the extent
that the discussion is based on new legislation yet to be subject to judicial or
administrative  interpretation,  there  can  be  no  assurance  that  the  views
expressed herein will accord with any such  interpretation  in the future.  This
discussion  does not cover all  possible tax  consequences  or  situations,  and
investors  should  consult  their tax advisors  regarding  the tax  consequences
unique to their situation.

                                       39
<PAGE>
Proposed Tax Reform

On May 4,  2000,  a  committee  chaired by the  former  Director  General of the
Israeli  Ministry of Finance issued a report  recommending a sweeping  reform in
the Israeli system of taxation.  The proposed reform would  significantly  alter
the  taxation of  individuals,  and would also  affect  corporate  taxation.  In
particular,  the  proposed  reform  would  reduce,  but not  eliminate,  the tax
benefits  available to approved  enterprises  such as ours. The Israeli  cabinet
approved the  recommendations  in principle,  but  implementation  of the reform
requires  legislation  by  Israel's  Knesset.  In the  interim  there  have been
significant political and economic changes. On February 26, 2002 the Minister of
Finance  appointed a new committee to recommend tax reforms,  and this committee
is expected  to submit a report  within 90 days.  The Company  cannot be certain
whether the  proposed  reform  will be adopted,  when it will be adopted or what
form any reform will ultimately take.

General Corporate Tax Structure

The regular general corporate tax rate in Israel is 36%. However,  the effective
rate payable by a company which derives  income from an Approved  Enterprise (as
further   discussed   below)  may  be  considerably   less.  See  "Law  for  the
Encouragement of Capital Investments, 1959."

Taxation Under Inflationary Conditions

The  Income  Tax Law  (Adjustment  for  Inflation),  1985 (the  "Adjustment  for
Inflation  Law")  attempts to overcome  some of the  problems  experienced  in a
traditional tax system by an economy experiencing rapid inflation, which was the
case in  Israel  at the time  the  Adjustment  for  Inflation  Law was  enacted.
Generally,  the  Adjustment  for Inflation  Law was designed to  neutralize  for
Israeli tax purposes the erosion of capital  investments  in  businesses  and to
prevent  unintended tax benefits  resulting  from the deduction of  inflationary
financing expenses. The Adjustment for Inflation Law applies a supplementary set
of  inflationary  adjustments to a normal taxable profit  computed  according to
regular historical cost principles.

The  Adjustment  for  Inflation  Law  introduced  a special  adjustment  for the
preservation  of equity for tax  purposes  based on changes in the Israeli  CPI,
whereby corporate assets are classified broadly into fixed (inflation resistant)
assets and  non-fixed  assets.  Where  shareholders'  equity,  as defined in the
Adjustment for Inflation Law,  exceeds the depreciated  cost of fixed assets,  a
corporate  tax  deduction - which takes into account the effect of  inflationary
change on such excess - is allowed (up to a ceiling of 70% of taxable  income in
any single tax year, with the unused portion  permitted to be carried forward on
an  inflation-linked  basis with no ceiling).  If the depreciated  cost of fixed
assets exceeds  shareholders'  equity, then such excess multiplied by the annual
rate of inflation is added to taxable income.

In addition,  subject to certain  limitations,  depreciation on fixed assets and
loss carry  forwards are adjusted for inflation  based on changes in the Israeli
CPI. The net effect of the  Adjustment  for Inflation Law on Commtouch  might be
that  Commtouch's  taxable  income,  as  determined  for Israeli  corporate  tax
purposes, will be different from Commtouch's U.S. dollar income, as reflected in
its financial  statements,  due to the difference  between the annual changes in
the CPI and in the NIS exchange  rate with respect to the U.S.  Dollar,  causing
changes in the actual tax rate.

Law for the Encouragement of Industry (Taxes), 1969

Commtouch is currently  viewed as qualifying as an "Industrial  Company"  within
the  meaning of the Law for the  Encouragement  of Industry  (Taxes),  1969 (the
"Industry  Encouragement Law").  According to the Industry Encouragement Law, an
"Industrial Company" is a company resident in Israel, at least 90% of the income
of which in any tax year,  determined in Israeli  currency  (exclusive of income
from defense loans,  capital  gains,  interest and dividends) is derived from an
"Industrial  Enterprise" that it owns. An "Industrial  Enterprise" is defined by
that law as an enterprise whose major activity in a given tax year is industrial
production activity.

Included among the tax benefits for an Industrial Company are:

         o    deductions of 12.5% per annum of the purchase price of a patent or
              of know-how that is utilized in the  development or advancement of
              its enterprise;

         o    an election under certain conditions to file a consolidated return
              with additional related industrial companies;

         o    accelerated depreciation rates on equipment and buildings; and

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<PAGE>
         o    deduction  of  expenses  incurred  in  connection  with  a  public
              issuance of shares  listed for trading  over a three year  period.
              The tax  authorities may construe this benefit to be relevant only
              upon a public issuance of shares in Israel.

Eligibility for the benefits under the Industry Encouragement Law is not subject
to receipt of prior approval from any governmental  authority.  No assurance can
be given that  Commtouch is and will continue to be considered as an "Industrial
Company" or that the benefits described above will be available in the future.

Law for the Encouragement of Capital Investments, 1959

The Law for the  Encouragement  of Capital  Investments,  1959,  as amended (the
"Investment Law"),  provides that a capital investment in production  facilities
(or other eligible  facilities) may, upon  application to the Israel  Investment
Center,  be designated as an Approved  Enterprise.  Each certificate of approval
for an Approved  Enterprise  relates to a specific  capital  investment  program
delineated both by its financial scope,  including its capital sources,  and its
physical  characteristics,  i.e.  the  equipment  to be  purchased  and utilized
pursuant to the program.  The tax benefits  derived from any such certificate of
approval  relate only to taxable profits  attributable to the specific  Approved
Enterprise.

Commtouch's  investment  plans  have been  granted  the  status  of an  Approved
Enterprise under the Investment Law, in three separate investment programs,  one
of which was cancelled in early 2002.  These  programs  provide  Commtouch  with
certain  tax  benefits as  described  below;  with regard to the first  program,
Commtouch also received long-term loans guaranteed by the State of Israel. Under
the  terms  of  Commtouch's  Approved  Enterprise  programs,  income  earned  by
Commtouch from its Approved  Enterprises  will be tax exempt for a period of two
years,  commencing  with the year in which it first earns  taxable  income,  and
subject to a reduced  corporate tax rate of 10% to 25% for an additional  period
of five to eight years  (provided that the total period of tax benefits will not
extend past (i) 12 years from the year of  commencement of production or (ii) 14
years from the year of  approval  of approved  enterprise  status).  The reduced
corporate tax rate, to which  Commtouch's  Approved  Enterprise  program will be
subject,  is dependent on the level of foreign  investment in Commtouch.  In the
event a  company  operates  under  more  than one  approval  or only part of its
capital investments are approved (a "Mixed Enterprise"), its effective corporate
tax rate is the  result of a  weighted  combination  of the  various  applicable
rates.  Notwithstanding  these tax benefits,  to the extent  Commtouch  receives
income  from  countries  other  than  Israel,  such  income  may be  subject  to
withholding tax.

Dividends paid by companies owning approved enterprises,  the source of which is
income  derived  from an  approved  enterprise  during the  applicable  benefits
period,  are generally  taxed at a reduced rate of 15% if the dividends are paid
during  the  benefits  period or at any time up to 12 years  after the  benefits
period.  This tax must be withheld at source by the company paying the dividend.
In the case of a "foreign investor's company," the 12 year limitation on reduced
withholding tax on dividends does not apply.  Subject to various  conditions,  a
foreign investor's company is a company more than 25% of whose share capital, in
terms of shares, rights to profits, voting and appointment of directors,  and of
whose combined  share and loan capital,  is owned by  non-Israeli  residents.  A
dividend paid from income  derived from an  enterprise  owned by a company which
has elected the "alternative  benefits program" during the period in which it is
exempt  from tax is also  generally  subject  to the 15.0% tax rate;  this would
render the company liable for corporate tax on the amount distributed,  which is
defined  for this  purpose as  including  the amount of the  corporate  tax that
applies  as a result  of the  distribution,  at the rate  that  would  have been
applicable had the company not elected the alternative  benefits program,  which
is generally 25.0%.  Generally,  any dividends  distributed are considered to be
attributable to the entire enterprise,  and the effective tax rate is the result
of a weighted  combination  of the  various  applicable  tax rates.  However,  a
company may elect to attribute any dividend distributed by it only to income not
subject to the alternative benefits program.

The Investment  Law also provides that a company with an Approved  Enterprise is
entitled to accelerated  depreciation on its property and equipment  included in
an approved investment program.

Future  applications to the Investment Center will be reviewed  separately,  and
decisions as to whether or not to approve such applications will be based, among
other things,  on the then prevailing  criteria set forth in the Investment Law,
on  the  specific  objectives  of  the  applicant  company  set  forth  in  such
applications  and  on  certain  financial  criteria  of the  applicant  company.
Accordingly,  there  can be no  assurance  that  any such  applications  will be
approved.  In addition,  the benefits  available to an Approved  Enterprise  are
conditional  upon  the  fulfillment  of  certain  conditions  stipulated  in the
Investment  Law and its  regulations  and the criteria set forth in the specific

                                       41
<PAGE>
certificate of approval,  as described above. In the event that these conditions
are violated,  in whole or in part,  the Company would be required to refund the
amount of tax  benefits,  with the  addition of the CPI linkage  adjustment  and
interest.

Capital Gains and Income Taxes Applicable to Non-Israeli Resident Shareholders

Under  existing   regulations   any  capital  gain  realized  by  an  individual
shareholder with respect to the ordinary shares acquired on or after the listing
of such shares for trading will be exempt from Israeli  capital gains tax if the
ordinary  shares are listed on an  approved  foreign  securities  market  (which
includes  Nasdaq in the United States),  provided that the company  continues to
qualify as an Industrial  Company under Israeli law and provided the  individual
does not hold such shares for business purposes.

If we do not maintain our status as an Industrial  Company,  then subject to any
applicable tax treaty the Israeli capital gains tax rates would be up to 50% for
non-Israeli resident  individuals and 36% for companies.  Upon a distribution of
dividends  other than bonus shares  (stock  dividends),  income tax is generally
withheld  at source at the rate of 25% (or the lower  rate of 15%  payable  with
respect to Approved  Enterprises),  unless double  taxation  treaty is in effect
between  Israel and the  shareholder's  country of residence that provides for a
lower tax rate in Israel on dividends.

A tax treaty between the United States and Israel (the "Treaty"), provides for a
maximum  tax of 25% on  dividends  paid to a resident  of the United  States (as
defined in the Treaty).  Dividends distributed by an Israeli company and derived
from  the  income  of an  approved  enterprise  are  subject  to a 15%  dividend
withholding  tax. The Treaty  further  provides  that a 12.5%  Israeli  dividend
withholding tax applies to dividends paid to a United States  corporation owning
10% or more of an Israeli company's voting shares throughout the current year to
the date the dividend is paid and the  preceding  taxable year (as  applicable).
The 12.5% rate applies  only on  dividends  from a company that does not have an
Approved Enterprise in the applicable period.

If for any reason  shareholders do not receive the above exemption for a sale of
shares in an Industrial  Company,  the Treaty provides U.S.  resident  investors
with an exemption from Israeli capital gains tax in certain circumstances (there
may still be U.S.  taxes) upon a disposition of shares in Commtouch if they held
under 10% of the  Company's  voting stock  throughout  the 12 months  before the
share disposition.  If Israeli capital gains tax is payable,  it can be credited
against U.S. federal tax under the circumstances specified in the Treaty.

A  non-resident  of Israel  who has had  dividend  income  derived or accrued in
Israel from which the applicable tax was withheld at source is currently  exempt
from the duty to file an annual  Israeli tax return with respect to such income,
provided  such  income was not derived  from a business  carried on in Israel by
such  non-resident and that such  non-resident does not derive other non-passive
income from sources in Israel.

Tax Benefits for Research and Development

Israeli tax law allows  under  certain  conditions  a tax  deduction in the year
incurred for expenditures in scientific  research and development  projects,  if
the  expenditures  are  approved by the  relevant  Israeli  Government  Ministry
(determined  by the field of research) and the research and  development  is for
the promotion of the  enterprise.  Expenditures  not so approved are  deductible
over a  three-year  period.  However,  expenditures  made out of the proceeds of
government grants are not deductible,  i.e. Commtouch will be able to deduct the
unfunded portion of the research and development  expenditures and not the gross
amount.

Law for the Encouragement of Industrial Research and Development, 1984

Under the Law for the Encouragement of Industrial Research and Development, 1984
(the  "Research  Law")  and the  Instructions  of the  Director  General  of the
Ministry of Industry and Trade,  research and development programs and the plans
for the intermediate  stage between research and development,  and manufacturing
and sales approved by a governmental  committee of the Office of Chief Scientist
(OCS) (the  "Research  Committee")  are  eligible for grants of up to 50% of the
project's expenditure if they meet certain criteria.  These grants are issued in
return for the payment of royalties  from the revenues  derived from the sale of
the product developed in accordance with the program, as follows: 3% of revenues
during the first three years,  4% of revenues  during the following three years,
and 5% of revenues in the seventh year and thereafter,  with the total royalties
not to exceed 100% of the dollar  value of the OCS grant (or in some cases up to
300%).  Following  the full  payment  of such  royalties,  there  is no  further
liability for payment.

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<PAGE>
The Israeli  government further requires that products developed with government
grants be manufactured in Israel.  However, in the event that any portion of the
manufacturing is not conducted in Israel,  if approval is received from the OCS,
the Company would be required to pay  royalties  that are adjusted in proportion
to  manufacturing  outside  of  Israel as  follows:  when the  manufacturing  is
performed  outside  of  Israel  by the  Company  or an  affiliate  company,  the
royalties  are to be paid as  described  above with the addition of 1%, and when
the  manufacturing  outside  of Israel is not  performed  by the  Company  or an
affiliate the royalties  paid shall be equal to the ratio of the amount of grant
received  from the OCS divided by the amount of grant  received from the OCS and
the investment(s)  made by the Company in the project.  The payback will also be
adjusted to 120%, 150% or 300% of the grant if the portion of manufacturing that
is performed  outside of Israel is up to 50%,  between 50% and 90%, or more than
90%,  respectively.  The  technology  developed  pursuant  to the terms of these
grants may not be transferred to third parties without the prior approval of the
Research Committee. Such approval is not required for the export of any products
resulting  from such  research  or  development.  Approval  of the  transfer  of
technology may be granted only if the recipient  abides by all the provisions of
the  Research  Law  and  regulations  promulgated   thereunder,   including  the
restrictions  on the transfer of know-how and the obligation to pay royalties in
an amount that may be increased. The Company is subject to various provisions of
the Research Law and regulations and derivatives thereunder.

In order to meet certain  conditions in connection  with the grants and programs
of the  OCS,  the  Company  has  made  certain  representations  to  the  Israel
government  about the Company's  future plans for its Israeli  operations.  From
time to time the extent of the Company's Israeli operations has differed and may
in the future differ,  from the Company's  representations.  If, after receiving
grants  under  certain  of such  programs,  the  Company  fails to meet  certain
conditions to those  benefits,  including,  with respect to grants received from
the OCS, the  maintenance of a material  preserve in Israel,  or if there is any
material deviation from the  representations  made by the Company to the Israeli
government, the Company could be required to refund to the State of Israel taxes
or other  benefits  previously  received  (including  interest  and CPI  linkage
difference)  and would likely be denied receipt of such grants or benefits,  and
participation of such programs, thereafter.

The Company has participated in programs sponsored by the OCS for the support of
research and development activities.  Through December 31, 2001, the Company had
recorded grants from OCS aggregating  approximately  $1.2 million for certain of
the Company's research and development projects. These grants were recorded as a
reduction of research and development  costs. As noted,  the Israeli  government
requires beneficiaries of such grants to pay royalties to the Israeli government
based  on the  revenues  derived  from the sale of  products,  technologies  and
services  developed with such grants.  We believe that we have no obligation for
royalties  in  2001,  related  to the  2001  grants,  since  we had not  started
generating  revenue for the product developed with such grants,  but we may have
obligations  for royalties in 2002 and future years. As of December 31, 2001, we
believe we have contingent  liabilities of $0.6 million for royalties to the OCS
regarding the 2001 grants.

With  regard  to  grants  before  2001,  the  Company  claims  that all of these
programs, which were funded at a total of $0.6 million, had failed and therefore
it will not be obligated to pay royalties.  In March 2002, the Company submitted
an application for project  failure with regard to these projects.  Accordingly,
the Company  decided to write down the $0.4 million  accrual it recorded in past
years  and  determined  that as of  December  31,  2001  there is no  contingent
liabilities for royalties for those projects.

Each application to the OCS is reviewed separately,  and grants are based on the
program approved by the Research Committee.  Expenditures  supported under other
incentive  programs of the State of Israel are not eligible for OCS grants. As a
result,  there can be no assurance that applications to the OCS will be approved
or, if  approved,  what the amounts of the grants will be. On January 31,  2001,
the Company submitted an application to the OCS. In the application, the Company
described  relevant R&D expenses  for the year 2001  amounting to  approximately
$3.2 million, which would entitle it to funding up to 50% of those expenses upon
approval of the application.  The application was approved on May 8, 2001. Under
this program, Commtouch has received the sum of $0.6 million in 2001.

Fund for the Encouragement of Marketing Activities

The Company has received grants relating to its overseas marketing expenses from
the Marketing Fund. These grants are awarded for specific  expenses  incurred by
the Company for overseas  marketing and are based upon the expenses  reported by
the Company to the  Marketing  Fund.  All  marketing  grants  recorded  from the
Marketing  Fund  until  1997 are  linked  to the  dollar  and are  repayable  as
royalties at the rate of 3% of the amount of increases in export sales  realized

                                       43
<PAGE>
by the Company from the Marketing  Fund.  Grants recorded  beginning  January 1,
1998 bear  royalties of 4% plus  interest at LIBOR rates.  The Company will face
royalty  obligations  on grants  from the  Marketing  Fund only to the extent it
actually  achieves  increases in export sales.  The proceeds of these grants are
presented  in the  Company's  consolidated  Financial  Statements  as offsets to
marketing  expenses.  Through December 31, 2000, the Company had received grants
from the Marketing Fund in the amount of approximately $279,000.

  U.S. TAX CONSIDERATIONS REGARDING ORDINARY SHARES ACQUIRED BY U.S. TAXPAYERS

The  following  discussion  summarizes  the  material  U.S.  federal  income tax
consequences  arising  from the  purchase,  ownership  and sale of the  ordinary
shares.  This summary is based on the provisions of the Internal Revenue Code of
1986, as amended (the  "Code"),  final,  temporary  and proposed  U.S.  Treasury
Regulations   promulgated   thereunder,    and   administrative   and   judicial
interpretations  thereof,  in effect as of the date of this report, all of which
are subject to change, possibly with retroactive effect. Commtouch will not seek
a ruling from the  Internal  Revenue  Service  with regard to the United  States
federal income tax treatment  relating to investment in the ordinary shares and,
therefore, no assurance exists that the Internal Revenue Service will agree with
the conclusions  set forth below.  The summary below does not purport to address
all  federal  income  tax  consequences  that  may  be  relevant  to  particular
investors. This summary does not address the consequences that may be applicable
to  particular  classes of  taxpayers,  including  investors  that hold ordinary
shares  as  part of a  hedge,  straddle  or  conversion  transaction,  insurance
companies,  banks or other financial  institutions,  broker-dealers,  tax-exempt
organizations   and   investors  who  own   (directly,   indirectly  or  through
attribution) 10% or more of Commtouch's  outstanding voting stock.  Further,  it
does not address the  alternative  minimum tax  consequences of an investment in
ordinary shares or the indirect  consequences to U.S. Holders, as defined below,
of equity interests in investors in ordinary  shares.  This summary is addressed
only to holders that hold ordinary  shares as a capital asset within the meaning
of Section  1221 of the Code,  are U.S.  citizens,  individuals  resident in the
United States for purposes of U.S. federal income tax, domestic  corporations or
partnerships  and estates or trusts  treated as "United  States  persons"  under
Section 7701 of the Code ("U.S. Holders").

EACH  INVESTOR  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.

Tax Basis of Ordinary Shares

A U.S.  Holder's  tax basis in his or her  ordinary  shares will be the purchase
price paid  therefore by such U.S.  Holder.  The holding period of each ordinary
share owned by a U.S.  Holder will commence on the day following the date of the
U.S.  Holder's purchase of such ordinary share and will include the day on which
such U.S. Holder sells the ordinary share.

Sale or Exchange of Ordinary Shares

A U.S.  Holder's  sale  or  exchange  of  ordinary  shares  will  result  in the
recognition  of gain or loss by such  U.S.  Holder  in an  amount  equal  to the
difference  between  the  amount  realized  and the U.S.  Holder's  basis in the
ordinary shares sold. Subject to the following discussion of the consequences of
Commtouch  being treated as a Passive  Foreign  Investment  Company or a Foreign
Investment  Company,  such  gain or loss  will be  capital  gain or loss if such
ordinary  shares are a capital  asset in the hands of the U.S.  Holder.  Gain or
loss realized on the sale of ordinary  shares will be long-term  capital gain or
loss if the  ordinary  shares  sold had been  held for more than one year at the
time of their sale.  Long-term  capital gains  recognized  by certain  taxpayers
generally  are subject to a reduced rate of federal tax  (currently a maximum of
20%). If the U.S.  Holder's  holding  period on the date of the sale or exchange
was one year or less, such gain or loss will be short-term capital gain or loss.
Short-term  capital  gains  generally  are  subject  to tax at the same rates as
ordinary income.  In general,  any capital gain recognized by a U.S. Holder upon
the sale or exchange of ordinary  shares will be treated as  U.S.-source  income
for U.S. foreign tax credit purposes.

See discussion under "Israeli  Taxation and Investment  Programs--Capital  Gains
and Income Taxes  Applicable to  Non-Israeli  Shareholders"  for a discussion of
taxation by Israel of capital gains realized on sales of capital assets.

                                       44
<PAGE>
Treatment of Dividend Distributions

For U.S. federal income tax purposes,  gross dividends  (including the amount of
any Israeli taxes withheld  therefrom) paid to a U.S. Holder with respect to his
or her  ordinary  shares will be included in his or her  ordinary  income to the
extent made out of current or accumulated earnings and profits of Commtouch,  as
determined based on U.S. tax principles,  at the time the dividends are received
and will be treated as  foreign  source  dividend  income  for  purposes  of the
foreign  tax credit  limitation  described  below.  Such  dividends  will not be
eligible for the dividends received deduction allowed to U.S. corporations under
Section 243 of the Code. Dividend distributions in excess of Commtouch's current
and  accumulated  earnings  and profits will be treated  first as a  non-taxable
return  of the U.S.  Holder's  tax  basis in his or her  ordinary  shares to the
extent  thereof and then as a gain from the sale of ordinary  shares.  Dividends
paid in NIS will be  includible  in income in a U.S.  dollar amount based on the
exchange rate at the time of their receipt,  and any gain or loss resulting from
currency  fluctuations during the period from the date a dividend is paid to the
date such payment is converted  into U.S.  dollars  generally will be treated as
ordinary income or loss.

Any Israeli withholding tax imposed on dividends paid to a U.S. Holder will be a
foreign income tax eligible for credit against such U.S.  Holder's U.S.  federal
income  tax  liability  subject to certain  limitations.  Alternatively,  a U.S.
Holder may claim a  deduction  for such  amount,  but only for a year in which a
U.S.  Holder  elects to do so with  respect to all  foreign  income  taxes.  The
overall limitation on foreign taxes eligible for credit is calculated separately
with respect to specific classes of income.  Dividends  distributed by Commtouch
with respect to ordinary  shares will  generally  constitute  "passive  income".
Foreign income taxes exceeding the credit  limitation for the year of payment or
accrual may be carried  back for two taxable  years and forward for five taxable
years in order to reduce  U.S.  federal  income  taxes,  subject  to the  credit
limitation  applicable in each of such years.  Other restrictions on the foreign
tax  credit  include a general  prohibition  on the use of the  credit to reduce
liability for the U.S.  individual and corporation  alternative minimum taxes by
more than 90% and an  allowance of foreign tax credits for  alternative  minimum
tax purposes only to the extent of  foreign-source  alternative  minimum taxable
income.  See "Israeli  Taxation  and  Investment  Programs -- Capital  Gains and
Income Taxes Applicable to Non-Israeli Shareholders."

Information Reporting and Backup Withholding

Any dividends paid on, or proceeds  derived from a sale of, the ordinary  shares
to,  or  by,  U.S.  Holders  may  be  subject  to  U.S.  information   reporting
requirements and the 30% U.S. backup  withholding tax unless the holder (i) is a
corporation or other exempt  recipient or (ii) provides a United States taxpayer
identification  number,  certifies  as to  no  loss  of  exemption  from  backup
withholding and otherwise complies with any applicable withholding requirements.
Any amounts withheld under the U.S. backup withholding tax rules will be allowed
as a refund or a credit  against  the U.S.  Holder's  U.S.  federal  income tax,
provided the required  information  is  furnished to the U.S.  Internal  Revenue
Service.

Tax Status of Commtouch for U.S. Federal Income Tax Purposes

Passive  Foreign  Investment  Company.  If Commtouch were deemed to be a passive
foreign investment company (a "PFIC") for U.S. federal income tax purposes,  any
gain  recognized  by a U.S.  Holder  upon the sale of  ordinary  shares  (or the
receipt of certain distributions) generally would be treated as ordinary income,
such income would be allocated over such U.S.  Holder's  holding period for such
ordinary  shares  and an  interest  charge  would be  imposed  on the  amount of
deferred  tax on  such  income  which  is  allocated  to  prior  taxable  years.
Generally,  Commtouch will be treated as a PFIC for any tax year if, in such tax
year or any  prior  tax  year,  either  (i) 75% or more of its  gross  income is
passive  in  nature,  or (ii) on  average,  50% or more of its  assets  by value
produce or are held for the  production of passive  income.  Commtouch  does not
believe it satisfies either of the tests for PFIC status for any of its pre-2002
tax years.  Commtouch  expects that the majority of its assets will  continue to
generate  sufficient  levels of active income,  and the percentage (by value) of
its assets not  producing  or held for the  production  of passive  income  will
continue  to be  sufficient,  for it to avoid PFIC  treatment  for U.S.  federal
income tax purposes in post-2001  tax years.  However,  since the  determination
whether  Commtouch  is  a  PFIC  will  be  made  annually  based  on  facts  and
circumstances that, to some extent, may be beyond Commtouch's control, there can
be no  assurance  that  Commtouch  will not  become  a PFIC at some  time in the
future. If Commtouch were determined to be a PFIC,  however, a U.S. Holder could
elect to treat his or her ordinary shares as an interest in a qualified electing
fund (a "QEF  Election"),  in which case,  the U.S.  Holder would be required to
include  in  income  currently  his or her  proportionate  share of  Commtouch's
earnings  and  profits  in years in which  Commtouch  is a PFIC  whether  or not
distributions  of such  earnings  and  profits  are  actually  made to such U.S.
Holder,  but any gain subsequently  recognized upon the sale by such U.S. Holder
of his or her  ordinary  shares  generally  would be taxed  as a  capital  gain.
Alternatively,  a U.S.  Holder may elect to mark the  ordinary  shares to market
annually,  recognizing  ordinary income or loss (subject to certain limitations)
equal to the difference between the fair market value of its ordinary shares and
the  adjusted  basis of such  stock.  See  "U.S.  Tax  Considerations  Regarding

                                       45
<PAGE>
Ordinary Shares Acquired by U.S. Taxpayers--Sale or Exchange of Ordinary Shares"
above.  U.S.  Holders should  consult with their own tax advisers  regarding the
eligibility,  manner and  advisability  of making a QEF Election if Commtouch is
treated as a PFIC.

Controlled  Foreign  Corporations.  Sections 951 through 964 and Section 1248 of
the Code relate to controlled foreign  corporations  ("CFC"). The CFC provisions
may impute some portion of such a corporation's  undistributed income to certain
U.S.  shareholders  on a current  basis and convert  into  dividend  income some
portion of gains on  dispositions  of stock  which would  otherwise  qualify for
capital gains treatment.  In general, the CFC provisions will apply to Commtouch
only if U.S.  shareholders,  who are  U.S.  Holders  and who  own,  directly  or
indirectly or by attribution,  10% or more of the total combined voting power of
all  classes of voting  stock own in the  aggregate  (or are deemed to own after
application  of complex  attribution  rules) more than 50%  (measured  by voting
power or value) of the outstanding ordinary shares of Commtouch.  It is possible
that  Commtouch  could  become  a CFC in the  future.  Even  if  Commtouch  were
classified as a CFC in a future year,  however,  the CFC rules referred to above
would apply only with respect to U.S. shareholders, who are U.S. Holders and who
own, directly or indirectly or by attribution, 10% or more of the total combined
voting power of all classes of voting stock of Commtouch.

Personal Holding  Company/Foreign  Personal Holding  Company/Foreign  Investment
Company.  A corporation will be classified as a personal  holding company,  or a
PHC, if (i) five or fewer  individuals at any time during the last half of a tax
year (without regard to their  citizenship or residence)  directly or indirectly
or by attribution own more than 50% in value of the corporation's stock and (ii)
at least 60% of its  ordinary  gross income for the taxable  year,  as specially
adjusted,  consists of personal  holding  company income  (defined  generally to
include dividends, interest, royalties, rents and certain other types of passive
income).  A PHC is subject to a United States federal income tax of 38.6% on its
undistributed personal holding company income (generally limited, in the case of
a foreign corporation, to United States source income).

A corporation will be classified as a foreign  personal  holding company,  or an
FPHC,  and  not a PHC if at any  time  during  a tax  year  (i)  five  or  fewer
individual  United  States  citizens or residents  directly or  indirectly or by
attribution own more than 50% of the total combined voting power or value of the
corporation's  stock and (ii) at least 60% of its gross income  consists of (50%
for years  following  the first  year it becomes a FPHC)  FPHC  income  (defined
generally to include  dividends,  interest,  royalties,  rents and certain other
types of passive income).  Each United States shareholder in an FPHC is required
to include in gross  income,  as a dividend,  an  allocable  share of the FPHC's
undistributed  foreign  personal  holding company income  (generally the taxable
income of the FPHC, as specially adjusted).

A corporation will be classified as a foreign investment  company, or an FIC, if
for any taxable year it (i) is registered  under the  Investment  Company Act of
1940, as amended, as a management company or unit investment trust or is engaged
primarily in the business of investing or trading in securities  or  commodities
(or any  interest  therein) and (ii) 50% or more of the total value or the total
combined  voting  power  of all  classes  of the  corporation's  stock  is owned
directly or  indirectly  (including  stock  owned  through  the  application  of
attribution rules) by United States persons. In general, unless an FIC elects to
distribute 90% or more of its taxable income (determined under United States tax
principles as specially  adjusted) to its shareholders,  any gain on the sale or
exchange  of stock in a foreign  corporation  which was a FIC at any time during
the period during which a taxpayer held such stock is treated as ordinary income
(rather than capital gain) to the extent of such shareholder's  ratable share of
the corporation's accumulated earnings and profits.

                              CONDITIONS IN ISRAEL

Commtouch  is  incorporated   under  the  laws  of  the  State  of  Israel,  and
substantially  all of our research and  development  and  significant  executive
facilities are located in Israel. Accordingly, Commtouch is directly affected by
political,  economic and military  conditions in Israel. Our operations would be
materially adversely affected if major hostilities involving Israel should occur
or if trade between Israel and its present trading partners should be curtailed.

Political Conditions

Since  the  establishment  of the  State of  Israel  in 1948,  a number of armed
conflicts  have taken place between  Israel and its Arab  neighbors.  A state of
hostility,  varying  from  time to  time in  intensity  and  degree,  has led to
security and economic  problems for Israel.  Despite a peace  agreement  between
Israel and Egypt signed in 1979,  a peace  agreement  between  Israel and Jordan
signed  in  1994  and,  since  1993,   several  agreements  between  Israel  and

                                       46
<PAGE>
Palestinian  representatives,  Israel  continues  to face  hostile  actions  and
threats from  various  elements in the region.  Further,  Israel has not entered
into any peace  agreement  with  Syria or  Lebanon,  and there  have been  major
difficulties  accompanied by violence in the negotiations with the Palestinians.
We cannot be certain as to how the current hostilities affecting the region will
develop or what effect they may have upon Commtouch.

Certain  countries,  companies and  organizations  continue to  participate in a
boycott of Israeli firms.  Commtouch does not believe that the boycott has had a
material  adverse  effect  on  Commtouch,  but  restrictive  laws,  policies  or
practices  directed  towards  Israel or Israeli  businesses  may have an adverse
impact on the expansion of Commtouch's business.

Generally,  all male adult citizens and permanent  residents of Israel under the
age of 51 are  obligated  to  perform  up to 39 days,  or longer  under  certain
circumstances,  of  military  reserve  duty  annually.  Additionally,  all  such
residents are subject to being called to active duty at any time under emergency
circumstances. Currently, a majority of our officers and employees are obligated
to perform annual reserve duty. While we have operated  effectively  under these
requirements since we began operations, no assessment can be made as to the full
impact of such  requirements  on our workforce or business if conditions  should
change, and no prediction can be made as to the effect on us of any expansion or
reduction of such obligations.

Economic Conditions

Israel's economy has been subject to numerous destabilizing factors, including a
period of rampant  inflation  in the early to  mid-1980s,  low foreign  exchange
reserves,  fluctuations in world commodity prices,  military conflicts and civil
unrest. The Israeli  government has, for these and other reasons,  intervened in
various  sectors  of the  economy,  employing,  among  other  means,  fiscal and
monetary policies,  import duties, foreign currency restrictions and controls of
wages,  prices and foreign currency  exchange rates. The Israeli  government has
periodically changed its policies in all these areas.

Until May 1998, Israel imposed restrictions on transactions in foreign currency.
These  restrictions  affected our  operations in various ways, and also affected
the right of  non-residents  of Israel to convert into foreign  currency amounts
they received in Israeli  currency,  such as the proceeds of a judgment enforced
in Israel.  Despite these  restrictions,  foreign investors who purchased shares
with foreign currency were able to repatriate in foreign currency both dividends
(after  deduction  of  withholding  tax) and the  proceeds  from the sale of the
shares.  There  are  currently  no  Israeli  currency  control  restrictions  on
remittances of dividends on the ordinary shares or the proceeds from the sale of
the shares;  however,  legislation  remains in effect pursuant to which currency
controls can be imposed by administrative action at any time.

Trade Agreements

Israel is a member of the United Nations,  the International  Monetary Fund, the
International  Bank for  Reconstruction  and Development  and the  International
Finance  Corporation.  Israel is also a signatory  to the General  Agreement  on
Tariffs and Trade,  which  provides for  reciprocal  lowering of trade  barriers
among its members.  In addition,  Israel has been granted  preferences under the
Generalized  System of  Preferences  from  Australia,  Canada and  Japan.  These
preferences  allow Israel to export the products covered by such programs either
duty-free or at reduced tariffs.

Israel has entered into  preferential  trade agreements with the European Union,
the United  States and the European  Free Trade  Association.  In recent  years,
Israel has established commercial and trade relations with a number of the other
nations, including Russia, China and India, with which Israel had not previously
had such relations.

Assistance from the United States

Israel receives significant amounts of economic and military assistance from the
United States, averaging approximately $3 billion annually over the last several
years.  In addition,  in 1992, the United States  approved the issuance of up to
$10 billion of loan  guarantees  during U.S.  fiscal  years 1993 to 1998 to help
Israel absorb a large influx of new immigrants,  primarily from the republics of
the former Soviet Union. Under the loan guarantee  program,  Israel may issue up
to $2 billion in  principal  amount of  guaranteed  loans each year,  subject to
reduction in certain circumstances.  There is no assurance that foreign aid from
the United States will continue at or near amounts  received in the past. If the
grants for economic and military assistance or the United States loan guarantees
are  eliminated  or reduced  significantly,  the Israeli  economy  could  suffer
material adverse consequences.

                                       47
<PAGE>
Item 11. Qualitative and Quantitative Disclosure about Market Risk.

We develop our  technology  in Israel and seek to provide our software  products
worldwide.  As a result, our financial results could be affected by factors such
as changes in foreign  currency  exchange  rates or weak economic  conditions in
foreign  markets.  As most of our sales are currently  made in U.S.  dollars,  a
strengthening  of the dollar could make our services less competitive in foreign
markets.  Due to the nature and level of our debts, we have concluded that there
is  currently  no material  market risk  exposure.  Therefore,  no  quantitative
tabular disclosures are required.

Item 12. Description of Securities Other than Equity Securities.

Not applicable.

                                     PART II

Item 13. Defaults, Dividend Arrearages and Delinquencies.

Not applicable.

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

Not applicable.

Item 15. Reserved

Item 16. Reserved

                                       48
<PAGE>

                                    PART III

Item 17. Financial Statements.

The Company has responded to Item 18.

Item 18. Financial Statements

    (a) Financial Statements

                                                                     Page
                                                                     ----
        Report of Independent Auditors.......................        F-1
        Consolidated Balance Sheets..........................        F-2
        Consolidated Statements of Operations................        F-3
        Statement of Changes in Shareholders' Equity.........        F-4
        Consolidated Statements of Cash Flows................        F-5
        Notes to Consolidated Financial Statements...........        F-8

    (b) Financial Statement Schedule:

The following  financial  statement schedule of Commtouch Software Ltd. for each
of the three years in the period ended December 31, 2001 is filed as part of the
Annual Report and should be read in conjunction with the consolidated  financial
statements of Commtouch Software, Ltd.

    Schedule II --Valuation and Qualifying Accounts

    Schedules  not  listed  above  have been  omitted  because  the  information
required  to be  set  forth  therein  is  not  applicable  or is  shown  in  the
consolidated financial statements or notes thereto.

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.

                                       49
<PAGE>

                         REPORT OF INDEPENDENT AUDITORS

To the Shareholders of COMMTOUCH SOFTWARE LTD.

We have  audited  the  accompanying  consolidated  balance  sheets of  Commtouch
Software Ltd. ("the  Company") and its  subsidiaries as of December 31, 2000 and
2001,  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, 2001.  Our audits also  included  the  financial  statement
schedules  listed in the Index at item 18(b).  These  financial  statements  and
schedules are the responsibility of the Company's management. Our responsibility
is to express an opinion on these  financial  statements and schedules  based on
our audits.

We  conducted  our  audits  in  accordance  with  generally   accepted  auditing
standards,  in the  United  States.  Those  standards  require  that we plan and
perform the audit to obtain  reasonable  assurance  about  whether the financial
statements are free of material misstatements. An audit includes examining, on a
test basis,  evidence  supporting  the amounts and  disclosures in the financial
statements.  An audit also includes assessing the accounting principles used and
significant  estimates made by the Company's  management,  as well as evaluating
the  overall  financial  statements  presentation.  We  believe  that our audits
provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above, present
fairly,  in all  material  respects,  the  consolidated  financial  position  of
Commtouch  Software Ltd. and its  subsidiaries as of December 31, 2000 and 2001,
and the consolidated  results of their operations and cash flows for each of the
three years in the period ended December 31, 2001, in conformity with accounting
principles  generally accepted in the United States.  Also, in our opinion,  the
related financial statment  schedules,  when considered in relation to the basic
financial  statements  taken as a whole,  present fairly in all material respect
the information set forth therein.

Tel-Aviv, Israel
February 27, 2002

                                              KOST, FORER & GABBAY
                                   A Member of Ernst & Young International

                                      F-1
<PAGE>
                             COMMTOUCH SOFTWARE LTD.

                           CONSOLIDATED BALANCE SHEETS
               (USD in thousands, except share and per share data)
<TABLE>
<CAPTION>
                                                                                 December 31,
                                                                            ----------------------
                                                                               2000         2001
                                                                            ---------    ---------
<S>                                                                         <C>          <C>
Assets
Current Assets:
 Cash and cash equivalents ..............................................   $  20,831    $   2,248
 Marketable securities ..................................................       8,607         --
 Trade receivables, net .................................................       4,355          864
 Prepaid expenses and other accounts receivable .........................       3,626          700
                                                                            ---------    ---------
 Total current assets ...................................................      37,419        3,812
                                                                            ---------    ---------
Long-term lease deposits ................................................       1,440          261
Severance pay fund ......................................................         949          320
Property and equipment, net .............................................      19,417        5,152
Long-term investment ....................................................       2,000         --
Goodwill and other purchased intangibles, net ...........................      16,055         --
                                                                            ---------    ---------
                                                                            $  77,280    $   9,545
                                                                            ---------    ---------
Liabilities and Shareholders' Equity
Current Liabilities:
 Bank credit line and current maturities of bank loans and capital leases   $   1,115    $     799
 Accounts payable .......................................................       4,205        1,374
 Employees and payroll accruals .........................................       3,279          633
 Deferred revenues ......................................................       1,523          839
 Accrued expenses and other liabilities .................................       3,529          774
                                                                            ---------    ---------
 Total current liabilities ..............................................      13,651        4,419
                                                                            ---------    ---------

 Long-term maturities of bank loans and capital leases ..................         841          260
 Other liabilities ......................................................        --            255
 Accrued severance pay ..................................................         984          425
                                                                            ---------    ---------
                                                                                1,825          940
                                                                            ---------    ---------
 Minority interest ......................................................          76          127
                                                                            ---------    ---------
Commitments and Contingencies

Shareholders' Equity
 Ordinary Shares, nominal value NIS 0.05 par value-
 Authorized: 40,000,000 shares as of
 December 31, 2000 and 2001; Issued and
 outstanding: 16,925,022 and 17,496,819 shares
 as of December 31, 2000 and 2001, respectively .........................         236          239
 Additional paid-in capital .............................................     150,994      152,162
 Deferred stock compensation ............................................      (2,729)        (828)
 Notes receivable from shareholders .....................................      (1,041)        (754)
 Accumulated other comprehensive income .................................          21         --
 Accumulated deficit ....................................................     (85,753)    (146,760)
                                                                            ---------    ---------
 Total shareholders' equity .............................................      61,728        4,059
                                                                            ---------    ---------
                                                                            $  77,280    $   9,545
                                                                            =========    =========
</TABLE>
The  accompanying  notes are an integral  part of these  consolidated  financial
statements.

                                      F-2
<PAGE>
                             COMMTOUCH SOFTWARE LTD.

                      CONSOLIDATED STATEMENTS OF OPERATIONS
                    (USD in thousands, except per share data)
<TABLE>
<CAPTION>
                                                                             Year ended
                                                                             December 31,
                                                                  --------------------------------
                                                                    1999        2000      2001
                                                                  --------    --------    --------
<S>                                                               <C>         <C>         <C>
Revenues:
 Email services ...............................................   $  4,251    $ 17,965    $ 14,697
 Software licenses ............................................       --         1,150         621
                                                                  --------    --------    --------
 Total revenues ...............................................      4,251      19,115      15,318
                                                                  --------    --------    --------
Cost of revenues:
 Email services ...............................................      3,643      11,864      14,605
 Software licenses ............................................       --          --          --
                                                                  --------    --------    --------
 Total cost of revenues .......................................      3,643      11,864      14,605
                                                                  --------    --------    --------
Gross profit ..................................................        608       7,251         713
                                                                  --------    --------    --------
Operating expenses:
 Research and development, net ................................      2,942      10,357       7,278
 Sales and marketing ..........................................      7,722      26,585      13,496
 General and administrative ...................................      4,328      13,621      11,236
 In-process research and development ..........................       --         1,280        --
 Amortization of the prepaid marketing expenses ...............      3,263       4,508        --
 Amortization of stock-based employee deferred  compensation(1)      3,436       3,050       2,204
 Amortization of goodwill and other purchased intangibles .....       --          --         2,794
 Write-off of impaired goodwill and other intangible assets ...       --          --        13,280
 Write-off of impaired property, equipment and other ..........       --          --        10,166
                                                                  --------    --------    --------

 Total operating expenses .....................................     21,691      59,401      60,454
                                                                  --------    --------    --------
Operating loss ................................................    (21,083)    (52,150)    (59,741)
 Interest and other income, net ...............................      1,232       2,870         449
 Write-off impaired long-term investments .....................       --        (5,000)     (2,000)
 Minority interest ............................................       --            55         285
                                                                  --------    --------    --------
Net loss ......................................................   $(19,851)   $(54,225)   $(61,007)
                                                                  ========    ========    ========
Basic and diluted net loss per share ..........................   $  (2.65)   $  (3.51)   $  (3.56)
                                                                  ========    ========    ========
Weighted average number of shares used in computing
 basic and diluted net loss per share .........................      7,487      15,462      17,152
                                                                  ========    ========    ========

<CAPTION>
                                                                             Year ended
                                                                             December 31,
                                                                  --------------------------------
                                                                    1999        2000         2001
                                                                  --------    --------    --------
<S>                                                               <C>         <C>          <C>
(1) Stock-based Employee Compensation Relates to the following:

 Cost of revenues .............................................   $  113      $  102       $   82
 Research and development, net ................................      320         284          226
 Sales and marketing ..........................................      897         795          554
 General and administrative ...................................    2,106       1,869        1,342
                                                                  --------    --------    --------
 Total ........................................................   $3,436      $3,050       $2,204
                                                                  ========    ========    ========
</TABLE>
The  accompanying  notes are an integral  part of these  consolidated  financial
statements.

                                      F-3
<PAGE>
                             COMMTOUCH SOFTWARE LTD.

            STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY (DEFICIENCY)
                      (USD in thousands, except share data)

<TABLE>
<CAPTION>
                                                             Convertible
                                                           Preferred shares           Ordinary shares       Additional
                                                        ---------------------     -----------------------     paid-in
                                                         Shares       Amount        Shares       Amount       capital
                                                        --------    ---------     ----------   ----------   ----------
<S>                                                      <C>              <C>      <C>               <C>        <C>
Balance as of January 1, 1999 .....................      221,265            74     1,450,040           27       11,256
 Issuance of shares, net ..........................      134,225            33          --           --         18,417
 Issuance of shares at initial public offering,
 net ..............................................         --            --       4,794,086           58       65,948
 Conversion of preferred shares to ordinary
 shares ...........................................     (355,490)         (107)    7,109,800          107         --
 Fair value of warrants issued for services
 and bank line of credit ..........................         --            --            --           --          8,131
 Deferred stock compensation ......................         --            --            --           --          8,797
 Ordinary shares issued for notes .................         --            --         670,180            8        1,029
 Issuance of shares upon exercise of warrants,
 net ..............................................         --            --       1,105,378           12       19,808
 Issuance of shares upon exercise of options ......         --            --          69,860            1           17
 Amortization of deferred stock compensation ......         --            --            --           --           --
 Repayment of notes receivable ....................         --            --            --           --           --
 Other comprehensive income-unrealized
 holding gains on marketable securities ...........         --            --            --           --           --
 Net loss .........................................         --            --            --           --           --
 Total comprehensive loss .........................         --            --            --           --           --
                                                        --------    ---------     ----------   ----------   ----------
Balance as of December 31, 1999 ...................         --            --      15,199,344          213      133,403
 Issuance of shares upon exercise of options ......         --            --         440,384            6        1,701
 Amortization of deferred stock compensation ......         --            --            --           --           --
 Repayment of notes receivable ....................         --            --            --           --           --
 Other comprehensive income-unrealized
 holding losses on marketable securities ..........         --            --            --           --           --
 Issuance of shares to minority interest in
 Japan-Note 2i ....................................         --            --            --           --          1,090
 Issuance of shares and vested options and warrants
 in consideration of the acquisition of Wingra ....         --            --       1,285,294           17       14,800
 Net loss .........................................         --            --            --           --           --
 Total comprehensive loss .........................         --            --            --           --           --
                                                        --------    ---------     ----------   ----------   ----------
Balance as of December 31, 2000 ...................         --            --      16,925,022          236      150,994
 Issuance of shares, net ..........................         --            --         315,789            2          256
 Issuance of shares upon exercise of options ......         --            --         256,008            1          116
 Stock based compensation related to warrants
 granted to a service provider ....................         --            --            --           --             53
 Amortization of deferred stock compensation ......         --            --            --           --           --
 Deferred stock compensation ......................         --            --            --           --            303
 Repayment of notes receivable ....................         --            --            --           --           --
 Forgiveness of notes receivable ..................         --            --            --           --           --
 Other comprehensive income-unrealized
 holding losses on marketable securities ..........         --            --            --           --           --
 Issuance of shares to minority interest in
 Japan-Note 2i ....................................         --            --            --           --            440
 Net loss .........................................         --            --            --           --           --
 Total comprehensive loss .........................         --            --            --           --           --
                                                        --------    ---------     ----------   ----------   ----------
Balance as of December 31, 2001 ...................         --      $     --      17,496,819   $      239   $  152,162
                                                        ========    =========     ==========   ==========   ==========
</TABLE>

                                      F-4
<PAGE>
<TABLE>
<CAPTION>
                                                      Stock-based        Notes        Accumulated
                                                       employee        receivable        other
                                                       deferred          from        comprehensive   Accumulated
                                                     compensation     shareholders       income        deficit        Total
                                                     -----------      ------------     ---------      ---------    ---------
<S>                                                   <C>              <C>             <C>            <C>          <C>
Balance as of January 1, 1999 .....................        (418)             (77)           --          (11,677)        (815)
 Issuance of shares, net ..........................        --               --              --             --         18,450
 Issuance of shares at initial public offering,
 net ..............................................        --               --              --             --         66,006
 Conversion of preferred shares to ordinary
 shares ...........................................        --               --              --             --           --
 Fair value of warrants issued for services
 and bank line of credit ..........................        --               --              --             --          8,131
 Deferred stock compensation ......................      (8,797)            --              --             --           --
 Ordinary shares issued for notes .................        --             (1,037)           --             --           --
 Issuance of shares upon exercise of warrants,
 net ..............................................        --               --              --             --         19,820
 Issuance of shares upon exercise of options ......        --               --              --             --             18
 Amortization of deferred stock compensation ......       3,436             --              --             --          3,436
 Repayment of notes receivable ....................        --                 54            --             --             54
 Other comprehensive income--unrealized
 holding gains on marketable securities ...........        --               --                63           --             63
 Net loss .........................................        --               --              --          (19,851)     (19,851)
 Total comprehensive loss .........................        --               --              --             --        (19,788)
                                                       --------        ---------       ---------      ---------    ---------
Balance as of December 31, 1999 ...................      (5,779)          (1,060)             63        (31,528)      95,312
 Issuance of shares upon exercise of options ......        --               --              --             --          1,707
 Amortization of deferred stock compensation ......       3,050             --              --             --          3,050
 Repayment of notes receivable ....................        --                 19            --             --             19
 Other comprehensive income--unrealized
 holding losses on marketable securities ..........        --               --               (42)          --            (42)
 Issuance of shares to minority interest in
 Japan-Note 2i ....................................        --               --              --             --          1,090
 Issuance of shares and vested options and warrants
 in consideration of the acquisition of Wingra ....        --               --              --             --         14,817
 Net loss .........................................        --               --              --          (54,225)     (54,225)
                                                                                                                   ---------
 Total comprehensive loss .........................        --               --              --             --        (54,267)
                                                       --------        ---------       ---------      ---------    ---------
Balance as of December 31, 2000 ...................      (2,729)          (1,041)             21        (85,753)      61,728
 Issuance of shares, net ..........................        --               --              --             --            258
 Issuance of shares upon exercise of options ......        --               --              --             --            117
 Amortization of deferred stock compensation ......       2,204             --              --             --          2,204
 Stock based compensation related to warrants
 granted to a service provider ....................        --               --              --             --             53
 Deferred stock compensation ......................        (303)            --              --             --           --
 Repayment of notes receivable ....................        --                144            --             --            144
 Forgiveness of notes receivable ..................        --                143            --             --            143
 Other comprehensive income--unrealized
 holding losses on marketable securities ..........        --               --               (21)          --            (21)
 Issuance of shares to minority interest in
 Japan-Note 2i ....................................        --               --              --             --            440
 Net loss .........................................        --               --              --          (61,007)     (61,007)
 Total comprehensive loss .........................        --               --              --             --        (61,028)
                                                       --------        ---------       ---------      ---------    ---------
Balance as of December 31, 2001 ...................   $    (828)       $    (754)      $    --        $(146,760)   $   4,059
                                                       ========        =========       =========      =========    =========

</TABLE>
The  accompanying  notes are an integral  part of these  consolidated  financial
statements.

                                      F-5
<PAGE>

                             COMMTOUCH SOFTWARE LTD.

                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                               (USD in thousands)

<TABLE>
<CAPTION>
                                                                                        Year Ended
                                                                                        December 31,
                                                                             -----------------------------------
                                                                                1999        2000         2001
                                                                             ---------    ---------    ---------
<S>                                                                          <C>          <C>          <C>
Cash flows from operating activities:
 Net loss ................................................................   $ (19,851)   $ (54,225)   $ (61,007)
 Adjustments to reconcile net loss to net cash used in
 operating activities:
         Depreciation and amortization ...................................       1,706        6,009       10,256
         Amortization of stock-based employee deferred
         compensation and warrants issued for services received
         and bank line of credit .........................................       3,796        3,050        2,204
         Amortization of prepaid marketing expenses ......................       3,263        4,508         --
         Amortization of in-process research and development .............        --          1,280         --
         Write-off of impaired long-term investments .....................        --          5,000        2,000
         Write-off of impaired goodwill and other intangible assets ......        --           --         13,280
         Write-off of impaired property, equipment and other..............        --           --         10,166
         Loss on sale of property and equipment ..........................        --           --            695
 Changes in assets and liabilities:
          Trade receivables, net .........................................      (2,245)      (1,719)       3,491
          Prepaid expenses and other accounts receivable .................      (1,028)      (1,933)       2,926
          Accounts payable ...............................................       1,064        2,142       (2,831)
          Employee and payroll accruals and other liabilities ............       1,645        4,076       (5,146)
          Deferred revenues ..............................................         487          656         (684)
          Accrued severance pay, net .....................................         (44)         (64)          70
          Forgiveness of notes receivable ................................        --           --            143
          Minority interest in losses of a subsidiary ....................        --            (55)        (285)
          Other ..........................................................          (9)          (5)           3
                                                                             ---------    ---------    ---------
Net cash used in operating activities ....................................     (11,216)     (31,280)     (24,719)
                                                                             ---------    ---------    ---------
Cash flows from investing activities:
 Proceeds from sales of marketable securities ............................        --         18,969        8,586
 Purchases of marketable securities ......................................     (17,987)      (9,568)        --
 Purchase of long-term investments .......................................        --         (7,000)        --
 Long-term lease deposits ................................................      (1,254)        (163)         204
 Advance to related party ................................................        (364)        --           --
 Proceeds from acquisition of Wingra .....................................        --            305         --
 Proceeds from sale of property and equipment ............................          13          337          160
 Purchase of property and equipment ......................................      (6,938)     (19,102)      (3,265)
                                                                             ---------    ---------    ---------
Net cash (used) provided in investing activities .........................     (26,530)     (16,222)       5,685
                                                                             ---------    ---------    ---------
Cash flows from financing activities:
 Short-term bank credit, net .............................................      (1,328)        --           --
 Repayment of note receivable by shareholder .............................          54           19          144
 Repayment of bank loans and notes payable ...............................        --           --           (873)
 Principal payment of capital lease ......................................        (112)        (610)        (204)
 Proceeds from issuance of shares, net ...................................     104,294        1,707
                                                                                                             428
 Proceeds from minority interest in subsidiary ...........................        --          1,090          440
 Contribution from minority interest of consolidated subsidiary ..........        --            131          336
                                                                             ---------    ---------    ---------
Net cash provided by financing activities ................................     102,908        2,337          451
                                                                             ---------    ---------    ---------
Increase (decrease) in cash and cash equivalents .........................      65,162      (45,165)     (18,583)
Cash and cash equivalents at the beginning of the year ...................         834       65,996       20,831
                                                                             ---------    ---------    ---------
Cash and cash equivalents at the end of the year .........................   $  65,996    $  20,831    $   2,248
                                                                             =========    =========    =========
</TABLE>

                                      F-6
<PAGE>

<TABLE>
<S>                                                                          <C>          <C>          <C>
Supplemental disclosure of cash flows activity: Cash paid during the year:
 Interest ................................................................   $     117    $      31    $     161
Supplemental disclosure of non-cash activity:
 Ordinary shares issued for notes receivable from shareholders ...........   $   1,037    $    --      $    --
 Issuance of Warrants for Prepaid Marketing Expenses .....................   $   7,771    $    --      $    --
</TABLE>

The proceeds from the  acquisition  of Wingra,  for year ended December 31, 2000
were as follows (in thousands):

         Net Tangible liabilities assumed
         Tangible assets:                                          $    475
         Tangible liabilities                                        (3,054)
         Net tangible liabilities assumed:                           (2,579)

         Intangibles assumed:
         Customer base                                                1,340
         Workforce-in-place                                             550
         Intellectual Property                                        1,660
         In-process research & development expenses                   1,280
         Goodwill                                                    12,590
         Intangibles assumed:                                        17,420

         Cash acquired:                                                 305
         Purchase price                                            $ 15,146

The  accompanying  notes are an integral  part of these  consolidated  financial
statements.

                                      F-7
<PAGE>
                             COMMTOUCH SOFTWARE LTD.

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1: GENERAL

Commtouch  Software  Ltd.  was  incorporated  under  the laws of Israel in 1991.
Unless otherwise  indicated,  all references in these notes to "Commtouch," "the
Company,"  "we,"  "us" or  "our"  are to  Commtouch  Software  Ltd.  or/and  its
wholly-owned  subsidiaries,  Commtouch Inc., Commtouch (UK) Ltd, Commtouch Latin
America Inc.,  Wingra,  Inc. and its majority-owned  subsidiary,  Commtouch K.K.
(Japan). We are a provider of email and messaging solutions to service providers
that target both residential and business  subscriber users.  Until December 31,
2001,  our customers  were large and small  businesses who offered our Web-based
email through their website to their end users. The Company  generated  revenues
by providing  email  services to its  customers.  Email  service  revenues  were
derived from contracts  that provide for either a monthly  per-email box fee and
fees for direct marketing and communications  services or a share of advertising
revenues subject to a minimum annual revenue commitment.  In September 2000, the
Company  began  to  derive  revenue  from  the  sale  of  software  licenses  to
enterprises.  In 2002,  the Company sold its,  migration  and most of its hosted
email service  businesses and changed its focus to providing email and messaging
solutions to service providers (see Note 15).

During  2001 and 2000,  no single  customer  accounted  for more than 10% of the
revenues.  During 1999,  approximately  11% of the revenues  were derived from a
single customer.

NOTE 2: SIGNIFICANT ACCOUNTING POLICIES

The  consolidated  financial  statements  have been prepared in accordance  with
accounting principles generally accepted in the United States.

a. Use of Estimates:

The  preparation  of  consolidated   financial  statements  in  conformity  with
generally accepted  accounting  principles requires management to make estimates
and assumptions that affect the amounts  reported in the consolidated  financial
statements  and  accompanying  notes.  Actual  results  could  differ from those
estimates.

b. Financial Statements in U. S. Dollars:

Most of the Company's revenues are denominated in U. S. dollars. In addition,  a
substantial  portion of the Company's  costs are incurred in dollars.  Since the
dollar is the primary currency in the economic  environment in which the Company
and its  subsidiaries  operate,  the dollar is their functional  currency,  and,
accordingly,  monetary  accounts  maintained in currencies other than the dollar
are  re-measured  into U.S.  dollars in accordance  with  Statement of Financial
Accounting  Standards  No.  52  "Foreign  Currency  Transactions."   Operational
accounts and  non-monetary  balance sheet  accounts are measured and recorded at
the rate in  effect  at the date of the  transaction.  The  effects  of  foreign
currency   re-measurement  are  reported  as  financial  income  or  expense  as
appropriate.

c. Principles of Consolidation:

The consolidated  financial  statements  include the accounts of the Company and
its wholly-owned subsidiaries and majority-owned  subsidiary.  All inter-company
balances and transactions have been eliminated in consolidation.

d. Cash, Cash Equivalents and Marketable Securities:

                                      F-8
<PAGE>
The Company considers all highly liquid  investments  originally  purchased with
maturities of three months or less to be cash equivalents.

The Company accounts for its marketable  securities in accordance with Statement
of Financial  Accounting  Standards No. 115, "Accounting for Certain Investments
in  Debt  and  Equity  Securities".   All  debt  securities  are  designated  as
available-for-sale.  Available-for-sale  securities  are  carried at fair value,
which is determined based upon the quoted market prices of the securities,  with
unrealized  gains  and  losses  reported  in  accumulated  other   comprehensive
income(loss), a separate component of shareholders' equity.

e. Prepaid Marketing Expenses:

The Company recorded prepaid marketing expenses,  representing the fair value of
warrants which have been issued to InfoSpace  Inc. and Microsoft  Corporation in
connection  with  commercial  agreements  into which the Company  entered during
1999.

The prepaid marketing expenses are amortized using the straight-line method over
the minimum term of the  agreements  (twelve  months).  These amounts were fully
amortized as of December 31, 2000.

f. Property and Equipment:

Property and  equipment  are stated at cost and  depreciated  using the straight
line method over the  estimated  useful lives of the assets  ranging from two to
seven years.  Leasehold  improvements are amortized by the straight-line  method
over the lease term.

The Company  periodically  assesses the recoverability of the carrying amount of
property and equipment and provides for any possible  impairment loss based upon
the  difference  between  the  carrying  amount and fair value of such assets in
accordance with Statement of Financial  Accounting  Standard No. 121 "Accounting
for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed
Of".  During 2001, due to the economic  slowdown,  the reduction of the employee
headcount and the transfer into its new facilities,  the Company determined that
an impairment  loss exists.  As of December 31, 2001, the Company had impairment
losses totaling $9.2 million which were recorded as operating expenses.

g. Long-Term Investments:

Long-term  investments  are recorded at lower of cost or  estimated  fair value,
since the Company  does not have the ability to exercise  significant  influence
over operating and financial policies of the investee. Long-term investments are
reviewed for impairment  whenever  events or changes in  circumstances  indicate
that  the  carrying   amount  of  such   investments  may  not  be  recoverable.
Determination of recoverability  is based on an estimate of undiscounted  future
cash  flows  resulting  from  the  use  of  the  investment.  Measurement  of an
impairment loss for long-term  investments  that management  expects to hold are
based on the fair value of the investment.  Impaired  long-term  investments are
reported at the lower of carrying amount or fair value less costs to sell.

Due to the economic slowdown and the significant decline in capital available to
and in valuations of these privately  funded  internet  centric  companies,  the
Company  believes all of these  investments are impaired.  During 2000 and 2001,
based on a  comprehensive  review  of the  Company's  investments,  the  Company
recorded  a non-cash  charge of $5  million  and $2  million,  respectively,  to
write-down the recorded investment values.

h. Goodwill and Other Purchased Intangible Assets:

The Company amortized goodwill using the straight-line method over its estimated
useful life, which is five years.

Workforce in place,  intellectual property and customer base are amortized using
the  straight-line  method over their useful  lives,  which are three,  four and
three years, respectively.

The  carrying  value of  goodwill  and other  purchased  intangible  assets  are
periodically  reviewed by management,  based on the expected future undiscounted
operating  cash  flows  over  the  remaining  goodwill  amortization  period  in
accordance with Accounting  Principles Board Opinion No. 17, "Intangible Assets.

                                      F-9
<PAGE>
If this review  indicates that goodwill and other  purchased  intangible  assets
will not be  recoverable  the  carrying  value of goodwill  and other  purchased
intangible assets is reduced to estimated fair value.

At December 31,  2001,  due to the economic  slowdown,  the Company  performed a
comprehensive  review of the Company's  goodwill and other purchased  intangible
assets. As a result, the Company recorded a non-cash charge of $13.3 million, to
write-down the recorded values to zero.

i. Minority Interest:

Minority interest  represents a stockholders'  proportionate share of the equity
of Commtouch,  K.K.  (Japan).  At December 31, 2000 and 2001,  the Company owned
94.17% and 70.6%,  respectively,  of the equity and voting  rights of Commtouch,
K.K. (Japan).

During 2000 and 2001, the Company's  strategic  partner in Japan,  CSK, invested
approximately  $1.2  million  and  $0.8  million  in  Commtouch,  K.K.  (Japan),
respectively.  According to Staff  Accounting  Bulletin No. 84  "Accounting  for
Sales of Stock by a Subsidiary",  the Company had not recognized gains from this
issuance of shares  (since it is  considered  to be an early stage  company) and
thus  classified it to  Shareholders'  Equity section of the balance sheet under
Additional paid-in capital.

j. Research and Development Costs:

Research and  development  costs are charged to the  statement of  operations as
incurred. Statement of Financial Accounting Standards No. 86 "Accounting for the
Costs of Computer  Software to be Sold, Leased or Otherwise  Marketed"  requires
capitalization   of  certain  software   development  costs  subsequent  to  the
establishment of technological feasibility.

Based on the Company's product development process, technological feasibility is
established  upon  completion of a working model.  The Company did not incur any
material  costs  between the  completion  of the working  model and the point at
which the product is ready for general release. Therefore,  through December 31,
1999, 2000 and 2001, the Company has charged all software  development  costs to
research and development expense in the period incurred.

k. Advertising Costs:

The Company accounts for advertising costs as expense in the period in which the
costs are incurred.  Advertising  expense for the years ended December 31, 1999,
2000 and 2001 were $0.6 million, $3.1 million and $0.1 million, respectively.

l. Revenue Recognition:

Since 1998, the Company has derived its revenues from providing  Web-based email
services.  Revenues from Email services are recognized in accordance  with Staff
Accounting Bulletin No. 101 "Revenue Recognition in Financial  Statements" ("SAB
No. 101") when delivery has occured, persuasive evidence of an agreement exists,
the  vendor's  fee is fixed and  determinable  and  collectibilty  is  probable.
Revenues from  contracts that are not dependent upon the number of mailboxes and
provide  non-refundable  fixed payments are recognized ratably over the contract
term.  Revenues from  contracts  specifying a  contractual  rate per mailbox per
month are recognized monthly for mailboxes covered by the respective  contracts.
Revenues  from  contracts  based on a share of  advertising  revenues  earned by
business partners are recognized when such revenues are earned. Amounts received
in advance of service delivery are recorded as deferred revenues.  Other service
revenues are primarily  comprised of revenues from consulting and training fees.
Consulting  services  are  billed  at an agreed  upon  rate  plus  out-of-pocket
expenses and training  services on a per session basis.  The Company  recognizes
service revenues from consulting and training when provided to the customer.

Revenues from  non-recurring  engineering  services are recognized  upon meeting
specified milestones as deemed earned by the agreement.

                                      F-10
<PAGE>
The Company recognizes  software license revenue in accordance with Statement of
Position 97-2, "Software Revenue Recognition" ("SOP 97-2"), as amended. SOP 97-2
generally  requires revenue earned on software  arrangements  involving multiple
elements to be allocated to each element based on the relative fair value of the
elements.  The Company has also  adopted  SOP 98-9,  "Modification  of SOP 97-2,
Software Revenue Recognition with Respect to Certain Transactions" ("SOP 98-9"),
for all transactions  entered into after January 1, 2000. SOP 98-9 requires that
revenue  be  recognized  under  the  "Residual  Method"  when  "Vendor  Specific
Objective  Evidence" ("VSOE") of fair value exists for all undelivered  elements
and no VSOE exists for the delivered elements.

Revenue from software  licenses fees to end users are recognized when persuasive
evidence of an  arrangement  exists,  delivery of the software has occurred,  no
significant  obligation with regard to the  implementation  remain, fee is fixed
and determinable and collectibility is probable.

m.  Concentrations of Credit Risk:

Financial  instruments that potentially subject the Company to concentrations of
credit risk consist  principally  of trade  receivables,  cash  equivalents  and
marketable securities.  The majority of the Company's cash, cash equivalents and
marketable  securities are invested in dollar and dollar linked  investments and
are  deposited  in major  banks in  United  States,  Israel  and  Ireland.  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  financially  sound and,
accordingly, minimal credit risk exists with respect to these investments.

The Company's  trade  receivables are derived from  transactions  with companies
located primarily in North America,  Europe,  Latin America,  Israel and the Far
East. The Company  maintains an allowance for doubtful trade  receivables  based
upon  the  expected  collectibility  of trade  receivables.  The  allowance  for
doubtful  accounts  was $0.9  million and $0.6  million at December 31, 2000 and
2001, respectively. Bad debt expense for the years-ended December 31, 1999, 2000
and 2001 were $0.4 million, $2.0 million and $0.3 million, respectively.

n. Accounting for Stock-Based Compensation:

The Company has elected to follow  Accounting  Principles  Board  Opinion No. 25
("APB 25") "Accounting for Stock Issued to Employees" and  Interpretation No. 44
"Accounting  for  Certain   Transactions   Involving  Stock   Compensation,"  in
accounting for its employee stock option plans.  Under APB 25, when the exercise
price of the Company's  stock options equals or is above the market value of the
underlying  stock on the date of grant, no  compensation  expense is recognized.
The  pro-forma  information  with  respect to the fair  value of the  options is
provided in accordance with the provisions of Statement of Financial  Accounting
Standard No. 123 "Accounting for Stock-Based Compensation"(" SFAS No. 123") (See
also Note 13 f).

In accounting for warrants  granted to those other than  employees,  the Company
applied the  provisions  of SFAS No. 123, and  Emerging  Issues Task Force 96-18
"Accounting for Equity  Instruments  That Are Issued to Other than Employees for
Acquiring or in Conjunction with Selling,  Goods or Services." The fair value of
these  warrants  was  estimated  at the  grant  date,  using  the  Black-Scholes
option-pricing model.

o. Royalty-bearing Grants;

Royalty-bearing  grants  from the  Government  of Israel  for  funding  approved
research  and  development  projects are  recognized  at the time the Company is
entitled to such  grants,  on the basis of the costs  incurred and included as a
deduction of research and development  costs.  Research and  development  grants
amounted to zero, zero and $0.6 million in 1999, 2000 and 2001, respectively.

p. Basic and Diluted Net Loss Per Share:

Basic and diluted net loss per share are presented in accordance  with Statement
of Financial  Accounting Standard No. 128, "Earnings per Share", for all periods
presented.

Basic net loss per share has been computed using the weighted-average  number of
ordinary  shares  outstanding  during  the year.  Diluted  net loss per share is
computed  based on the weighted  average number of ordinary  shares  outstanding
during  each  year,  plus the  weighted  average  number of  dilutive  potential
ordinary shares considered outstanding during the year.

                                      F-11
<PAGE>
All convertible  preferred shares,  outstanding stock options, and warrants have
been  excluded  from the  calculation  of the diluted loss per share because all
such securities are anti-dilutive for all periods presented. The total number of
shares related to the  convertible  preferred  shares,  outstanding  options and
warrants  excluded  from the  calculations  of  diluted  net loss per share were
2,497,470, 4,096,455 and 4,990,673 for 1999, 2000 and 2001, respectively.

q. Severance Pay:

The Company's  liability  for  severance  pay is calculated  pursuant to Israeli
severance pay law based on the most recent salary of the employees multiplied by
the number of years of employment  as of the balance  sheet date.  Employees are
entitled to one month's salary for each year of employment or a portion thereof.
The Company's  liability  for all of its employees is fully  provided by monthly
deposits with severance pay fund's insurance policies and by an accrual.

The deposited  funds include  profits  accumulated up to the balance sheet date.
The deposited funds may be withdrawn only upon the fulfillment of the obligation
pursuant  to Israeli  severance  pay law or labor  agreements.  The value of the
deposited  funds is based on the cash  surrender  value of these  policies,  and
includes immaterial profits.

Severance expenses for 1999, 2000 and 2001 were approximately $0.1 million, $0.5
million and $1.0 million, respectively.

r. Fair Value of Financial Instruments:

The following methods and assumptions were used by the Company in estimating its
fair value disclosures for financial  instruments.  The carrying amounts of cash
and cash equivalents,  trade receivables, other accounts receivable and accounts
payable, approximate their fair values due to the short-term maturities of these
instruments.

The fair value for marketable securities are based on quoted market prices.

The fair value of long-term  deposits  and loans is  estimated  based on current
interest rates available to the Company for debt instruments with similar terms,
degrees  of  risk  and  remaining  maturities.   The  carrying  value  of  these
obligations  approximates  their  respective fair values as of December 31, 2000
and 2001.

s. Reclassification:

Certain  amounts  from  prior  years  have been  reclassified  to conform to the
current year's  presentation.  The  reclassification had no effect on previously
reported net loss, shareholder's equity or cash flows.

t. Recently Issued Accounting Pronouncements:

In June 2001, the Financial  Accounting  Standards Board (FASB) issued Statement
of Financial Accounting Standards No. 141, "Business  Combinations" and No. 142,
"Goodwill and other  Intangible  Assets",  effective for fiscal years  beginning
after December 15, 2001.  Under the new rules,  goodwill and  intangible  assets
deemed to have indefinite  lives will no longer be amortized but will be subject
to annual  impairment tests in accordance with the Statements.  Other intangible
assets will continue to be amortized  over their useful lives.  The Company does
not  expect  that the  adoption  of the  Statement  will  have an  impact on the
Company's financial position and results of operations.

In August 2001, FASB issued Statement of Financial Accounting Standards No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets" (SFAS No. 144),
which  addresses  financial  accounting  and  reporting  for the  impairment  or
disposal of long-lived  assets and supersedes FAS No. 121,  "Accounting  for the
Impairment of Long-Lived  Assets and for  Long-Lived  Assets to be Disposed Of",
and the  accounting and reporting  provisions of APB Opinion No. 30,  "Reporting
the Results of Operations  for a disposal of a segment of a business".  SFAS 144
is effective for fiscal years  beginning  after December 15, 2001,  with earlier
application  encouraged.  The Company expects to adopt SFAS 144 as of January 1,
2002.  The sale of  Wingra  (see Note 15a)  will be  treated  as a  discontinued
operation and reported on a separate line item in the first quarter Statement of
Operations,  since Wingra is  considered  to be a component of the Company.  The
accounting will result in revenues,  net loss and loss per share from continuing

                                      F-12
<PAGE>
operations  being reduced by $1.7 million,  $1.9 million and $0.11  respectively
for 2001. The 2000 results will not materially  change since Wingra was acquired
in late November 2000.

NOTE 3: MARKETABLE SECURITIES

                                                             December 31,
                                                          ------------------
                                                           2000        2001
                                                          -------     ------
       Marketable securities are comprised of
         the following (in thousands):

       Government securities...........................   $ 2,003     $   --
       Corporate debt securities.......................     6,604         --
                                                          -------     ------
                                                          $ 8,607     $   --
                                                          -------     ------

During 2000, the unrealized  net holding  losses on marketable  securities  were
$21,000.

Note 4:  WINGRA ACQUISITION:

On  November  24,  2000,  the  Company  entered  into a  definitive  acquisition
agreement to acquire Wingra Technologies Inc.  ("Wingra").  Wingra is a provider
of messaging integration and migration solutions for large enterprises.

Pursuant  to the  Wingra  Agreement,  the  shareholders  of Wingra  received  an
aggregate  of  1,285,294  of  Commtouch   ordinary  shares.  In  addition,   all
outstanding Wingra options and warrants converted into fully-vested  options and
warrants to purchase  305,615 of  Commtouch  ordinary  shares.  The Company also
assumed certain operating assets and liabilities of Wingra.  The 137,500 assumed
warrants  were granted by Wingra in  connection  with loans granted to Wingra by
banks and shareholders. The exercise price of those warrants range from $6.25 to
$9.39 and the  expiration  dates range from March 2001 through  August 2002. The
acquisition  was  accounted  for  under  the  purchase  method,  for  accounting
purposes,   in  accordance  with  Accounting   Principles   Board  16  "Business
Combinations".  The  purchase  price was  allocated  to the assets  acquired and
liabilities  assumed based on their  respective fair values.  The purchase price
was  determined  to be $15.1  million  (based on the closing  price of Commtouch
ordinary shares on the date of the final  agreement).  The  consolidation of the
assets and  liabilities  affected the  Company's  balance  sheet at December 31,
2000, as described in the following tables:

 Total purchase price (in thousands):
 Ordinary shares                                 $ 11,970
 Options and warrants                               2,846
 Acquisition expenses                                 330
                                                 --------
                                                 $ 15,146
                                                 --------

The purchase price was allocated to the acquired assets and assumed  liabilities
in the accompanying consolidated financial statements as follows (in thousands):

                                                  Estimated
                                                   Useful
                                                    Life
                                                 (In Years)
                                              ------------
    Customer base                                    3        $  1,340
    Workforce-in-place                               3             550
    Intellectual Property                            4           1,660
    In-process research & development         expensed           1,280
    Goodwill                                         5          12,590
    Less assumed net tangible liabilities          n/a          (2,274)
                                                              --------
                                                              $ 15,146
                                                              ========

                                      F-13
<PAGE>
The Company  recorded a one-time charge of $1.3 million in the fourth quarter of
2000 for purchased  in-process  technology related to a development project that
had not reached  technological  feasibility,  had no alternative future use, and
for which successful development was uncertain.

The fair value of the  in-process  technology  was  determined  using the income
approach.  Under the income  approach,  the expected future cash flows from each
project under  development  are  estimated  and  discounted to their net present
value  at an  appropriate  risk-adjusted  rate of  return.  Significant  factors
considered  in the  calculation  of the rate of return are the  weighted-average
cost of  capital  and  return on assets,  as well as the risks  inherent  in the
development process, including the likelihood of achieving technological success
and market  acceptance.  Each  project  was  analyzed  to  determine  the unique
technological innovations,  the existence and reliance upon core technology, the
existence of any alternative  future use or current  technological  feasibility,
and the complexity, cost and time to complete the remaining development.  Future
cash flows for each project were estimated  based upon  forecasted  revenues and
costs,  taking into  account  product life cycles,  and market  penetration  and
growth  rates.  Pro  forma is not  disclosed  due to the sale of Wingra in early
2002, see Note 15a.

See Note 2 h for impairment charges during 2001.

NOTE 5: PREPAID EXPENSES AND OTHER ACCOUNTS RECEIVABLES
<TABLE>
<CAPTION>
                                                                         December 31,
                                                                       ---------------
                                                                         2000     2001
                                                                       ------   ------
<S>                                                                    <C>      <C>
Prepaid expenses and other accounts receivables are comprised of the
following (in thousands):
Prepaid Expenses ...................................................   $2,159   $  374
Other accounts receivable ..........................................    1,467      326
                                                                       ------   ------
Prepaid expenses and other accounts receivables ....................   $3,626   $  700
                                                                       ======   ======
</TABLE>

NOTE 6: PROPERTY AND EQUIPMENT, NET
<TABLE>
<CAPTION>
                                                                            December 31,
                                                                        --------------------
                                                                          2000        2001
                                                                        --------    --------
<S>                                                                     <C>         <C>
Property and equipment are comprised of the following (in thousands):
Computers and peripheral equipment ..................................   $ 20,687    $  7,314
Office furniture and equipment ......................................        977       1,168
Motor vehicles ......................................................        143          88
Leasehold improvements ..............................................      5,908       1,217
                                                                        --------    --------
                                                                          27,715       9,787
Less accumulated depreciation .......................................     (8,298)     (4,635)
                                                                        --------    --------
Property and equipment, net .........................................   $ 19,417    $  5,152
                                                                        ========    ========
</TABLE>

Depreciation  expenses amounted to approximately $1.7 million,  $5.9 million and
$7.5 million for 1999, 2000 and 2001, respectively.

See Note 2 f and Note 11 for impairment charges during 2001.

NOTE 7: LONG-TERM INVESTMENTS

The  Company  invested  $7.0  million in the first nine  months of 2000 in three
internet  centric  companies in which the Company  believed it had a significant
ongoing strategic interest.  See Note 2 g for impairment charges during 2000 and
2001.

                                      F-14
<PAGE>
NOTE 8: GOODWILL AND OTHER PURCHASED INTANGIBLES
<TABLE>
<CAPTION>

                                                                December 31,       December 31,
                                                                ------------       ------------
                                                                   2000               2001
                                                                  -------            -------
Goodwill and other purchased intangibles are comprised of
  the following (in
thousands):
<S>                                                               <C>                <C>
Customer Base.................................................    $ 1,340            $   --
Workforce in Place............................................        550                --
Intellectual Property.........................................      1,660                --
Goodwill......................................................     12,590                --
                                                                  -------            -------
                                                                   16,140                --
Less accumulated amortization.................................        (85)               --
                                                                  -------            -------
Goodwill and other purchased intangibles, net.................    $16,055            $   --
                                                                  =======            =======
</TABLE>

Amortization  expenses  amounted to  approximately  none,  $0.1 million and $2.8
million for 1999, 2000 and 2001, respectively.

See Note 2 h for impairment charges.

NOTE 9: LONG TERM BANK LOANS AND CAPITAL LEASES

Bank loans and capital  leases  comprised of the following (in thousands  except
for percentages):
<TABLE>
<CAPTION>
                                                Weighted                      Weighted
                                                 Average                       Average
                                                Interest     December 31,      Interest     December 31,
                                                  Rate           2000            Rate           2001
                                                --------     -----------      ---------     ------------
<S>                                               <C>          <C>              <C>           <C>
Promissory notes with shareholders............    9.28%        $   886          9.74%         $   585
Promissory notes with financial institutions..   10.78%            692         11.00%             126
Capital lease obligations.....................                      69                             45
Royalties in connection with Wingra's product                      218                            218
                                                               ---------                      ----------
                                                                 1,865                            974
Less - current maturities.....................                  (1,024)                          (714)
                                                               ---------                      ----------
Total Long-term debt..........................                 $   841                        $   260
                                                               =========                      ==========
</TABLE>

    Future  maturities of long-term debt at December 31, 2001 are as follows (in
thousands):

                            2002                      $714
                            2003                       260
                                                      ----
                                                      $974
                                                      ====

NOTE 10: COMMITMENTS AND CONTINGENCIES

a. Operating Leases:

The Company  leases  certain  facilities  and equipment  under  operating  lease
agreements  expiring  through 2007.  Future  minimum lease  payments under these
non-cancelable leases are as follows (in thousands):

                  2002.......................   $    366
                  2003.......................        382
                  2004.......................        201
                  2005.......................        103
                  2006.......................        107
                  Thereafter.................        100
                                                --------
                                                $  1,259
                                                ========

                                      F-15
<PAGE>
Rent expenses for 1999,  2000 and 2001 were  approximately  $0.6  million,  $2.3
million  and  $2.8  million,  respectively.  The  above  rent  expense  includes
sub-lease rental income from various of the Company's  unused premises  totaling
approximately $0.7 million in 2001 and none in 1999 and 2000.

b. Royalties:

In 2001, the Company received  royalty-bearing grants totaling $0.6 million from
the Israeli  government,  which were  recorded as a  reduction  of research  and
development  expenses.  The Israeli  government  requires  beneficiaries of such
grants to pay royalties to the Israeli  government based on the revenues derived
from the sale of products, technologies and services developed with such grants.
The Royalties amount to 3%-5% of the above-mentioned  revenues,  up to an amount
equal to 100% - 150% of the  grants  received  linked to the US dollar and bears
interest at an annual rate of LIBOR.  We believe that we have no obligation  for
royalties  in  2001,  related  to the  2001  grants,  since  we had not  started
generating  revenue from the product developed with such grants, but we may have
obligations  for royalties in 2002 and future years.  The ultimate  liability is
subject to the review of the Israeli  government.  As of  December  31, 2001 the
Company had a  contingent  liability  to pay  royalties  of  approximately  $0.6
million.

In previous years, the Company participated in programs sponsored by the Israeli
Government for the support of research and development  activities.  The Company
is obligated  to pay  royalties  to the Office of the Chief  Scientist  ("OCS"),
amounting  to 3%-5% of the  sales of the  products  and other  related  revenues
generated from such projects, up to an amount equal to 100% - 150% of the grants
received  linked  to the  US  dollar.  The  Company  received  grants  from  the
Government  of Israel,  through the OCS,  for the  financing of a portion of its
research and development expenditures in Israel. The related funded projects had
ultimately failed and the relevant payments were made for the revenues generated
from these  projects but it will not be obligated  to pay future  royalties  for
such  projects  through 2001 as the Company  does not expect any future  revenue
from these  projects.  In March 2002, the Company  submitted an application  for
project failure with regard to these projects.  Accordingly, the Company decided
to write down the $0.4 million  accrual it recorded in past years and determined
that as of December 31, 2001 there are no contingent  liabilities  for royalties
for these projects.  However, The ultimate liability is subject to the review of
the Israeli government.

c. Employee Options Withholding Tax

In April 2001, the Israeli Tax Authority  ("ITA") demanded  withholding tax from
the Company on behalf of former employees who exercised options, and immediately
confiscated  the bank account in Israel and demanded to receive from the Company
a bank  guarantee.  The Company  issued a bank guarantee of $650 thousand to the
ITA and  accrued a reserve for the amount of $300  thousand  as of December  31,
2000.  The  Company's  position is that there was no  obligation to withhold tax
since that at the date of the exercise of the options,  the Company did not have
an  employer-employee  relations  with those  former  employees.  Consequent  to
negotiations  with the  ITA,  the ITA  cancelled  its  confiscation  of the bank
account  and the bank  guarantee  and began  demanding  the tax from the  former
employees directly.  Accordingly,  as of December 31, 2001, the Company does not
believe it has any liability and thus the reserve was cancelled.

d. Bank Line of Credit:

Due to the acquisition of Wingra,  Inc., the Company assumed a revolving  credit
arrangement with a financial institution. The credit agreement is collateralized
by certain assets of the Company.  The provisions of the credit agreement enable
the Company to borrow up to  $100,000  on a  revolving  line of credit at annual
interest  rate of 14.25%.  The  amount  outstanding  at  December  31,  2001 was
approximately $0.1 million.

e. Collateral and Guarantees:

Due to the Acquisition of Wingra,  Inc., the Company assumed a revolving line of
credit  in the  amount of $0.1  million,  collateralized  by a chattel  security
agreement and the personal guarantee of a shareholder.

                                      F-16
<PAGE>

f. Class Action Litigation

Following  the  restatement  of revenues  for the first three  quarters of 2000,
several class action lawsuits were filed in the United States District Court for
the  Northern  District  of  California  against  the Company and certain of its
officers and a director,  alleging violations of the antifraud provisions of the
Securities Exchange Act of 1934 arising from the Company's financial statements.
These lawsuits were consolidated into one action in late 2001.  Thereafter,  the
Company filed a Motion to Dismiss, which has been granted, though the plaintiffs
have been granted  leave to amend the  complaint.  On April 22, 2002, an amended
lawsuit was filed.  While the Company and its legal counsel is unable to predict
the ultimate outcome of the consolidated  claim, the Company believes that it is
without merit and intends to continue to vigorously defend itself.

NOTE 11: RESTRUCTURING CHARGES

During  2001,  the  Company   announced  that  it  was  implementing   strategic
initiatives  intended to further reduce costs.  In connection with the strategic
initiatives,  and in accordance with SFAS 121, "Accounting for the Impairment of
Long-Lived  Assets  and  for  Long-Lived  Assets  To Be  Disposed  Of",  SAB 100
"Restructuring and Impairment Charges" and EITF 94-3, "Liability Recognition for
Certain  Employee  Termination  Benefits  and  Other  Costs to Exit an  Activity
(Including   Certain   Costs  in  a   Restructuring)",   the  Company   recorded
restructuring and other  non-recurring  charges of approximately $11.2 million .
The  restructure  included  curtailing  expenses  and  reducing  the  number  of
employees.   The  cash  and  non-cash  elements  of  the  restructuring   charge
approximate  $2.0 million and $9.2 million,  respectively  (the non-cash  charge
represents property, equipment and other write-downs).

The cash charges  consisted of $1.0 million in severance  pay which was recorded
in the  statement  of  operations  under  operating  expenses  according  to the
relevant  section  and $1.0  million  for other exit costs was  recorded  in the
statement of operations as write off of property and equipment.

As  a  result  of  strategic  initiatives,   approximately  118  positions  were
eliminated in the Company.

As of  December  31,  2001,  there are no  accruals  recorded  in the  financial
statements.

As a part of the Company's  cost  containment  efforts,  it reached  settlements
agreements with a few of its vendors. Some of the settlement agreements included
issuance of shares or warrants  while other  included  only cash  payments.  The
amount written off totaled  approximately $0.8 million,  which was deducted from
the relevant  categories  of operating  expenses,  and the Company also recorded
approximately $0.1 million  compensation  expenses regarding the warrants issued
(see Note 13 b) and  agreed to pay a letter of  credit  for  approximately  $1.0
million it granted its landlord.

NOTE 12: INCOME TAXES

Israeli Income Tax:

The  Company's  production  facilities  in Israel  have been  granted  "Approved
Enterprise" status for three separate investment programs in 1992, 1996 and 2000
by the Israeli  Investment  Center  under the Law for  Encouragement  of Capital
Investments, 1959 ("the Law").

During 2001, the "Approved  Enterprise"  status for the 1996 investment  program
was cancelled.

The Company's  first program was approved in 1995. The Company's  second program
(which was later cancelled)  received a letter of approval in April 1996 and the
Company's third program received a letter of approval in December 2000.

Undistributed  Israeli  income  derived from each of its  "Approved  Enterprise"
programs  entitle  the  Company  to a  tax-exemption  for a period  of two years
commencing  with the first year it will earn taxable  income (not commenced yet)
and to a reduced tax rate of 10%-25% for an  additional  period of five to eight
years (depending on the level of foreign  investment in the Company).  These tax
benefits cannot continue beyond the earlier of twelve years from commencement of
operations,  or  fourteen  years  from  receipt  of  approval.  Thereafter,  the
Company's  income will be subject to the regular income tax rate of 36%.  Income
that was not derived from "Approved  Enterprise"  during the benefits  period is
taxed at the regular rate of 36%.  Distribution  of cash  dividends  from income

                                      F-17
<PAGE>
that was not derived  from  "Approved  Enterprise"  generally  is subject to 25%
withholding tax. As currently only a part of the Company's  capital  investments
are approved (a "Mixed  Enterprise"),  its effective  corporate tax rate will be
the determined by the weighted combination of the various applicable rates.

Distribution  of cash  dividends  from  income  that was tax  exempt  due to the
"Approved  Enterprise" status is subject to corporate tax at the rate that would
have been  applicable  to the income of the Company had the Company not been tax
exempt.  In  addition,  these  dividends  will  generally  be  subject  to a 15%
withholding tax.

The  tax  exempt  income  attributable  to  the  "Approved  Enterprise"  can  be
distributed to  shareholders  without  subjecting the Company to taxes only upon
the complete liquidation of the Company.

The  entitlement  to the  above  benefits  is  conditional  upon  the  Company's
fulfilling the  conditions  stipulated by the above law,  regulations  published
thereunder  and the  instruments  of approval  for the specific  investments  in
"approved enterprises". In the event of failure to comply with these conditions,
the  benefits  may be  canceled  and the  Company  may be required to refund the
amount of the benefits, in whole or in part, including interest.

As the  Company  currently  has no taxable  income,  the  benefits  have not yet
commenced for all programs.

The Company's Board of Directors has determined that such tax exempt income will
not be distributed as dividends.  The Company is currently  viewed as qualifying
as an  "industrial  company"  under the Law for the  Encouragement  of  Industry
(Taxation),  1969  and as such is  entitled  to  certain  tax  benefits,  mainly
accelerated  rates of  depreciation  and the  right to  deduct  public  issuance
expenses.

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 2 b, 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 SFAS No. 109,  the Company has not provided  deferred  income
taxes on the  difference  between the  functional  currency and the tax bases of
assets and liabilities.

As of December 31, 2001, Israeli net operating loss  carry-forwards  amounted to
$38.0 million.  Such net operating loss may be carried forward  indefinitely and
offset against future taxable income.

U.S. Income Tax:

Commtouch, Inc. is taxed based upon tax laws in the U.S.

As of December 31, 2001,  Commtouch,  Inc. had a U.S. federal net operating loss
carry-forward of approximately $66.6 million.  The net operating loss expires in
various  amounts  between  the years  2008 and  2022.  Utilization  of U.S.  net
operating losses may be subject to the substantial  annual limitation due to the
"change  in  ownership"  provisions  of the  Internal  Revenue  Code of 1986 and
similar state provisions.  The annual limitation may result in the expiration of
net operating losses before utilization.

Deferred Income Taxes:

Deferred  income  taxes  reflect  the net tax effects of  temporary  differences
between the carrying  amounts of assets and liabilities for financial  reporting
purposes and the amounts used for income tax purposes. Significant components of
the Company's deferred tax liabilities and assets are as follows:

                                                               December 31,
                                                           -------------------
                                                             2000       2001
                                                           --------   --------
Deferred tax assets are as follows (in thousands):
U.S. operating loss carry-forwards.......................  $ 12,594   $ 25,020
Reserves and allowances not currently deductible.........     4,144      2,565
                                                           --------   --------
Net deferred tax asset before valuation allowance........    16,738     27,585
Valuation allowance......................................   (16,738)   (27,585)
                                                           --------   --------
Net deferred tax asset...................................  $     --   $     --
                                                           ========   ========

As of December 31, 2001,  the Company and its  subsidiary  have  provided a 100%
valuation  allowance with respect to deferred tax assets resulting from tax loss
carry-forwards.  The  valuation  allowance  has increased by 10,847 during 2001.
Management  currently  believes that since the Company and its subsidiary have a
history of losses it is more likely than not that the deferred tax regarding the
loss carry-forwards and other temporary  differences will not be realized in the
foreseeable future.

                                      F-18
<PAGE>
Pretax loss:

Pretax losses are as follows (in thousands):

                                            1999        2000        2001
                                          --------    --------    --------
Israel..................................  $ 11,259    $ 23,209    $ 26,951
U.S.....................................     8,592      27,821      33,419
Other...................................        --       3,140         352
                                          --------    --------    --------
                                          $ 19,851    $ 54,170    $ 60,722
                                          ========    ========    ========

NOTE 13: SHAREHOLDERS' EQUITY

The ordinary shares of the Company are traded on the NASDAQ National Market.

a. Shares Issued:

In April 1999, the Company's  Board of Directors  approved:  a 20 for 1 split of
ordinary  shares,  a change  in the  conversion  ratio of  preferred  shares  to
ordinary shares to 1 to 20 and an increase to the authorized  ordinary shares to
40,000,000 shares of NIS 0.05 par value. The consolidated  financial  statements
have been  retroactively  adjusted  to  reflect  such  changes  for all  periods
presented.

In July 1999, the Company  completed an Initial Public  Offering  ("IPO") of its
ordinary  shares.  The Company  sold  3,450,000  shares to the public at $16 per
share. Concurrent with the closing of the IPO, the Company sold 1,344,086 shares
at $14.88 per share to  InfoSpace,  Inc. In  addition,  the holders of Series A,
Series B, Series C and Series D convertible  preferred shares received  ordinary
shares  pursuant  to an  automatic  conversion,  resulting  in the  issuance  of
7,109,800 ordinary shares in exchange for all outstanding  convertible preferred
shares.

On June 1, 2001, the Company  entered into an ordinary share purchase  agreement
with Rideau Ltd. ("Rideau"), a Bahamian limited liability company.  According to
the  agreement  the  Company  issued  315,789  shares  to  Rideau  for  a  total
consideration of approximately $0.3 million.  The price per share was determined
according  to the then  trading  prices of the  Company's  shares on the  Nasdaq
National Market, less a discount of 10% or $0.106 per share.

b. Warrants Issued:

Warrants to Investors. In 1996, the Company issued to certain Series B investors
warrants to purchase 13,873 Series B Convertible Preferred shares at an exercise
price of $44.04. These warrants were exercised  concurrently with the closing of
the IPO.

Warrants to Vendors in connection with Settlement Agreements.  In furthering the
settlement of significant  outstanding and future lease obligations to Commtouch
Inc's Mountain View facility lessor,  Equity Office Properties  ("EOP"), as well
as Commtouch Inc's equipment  vendor,  Compaq  Financial  Services,  the Company
issued warrants to these  companies.  The Compaq fully vested warrant was issued
in January  2002 and allows for purchase of up to 200,000  ordinary  shares at a
price of $0.29 per share,  and the EOP warrant  was issued in December  2001 and
allows for purchase of up to 175,000 ordinary shares at a price of $0.26.  These
warrants expire in December 2006 and January 2007.

The fair value for the EOP  warrant was  estimated  at the date of grant using a
Black-Scholes   Option   Pricing  Model  with  the  following   weighted-average
assumptions: risk-free interest rates of 4.0%, dividend yields of 0%, volatility
factors of the expected  market price of the Company's  ordinary shares of 1.482
and an  expected  life of the  option of 6 months  after the  option is  vested.
Accordingly,  the Company recorded approximately $53,000 as compensation expense
and included the amount in operating expenses.

Warrants Issued for Services Received and Financing Transactions.  Through 1999,
the Company granted warrants in connection with a bank line of credit, loans and
consulting  services  received.  At  December  31,  1999,  one warrant for 4,860
ordinary shares with an exercise price of $3.61 per share remained  outstanding.
This warrant was net exercised into 4,461 shares in January 2000.

                                      F-19
<PAGE>
In  connection  with the  amounts of the  warrants,  the Company  recorded  $0.4
million in 1999 and, none in 2000 and 2001, as  compensation  expenses that were
included in interest expenses.

Warrants Issued to Strategic Partners and Customers. Concurrent with the closing
of the IPO,  the Company  entered  into a  customary  commercial  email  service
agreement  with  InfoSpace  (Formerly,  Go2Net),  a related  party.  Under  this
agreement,  the Company  provides email services to the end users of InfoSpace's
various email properties.  In connection with this agreement, the Company issued
a warrant  expiring in July 2004 to  purchase  1,136,000  ordinary  shares at an
exercise  price of $12.80 per share.  As of December 31, 2001,  this warrant had
not been  exercised.  At the grant  date,  the fair  value of this  warrant  was
estimated as $5.8  million and was  amortized  to  operating  expenses  over the
minimum term of the contract (twelve months through July 2000).

c. Issuance of Ordinary Shares Against Promissory Notes:

From February 1, 2000 through August 10, 2000 the Company  granted certain loans
to certain officers and directors to enable them to finance an early exercise of
their options into restricted shares. In December 2000, the Company was notified
by its legal  counsel,  that  under the new  Israeli  Companies  Law,  effective
February 1, 2000,  the Company was currently  prohibited  from financing a third
party purchase of its shares.  Accordingly,  the loans to officers and directors
were in violation of Israeli  corporate law and considered  null and void.  Upon
notification,  the Company decided to void the loans and the underlying exercise
of options.

During 1999,  several  employees and officers early  exercised  670,180  options
granted to them by Commtouch. In consideration for the ordinary shares purchased
pursuant to the early exercise of the options, they provided Commtouch with full
recourse promissory notes in the original principal amount of approximately $1.0
million.  The promissory notes bear interest at 4.83%, with interest payment due
at  the  end of  each  calendar  year,  with  the  principal  due on the  fourth
anniversary  of the date of the  promissory  notes.  The  shares  purchased  are
subject to a right of repurchase in favor of Commtouch according to the original
vesting schedule of the options exercised,  generally four years. As of December
31, 2001, approximately 6,308 shares are subject to this right of repurchase.

During 2001,  the Company had forgiven a promissory  note of $143,000 for one of
its employees and demanded the then current value of the shares ($7,266 relating
to the 7,500 shares) and the full interest on the original  note.  Both interest
and the adjusted note was repaid in March 2001.  The Company  accounted for this
note in accordance  with EITF 00-23 "Issues  Related to the Accounting for Stock
Compensation  under APB Opinion No. 25 and FASB  Interpretation No. 44" and EITF
95-16  "Accounting  for  Stock  Compensation  Arrangements  with  Employer  Loan
Features  under APB Opinion No. 25". A note for  $137,112  was repaid by another
employee for 94,560 shares.

d. Employee Stock Purchase Plan:

Commtouch  reserved a total of  1,229,156  shares for  issuance  under the plan.
Eligible  employees were able to purchase ordinary shares at 85% of the lower of
the  market  value of the  Company's  Ordinary  shares  on the  first day of the
applicable  offering period or the last day of the applicable  purchase  period.
The total  shares  issued  under the plan were zero,  80,545 and 136,782 for the
years 1999, 2000 and 2001, respectively. This Plan terminated in late 2001.

e.  Repricing

On April 30, 2001 the Company's  Board of Directors  approved the "repricing" of
options previously granted to employees  according to the criteria stated below.
Accordingly,  the Company  filed a Tender Offer which  expired on September  14,
2001,  and  Commtouch  has accepted for exchange  options to purchase  1,273,513
Ordinary Shares.  Previously granted options were cancelled and new options were
issued with an exercise price equal to the par value of the shares.
In order to enjoy the repricing mechanism, previously granted stock options must
have met the following conditions:

o The exercise price of the original  options exceeds $10

o The option is issued but not exercised

The  repriced  stock  options vest over three years with 1/3 vesting on February
15, 2002 and the  remaining  2/3 vesting  every six months for the following two
years. In connection with this repricing, the Company charged approximately $0.3
million as compensation expense in 2001.

                                      F-20
<PAGE>

During  October  2001,  the Company  decided that 1/3 of the options  granted on
September 14, 2001 to employees  dismissed  during  October 2001 will not expire
upon  termination  of employment.  The Company  decided that this portion of the
options will vest according to the original grant terms on February 15, 2002 and
will be exercisable until August 15, 2002.

The  modification  of  the  grant  term  was  accounted  for  under  APB  25 and
Interpretation  No. 44  "Accounting  for Certain  Transactions  Involving  Stock
Compensation," and resulted in no effect.

f. Stock Options:

The Company has reserved  5,219,574  ordinary shares for issuance under employee
stock option  plans and  agreements.  As of December  31, 2001,  an aggregate of
2,303,885  ordinary  shares of the Company are still available for future grant.
Options granted under such plans and agreements  expire generally after 10 years
from  the  date of  grant  and  terminate  upon  termination  of the  optionee's
employment or other  relationship  with the Company.  The options generally vest
ratably over a 4-year period,  though certain  repriced stock options offered to
employees in a Tender Offer Statement of July 20, 2001, as amended,  vest over a
three  year  period.  The  exercise  price  of the  options  granted  under  the
individual  agreements may not be less than the nominal value of the shares into
which such  options  are  exercisable.  Any  options  that are  canceled  or not
exercised within the options period become available for future grant.

In 1996, the Company adopted the 1996 CI Stock Option Plan for granting  options
to its U.S.  employees  and  consultants  to  purchase  ordinary  shares  of the
Company.  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 2001 to include Section 102 applicability (the
sections relate to code sections under the Israel tax law).

As a result of the Wingra acquisition, the Company assumed stock options granted
to employees under Wingra's stock option plan. At the date of acquisition  these
stock options were immediately converted into approximately 168,000 fully vested
stock options convertible into Commtouch Ordinary Shares.

A summary of the Company's share option activity under the plans is as follows:

<TABLE>
<CAPTION>
                                                                                                    Weighted Average
                                                      Number of Shares                               Exercise Price
                                        --------------------------------------------      ---------------------------------------
                                            1999            2000             2001            1999          2000          2001
                                        ----------       ----------       ----------      -----------   -----------   -----------
<S>                                        <C>            <C>              <C>            <C>           <C>           <C>
Outstanding at beginning of period         849,520        1,383,110        2,650,455      $      1.20   $      9.62   $     19.91
 Granted .........................       1,342,670        2,046,520        3,009,388*           10.13         24.10          0.2
 Exercised .......................        (740,040)        (359,839)        (119,268)            1.42          2.66          0.39
 Canceled ........................         (69,040)        (419,336)      (2,624,886)            4.49         21.77         19.68
                                         ---------        ---------        ---------      -----------   -----------   -----------
Outstanding at end of period .....       1,383,110        2,650,455        2,915,689      $      9.62   $     19.91   $      0.46
                                         =========        =========        =========      ===========   ===========   ===========
Exercisable at end of period .....         381,315          526,986          281,830      $      3.50   $      8.61   $      2.70
                                         =========        =========        =========      ===========   ===========   ===========
</TABLE>

* - Includes 1,273,513 options repriced to par value during 2001.
<TABLE>
<CAPTION>
                                                               For exercise prices on the date of grant that:
                                                               ----------------------------------------------

                                                             Equals market price                  Are less than market price
                                                   ---------------------------------------   -----------------------------------
                                                            Year ended December 31,                 Year ended December 31,
                                                       1999          2000          2001          1999      2000          2001
                                                   -----------   -----------   -----------   -----------   ------    -----------
<S>                                                <C>           <C>           <C>           <C>           <C>       <C>
Weighted average exercise prices ............      $     15.75   $     24.10   $      0.27   $      3.65   $--       $      0.01
Weighted average fair values on date of grant      $     11.98   $     20.20   $      0.10   $     14.80   $--       $      0.44
</TABLE>

                                      F-21
<PAGE>
The options outstanding as of December 31, 2001, have been separated into ranges
of exercise price, as follows:
<TABLE>
<CAPTION>
                                                 Weighted
                            Options               Average                                 Options           Weighted Average
                       Outstanding as of         Remaining            Weighted        Exercisable as of         Price of
                          December 31,       Contractual Life     Average Exercise       December 31,          Exercisable
   Exercise Price             2001                (years)               Price                2001                Options
 -----------------     -----------------     ----------------     ----------------    -----------------     ----------------
<S>                          <C>                     <C>              <C>                     <C>              <C>
 $0.01                       1,429,317               9.62             $     0.10              1,291            $       0.01
 $0.20-$1.47                 1,349,773               8.41             $     0.52            216,818            $       1.26
 $2.25-$6.88                   120,100               8.89             $     4.90             50,769            $       3.50
 $14.19-$17.75                   5,928               8.37             $    16.55              3,340            $      17.13
 $21.13-$35.56                  10,571               8.24             $    26.41              9,612            $      25.95
                             ---------               ----             ----------            -------            ------------
 $ 0.01-$35.56               2,915,689               9.26             $     0.46            281,830            $       2.70
                             =========               ====             ==========            =======            ============
</TABLE>

Under SFAS 123, pro forma  information  regarding net income (loss) and earnings
(loss) per share is  required  and has been  determined  as if the  Company  had
accounted  for its employee  stock  options  under the fair value method of that
Statement.  The fair value for these  options was estimated at the date of grant
using a Black-Scholes  Option Pricing Model with the following  weighted-average
assumptions for 1999, 2000 and 2001:  risk-free interest rates of 5.5% for 1999,
5.5% for 2000, and 4.0% for 2001,  dividend yields of 0%, volatility  factors of
the expected  market price of the  Company's  ordinary  shares of 0.5 - 0.56 for
1999, 1.348 for 2000, and 1.482 for 2001 and an expected life of the option of 6
months after the option is vested for 1999, 2000 and 2001.

The Black-Scholes option valuation model was developed for use in estimating the
fair value of traded  options  that have no vesting  restrictions  and are fully
transferable.  In addition,  option valuation models require the input of highly
subjective assumptions,  including the expected stock price volatility.  Because
the  Company's  employee  stock  options  have   characteristics   significantly
different from those of traded  options,  and because  changes in the subjective
input assumptions can materially affect the fair value estimate, in management's
opinion,  the  existing  models do not  necessarily  provide a  reliable  single
measure of the fair value of its employee stock options.

Pro forma  information  under SFAS 123 are as follows (in  thousands  except per
share amounts):

<TABLE>
<CAPTION>
                                                      1999        2000        2001
                                                   ---------   ---------   ---------
<S>                                                <C>         <C>         <C>
Net loss as reported.............................. $ (19,851)  $ (54,225)  $ (61,007)
                                                   =========   =========   =========
Pro forma net loss................................ $ (20,224)  $ (68,309)  $ (65,734)
                                                   =========   =========   =========
Pro forma basic and diluted net loss per share     $   (2.70)  $   (4.42)  $   (3.83)
                                                   =========   =========   =========
</TABLE>

The Company recorded deferred  compensation  representing the difference between
the exercise price and the deemed fair value of the Company's ordinary shares at
the date of grant. Such amount is being amortized using the sum-of-digits method
over the vesting period of the options, generally four years.

Deferred compensation is as follows (in thousands):
Balance as of January 1, 2001.....................................    $  2,729
Deferred compensation related to options issued to employees......       1,028
Less amounts reduced for terminated employees.....................        (725)
Less amortization of deferred compensation........................      (2,204)
                                                                      --------
Balance as of December 31, 2001...................................    $    828
                                                                      ========

g. Non-Employee Directors Stock Option Plan:

The Company  adopted the 1999  Non-Employee  Directors  Stock Option  Plan.  The
original allotment of shares was in the amount of 180,000 ordinary shares,  with
an additional  allotment in 2000 bringing the plan's total  allotment to 500,000
shares and a further  allotment  in 2001  bringing  the plan's  total to 750,000
ordinary  shares.  During 1999,  each  individual  who first joined the Board of
Directors  as a  non-employee  director  on or after the  effective  date of the
initial public offering  received an option grant for 10,000 shares.  Subsequent
to July 2000,  individuals  who joined the board  received  an initial  grant of
30,000   options.   Directors  who  are  reelected  at  the  annual  meeting  of
shareholders  are  generally  entitled to  additional  grants of 10,000  shares,
though  those  directors  reelected  at the August 22,  2001  annual  meeting of
shareholders  were  entitled to a grant of 33,750 and those  directors in office
immediately after the extraordinary  general meeting of shareholders on February
25, 2002 were granted a one-time  option grant of 150,000  ordinary  shares.  In
addition a senior board member received a grant of 221,250 ordinary shares. Each

                                      F-22
<PAGE>
option  granted under the  Non-Employee  Directors  Plan  originally was to have
become exercisable with respect to one-fourth of the number of shares covered by
such option  three  months after the date of grant and with respect to one-third
of the  remaining  shares  subject to the option every three months  thereafter;
however,  this  changed  pursuant  to an  amendment  to  the  plan  approved  by
shareholders  at the August 10, 2000 annual meeting of  shareholders,  such that
options become 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.  However,  certain options  outstanding
and  unexercised at the time of the effective date of the Tender Offer Statement
of July 20, 2001, as amended,  were repriced in accordance with the terms of the
Tender Offer Statement, as amended. Each option has a maximum term of ten years,
but will terminate earlier if the optionee ceases to be a member of the Board of
Directors.

During 2001, the Company granted 623,750 options to non-employee  directors at a
weighted  average  exercise  price of $0.20 per share.  As of December 31, 2001,
66,013 options were exercisable and 563,894 were outstanding.

NOTE 14: GEOGRAPHIC INFORMATION

The Company  conducts its business on the basis of one  reportable  segment (see
Note 1 for brief description of the Company's business). The Company has adopted
Statement of Financial Accounting Standard No. 131,  "Disclosures About Segments
of an Enterprise and Related Information".

Revenues from external customers (in thousands):

                                                       Revenues
                                              ---------------------------
                                                1999     2000      2001
                                              -------  --------  --------
          Israel............................  $   369  $    196  $    451
          U.S.A.............................    3,056    11,047     7,536
          Europe............................      344     1,927     2,500
          Japan.............................      250     1,295       656
          Latin America.....................       38     4,085     2,910
          Other.............................      194       565     1,265
                                              -------  --------  --------
                                              $ 4,251  $ 19,115  $ 15,318
                                              =======  ========  ========

The Company's long-lived assets as follows (in thousands):

                                                   2000        2001
                                                --------     -------
          Israel.............................   $ 18,911     $ 2,953
          U.S.A..............................     18,016       1,773
          Other..............................        545         426
                                                --------     -------
                                                $ 37,472     $5,152
                                                ========     =======

NOTE 15: SUBSEQUENT EVENTS (UNAUDITED)

a. Sale of Wingra

Commtouch  sold off its migration  service  business,  Wingra,  Inc. to Wingra's
current senior  management at the end of February 2002. The terms include mutual
release  of all  liabilities,  obligations  and  rights  of the  parties  to the
agreement. This sale reduced the Company's net liabilities by approximately $0.7
million.

b.  Private Placement

On February 17, 2002,  Commtouch signed a private placement  agreement according
to which it will issue  approximately  4.4  million  ordinary  shares to private
investors  for  approximately  $1.3  million;  one-third of the shares are being
purchased by Commtouch's founders,  who are currently Commtouch directors and/or
executive  officers.  The purchasers in the private  placement will also receive
five-year  warrants to purchase up to an additional 2.66 million ordinary shares
(approximately).  The exercise price for one-third of the warrants will be $0.37

                                      F-23
<PAGE>

per share, the exercise rice for an additional one-third of the warrants will be
$1.00 per share and the exercise  price for the final  one-third of the warrants
will be $2.00 per share. The funds were received on April 15, 2002.

c. Sale of Hosted Exchange

In  January  2002,   Commtouch  sold  its  Hosted  Exchange   business  unit  to
Telecomputing,  Inc. Terms of the  transaction  include the  transference of the
Company's customer base and certain equipment to Telecomputing,  in exchange for
certain cash payments and royalties. Furthermore, the Company assigned equipment
leases to Telecomputing,  thereby  eliminating the Company's  obligation to make
lease payments thereunder. In consideration for the transaction,  the Company is
entitled  to receive  royalty  payment  of 20% from  sales in 2002 ,  additional
royalty payment of 20% from sales  performed in 2002 to potential  customers and
royalties  of 10% from sales in 2002 and 2003 to  customers  referred  to be the
Company. No material loss or gain resulted from the transaction.

d. Strategic Agreement with MailCentro

Within the framework of an agreement with MailCentro Inc.  ("MC"),  MC (a wholly
owned  subsidiary of CP Software  Group,  Inc.) assumed all aspects of servicing
most of the Company's consumer customers, including its free email service known
as Zap Zone  service.  According  to the  agreement  entered  into with MC,  the
Company  transferred  customers  to MC and is expected to realize  royalties  on
payments made by these former customers to MC (primarily in 2002). Additionally,
certain Commtouch trademarks, domain names, software licenses and equipment were
sold to MC.
In consideration for the transaction, the Company is entitled to receive royalty
payment from sales at a rate of 70% in Q1 , 50% from sales in Q2 and Q3, and 25%
of sales in Q4 of year 2002.

                                      F-24
<PAGE>

                                   SIGNATURES

Pursuant to the requirements of Section 12 of the Securities and Exchange Act of
1934, the registrant  certifies that it meets all of the requirements for filing
on Form 20-F and has duly caused  this annual  report to be signed on its behalf
by the undersigned, thereunto duly authorized.

                                            COMMTOUCH SOFTWARE LTD.

                                            By: /s/ Devyani Patel
                                            ------------------------------------
                                            Devyani Patel
                                            V.P. Finance
April 26, 2002

                                      F-25
<PAGE>

                             COMMTOUCH SOFTWARE LTD.

                SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
                            U.S. Dollars in thousands
<TABLE>
<CAPTION>
                                                         Balance at
                                                            the          Charged to                    Balance at
                                                        beginning of      cost and                     end of the
                                                         the period       expenses      Deductions       period
                                                        ------------     ----------     ----------     ----------
<S>                                                       <C>            <C>             <C>             <C>
  Year ended December 31, 1999:
    Bad debt........................................      $   --         $   405         $    --         $ 405
                                                          ======         =======         =======         =====
  Year ended December 31, 2000:
    Bad debt........................................      $  405         $ 1,990         $(1,533)        $ 862
                                                          ======         =======         =======         =====
  Year ended December 31, 2001:
    Bad debt........................................      $  862         $   259         $  (551)        $ 570
                                                          ======         =======         =======         =====
</TABLE>

<PAGE>
Item 19. Exhibits

  Exhibit
   Number                         Description of Document
   ------                         -----------------------

     1.1      Memorandum of Association of the Registrant.(1)

     1.2      Articles of Association of the Registrant.(6)

     2.1      Specimen Certificate of Ordinary Shares.(1)

     2.2      Amended and Restated  Registration  Rights  Agreement  dated as of
              April 19, 1999.(1)

     2.2.1    Amendment  No.  1 to  Amended  and  Restated  Registration  Rights
              Agreement dated as of December 29, 1999.(4)

     2.2.2    Amendment  No.  2 to  Amended  and  Restated  Registration  Rights
              Agreement dated as of March 10, 2000.(5)

     2.3      Form of  Tag-Along  Rights  (Right of First  Refusal and  Co-Sale)
              Agreement dated as of December 23, 1998.(1)

     2.4      Form of Drag-Along Letter dated as of April 15, 1999.(1)

     2.5      Ordinary Shares Purchase Agreement between Commtouch Software Ltd.
              And Torneaux Fund Ltd., dated January 23, 2001.(9)

     2.6      Amended and Restated Merger and Exchange  Agreement dated November
              24,  2000  among  Commtouch  Software  Ltd.,  Commtouch  Inc.,  CW
              Acquisition  Corporation,  Wingra,  Incorporated,  the  holder  of
              certain of the outstanding capital stock of Wingra,  Incorporated,
              and the holders of all the  outstanding  membership  interests  in
              Wingra  Technologies,   LLC  other  than  that  owned  by  Wingra,
              Incorporated.(10)

     2.7      Registrant  hereby agrees to furnish the  Securities  and Exchange
              Commission, upon request, with the instruments defining the rights
              of holders of  long-term  debt of the  registrant  with respect to
              which the total amount of  securities  authorized  does not exceed
              10% of the total assets of the Registrant.

     2.8      Ordinary  Shares  and  Warrants  Purchase  Agreement  dated  as of
              February 27, 2002 by and between Commtouch  Software Ltd., and the
              Investors Listed on Exhibit A Thereto

     4.1      Registrant's  1996 CSI Stock  Option Plan and forms of  agreements
              thereunder.(1)

     4.2      Registrant's   form  of  Stock   Option   Agreement   for  Israeli
              Employees.(1)

     4.3      Registrant's   1999  Stock  Option  Plan  and  form  of  agreement
              thereunder.(1)

     4.4      Commtouch  Software Ltd. 1999  Nonemployee  Directors Stock Option
              Plan.(1)

     4.4.1    Amendment to Commtouch  Software Ltd. 1999  Nonemployee  Directors
              Stock Option Plan.(7)

     4.5      Commtouch  Software  Ltd. 1999  Employee  Stock  Purchase Plan and
              forms thereunder.(1)

     4.6      Sublease  between  ASCII  of  America,   Inc.  and  Commtouch  for
              Commtouch's offices in Santa Clara, California, dated December 16,
              1998.(1)

     4.7      Lease  between  DeAnza  Building  and  Commtouch  for  Commtouch's
              offices in  Sunnyvale,  California,  dated  February  5, 1996,  as
              amended.(1)

<PAGE>
     4.8      Form of Letter  Agreement  between the Registrant and U.S. Bancorp
              Piper Jaffray.(2)

     4.9      Form  of  Customized  Web-based  Email  Service  Agreement  by and
              between Go2Net, Inc. and the Registrant.(3)

     4.9.1    Form of Share Warrant for Go2Net, Inc. to purchase ordinary shares
              of the Registrant.(3)

     4.9.2    Form of  Share  Warrant  for  Microsoft  Corporation  to  purchase
              ordinary shares of the Registrant dated October 26, 1999.(4)

     4.9.3    Amendment  dated  December  29, 1999 to Form of Share  Warrant for
              Microsoft   Corporation  to  purchase   ordinary   shares  of  the
              Registrant.(4)

     4.9.4    Lockup Agreement between the Registrant and Microsoft  Corporation
              dated December 29, 1999.(4)

     4.10     Form of Share  Purchase  Agreement  by and among  the  Registrant,
              Go2Net, Inc. and Vulcan Ventures Incorporated.(3)

     4.10.1   Form of Registration Rights Agreement by and among the Registrant,
              Go2Net, Inc. and Vulcan Ventures Incorporated.(3)

     4.10.2   Form of Letter  Agreement  between  the  Registrant  and  Selling.
              Securityholders extending deadline for SEC registration.(4)

     4.11     Commtouch Software Ltd. 1999 Section 3(I) Share Option Plan.(8)

     4.12     Office Lease between  EOP-Shoreline  Technology  Park,  L.L.C. and
              Commtouch Software, Inc. dated October 28, 1999.(11)

     4.13     Wingra Technologies, LLC 1998 Unit Option Plan (13)

     4.14     Stock  Purchase  Agreement  between  Commtouch  Software  Ltd. and
              Rideau Ltd., dated June 1, 2001 (12)

     4.15     Form of Wingra Technologies, LLC Investor Option Agreement (14)

     4.16     Form of Wingra Technologies, LLC Investor Warrant Agreement (15)

     4.17     Stock  Purchase  Agreement  between  Commtouch  Software  Ltd. and
              Hughes Holdings LLC., dated June 5, 2001 (16)

     4.18     Agreement of Commercial  Lease between  Am-Ram Pituah Drom Netanya
              (South Netanya  Development)  Ltd. as Lessor and Comtouch Software
              Ltd.  as  Lessee  dated  June 3,  2000 for  premises  in  Netanya,
              Israel.(17)

     4.19     Conditional  Lease  Termination  Agreement  between  EOP-Shoreline
              Technology Park, L.L.C. and Commtouch Inc. dated December 21, 2001

     4.20     Settlement  between  Compaq  Financial  Services  Corporation  and
              Commtouch Inc. and Commtouch Software Ltd. dated December 21, 2001

     4.21     Settlement and  Termination of Services  Agreement  between Exodus
              Communications, Inc. and Commtouch Inc. dated January 10, 2002

     4.22     Amended  and  Restated  1996 CSI  Stock  Option  Plans and form of
              agreement thereunder (18)

     4.23     Amended and Restated  1999 Section 3(i) Share Option Plan and form
              of option agreement thereunder (19)

<PAGE>
     4.24     Amended 1999 Non-Employee  Directors Stock Option Plan and form of
              agreement thereunder (20)

     4.25     Agreement  of Merger  between CP Software  Group  Inc.,  Commtouch
              Software Ltd, MailCentro,  Inc. and CPSGNEWCO, Inc. dated November
              16, 2001

     4.26     Business  Unit  Purchase  Agreement by and between  Telecomputing,
              Inc. and Commtouch Inc. dated January 15, 2002

     4.27     Sale and  Purchase  Agreement  by and between  Commtouch  Software
              Ltd., Commtouch Inc., Wingra,  Incorporated,  Wingra Technologies,
              L.L.C., Jan Eddy and Steven Entine dated February 25, 2002

     8        Subsidiaries of the Company.

     10.1     Consent of Kost, Forer & Gabbay, independent auditors.

     10.2     Memorandum of Understanding  between the Registrant,  Go2Net, Inc.
              and Vulcan Ventures Incorporated, dated July 7, 1999.(2)

-------------------------
(1)  Incorporated by reference to similarly  numbered exhibit in Amendment No. 1
     to Registration  Statement on Form F-1 of Commtouch Software Ltd., File No.
     333-78531.
(2)  Incorporated by reference to similarly  numbered exhibit in Amendment No. 4
     to Registration  Statement on Form F-1 of Commtouch Software Ltd., File No.
     333-78531.
(3)  Incorporated by reference to similarly  numbered exhibit in Amendment No. 5
     to Registration  Statement on Form F-1 of Commtouch Software Ltd., File No.
     333-78531.
(4)  Incorporated by reference to similarly  numbered exhibit in Amendment No. 1
     to Registration  Statement on Form F-1 of Commtouch Software Ltd., File No.
     333-89773.
(5)  Incorporated by reference to similarly  numbered exhibit in Amendment No. 2
     to Registration  Statement on Form F-1 of Commtouch Software Ltd., File No.
     333-89773, filed March 28, 2000.
(6)  Incorporated  by reference to Exhibit 2 to Report on Form 6-K for the month
     of August 2000.
(7)  Incorporated  by reference to Exhibit 3 to Report on Form 6-K for the month
     of August 2000.
(8)  Incorporated by reference to Exhibit 10.2 to Registration Statement on Form
     S-8 No. 333-94995.
(9)  Incorporated  by reference to Exhibit 2 to Report on Form 6-K for the month
     of January 2001.
(10) Incorporated  by reference to Exhibit 3 to Report on Form 6-K for the month
     of January 2001.
(11) Incorporated  by reference to Exhibit 1 to Report on Form 6-K for the month
     of January 2001.
(12) Incorporated  by reference to Exhibit 1 to Report on Form 6-K for the month
     of May 2001, filed June 1, 2001.
(13) Incorporated  by reference to Exhibit 2 to Report on Form 6-K for the month
     of May 2001, filed June 1, 2001.
(14) Incorporated  by reference to Exhibit 3 to Report on Form 6-K for the month
     of May 2001, filed June 1, 2001.
(15) Incorporated  by reference to Exhibit 4 to Report on Form 6-K for the month
     of May 2001, filed June 1, 2001.
(16) Incorporated  by reference to Exhibit 4 to Report on Form 6-K for the month
     of May 2001, filed June 12, 2001.
(17) Incorporated  by  reference to Exhibit  10.13 to Amendment  No. 1 to Annual
     Report on Form 20-F for the year ended December 31, 2000.
(18) Incorporated by reference to Exhibit 4 to Schedule TO, filed July 20, 2001.
(19) Incorporated by reference to Exhibit 5 to Schedule TO, filed July 20, 2001.
(20) Incorporated by reference to Exhibit 6 to Schedule TO, filed July 20, 2001.