COMMTOUCH SOFTWARE LTD


                                 Filing Type: 20-F
                                 Description: Annual Report for Foreign Private
                                              Issuers
                                 Filing Date:
                                  Period End: Dec 31, 1999


                            Primary Exchange: NASDAQ - National Market System
                                              Ticker:  CTCH






<PAGE>


                                Table of Contents

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                                      20-F



Item 17.......................................................................2

PART I........................................................................5

Item I........................................................................5

Item 2.......................................................................29

Item 3.......................................................................29

Item 4.......................................................................29

Item 5.......................................................................30

Item 6.......................................................................30

Item 7.......................................................................30

Item 8.......................................................................40

Item 9.......................................................................41
Income Statement.............................................................41

Item 10......................................................................48

Item 11......................................................................55

Item 12......................................................................55

Item 13......................................................................55

PART  II.....................................................................58

Item 14......................................................................58

Part III.....................................................................58

Item 15......................................................................58

Item 16......................................................................58

Part IV......................................................................58

Item 17......................................................................58

Item 18......................................................................58

Item 19......................................................................59
Balance Sheet................................................................60
Income Statement.............................................................61
Cash Flow Statement..........................................................63




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

                                ----------------

                                    FORM 20-F

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

                   For the fiscal year ended December 31, 1999

                        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)

                    James E. Collins, Chief Financial Officer
                         3945 Freedom Circle, Suite 400
                          Santa Clara, California 95054
                                  (408)653-4330
            (name, address, including zip code, and telephone number,
              including area code of agent for service of process)


         ---------------------------------------------------------------
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.

     Ordinary Shares, par value NIS 0.05                        15,199,344

     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]

--------------------------------------------------------------------------------
--------------------------------------------------------------------------------


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                                     PART I


Item 1. Description of Business.

This  Annual  Report on form 20-F  contains  forward-looking  statements.  These
forward-looking statements include, but are not limited to, statements about our
plans, objectives, expectations and intentions and other statements contained in
this annual  report that are not  historical  facts.  Prospective  investors are
cautioned that any such forward-looking  statements are not guarantees of future
performance  and involve risks and  uncertainties,  and that actual  results may
differ  materially from those in the  forward-looking  statements as a result of
various  factors.  The  information  contained in this annual report  identifies
important factors that could cause such differences.

Amounts and  percentages  appearing  in this Annual  Report may not total due to
rounding.

Overview

Commtouch Software Ltd.  ("Commtouch" or the "Company") and its subsidiaries are
a leading global provider of 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.  As of December 31, 1999, we had
over 250 global customers.  Through our customers' sites we serve  approximately
8.4 million active emailboxes.  We also serve over 1.0 million active emailboxes
to small businesses and websites through our ZapZone Network.

Industry Background

Growth of the Internet Worldwide and Proliferation of Email

The Internet has become a vitally  important  global  medium for  communication,
commerce, content distribution and advertising.  International Data Corporation,
or IDC, estimates that as of December 1999, there were over 80 million Web users
in the United States and over 115 million users outside of the U.S. IDC




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projects  that,  by the end of 2003,  these  numbers  will  increase to over 175
million Web users in the United States and over 325 million users outside of the
U.S.  This  growth  in  the  global  usage  of  the  Web  provides   significant
opportunities for emerging Web-based  businesses and other companies  developing
an online presence.

Email is one of the most widely used applications on the Internet and has become
a primary  platform  for  business  and  personal  communication.  According  to
Forrester Research,  over 80% of Internet users access their email while online,
making this activity the most popular use of the Internet. IDC estimates that at
the end of 1999 there were over 180 million  emailboxes in the United States and
over 130 million  outside of the United States.  IDC projects that by the end of
2003,  these numbers will increase to over 280 million  emailboxes in the United
States and over 305 million emailboxes outside the United States.

Web-based Email

Historically,  most email systems were provided by employers,  Internet  service
providers  (ISPs) or  universities  to individuals or closed groups of end users
through  software  applications  located  on the users'  desktops  or local area
networks.  Such email systems,  however, only permit access through the computer
or network on which the email  software  resides  or through  cumbersome  remote
access systems. The emergence of email systems that use Internet browsers as the
application for sending and receiving email has resulted in tremendous  advances
in email access,  functionality and ease of use. This email standard is commonly
referred to as "Web-based email."

Web-based email offers the following benefits over traditional closed systems:

     o   anytime,  anywhere  (universal)  access to both  business  and personal
         email accounts;

     o   advanced  integrated  communication  services  over  the  Web,  such as
         unified  messaging  (receiving  faxes  and  voicemail  via  email)  and
         integrated calendars and directories; and

     o   easy to use registration, setup and administration.

Businesses worldwide are seeking to differentiate themselves online. A Web-based
email service provides an optimal solution to address this business need because
it increases brand  awareness,  builds and reinforces a loyal,  connected member
base and facilitates commerce in the following ways:

     o   Companies embracing Web-based email can enhance their brand identity by
         controlling  the look and feel of their  Web-based  email interface and
         also by providing end users with  distinctive  branded email  addresses
         such as user@companyname.com.

     o   Web-based  email  significantly  enhances the frequency and duration of
         website visits, commonly referred to as the website's "stickiness." The
         personalized  nature  of  email  and  the  ability  to  bundle  it with
         additional  services,  such  as  calendaring,  scheduling  and  unified
         messaging,  establishes an important one-to-one relationship with email
         users.

     o   Email is  emerging as an  effective  application  for direct  marketing
         online,  as email users provide  important  demographic  data when they
         register for and use email  services.  This  information can be used to
         create highly targeted  marketing  campaigns with minimal  distribution
         costs.

The Opportunity to Provide Outsourced Web-based Email Services

While many organizations  worldwide  recognize the advantages of Web-based email
services,  they often lack the infrastructure,  expertise and resources to fully
realize  these  benefits  through  internal  development.  Due  to  the  growing




<PAGE>


complexity of in-house email systems and the increasing levels of infrastructure
investment  and  management  resources  needed to  provide  comprehensive  email
services,  organizations  around  the  world  are  seeking  to  outsource  email
services.  Businesses  worldwide  seek to partner  with a dedicated  provider of
Web-based email to quickly implement high quality,  feature-rich  email services
without having to invest internally in email management and systems.

The Commtouch Solution

We are a  leading  global  provider  of  outsourced  Web-based  email  and other
messaging services to businesses worldwide. Our flexible and highly customizable
solutions enable us to satisfy the different email and messaging needs of a wide
range of customers.

Benefits of The Commtouch Solution

Extensive Email Features. Our solution is easy to use and provides a broad range
of  industry-leading  functionality.  This includes the ability for end users to
collect email from other email accounts, to create folders, to attach electronic
documents,  to store  messages,  to  maintain a contact  center,  to maintain an
integrated calendar, to create distribution lists and to establish user profiles
and signatures. Our service uses IMAP4, an advanced email protocol, which allows
email folders to be accessed from multiple email environments.

The value of our  solution is increased  by our  provision of premium  services,
which allow end users to send and receive  faxes,  voicemail  and pages from the
emailbox;  access  the  Web-based  emailbox  from an  off-line  client  (such as
Microsoft  Outlook);  and have email  forwarded to other  addresses.  We believe
that, by providing a single  platform which  integrates  multiple  communication
services and devices,  the  Web-based  emailbox we provide has the  potential to
become our end users' primary online communications center.

Ability to Support  Hundreds of Millions of Emailboxes.  Our modular  technology
architecture  enables the rapid set up of  full-service  hosting  facilities and
enables us to rapidly and easily  expand our system as our user base  grows.  In
addition,  we utilize  redundant  servers and server load balancing to re-direct
traffic to prevent service  interruptions.  Our system architecture and software
platform  have been  designed  to provide  high  quality  service to hundreds of
millions of emailboxes  across  millions of domains.  We believe that our robust
and  flexible  technology  platform  enables us to  maintain  one of the highest
service performance levels in the industry.

Customization.  Our solutions  enable our customers to leverage their email as a
brand building tool.  Customers offer our email and messaging  services to their
end users with the customer's  domain name. For example,  a customer can provide
email at its website with an address such as user@companyname.com. This repeated
visibility  of the  customer's  name  on  every  email  message  promotes  brand
awareness  and  customer  loyalty.  In  addition,  our  customers  can  use  our
proprietary  customization  tool to design the look and feel of their  Web-based
email interface so that it reflects their own brand image.

Rapidly  Deployable  and  Cost-Effective  Solutions. Our solutions for customers
can be implemented in as few as several days.

Our  flexible  technology  and  economies  of scale  enable us to provide  email
solutions in a cost-effective manner, allowing businesses to achieve significant
economic  advantages.  We believe  that this rapid time to market is critical to
our customers,  who desire to realize the benefits of Web-based email as quickly
as possible. We also provide comprehensive maintenance and administration of our
email  service,  which  eliminates  the need for our  customers to undertake the
significant burden of developing and maintaining an in-house email system.




<PAGE>


Extensive Language  Capabilities.  We provide email services in the following 18
languages:  English,  Chinese (Simplified and Traditional),  Japanese,  Spanish,
French, German, Portuguese, Dutch, Finnish, Danish, Norwegian, Swedish, Russian,
Hebrew,  Icelandic,  Korean and Italian.  Additionally,  we can support multiple
languages on the same site for any of our customers and offer  spell-checking in
many of these languages.  Our multi-lingual  capabilities enable us to serve the
needs of businesses worldwide as well as multinational organizations.

Increased Website Usage. Our solutions  increase the potential for our customers
to generate  revenue by increasing the stickiness of their websites.  We believe
that traffic to our customers'  websites increases as end users frequently visit
the website to check their email. The benefits of increased  website  stickiness
include more frequent  communication  with end users,  enhanced customer loyalty
and the opportunity to generate revenues from advertising,  direct marketing and
ecommerce transactions.

Online  Marketing  Capabilities.  Our customers can leverage our email solutions
along with the demographic  information of their end users to conduct one-to-one
marketing and targeted advertising campaigns. We collect demographic information
from  end  users  when  they  register  for  their  emailbox.  We  believe  this
information  provides a powerful platform on which to design targeted  marketing
campaigns.  To enhance our  customers'  marketing  capabilities,  we provide our
MailTarget  tool which enables them to select and deliver  tailored  messages to
targeted segments of their user population.

Commtouch Strategy

Our  objective is to be the leading  global  provider of  outsourced,  Web-based
integrated  email  and  messaging  services.  We plan to  achieve  this  goal by
pursuing the following key strategies:

Focus Sales and Marketing Efforts on Acquiring New Business Customers

We are  focused on selling  our  outsourced  email  communications  solution  to
business  customers,  which enables them to rapidly provide our service to their
users and customers  without needing to build or maintain an  infrastructure  to
support the service.  We target  customers who are  increasingly  relying on the
Internet to conduct their business and  communications but do not want to devote
the time and  resources to develop,  support,  or maintain an  integrated  email
service.  Commtouch  enables our  business  customers to quickly  implement  our
co-branded  "Powered by Commtouch" service with minimal upfront investment while
retaining their direct user and customer relationships.

We are focusing our business-to-business sales efforts on several target markets
which we believe are particularly receptive to using our solution. These include
application service providers (ASPs),  Internet service providers (ISPs),  large
corporations,   and  web  portals.   Businesses  in  these  target  markets  are
experiencing  increasing  pressure to offer  enhanced  Web-based  email to their
customers.  However,  because  they  need to  remain  focused  on their own core
business   operations,   we  believe  that  they  will  outsource   their  email
capabilities.

Accelerate Transition to a Price-Per-Emailbox Fee Structure

We generate an increasing  share of our revenue through a pricing strategy based
on a  per-emailbox  fee. We believe that this fee structure  results in a higher
and more  predictable  revenue  stream  compared  with  one  based on a share of
advertising  revenue.  Contracts with individual  business  customers  typically
include a guaranteed  revenue component and fees per emailbox based on the total
number of emailboxes and level of service provided.




<PAGE>


Leverage Business Accounts Through Focused Sales Force

We believe that there is a significant  opportunity for us to further  penetrate
and derive increasing revenues from our existing customer base. A portion of our
sales force is dedicated to building our relationships  with existing  accounts,
selling them  product  upgrades and  enhancements  and keeping  abreast of their
growing email and messaging  requirements.  As our customers  grow,  develop new
online strategies and expand  geographically,  our sales force plans to identify
new ways we can offer them enhanced  messaging  services.  We believe this sales
effort will also serve to solidify our business relationships.

Extend International Leadership

We plan to  continue to  aggressively  market our  solutions  to  businesses  in
non-U.S. markets that we believe will experience significant growth in Web-based
email  usage.  We have  developed  multiple  language  interfaces  for our email
services to be used in the world's most widely used  non-English  languages.  We
have also established  marketing  groups in Israel,  to support our expansion in
Europe and Asia,  and in the United  States to support  our  expansion  in North
America and Latin America. We have a sales office in London, England and we plan
to open a sales office in Japan. Additionally,  we plan to pursue joint ventures
with local partners in attractive non-U.S. markets to accelerate our penetration
globally.   We   believe   that  our   multi-language   capabilities,   targeted
international  sales efforts and  experience  in  penetrating  non-U.S.  markets
positions us favorably in non-U.S. markets.

Enhance Technology Leadership in Email Services

We intend to leverage our core  technology,  software  platform and expertise in
developing  and  managing a  comprehensive  Web-based  email  service to deliver
industry-leading functionality and advanced messaging services. We have recently
added new services,  including calendar  integration,  webmaster  administration
tools,  message boards,  list server features and HTML editing.  We also plan to
offer new services including email message language  translation and integration
of our email  services  with remote  personal  devices and wireless  access.  We
intend to continue to work closely with our customers to identify new trends and
functionality  that will be popular  with end users.  In  addition  to  internal
development,  we plan to seek,  partner with and invest in companies  developing
leading edge technologies to enhance our existing functionality.

Maintain Our Cost-Effective Technology Platform

Our proprietary,  open and scalable architecture gives us the flexibility to use
servers that provide us with the best  cost-quality  combination and to leverage
third-party  hosting  providers.  This  enables  us to  achieve  a  low  service
cost-per-emailbox  while  maintaining a high level of service  quality.  We will
seek to maintain this  cost-effective  technology  platform as we add additional
functionality and features to our solution.

Leverage Relationships with Go2Net, Vulcan Ventures and Microsoft

Go2Net,  Vulcan Ventures and Microsoft have invested an aggregate of $40 million
in our Company.  Go2Net and Vulcan Ventures have a joint  representative  on our
Board of Directors  and we have entered into  business  relationships  with both
Go2Net and  Microsoft.  We will seek to leverage  our  relationships  with these
customers  to expand our service  offerings  to them and to gain access to other
potential customers with whom they have relationships.

Services

We provide  outsourced  email and messaging  services to customers of all sizes.
Our solutions  enable these  organizations to attract,  retain,  communicate and




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conduct ecommerce with their end users.

We provide  our email and  messaging  solutions  through a variety  of   service
arrangements. These arrangements typically consist of one of the following:

     o   price-per-emailbox, subject to a minimum annual service fee;

     o   a minimum annual service fee plus advertising revenue sharing; or

     o   advertising revenue sharing only.

We also provide direct marketing and communications services for a fee.

For our ZapZone  Network  service  members,  we provide our email and  messaging
solutions free of charge.  We currently derive revenue from this network through
advertising and direct online marketing.

Classic Service

Our Classic Service provides the following features:

--------------------------------------------------------------------------------

          Feature                                  Description

--------------------------------------------------------------------------------

  Web-based Emailbox               Includes  a full  range of  industry-standard
                                   functionality,  such as the  ability  for end
                                   users to create  folders,  attach  electronic
                                   documents, store messages, maintain a contact
                                   center,  distribute lists, and establish user
                                   profiles and signatures.
--------------------------------------------------------------------------------
  Highly Customized Interface      Customers  offer our email  services to their
                                   end users with the  customer's  name included
                                   in  the   domain   address.   This   repeated
                                   visibility  of the  customer's  name promotes
                                   brand   awareness   and   customer   loyalty.
                                   Additionally,  our  customers  can design the
                                   look  and  feel  of  their   Web-based  email
                                   interfaces with our proprietary customization
                                   wizard tool.
--------------------------------------------------------------------------------
  Unified Messaging                This  service  enables the emailbox to become
                                   an   integrated    communications    platform
                                   allowing  the user to  access  email and send
                                   and  receive  voicemail  messages,  faxes and
                                   pages via land or mobile  phones or  personal
                                   computers.
--------------------------------------------------------------------------------
  Enhanced Management Features     Includes advanced email functionality such as
                                   the ability to collect email from other email
                                   accounts,   sort  email  and  access  a  sent
                                   messages folder. Also includes a draft folder
                                   option,  message  notification upon login and
                                   IMAP4 support,  which allows email folders to
                                   be accessed from multiple email environments.
--------------------------------------------------------------------------------
  Contact Center                   Enhanced  address  book   functionality  that
                                   includes  the  ability  to create  and manage
                                   groups  and to  import  personal  information
                                   from the contact databases.
--------------------------------------------------------------------------------
  Calendar Integration             The web-based  calendar  feature allows users
                                   to access  their  events  and tasks  from any
                                   browser.   Functionality   includes   adding,
                                   modifying,  and viewing  appointments,  to-do
                                   tasks,  notes  or  events.  Create  recurring
                                   appointments and tasks on a daily,  weekly or
                                   monthly  basis  setting   notifications   for
                                   upcoming  events  via  email,   ICQ  (instant
                                   messaging) or pager.
--------------------------------------------------------------------------------
  Spam Protection                  Advanced  anti-spamming  controls  and  email
                                   filtering.
--------------------------------------------------------------------------------



<PAGE>
--------------------------------------------------------------------------------

          Feature                                  Description

--------------------------------------------------------------------------------

  Multiple Language Capability     Our  email   services   are  provided  in  18
                                   languages:  English,  Chinese (Simplified and
                                   Traditional),   Japanese,   Spanish,  French,
                                   German,  Portuguese,  Dutch, Finnish, Danish,
                                   Norwegian,    Swedish,    Russian,    Hebrew,
                                   Icelandic, Korean and Italian.  Additionally,
                                   we  provide  spell-checking  in many of these
                                   languages  and  can  support  more  than  one
                                   language  on any of  our  customer  websites,
                                   except websites using Hebrew.
--------------------------------------------------------------------------------
  Kids' Email                      An  email  option  that  enables  parents  to
                                   control  who  may  correspond  electronically
                                   with their children.
--------------------------------------------------------------------------------
  Unified Registration             Allows our  customers  to  capture  important
                                   demographic  information  as new email  users
                                   sign up in  conjunction  with our  customer's
                                   website  registration  process.  As a result,
                                   the user will be capable of entering a single
                                   username  and password  for  accessing  other
                                   online services offered by our customers.
--------------------------------------------------------------------------------
  Integrated Instant Messaging     This integrated software  application enables
                                   users to chat with one  another  and  provide
                                   users with  notification  of new messages and
                                   events.
--------------------------------------------------------------------------------
  New Message Notification         For the mobile professionals, important email
                                   messages  need to be alerted  via  offline as
                                   well as online  modes.  When a new message or
                                   event   arrives   in  a   user's   inbox,   a
                                   notification  alert may be  enabled  via fax,
                                   pager,  or voicemail.  Notification  at login
                                   page is also available.
--------------------------------------------------------------------------------
  Secure Login (SSL)               Secure Socket Layer (SSL) encryption protects
                                   the   privacy  of  the  login  and   password
                                   information transferred between end-users and
                                   the email system during sign up.
--------------------------------------------------------------------------------
  Direct Marketing Tools           With the Custom  Mail  Opt-In and Mail Target
                                   programs,  customers  have access to low-cost
                                   direct  marketing  tools.  Custom Mail Opt-In
                                   allows  users  to  select  specific   product
                                   categories  from  which  to  receive  special
                                   offers  and  promotions   targeted  to  their
                                   interests.  Mail Target  allows our customers
                                   to send targeted  marketing messages to their
                                   email user database or to an imported list.
--------------------------------------------------------------------------------
  Online Statistics                Includes  around the clock  online  access to
                                   password protected online email usage reports
                                   that  include  detailed  information  on  the
                                   number of daily users,  number of page views,
                                   number   of   active   accounts,   and  other
                                   important usage data for auditing and billing
                                   purposes.
--------------------------------------------------------------------------------

Premium Services

Our  premium  services  combine  all of the  features  included  in our  Classic
Service, plus the following features:

--------------------------------------------------------------------------------

          Feature                                  Description

--------------------------------------------------------------------------------

  Offline Email Client Access      End users can  access  their  emailbox  using
                                   either a Web browser or their offline  client
                                   software,   such  as  Microsoft   Outlook  or
                                   Eudora.
--------------------------------------------------------------------------------
  Additional Disk Space Storage    End users can increase their storage capacity
                                   up to an  additional  ten  megabytes  of disk
                                   space to maintain  more  folders and messages
                                   in their emailbox.
--------------------------------------------------------------------------------
  Automated, User-Defined          Incoming   emails   can   be    automatically
  Email Forwarding                 forwarded to an alternate  emailbox  based on
                                   the end user's pre-set criteria.
--------------------------------------------------------------------------------



<PAGE>


  Automated, Rules-Based           Incoming   emails   can   be    automatically
  Pager Notification               forwarded  to the end user's  pager  based on
                                   the end user's pre-set criteria.
--------------------------------------------------------------------------------


The unified messaging,  email-by-phone and IP telephony services integrate third
party technology.

Planned Services

We are developing new messaging services to complement our existing services. We
actively  monitor the email and  communication  needs of our  customers  and end
users and work to develop new features and  enhancements  to meet their evolving
requirements.   The  following  services  are  currently  in,  or  planned  for,
development:


--------------------------------------------------------------------------------

          Feature                                  Description

--------------------------------------------------------------------------------

  Enhanced Email Security          Support for SSL encryption  and  technologies
                                   with  enhanced   anti-virus  and  anti-vandal
                                   security measures. (Anticipated in the fourth
                                   quarter of 2000.)
--------------------------------------------------------------------------------
  Community-Building Applications  Additional   functionality  such  as  message
                                   boards  and  list   servers,   which   enable
                                   frequent   communication   among  end  users.
                                   (Anticipated in the third quarter of 2000.)
--------------------------------------------------------------------------------
  Email Message Language           Email   messages   will   be    automatically
  Translation                      translated  between  languages  according  to
                                   pre-defined user preferences. (Anticipated in
                                   the fourth quarter of 2000.)
--------------------------------------------------------------------------------

The  statements  in  this  report  regarding   planned  service   offerings  and
anticipated  features of such offerings are forward-looking  statements.  Actual
service offerings and benefits could differ materially from those projected.

Direct Online Marketing Services.

We have a large and  growing  network of end users.  As of  December  31,  1999,
through our customers we serve  approximately  8.4 million active emailboxes and
through our ZapZone Network service, which has over 190,000 sites registered, we
are serving  approximately  1.0 million active  emailboxes.  This extensive user
network,  along with our  advanced  technologies  and  strategic  relationships,
allows us to offer  value-added  direct marketing  services to our customers and
third parties. We currently provide the following services:

     Opt-in.  Users  can  elect to  receive  specific  newsletters  or  commerce
     offerings.  Whenever end users  choose to establish a direct  communication
     with one of our opt-in partners, we receive a referral fee.

     MailTarget.  We provide our customers  with a Web-based  tool which enables
     them to select and send tailored messages to targeted segments of their end
     user base.  We earn  revenues by charging  customers a fee for each message
     sent with this tool.

     Third-party  marketing  programs.  In addition to our own  internal  opt-in
     program,  we also provide other third-party direct marketing companies with
     the  opportunity  to  leverage  our  extensive  user base to  market  their
     products.  We  earn  revenues  by  charging  third-party  direct  marketing
     companies a fee for each message sent.

The ZapZone Network Email Service

Our ZapZone Network service delivers email messaging solutions to small websites
and homepages.  This service enables  individuals and website  administrators to
set  up  Web-based   email   online,   often  in  under  ten  minutes.   ZapZone
Network-enabled  sites are able to provide our core Web-based  email





<PAGE>


services to their end users in multiple  languages.  Our ZapZone Network service
enables  websites  to  collect  valuable  user  demographic  information,  which
facilitates  their ability to conduct  targeted  marketing  campaigns with their
members. Webmasters can then communicate with and market to those users.

Customers

We offer email and messaging communications services to businesses worldwide. As
of  December  31,  1999,  we  provided  our email  services  to over 250  global
customers. Our customer base includes Internet-centric businesses like community
sites and portals, and companies where a significant online presence is integral
to the overall enterprise. These customers represent a broad range of businesses
and services and are geographically diverse. We also have customers comprised of
small  websites and website  owners who offer  Web-based  email and messaging to
their end users through our ZapZone Network service.


Sales and Marketing

Sales Strategy

Our sales strategy is to target  businesses  worldwide  through a combination of
direct,  indirect and online  selling  initiatives.  While our  salespeople  are
responsible  for  selling  our  solutions  in  a  geographic  area,  they  often
collaborate   to  recruit  new   customers,   particularly   when  dealing  with
multinational  organizations.  Our sales  offices  are  located in Santa  Clara,
California, New York, New York, London, England, and Netanya, Israel. We plan to
extend our sales  force into  Europe  and Japan  within the next 12 months.  Our
sales force includes  salespeople who focus on acquiring new customers,  as well
as dedicated  salespeople who cultivate existing customers and seek to sell them
premium and other services.  As of December 31, 1999, we had 30 salespeople.  We
also plan to pursue joint  ventures with local  partners in attractive  non-U.S.
markets to assist us in the penetration of those markets.

Marketing Strategy

Our marketing strategy is focused on increasing global awareness of our solution
and  building  our  brand as a  leading  international  provider  of  email  and
messaging  services.  We plan to market our solution  primarily through a mix of
print advertising,  direct marketing,  public relations and online  initiatives.
Through  our  "Powered  by  Commtouch"  co-branding  of our  email  solution  on
customers'  websites,  we increase our brand awareness and receive a significant
number of  click-through  business leads.  We plan to  aggressively  promote our
premium services to our customers and their end users and our direct e-marketing
services to our  customers and third  parties.  We intend to leverage our direct
sales force and  develop  co-branding  and  marketing  opportunities  with other
online organizations to augment our marketing efforts.

Customer Support

Commtouch  provides its customers  rapid callback  technical  support 24 hours a
day, seven days a week. We initally  developed a proprietary  software tool that
provides end users with  immediate  online  support  without  intervention  from
customer service  representatives or technical staff and subsequently have begun
implementation  of  other  customer  relationship  management  applications.  We
believe that this technical support model enables us to provide high quality and
cost-effective support service to our customers and end users.

Technology

We  leverage  our nine  years of  email  and  technology  experience  to  create
world-class,  robust,  full-featured,  reliable email solutions. We believe that




<PAGE>


our  Web-based  email  solutions  possess  three  major  advantages  over  other
Web-based email solutions:

Scalable and Reliable Modular System Architecture

Our Web-based email system is designed to provide maximum  flexibility.  We have
developed  a system  architecture  consisting  of  three  main  components:  Web
servers,  mail servers and database servers. Web servers are responsible for the
front-end  email  application,  mail servers are responsible for the storage and
transmittal of email messages and database  servers are  responsible for storing
all other important end user and customer  information.  These servers  interact
through standard communications protocols such as HTTP, IMAP4, POP3 and SMTP and
ODBC.


                             Hardware Infrastructure

The modularity of our network  architecture  provides several key  technological
advantages:

Rapidly  deployable and  cost-effective.  The design of our system enables us to
significantly  reduce  our  deployment  time as well as  costs to  support  each
mailbox.

     o   We outsource server hosting and Internet backbone access to third party
         providers  because they are able to offer such  services at bulk rates.
         In addition,  there are numerous third-party providers from whom we can
         obtain these  services,  so our capacity is not limited and we are able
         to obtain  favorable  rates.  This  significantly  reduces our Internet
         connectivity and server maintenance costs.

     o   The  modularity  of our system  architecture  allows us to choose  from
         among a broad range of  industry-standard  mail servers, and select the
         servers with optimal price/performance  characteristics.  Again, we are
         able to obtain these servers from a number of vendors,  so our capacity
         is not limited.

     o   The  outsourcing  of our server needs  enables us to focus on the rapid
         deployment of  applications  for our clients  rather than on the costly
         and time-consuming  maintenance and development of an internal hardware
         infrastructure.

     o   Because  third-party mail servers are constantly upgraded with the most
         advanced features (LDAP support, HTML messaging,  etc.), we are able to
         reduce  our  development  time  by  leveraging  existing  off-the-shelf
         technology and immediately  integrating these features into our service
         offerings.

Scalable and reliable.  Our modular  technology  architecture  enables the rapid
setup of  full-service  email hosting  facilities  and enables us to quickly and
seamlessly  expand our system as our user base grows.  In  addition,  we utilize
redundant servers and server load balancing capabilities to re-direct traffic if
a server  malfunctions.  Our system architecture and software platform have been
designed to provide  excellent  service to  hundreds  of millions of  emailboxes
across millions of domains.  We believe that our robust and flexible  technology
platform enables us to maintain one of the highest service performance levels in
the industry.

Portable. As the market for outsourced email systems evolves, some organizations
may demand their own in-house hosting facility. The highly modular nature of our
system  architecture  provides  us with the  ability  to  duplicate  a system in
another  location  within  a  period  of  several  days.  As a  result,  we  are
well-equipped  to rapidly  deploy email  services to this growing  subset of the
outsourced email systems market.




<PAGE>


Proprietary Development Language

We  have  custom-built  a  proprietary   software  development  language  called
Application  Dynamic Markup Language (ADML) in order to maximize the flexibility
and minimize the development time of our email solutions.

The ADML  environment  encapsulates  the  functionality  and layout of a generic
Web-based email interface,  while allowing our developers to rapidly customize a
business partner's email system with specific features.  All external resources,
such as text strings, images and site-dependent parameters are stored in various
databases.  When a new  site is  built,  the  ADML  code is  compiled  into  ASP
(Microsoft's  Active Server Pages technology) code which runs on the web servers
and translates  the ADML code into HTML.  This enables the developer to build an
email interface for a business  partner without having to write a single line of
HTML code. This provides us with a competitive advantage for several reasons:

     o   we can add new  functionality  and  features  (languages,  premium  and
         direct marketing  services,  etc.) to any business  partner's  existing
         email system in as little as a few hours;

     o   we can simultaneously  upgrade more than one email system (for example,
         immediately making additional  languages available to any end user of a
         ZapZone Network service email site); and

     o   we can offer automated email  customization tools to our end users. For
         example, the ZapZone Network service takes advantage of the flexibility
         provided by ADML to allow  webmasters  to build,  customize  and deploy
         ready-to-use email sites in very little time.

Advanced Proprietary Technologies

We have developed the following proprietary technologies:

     o   Complex  Foreign  Language  Support.  Currently,  our  system  is fully
         double-byte-enabled  to handle  intricate  character  languages such as
         Chinese,  Korean and  Japanese,  as well as  right-to-left  support for
         languages like Hebrew and Arabic.

     o   Integrated  Open Platform  Interface.  We have  developed an integrated
         platform and series of application  programming  interfaces that enable
         us to rapidly and fully integrate  additional  communications  features
         and functionality into our service offering.

     o   Advanced  Direct  Marketing  Technology.  Our  MailTarget  service is a
         Web-based tool which provides customers with a user-friendly  method of
         selecting and  delivering  tailored  messages to a targeted  segment of
         their user populations.

     o   Customization  Wizard Tool. We have developed a proprietary  technology
         tool  which  enables  customers  to  design  the look and feel of their
         Web-based email interface so that it is consistent with their own brand
         images.

Competition

In the  market  for email and  messaging  services,  we  compete  directly  with
Web-based  email  service  providers,  including  Critical  Path,  Mail.com  and
USA.NET,  as well as with  companies  that develop and maintain  in-house  email
solutions.  In addition,  companies such as  Software.com  currently offer email
software products to ISPs, web hosting companies,  web portals and corporations.
Furthermore, numerous small-scale email providers offer low-cost basic services,
but  without  scalable  systems or  value-added  functionality.  These and other
companies   could   potentially   leverage  their  existing   capabilities   and
relationships  to enter the email service  industry by redesigning  their system




<PAGE>


architecture,  pricing and  marketing  strategies  to sell through to the entire
market.   The  ability  of  these  competitors  to  offer  a  broader  suite  of
complementary  services may give them a  considerable  advantage over us. In the
future,  ISPs, web hosting  companies and outsourced  application  companies may
broaden their service offerings to include outsourced email.

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 service  offerings,  we may  encounter
increased competition in the development and delivery of these services. 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.  Further,  certain of our competitors may
offer services at or below cost. In addition, new technologies and the expansion
of existing  technologies  may increase  competitive  pressures on us. Increased
competition may result in reduced operating margins and loss of market share.

We believe that our solution has the following competitive advantages:

     o   highly customizable and flexible;

     o   rapidly deployable;

     o   available in 18 languages;

     o   designed to integrate numerous messaging applications; and

     o   has the ability to effectively address multiple market needs.

However,  despite  our  competitive  positioning,  we may not be able to compete
successfully against current and future competitors.

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.); PRONTO (U.S. and other countries);  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  (Israel and other  countries),  ZAPZONE  NETWORK,  ZZN
(U.S.,  Israel and other countries) and PRONTO (Mexico,  European  Community and
India).  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.  Certain end user license  provisions  protecting against
unauthorized use,  copying,  transfer and disclosure of the licensed program may
be unenforceable under the laws of certain  jurisdictions and foreign countries.
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 us and our  licensees.  Such
claims, even if not meritorious,  could result in the expenditure of significant
financial and managerial resources.

Our ZapZone Network  service allows  webmasters to select the email service name




<PAGE>


of their choice.  There is,  therefore,  the  possibility  that they will select
email  service  names that may infringe  the rights of others  under U.S.  state
and/or  federal or  foreign  trademark  and/or  anti-dilution  or similar  laws.
ZapZone  Network  service's  placement  of  ZapZone  Network  service  icons and
advertisements  on ZapZone Network service  webmasters' web pages may contribute
to our perceived  liability for any allegedly  infringing  acts. We do not audit
webmasters'  email  service name choices for  compliance  with any  intellectual
property rights of others. However, in our current webmaster license agreements,
we require  webmasters  to indemnify us for claims  resulting  from their chosen
email  service  names;  we also require  users to indemnify us in their  license
agreements. Furthermore, in our license agreements with webmasters and users, we
expressly  reserve the right to eliminate their account or to change their email
service names, in our sole discretion.  We have received complaints from several
parties  that email  service  names  chosen and  registered  by ZapZone  Network
service  users are similar or identical to domain  names  and/or  trademarks  in
which the  complainants  claim an interest.  We have  responded by reviewing the
content of the  complainants'  complaints,  and  either  (a)  sought  additional
substantiating  information  (b) requested a response to the complaint  from the
relevant  webmaster,  and/or (c)  changed or deleted the email  service  name in
question.

We also intend to continue to  strategically  license  certain  technology  from
third parties,  including our mail server and SSL encryption technology.  In the
future,  if we add  certificate  technology  to  our  systems,  we  may  license
additional  technology from third-party vendors. We cannot be certain that these
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 and services.  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 and service  development  until
equivalent  technology  can be  identified,  licensed and  integrated.  Any such
delays in services could cause our business,  financial  condition and operating
results to suffer.

Government Regulation

There are currently few laws and regulations directly applicable to the Internet
and commercial email services.  Examples  include the 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.  However,  it is possible
that a  number  of laws and  regulations  may be  adopted  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 services 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.

Employees

As  of  December  31,  1999,  we  had  214 full-time employees. None of our U.S.




<PAGE>


employees  is  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 work day and work week,
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  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. Commtouch currently funds its 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.  Commtouch  also
provides certain  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.


                                  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.

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.  You will
find  forward-looking  statements under the captions  "Summary," "Risk Factors,"
"Management's  Discussion  and  Analysis of Financial  Condition  and Results of
Operations"  and  "Business" and elsewhere in this report.  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.

Risks Relating to the Company

Because  we have a  limited  operating  history  as a  Web-based  email  service
provider, it is difficult to evaluate our business and prospects.

We  commenced  operations  in  1991, but we began commercially selling Web-based




<PAGE>


email  services only in 1998 after  changing our strategic  focus from the sale,
maintenance  and service of  stand-alone  email  client  software  products  for
mainframe and personal computers. This change required us to adjust our business
processes  and to  restructure  Commtouch  to become a Web-based  email  service
provider.  Therefore,  we have only a limited operating history as a provider of
Web-based email services upon which you can evaluate our business and prospects.

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

We incurred net losses of  approximately  $3.5 million in 1997,  $4.4 million in
1998 and $19.9 million in 1999.  As of December 31, 1999, we had an  accumulated
deficit of approximately  $31.5 million.  We have not achieved  profitability in
any period,  and we expect to  continue to incur net losses for the  foreseeable
future.

We have invested heavily in technology and infrastructure development. We expect
to continue to spend substantial financial and other resources on developing and
introducing  new  service  offerings  and  expanding  our  sales  and  marketing
organizations,  strategic relationships and operating infrastructure.  We expect
that our expenses will continue to increase in absolute dollars. If our revenues
do not correspondingly  increase,  our operating results and financial condition
will be negatively affected.  We may never attain sufficient revenues to achieve
profitability.  If we do achieve  profitability,  we may not sustain or increase
profitability  in the  future.  This may,  in turn,  cause  our  stock  price to
decline.

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

Because we have a limited  operating history in the provision of Web-based email
services and because of the emerging  nature of the markets in which we compete,
our revenue is  unpredictable.  Our current and future  expense  levels 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 stock price.

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

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

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

     o   our mix of service  offerings,  including  our ability to  successfully
         implement new services;

     o   pricing of our services; and

     o   effectiveness of our customer support.

Because of these factors,  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.

We have recently  changed our fee  structure and cannot  predict the effect this
change will have on our future revenues.

In recent  months we have moved from a pricing  strategy  based  primarily  on a
share of  advertising  revenues with a minimum  annual  service fee to one based
primarily on charging a per-emailbox  fee with a minimum annual  commitment fee.
While we believe  that this new fee  structure  will result in a higher and more
predictable  revenue  stream  compared with one based on a share of  advertising




<PAGE>


revenues,  we cannot predict  whether this new pricing  strategy will in fact be
successful in generating  higher and more predictable  revenues.  We may need to
change our pricing strategy again from time to time.

If the market for our Web-based  email  services does not grow rapidly,  we will
fail to generate revenues.

Our success will depend on the widespread  acceptance and use of Web-based email
by our  customers  as a means to  increase  the value of their  services or as a
means of  communication.  The market for  Web-based  email  services  is new and
rapidly  evolving.  We cannot  estimate the size or growth rate of the potential
market for our service  offerings.  If the market for  Web-based  email fails to
grow or grows more slowly than we currently anticipate, our business will suffer
dramatically.  Even if that market  grows,  our  service  may not achieve  broad
market acceptance.  Since we have only recently  introduced our services,  we do
not have  sufficient  experience  to evaluate  whether they will  achieve  broad
market  acceptance.  Also,  because  all of our  revenue is derived  directly or
indirectly from our Web-based email solutions, if that market does not grow, our
business will likely fail.

If we do not expand our sales and marketing  organization we will not be able to
increase our revenues.

Our ability to increase our revenues will depend on our ability to  successfully
expand our sales and  marketing  organization.  The  complexity  of our Internet
messaging services and the emerging nature of the Web-based email market require
highly trained sales and marketing  personnel to educate  prospective  customers
regarding  the use and benefits of our  services.  The majority of our sales and
marketing  personnel  have  only  recently  joined  Commtouch  and have  limited
experience working together.  It will take time for these employees to learn how
to market  our  solutions  and to be  integrated  into our  sales and  marketing
organization.   Some  of  them  may  not  succeed  in  making  this  transition.
Additionally,  we are planning to introduce  additional services that we have no
experience  marketing  and will rely on these  services 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.

Even if our email services are successful with our customers,  we may not derive
revenue from the users of the emailboxes,  which would prevent our business from
growing.

Even if our services are a success with our customers, we will not succeed if we
do not derive revenue from the email users that our customers give us access to.
We plan to derive  revenue  from these email  users  primarily  by charging  our
customers per-emailbox fees for our email services, as well as by selling access
to email users for direct marketing services and from the sale of advertisements
that the email  users will see. If one or more of these  revenue  sources is not
successful, we will not succeed. To date, we have generated only limited revenue
from  these  potential  revenue  sources  and  they may not be  successful.  Our
existing  and  potential  customers  may not be  willing  to pay  for our  email
services.  Advertisers  and direct  marketers may not accept email as a means of
placing  advertisements  and conducting direct marketing and email users may not
want to receive direct marketing materials.

Our ability to generate revenues from the emailbox base that our customers bring
to us also  depends  on the  emailboxes  being  used on a regular  basis.  On an
ongoing  basis,  many of our end users will not regularly use their  emailboxes,
and a significant number will cease using our services each month.  Accordingly,
there may be no  relationship  between the number of active  emailboxes  and our
revenues.

We have a  strategic  relationship  with  Go2Net  pursuant  to which we issued a




<PAGE>


warrant  to  Go2Net  that  diluted  our  shareholders,  but we may  not  realize
substantial  revenues  or  other  business  benefits  from  this or any  similar
transaction.

We entered into a strategic  relationship  with Go2Net  simultaneously  with the
closing of our initial public offering.  Our Customized  Web-Based Email Service
Agreement  with Go2Net  provides  that we share  revenues from  advertising  and
premium  services  offered to Go2Net's end users through our email service.  The
terms of this agreement are substantially the same as our commercial  agreements
with other  customers  except that we have  agreed  that  Go2Net will  receive a
materially greater portion of advertising  revenues than other customers receive
under other similar agreements. As part of this transaction, we issued to Go2Net
a warrant to purchase up to 1,136,000  ordinary  shares at an exercise  price of
$12.80 per share.  This warrant is  exercisable  at any time until it expires on
July 16, 2004. We agreed to register  these  shares,  the warrant and the shares
issuable  upon  exercise  of  the  warrant  with  the  Securities  and  Exchange
Commission and the registration  statement  relating to those securities  became
effective  on January 7,  2000.  Exercise  of the  warrant  will cause  existing
investors significant dilution.  However, we may not realize any revenues or any
other business benefits from this strategic  relationship with Go2Net because we
and  Go2Net  may not be able to sell  significant  amounts  of  advertising  and
premium  Web-based email services to Go2Net's end users.  In the future,  we may
have to issue in-the-money  warrants to acquire our ordinary shares to customers
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  customers  may  further  dilute  our
shareholders,  increase  our  operating  loss in the  future and cause our stock
price to fall.

We entered  into an email  services  agreement  with  Microsoft  Corporation  in
connection  with  which we  issued a  warrant  to  Microsoft  that  diluted  our
shareholders,  but we may not realize  substantial  revenues  or other  business
benefits from this transaction.

We  entered  into an Email  Services  Agreement  dated  October  26,  1999  with
Microsoft  Corporation.  Under this  agreement,  Commtouch  will, at Microsoft's
option,  customize,  host and maintain email services for Microsoft  websites in
the U.S. and  internationally.  Microsoft  will pay one-time fees for the set-up
and  customization  of the email  service for each website with respect to which
Microsoft chooses to use our services, as well as quarterly service fees for the
email service based on the number of mailboxes hosted. The term of the agreement
shall continue for 12 months after the first commercial distribution date of the
email service and Microsoft may extend the initial term on a quarterly or annual
basis upon 60 days prior  written  notice.  The  agreement  may be terminated by
Microsoft for convenience upon 90 days' prior written notice, or by either party
upon a  material  breach by the other  party  upon the  terms  specified  in the
agreement.  In connection  with the agreement,  Commtouch  issued to Microsoft a
warrant, exercisable until December 29, 1999, to purchase 707,965 of Commtouch's
ordinary  shares  at an  exercise  price of $28.25  per  share for an  aggregate
exercise price of approximately $20.0 million.  On December 29, 1999,  Microsoft
exercised  the  warrant  and now holds  707,965  ordinary  shares.  We agreed to
register these shares with the Commission.  The registration became effective on
January 7, 2000.  However, we may not realize any revenues or any other business
benefits  from this  transaction  because  Microsoft is not obligated to use our
services  with  respect to any website and has not agreed to provide us with any
other business benefits.

We depend on our customer  relationships,  which are based on  relatively  short
term, nonexclusive agreements,  and the loss of one or more customers could harm
our business.

Our  ability to increase  revenues  depends  upon  successful  marketing  of our
services through new and existing  customers.  Our agreements with our customers
generally can be terminated  for any or for no reason after the first year.  The
agreements  with our customers are  non-exclusive  and do not restrict them from
introducing   competing   services.   Also,  some  of  our  relationships  allow



<PAGE>


termination  earlier  than one year.  Loss of one or a few key  customers  could
damage our reputation and hurt our ability to develop new  relationships.  If we
fail to develop new relationships or if our customers  terminate or do not renew
their  contracts  with us, our business will suffer,  as we will lose  potential
revenue from the lost customers and from their  underlying  base of email users.
One customer,  Excite,  accounted for 54% of our revenues in 1998. Revenues from
MyPoints,  a permission  based email  service  company,  represented  11% of our
revenues in 1999.  Customers may provide us with a large number of users but pay
a relatively small minimum annual service fee.

We have  many  established  competitors  who are  offering  the same or  similar
services  and we will not be able to compete  effectively  against  them if they
provide superior services at better prices.

The market for Web-based  email services is intensely  competitive and we expect
it to be increasingly competitive. Increased competition could result in pricing
pressures,  reduced  operating  margins and loss of market  share,  any of which
could cause our business to suffer.

In the  market  for email and  messaging  services,  we  compete  directly  with
Web-based  email  service  providers,  including  Critical  Path,  Mail.com  and
USA.NET,  as well as with  companies  that develop and maintain  in-house  email
solutions.  In addition,  companies such as  Software.com  currently offer email
software products to ISPs, web hosting companies,  web portals and corporations.
Furthermore, numerous small-scale email providers offer low-cost basic services,
but  without  scalable  systems or  value-added  functionality.  These and other
companies   could   potentially   leverage  their  existing   capabilities   and
relationships  to enter the email service  industry by redesigning  their system
architecture,  pricing and  marketing  strategies  to sell through to the entire
market.   The  ability  of  these  competitors  to  offer  a  broader  suite  of
complementary  services may give them a  considerable  advantage over us. In the
future,  ISPs, web hosting  companies and outsourced  application  companies may
broaden their service offerings to include outsourced email.

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 service  offerings,  we may  encounter
increased competition in the development and delivery of these services. 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.  Further,  certain of our competitors may
offer services at or below cost. 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  and
increased competition may result in reduced operating margins and loss of market
share.

We are  experiencing  rapid internal growth which has and likely will strain our
management resources.

We recently began to expand our  operations  rapidly and intend to continue this
expansion. The number of employees increased from 45 on December 31, 1998 to 214
on December 31, 1999. This expansion has placed,  and is expected to continue to
place,  a  significant  strain  on our  managerial,  operational  and  financial
resources. To manage any further growth, we will also need to improve or replace
our existing operational, customer service and financial systems, procedures and
controls.

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

Our success  depends on the skills,  experience  and  performance  of our senior
management and other key personnel, many of whom have worked together for only a
short period of time.  The loss of the services of any of our senior  management
or other key personnel,  including Gideon Mantel,  our Chief Executive  Officer,




<PAGE>


Isabel Maxwell, the President of our United States subsidiary, and Amir Lev, our
President and Chief Technical Officer, could materially and adversely affect our
business. We do not have employment agreements with any of our senior management
or other 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.

Because our business is based on communications and messaging  services,  we are
susceptible to system interruptions and capacity  constraints,  which could harm
our business and reputation.

Our ability to  successfully  receive and send our end users' email messages and
provide  acceptable  levels of  service  largely  depends on the  efficient  and
uninterrupted  operation of our computer and communications hardware and network
systems and those of our outsourced hosting service. In addition,  the growth in
the  use of the  Internet  has  caused  frequent  interruptions  and  delays  in
accessing  the  Internet  and  transmitting  data over the  Internet.  We do not
possess  insurance to cover losses caused by unplanned system  interruptions and
software  defects.  In the past, we have experienced  some  interruptions in our
email service.  We believe that these  interruptions will continue to occur from
time to time. These  interruptions may be due to hardware failures,  unsolicited
bulk  email  (also  known as  "spam"),  operating  system  failures,  inadequate
Internet  infrastructure  capacity,  and other  mechanical and human causes.  We
expect to experience  occasional,  temporary capacity constraints due to sharply
increased traffic,  which may cause  unanticipated  system  disruptions,  slower
response times,  impaired quality and degradation in levels of customer service.
If we experience  frequent or long system  interruptions that reduce our ability
to provide email  services,  we may have fewer users of our email  services.  In
addition,  we have entered into service  agreements  with some of our  customers
that require minimum performance standards.  If we fail to meet these standards,
our customers could terminate their relationships with us.

We must  continue  to expand and adapt our  network  infrastructure  to changing
requirements  and increasing  numbers of end users. The expansion and adaptation
of our network  infrastructure will require substantial  financial,  operational
and managerial  resources.  In addition, we depend on improvements being made to
the entire Internet  infrastructure  to alleviate  overloading and congestion of
the  Internet.  The  ability of our network to continue to connect and manage an
expanding  number of  customers,  end users and  messages  at high  transmission
speeds is unproven and uncertain. We face risks related to our network's and the
Internet's ability to operate with higher use levels while maintaining  expected
performance levels.

We are a relatively small competitor in the electronic  messaging  industry and,
as  a  result,  we  may  not  have  the  resources  to  adapt  to  the  changing
technological   requirements  and  the  shifting  consumer  preferences  of  our
industry.

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 existing  services and
proprietary technology obsolete. Our success depends, in part, on our ability to
continually enhance our existing email and messaging services and to develop new
services,  functions and technology that address the increasingly  sophisticated
and varied needs of our  prospective  customers.  The development of proprietary
technology and necessary service 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 our services to customer or
end user  requirements  or emerging  industry  standards.  Also,  in addition to
addressing  changing  technologies  and end user needs,  we must also do so more
quickly than our competition.

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

Our  service  offerings  depend on  complex  software.  Complex  software  often




<PAGE>


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 services or enhancements until after they
are deployed.  Although we have not experienced any material software defects to
date,  it is  possible  that,  despite  testing by us,  defects may exist in the
software we use.  These  defects could cause  service  interruptions  that could
damage our reputation or increase our service  costs,  cause us to lose revenue,
delay market acceptance or divert our development resources,  any of which could
cause our  business  to  suffer.  Some of our  services  are  based on  software
provided by third parties. We have no control over the quality of such software.

We rely on the integrity of our network  security,  which may be  susceptible to
breaches that could harm our reputation and business.

A fundamental  requirement for online  communications is the secure transmission
of confidential  information over public networks.  Third parties may attempt to
breach our  security or that of our  customers.  Despite our  implementation  of
third party encryption technology and network security measures, our servers are
vulnerable to computer  viruses,  physical or  electronic  break-ins and similar
disruptions,  which could lead to interruptions,  delays or loss of data. We may
be liable to our  customers  and their end users for any breach in our security,
including  claims for  impersonation  or other similar fraud claims,  as well as
claims for other misuses of personal  information,  for example for unauthorized
marketing  purposes.   Also,  such  a  breach  could  harm  our  reputation  and
consequently our business. We may also be required to expend significant capital
and other resources to license encryption technology and additional technologies
to protect  against  security  breaches or to alleviate  problems  caused by any
breach.  Our failure to prevent security  breaches could have a material adverse
effect on our business and operating results.

In  addition,  the  Federal  Trade  Commission  and  several  states  have  been
investigating   some  Internet   companies   regarding  their  use  of  personal
information. We could incur additional expenses if new regulations regarding the
use of  personal  information  are  introduced,  if our  privacy  practices  are
investigated  or if our  privacy  policies  are viewed  unfavorably  by users or
potential users.

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

We regard our 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  with 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. End user license provisions protecting against unauthorized use,
copying,  transfer and disclosure of the licensed  program may be  unenforceable
under the laws of some  jurisdictions and foreign  countries.  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.

Our ZapZone Network  service allows  webmasters to select the email service name




<PAGE>


of their choice  (although we reserve the right to eliminate their account or to
change their email service name).

There is,  therefore,  the possibility that they will select email service names
that may  infringe the rights of others.  We have  received  several  complaints
about ZapZone Network service webmasters'  registered email service names and we
have  referred  these  complainants  directly  to the  ZapZone  Network  service
subscribers who are allegedly  engaging in the infringing  activities.  However,
these  complainants  may seek to enforce their rights against us in addition to,
or instead of, the infringing webmasters.

We may have  liability for email content and we may not have adequate  liability
insurance.

As a provider of email  services,  we face potential  liability for  defamation,
negligence,  copyright,  patent or trademark infringement and other claims based
on the nature and content of the materials  transmitted via email. We do not and
cannot screen all of the content generated by end users, and we could be exposed
to liability with respect to this content. Some foreign governments, such as the
government of Germany,  have enforced  laws and  regulations  related to content
distributed over the Internet that are more strict than those currently in place
in the United  States.  Although  we carry  general and  professional  liability
insurance  coverage,  our  insurance  may not  adequately  protect  us from such
claims. Any imposition of liability,  particularly liability that is not covered
by insurance, or is in excess of insurance coverage, could damage our reputation
and hurt our  business  and  operating  results,  or could  result  in  criminal
penalties.

Governmental  regulation and legal  uncertainties could impair the growth of the
Internet  and  decrease  demand for our  services 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 services and increase
our  cost of doing  business,  or  otherwise  harm our  business  and  operating
results.

Due to  the  global  nature  of the  Web,  it is  possible  that,  although  our
transmissions currently originate in California, the governments of other states
or foreign  countries might attempt to regulate our  transmissions or levy sales
or other taxes relating to our activities. The European Union recently adopted a
directive  addressing  data privacy that may result in limits on the  collection
and use of user information.

On October 20,  1999,  The  Federal  Trade  Commission  issued the final rule to
implement the Children's  Online Privacy  Protection Act of 1998 ("COPPA").  The
main goal of the COPPA and the rule is to protect the privacy of children  using
the  Internet.  As of April 21,  2000,  certain  commercial  websites and online
services directed to, or that knowingly collect  information from, children must
obtain  parental  consent  before  collecting,  using,  or  disclosing  personal
information  from  children  under 13. The COPPA  regulations  could  reduce our
ability to engage in direct marketing. The cost to the Company of complying with
the new  requirements is not known and such cost may have a material effect upon
operating results or financial condition.




<PAGE>


We may need  additional  capital  and  raising  additional  capital  may  dilute
existing shareholders.

We believe that our existing  capital  resources  will enable us to maintain our
current and planned operations for at least the next 12 months.  However, we may
be required to raise  additional funds due to unforeseen  circumstances.  If our
capital  requirements  vary  materially  from those  currently  planned,  we may
require additional financing sooner than anticipated.  Such financing may not be
available  in  sufficient  amounts  or on terms  acceptable  to us and may cause
dilution to existing shareholders.  Also, we may raise additional capital in the
future by issuing  securities  that have superior  rights and preferences to our
ordinary shares.

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  own  over  five  percent  of our  ordinary  shares
beneficially own approximately  30% 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.

Go2Net and Vulcan Ventures beneficially own approximately 14% of our outstanding
ordinary  shares  (assuming  exercise  of the Go2Net  warrant on a net  issuance
basis).  Vulcan  Ventures is a significant  shareholder of Go2Net.  Accordingly,
Go2Net and Vulcan Ventures 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.  Go2Net and Vulcan also have the
right to name one  director  to our  Board as long as they  continue  to hold at
least 620,022 shares,  including the shares issuable upon exercise of the Go2Net
warrant.  They have named  Thomas  Camp to the Board  under this  provision.  In
addition,  conflicts of interest may arise as a consequence of Go2Net's  control
relationship with us, including:

     o   conflicts   between   Go2Net  and  Vulcan   Ventures,   as  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 Go2Net, on the other hand; or

     o   conflicts related to existing or new contractual  relationships between
         us, on the one hand, and Go2Net and its other affiliates,  on the other
         hand.

Our  business  and  operating  results  could  suffer if we do not  successfully
address the risks inherent in the expansion of our international operations.

At present,  we have sales offices in the United States,  Israel and England. We
intend to continue to expand into international markets and to spend significant
financial  and  managerial  resources  to do so. We have limited  experience  in
international  operations  and  may  not  be  able  to  compete  effectively  in
international  markets.  The  Company  will face risks  inherent  in  conducting
business internationally, such as:

     o   difficulties   and  costs  of  staffing  and   managing   international
         operations;

     o   fluctuations in currency exchange rates;




<PAGE>


     o   imposition of currency exchange controls;

     o   differing technology standards;

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

     o   difficulties in collecting  accounts  receivable and longer  collection
         periods;

     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
operations  and,  consequently,  business and operating  results.  Specifically,
failure to  successfully  manage  international  growth  could  result in higher
operating  costs than  anticipated  or could  delay or preclude  altogether  the
Company's ability to generate revenues in key international markets.

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

The sale, or  availability  for sale, of substantial  quantities of our ordinary
shares  may have the  effect  of  depressing  its  market  price by  potentially
introducing  a large  number of sellers  into the market.  A large number of our
ordinary  shares are  currently  eligible for resale.  In addition a significant
number of shares will be eligible for resale at various dates in the future. See
"Shares Eligible for Future Sale."

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 sales  currently  are being 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 companies doing business with Israel have been
the  subject  of an  economic  boycott  by the  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 the Arab countries.
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, we cannot  predict  whether or in what manner these problems
will be resolved.




<PAGE>


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

In addition,  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,
while a significant 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 but incur a
significant portion of our expenses,  principally salaries and related personnel
expenses,  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.

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 will 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 stock.

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.

The new Israeli Companies Law imposes substantial duties on shareholders and may
cause uncertainties regarding corporate governance.




<PAGE>


The new Israeli  Companies Law, which became  effective on February 1, 2000, has
brought about significant changes to Israeli corporate law. The new law includes
provisions   imposing    substantial   duties   on   certain   controlling   and
non-controlling shareholders.



I
tem 2. 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 3945 Freedom  Circle,  Santa Clara,  California  95054,
where our telephone number is (408) 653-4330. In addition, we have sales offices
in London and New York. All of our properties are leased.



Item 3. Legal Proceedings.

The Company is not a party to any legal  proceedings  which,  individually or in
the aggregate, are believed to be material to the Company's business.



Item 4. Control of Registrant.

The following table presents information with respect to beneficial ownership of
our ordinary shares as of May 31, 2000:

     o   each person or entity known to Commtouch to own beneficially  more than
         ten 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 and investment power with
respect to shares. To our knowledge,  except under applicable community property
laws or as otherwise indicated,  the persons named in the table have sole voting
and sole investment control with respect to all shares  beneficially  owned. The
applicable  percentage of ownership for each  shareholder is based on 16,415,069
ordinary shares outstanding as of May 31, 2000 (assuming the issuance of 368,270
ordinary  shares  upon the assumed  net  exercise  at an assumed  share price of
$18.94 per share of the  in-the-money  warrant to  purchase  1,136,000  ordinary
shares  issued to Go2Net at an  exercise  price of $12.80 per  share).  Ordinary
shares issuable upon exercise of options and other rights beneficially owned are
deemed outstanding for the purpose of computing the percentage  ownership of the
person  holding those options and other rights,  but are not deemed  outstanding
for computing the percentage ownership of any other person.


                                                         Amount  Percent of
                                                         Owned      Class
                                                       --------- ----------


Thomas Camp/Go2Net, Inc. and Vulcan Ventures (1)        1,722,356    10.5%
All directors and officers as a group (10 persons)      4,744,187    28.9%


(1) Includes  896,057  shares  purchased in the private  placement by Go2Net and
368,270 shares  exercisable  under a warrant granted to Go2Net on a net exercise
basis based on the assumptions  set forth in the paragraph  preceding the table.
Mr. Camp,  who is a director of the  Company,  is the Vice  President,  Business
Development  of  Go2Net,  and as such,  may be deemed to  beneficially  own such
shares.  Also  includes  448,029  shares  purchased in the private  placement by
Vulcan Ventures, which beneficially owns approximately 30.0% of Go2Net. Mr. Camp
disclaims  beneficial ownership of all such ordinary shares. Also includes 7,500
shares subject to an option held by Mr. Camp.  William D. Savoy,  Vice-President
of Vulcan Ventures, and Diane Daggatt, an investment analyst at Vulcan



<PAGE>


Northwest  Inc.,  an affiliate of Vulcan  Ventures,  are members of the board of
directors of Go2Net.



Item 5. Nature of Trading Market.

The Company's  Ordinary  Shares have traded  publicly on The Nasdaq Stock Market
under the symbol  "CTCH"  since July 13,  1999.  The  Company's  initial  public
offering price was $16.00 per share.

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)         $ 22.625   $ 11.0625
  Fourth Quarter                                  $ 49.125   $ 14.3125

2000:
  First Quarter                                   $ 66.50    $ 35.5625


If the Company decides to distribute a cash dividend out of income that has been
exempted from tax, the income out of which the dividend is  distributed  will be
subject to the 25% Israeli corporate tax rate. 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.



Item 6. Exchange Controls and Other Limitations Affecting Security Holders.

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 or 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.



Item 7. Taxation.

                    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




<PAGE>


unique to their situation.

Proposed Tax Reform

On May 4, 2000,  a  committee  chaired by the  Director  General of the  Israeli
Ministry of Finance,  Avi  Ben-Bassat,  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 has approved the recommendations in principle, but implementation of the
reform requires  legislation by Israel's Knesset.  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."

Israeli tax loss carryforwards  were approximately  $22.5 million as of December
31, 1999. The amount of our tax loss carryforwards will be reduced by our future
taxable income.

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 the tax purpose 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 carried 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  considered to qualify as an "Industrial  Company" within
the  meaning of the Law for the  Encouragement  of Industry  (Taxes),  1969 (the




<PAGE>


"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

     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 two separate investment programs.  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.

The  implementation  of the  investments  under the first plan was  finalized by
Commtouch in 1995. In early 2000,  we filed an  application  to  supplement  our




<PAGE>


second plan and we also filed an application for a new, third plan.

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 15.0% 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 25.0% 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 would also  generally be subject to the 15.0% tax rate but 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,
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
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 provide 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




<PAGE>


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 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.

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




<PAGE>


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 tax
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  participated  in programs  sponsored  by the OCS for the support of
research and development activities.  Through December 31, 1999, the Company had
recorded  grants from OCS  aggregating  $653,000  for  certain of the  Company's
research and development projects.  The Company is obligated to pay royalties to
the OCS of 3% to 5% of the  sales of the  products  and other  related  revenues
developed  from  such  projects,  up to an  amount  equal to 100% to 150% of the
grants received.

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.

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
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, 1999, 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




<PAGE>


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
the ordinary share is sold by such U.S. Holder.

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.

Treatment of Dividend Distributions

For U.S. federal income tax purposes,  gross dividends  (including the amount of
any Israeli taxes withheld there from) 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




<PAGE>


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 31% 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 or,
if  Commtouch  elects  or if  Commtouch  is  treated  as a  "controlled  foreign
corporation"  under the Code, by their adjusted basis for computing earnings and
profits)  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-1999 tax years.  Because Commtouch  acquired  substantial cash in connection
with its initial public offering in 1999, it is possible that Commtouch became a
PFIC in its 1999 tax year. Commtouch will not be able to




<PAGE>


determine  whether  it in fact  became a PFIC in its 1999  tax  year  until  its
operating  results for the last quarter of 1999 are available.  If Commtouch did
not become a PFIC in its 1999 tax year, then Commtouch expects that the majority
of its assets will continue to generate  sufficient  levels of active income for
it to avoid PFIC treatment for U.S. federal income tax purposes in post-1999 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,  if Commtouch  did not become a PFIC in its 1999 tax year,
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.  Consequences  Regarding  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  stock 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 39.6% 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




<PAGE>


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.

Commtouch will not be able to determine whether it became a PFIC in its 1999 tax
year until its operating results for the last quarter of 1999 are available.


                              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.  However,  a peace agreement between
Israel and Egypt was signed in 1979, a peace agreement between Israel and Jordan
was  signed in 1994 and,  since  1993,  several  agreements  between  Israel and
Palestinian  representatives  have been signed. In addition,  Israel and several
Arab  States  have  announced  their  intention  to  establish  trade  and other
relations and are discussing  certain projects.  Israel has not entered into any
peace agreement with Syria or Lebanon,  and there have been  difficulties in the
negotiations  with the  Palestinians.  We cannot be  certain as to how the peace
process will develop or what effect it may have upon Commtouch.

Despite the progress towards peace between Israel and its Arab neighbors and the
Palestinians,   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.




<PAGE>


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  current  Israeli
government  elected in 1996 has  expressed  its  intention to reduce  government
involvement  in the economy by various  means,  including  relaxation of foreign
currency controls and certain budgetary restraints, and privatization of certain
government-owned  companies. 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.



Item 8. Selected Consolidated Financial Data.

The selected  consolidated  statements  of  operations  data for the years ended
December 31, 1997,  1998 and 1999 and the selected  consolidated  balance  sheet
data as of December 31, 1998 and 1999 have been  derived  from the  Consolidated




<PAGE>



<TABLE>
Financial  Statements  of  Commtouch  included  elsewhere  in this  report.  The
selected consolidated  statement of operations data for the years ended December
31,  1995  and 1996  and the  selected  consolidated  balance  sheet  data as of
December  31,  1995,  1996 and 1997  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 9--Management's Discussion and Analysis of Financial Condition and Results
of Operations" and the Consolidated  Financial  Statements and the Notes thereto
included elsewhere herein:


<CAPTION>
                                                                                     Year Ended December 31,
                                                               --------------------------------------------------------------------
                                                                 1995           1996           1997           1998           1999
                                                               --------       --------       --------       --------       --------
                                                                             (in thousands, except per share data)
<S>                                                            <C>            <C>            <C>            <C>            <C>     
Consolidated Statement of Operations Data:
Revenues:
 Email services .........................................      $   --         $   --         $   --         $    389       $  4,251
 Software licenses, maintenance and services ............         1,733          3,134            899           --             --
                                                               --------       --------       --------       --------       --------
   Total revenues .......................................         1,733          3,134            899            389          4,251
Cost of revenues:
 Email services .........................................          --             --             --              569          3,643
 Software licenses, maintenance and services ............           327            463            165           --             --
                                                               --------       --------       --------       --------       --------
   Total cost of revenues ...............................           327            463            165            569          3,643
                                                               --------       --------       --------       --------       --------
Gross profit (loss) .....................................         1,406          2,671            734           (180)           608
                                                               --------       --------       --------       --------       --------
Operating expenses
 Research and development, net ..........................           463          1,478          1,108          1,149          2,942
 Sales and marketing ....................................           832          1,965          2,202          2,001          7,722
 General and administrative .............................           369            465            829            604          4,328
 Amortization of prepaid marketing expenses .............          --             --             --             --            3,263
 Amortization of stock-based employee
   deferred compensation ................................          --             --             --               91          3,436
                                                               --------       --------       --------       --------       --------
   Total operating expenses .............................         1,664          3,908          4,139          3,845         21,691
Operating loss ..........................................          (258)        (1,237)        (3,405)        (4,025)       (21,083)
Interest and other income (expenses), net ...............           (62)           (45)           (68)          (326)         1,232
                                                               --------       --------       --------       --------       --------
Net loss ................................................      $   (320)      $ (1,282)      $ (3,473)      $ (4,351)      $(19,851)
                                                               ========       ========       ========       ========       ========
Basic and diluted net loss per share ....................      $  (0.11)      $  (0.66)      $  (2.40)      $  (3.00)      $  (2.65)
                                                               ========       ========       ========       ========       ========
Weighted average number of shares used in
Computing--basic and diluted net loss per share .........         2,885          1,934          1,450          1,450          7,487
                                                               ========       ========       ========       ========       ========
</TABLE>




<TABLE>
<CAPTION>
                                                                                       December 31,
                                                         ---------------------------------------------------------------------------
                                                           1995             1996            1997             1998             1999
                                                         --------         --------        --------         --------         --------
                                                                                      (in thousands)
<S>                                                      <C>              <C>             <C>              <C>              <C>     
Consolidated Balance Sheet Data:
 Cash and cash equivalents ......................        $     54         $    690        $    324         $    834         $ 65,996
 Marketable securities ..........................            --               --              --               --             18,050
 Working capital (deficit) ......................            (734)             539          (1,264)          (1,440)          88,053
 Total assets ...................................             773            2,180           1,065            2,366          100,336
 Long-term liabilities ..........................             324              371             366              530              497
 Shareholders' equity (deficit) .................            (650)             777          (1,018)            (815)          95,312
</TABLE>




Item 9. Management's Discussion and Analysis of Financial Condition and Results
of Operations.

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




<PAGE>


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  1--Risk  Factors"
and in the Company's other filings with the Securities and Exchange Commission.

Overview

We are a leading global  provider of 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.  As
of December 31, 1999, we had over 250 global  customers.  Through our customers'
sites we serve  approximately 8.4 million active emailboxes.  We also serve over
1.0 million  active  emailboxes  to small  businesses  and websites  through our
ZapZone Network.

Revenue Sources

Service  Fees.  During 1999,  most of our email  service  revenue  resulted from
contracts  that required our  customers to pay us either a share of  advertising
revenues  subject  to a minimum  annual  revenue  commitment  or a  monthly  per
emailbox  price  subject  to a  minimum  commitment  fee,  and fees  for  direct
marketing and communications services.

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.  Ecommerce  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  ecommerce  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 ecommerce vendors on a test basis. In 1999, direct
e-marketing  revenues became a meaningful portion of revenue.  We recognized 11%
of our total revenues from MyPoints, a permission based email service company.

Strategic Transaction with Go2Net

Concurrent with the sale of our shares in the initial public offering we entered
into  an  agreement  with  Go2Net,   a  network  of  branded,   technology-  and
community-driven  websites  focused on personal  finance,  commerce,  and games.
Go2Net also  develops  Web-related  software.  Pursuant to the  agreement we are
offering Go2Net's end users a private label email service,  including our email,
calendaring and other services. The services are customized to the look and feel
of Go2Net's websites.  The terms of this agreement are substantially the same as
our commercial  agreements  with other  customers  except that we have agreed to
share a materially greater portion of our advertising  revenues with Go2Net than
we are sharing under other similar agreements.  In addition,  in connection with
the  agreement,  we issued to Go2Net 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,




<PAGE>


estimated at $5.8 million, is being amortized to operating expenses ratably over
the minimum term of the agreement,  which is one year.  Simultaneously  with the
sale of the shares in the initial public offering,  we sold a total of 1,344,086
ordinary shares to Go2Net and Vulcan  Ventures  Incorporated at $14.88 per share
in a  private  placement.  In the  future,  we may  have to  issue  in-the-money
warrants to acquire our ordinary shares to customers 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 customers may further dilute our  shareholders,  increase our operating
loss in the future and cause our stock price to fall.

Issuance of Shares Upon Exercise of Microsoft Warrant

We entered into an Email Services  Agreement with  Microsoft  Corporation  dated
October 26, 1999. Under this agreement,  Commtouch will, at Microsoft's  option,
customize,  host and maintain email services for Microsoft  websites in the U.S.
and  internationally.  Microsoft  will  pay  one-time  fees for the  set-up  and
customization  of the email  service  for each  website  with  respect  to which
Microsoft chooses to use our services, as well as quarterly service fees for the
email service based on the number of mailboxes hosted. The term of the agreement
shall continue for 12 months after the first commercial distribution date of the
email service and Microsoft may extend the initial term on a quarterly or annual
basis upon 60 days prior  written  notice.  The  agreement  may be terminated by
Microsoft for convenience upon 90 days' prior written notice, or by either party
upon a  material  breach by the other  party  upon the  terms  specified  in the
agreement.  In connection  with the agreement,  Commtouch  issued to Microsoft a
fully vested warrant,  exercisable  until December 29, 1999, to purchase 707,965
of Commtouch's  ordinary  shares at an exercise price of $28.25 per share for an
aggregate  exercise  price of $20.0  million.  On December 29,  1999,  Microsoft
exercised the warrant and now holds 707,965 ordinary  shares.  The fair value of
the warrant,  estimated at $1.9 million, is amortized to operating expenses over
the minimum term of the agreement (12 months).

Results of Operations


<TABLE>
The following  table sets forth  financial data for the years ended December 31,
1997, 1998 and 1999 (in thousands):

<CAPTION>
                                                                                               Year Ended December 31,
                                                                                       --------------------------------------------
                                                                                         1997              1998              1999
                                                                                       --------          --------          --------
Revenues:
<S>                                                                                    <C>               <C>               <C>     
 Email services ..............................................................         $   --            $    389          $  4,251
 Software licenses, maintenance and services .................................              899              --                --
                                                                                       --------          --------          --------
   Total revenues ............................................................              899               389             4,251
                                                                                       --------          --------          --------
Cost of revenues:
 Email services ..............................................................             --                 569             3,643
 Software licenses, maintenance and services .................................              165              --                --
                                                                                       --------          --------          --------
   Total cost of revenues ....................................................              165               569             3,643
                                                                                       --------          --------          --------
 Gross profit (loss) .........................................................              734              (180)              608
                                                                                       --------          --------          --------
Operating expenses:
 Research and development, net ...............................................            1,108             1,149             2,942
 Sales and marketing .........................................................            2,202             2,001             7,722
 General and administrative ..................................................              829               604             4,328
 Amortization of prepaid marketing expenses ..................................             --                --               3,263
 Amortization of stock-based employee deferred compensation ..................             --                  91             3,436
                                                                                       --------          --------          --------
   Total operating expenses ..................................................            4,139             3,845            21,691
                                                                                       --------          --------          --------
Operating loss ...............................................................           (3,405)           (4,025)          (21,083)
Interest and other income (expenses), net ....................................              (68)             (326)            1,232
                                                                                       --------          --------          --------




<PAGE>


Net loss .....................................................................         $ (3,473)         $ (4,351)         $(19,851)
                                                                                       ========          ========          ========
</TABLE>




Comparison of Years Ended December 31, 1997, 1998 and 1999

In 1997,  we ceased all sales of  stand-alone  email client  software  licenses,
maintenance  and services and focused on developing our Web-based  email service
business. Accordingly, comparisons between 1997 and 1998 are not meaningful.

Revenues.  Email service  revenues  increased 993% from $389,000 in 1998 to $4.3
million in 1999. One customer,  Excite,  represented 54% of the revenue in 1998.
Revenues from MyPoints,  a permission based email service  company,  represented
11% of total  revenues  during 1999.  As of December  31, 1999,  the Company had
backlog from contracts amounting to approximately  $13.1 million,  which will be
recognized as revenue over future quarters.

Cost of Revenues.  Cost of revenues increased 540% from $569,000 in 1998 to $3.6
million in 1999, due to the increase in contracts with customers during 1999 and
the related  service  provided.  Cost of revenues  consisted  primarily of costs
related  to  Internet  data  center   services  from  a  third-party   provider,
depreciation  of equipment,  Internet  access,  personnel and related costs.  We
expect cost of revenues to increase on an absolute basis,  primarily as a result
of an increase in our email service revenues, but to decrease as a percentage of
email service revenues due to economies of scale.

Research and Development Costs, Net. Research and development expenses increased
156% from $1.1  million in 1998 to $2.9  million in 1999 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.  We have an obligation to pay royalties to the
Israeli  government with a remaining future  liability of $270,000.  In 1998, we
transferred  several key research and development  personnel into our operations
group to support and  maintain  our newly  developed  Web-based  email  services
infrastructure.  Costs  relating  to these  personnel  were  included in cost of
revenues in 1998.  We expect that research and  development  costs will increase
due to increased  personnel and related costs  associated  with the  accelerated
development of new email service offerings.

Sales and  Marketing.  Sales and  marketing  expenses  increased  286% from $2.0
million in 1998 to $7.7 million in 1999, 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.  We expect sales and marketing
expenses to increase  significantly in the future in absolute dollar amounts due
to increases in personnel costs related directly to new employees being hired to
conduct sales and the related market support to further develop our brand. Sales
and  marketing  expenses  were  $2.2  million  in 1997 and  related  only to the
software license sales that were discontinued in 1997.

General and Administrative.  General and administrative  expenses increased 617%
from $604,000 in 1998 to $4.3 million in 1999,  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.  We expect general and administrative costs to increase on an absolute
basis due to  increased  personnel  and related  costs,  higher  facility  costs
associated  with  additional  personnel and other costs necessary to support and
develop the email service  business.  General and  administrative  expenses were
$829,000  in 1997 and  related  only to the  software  license  sales  that were
discontinued in 1997.

Amortization of Prepaid  Marketing  Expenses.  Amortization of prepaid marketing
expenses  related to the Go2Net and Microsoft  warrants and totaled $3.3 million




<PAGE>


for  1999.  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 increased 3,676% from $91,000 for 1998
to $3.4 million for 1999. The deferred compensation is being amortized using the
sum-of-digits method over the vesting schedule, generally four years.

Interest  and Other  Income  (Expense),  Net.  Our  interest  and  other  income
(expense),  net,  increased  from a net  expense of  $326,000  for 1998 to a net
income of $1.2 million for 1999,  due  primarily to  increased  interest  income
earned from cash equivalents and marketable securities.

Income  Taxes. As  of  December  31, 1999, we had approximately $22.5 million of
Israeli  net  operating loss carryforwards and $14.2 million of U.S. federal net
operating  loss  carryforwards  available  to  offset future taxable income. The
U.S.  net  operating  loss  carryforwards  will expire in various amounts in the
years  2008  to  2020.  The  Israeli  net  operating  loss carryforwards have no
expiration date.

Quarterly Results of Operations


<TABLE>
The  following  table sets  forth  certain  unaudited  quarterly  statements  of
operations data for the eight quarters ended December 31, 1999. 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.

<CAPTION>
                                                                                Three Months Ended
                                               ------------------------------------------------------------------------------------
                                               Mar. 31,  Jun. 30,   Sept. 30,  Dec. 31,   Mar. 31,   Jun. 30,  Sept. 30,    Dec. 31,
                                                1998       1998       1998       1998       1999       1999       1999        1999
                                               -------    -------    -------    -------    -------    -------    -------    -------
                                                                                   (in thousands)
<S>                                            <C>        <C>        <C>        <C>        <C>        <C>        <C>        <C>    
Email service revenues .....................   $    32    $    59    $   130    $   168    $   346    $   552    $ 1,117    $ 2,236
Cost of email service revenues .............        59         85        166        259        435        605      1,043      1,560
                                               -------    -------    -------    -------    -------    -------    -------    -------
Gross profit (loss) ........................       (27)       (26)       (36)       (91)       (89)       (53)        74        676
                                               -------    -------    -------    -------    -------    -------    -------    -------
Operating expenses:
 Research and development,
   net .....................................       266        305        308        270        340        510        857      1,235
 Sales and marketing .......................       459        506        509        527        608      1,363      2,368      3,383
 General and administrative ................       138        137        151        178        617        683      1,345      1,683
 Amortization of prepaid
   marketing expenses ......................      --         --         --         --         --         --        1,464      1,799
 Amortization of stock-based
   employee compensation ...................         2          8         18         63        386      1,013      1,096        941
                                               -------    -------    -------    -------    -------    -------    -------    -------
   Total operating expenses ................       865        956        986      1,038      1,951      3,569      7,130      9,041
                                               -------    -------    -------    -------    -------    -------    -------    -------
Operating loss .............................      (892)      (982)    (1,022)    (1,129)    (2,040)    (3,622)    (7,056)    (8,365)
Interest and other income
 (expenses), net ...........................       (27)       (59)       (28)      (212)      (271)         6        577        920
                                               -------    -------    -------    -------    -------    -------    -------    -------
Net loss ...................................   $  (919)   $(1,041)   $(1,050)   $(1,341)   $(2,311)   $(3,616)   $(6,479)   $(7,445)
                                               =======    =======    =======    =======    =======    =======    =======    =======
</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




<PAGE>


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 Web-based email services;

     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 services;

     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.

Liquidity and Capital Resources

We have financed our operations  principally from the sale of equity  securities
and to a lesser extent from bank loans and research and development  grants from
the  Israeli  government.  In the first  quarter  of 1999,  we  issued  Series C
Convertible  Preferred  Shares to  investors  resulting  in net proceeds of $5.3
million.  In the second  quarter  of 1999,  we issued to  investors  Convertible
Promissory  Notes  which  later  converted  into  42,081  Series  D  Convertible
Preferred Shares,  resulting in net proceeds of approximately $13.2 million. All
of our convertible preferred shares automatically converted into ordinary shares
upon the closing of our initial  public  offering on July 16, 1999.  On July 16,
1999, we raised $70.8 million, net of underwriters commissions, from our initial
public  offering  (including  the  exercise of the  underwriters'  overallotment
option) and the private  placement of our ordinary shares in connection with the
strategic  partnership with Go2Net and Vulcan Ventures.  On December 29, 1999 we
raised an additional $20.0 million from the sale of ordinary shares to Microsoft
Corporation  upon the exercise of a warrant  issued in connection  with an email
services agreement with Microsoft. As of December 31, 1999, we had $66.0 million
in cash and cash equivalents and $18.1 million in marketable securities.

Net cash provided by financing  activities  was $102.9 million in 1999. Net cash
used in  operating  activities  was  $11.2  million  in 1999.  Net cash used for



<PAGE>


operating  activities is primarily  comprised of a net loss for 1999,  partially
offset by depreciation  and amortization  expenses,  increases in other accounts
receivable and prepaid expenses. Net cash used in investing activities was $26.5
million in 1999. These investing  activities consisted primarily of purchases of
property and equipment and purchases of marketable securities.

As of December 31, 1999, we had net working capital of $88.1 million.

We believe that the existing cash and our other financing arrangements,  provide
us with sufficient funds to finance  operations and continued growth through the
next 12 months.

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.  The majority of
our income,  however,  is derived from our 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  1999,  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 dollars.  However, a large portion of our costs relates
to our operations in Israel.  A substantial  portion of our operating  expenses,
primarily our research and development  expenses, is denominated in NIS. For the
purposes of our  financial  statements,  costs not  effectively  denominated  in
dollars are  translated to dollars at prevailing  exchange  rates when recorded,
and will increase if the rate of inflation in Israel exceeds the  devaluation of
the NIS as  compared  to the dollar or if the timing of such  devaluations  lags
considerably  behind  inflation.  Consequently,  we are and will be  affected by
changes in the prevailing NIS/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 rate of inflation in Israel was 8.1% and 10.6% in 1995 and 1996. The rate of
devaluation  in Israel was 3.9% and 3.7% in 1995 and 1996.  This  imbalance  was
reversed when the rate of inflation was 7.0% and 8.6% in 1997 and 1998. The rate
of  devaluation in Israel was 8.8% and 17.6% in 1997 and 1998. In 1999, the rate
of inflation was 1.3% and the rate of devaluation in Israel was 0.2%.

Because  exchange  rates between the NIS and the dollar  fluctuate  continuously
(albeit with a historically  declining trend in the value of the NIS),  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  remeasurements  are  reported in the  Consolidated
Financial Statements in current operations.

The  representative  exchange  rate, as reported by the Bank of Israel,  was NIS
4.153 for one dollar on December  31,  1999 (NIS 4.160 on December  31, 1998 and
NIS 3.536 on December 31, 1997).




<PAGE>



I
tem 9A. Qualitative and Quantitative Disclosure about Market Risk

We develop our  technology in Israel and provide our services in North  America.
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.  Our  interest  expense on our capital  lease  obligations  with a U.S.
leasing  company is sensitive to changes in the general  level of U.S.  interest
rates. 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 10. Directors and Officers of Registrant.

The  following  table sets forth  certain  information  regarding  our executive
officers and directors:

Name                       Age                         Position
----                       ---                         --------
Gideon Mantel(1) .......... 40  Chief Executive Officer and Director
Amir Lev .................. 40  President, Chief Technology Officer and Director
Isabel Maxwell ............ 49  President, Commtouch Software, Inc.
James Collins ............. 41  Chief Financial Officer
Allan Barkat(1) ........... 40  Chairman of the Board of Directors
Yair Safrai(2) ............ 41  Director
Nahum Sharfman(1) ......... 52  Director
Richard Sorkin ............ 38  Director
Thomas Camp(2) ............ 36  Director
Thomas Calandra(2) ........ 43  Director
------------
(1) Member of the Compensation Committee
(2) Member of the Audit Committee


Other Management Employees

The  following  table sets  forth the names and  positions  of other  management
employees:

Name                     Age                      Position
----                     ---                      --------

Robert "Rip" Gerber ....  37  Vice President, Marketing and Ecommerce,
                              Commtouch Software, Inc.
Avner Amram ............  38  Vice President, Operations, Commtouch
                              Software, Inc.
Yael Elish .............  31  Vice President, Strategic Development, Commtouch
                              Software, Inc.
Igor Gusak .............  44  Vice President and General Manager, Custom Mail
                              (US), a division of Commtouch Software, Inc.
Yuval Neria  ...........  40  Vice President, International Sales
Ronni Zahavi ...........  33  Vice President, Human Resources
Scott Slater ...........  45  Vice President, Corporate Development, Commtouch
                              Software, Inc.




<PAGE>


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.

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 January  2000 became
President. Mr. Lev received a B.A. in Computer Science and Economics from Hebrew
University, Jerusalem.

Isabel  Maxwell  has  served  as the President of Commtouch Software, Inc. since
February  1997. Ms. Maxwell was a co-founder, and from March 1993 to August 1996
served  as  the  Senior  Vice  President  of International Business Development,
Corporate  Affairs  and  Investor  Relations,  of  The  McKinley  Group Inc., an
Internet  search  engine  company. From August 1996 to October 1996, Ms. Maxwell
was  an Executive Vice President of Excite, Inc. Ms. Maxwell received a B.A. and
M.A. in History and Modern Languages from Oxford University.

James Collins has served as the Chief Financial Officer of Commtouch since March
1999 and as the  Secretary of Commtouch  since April 1999.  From October 1997 to
February 1999, Mr. Collins was a private  investor.  From March 1992 to December
1996, Mr. Collins served as the Chief Financial Officer and Secretary,  and from
January 1997 to September 1997 as the Vice  President of  Operations,  of Pete's
Brewing  Company,  a specialty  brewer.  Mr. Collins received a B.S. in Business
Administration  from the  University  of the Pacific  and is a Certified  Public
Accountant in the State of California.

Allan  Barkat  has  served  as  a  Director of Commtouch since February 1996 and
Chairman  of  the  Board  of  Directors  since April 1999. From June 1999 to the
present,  Mr.  Barkat  has  been  a  Managing  Director of Apax Partner Ventures
Israel,  Ltd.  From  March  1997  to the present, Mr. Barkat has been a Managing
Director  of  Apax-Leumi  Partners, Ltd. the investment advisor to Israel Growth
Fund,  LP, a technology-focused venture capital fund. From January 1995 to March
1997,  Mr.  Barkat  served  as an Assistant Director of Apax-Leumi Partners Ltd.
From  1992  to 1994, Mr. Barkat served as Vice President of Marketing & Sales of
DSP  Communications  Group,  Inc.,  a wireless semiconductor company. Mr. Barkat
has  also served as a director of Fundtech Ltd. Mr. Barkat received a B.Sc. from
the Technion, Haifa.

Yair  Safrai  has  served  as  a  Director of Commtouch since January 1999. From
September  1996  to  the  present,  Mr.  Safrai has been the Managing Partner of
Concord  Ventures,  a technology-focused venture capital fund. From July 1994 to
September  1996,  Mr.  Safrai  served  as  Vice President of Nitzanim, a venture
capital  fund.  Mr.  Safrai received a B.A. in Management and Economics from Tel
Aviv  University,  an  M.A.  from  the University of Pennsylvania, and an M.B.A.
from the Wharton Business School, University of Pennsylvania.

Nahum  Sharfman  will join 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
stepped  down  as  Chief  Executive Officer to become a founder of Dealtime.com.
Mr.  Sharfman  remained  Chairman of the Board of Commtouch until he resigned in
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,
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




<PAGE>


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.

Thomas Camp has served as a Director of Commtouch  since July 1999.  Since April
1999, Mr. Camp has served as Vice President,  Business  Development at Go2Net, a
network of branded,  technology-and  community-driven  websites.  From September
1990 to April 1999, he was an attorney with the law firm of Hutchins,  Wheeler &
Dittmar,  most  recently as a  stockholder.  Mr. Camp received a B.A. from Tufts
University,  an M.B.A.  from Boston College  Graduate School of Management and a
J.D. from Boston  College Law School.  Go2Net and Vulcan  Ventures  Incorporated
entered into an agreement with us in which they purchased  shares and received a
warrant to purchase additional shares. Under that agreement, they have the right
to name one director to our board, as long as they continue to hold at least 25%
of their  combined  number of shares and the  shares  available  to Go2Net  upon
exercise of the warrant.  Mr. Camp was  appointed to the board  pursuant to that
agreement.

Thomas  Calandra  has served as a Director of  Commtouch  since April 2000.  Mr.
Calandra has served as Editor-in-Chief and Executive Vice President of News, CBS
MarketWatch.com  (MKTW),  since  October  1997.  He is also  editor-in-chief  of
Financial  Times  MarketWatch  in London.  From March 1996 to October 1997,  Mr.
Calandra  was editor in chief and vice  president  of news at Data  Broadcasting
(DBCC), the predecessor to CBS MarketWatch. From December 1993 to February 1996,
Mr.  Calandra  was editor of USA  Today's  Online  Money  Section and editor and
financial  reporter at Bloomberg  London.  Mr. Calandra received a B.A. from the
City  University of New York at Brooklyn  College and a M.A. in English from the
University of Arizona.

Robert  "Rip" Gerber  has served  as  Vice President, Marketing and Ecommerce of
Commtouch  Software, Inc. since March 1999. Mr. Gerber was the founder of @Once,
an  email  direct  marketing  company,  and  from February 1998 to February 1999
served  as its President. From September 1995 to January 1998, Mr. Gerber served
as  Managing Director of Pantheon Consulting Group LLC, a marketing and planning
services  company.  From August 1992 to August 1995, Mr. Gerber was a consultant
for  Deloitte & Touche LLP, a public accounting firm. Mr. Gerber received a B.S.
in  Chemical  Engineering  from  the  University  of Virginia and an M.B.A. from
Harvard Business School.

Avner  Amram  has  served  as  Vice President, Operations of Commtouch Software,
Inc.  since  April  1999.  Mr.  Amram  was  Director  of Operations of Commtouch
Software,  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, Haifa.

Yael  Elish has served as the Vice President, Strategic Development of Commtouch
Software,  Inc. since April 1999. Ms. Elish was Commtouch's Director of Business
Development  from  August  1998  to  March  1999 and was Commtouch's Director of
Sales  from  December  1996 to August 1998. From August 1993 to August 1996, Ms.
Elish  was  a  Marketing  Manager  of  Widecom  Ltd.,  a  provider  of  Internet
integration  services  and  software  development.  Ms. Elish received a B.A. in
International Relations from Hebrew University in Jerusalem.

Igor Gusak has served as the Vice  President  and General  Manager,  Custom Mail
(US), a division of Commtouch  Software,  Inc.,  since April 1999. Dr. Gusak was
the Director of Sales and  Marketing of Commtouch  from  February  1997 to March
1999 and the Director of Original  Equipment  Manufacturer  Sales for  Commtouch
from January 1995 to January 1997.  Dr. Gusak  received a Ph.D.  in  Mathematics
from Urals University, Ekaterinburg, Russia.

Yuval  Neria  has served as the Vice President, International Sales of Commtouch
since  April  1999.  Mr.  Neria  was the Director of International Marketing and
Sales  for  Commtouch from March 1997 to April 1999, the Director of Pacific Rim
Operations  for  Commtouch  from March 1996 to April 1997, a Product Manager for
Commtouch  from  March  1995  to April 1996, and a Quality Assurance Manager for
Commtouch  from  March 1993 to April 1995. Mr. Neria received a B.A. in Computer




<PAGE>


Science from the City University of New York.

Ronni  Zahavi  has  served  as  a  Vice  President Human Resources for Commtouch
Software  Ltd.  since  July  1999.  From  June 1997 to July 1999, Mr. Zehavi was
Human  Resources and Training Manager at Mondex -- Electronic Cash, a subsidiary
of  Mastercard  International.  From  January  1994  to  June  1997,  he  was an
organizational  consultant. Mr. Zehavi received his BA in Educational Psychology
and  History  from  Tel Aviv University, and received his M.A. in Organizational
Sociology from Bar-Ilan University.

Scott  Slater  has  served  as the  Vice  President,  Corporate  Development  of
Commtouch  Software Inc.,  since  December 1999.  From February 1998 to December
1999, Mr. Slater was Senior Vice President,  Business  Development for NewsReal,
Inc. and from  September,  1996 to February,  1998, Mr. Slater was President and
Chief Executive Officer of O2Works, Inc. Mr. Slater studied psychology at Boston
University from 1972 to 1976.

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 annual general  meeting next  following the annual general  meeting or
general  meeting at which such  Director is elected and until his  successor  is
elected or until he is removed. An annual general meeting shall be held at least
once in every  calendar  year,  but not more than fifteen  months after the last
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 as aforesaid,
the Board of Directors may appoint new directors  temporarily  to fill vacancies
on the Board of Directors.  The Articles of Association  of Commtouch  authorize
nine directors or such greater number as may be determined  from time to time by
an ordinary  resolution of the shareholders.  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,  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 new Israeli  Companies Law, which took effect on February 1, 2000,  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;




<PAGE>


     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
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, as that term is defined in the Companies
         Law, 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 her  appointment or if she violates her fiduciary duty to the company.  Each
committee of a company's  Board of  Directors  must include at least one outside
director.  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  us to have at least  two
independent  directors  on our  Board of  Directors  and to  establish  an audit
committee,  at least a majority of whose members are  independent of management.
We  intend  to  appoint  new  directors  who will  qualify  both as  independent
directors under the Nasdaq National Market requirements and as outside directors
under the Companies Law at our next annual shareholders  meeting,  which will be
held on August 10, 2000.

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. An audit committee may
not approve an action or a transaction with a controlling  shareholder,  or with
an office  holder,  unless at the time of  approval  two outside  directors  are
serving  as  members  of the audit  committee  and at least  one of the  outside
directors was present at the meeting in which an approval was granted.

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




<PAGE>


law and orderly  business  procedure.  Under the  Companies  Law,  the  internal
auditor  may be an  employee  of the  company  but not an office  holder,  or an
affiliate, or a relative of an office holder or affiliate, and he or she may not
be the company's independent accountant or its representative.

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

The Israeli  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 table that appears above
at the beginning of this Item 10 is an office holder.

Under the Israeli  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 Israeli  Companies Law requires that an office holder promptly  disclose any
personal  interest that he or she may have and all related material  information
known to him or her, in connection with any existing or proposed  transaction by
the company.  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  Israeli  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.




<PAGE>


Under the Israeli  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,  voting in 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 Israeli
Companies Law does not describe the substance of this duty.

Compensation Committee Interlocks and Insider Participation

The Compensation Committee,  which was established by the Board in January 1996,
is  responsible  for  determining  salaries,   incentives  and  other  forms  of
compensation   for  our  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 outside  Directors.
Allan Barkat and Nahum  Sharfman are currently the two outside  directors on our
Compensation Committee.

Conflicts of interest may arise as a consequence of the  relationship  of one of
our directors,  Thomas Camp, with Vulcan and Go2Net, including conflicts related
to corporate  opportunities  that could be pursued by us, on the one hand, or by
Go2Net,  Vulcan  Ventures or their  affiliates,  on the other hand, or conflicts
related to  existing  or new  contractual  relationships  between us, on the one
hand,  or by Go2Net,  Vulcan  Ventures or their  affiliates,  on the other hand.
Transactions  between  us and our  officers  and  directors,  and  extraordinary
transactions  between us and our  principal  shareholders  or a third party if a
principal  shareholder  has a personal  interest in such  transaction  generally
require  the  approval  of a majority  of the board of  directors,  including  a
majority of the independent and  disinterested  outside  directors,  and in some
circumstances,  audit committee and shareholder approvals as well (See "Approval
of Certain Transactions").

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
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 by the audit  committee.  The Company has  acquired
directors' and officers' liability insurance covering the officers and directors
of the Company and its subsidiaries for certain claims.




<PAGE>



Item 11. 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 at a general meeting. 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 (10 persons) in 1999 was approximately  $800,000.  During the
same period Commtouch  accrued or set aside  approximately  $27,000 for the same
group to provide  pension,  retirement or similar  benefits.  As of December 31,
1999,  directors  and  executive  officers of Commtouch  (10 persons) held stock
options to purchase an aggregate of 170,080 ordinary shares.



Item 12. Options to Purchase Securities from Registrant or Subsidiaries.

As of May 31, 2000, stock options to purchase 3,227,316 ordinary shares had been
granted to employees, consultants,  executive officers and nonemployee directors
under the Company's stock option plans, net of cancelled options. Of that number
2,042,261 had not been  exercised and had exercise  prices ranging from $1.45 to
$66.50 per share and a weighted average per share exercise price of $22.57,  and
were held by 351 persons;  these  options have  termination  dates  ranging from
April 2005 to May 2010. At May 31, 2000, the persons named in Item 10 as a group
(10 persons) held options to acquire 397,580 Ordinary Shares.  Reference is also
made to the information contained in Item 4 above.



Item 13. Interest of Management in Certain Transactions.

Relationship with Go2Net

Concurrent with the closing of the initial public offering, our U.S. subsidiary,
Commtouch  Software,  Inc.,  entered into a Customized  Web-based  Email Service
Agreement with Go2Net. Under that agreement, we provide customer email services,
including  calendaring and other products and services, to end users of Go2Net's
various   properties,   which  may   include   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 Go2Net
sponsors or provides content to. Under the agreement,  Commtouch  hosts,  serves
and  maintains  the email,  calendaring  and other  services  and  Go2Net  sells
advertising  to be  displayed  in the  products  and  services.  Go2Net will pay
Commtouch a share of revenues from advertising generated from email, calendaring
or other services and related upgrades provided by Commtouch for Go2Net's users.
The agreement between Commtouch and Go2Net has a three year duration, but Go2Net
has the right on each  anniversary to terminate the  agreement.  Go2Net also has
the right to terminate the  agreement if there are  technical  problems with the
products or services provided by Commtouch.  The performance  specifications set
forth in the agreement  include requiring us to maintain certain levels of email
system  availability and response time, as well as technical support to Go2Net's
email end users and to Go2Net, among other things.

In  connection  with entering into the email  services  agreement,  we issued to
Go2Net 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 email  service
agreement.

Concurrent with our entering into the email services agreement,  we issued $13.3
million in  ordinary  shares to Go2Net and $6.7  million in  ordinary  shares to
Vulcan  Ventures  in a private  placement  at $14.88 per share.  Pursuant to the
share purchase agreement,  Go2Net 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




<PAGE>


combined  number of shares  purchased by them in the private  placement  and the
shares  issuable to Go2Net upon exercise of the warrant.  Mr. Camp was appointed
to the board pursuant to that agreement. 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.

Ordinary Share Financings

Mr.  Yiftah  Atir,  a director of Commtouch, is a Managing Director of Evergreen
Canada  Management  Ltd.,  the  general  partner  of Harbour Vest-Evergreen L.P.
Pursuant  to  several  Share  Purchase  Agreements  we  issued and sold ordinary
shares  to  Evergreen  Canada Israel Investments and Company Ltd., Yarok Ad Fund
Investment  Partnership  L.P.  and  Gmul  Investment Company Ltd (the "Evergreen
Investors").  These shares were subsequently converted into Series A Convertible
Preferred   Shares   and   certain   of   these   shares   were  transferred  to
HarbourVest-Evergreen L.P.

Preferred Share Financings

Mr. Yair  Safrai,  a director  of  Commtouch,  is a Managing  Partner of Concord
Ventures,  which  manages the  Concord  Funds (as  defined  below).  Pursuant to
Preferred  Share Letter  Agreements  entered into in December  1998 and February
1999,  we issued and sold (i) 41,570 Series C  Convertible  Preferred  Shares to
k.t.  Concord  Venture Fund (Cayman) L.P.,  k.t.  Concord  Venture Fund (Israel)
L.P.,  k.t.  Concord  Venture  Advisors  (Cayman) L.P. and k.t.  Concord Venture
Advisors  (Israel)  L.P.  (the  "Concord  Funds"),  for a  total  investment  of
approximately $3.0 million; (ii) 16,249 Series C Convertible Preferred Shares to
IGF for a total  investment  of  approximately  $1.2  million;  and (iii) 12,779
Series C Convertible Preferred Shares to GIF for approximately $922,000.

Option  Exercises  and  Purchases  of  Shares  Subject  to Repurchase 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 February
29, 2000 is $341,272.

Isabel Maxwell is the President of Commtouch  Software,  Inc. On March 17, 1999,
Ms.  Maxwell  exercised  certain  options  granted  to  her  by  Commtouch.   As
consideration for the ordinary shares purchased  pursuant to the exercise of the
options, she provided Commtouch with a full-recourse promissory note dated March
17, 1999 in the original principal amount of $295,858. 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 Ms.  Maxwell  to  purchase
204,040 ordinary shares of Commtouch at a purchase price of $1.45 per share. The
promissory  note is  collateralized  by a pledge  of the  stock  purchased.  The
outstanding principal amount of the note as of February 29, 2000 is $295,858.




<PAGE>


James Collins is the Chief Financial Officer of Commtouch.  On February 1, 2000,
Mr.  Collins  exercised  certain  options  granted  to  him  by  Commtouch.   As
consideration for the ordinary shares purchased  pursuant to the exercise of the
options,  Mr. Collins  provided  Commtouch with a full-recourse  promissory note
dated  February 1, 2000 in the  original  principal  amount of  $1,066,890.  The
promissory note bears interest at 6.56% annually, with payments of interest only
due on  February  1 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.
Collins to purchase  30,000  ordinary shares of Commtouch at a purchase price of
$35.36 per share. The promissory note is collateralized by a pledge of the stock
purchased.  The outstanding  principal  amount of the note as of May 31, 2000 is
$137,112.  On March 17, 1999, Mr. Collins  exercised  certain options granted to
him by Commtouch. As consideration for the ordinary shares purchased pursuant to
the exercise of the options, Mr. Collins provided Commtouch with a full-recourse
promissory  note  dated  March  17,  1999 in the  original  principal  amount of
$137,112. 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.  Collins to purchase  94,560  ordinary  shares of Commtouch at a purchase
price of $1.45 per share. The promissory note is  collateralized  by a pledge of
the stock purchased. The outstanding principal amount of the note as of Februray
29, 2000 is $137,112.

Loan  to  Dr.  Nahum  Sharfman and Relationship among Commtouch and DealTime.com
Ltd., Dr. Nahum Sharfman and Amir Ashkenazi

Dr. Nahum  Sharfman was a co-founder  of Commtouch  and served as a director and
Chairman of the Board of Directors of Commtouch  from  inception  until  January
1999. Dr.  Sharfman  rejoined the board of directors in April 2000. Dr. Sharfman
also served as the Chief  Executive  Officer of Commtouch  until March 31, 1998.
Dr.  Sharfman  rejoined  the Board as a director in March 2000.  On December 31,
1995, Commtouch made a loan of approximately  $58,000 to Dr. Sharfman.  The loan
plus linkage to the Israeli  Consumer Price Index was to have been repaid within
three years, or within 30 days of the termination of Dr. Sharfman's  employment,
if  earlier.  At  December  31,  1998 the  outstanding  balance of this loan was
approximately $55,000, payable in NIS.

In   1997   Dr.  Sharfman  established  DealTime.com  Ltd.  (formerly  known  as
Papricom), together with Mr. Amir Ashkenazi, a former employee of Commtouch.

During  an  interim  period  in  which  Commtouch  and  DealTime.com  Ltd.  were
negotiating  a  technology  exchange agreement, which ultimately was not signed,
Commtouch   provided   DealTime.com  Ltd.  with  certain  services  (office  and
secretarial   services,   computers  and  other  facilities  including,  without
limitation,  all payments made for or on behalf of DealTime.com Ltd.) and access
to  certain  of  Commtouch's  technology.  At  the request of DealTime.com Ltd.,
Commtouch  also  entered into a Product Distribution Agreement (the "Stock Alert
Agreement")  with  News  Alert  Inc. DealTime.com has provided technical support
and  services  to  News Alert Inc. in connection with the Stock Alert Agreement.
Commtouch   has  entered  into  three  agreements  to  clarify  the  rights  and
obligations of Commtouch, DealTime.com, Dr. Sharfman and Mr. Amir Ashkenazi.

Under the first  agreement,  Dr.  Sharfman and Mr.  Ashkenazi  acknowledge  that
Commtouch  is the sole owner of all of their  inventions  invented  during their
employment  with Commtouch and for two years  following the termination of their
employment,  which  inventions  relate  to  Commtouch's  business  and  research
activities  as of April 1, 1998 (except in the field of  e-commerce).  They also
acknowledge  Commtouch's  rights to  inventions  that result from work that they
performed  for  Commtouch  at any  time,  or which are the  subject  matter of a
specified patent application.  Dr. Sharfman and Mr. Ashkenazi also agreed not to
compete with Commtouch's actual business and research activities as they were on
April 1, 1998 (except in the field of e-commerce), through March 31, 2000.

The  second  agreement,  which  is  between  Commtouch  and  DealTime.com  Ltd.,
confirms  that DealTime.com Ltd. shall be solely responsible for all obligations
of   Commtouch   under   the  Stock  Alert  Agreement.  DealTime.com  Ltd.  also
acknowledges  that  Commtouch  is  the  sole  owner  of  the  Multimedia Desktop




<PAGE>


Software  Technology  that  Commtouch  developed  and  that was licensed to News
Alert   Inc.,   and   Commtouch   grants   DealTime.com   Ltd.  a  royalty-free,
non-exclusive,  limited  license  to  use  that  technology  to  provide support
services  under  the Stock Alert Agreement. DealTime.com Ltd. also agreed to pay
$50,000  to  Commtouch for all of the services rendered by Commtouch and for the
license  fees  that  DealTime.com Ltd. received under the Stock Alert Agreement,
and  to  divide  any  future  revenues and license fees received under the Stock
Alert  Agreement  equally  with  Commtouch.  Commtouch, for its part, waived any
claim  to  an  equity interest in DealTime.com Ltd., and agreed that it does not
own  intellectual  property  developed by DealTime.com Ltd. other than in breach
of the agreements with DealTime.com Ltd. and Messrs. Sharfman and Ashkenazi.

Finally,  Commtouch  and  Dr.  Sharfman entered into a Termination of Employment
Agreement  requiring the repayment by Dr. Sharfman of Commtouch's loan to him by
December  31,  1999  and  the  release  to  Dr.  Sharfman of funded and unfunded
severance  pay  within  20  days  of  the date of approval

of the Termination of Employment  Agreement by our shareholders and containing a
waiver by Dr.  Sharfman of any rights  under stock  options that were granted to
him. Dr. Sharfman repaid the loan and Commtouch  released the severance payments
in the third quarter of 1999.

Loan to Amir Lev

Amir Lev has been a  director  and  executive  officer  of  Commtouch  since its
inception in 1991.  In 1999,  Mr. Lev exercised  options for Commtouch  ordinary
shares. We loaned him $364,000 so that he could make an estimated tax payment in
connection  with this option.  This full recourse loan was linked to the Israeli
Consumer  Price Index and interest  accrued at a rate of 2% per annum.  The loan
was repaid in full on February 10, 2000.



                                     PART II


Item 14. Description of Securities to be Registered.

   Not applicable.



                                    PART III



Item 15. Defaults Upon Senior Securities.

   Not applicable.



Item 16. Changes in Securities and Changes in Security for Registered
Securities.

   Not applicable.



                                     PART IV



Item 17. Financial Statements.

   The Company has responded to Item 18.



Item 18. Financial Statements

   Reference is made to Item 19 for a list of all financial  statements filed as
part of this Annual Report on Form 20-F.




<PAGE>



Item 19. Financial Statements and Exhibits

   (a) (1) 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 (Deficit) ........    F-4
Consolidated Statements of Cash Flows .........................    F-5
Notes to Consolidated Financial Statements ....................    F-6

   (a) (2) Financial Statement Schedules:

The following  financial  statement schedule of Commtouch Software Ltd. for each
of the three years in the period ended December 31, 1999 is filed as part of the
Annual Report and should be read in conjunction with the consolidated  financial
statements of Commtouch Software, Inc.


  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.

   (b) Exhibits

  Exhibit 4.1--Consent of Independent Auditors



                         REPORT OF INDEPENDENT AUDITORS

The Board of Directors and Shareholders COMMTOUCH SOFTWARE LTD.

We have  audited  the  accompanying  consolidated  balance  sheets of  Commtouch
Software  Ltd. and its  subsidiaries  as of December 31, 1998 and 1999,  and the
related consolidated  statements of operations,  changes in shareholders' equity
(deficit),  and cash  flows  for each of the  three  years in the  period  ended
December 31, 1999.  These  financial  statements are the  responsibility  of the
Company's  management.  Our  responsibility  is to  express  an opinion on these
financial statements based on our audits.

We  conducted  our  audits  in  accordance  with  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 misstatement.  An audit includes examining, on a
test basis,  evidence  supporting  the amounts and  disclosures in the financial
statements.  An audit also includes assessing the accounting principles used and
significant  estimates made by the Company's  management,  as well as evaluating
the overall financial statement presentation. We believe that our audits provide
a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above, present
fairly,  in all  material  respects,  the  consolidated  financial  position  of
Commtouch  Software Ltd. and its  subsidiaries as of December 31, 1998 and 1999,
and the consolidated results of their operations,  and their cash flows for each
of the three years in the period ended  December 31, 1999,  in  conformity  with
generally accepted accounting principles in the United States.




<PAGE>

Tel-Aviv, Israel
January 31, 2000



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



<TABLE>
                                                       COMMTOUCH SOFTWARE LTD.

                                                     CONSOLIDATED BALANCE SHEETS
                                           (In thousands, except share and per share data)


<CAPTION>
                                                                                                             December 31,
                                                                                                    -------------------------------
                                                                                                      1998                  1999
                                                                                                    ---------             ---------
<S>                                                                                                 <C>                   <C>      
                                         Assets
Current Assets:
   Cash and cash equivalents ...........................................................            $     834             $  65,996
   Marketable securities ...............................................................                 --                  18,050
   Trade receivables, net ..............................................................                  133                 2,378
   Prepaid marketing expenses ..........................................................                 --                   4,508
   Prepaid expenses and other accounts receivable ......................................                  244                 1,648
                                                                                                    ---------             ---------
      Total current assets .............................................................                1,211                92,580
                                                                                                    ---------             ---------
Long-term Lease Deposits ...............................................................                 --                   1,254
Severance Pay Fund .....................................................................                  223                   354
Property and Equipment, net ............................................................                  932                 6,148
                                                                                                    ---------             ---------
                                                                                                    $   2,366             $ 100,336
                                                                                                    =========             =========

                     Liabilities and Shareholders' Equity (Deficit)
Current Liabilities:
   Short-term bank credit ..............................................................            $   1,328             $    --
   Current portion of capital leases ...................................................                  112                   120
   Accounts payable ....................................................................                  446                 1,510
   Employees and payroll accruals ......................................................                  313                 1,032
   Deferred revenues ...................................................................                   74                   561
   Accrued expenses and other liabilities ..............................................                  378                 1,304
                                                                                                    ---------             ---------
      Total current liabilities ........................................................                2,651                 4,527
                                                                                                    ---------             ---------
   Long-term portion of capital leases .................................................                  164                    44
   Accrued severance pay ...............................................................                  366                   453
                                                                                                    ---------             ---------
                                                                                                          530                   497
                                                                                                    ---------             ---------
Commitments and Contingent Liabilities (Note 6) ........................................                 --                    --
Shareholders' Equity (Deficit)
   Convertible Preferred Shares of NIS 1 par value --
    Authorized: 524,250 shares as of December 31, 1998; and
    none as of December 31, 1999; Issued and outstanding:
    221,265 shares as of December 31, 1998 and none as of
    December 31, 1999 Aggregate liquidation preference of
    approximately $13,200 as of December 31, 1998 and none as
    of December 31, 1999 ...............................................................                   74                  --
   Ordinary Shares of NIS 0.05 par value --
    Authorized: 11,515,000 and 40,000,000 shares
    as of December 31, 1998 and 1999, respectively; Issued and
    outstanding: 1,450,040 and 15,199,344 shares as of
    December 31, 1998 and 1999, respectively ...........................................                   27                   213
   Additional paid-in capital ..........................................................               11,256               133,403
   Deferred compensation ...............................................................                 (418)               (5,779)
   Notes receivable from shareholders ..................................................                  (77)               (1,060)

   Accumulated other comprehensive income ..............................................                 --                      63
   Accumulated deficit .................................................................              (11,677)              (31,528)
                                                                                                    ---------             ---------
      Total shareholders' equity (deficit) .............................................                 (815)               95,312
                                                                                                    ---------             ---------
                                                                                                    $   2,366             $ 100,336
                                                                                                    =========             =========

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



<PAGE>




<TABLE>
                                                       COMMTOUCH SOFTWARE LTD.

                                                CONSOLIDATED STATEMENTS OF OPERATIONS
                                                (In thousands, except per share data)


<CAPTION>
                                                                                                    Year ended
                                                                                                   December 31,
                                                                                   ------------------------------------------------
                                                                                     1997                1998                1999
                                                                                   --------            --------            --------
<S>                                                                                <C>                 <C>                 <C>     
Revenues:
   Email services ......................................................           $   --              $    389            $  4,251
   Software licenses ...................................................                711                --                  --
   Software maintenance and services ...................................                188                --                  --
                                                                                   --------            --------            --------
      Total revenues ...................................................                899                 389               4,251
                                                                                   --------            --------            --------
Cost of revenues:
   Email services ......................................................               --                   569               3,643
   Software licenses ...................................................                 21                --                  --
   Software maintenance and services ...................................                144                --                  --
                                                                                   --------            --------            --------
      Total cost of revenues ...........................................                165                 569               3,643
                                                                                   --------            --------            --------
Gross profit (loss) ....................................................                734                (180)                608
                                                                                   --------            --------            --------
Operating expenses:
   Research and development, net .......................................              1,108               1,149               2,942
   Sales and marketing .................................................              2,202               2,001               7,722
   General and administrative ..........................................                829                 604               4,328
   Amortization of the prepaid marketing expenses ......................               --                  --                 3,263
   Amortization of stock-based employee compensation ...................               --                    91               3,436
                                                                                   --------            --------            --------
      Total operating expenses .........................................              4,139               3,845              21,691
                                                                                   --------            --------            --------
Operating loss .........................................................             (3,405)             (4,025)            (21,083)
Interest and other income (expenses), net ..............................                (68)               (326)              1,232
                                                                                   --------            --------            --------
Net loss ...............................................................           $ (3,473)           $ (4,351)           $(19,851)
                                                                                   ========            ========            ========
Basic and diluted net loss per share ...................................           $  (2.40)           $  (3.00)           $  (2.65)
                                                                                   ========            ========            ========
Weighted average number of shares used in computing
 basic and diluted net loss per share ..................................              1,450               1,450               7,487
                                                                                   ========            ========            ========

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





<PAGE>



<TABLE>
                                                       COMMTOUCH SOFTWARE LTD.

                                       STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY (DEFICIT)
                                                  (In thousands, except share data)


<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, 1997 .........................        160,316      $       56       1,450,040     $       27     $    4,624
 Issuance of shares, net ..............................         23,321               7            --             --            1,625
 Warrants issued for services received and
  bank line of credit .................................           --              --              --             --               46
 Net loss .............................................           --              --              --             --             --
                                                            ----------      ----------      ----------     ----------     ----------
Balance as of December 31, 1997 .......................        183,637              63       1,450,040             27          6,295
 Issuance of shares, net ..............................         37,628              11            --             --            4,061
 Warrants issued for services received and
  bank line of credit .................................           --              --              --             --              391
 Deferred compensation ................................           --              --              --             --              509
 Amortization of deferred compensation ................           --              --              --             --             --
 Net loss .............................................           --              --              --             --             --
                                                            ----------      ----------      ----------     ----------     ----------
Balance as of December 31, 1998 .......................        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 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 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
                                                            ==========      ==========      ==========     ==========     ==========
</TABLE>





<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, 1997 ............................      $   --         $    (77)      $   --        $ (3,853)      $    777
 Issuance of shares, net .................................          --             --             --            --            1,632
 Warrants issued for services received and
  bank line of credit ....................................          --             --             --            --               46
 Net loss ................................................          --             --             --          (3,473)        (3,473)
                                                                --------       --------       --------      --------       --------
Balance as of December 31, 1997 ..........................          --              (77)          --          (7,326)        (1,018)
 Issuance of shares, net .................................          --             --             --            --            4,072
 Warrants issued for services received and
  bank line of credit ....................................          --             --             --            --              391
 Deferred compensation ...................................          (509)          --             --            --             --
 Amortization of deferred compensation ...................            91           --             --            --               91
 Net loss ................................................          --             --             --          (4,351)        (4,351)
                                                                --------       --------       --------      --------       --------
Balance as of December 31, 1998 ..........................          (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 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 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
                                                                ========       ========       ========      ========       ========

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



<PAGE>



<TABLE>
                                                       COMMTOUCH SOFTWARE LTD.

                                                CONSOLIDATED STATEMENTS OF CASH FLOWS
                                                           (In thousands)



<CAPTION>
                                                                                                     Year Ended
                                                                                                    December 31,
                                                                                    -----------------------------------------------
                                                                                      1997               1998                1999
                                                                                    ---------          ---------          ---------
<S>                                                                                 <C>                <C>                <C>       
Cash flows from operating activities:
   Net loss ...............................................................         $  (3,473)         $  (4,351)         $ (19,851)
   Adjustments to reconcile net loss to net cash used in
    operating activities:
      Depreciation and amortization .......................................               206                236              1,706
      Amortization of stock-based employee deferred
       compensation and warrants issued for service
       received and bank line of credit ...................................                46                482              3,796
      Decrease (increase) in trade receivables, net .......................               738                (84)            (2,245)
      Amortization of prepaid marketing expenses ..........................              --                 --                3,263
      Decrease (increase) in prepaid expenses and other
       accounts receivable ................................................                14               (164)            (1,028)
      Increase in accounts payable ........................................                99                 91              1,064
      Increase (decrease) in employee and payroll accruals
       and other liabilities ..............................................              (147)               128              1,645
      Increase in deferred revenues .......................................              --                   74                487
      Increase (decrease) in accrued severance pay, net ...................               (54)                19                (44)
      Other ...............................................................              --                 --                   (9)
                                                                                    ---------          ---------          ---------
Net cash used in operating activities .....................................            (2,571)            (3,569)           (11,216)
                                                                                    ---------          ---------          ---------
Cash flows from investing activities:
Purchase of available-for-sale marketable
 securities ...............................................................              --                 --              (17,987)
   Long-term lease deposits ...............................................              --                 --               (1,254)
   Advance to related party ...............................................              --                 --                 (364)
   Proceeds from sale of property and equipment ...........................              --                 --                   13
   Purchase of property and equipment .....................................               (93)              (442)            (6,938)
                                                                                    ---------          ---------          ---------
Net cash used in investing activities .....................................               (93)              (442)           (26,530)
                                                                                    ---------          ---------          ---------
Cash flows from financing activities:
   Short-term bank credit, net ............................................               733                595             (1,328)
   Repayment of note receivable by shareholder ............................              --                 --                   54
   Principal payment of capital lease .....................................               (67)              (146)              (112)
   Proceeds from issuance of shares, net ..................................             1,632              4,072            104,294
                                                                                    ---------          ---------          ---------
Net cash provided by financing activities .................................             2,298              4,521            102,908
                                                                                    ---------          ---------          ---------
Increase (decrease) in cash and cash equivalents ..........................              (366)               510             65,162
Cash and cash equivalents at the beginning of the year ....................               690                324                834
                                                                                    ---------          ---------          ---------
Cash and cash equivalents at the end of the year ..........................         $     324          $     834          $  65,996
                                                                                    =========          =========          =========
Supplemental disclosure of cash flows activity:
   Cash paid during the year:
   Interest ...............................................................         $      48          $      97          $     117
                                                                                    =========          =========          =========
Supplemental disclosure of non-cash activity:
   Capital lease obligations ..............................................         $    --            $     328          $    --
                                                                                    =========          =========          =========
   Ordinary shares issued for notes receivable from
    shareholders ..........................................................         $    --            $    --            $   1,037
                                                                                    =========          =========          =========
   Issuance of Warrants for Prepaid Marketing Expenses ....................         $    --            $    --            $   7,771
                                                                                    =========          =========          =========
<FN>
                       The accompanying notes are an integral part of these consolidated financial statements.
</FN>
</TABLE>




<PAGE>


                             COMMTOUCH SOFTWARE LTD.

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


NOTE 1: GENERAL

Commtouch  Software Ltd. (the "Company" or "Commtouch") was  incorporated  under
the laws of  Israel  in 1991.  The  Company,  together  with its  United  States
subsidiary,  Commtouch  Software Inc.,  ("CSI") a California  corporation,  is a
provider of Web-based  email and  communications  solutions to customers  who in
turn offer those solutions to their end-users.  From inception through 1997, the
Company  generated  revenues  primarily  from sale,  maintenance  and service of
stand-alone  email  client  software  products for both  mainframe  and personal
computers.  From 1998, the Company began to generate revenues by providing email
services to its  customers.  Email service  revenues are derived from  contracts
that  provide for either a share of  advertising  revenues  subject to a minimum
annual  revenue  commitment or a monthly  per-email box fee, and fees for direct





marketing and communications services. In November 1999, the Company established
a  wholly-owned  subsidiary  in England,  Commtouch  Software (UK) Ltd. (the "UK
company"). The UK company had not yet commenced operations.

During  1999,  approximately  11% of the  revenues  were  derived  from a single
customer.  During  1998,  approximately  54% of the  revenues  were derived from
another single customer.


NOTE 2: SIGNIFICANT ACCOUNTING POLICIES

The  consolidated  financial  statements  have been prepared in accordance  with
generally accepted accounting principles 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 Denominated in United States Dollars:

Most of the Company's  revenues are  denominated  in United States  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  remeasured  using the foreign  exchange rate at the balance
sheet date.  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 remeasurement are reported in current operations.

c. Principles of Consolidation:

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

d. Cash Equivalents and Marketable Securities:

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  ("SFAS")  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 shareholders'  equity, as items of other
comprehensive income.

e. Prepaid Marketing Expenses:

The Company recorded prepaid marketing expenses,  representing the fair value of
warrants  which have been issued to Go2Net 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




<PAGE>


over the minimum term of the agreements (twelve months).

In 1999, operating expenses included  amortization of prepaid marketing expenses
amounting to $3.3 million.

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
sixteen 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. As of
December 31, 1999, no impairment losses have been identified.

g. Research and Development:

Research and  development  costs are charged to the  statement of  operations as
incurred.  Statement of Financial  Accounting Standards Board 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 does 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,  the Company has charged all  software  development  costs to research and
development expense in the period incurred.

h. Revenue Recognition:

Since 1998, the Company has derived its revenues from providing  Web-based email
services.  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  billed or  received  in advance of service  delivery  are  recorded  as
deferred revenues.

Revenues from software products sales that occurred through 1997 were recognized
upon delivery of the software master for reproduction and distribution  provided
no  significant  vendor  obligations  remained,  and  collection  of the related
receivable was probable in accordance with Statement of Position 91-1.

i. 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,  when  expenses  under  such  approved  projects  are
incurred. Development grants amounted to $288 in 1997 and none in 1998 and 1999.

j. Concentrations of Credit Risk:

Financial  instruments that potentially subject the Company to concentrations of




<PAGE>


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 Israel and in the United  States.  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, 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
none and  $405,000 at December  31, 1998 and 1999,  respectively.  In 1997,  the
Company wrote off approximately  $170,000 of trade receivables that were derived
from revenues recognized in 1996.

k. 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",  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 No. 123.

In accounting for warrants  granted to those other than  employees,  the Company
applied  the   provisions  of  SFAS  No.  123,   "Accounting   for   Stock-Based
Compensation"  and Emerging  Issues Task Force  ("EITF") 96-18  "Accounting  for
Equity  Instruments  That Are Issued to other  than  Employees  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.

l. Basic and Diluted Net Loss Per Share:

Basic and diluted net loss per share are presented in  accordance  with SFAS No.
128, "Earnings per Share" ("SFAS 128"), for all periods presented.

Basic net loss per share has been computed using the weighted-average  number of
ordinary  shares  outstanding  during the period.  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.

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 antidilutive for all periods presented.  The total number of
shares  related  to the  outstanding  options  and  warrants  excluded  from the
calculations of diluted net loss per share were 911,680, 1,236,100 and 2,497,470
for 1997, 1998 and 1999, respectively.

m. 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 funds 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.




<PAGE>


The value of the deposited  funds is based on the cash surrender  value of these
policies, and includes immaterial profits.

Severance expenses for 1997, 1998 and 1999 were approximately  $73,000,  $62,000
and $129,000, respectively.

n. Fair Value of Financial Instruments:

The carrying amounts of cash and cash equivalents,  marketable securities, trade
receivables  and  accounts  payable,  approximate  their fair  values due to the
short-term maturities of these instruments.

The fair value of long term  deposits  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, 1999.

o. Future Adoption of New Accounting Standards:

In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement
No. 133 "Accounting for Derivative  Instruments and Hedging  Activities"  ("SFAS
No.  133").  This  statement  establishes  accounting  and  reporting  standards
requiring  that  every  derivative   instrument  (including  certain  derivative
instruments  embedded in other  contracts)  be recorded in the balance  sheet as
either an asset or  liability  measured at its fair value.  The  statement  also
requires that changes in the derivative's fair value be recognized  currently in
earnings unless specific hedge accounting  criteria are met. Special  accounting
for qualifying  hedges allows a derivative's  gains and losses to offset related
results on the hedged item in the income statement,  and requires that a company
must formally document,  designate, and assess the effectiveness of transactions
that receive hedge accounting.

The FASB has issued SFAS No. 137,  "Accounting  for Derivative  Instruments  and
Hedging  Activities--Deferral  of the Effective Date of FASB Statement No. 133".
The Statement  defers for one year the effective  date of SFAS No. 133. The rule
will apply to all fiscal  quarters of all fiscal years  beginning after June 15,
2000.  The  Company  does not  expect the  impact of this new  statement  on the
consolidated financial statements to be material.


NOTE 3: MARKETABLE SECURITIES

                                                                  December 31,
                                                                     1999
                                                                    -------
Marketable securities are as follows (in thousands):
Commercial papers .........................................         $ 2,230
Government securities .....................................           9,918
Corporate debt securities .................................           5,902
                                                                    -------

                                                                    $18,050
                                                                    =======


During 1999, the unrealized  gross holding gains on marketable  securities  were
$80,000, while the unrealized gross holding losses were $17,000.


NOTE 4: PROPERTY AND EQUIPMENT

                                                                December 31,
                                                           ---------------------
                                                            1998           1999
                                                           ------         ------
Property and equipment are as follows (in thousands):




<PAGE>


Computers and peripheral equipment ...............         $1,260         $7,704
Office furniture and equipment ...................             90            232
Motor vehicles ...................................            118            135
Leasehold improvements ...........................            137            454
                                                           ------         ------
                                                            1,605          8,525
Less accumulated depreciation ....................            673          2,377
                                                           ------         ------
                                                           $  932         $6,148
                                                           ======         ======


Computers  and  peripheral  equipment  under various  capital  lease  agreements
amounted to  approximately  $328,000  and  $328,000 as of December  31, 1998 and
1999, respectively, and their accumulated depreciation amounted to approximately
$38,000 and $185,000 as of December 31, 1998 and 1999, respectively.

Depreciation   expenses  amounted  to  approximately   $145,000,   $236,000  and
$1,706,000 for 1997, 1998 and 1999, respectively.


NOTE 5: CAPITAL LEASES

During 1998, CSI leased computers and peripheral equipment under various capital
lease  agreements,  with an option to purchase the equipment upon the expiration
of the initial  lease term,  for the fair market value  prevailing at that time,
not to exceed 10% of the original  cost of the  equipment.  The annual  interest
rate of such capital leases ranges between 19.5% and 23%.


NOTE 6: COMMITMENTS AND CONTINGENT LIABILITIES

Operating Leases:

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

                  2000 ............................. $  2,251
                  2001 .............................    2,803
                  2002 .............................    2,889
                  2003 .............................    2,782
                  2004 .............................    2,770
                  Thereafter .......................    6,168
                                                     --------
                                                     $ 19,663
                                                     ========

Rent expenses for 1997, 1998 and 1999 were  approximately  $55,000,  $56,000 and
$578,000,  respectively.  In  connection  with the lease  agreement on an office
building,  CSI deposited  $1.3 million in long term lease deposits of which $1.1
million was held as collateral.

Royalties:

The  Company is required to pay royalties on grants received from the Government
of Israel for research and  development  projects at the rate of 3%--5% of total
revenues,  up to an amount equal to 100% to 150% of the original amount received
linked to the dollar.

As of December 31, 1999, the Company had an outstanding contingent obligation to
pay royalties in the aggregate amount of $275,000.




<PAGE>


NOTE 7: INCOME TAXES

Israeli Income Tax

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

The Company's  first program was approved in 1995. The Company's  second program
received  a  letter  of  approval  in  April  1996  and  an  application  for an
enlargement was submitted in February 2000 and has not yet been approved.

In February  2000 the Company  submitted an  application  for another  expansion
(third program).

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"  in is  period  of  benefit
mentioned above is taxed at the regular rate of 36%.

Distribution  of cash  dividends  from  income  that was tax  exempt  due to the
"approved enterprise" status are subject to a tax of 10%-25%. In addition, these
dividends will 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 Company's Board of Directors has determined that such tax exempt income will
not be  distributed as dividends.  The Company is 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 claim public issuance expenses.

As of December 31, 1999,  Israeli net operating loss  carryforwards  amounted to
approximately  $22.5  million.  Such net operating  loss may be carried  forward
indefinitely and offset against future taxable income.

U.S. Income Tax:

CSI is taxed based upon tax laws in the U.S.

As of December 31, 1999, CSI had a U.S. federal net operating loss  carryforward
of  approximately  $14.2  million.  The net  operating  loss  expires in various
amounts between the years 2008 and 2020.

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:

The Company  expects  that during the period in which its Israeli tax losses are
utilized its Israeli income would be substantially tax exempt. Accordingly there
will be no tax benefit available from such losses and no Israeli deferred income
taxes have been included in these financial statements.




<PAGE>


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,
                                                            -------------------
                                                             1998         1999
                                                            -------     -------
Deferred tax assets are as follows (in thousands):
U.S. operating loss carryforwards ......................    $ 1,656     $ 4,970
Reserves and allowances not currently deductible .......         15          57
                                                            -------     -------
Net deferred tax asset before valuation allowance ......      1,671       5,027
Valuation allowance ....................................     (1,671)     (5,027)
                                                            -------     -------
Net deferred tax asset .................................    $  --       $  --
                                                            =======     =======


For the year ended  December  31,  1999 the  valuation  allowance  increased  by
approximately $3.4 million. No utilization of CSI's tax losses  carryforwards is
expected in the foreseeable future,  because of its history of operating losses.
In 1997, 1998 and 1999, the Company provided a 100% valuation  allowance against
the  deferred  tax assets in respect  of these tax loss  carryforward  and other
temporary differences because of the uncertainty of realizing these deferred tax
assets.

Pretax loss:

Pretax losses are as follows (in thousands):

                                           1997          1998           1999
                                          -------       -------       --------
Israel .................................  $ 1,602       $ 2,497       $ 11,259
U.S. ...................................    1,871         1,854          8,592
                                          -------       -------       --------
                                          $ 3,473       $ 4,351       $ 19,851
                                          =======       =======       ========


NOTE 8: SHAREHOLDERS' EQUITY

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

a. Capital Shares:

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 Go2Net, 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.




<PAGE>


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 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.

The Company recorded  $17,000,  $264,000,  and $360,000 as interest  expenses in
1997, 1998 and 1999,  respectively.  The Company recorded $29,000,  $127,000 and
none in 1997, 1998 and 1999, respectively,  as compensation expense and included
these amounts in operating 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  Go2Net,  a related  party.  Under this  agreement,  the Company
provides email services to the end users of Go2Net'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, 1999,  this  warrant had not been  exercised.  At the
grant date,  the fair value of this warrant was estimated as $5.9 million and is
being  amortized  to  operating  expenses  over the minimum term of the contract
(twelve months).

In October 1999, the Company  entered into a customary  email service  agreement
with Microsoft  Corporation.  Under this agreement,  the Company  delivers email
services to Microsoft Web sites. In connection with this agreement,  the Company
issued a warrant to purchase  707,965  ordinary  shares at an exercise  price of
$28.25 per share.  The warrant was  exercised on December 29, 1999. At the grant
date,  the fair value of this warrant was estimated at $1.9 million and is being
amortized to operating  expenses  over the minimum term of the contract  (twelve
months).

c. Issuance of Ordinary Shares Against Promissory Notes:

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, 1999, approximately 279,584 shares are subject to this right of repurchase.

d. Employee Stock Purchase Plan:

Commtouch  reserved  a total of  150,000  shares  for  issuance  under the plan.
Eligible  employees  may  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.

e. Stock Options:

The Company has reserved  5,000,000  ordinary shares for issuance under employee
stock  option  plans  and  agreements.  Options  granted  under  such  plans and
agreements  expire generally after 10 years from the date of grant and terminate




<PAGE>


upon  termination of the optionee's  employment or other  relationship  with the
Company.  The options generally vest ratably over a 4-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  or in the case of the
subsidiary's  plan it may not be less than fair market  value.  Any options that
are canceled or not exercised  within the options  period  become  available for
future grant.

In 1996, the Company adopted the 1996 CSI Stock Option Plan for granting options
to its U.S.  employees to purchase  ordinary shares of the Company.  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.


<TABLE>
A summary of the company's share option activity under the plans is as follows:


<CAPTION>
                                                                                               Weighted Average
                                                        Number of Shares                        Exercise Price
                                             ----------------------------------------   -------------------------------
                                               1997          1998          1999         1997        1998       1999
                                             ---------     --------     ----------      --------    -------    --------
<S>                                            <C>         <C>            <C>           <C>         <C>        <C>    
Outstanding at beginning of period   ......    457,520     607,040        849,520       $  0.99     $ 1.10     $  1.20
Granted   .................................    213,820     251,900      1,342,670          1.45       1.45       10.13
 Exercised   ..............................        --          --        (740,040)          --         --         1.42
 Canceled    ..............................    (64,300)     (9,420)       (69,040)         1.45       1.45        4.49
                                             ---------     --------     ----------      --------    -------    --------
Outstanding at end of period   ............    607,040     849,520      1,383,110          1.10       1.20        9.62
                                             =========     ========     ==========      ========    =======    ========
Exercisable at end of period   ............    165,480     375,580        381,315          1.45       1.45        3.50
                                             =========     ========     ==========      ========    =======    ========
Deemed fair value of options granted
 at an exercise price of:
 -- Less than fair market value at
   date of grant   ........................  $     --      $  2.46      $    3.65
                                             =========     ========     ==========
 -- Equals to fair market value at
   date of grant   ........................  $    0.61     $   --       $   15.75
                                             =========     ========     ==========
 -- Exceeds fair market value at
   date of grant   ........................  $     --      $   --       $     --
                                             =========     ========     ==========
</TABLE>




<TABLE>
The options outstanding as of December 31, 1999, have been separated into ranges
of exercise price, as follows:

<CAPTION>
                        Options              Weighted                                   Options          Weighted Average
                   Outstanding as of         Average              Weighted         Exercisable as of         Price of
                     December 31,           Remaining         Average Exercise       December 31,          Exercisable
Exercise Price           1999            Contractual Life          Price                 1999                Options
----------------   -------------------   ------------------   ------------------   -------------------   ------------------
<S>                     <C>                    <C>                  <C>                  <C>                   <C>
  $ 0.55-$ 2.50           660,760              8.23                 $ 1.52               320,282               $ 1.42
  $11.00-$15.75           522,500              9.56                 $14.13                61,033               $14.43
  $16.06-$48.56           199,850              9.84                 $24.65                   --                   --
                   -------------------   ------------------   ------------------   -------------------   ------------------
  $ 0.55-$48.56         1,383,110              8.96                 $ 9.62               381,315               $ 3.50
                   ===================   ==================   ==================   ===================   ==================
</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




<PAGE>


assumptions for 1997, 1998 and 1999: risk-free interest rates of 6% for 1997 and
1998 and  5.5% for  1999,  dividend  yields  of 0%,  volatility  factors  of the
expected market price of the Company's ordinary shares of 0.5 for 1997, 1998 and
0.5 - 0.56 for 1999 and an  expected  life of the  option of 6 months  after the
option is vested.

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.


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

<CAPTION>
                                                    1997         1998        1999
                                                 ---------    ---------    -------- 
<S>                                              <C>          <C>          <C>      
Net loss as reported .........................   $  (3,473)   $  (4,351)   $(19,851)
                                                 =========    =========    ========
Pro forma net loss ...........................   $  (3,600)   $  (4,402)   $(20,224)
                                                 =========    =========    ========
Pro forma basic and diluted net loss per share   $   (2.48)   $   (3.04)   $  (2.70)
                                                 =========    =========    ========
</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  based on an  accelerated
vesting method over the vesting period of the options, generally 4 years.


Deferred compensation is as follows (in thousands):
Balance as of January 1, 1999 .....................................     $   418
Deferred compensation related to options issued to employees ......       8,797
Less amortization of deferred compensation ........................      (3,436)
                                                                        -------
Balance as of December 31, 1999 ...................................     $ 5,779
                                                                        =======

f. Non-Employee Directors Stock Option Plan:

The Company adopted the 1999 Non-Employee Directors Stock Option Plan. Commtouch
reserved a total of 250,000 shares for issuance under this plan. Each individual
who first joined the Board of Directors  as a  nonemployee  director on or after
the effective date of the initial public  offering  received an option grant for
10,000 ordinary  shares.  Each option granted under the  Non-Employee  Directors
Plan would 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.  Each option has an exercise price equal to the fair market value of
the ordinary shares on the grant date of such option.  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  1999,  the Company  granted  60,000  shares to  directors  at a weighted
average  exercise  price of $15.83 per share.  As of December 31,  1999,  25,000
shares were exercisable and 60,000 shares were outstanding.




<PAGE>


NOTE 9: RELATED PARTY TRANSACTION

Other  accounts  receivables  includes  an  advance  to a  related  party of the
Company.  In October 1999,  the Company  advanced  $364,000 to an officer who is
also a director.  The loan is linked to the Israeli Consumer Price Index, plus a
2% interest rate. The loan was fully repaid on February 10, 2000.


NOTE 10: SELECTED STATEMENTS OF OPERATIONS DATA

Geographic information:

The  Company  conducts  its  business  on the basis of one  reportable  segment.
Revenues from external customers (in thousands):

                                                        Revenues
                                        ----------------------------------------
                                         1997             1998             1999
                                        ------           ------           ------
Israel ......................           $    1           $ --             $  369
U.S.A .......................              543              109            3,056
Europe ......................               28              130              344
Japan .......................              282              103              250
Other .......................               45               47              232
                                        ------           ------           ------
                                        $  899           $  389           $4,251
                                        ======           ======           ======

The  Company's  long-lived  assets  as  of  December  31,  are  as  follows  (in
thousands):

                                                      1998                 1999
                                                     ------               ------
Israel ...............................               $  291               $  789
U.S.A ................................                  641                5,359
                                                     ------               ------
                                                     $  932               $6,148
                                                     ======               ======



<TABLE>
                                                       COMMTOUCH SOFTWARE LTD.

 
                                         SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
                                                      U.S. Dollars in thousands

<CAPTION>
                                                                 Balance at
                                                                     the            Charged to                          Balance at
                                                                 beginning of        costs and                          end of the
                                                                  the period         expenses         Deductions          period
                                                                  ----------         --------         ----------          ------
<S>                                                                    <C>              <C>               <C>               <C>
Year ended December 31, 1997:
 Bad debt ...................................................          --               170               170               --
                                                                       ==               ===               ===               ===
Year ended December 31, 1998:
 Bad debt ...................................................          --               --                --                --
                                                                       ==               ===               ===               ===
Year ended December 31, 1999:
 Bad debt ...................................................          --               405               --                405
                                                                       ==               ===               ===               ===
</TABLE>



<PAGE>


                         CONSENT OF INDEPENDENT AUDITORS

We consent to the  incorporation by reference in the  Registration  Statement on
Form S-8  (333-94995)  pertaining  to the 1996 CSI Stock Option  Plan,  the 1999
Section 3(i) Share Option Plan,  the 1999 Employee  Stock  Purchase Plan and the
1999 Nonemployee  Directors Stock Option Plan of Commtouch  Software Ltd. of our
report  dated  January  31,  2000 with  respect  to the  consolidated  financial
statements and schedule of Commtouch Software Ltd. included in its Annual Report
on Form 20-F for the year ended December 31, 1999, filed with the Securities and
Exchange Commission.


Tel-Aviv, Israel
June 19, 2000


KOST, FORER & GABBAY
A member of Ernst & Young international



                                   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/ JAMES E. COLLINS
                                             -----------------------------------
                                                         James E. Collins
                                                     Chief Financial Officer
June 19, 2000