# SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 _______________
## FORM 20-F
(Mark One)
( ) REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES EXCHANGE ACT
OF 1934
## OR
(X) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2003
**OR**
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission file number 0-28584
CHECK POINT SOFTWARE TECHNOLOGIES LTD.
(Exact name of Registrant as specified in its charter)
| ISRAEL | |
| --- | --- |
| (Jurisdiction of incorporation or organization) | |
| 3A Jabotinsky Street, Ramat-Gan 52520, Israel | |
| (Address of principal executive offices) | |
Securities registered or to be registered pursuant to Section 12(b) of the Act: None
Securities registered or to be registered pursuant to Section 12(g) of the Act: Ordinary shares, NIS 0.01 nominal value
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: 249,276,058 ordinary shares, NIS 0.01 nominal value.
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
---
## TABLE OF CONTENTS
## PART I
Item 1. Identity of Directors, Senior Management and Advisors ........................................................................................ 3
Item 2. Offer Statistics and Expected Timetable .................................................................................................................. 3
Item 3. Key Information........................................................................................................................................................ 3
Item 4. Information on the Company.................................................................................................................................... 9
Item 5. Operating and Financial Review and Prospects....................................................................................................... 19
Item 6. Directors, Senior Management and Employees ....................................................................................................... 26
Item 7. Major Shareholders and Related Party Transactions ............................................................................................... 31
Item 8. Financial Information................................................................................................................................................ 31
Item 9. The Offer and Listing ............................................................................................................................................... 32
Item 10. Additional Information ............................................................................................................................................. 32
Item 11. Quantitative and Qualitative Disclosures about Market Risk.................................................................................. 40
Item 12. Description of Securities Other than Equity Securities............................................................................................ 42
## PART II
Item 13. Defaults, Dividend Arrearages and Delinquencies .................................................................................................. 43
Item 14. Material Modifications to the Rights of Security Holders and Use of Proceeds..................................................... 43
Item 15. Controls and Procedures ........................................................................................................................................... 43
Item 16. Reserved.................................................................................................................................................................... 43
Item 16A. Audit Committee Financial Expert........................................................................................................................... 43
Item 16B. Code of Ethics........................................................................................................................................................... 43
Item 16C. Principal Accounting Fees and Services .................................................................................................................. 44
## PART III
Item 17. Financial Statements ................................................................................................................................................. 45
Item 18. Financial Statements ................................................................................................................................................. 45
Item 19. Exhibits ..................................................................................................................................................................... 45
---
## ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS
Not applicable.
## ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE
Not applicable.
## ITEM 3. KEY INFORMATION
The following selected consolidated statement of income data for the years ended December 31, 2001, 2002 and 2003,
and the selected consolidated balance sheet data as of December 31, 2002 and 2003, have been derived from the audited
consolidated financial statements of Check Point Software Technologies Ltd. (together with its subsidiaries, the “Company” or
“Check Point”) set forth elsewhere in this Form 20-F. These financial statements have been prepared in accordance with
generally accepted accounting principles in the United States (“U.S. GAAP”). The selected consolidated statement of income data
for the years ended December 31, 1999 and 2000 and the selected consolidated balance sheet data as of December 31, 1999, 2000 and
2001 have been derived from the Company’s audited consolidated financial statements not included in this Form 20-F and have
also been prepared in accordance with U.S. GAAP. The selected consolidated financial statements set forth below should be read
in conjunction with and are qualified by reference to the Company’s consolidated financial statements and the related notes as
well as “Item 5 - Operating and Financial Review and Prospects” included elsewhere in this Form 20-F.
On December 20, 1999, the Company’s Board of Directors approved a two-for-one stock split in the form of a stock
dividend effective January 23, 2000. On June 29, 2000 the Company’s Board of Directors approved a two-for-one stock split in the
form of a stock dividend effective July 14, 2000. On January 18, 2001, the Company’s Board of Directors approved a three-for-two
stock split in the form of a stock dividend effective February 1, 2001. All share and per share numbers herein reflect adjustments
resulting from these stock splits.
| | Year Ended December 31, | | | | |
| --- | --- | --- | --- | --- | --- |
| | 1999 | 2000 | 2001 | 2002 | 2003 |
| | (in thousands, except share data) | | | | |
| Consolidated Statement of Income Data: | | | | | |
| Revenues | $219,567 | $425,283 | $527,643 | $426,989 | $432,572 |
| Operating expenses: | | | | | |
| Cost of revenues | 22,423 | 35,265 | 26,571 | 20,693 | 18,923 |
| Research and development | 18,923 | 30,309 | 33,221 | 28,709 | 29,314 |
| Selling and marketing | 68,229 | 110,003 | 109,086 | 104,606 | 111,007 |
| General and administrative | 13,069 | 20,409 | 22,002 | 17,969 | 17,644 |
| Total operating expenses | 122,644 | 195,986 | 190,880 | 171,977 | 176,888 |
| Operating income | 96,923 | 229,297 | 336,763 | 255,012 | 255,684 |
| Financial income, net | 12,962 | 29,147 | 44,760 | 49,314 | 43,506 |
| Income before taxes on income | 109,885 | 258,444 | 381,523 | 304,326 | 299,190 |
| Taxes on income | 14,104 | 37,231 | 59,603 | 49,246 | 55,311 |
| Net Income | $95,781 | $221,213 | $321,920 | $255,080 | $243,879 |
| Basic net earnings per share(1) | $0.43 | $0.95 | $1.34 | $1.04 | $0.98 |
| Shares used in computing basic net earnings per share(1) | 222,930 | 232,611 | 240,008 | 244,097 | 247,691 |
| Diluted net earnings per share(1) | $0.39 | $0.84 | $1.25 | $1.00 | $0.96 |
| Shares used in computing diluted net earnings per share(1) | 246,456 | 262,515 | 258,075 | 254,772 | 255,083 |
(1) See Note 2p of Notes to the Consolidated Financial Statements for an explanation of the determination of shares used in
computing net earnings per share.
---
| | December 31, | | | | |
| --- | --- | --- | --- | --- | --- |
| | 1999 | 2000 | 2001(in thousands) | 2002 | 2003 |
| Consolidated Balance Sheet Data: | | | | | |
| Working capital | $198,204 | $313,218 | $355,032 | $643,318 | $983,533 |
| Total assets | 394,346 | 777,639 | 1,145,665 | 1,425,611 | 1,713,665 |
| Shareholders' equity | 292,508 | 549,283 | 915,728 | 1,187,042 | 1,461,545 |
## RISK FACTORS
This Form 20-F contains forward-looking statements that involve risks and uncertainties. The statements contained in this
Form 20-F that are not purely historical are forward-looking statements within the meaning of Section 21E of the Securities
Exchange Act of 1934, as amended (the “Exchange Act”), including, without limitation, statements regarding the Company’s
expectations, beliefs, intentions, goals, plans, investments or strategies regarding the future and any assumptions underlying any of
the foregoing. Forward-looking statements include, among other, statements in (i) “Item 4 – Information on the Company” regarding
the Company’s belief as to increased acceptance of Internet technologies, expansion of connectivity services, acceleration of the use
of networks, increasing demands on enterprise security systems, the impact of the Company’s relationship with technology partners
on its sales goals, the contribution of the Company’s network security products to the Company’s future revenue and the
development of future products and (ii) “Item 5 - Operating and Financial Review and Prospects” regarding, among other things,
charges that may be taken in connection with the acquisition of Zone Labs future amounts and sources of revenue, ongoing
relationships with current and future end-user customers and distributors, future costs and expenses, and adequacy of capital
resources. Forward-looking statements involve risks and uncertainties, as well as assumptions that, if they never materialize or prove
incorrect, could cause the Company’s actual results to differ materially from such results discussed in these statements. Many of
these risks and uncertainties are described in the risk factors set forth below in this section and elsewhere in this Form 20-F. All
forward-looking statements included in this document are based on information available to the Company on the date hereof, and the
Company assumes no obligation to update any such forward-looking statements.
## Risks Relating to Recent Acquisition of Zone Labs
In March 2004 we completed the acquisition of Zone Labs, Inc. (“Zone Labs”). The acquisition of Zone Labs involves the
integration of two companies that have previously operated independently. The difficulties of combining the companies’
operations include but are not limited to: the necessity of coordinating geographically separated organizations and integrating
personnel with diverse business backgrounds, potential difficulties to retain employees, adverse effects on relationships with
existing partners, etc. The process of integrating operations could cause an interruption of, or loss of momentum in, the activities
of one or more of the combined company’s businesses and the loss of key personnel. The diversion of management’s attention
and any delays or difficulties encountered in connection with the proposed acquisition and the integration of the two companies’
operations could have an adverse effect on the business, results of operations, financial condition or prospects of the Company
after the acquisition.
In addition, the Company expects to incur material charges, estimated to be between $70 million and $100 million, in
connection with the recent acquisition of Zone Labs in 2004, mainly related to the write-off of in-process research and
development, amortization of intangible assets and deferred compensation expenses related to non-vested employee stock options
assumed by the Company.
The recent acquisition may have a dilutive effect on the Company’s earnings per share due to the additional 8.1 shares
that will be issued as part of the acquisition, including 2.8 shares that may be issued in connection with the assumption of Zone
Labs’ options.
## Competition
The market for Internet security and Virtual Private Networking (VPN) products and services is intensely competitive
and the Company expects competition to increase in the future. The Company’s principal Internet security competitors include
Cisco Systems, Inc., Internet Security Systems (ISS), Microsoft Corporation, NetScreen Technologies Inc., Network Associates
Inc., Nortel Networks Limited, Secure Computing Corporation, SonicWALL Inc., Symantec Inc. and WatchGuard Technologies
Inc.
Some of the Company’s current and potential competitors have longer operating histories, greater name recognition,
access to larger customer bases and significantly greater financial, technical and marketing resources than the Company’s. As a
result, they may be able to adapt more quickly to new or emerging technologies and changes in customer requirements or to
devote greater resources to the promotion and sale of their products than the Company. In addition, the Company believes that
there may be increasing consolidation in the Internet security market that may result in the introduction of combined or bundled
products at lower prices than the prices of the Company’s products. These consolidations, together with other strategic alliances
among other industry participants, may also result in loss of market share. There can be no assurance that the Company will be
able to compete successfully against current and future competitors. Increased competition may result in price reductions,
4 reduced gross margins and loss of market share, any of which will materially adversely affect the Company’s business, operating
results and financial condition.
Vendors of operating system software or networking hardware may enhance their products to include functionality that is
currently provided by the Company’s products. The widespread inclusion of the functionality of the Company’s software as
standard features of operating system software or networking hardware could render the Company’s products obsolete and
unmarketable, particularly if the quality of such functionality were comparable to that of the Company’s products. Furthermore,
even if the network security functionality provided as standard features by operating systems software or networking hardware is
more limited than that of the Company’s VPN-1/FireWall-1 software, there can be no assurance that a significant number of
customers would not elect to accept more limited functionality in lieu of purchasing additional software. In the event of any of the
foregoing, the Company’s business, operating results and financial condition will be materially and adversely affected. See “Item
4 – Information on the Company.”
## Rapid Technological Change
The Internet security and VPN industry is characterized by rapid technological advances, changes in customer
requirements, frequent new product introductions and enhancements and evolving industry standards in computer hardware and
software technology. As a result, the Company must continually change and improve its products in response to changes in
operating systems, application software, computer and communications hardware, networking software, programming tools and
computer language technology. The introduction of products embodying new technologies and the emergence of new industry
standards may render existing products obsolete or unmarketable. In particular, the market for Internet and intranet applications is
relatively new and is rapidly evolving. The Company’s future operating results will depend upon the Company’s ability to
enhance its current products and to develop and introduce new products on a timely basis that address the increasingly
sophisticated needs of its end-users and that keep pace with technological developments, new competitive product offerings and
emerging industry standards. While the Company has been successful in developing and marketing new products or product
enhancements that respond to technological change and evolving industry standards, there can be no assurance that the Company
will continue to do so, or that the Company will not experience difficulties that could delay or prevent the successful development,
introduction and marketing of these products, or that any new products and product enhancements will adequately meet the
requirements of the marketplace and achieve market acceptance. If the Company does not respond adequately to the need to
develop and introduce new products or enhancements of existing products in a timely manner in response to changing market
conditions or customer requirements, the Company’s business, operating results and financial condition will be materially
adversely affected. See “Item 4 – Information on the Company.”
## Potential Fluctuations in Future Operating Results
The quarterly operating results of the Company can vary significantly due to several factors, including the occurrence of
Internet security breaches or threats, regional or global prevailing economic and political conditions, seasonal trends in customer
purchasing, the volume and timing of orders and the ability to fulfill orders, the level of product and price competition, the
Company’s ability to develop new and enhanced products and control costs, the mix of products and goods sold, the mix of
distribution channels through which products are sold, the Company’s ability to integrate the technology and operations of
acquired businesses with those of the Company, changes in customer capital spending budgets, fluctuations in foreign currency
exchange rates and general economic factors.
The Company’s sales to Asia and the Pacific Rim (including Japan) were $93 million in 2001, $69 million in 2002 and
$71 million in 2003, representing 17%, 16% and 16% of the Company’s revenues for 2001, 2002 and 2003, respectively. The
economy in this region is still unstable and therefore the Company cannot predict if similar levels of sales in the region are
sustainable.
The Company’s revenues are subject to seasonal fluctuations related to the slowdown in spending activities for the
quarter ending September 30 and the increased activity related to the year-end purchasing cycles of many end-users of the
Company’s products. The Company believes that it will continue to encounter quarter-to-quarter seasonality that could result in
proportionately lower sales in the quarters ending September 30 and March 31 relative to sales in the quarters ending June 30 and
December 31.
The Company operates with virtually no backlog and, therefore, the timing and volume of orders within a given period
and the ability to fulfill such orders determines the amount of revenues within a given period. The Company’s sales are
principally derived through indirect channels, which make revenues from such sales difficult to predict. Furthermore, the
Company’s expense levels are based, in part, on expectations as to future revenues. If revenue levels are below expectations,
operating results are likely to be adversely affected, since most of the Company’s expenses are not variable. As a result, the
Company believes that period-to-period comparisons of its results of operations are not necessarily meaningful and should not be
relied upon as indications of future performance. If the Company’s operating results were below the expectations of public
market analysts and investors, the price of the Company’s ordinary shares would likely be materially adversely affected. See
“Item 5- Operating and Financial Review and Prospects.”
---
## Potential Decline in Operating Margins
The Company may experience a decline in operating margins due to the following reasons: the integration of Zone Labs,
including estimated charges of $70 million to $100 million for in-process research and development, amortization of intangible assets
and deferred compensation expense; increasing competition and pricing pressure; additional investments in the continuing
development and expansion of the Company’s sales and marketing organization, including the expansion of its field organization
both in the United States and additional countries in Europe, Asia, and Latin America; additional expansion of the research and
development organization and the expected growth in revenues derived from products incorporating hardware. As a result, operating
margins may decrease from historical levels. The amount and timing of the abovementioned additional expenses are likely to result
in fluctuations in operating margins. See “Item 5 - Operating and Financial Review and Prospects.”
## Risks Associated With Emerging Network Security, Internet and Intranet Markets
The markets for the Company’s products are rapidly evolving. There can be no assurance that the market for Internet
security solutions will continue to expand. Continued growth of this market will depend, in large part, upon the continued
expansion of Internet usage and the number of organizations adopting or expanding intranets, upon the ability of their respective
infrastructures to support an increasing number of users and services, and upon the continued development of new and improved
services for implementation across the Internet, and between the Internet and intranets. If the necessary infrastructure or
complementary products and services are not developed in a timely manner and, consequently, the enterprise security, Internet and
intranet markets fail to grow or grow more slowly than the Company currently anticipates, the Company’s business, operating
results and financial condition will be materially adversely affected. See “Item 4 – Information on the Company.”
## Dependence upon Limited Number of Key Distributors and Resellers; Product Concentration; Impact of New Product Introductions
In 2003, sales to the Company’s five largest distributors accounted for approximately 35% of the Company’s revenues. The
Company expects that it will continue to be dependent upon a limited number of distributors for a significant portion of its revenues.
If anticipated orders from these resellers fail to materialize, the Company’s business, operating results and financial condition will be
materially adversely affected.
The Company has derived most of its revenues, and expects to continue to derive the vast majority of its revenues in the
foreseeable future, from sales of its Internet security products, packaged and marketed mostly under the VPN-1 brand, including
related software subscriptions, support and technical services and training programs. The Company’s future financial
performance will depend in significant part on the successful development, introduction, marketing and customer acceptance of
new products and enhancements and new features for its existing product lines. See “Item 4 – Information on the Company” and
“Item 5 - “Operating and Financial Review and Prospects.”
## Dependence upon Key Personnel
The Company’s future performance depends, in significant part, upon the continued service of its key technical, sales and
management personnel, including Gil Shwed, Marius Nacht and Jerry Ungerman. The loss of the services of one or more of the
Company’s key personnel could have a material adverse effect on the Company’s business, operating results and financial
condition. The Company’s future success also depends on its continuing ability to attract and retain highly qualified technical,
sales and managerial personnel. Competition for such personnel is significant, and there can be no assurance that the Company
can retain its key technical, sales and managerial employees or that it can attract, motivate or retain other highly qualified
technical, sales and managerial personnel in the future. If the Company cannot retain or is unable to hire such key personnel, the
Company’s business, operating results and financial condition will be materially adversely affected. See “Item 4 – Information on
the Company.”
## Risk of Litigation
The Company has been a party to various lawsuits and other legal proceedings in the normal course of its business. In
addition, the Company has received a number of class action complaints alleging violations of the federal securities laws. See
“Item 8 – Financial Information.” Legal proceedings can be expensive, lengthy and disruptive to normal business operations,
regardless of their merit. Moreover, the results of complex legal proceedings are difficult to predict and an unfavorable resolution
of a lawsuit or proceeding could have a material adverse effect on the Company’s business, results of operations or financial
condition.
## Principal Operations in Israel
The Company is incorporated under the laws of the State of Israel, and its principal offices and research and development
facilities are located in Israel. Although most of the Company’s sales are currently made to distributors outside Israel, the
Company is nonetheless directly influenced by the political, economic and military conditions affecting Israel. Major hostilities
involving Israel or the interruption or curtailment of trade between Israel and its present trading partners could have a material
adverse effect on the Company’s business, operating results and financial condition. Furthermore, several countries restrict
6 business with Israeli companies. In addition, all nonexempt male adult citizens of Israel, including some of the Company’s
officers and employees, are obligated to perform military reserve duty and are subject to being called for active duty under
emergency circumstances. While the Company has operated effectively under these requirements since its incorporation, the
Company cannot predict the full impact of such conditions on the Company in the future, particularly if emergency circumstances
occur. If many of the Company’s employees are called for active duty, the Company’s operations in Israel and its business may
be adversely affected.
## International Operations
The Company intends to continue to expand its international operations, which will require significant management
attention and financial resources. In order to continue to expand worldwide sales, the Company needs to establish additional
marketing and sales operations, hire additional personnel and recruit additional distributors internationally. To the extent that the
Company is unable to do so effectively, the Company’s growth is likely to be limited and the Company’s business, operating
results and financial condition will be materially adversely affected. In addition, as the Company expands its international
operations, a portion of revenues generated in international jurisdictions may be subject to taxation by such jurisdictions at rates
higher than those to which the Company is subject in Israel. Most of the Company’s worldwide sales are currently denominated
in U.S. dollars. An increase in the value of the U.S. dollar relative to foreign currencies would make the Company’s products
more expensive and, therefore, potentially less competitive in those markets. Additional risks inherent in the Company’s
worldwide business activities generally include unexpected changes in regulatory requirements, tariffs and other trade barriers,
costs of localizing products for foreign countries, lack of acceptance of localized products in foreign countries, longer accounts
receivable payment cycles, difficulties in operations management, potentially adverse tax consequences, including restrictions on
the repatriation of earnings, and the burdens of complying with a wide variety of foreign laws. There can be no assurance that
such factors will not have a material adverse effect on the Company’s future international sales and, consequently, the Company’s
business, operating results and financial condition. See “Item 4 – Information on the Company” and “Item 5 – Operating and
Financial Review and Prospects.”
## Product Liability; Risk of Product Defects
The Company’s sales agreements typically contain provisions designed to limit the Company’s exposure to potential
product liability or related claims. In selling its products, the Company relies primarily on “shrink wrap” licenses that are not
signed by the end-user, and, for this and other reasons, such licenses may be unenforceable under the laws of certain jurisdictions.
As a result, the limitation of the liability provisions contained in the Company’s agreements may not be effective. The
Company’s products are used to manage network security, which may be critical to organizations, and, as a result, the sale and
support of products by the Company may entail the risk of product liability and related claims. A product liability claim brought
against the Company could have a material adverse effect upon the Company’s business, operating results and financial condition.
Software products as complex as those offered by the Company may contain undetected errors or failures when first introduced or
when new versions are released. In particular, the personal computer hardware environment is characterized by a wide variety of
non-standard configurations that make pre-release testing for programming or compatibility errors very difficult and
time-consuming. Despite testing by the Company and by current and potential distributors, there can be no assurance that errors
will not be found in new products or releases after commencement of commercial shipments. The occurrence of these errors
could result in adverse publicity, loss of or delay in market acceptance or claims by distributors against the Company, any of
which could have a material adverse effect upon the Company’s business, operating results and financial condition. See “Item 4 –
Information on the Company.”
## Dependence on Proprietary Technology; Risks of Infringement
The Company relies primarily on a combination of common law copyright and trademark laws, trade secrets,
confidentiality procedures and contractual provisions to protect its proprietary rights as set forth below in the section entitled
“Proprietary Rights” in “Item 4 – Information on the Company.” The Company has certain patents in the U.S. and some other
countries, as well as patent applications pending. There can be no assurance that the Company’s patent applications will be issued
either at all or within the scope of the claims sought by the Company. Furthermore, there can be no assurance that any issued
patent will not be challenged, and if such challenges are brought, that such patents will not be invalidated. In addition, there can
be no assurance that others will not develop technologies that are similar or superior to the Company’s technology or design
around any patents issued to the Company. Despite the Company’s efforts to protect its proprietary rights, unauthorized parties
may copy aspects of the Company’s products or obtain and use information that the Company regards as proprietary. Policing
any of such unauthorized uses of the Company’s products is difficult, and although the Company is unable to determine the extent
to which piracy of its software products exists, software piracy can be expected to be a persistent problem. In addition, the laws of
some foreign countries do not protect the Company’s proprietary rights as fully as do the laws of the United States or Israel.
There can be no assurance that the Company’s efforts to protect its proprietary rights will be adequate or that the Company’s
competitors will not independently develop similar technology.
---
## Approved Enterprise Status
The Company receives significant tax benefits in Israel, particularly as a result of the Approved Enterprise status of the
Company’s facilities and programs. To be eligible for tax benefits, the Company must meet certain conditions, relating
principally to adherence to the investment program filed with the Investment Center of the Israeli Ministry of Industry, Trade and
Labor and to periodic reporting obligations. Although the Company believes that it will be able to meet such conditions in the
future, if the Company fails to meet such conditions it would be subject to corporate tax in Israel at the statutory rate of 36%, and
could be required to refund the tax benefits already received, together with linkage adjustment to the Israeli consumer price index
and interest. The law and regulations prescribing the benefits provide for an expiration date for the grant of new benefits. The
expiration date has been extended several times in the past. The expiration date currently in effect is June 30, 2004 (which may be
extended by ministerial decision until December 31, 2004), and no new benefits will be granted after that date unless the
expiration date is again extended. There can be no assurance that new benefits will be available after June 30, 2004, or that
existing benefits will be continued in the future at their current level or at any level. A termination or reduction of certain
programs and tax benefits (particularly benefits available to the Company as a result of the Approved Enterprise status of the
Company’s facilities and programs) or a requirement to refund the tax benefits already received, would have a material adverse
effect on the Company’s business, operating results and financial condition. See “Item 4 – Information on the Company” and
“Israeli Taxation, Foreign Exchange Regulation and Investment Programs” in “Item 10 – Additional Information.”
## Anti-Takeover Effects of Israeli Laws
Under the Israeli Companies Law, a merger is generally required to be approved by the shareholders and board of directors
of each of the merging companies. Shares held by a party to the merger and certain of its affiliates are not counted toward the
required approval. If the share capital of the company that will not be the surviving company is divided into different classes of
shares, the approval of each class is also required. A merger may not be approved if the surviving company will not be able to satisfy
its obligations. At the request of a creditor, a court may block a merger on this ground. In addition, a merger can be completed only
after all approvals have been submitted to the Israeli Registrar of Companies and 70 days have passed from the time that a proposal
for approval of the merger was filed with the Registrar.
The Israeli Companies Law provides that an acquisition of shares in a public company must be made by means of a tender
offer, if as a result of the acquisition, the purchaser would become a 25% shareholder of the company. This rule does not apply if
there is already another 25% shareholder of the company. Similarly, the Israeli Companies Law provides that an acquisition of shares
in a public company must be made by means of a tender offer if, as a result of the acquisition, the purchaser would become a 45%
shareholder of the company, unless someone else already holds a majority of the voting power of the company. These rules do not
apply if the acquisition is made by way of a merger.
Regulations promulgated under the Israeli Companies Law provide that these tender offer requirements do not apply to
companies whose shares are listed for trading outside of Israel if, according to the law in the country in which the shares are
traded, including the rules and regulations of the stock exchange on which the shares are traded, either:
- There is a limitation on acquisition of any level of control of the company; or
- The acquisition of any level of control requires the purchaser to do so by means of a tender offer to the public.
The Israeli Companies Law provides specific rules and procedures for the acquisition of shares held by minority
shareholders, if the majority shareholder holds more than 90% of the outstanding shares. Israeli tax law treats specified
acquisitions, including a stock-for-stock swap between an Israeli company and a foreign company, less favorably than does U.S.
tax law.
These laws may have the effect of delaying or deterring a change in control of the Company, thereby limiting the
opportunity for shareholders to receive a premium for their shares and possibly affecting the price that some investors are willing
to pay for the Company’s securities.
## Provisions Affecting a Potential Change of Control; Potential Rights of Unissued Preferred Shares
The Company’s Articles of Association provide that the Company’s Board of Directors has the authority to issue up to
5,000,000 preferred shares and to determine the price, rights (including voting rights), preferences, privileges and restrictions of
such preferred shares, without any vote or actions by the Company’s shareholders. If this provision withstands judicial scrutiny
under the Israeli Companies Law, the rights and preferences of such preferred shares could include a preference over the ordinary
shares on the distribution of the Company’s assets upon a liquidation or sale of the Company, preferential dividends, redemption
rights, and the right to elect one or more directors and other voting rights. The rights of the holders of the ordinary shares will be
subject to, and may be adversely affected by, the rights of the holders of any preferred shares that may be issued in the future. The
Company has no current plans to issue preferred shares. The issuance of preferred shares, while providing desirable flexibility in
connection with possible acquisitions and other corporate purposes, could have the effect of making it more difficult for a third
party to acquire a majority of the outstanding voting shares of the Company. Furthermore, certain provisions of the Company’s
---
Articles of Association could delay or make more difficult a merger, tender offer or proxy contest involving the Company. These
provisions stipulate that the Company cannot engage in a business combination with an interested shareholder (defined generally
as the beneficial owner of 15% of the outstanding shares and its affiliates) for a period of three years following the date that such
shareholder became an interested shareholder, unless certain conditions are met. These provisions may have the effect of delaying
or deterring a change in control of the Company, thereby limiting the opportunity for shareholders to receive a premium for their
shares and possibly affecting the price that some investors are willing to pay for the Company’s securities.
## Concentration of Share Ownership
As of February 16, 2004, the directors and executive officers of the Company beneficially owned approximately 29% of
the outstanding ordinary shares of the Company. The percentage of ownership is calculated based on number of ordinary shares
owned, directly or indirectly, and the number of options immediately exercisable or that are exercisable within 60 days from
December 31, 2003. As a result, these shareholders are able to exercise significant influence over all matters requiring
shareholder approval, including the election of directors and approval of significant corporate transactions. Such concentration of
ownership may have the effect of delaying or preventing a change in control of the Company. See “Item 7 - Major Shareholders
and Related Party Transactions.”
## Indemnification of Directors and Officers
The Company has agreements with its directors and senior officers which provide, subject to Israeli law, for the
Company to indemnify these directors and senior officers for (a) monetary liability imposed upon them in favor of a third party by
a judgment, including a settlement or an arbitral award confirmed by the court, as a result of an act or omission of such person in
his capacity as a director or officer of the Company, and (b) reasonable litigation expenses, including attorney’s fees, incurred by
such a director or officer or imposed on him by a court, in a proceeding brought against him by or on behalf of the Company or by
a third party, or in a criminal action in which he was acquitted, or in a criminal action which does not require criminal intent in
which he was convicted, in each case relating to acts or omissions of such person in his capacity as a director or officer of the
Company.
## Exchange Controls and Other Limitations Affecting Security Holders
In 1998, the Israeli currency control regulations were liberalized significantly, and there are currently no control
restrictions on remittances of dividends on securities of Israeli companies (provided that Israeli income tax has been paid or
withheld thereon) or on the proceeds from the sale of Israeli securities. Legislation remains in effect, however, pursuant to which
currency controls can be imposed by administrative action at any time.
Neither the Memorandum and Articles of Association of the Company nor the laws of Israel restrict in any way the
ownership or voting of ordinary shares by non-residents of Israel, except with respect to citizens of countries, which are in a state
of war with Israel.
## ITEM 4. INFORMATION ON THE COMPANY
## General
Check Point develops markets and supports Internet security and VPN solutions for enterprise and high-end networks,
service providers, small and medium businesses, and consumers. The Company delivers solutions that enable secure, reliable and
manageable communications over Internet Protocol (IP) networks including the Internet, intranets and extranets. The technology of
Check Point is aimed to provide enterprises with intelligent security solutions for their most critical information security challenges in
three distinct areas: perimeter, Web and internal networks. The capabilities of Check Point products can be extended with the Open
Platform for Security (OPSEC), enabling integration with leading hardware appliances and third-party security software applications.
In March 2004, the Company completed the acquisition of privately held Zone Labs for approximately $114 million in cash
and 5.3 million ordinary shares. The Company also assumed Zone Labs’ outstanding employee stock options which could convert to
approximately 2.8 million Check Point shares.
Zone Labs is a provider of endpoint security solutions for enterprises, small businesses and consumers. Zone Labs’ product
offerings include Zone Labs Integrity security platform for the enterprise market, ZoneAlarm and ZoneAlarm Pro desktop security
software mainly to consumers and small businesses, and the IMsecure product line, its instant messaging (IM) security solutions for
enterprises, small businesses and consumers.
Check Point was incorporated in 1993 and its address is 3A Jabotinsky Street, Ramat-Gan 52520, Israel. The telephone
number is 972-3-753-4555. The Company’s website is www.checkpoint.com. The contents of the Company’s website are not
incorporated by reference into this Form 20-F. This Form 20-F can be obtained upon request from the Company’s investor relations
department, 800 Bridge Parkway, Redwood City, California 94065 (telephone no. 650-628-2000).
---
## Industry Background
Information, and the ability to access and distribute it, is a key strategic asset in today’s competitive business
environment. This need to effectively use and communicate information as well as work more collaboratively has led to the
extensive deployment of network-based communications systems (connectivity). Increased connectivity is in turn increasing the
need for technology to safeguard and manage the access to information available over these increasingly global networks.
## Increase in Connectivity
The network computing market has undergone three major transitions over the past decade, which has contributed to the
increase in global connectivity. The first of these transitions was the migration of corporate computing environments from
centralized mainframe systems to distributed client/server environments. The ability to access and share information through
client/server technology has expanded the need for connectivity beyond workgroup LANs (Local Area Networks) to
enterprise-wide networks spanning multiple LANs and WANs (Wide Area Networks). The second major transition has been the
widespread adoption of the Internet for business-to-business communications. Internet-based business applications have rapidly
expanded beyond e-mail to a broad range of business applications and services including electronic publishing, direct to customer
transactions, product marketing, advertising and customer support. The emergence of increased reliance on the Internet for
business communications and transactions increases the need for and associated challenges in providing secure access to
information and applications. Finally, companies of all sizes in most industries are embracing and supporting increased
connectivity for mobile and remote employees. This includes connectivity to corporate data and application resources, as well as
general Internet access. Remote users are increasingly able to receive more and better information from a growing spectrum of
devices, including laptops, personal digital assistants, and cell phones. The expansion of network access to mobile workers is
driving demand to secure all devices with Internet access, as well as those connecting to the corporate network. These transitions
and the need for secure, managed communications, have led to the broad acceptance of virtual private networks through the use of
the public Internet infrastructure and associated protocols and applications, sharing information and utilizing services both within
the enterprise and with business partners and customers are now widely adopted. As a result, businesses are able to share internal
information and to run enterprise applications across geographically dispersed facilities as well as enable customers, suppliers and
other business partners to inexpensively link into their enterprise information systems. As Internet protocols and infrastructure
gain increasingly widespread acceptance for global communication, new wide-area connectivity services continue to emerge at a
rapid rate, such as database access, transaction-processing services, voice over IP services and video teleconferencing services.
This expansion of services and applications is further accelerating the use of networks as global communication systems.
## The Need for Security
The growth of Internet connectivity among organizations of all sizes has increased the risk that corporate Information
Technology (IT) resources can be attacked via the Internet. Firms have recognized this risk and are deploying security solutions
in an effort to protect company confidential information from unauthorized access. The primary means of controlling access to
corporate networks and protecting against attacks is the deployment of Internet firewalls. Firewalls are typically deployed at the
demarcation of the corporate LAN and the Internet, and are used to strictly control traffic into and out of the company’s network.
Firewall technology is currently undergoing an evolution, enabling it to detect and defeat highly sophisticated network and
application-level attacks that are increasingly prevalent on the Internet today.
In addition to protecting corporate IT assets from attack, corporations take steps to guard sensitive company information
traversing untrusted networks, such as the Internet. Securing company information on the Internet is critical as more
organizations are utilizing the Internet as their corporate network backbone to link company offices and employees. Putting
sensitive information on the Internet without adequate security exposes confidential data to the public. To mitigate this risk,
increasing number of firms is deploying VPNs to encrypt and authenticate their Internet-bound traffic. Leveraging standardsbased VPN technology enables organizations to connect offices and remote employees via the Internet, while maintaining the
privacy and integrity of communications.
IT security administrators within corporations have long focused on securing the network perimeter. With the rise of costly
worms and other attacks introduced from within the internal network through mobile and wireless devices, organizations have
realized the importance of securing their internal networks. But while many of the same principles used to construct and operate
perimeter security solutions also apply to internal networks, internal networks are much more complex and have unique security
requirements.
Frequently, firewalls and VPNs are deployed together on the same platform. Integrating firewall and VPN functionality
delivers greater security for all traffic and eases the management burden on security and network administrators.
---
## Technology
Check Point network security solutions include various technologies that enable our customers to define their network
security policies, enforce these policies across their networks, collect information and monitor the security and traffic flow and
analyze and update those configurations to reflect changes in the network and in the security policies. The Company’s products are
packaged and marketed under different names and address security tasks in various environments and a variety of price points.
## Stateful Inspection Technology
Check Point’s VPN-1 product offerings are based upon Stateful Inspection technology that enables the screening of all
communications attempting to pass through a gateway in a secure but efficient manner. By extracting and maintaining extensive
“state information” from all relevant communication layers, the system can verify data for full compliance with the security and
traffic policy and make intelligent security and traffic prioritization decisions. By extracting and analyzing data in place without
making a copy, Stateful Inspection results in virtually no performance degradation, enabling VPN-1 product offerings to scale
effectively with increasing network bandwidth. In addition, Check Point’s proprietary implementation of Stateful Inspection in a
“virtual machine” design provides in-place upgradeability and is designed to enable the Company’s products to be easily ported to
a wide range of platforms. Furthermore, because Check Point’s products reside at network access points, which are the critical
convergence points for network security and traffic management, the Company is able to apply this same architectural foundation
and inspect traffic only once for both critical network decisions and traffic management, resulting in increased network
performance.
## Security and Network Traffic Enforcement Technologies (based on Stateful Inspection)
Check Point VPN-1 enforcement points are typically installed at the network perimeter (as security gateways), deployed on
critical servers and installed on client platforms (with VPN-1 SecureClient). These enforcement points implement the company’s
patented Stateful Inspection technology using the INSPECT engine. The INSPECT engine scans all incoming and outgoing IP traffic
and is based on the Company’s patented Stateful Inspection technology, which matches all traffic against the security policy. The
INSPECT engine can be enhanced by the Company, its partners, or users by using the INSPECT programming language.
Based on fine-grained matching, network traffic can be dropped (indicating a violation of the security policy), encrypted and
forwarded (secured VPN traffic), prioritized (FloodGate-1 QoS) or sent for further analysis through additional enforcement modules.
Additional enforcement modules perform functions such as checking the credentials and authentication of requesting users or
inspecting traffic through screening technology such as URL filtering or an Anti-Virus system. Many of these additional security
technologies are provided by third party vendors and are integrated through the OPSEC architecture. In addition, technologies like
Check Point’s SecureXL further accelerate the performance of security and network operations using system extensions or third party
ASIC-based accelerators and platforms.
## Application Intelligence
Check Point’s Application Intelligence is a set of advanced capabilities, integrated into VPN-1, Check Point InterSpect
and SmartDefense product offerings, which detect and prevent application-level attacks. Some of the most serious threats in
today’s Internet environment come from attacks that attempt to exploit application vulnerabilities. Since application-level attacks
tend to be sophisticated in nature, effective defenses must be equally sophisticated and intelligent.
## Security Management Architecture (SMART)
Check Point’s products are based on its SMART architecture, which allows configuration and management of security
policies from a single, centralized administrative workstation. Security policies can be defined and deployed for a single security
gateway protecting a small business, for multiple gateways in an enterprise network environment, or for multiple security domains
allowing a service provider to deliver security to a large number of customers, or subscribers. An object-oriented architecture
allows for the efficient storage and specification of security policy elements (such as computers, users, networks and network
devices, network services and security rules). Powerful management tools, such as object managers, audit and network activity
logs, monitoring tools and policy editors are based on this unifying architecture. The Company’s products contain extensive
monitoring and reporting capabilities designed to improve the manageability of the system.
## SecurePlatform
SecurePlatform enables easy deployment of the Company’s products on a variety of open systems. SecurePlatform
bundles certain Company’s products with a hardened and optimized version of the Linux operating system, with a set of tools in
order to ease the setup and network configuration. SecurePlatform allows improved cost/performance and reduced total cost of
ownership for security open servers.
---
Check Point's SecureXL™ is a software interface that enables Check Point to leverage technologies from multiple
silicon, appliance and computer system partners to accelerate the performance of firewall and VPN gateways by off-loading
simple, though computationally intensive functions to third-party packet processors. Using SecureXL different hardware
appliance vendors can stimulate the performance of “Secured by Check Point” appliances and provide greater value to their
customers that are benefiting from wire-speed advanced security.
## Open Platform for Security (OPSEC)
The OPSEC architecture provides a single platform that manages various aspects of network security through an open,
extensible management framework. Various third-party security applications plug into the OPSEC framework through published
application programming interfaces (APIs), such as the CVP (Content Vectoring Protocol) which integrates virus scanning software
and other content inspection programs, UFP (URL Filtering Protocol) which integrates URL list services, and SAMP (Suspicious
Activity Monitoring Protocol) which integrates suspicious activity monitoring programs. OPSEC also supports industry-standard
protocols such as RADIUS, IPSec, and SNMP. Once integrated into the OPSEC framework, all applications can be set-up and
managed from a central point, utilizing a single policy editor.
## SmartDefense
Check Point SmartDefense is an Active Defense solution which utilizes Stateful Inspection and Application Intelligence
technologies to actively protect organizations against network and application level attacks by using intelligent security technology,
which blocks attacks by type and class. SmartDefense provides a centralized console for real-time information on attacks, as well as
attack detection, blocking, logging, auditing and alerting. Check Point is offering a real time update subscription service to
SmartDefense users, allowing security administrators to mitigate new vulnerabilities in a simple and convenient way. Check Point
provides up to date security for its customers using SmartDefense Updates service, a supplementary service based on SmartDefense
capabilities, which provides both advisories and additional attack mitigation capabilities.
The main technologies used by recently acquired Zone Labs include the following:
## Cooperative Enforcement
The Zone Labs Cooperative Enforcement technology enables to integrate with network gateway products - from VPNs to
switches to wireless access points - in order to ensure that every endpoint is compliant with security policy before it is allowed
access to network resources.
## TrueVector Technology
TrueVector Technology is flexible and efficient software platform for enabling high-performance, scalable and robust
Internet security technology. TrueVector, the basis for Zone Labs’ entire consumer and enterprise product lines, makes it much
easier for Zone Labs and their partners to secure Internet access.
## Check Point’s Products
Check Point products are packaged in different ways and address various customer needs and deployment scenarios.
Most products run on a broad range of hardware platforms, running primarily on the following operating systems: Nokia IPSO,
Microsoft (Windows), Sun Microsystems (Solaris) and Linux. Check Point offers a broad and integrated range of policy-based
solutions for perimeter, internal and Web security:
## Perimeter Security
Perimeter solutions are used to control the access between the customer internal network or computers and external
network such as the internet. Check Point historically focused on VPN and firewalls which are the main building blocks for
perimeter security. In June 2003, the Company introduced a new version of its flagship product named NG with Application
Intelligence which integrates both network and application-level capabilities to deliver comprehensive attack protection and
network security. The following products are marketed primarily as perimeter security products:
---
## VPN-1 Pro
Check Point VPN-1 Pro family of products integrates access control, authentication, and encryption to guarantee the
security of network connections, the authenticity of local and remote users, and the privacy and integrity of data
communications. It also includes FireWall-1 for effective security and efficient administration, using Check Point’s Stateful
Inspection and Application Intelligence technologies. VPN-1 Pro is offered in multiple packages, depending on the size of
the network protected, some packages include the SmartCenter/SmartCenter Pro management software and some include only
the security gateway software.
## VPN-1 SecureClient & VPN-1 SecureRemote
VPN-1 SecureClient and VPN-1 SecureRemote are VPN endpoints which provide secure connectivity from laptops and
other mobile devices, work seamlessly with Check Point’s VPN-1 products and enable the set up of secure remote access as part
of an overall security policy, including access control, user authentication and logging. VPN-1 SecuRemote licenses are
included with VPN-1 gateway products at no cost.
VPN-1 SecureClient also includes personal firewall capabilities, secure configuration verification and streamlined
software distribution and management and is licensed by the number of users.
## VPN-1 Edge
VPN-1 Edge appliances provide secure connectivity for remote sites such as branch and retail sites. Integrating VPN-
1/FireWall-1 technology, high availability and networking features, VPN-1 Edge appliances are managed centrally through
SMART management, enabling the efficient setup of thousands of gateways.
## Security Management Solutions - SMART
Check Point’s management solutions using SMART technology enable organizations of different sizes to define,
deploy and enforce security policies consistently across multiple enforcement points. SMART Solutions for enterprises
include the following product offerings:
## SmartCenter
SmartCenter is Check Point's comprehensive management product, comprised of an intuitive “Dashboard” that
enables administrators to centrally define the VPN, firewall and QoS policies of a network, and a management server that
stores and distributes these different elements of the security policy. This product provides administrators with enhanced
understanding of distributed security deployments, and is combined with automatic policy distribution to deliver greater
control, improved security and enhanced ease of use. It also includes the elements to collect, record and manage the network
and security events as well as the SmartView Tracker to view and analyze those events.
## SmartView Family
The SmartView product family includes the SmartView Tracker for viewing, searching and analyzing of network
and security events recorded by the Company’s products. SmartView Monitor enables real-time viewing of network and
security traffic graphs by various criteria. SmartView Reporter enables the automatic creation of high-level reports
demonstrating the network and security operations.
## SmartCenter Pro
SmartCenter Pro is an extension of our SmartCenter management products that bundles an additional set of
management tools to provide a unique enterprise security management product. Included in SmartCenter Pro is the
SmartLSM large scale management tool, SmartUpdate for distributed software version management and updates, SmartMap
topological network view, Management Server High Availability, SmartDirectory for integration with LDAP directories and
the SmartView Monitor for graphical reporting and analysis.
---
## Check Point Express
Check Point Express is a perimeter security product designed for mid-sized companies with up to 500 employees
and multiple sites. It provides access control, network and application level protection, remote access and site-to-site VPN
capabilities, along with an intuitive SMART management interface.
## Safe@Office
Check Point’s Safe@Office product line is based on the Stateful Inspection technology found in VPN-1, and delivers
VPN and firewall capabilities to small businesses, consumers, and the Managed Service Providers (MSPs). Safe@Office
products can be managed individually using a web browser and can be provided with centralized management service via an
MSP using the Security Management Portal (SMP.)
The recent acquisition of Zone Labs contributed the following product lines to the small business and consumers
perimeter product offerings:
## ZoneAlarm Pro
ZoneAlarm Pro is designed to protect Internet-connected PCs at homes and small businesses with strong security,
ease of use and online privacy protection. ZoneAlarm Pro includes ad blocking and cookie control capabilities as well as
simple set-up for networks, including wireless networks. It also includes features which reduce the risk of online fraud and
identity theft by guarding against the theft of personally-identifiable information, intellectual property and other confidential
data.
## ZoneAlarm
ZoneAlarm is designed to provide basic Internet security, ideal for the home PC. ZoneAlarm is free for personal and
non-profit use.
## IMsecure Pro
IMsecure Pro is a consumer instant messaging security product for any program that accesses IM services such as
AOL Instant Messenger, MSN Messenger and Yahoo! Messenger. IMsecure Pro is designed to maintain the privacy and
security of IM conversations protect PCs and personal information from spammers and identity thieves, hackers and predators
who exploit vulnerable IM connections. IMsecure Pro protects the PC transparently, regardless of service or client used,
requiring no change to existing habits or software. Inbound and Outbound Threat Protection reduces exposure to
malware and prevents eavesdropping, impersonation, and theft of personally-identifiable information, intellectual property
and other confidential data stored on the PC.
## IMsecure
IMsecure is free for personal and non-profit use, offers basic inbound threat protection from buffer overflow attacks
as well as Message Encryption for one IM account to protect instant messages from being monitored.
## Products for service providers, data centers and large enterprises:
## VPN-1/FireWall-1 VSX
VPN-1®/FireWall-1® VSX is a high-speed, multi-policy security product designed for VLAN-enabled corporate
networks, data centers and service provider POPs. It uses the same, patented Stateful Inspection technology used in the VPN-
1 Pro. By aggregating up to 250 individual security domains on a single platform, VPN-1/ FireWall-1 VSX minimizes
hardware investment. VPN-1/FireWall-1 VSX can be run on multiple gigabit platforms to deliver the required performance
in high-bandwidth environments. It is managed using Check Point's SmartCenter products and Provider-1, delivering a
unified management architecture that service providers and enterprises can also use to manage all their other Check Point
enforcement points centrally.
---
Provider-1 is a security management product designed to meet the unique challenges of service providers and large
enterprises and is available in two editions designated for these two segments. Provider-1 consolidates customer security
policies into a centralized policy management architecture that scales to support thousands of customers while minimizing
investment in hardware and labor. For large enterprises, Provider-1 simplifies a complex security policy by segmenting it
into more manageable sub-policies to match geographic, functional, or other logical groupings.
## Security Management Portal
The Security Management Portal (SMP) is a management product for service providers, which delivers outsourced
Internet security to small businesses. Developed by SofaWare Technologies Ltd., a company affiliated to Check Point, the
SMP enables service providers to create flexible service categories and to centrally manage tens of thousands of subscribers.
*Product for wireless carriers:*
## FireWall-1 GX
FireWall-1 GX provides security to GPRS- (2.5G) and UMTS- (3G) enabled wireless networks. FireWall-1 GX is
designed to protect these wireless infrastructures from the threats of untrusted networks. With FireWall-1 GX, wireless
network operators can offer seamless roaming to their data customers without exposing their network to potential security
threats.
## Internal Security
Historically, IT security organizations have focused on protecting the perimeter of their networks. However, many of
today's security threats are introduced within the boundaries of the corporate internal network.
## Check Point InterSpect
Check Point InterSpect products were introduced in January 2004. They are sold as a Check Point appliance
including the hardware and software. InterSpect internal security gateways segment internal network into multiple “security
zones”, controlling traffic flow between those zones. InterSpect blocks the spread of certain attacks and worms, isolates
computers that generate suspicious activity from communicating with other network segments and can also allow only certain
types of traffic to different security zones.
The recent acquisition of Zone Labs contributed the following product line to the Company’s Internal Security
product offerings:
## Zone Labs Integrity
Zone Labs Integrity products are designed to enable enterprises to enforce and control security policy on desktops
across the organization from a centralized management console, regardless of whether users are accessing the network
remotely or from inside the enterprise network. Zone Labs Integrity reduces exposures to vulnerabilities by protecting
individual endpoints and thus enabling deeper level of security enforcement.
## Web Security
Companies are increasingly dependent on Web and Internet systems to run their businesses. As usage and dependence of
Web-based systems increases, companies are focusing on specialized protection for Web servers and applications, and have a
concentrated need to provide secure, unified access to these systems.
## User Authority
Check Point’s UserAuthority provides centralized administration and distributed enforcement of authorization access
policies for Web applications, Check Point UserAuthority centralizes the administration and enforcement of user
authentication in enterprise networks, uniformly implementing best-of-breed authentication products (PKI, tokens, LDAP,
etc.) across enterprise networks.
Check Point intends to expand its web based security solutions and launch new web security technologies and
products in 2004.
---
## Sales and Marketing
Check Point **Sales and Marketing** efforts are focused on expanding the installed base and increasing penetration levels of
end-user customers worldwide by leveraging multiple channels of distribution (channel partners): distributors, resellers and Value
Added Resellers (VARs), system integrators, and MSPs. The Company sells its products to end-user customers primarily through
numerous resellers and distributors worldwide. The Company expects that it will continue to be dependent upon a limited number
of distributors for a significant portion of its revenues. In 2003, sales to the Company’s five largest distributors represented
approximately 35% of the Company’s revenues. The Company’s agreements with its channel partners are generally
non-exclusive.
The Company promotes its products in various ways, including its website, seminars and trade shows, print-media, online advertising and software evaluation for a limited period.
The Company has relationships with server and workstation vendors and appliance manufacturers, such as Nokia, IBM,
Hewlett-Packard Co., Dell Inc., Sun Microsystems Inc., Siemens AG, Crossbeam Systems Inc., Nortel Networks Corp, and other
suppliers of enterprise network hardware products. The Company believes that strategic relationships can significantly contribute
to the achievement of its sales and marketing goals by integrating complementary technologies. Additionally, these hardware
partners provide primary support and training to their customers thereby enabling Check Point to concentrate its support efforts on
high-level technical assistance for its partners.
The Company has derived substantially all of its revenues, and expects to continue to derive the vast majority of its
revenues in the foreseeable future, from sales of its network security products, packaged and marketed mostly under the VPN-1
product family (which includes the firewall functionality), including related software subscriptions, support and technical services
and training programs. For information concerning the Company's sales to geographic areas, see “Item 5 - Operating and
Financial Review and Prospects.”
The Company’s OPSEC Alliance program is focused on delivering integration and interoperability with complimentary
products and developing marketing relationships with partners to promote “best-of-breed” security frameworks. OPSEC’s wide
range of integration interfaces addresses all areas of a complete Internet security architecture. Products that carry the “OPSEC
Certified” and “Secured by Check Point” seals have been tested to enable integration and interoperability. OPSEC partners (currently
over 325) include appliance companies like Nokia Corporation, Sun Microsystems, Inc. and Nortel Networks Limited, application
companies like Network Associates Inc., Computer Associates International Inc., Trend Micro, Inc., RSA Security Inc. and VeriSign,
Inc and system integrators including Accenture, Computer Sciences Corp, Electronic Data Systems Corp, PriceWaterhouseCoopers,
and IBM Global Services. In addition, the Company maintains marketing relationships with other companies to promote integrated
products.
The Company conducts a number of marketing programs to support the sale and distribution of its products. These
programs are designed to inform existing and potential partners and end-user customers about the capabilities and benefits of the
Company’s products.
**Customer Service and Support**
The Company operates a worldwide technical services organization, providing a wide range of technical, customer,
educational and professional services.
The Company’s channel partners generally provide the installation, training, maintenance and support for their customers,
with Check Point providing the high-level technical backup support. Alternatively customers may elect to receive support directly
from Check Point. As part of Check Point’s direct market participation, the Company employs technical consultants and systems
engineers who work closely with its field and channel partners to assist with the pre-sales configuration, use and application support.
At the end of 2003 the Company has transitioned its subscription and support programs from being based on single products
into more comprehensive offerings that cover the customer’s entire installed base. These programs offers lower cost to the customer
and require full customer account coverage. This change is likely to have an impact on the Company’s future operating results.
The Company operates a worldwide 24-hour, 7-day call center, based primarily in Dallas, Texas.
---
## Research and Product Development
The Company believes that its future success will depend upon its ability to enhance its existing products and develop
and introduce new products that address the increasingly sophisticated needs of end-users. The Company works closely with
existing and potential customers, distribution channels and major resellers, which provide significant feedback for product
development and innovation. The Company’s new product development efforts are focused on enhancements to its current family
of products and new products for perimeter, internal and web security and management. Although the Company expects to
develop its new products internally, it may, based upon timing and cost considerations, acquire or license certain technologies or
products from third parties.
Research and development expenses for 2001, 2002 and 2003 were $33.2 million, $28.7 million and $29.3 million,
respectively. At December 31, 2003, the Company had 321 employees dedicated to research and development activities and
quality assurance, mostly located in Israel. With the recent acquisition of Zone Labs the company now has an additional 91 such
employees based in San Francisco, CA.
## Competition
See “Risk Factors – Competition” in “Item 3 - Key Information.”
## Proprietary Rights
The Company relies primarily on a combination of copyright and trademark laws, trade secrets, confidentiality
procedures and contractual provisions to protect its proprietary rights. The Company seeks to protect its software, documentation
and other written materials under trade secret and copyright laws, which afford only limited protection. The Company generally
enters into confidentiality agreements with employees, consultants, customers and potential customers and limits access to, and
distribution of, its proprietary information.
The Company has patents pending worldwide and holds three U.S. patents. There can be no assurance that the
Company’s efforts to protect its proprietary rights will be adequate or that the Company’s competitors will not independently
develop similar technology.
## Organizational Structure
The Company is organized under the laws of the State of Israel and wholly owns the subsidiaries specified below:
| NAME OF SUBSIDIARY | COUNTRY OF INCORPORATION |
| --- | --- |
| Check Point Software Technologies, Inc | United States of America (Delaware) |
| Check Point Software Technologies (Canada) Inc. | Canada |
| Check Point Software Technologies (Japan) Ltd. | Japan |
| Check Point Software Technologies (Singapore) PTE Ltd. | Singapore |
| Check Point Software Technologies (Netherlands) B.V. | Netherlands |
| Israel Check Point Software Technologies Ltd. China(1) | China |
| Check Point Holding(Singapore) PTE Ltd. | Singapore |
| Check Point Holding(Singapore) PTE Ltd.-US Branch(2) | United States of America |
| Check Point Software Technologies Cayman Islands | Cayman Islands |
| Zanzibar Acquisition LLC(3) | United States of America(California) |
(1) Branch of Check Point Software Technologies Ltd.
(2) Branch of Check Point Holding (Singapore) PTE Ltd.
(3) 100% owned by Check Point Software Technologies, Inc.
---
Check Point Software Technologies (Netherlands) B.V. acts as a holding company and wholly owns the following principal
operating subsidiaries specified below:
## NAME OF SUBSIDIARY
## COUNTRY OF INCORPORATION
| Check Point Software Technologies(Australia)PTY Ltd. | Australia |
| --- | --- |
| Check Point Software TechnologiesSARL | France |
| Check Point Software TechnologiesB.V. | Netherlands |
| Check Point Software Technologies(Italia)Srl(4) | Italy |
| Check Point Software Technologies(Switzerland)A.G. | Switzerland |
| Check Point Software TechnologiesNorwayA.S. | Norway |
| Check Point Software Technologies(Spain)S.A. | Spain |
| Check Point Software TechnologiesMexicoS.A.deC.V. | Mexico |
| Check Point Software Technologies(Brazil)LTDA | Brazil |
| Check Point Software Technologies(UK)Ltd. | United Kingdom |
| Check Point Software TechnologiesGmbH | Germany |
| C.P.S.T. SwedenA.B. | Sweden |
| Check Point Software Technologies(Denmark)ApS | Denmark |
| Check Point Software Technologies(Poland)Sp.z.o.o. | Poland |
| Check Point Software Technologies(Czech Republic)s.r.o. | Czech Republic |
| Check Point Software Technologies(Hong Kong)Ltd. | Hong Kong |
| Check Point Software Technologies(Korea)Ltd. | S.Korea |
| Check Point Software Technologies(Finland)Oy | Finland |
| Check Point Yazilim TeknolojileriPazarlamaA.S.(5) | Turkey |
| Check Point Software Technologies(Belgium)S.A. | Belgium |
| Check Point Software Technologies(Austria)GmbH | Austria |
| Check Point Software Technologies(India)Private Limited | India |
Check Point Software Technologies (India) Private Limited India
(4) 97% owned by Check Point Software Technologies (Netherlands) B.V and 3% owned by Check Point Software Technologies
Ltd.
(5) 96% owned by Check Point Software Technologies (Netherlands) B.V, 1% owned by Check Point Software Technologies Ltd.
and 3% owned in trust by the directors of Check Point Yazilim Teknolojileri Pazarlama A.S. on behalf of Check Point Software
Technologies (Netherlands) B.V.
## NAME OF AFFILIATED COMPANY
## COUNTRY OF INCORPORATION
SofaWare Technologies Ltd.
Israel
Check Point has provided a convertible loan to SofaWare and has the right to convert this loan into 60% of the equity of
SofaWare on a fully diluted basis exercisable until June 30, 2004. Check Point also holds warrants that allow it to further increase
its holdings in SofaWare to approximately two-thirds of the equity of SofaWare on a fully diluted basis. Accordingly, the
accounts of SofaWare are consolidated with the Company’s financial statements.
---
## Plants, Property and Equipment
The Company’s headquarters and research and development facilities are located in Ramat-Gan, Israel, near Tel-Aviv,
where the Company leases approximately 106,000 square feet of office space. These facilities are leased under leases that expire
between 2005 and 2011, including renewal options. The Company also leases approximately a total of 104,000 square feet of office
space in the United States. Of that, approximately 48,000 square feet of office space are leased for the US headquarters in Redwood
City, California, and approximately 31,000 square feet of office space for its technical services center in Dallas, Texas. These
facilities are leased under leases for periods of up to five years. In addition, the Company leases regional office space in the United
States, Latin America, Canada, Europe and Asia.
## ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS
The following discussion and analysis is based on and should be read in conjunction with the Company’s consolidated
financial statements, including the related notes, contained in “Item 18 - “Financial Statements.”
## Overview
Check Point develops, markets and supports Internet security and VPN solutions for enterprise and high-end networks,
service providers, small and medium businesses and consumers. The Company delivers solutions that enable secure, reliable and
manageable communications over Internet Protocol networks, including the Internet, intranets and extranets. The technology of
Check Point is aimed to provide enterprises with intelligent security solutions for their most critical information security
challenges in three distinct areas: Perimeter, Web and Internal networks. The capabilities of Check Point products can be
extended with the Open Platform for Security (OPSEC), enabling integration with leading hardware appliances and third-party
security software applications.
The Company’s business is subject to the effects of general global economic conditions and in particular, market
conditions in the IT industry and Internet security industry. During the past few years these economic and market conditions have
reduced the high growth that the industry had previously experienced. As a result, the market value, financial results and capital
spending levels of many of the Company’s customers have been materially adversely affected. Notwithstanding recent
improvement, if general economic and industry conditions fail to improve or deteriorate, demand for the Company’s products
could be adversely affected, as could the financial health of the Company’s suppliers and distributors, and the Company’s
financial results may be adversely affected.
The Company has derived most of its revenues, and expects to continue to derive the vast majority of its revenues in the
foreseeable future, from sales of its Internet security products, packaged and marketed mostly under the VPN-1 brand, including
related software subscriptions, support, technical services and training programs.
No distributor accounted for more than 10% of the Company’s revenues in 2001. During 2002 and 2003 approximately
13% of the Company’s revenues were derived from a single distributor.
The following table sets forth, for the periods indicated, the percentage of total consolidated revenues derived from sales
into each of the regions identified in the table:
| | Year Ended December 31, | | |
| --- | --- | --- | --- |
| Region: | 2001 | 2002 | 2003 |
| Americas | 45% | 43% | 43% |
| Europe, Middle East and Africa | 38% | 41% | 41% |
| Japan | 10% | 9% | 9% |
| Asia Pacific | 7% | 7% | 7% |
Zone Labs' endpoint security products for enterprises, small businesses and consumers which include the Integrity,
ZoneAlarm and IM secure product lines, are expected to further strengthen Check Point's perimeter, internal and Web security
portfolio, enabling the Company to deliver a comprehensive end-to-end Internet security to all types of customers.
---
The Company expects to incur material charges, estimated to be between $70 million and $100 million, in connection
with the proposed acquisition of Zone Labs in 2004, mainly related to write-off of in-process research and development and
amortization of intangible assets and deferred compensation expenses related to non-vested employee stock options assumed by the
Company.
## Critical Accounting Policies:
The Company’s consolidated financial statements are prepared in accordance with accounting principles generally
accepted in the United States (“GAAP”). These accounting principles require management to make certain estimates, judgments
and assumptions based upon information available at the time that they are made, historical experience and various other factors
that are believed to be reasonable under the circumstances. These estimates, judgments and assumptions can affect the reported
amounts of assets and liabilities as of the date of the financial statements, as well as the reported amounts of revenues and
expenses during the periods presented.
In many cases, the accounting treatment of a particular transaction is specifically dictated by GAAP and does not require
management’s judgment in its application. There are also areas in which management’s judgment in selecting among available
alternatives would not produce a materially different result. The Company’s management has reviewed these critical accounting
policies and related disclosures with the Audit Committee. See Note 2 to the Company’s Consolidated Financial Statements, which
contain additional information regarding the Company’s accounting policies and other disclosures required by GAAP.
Management believes the significant accounting policies which affect management’s more significant judgments and
estimates used in the preparation of the Company’s consolidated financial statements and which are the most critical to aid in fully
understanding and evaluating the Company’s reported financial results include the following:
- Revenue Recognition
- Allowance for Doubtful Accounts and Sales Returns
- Legal Contingencies
- Income taxes
## Revenue Recognition
The Company derives its revenues from three primary sources: (1) new software licenses (2) software subscriptions and
(3) services revenues, which include support, technical services and training programs. The basis for new software license
revenue recognition is substantially governed by the provisions of Statement of Position No. 97-2, “Software Revenue
Recognition,” issued by the American Institute of Certified Public Accountants (“SOP 97-2”).
According to SOP 97-2, the Company recognizes revenue when: (1) persuasive evidence of an arrangement for the
license of software exists; (2) the products are delivered or services are performed; (3) customer payment is deemed fixed or
determinable and free of contingencies or significant uncertainties; and (4) collection is probable.
Management considers arrangements regarding certain channel partners with payment terms extending beyond the
Company’s customary payment terms not to be fixed or determinable. If the fee is considered to be not fixed or determinable,
revenue is deferred and recognized when payments become due from the channel partners, or are actually collected, provided that all
other revenue recognition criteria have been met.
Software subscription, support, technical services and training program revenues included in multiple-element arrangements
are deferred and either recognized on a straight-line basis over the term of the software subscription and support agreement or when
services are performed. Revenues earned on software arrangements involving multiple-elements are allocated to each element based
on the relative fair value of the element. The Vendor Specific Objective Evidence ("VSOE") of fair value of the undelivered
elements (software subscription, support, consulting services and training) is generally determined based on the price charged for the
undelivered element when sold separately. In addition the Company has adopted Statement of Position 98-9, "Modification of SOP
97-2, Software Revenue Recognition with Respect to Certain Transactions, "("SOP 98-9"). SOP 98-9 requires that revenue be
recognized under the "residual method" when VSOE of Fair Value exists for all undelivered elements and VSOE does not exist for
all of the delivered elements.
## Allowance for Doubtful Accounts and Sales Returns
The Company maintains an allowance for doubtful accounts for estimated losses, which may result from the inability of
its channel partners to make required payments. Management exercises judgment as to its ability to collect outstanding
receivables. Allowances for doubtful accounts are made based upon a specific review of all significant outstanding invoices. For
those invoices not specifically reviewed, allowances for doubtful accounts are made based upon the age of the receivable. In
determining the allowance, the Company analyzes its historical collection experience and current economic trends. If the
historical data used to calculate the allowances for doubtful accounts do not reflect the future ability to collect outstanding
receivables, additional allowances for doubtful accounts may be needed and the future results of operations could be materially
affected.
20
---
The Company also records a provision for estimated sales returns in the same period as the related revenues are recorded.
This estimate is based on historical sales returns, analysis of credit memo data and other known factors. If the historical data used
to calculate these estimates do not properly reflect future returns, additional provision for sales returns may be required, and
revenues in that period could be adversely affected.
## Legal Contingencies
As discussed in ”Legal Proceedings” in “Item 8 - Financial Information,” under the caption ”Legal Proceedings,”
beginning on August 29, 2003, the Company received a number of class action complaints, which were later consolidated by the
court into one action. On January 14, 2004, the appointed lead plaintiff filed a consolidated amended complaint. Management
believes that applicable insurance as well as a provision in the financial statements as of December 31, 2003, are adequate to
cover probable costs arising from this matter. Due to the uncertainties related to this matter, the provision is based on the best
information available at the time the accrual was made. As additional information becomes available, management will reassess
the potential liability related to the pending litigation and may revise its estimate of the probable cost of this litigation. Such
revisions in the estimate of the probable cost could have a material impact on the Company’s future results of operations and
financial position.
## Income taxes
The Company operates within multiple taxing jurisdictions and is subject to audits in these jurisdictions. These audits
can involve complex issues, which may require an extended period of time to resolve. In management's opinion, adequate
provisions for income taxes have been made for all years. Although management believes that its estimates are reasonable, no
assurance can be given that the final tax outcome of these issues will not be different than those, which are reflected in the
Company’s historical income tax provisions. Such differences could have a material effect on the Company’s income tax
provision and net income in the period in which such outcome occurs.
## Results of Operations
The following table presents, for the periods indicated, information concerning the Company’s results of operations:
Year Ended December 31,
| | Year Ended December 31, | | |
| --- | --- | --- | --- |
| | 2001 | 2002 | 2003 |
| | (in thousands) | | |
| Revenues: | | | |
| Products and licenses | $374,026 | $256,113 | $230,096 |
| Software subscriptions | 110,236 | 130,879 | 161,690 |
| Support, training and consulting | 43,381 | 39,997 | 40,786 |
| Total revenues | 527,643 | 426,989 | 432,572 |
| Operating expenses: | | | |
| Cost of revenues | 26,571 | 20,693 | 18,923 |
| Research and development | 33,221 | 28,709 | 29,314 |
| Selling and marketing | 109,086 | 104,606 | 111,007 |
| General and administrative | 22,002 | 17,969 | 17,644 |
| Total operating expenses | 190,880 | 171,977 | 176,888 |
| Operating income | 336,763 | 255,012 | 255,684 |
| Financial income, net | 44,760 | 49,314 | 43,506 |
| Income before taxes on income | 381,523 | 304,326 | 299,190 |
| Taxes on income | 59,603 | 49,246 | 55,311 |
| Net income | $321,920 | $255,080 | $243,879 |
---
The following table presents, for the periods indicated, information concerning the Company’s results of operations as a
percentage of the Company’s revenues:
| | Year Ended December 31, | | |
| --- | --- | --- | --- |
| | 2001 | 2002 | 2003 |
| Revenues: | | | |
| Products and licenses | 71% | 60% | 53% |
| Software subscriptions | 21 | 31 | 37 |
| Support, training and consulting | 8 | 9 | 10 |
| Total revenues | 100 | 100 | 100 |
| Operating expenses: | | | |
| Cost of revenues | 5 | 5 | 4 |
| Research and development | 6 | 7 | 7 |
| Selling and marketing | 21 | 24 | 26 |
| General and administrative | 4 | 4 | 4 |
| Total operating expenses | 36 | 40 | 41 |
| Operating income | 64 | 60 | 59 |
| Financial income, net | 8 | 12 | 10 |
| Income before taxes on income | 72 | 72 | 69 |
| Taxes on income | 11 | 12 | 13 |
| Net income | 61% | 60% | 56% |
## Revenues
The Company's revenues are derived from the sale of software products and related software subscriptions, support
contracts, training and consulting. The Company's revenues were $527.6 million, $427.0 million and $432.6 million in 2001, 2002
and 2003, respectively. In 2002, the decrease in revenues was primarily a result of lower spending by the Company’s customers,
much of which was attributable to the global economic slow down, continuous weakness in the service providers sector and a more
competitive market place. In 2003, we continued to experience a gradual shift of revenues from products and licenses to software
subscription, while total revenue remained at the same level. The increase in software subscription revenues is attributed mainly to
the introduction of a new subscription and support program in early 2003 and the increase of our install base. Management
anticipates that revenues in 2004 will increase both due to internal growth and the effect of the recent acquisition of Zone Labs.
However, there can be no assurance that revenues will grow in 2004 due to several factors, any of which could have a material
adverse affect on revenues, including the uncertainty of the global economic conditions, the Company’s ability to integrate the
technology and operations of Zone Labs, the market acceptance of new products and the level of products and price competition.
## Cost of revenues
The Company's cost of revenues is comprised of the cost of post-sale customer support, training and consulting, cost of
freight, software and hardware production, manuals, packaging and license fees. Cost of revenues was $26.6 million, $20.7 million
and $18.9 million for 2001, 2002 and 2003, respectively. In 2002, the decrease in cost of revenues was mainly attributable to a
decrease in license payments to third parties and an increase in the Company’s operational efficiency. In 2003, cost of sales has
continued to decrease due to the further improvement of operational efficiencies. Management anticipates that cost of revenues will
increase in 2004 in line with an expected growth in revenues derived from products incorporating hardware.
## Research and development
Research and development expenses consist primarily of salaries and other related expenses for research and development
personnel, as well as the cost of facilities and depreciation of capital equipment. Research and development expenses were $33.2
million, $28.7 million and $29.3 million in 2001, 2002 and 2003, respectively, representing 6%, 7% and 7% of revenues,
respectively. In 2002, the decrease related both to lower compensation expense and limited amounts being spent on special projects.
The increase in 2003 related mainly to the increase in the number of research and development employed by the Company.
Management anticipates that research and development expenses in 2004 will increase mainly due to the inclusion of Zone Labs as a
new division of the Company and expected increase in compensation expense.
---
## Selling and marketing
Selling and marketing expenses consist primarily of salaries, commissions, advertising, trade shows, travel and other related
expenses. Selling and marketing expenses were $ 109.1 million, $104.6 million and $111.0 million in 2001, 2002 and 2003,
respectively, representing 21%, 24% and 26% of revenues, respectively. In 2002, the decrease was mainly due to lower marketing
activities, offset by an increase in headcount-related sales expenses, which derived from the expansion of Check Point’s sales force to
new countries. In 2003, the increase resulted mostly from higher compensation related expenses and the effect of the strong position
of the Euro. Management anticipates that selling and marketing expenses in 2004 will increase due to the inclusion of Zone Labs’
financial results, increased investment in marketing activities, and an expected increase in compensation expense.
## General and administrative
General and administrative expenses consist primarily of salaries and headcount related expenses, professional fees,
insurance costs and other. General and administrative expenses were $22.0 million, $18.0 million and $17.6 million in 2001, 2002
and 2003, respectively, representing 4% of revenues in all years. The decrease in 2002 and 2003 compared to 2001 was mainly due
to lower non-headcount related expenses. Management anticipates that in 2004, general and administrative expenses will increase
both due to market increase in insurance costs and the inclusion of Zone Labs’ financial results.
## Operating Margin
The Company may experience future decline in operating margins from historical levels due to the following reasons: the
inclusion of Zone Labs as a new division of the company, including the post acquisition charges of in-process research and
development and amortization of intangible assets and deferred stock based compensation expense; increasing competition and
pricing pressure; additional investments in the further development and expansion of the Company’s selling and marketing
organization; additional expansion of the research and development organization and the expected growth in revenues derived from
products incorporating hardware. The amount and timing of the abovementioned additional expenses are likely to result in
fluctuations in operating margins
## Financial income, net
Financial income, net consists primarily of interest earned on cash and cash equivalents, short and long term deposits and
marketable securities. Financial income, net was $44.8 million, $49.3 million, and $43.5 million in 2001, 2002 and 2003,
respectively. The increase in 2002 was primarily attributable to the increase in the Company’s cash and cash equivalents, short and
long-term deposits and marketable securities, all of which grew as a result of the Company’s cash flow from its operations. The
decrease in 2003 was due to continuous decrease in interest rates during 2003, despite the increase in total cash and investments.
Interest income is heavily dependent on prevailing U.S. interest rates.
## Taxes on Income
The Company’s effective tax rate was 15.6%, 16.2% and 18.5% in 2001, 2002 and 2003, respectively. These relatively
low tax rates were mainly achieved as a result of the Approved Enterprise status granted to the production facilities in Israel. We
expect that our effective tax rate in 2004 will not increase significantly compared to our 2003 effective tax rate.
Under the provisions of the Israeli law, the Company has elected to enjoy the alternative package of tax benefits relating
to these facilities, which grant tax exemptions and a reduction of tax rates. Accordingly, the Company's income from its
Approved Enterprise is tax-exempt for a period of two years and is subject to a reduced corporate tax rate of 10% to 25% for an
additional period of five to eight years, based on the percentage of foreign investment. The tax benefits granted are scheduled to
expire gradually from 2005 through 2013. The period of tax benefits, for each capital investment plan, is limited to the earlier of
twelve years from completion of the investment under the approved plan or fourteen years from receipt of approval.
Out of the Company’s retained earnings as of December 31, 2003 approximately $ 461 million were tax-exempt. If such
retained tax-exempt income is distributed in a manner other than upon the complete liquidation of the Company, it would be taxed
at the reduced corporate tax rate applicable to such profits (10% to 25%) and an income tax liability of up to approximately $ 115
million would be incurred. The Company currently intends to reinvest the amount of its tax-exempt income and not to distribute
such income as a dividend. Accordingly, no deferred income taxes have been provided with respect to this income. Distribution
of other earnings derived from the Company’s status as an Approved Enterprise which were previously taxed at reduced tax rates,
would not result in additional tax to the Company.
If the Company fails to meet the requirements of an Approved Enterprise in the future, the Company could be subject to
the statutory Israeli corporate tax rate of 36% and could be required to refund tax benefits already received plus linkage
adjustment to the Israeli consumer price index and interest. In addition, the law and regulations prescribing the benefits provide
for an expiration date for the grant of new benefits. The expiration date has been extended several times in the past. The
expiration date currently in effect is June 30, 2004 (which may be extended by ministerial decision until December 31, 2004).
There can be no assurance that new benefits will be available after June 30, 2004, or that existing benefits will be continued in the
future at their current levels or at any level.
23
---
## Quarterly Results of Operations
The following table sets forth certain unaudited consolidated statements of income data for each of the quarters in 2002 and
2003, as well as the percentage of the Company’s revenues represented by each item. The unaudited consolidated financial
statements have been prepared on the same basis as the audited consolidated financial statements contained herein and include all
adjustments (consisting only of normal recurring adjustments) that the Company considers necessary for a fair presentation of such
information, when read in conjunction with the Company’s consolidated financial statements and notes thereto appearing elsewhere
in this annual report.
| | Year Ended December 31,2002 | | | | Year Ended December 31,2003 | | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- |
| | Q1 | Q2 | Q3 | Q4 | Q1 | Q2 | Q3 | Q4 |
| (in thousands,except share data) | | | | | | | | |
| Revenues | $104,583 | $108,587 | $103,559 | $110,260 | $104,847 | $106,103 | $106,322 | $115,300 |
| Operating expenses: | | | | | | | | |
| Cost of revenues | 4,615 | 4,889 | 5,676 | 5,513 | 5,113 | 4,621 | 4,597 | 4,592 |
| Research and development | 7,399 | 7,383 | 6,988 | 6,939 | 6,858 | 7,263 | 7,670 | 7,523 |
| Selling and marketing | 25,033 | 27,865 | 24,625 | 27,083 | 26,688 | 26,768 | 27,598 | 29,953 |
| General and administrative | 4,837 | 4,364 | 4,215 | 4,553 | 4,344 | 4,581 | 4,369 | 4,350 |
| Total operating expenses | 41,884 | 44,501 | 41,504 | 44,088 | 43,003 | 43,233 | 44,234 | 46,418 |
| Operating income | 62,699 | 64,086 | 62,055 | 66,172 | 61,844 | 62,870 | 62,088 | 68,882 |
| Financial income,net | 12,227 | 12,332 | 12,276 | 12,479 | 11,343 | 10,497 | 10,921 | 10,745 |
| Income before taxes on income | 74,926 | 76,418 | 74,331 | 78,651 | 73,187 | 73,367 | 73,009 | 79,627 |
| Taxes on income | 11,390 | 11,684 | 12,015 | 14,157 | 13,108 | 13,189 | 14,643 | 14,371 |
| Net Income | $63,536 | $64,734 | $62,316 | $64,494 | $60,079 | $60,178 | $58,366 | $65,256 |
| Basic net earnings per share | $0.26 | $0.27 | $0.25 | $0.26 | $0.24 | $0.24 | $0.24 | $0.26 |
| Shares used in computing basic net earnings per share | 243,179 | 243,740 | 244,739 | 245,503 | 246,255 | 247,221 | 248,172 | 248,945 |
| Diluted net earnings per share | $0.25 | $0.26 | $0.25 | $0.26 | $0.24 | $0.24 | $0.23 | $0.26 |
| Shares used in computing diluted net earnings per share | 259,042 | 253,559 | 253,336 | 252,807 | 253,195 | 255,199 | 256,106 | 255,834 |
## As a Percentage of Revenues:
| | Year Ended December 31,2002 | | | | Year Ended December 31,2003 | | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- |
| | Q1 | Q2 | Q3 | Q4 | Q1 | Q2 | Q3 | Q4 |
| Revenues | 100% | 100% | 100% | 100% | 100% | 100% | 100% | 100% |
| Operating expenses: | | | | | | | | |
| Cost of revenues | 4 | 5 | 5 | 5 | 5 | 5 | 5 | 4 |
| Research and development | 7 | 7 | 7 | 6 | 7 | 7 | 7 | 7 |
| Selling and marketing | 24 | 25 | 24 | 25 | 25 | 25 | 26 | 25 |
| General and administrative | 5 | 4 | 4 | 4 | 4 | 4 | 4 | 4 |
| Total operating expenses | 40 | 41 | 40 | 40 | 41 | 41 | 42 | 40 |
| Operating income | 60 | 59 | 60 | 60 | 59 | 59 | 58 | 60 |
| Financial income, net | 12 | 11 | 12 | 11 | 11 | 10 | 11 | 9 |
| Income before taxes on income | 72 | 70 | 72 | 71 | 70 | 69 | 69 | 69 |
| Taxes on income | 11 | 10 | 12 | 13 | 13 | 12 | 14 | 12 |
| Net Income | 61% | 60% | 60% | 58% | 57% | 57% | 55% | 57% |
---
The Company's future revenues and operating results are uncertain and may fluctuate from quarter to quarter and from year
to year due to a combination of factors, including the timing of new product releases and acceptance of new products, the demand for
the Company's products, the volume and timing of orders and the ability to fulfill orders, the level of product and price competition,
the expansion of the Company's selling and marketing organizations, the Company's ability to develop new and enhanced products
and control costs, the Company's ability to attract and retain key technical, sales and managerial employees, the mix of distribution
channels through which products are sold, the mix of products and services sold, the growth in the acceptance of and activity on the
Internet and World Wide Web, the growth of intranets, seasonal trends in customer purchasing, customer capital spending budgets,
foreign currency exchange rates and general economic factors and potential acquisitions. The Company's revenues are subject to
seasonal fluctuations related to the slowdown in spending activities in Europe for the quarter ending September 30 and the increased
activity related to the year-end purchasing cycles of many end-users of the Company's products. The Company believes that it will
continue to encounter quarter-to-quarter seasonality that could result in proportionately lower sales in the quarters ending
September 30 and March 31 relative to sales in the quarters ending June 30 and December 31, respectively.
The Company's expense levels are based, in part, on expectations as to future revenues. If revenue levels are below
expectations, operating results are likely to be adversely affected, since most of the Company’s expenses are not variable. As a result,
the Company believes that period-to-period comparisons of its results of operations are not necessarily meaningful and should not be
relied upon as indications of future performance. Due to all of the foregoing factors, it is likely that in some future quarter the
Company's operating results may be below the expectations of public market analysts and investors. In such event, the price of the
Company's ordinary shares would likely be materially adversely affected.
## Liquidity and Capital Resources
The Company has financed its operations through cash generated from operations. Cash and cash equivalents and short
term investments were $1,136.3 million, and long term interest bearing investments were $466.4 million, totaling $ 1,602.7 million as
of December 31, 2003, as compared with cash and cash equivalents and short term investments of $785.9 million and long term
interest bearing investments of $528.9 million totaling $1,314.8 million as of December 31, 2002. At the end of 2002, the Company
established a wholly owned subsidiary in Singapore in order to manage its financial assets. This subsidiary currently holds the
majority of the Company’s investments. The Company generated net cash from operations of $347.2 million, $283.9 million and
$290.9 million in 2001, 2002 and 2003, respectively. Net cash from operations for 2003 and 2002 consisted primarily of net income
plus increases in deferred revenues, employees and payroll accruals, accrued expenses and other liabilities, tax benefits related to
exercise of stock options and depreciation and amortization. Net cash from operations for 2001 consisted primarily of net income
plus increases in accrued expenses and other liabilities, depreciation and amortization and decrease in trade receivables, offset by
decreases in deferred revenues and employees and payroll accruals.
The Company's capital expenditures amounted to approximately $9.7 million, $4.6 million, and $3.0 million in 2001, 2002
and 2003, respectively. Currently, the Company’s capital expenditures consist primarily of computer equipment and software for the
Company’s research and development and technical service organization efforts as well as increasing infrastructure to enable
operation expansion. The Company does not anticipate any change to this policy in the foreseeable future. As of December 31,
2003, the Company had no material commitments for capital expenditures.
Net cash provided by financing activities was approximately $36.3 million, $14.7 million and $17.7 million in 2001, 2002
and 2003, respectively, primarily as a result of stock options exercised. Excess cash is invested in marketable securities and bank
deposits of varying maturities, depending on projected cash needs for operations, capital purchases and other business purposes.
The Company’s principal sources of liquidity consist of its current assets and long-term investments (which aggregated
$1,602.7 million as of December 31, 2003), its cash flow from operations and its financial income, net. The Company believes that
these sources of liquidity will be sufficient to satisfy the Company’s capital requirements for the foreseeable future.
In October 2003, the Company announced that its Board of Directors has authorized the repurchase of up to $200 million of
its outstanding ordinary shares in the open market or through privately negotiated transactions. Under the repurchase program, share
purchases may be made from time to time depending on market conditions, share price, trading volume and other factors and will be
funded from available working capital. The repurchase program has no time limit and may be suspended from time to time or
discontinued. As of March 29, 2004, no shares had been repurchased under the plan.
In March 2004 the Company completed the acquisition of privately held Zone Labs for approximately $114 million in cash
and 5.3 million ordinary shares.
## Off-Balance Sheet Arrangements
We are not a party to any material off-balance sheet arrangements. In addition, we have no unconsolidated special purpose
financing or partnership entities that are likely to create material contingent obligations.
---
## Disclosure of Contractual Obligations
The Company does not have material contractual obligations and commercial commitments except for the lease of its
facilities as of December 31, 2003. The lease commitments due within one year amount to $5.2 million. Lease commitments due
between one to five years amount to $6.2 million (see also Note 7a to the financial statements).
## ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES
## The directors and executive officers of the Company as of December 31, 2003 were as follows:
| Name | Position |
| --- | --- |
| Gil Shwed | Chief Executive Officer and Chairman of the Board |
| Marius Nacht | Senior Vice President and Vice Chairman of the Board |
| Jerry Ungerman | President |
| Eyal Desheh | Chief Financial Officer |
| Irwin Federman(1)(2)(3) | Director |
| David Rubner(2) | Director |
| Ray Rothrock(1)(2)(3) | Director |
| Alex Vieux | Director |
| Tal Shavit | Director |
(1) Member of Compensation Committee
(2) Member of Audit Committee
(3) Outside Director, see “Outside and Independent Directors” below in this Item 6.
Gil Shwed, a co-founder of the Company, is Chairman of the Board of the Company, a position he has held since 1998,
and is also the Company’s Chief Executive Officer and a Director of the Company, both positions he has held since the
Company‘s inception in 1993. Mr. Shwed also served as President of the Company from its inception until 2001. Mr. Shwed is
also a Director of Backweb Technologies Ltd.
Marius Nacht, a co-founder of the Company, has served as the Company's Vice Chairman of the Board since 2001 and
has also been the Company’s Senior Vice President since 1999. Mr. Nacht has served as a director of the Company since its
inception in 1993. Mr. Nacht received a Masters degree in Electrical Engineering and Communication Systems from Tel Aviv
University, as well as a B.S. Cum Laude in Physics and Mathematics from Hebrew University of Jerusalem.
Jerry Ungerman was appointed President of the Company in 2001 and has global responsibility for sales, marketing,
business development and product management. He served as Executive Vice President from 1998 until 2000. He began his
career with IBM in 1967 and from 1971 to 1998, Mr. Ungerman held a number of senior management positions with Hitachi Data
Systems Corp., a provider of computer networking and data storage solutions for computing environments. Mr. Ungerman holds
a B.S.B. in business from the University of Minnesota.
Eyal Desheh has been Chief Financial Officer of the Company since 2000. From 1996 until 2000 he was Chief Financial
Officer for Scitex Corporation Ltd., a company engaged in digital imaging for graphics communications, where he was
responsible for all the major finance functions, investor relations, risk management, mergers and acquisitions and legal affairs.
Before joining Scitex, he served as Vice President for business development and strategy at Bezeq, The Israeli
Telecommunications Corp. Ltd., Deputy Chief Financial Officer of Teva Pharmaceuticals Ltd., Chief Executive Officer of H.L.
Financial Services Ltd. and numerous positions in Bank Hapoalim. Mr. Desheh holds a B.A. in Economics and an M.B.A in
Finance, both from Hebrew University of Jerusalem.
Irwin Federman has served as a director of the Company since 1995. Mr. Federman has been a General Partner of U.S.
Venture Partners, a venture capital firm, since 1990. Mr. Federman is a director of Centillium Communications, Inc., Nuance
Communications, Inc., SanDisk Corp., and a number of private companies. Mr. Federman received a B.S. in Economics from
Brooklyn College.
Ray Rothrock has served as a director of the Company since 1995. Mr. Rothrock has been a member of Venrock
Associates, a venture capital firm, since 1988 and a General Partner of Venrock Associates since 1995. Mr. Rothrock is also a
director of a number of private companies. Mr. Rothrock received a B.S. in engineering from Texas A&M University, an M.S.
from the Massachusetts Institute of Technology and an M.B.A. from the Harvard Business School.
---
David Rubner has served as a director of the Company since 1999. Mr. Rubner is Chairman and Chief Executive Officer
of Rubner Technology Ventures Ltd., a venture capital firm, and is a general partner in Hyperion Israel Advisors Ltd., a venture
capital firm. Prior to starting this company, Mr. Rubner served as President and Chief Executive Officer of ECI
Telecommunications Ltd. Prior to this appointment, he held various management positions in ECI Telecom. Mr. Rubner holds a
B.S. degree in engineering from Queen Mary College, University of London, and an M.S. degree from Carnegie Mellon
University. Mr. Rubner was a recipient of the Industry Prize in 1995 and serves on the boards of directors of a number of
companies, and is a member of the Board of Trustees of Bar Ilan University and Shaare Zedek hospital.
Alex Vieux has served as a director of the Company since 1998. Mr. Vieux is Chairman, Chief Executive Officer and
founder of DASAR Brothers, Inc., which he founded in 1990 and the owner of ETRE, the European Technology Roundtable
Exhibition. He is a member of the board of several public and private technology companies including BVRP software, Cibox,
Commerce One, Kyriba, madge, Thrunet and White Pajama. Mr. Vieux has served as a senior advisor to both government and
industry and was lately named, for the second year in a row, one of the most influential people in the European technology
community. Mr. Vieux is currently a visiting professor at the French University Paris Dauphine, where he is teaching
telecommunications in the United States. Mr. Vieux is a graduate of the Institut d'Etudes Politiques in Paris and HEC. He also
holds a law degree from the Université de Paris II-Assas and an M.B.A. from Stanford University, where he was a Fulbright
Scholar.
Dr. Tal Shavit has served as a director of the Company since 2002. Dr. Shavit is an organizational consultant
specializing in international collaboration between Israeli and American companies, consulting in the management of cultural
differences in order to forge effective collaboration. Her focus is on consultation to R&D upgrade in both Israeli companies and
in American companies with Israeli-based R&D centers. Her work with leading management teams includes a defining of
organizational culture as the engine of the company's activities. She consults to companies undergoing structural change and a
redefining of management roles in order to meet market changes.
Except for Messrs. Shwed and Nacht, as of February 16, 2004, none of the directors or executive officers of the
Company owned more than one percent of the outstanding ordinary shares. For information as to the share ownership of Messrs.
Shwed, Nacht and Kramer, see “Item 7 – Major Shareholders and Related Party Transactions.”
## Board Composition
The Company’s Articles of Association provide for a Board consisting of not less than six nor more than twelve
members. Each director (other than an outside director, as explained below) is elected to serve until the next annual general
meeting of shareholders and until his or her successor has been elected. Each officer is elected by and serves at the discretion of
the Board of Directors. Each of the Company’s officers and directors, other than non-employee directors, devotes substantially all
of his business time to the affairs of the Company. There are no family relationships among any of the directors, officers or key
employees of the Company.
The Articles of Association of the Company provide that any director may, by written notice to the Company, appoint
another person to serve as an alternate director and may cancel such appointment. Any person, other than a person who is already
a director or an alternate director, may act as an alternate director. The term of appointment of an alternate director may be for
one meeting of the Board or for a specified period or until notice is given of the cancellation of the appointment. To the
Company’s knowledge, no director currently intends to appoint any other person as an alternate director.
The Company’s Articles of Association provide that the Board of Directors may delegate all of its powers to committees
of the Board of Directors, as it deems appropriate, subject to the provisions of Israeli law. The Board of Directors has appointed a
Compensation Committee and an Audit Committee.
## Outside and Independent Directors
In accordance with the Israeli Companies Law and the regulations promulgated under the Companies Law, the Company
must have two outside directors. The outside directors must meet certain statutory requirements of independence. The term of office
of an outside director is three years and may be extended for one additional three-year term. An outside director can be removed
from office only under very limited circumstances. Both of the outside directors must serve on the Company’s statutory audit
committee, and at least one outside director must serve on each committee of the Board of Directors. The Company has appointed
Irwin Federman and Ray Rothrock as its outside directors under the Israeli Companies Law.
In addition, the rules of the NASDAQ National Market currently applicable to foreign private issuers such as the Company
require the Company to have at least three independent directors as that term is defined under NASDAQ National Market rules. The
current independent directors of the Company under the rules of the NASDAQ National Market are Irwin Federman, Ray Rothrock
and David Rubner.
---
## Audit Committee
The Israeli 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 both 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. In addition, the rules of the NASDAQ National Market currently applicable to foreign private issuers such as the
Company require the Company to establish an audit committee of at least three members, comprised solely of independent directors.
The responsibilities of the audit committee under the NASDAQ National Market rules include the selection and evaluation of the
Company’s outside auditors. The Company’s Audit Committee satisfies both the Israeli law and the NASDAQ National Market
requirements. The current members of the Company’s audit committee are Irwin Federman, Ray Rothrock and David Rubner. In
2003 the audit committee has adopted an Audit Committee Charter as required by the NASD.
## Compensation Committee
The Company’s Compensation Committee reviews and, as required, approves policies under which compensation is
awarded to the Company’s executive officers and key managers and oversees the administration of the Company’s executive
compensation programs, including the Company’s stock option plans. The current members of this committee are Irwin
Federman and Ray Rothrock.
## Compensation of Directors and Officers
The aggregate accrued compensation of all 9 persons as a group who served in the capacity of director or executive
officer during the year ended December 31, 2003 was approximately U.S. $3.3 million. This does not include amounts expended
by the Company for business travel, professional and business association dues and expenses reimbursed to officers. Except for
severance payments mandated by Israeli law for all employees employed in Israel, the Company does not have any agreements
with those directors who are also officers of the Company providing for benefits upon termination of employment. The
Company’s directors who are officers will not receive compensation for serving as directors in 2004; the Company’s directors
who are not officers will receive compensation for serving as directors in 2004. From time to time, the Company grants options
under its stock option plans (described below) to its executive officers and directors. As of February 16, 2004, the Company’s
executive officers and directors held options to purchase an aggregate of 17,174,750 shares under the Company’s stock option
plans. The exercise prices of these options range between $2.65 and $79.79, and their expiration dates range between June 2005
and August 2010. Other than as set forth in the share ownership table under Item 7 – “Major Shareholders and Related Party
Transactions,” none of our directors and officers holds more than 1% of the outstanding shares of the Company.
## Stock Options
## Israel Stock Option Plan
The Company’s 1996 Israel Stock Option Plan (the “1996 Israel Plan”) was adopted by the Board of Directors on April
12, 1996 and subsequently restated, most recently in February 2003. The 1996 Israel Plan authorizes the issuance of up to
76,229,310 ordinary shares. As of February 17, 2004, 13,349,939 ordinary shares had been issued under the 1996 Israel Plan,
options to purchase 21,321,788 ordinary shares were outstanding (including options incorporated from previous grants to
employees in Israel prior to the adoption of the 1996 Israel Plan) and 41,557,583 shares remained available for future grant. The
options exercise prices range between $2.65 and $86.54. The 1996 Israel Plan is administered by the Board of Directors, which
has broad discretion, subject to certain limitations, to determine the persons entitled to receive options, the terms and conditions
on which options are granted and the number of shares subject to each grant. Options under the 1996 Israel Plan are issued to
Israeli employees, directors, consultants, advisers and service providers of the Company. In addition, options are issued under
subsidiary plans of the 1996 Israel Plan, that are tailored for various other jurisdictions worldwide, to employees of the
Company’s subsidiaries in other countries outside the United States. In accordance with the terms and conditions imposed by
Section 102 of the Israel Income Tax Ordinance, grantees that receive options under the 1996 Israel Plan are afforded certain tax
benefits (excluding grantees who previously received options that were incorporated upon the adoption of the 1996 Israel Plan,
and excluding controlling shareholders of the Company or those who are not employees or directors of the Company). The
Company has elected the benefits available under the “capital gains” alternative. There are various conditions that must be met in
order to qualify for these benefits, including registration of the options in the name of a trustee (the “Trustee”) for each of the
employees who is granted options. Each option, and any ordinary shares acquired upon the exercise of the option, must be held
by the Trustee for a period commencing on the date of grant and ending no earlier than 24 months after the end of the tax year in
which the option was granted and deposited in trust with the Trustee. The 1996 Israel Plan provides for the options granted under
the Plan to have a maximum exercise period of seven years from the date of grant. Options granted under the 1996 Israel plan are
generally exercisable over five years. Options that are not exercised will become available for further grant by the Board under
the 1996 Israel Plan.
---
The Company’s 1996 United States Stock Option Plan (the “1996 U.S. Plan”) was adopted by the Board of Directors on
April 12, 1996 and was approved by the shareholders as the successor to the Company’s 1995 Stock Option Plan (the “1995
Plan”). The 1996 U.S. Plan authorizes the issuance of up to 107,443,964 ordinary shares. As of February 17, 2004, 36,141,516
ordinary shares have been issued under the 1996 U.S. Plan, options to purchase 7,079,890 ordinary shares were outstanding
(including options incorporated from the 1995 Plan) and options to purchase 64,222,559 ordinary shares remained available for
future grant. The options exercise prices range between $2.65 and $86.54. Ordinary shares subject to outstanding options,
including options granted under the 1995 Plan, which expire or terminate prior to exercise, would be available for future issuance
under the 1996 U.S. Plan. Options granted under the 1996 U.S. plan are generally exercisable over four years.
Under the 1996 U.S. Plan, employees (including officers) and independent consultants may, at the discretion of the plan
administrator, be granted options to purchase ordinary shares at an exercise price not less than 85% of the fair market value of
such shares on the grant date (the Company does not intend to issue options at an exercise price of less than fair market value).
Non-employee members of the Board of Directors will be eligible solely for automatic option grants under the 1996 U.S. Plan.
The Compensation Committee of the Board administers the 1996 U.S. Plan. The Compensation Committee has complete
discretion to determine which eligible individuals are to receive option grants, the number of shares subject to each such grant, the
status of any granted option as either an incentive option or a non-statutory option under U.S. Federal tax laws, the vesting
schedule to be in effect for each option grant and the maximum term for which each granted option is to remain outstanding. In
no event, however, may any one participant in the 1996 U.S. Plan acquire ordinary shares under the 1996 U.S. Plan in excess of
3,000,000 shares, exclusive of any option grants received prior to January 1, 1996.
The exercise price for options granted under the 1996 U.S. Plan may be paid in cash. Options may also be exercised on a
cashless basis through the same-day sale of the purchased shares. The Compensation Committee may also permit the optionee to
pay the exercise price through a promissory note payable in installments over a period of years. The amount financed may include
any U.S. Federal or state income and employment taxes incurred by reason of the option exercise.
The Compensation Committee has the authority to effect, from time to time, the cancellation of outstanding options
under the 1996 U.S. Plan in return for the grant of new options for the same or a different number of option shares with an
exercise price per share based upon the fair market value of the ordinary shares on the new grant date.
In the event the Company is acquired by merger, consolidation or asset sale, the ordinary shares subject to each option
outstanding at the time under the 1996 U.S. Plan will terminate to the extent not assumed by the acquiring entity. The
Compensation Committee also has discretion to provide for the acceleration of one or more outstanding options under the 1996
U.S. Plan and the vesting of shares subject to outstanding options upon the occurrence of certain hostile tender offers.
The Board may amend or modify the 1996 U.S. Plan at any time. The 1996 U.S. Plan will terminate on April 11, 2006,
unless terminated sooner by the Board.
## Stock Option Grants to Board Members
Under the automatic grant program, each individual joining the Board as a non-employee director receives at that time,
an automatic option grant for up to 30,000 ordinary shares, vesting over four years. In addition, at each annual shareholders
meeting, each non-employee director who is to continue to serve as a non-employee director after such annual meeting is
automatically granted a fully vested option to purchase up to an additional 18,000 ordinary shares, provided that the director has
served as a non-employee director for at least six months prior to the date of such annual meeting. The exact number of ordinary
shares covered by the options to be granted to each non-employee director is determined by the other directors in office
immediately prior to the date of his or her election or appointment, or the date of the annual meeting, as the case may be. Each
option has an exercise price not less than the fair market value of the ordinary shares on the automatic grant date and a maximum
term of ten years, subject to earlier termination following the optionee’s cessation of Board service.
## Zone Labs 1998 Stock Option
In connection with its acquisition of Zone Labs in March 2004, the Company assumed all of the outstanding Zone Labs
stock options under the Zone Labs 1998 Stock Option Plan (the “Zone Labs Plan”), which were converted into options to
purchase 2,847,318 shares of the Company’s ordinary shares. The stock options generally have terms of between five and ten
years and generally vest over a four-year period. These options were assumed at prices of between $1.33 and $6.08 per share,
with a weighted average exercise price of $4.67 per share. Of the stock options assumed 1,621,284 were exercisable with a
weighted average exercise price of $3.99 per share. No further stock options can be granted under the Zone Labs Plan.
---
## Employee Stock Purchase Plan
On November 24, 1996, the Company adopted an Employee Stock Purchase Plan (the “Purchase Plan”), which was
ratified by the Company’s shareholders. Under the Purchase Plan, 6,000,000 ordinary shares were authorized for issuance. As of
February 17, 2004, 1,298,000 ordinary shares have been issued under the Purchase Plan. The Purchase Plan, which is intended to
qualify under Section 423 of the United States Internal Revenue Code, is implemented by six-month offerings with purchases
occurring at six-month intervals in January and July. The Compensation Committee of the Board administers the Purchase Plan.
Employees of the Company and some of its subsidiaries are eligible to participate if they are full time employed for more than
20 hours per week. The Purchase Plan permits eligible employees to purchase ordinary shares through payroll deductions, which
may not exceed 15% of an employee’s compensation, nor more than 1,250 shares per participant on any purchase date. The price
of the ordinary shares purchased under the Purchase Plan will be 85% of the lower of the fair market value of the ordinary shares
at the beginning of the six-month offering period or on the semi-annual purchase date. Employees may terminate their
participation in the Purchase Plan at any time during the offering period, and participation ends automatically on termination of
employment with the Company. Each outstanding purchase right will be exercised immediately prior to a merger or consolidation
of the Company. The Board may amend or terminate the Purchase Plan immediately after the close of any purchase date.
However, the Board may not, without shareholders approval, materially increase the number of ordinary shares available for
issuance, alter the purchase price formula so as to reduce the purchase price payable for ordinary shares, or materially modify the
eligibility requirements for participation or the benefits available to participants. The Purchase Plan terminates by its terms in July
2006.
## Change of Control Arrangements
The Compensation Committee of the Board of Directors, as administrator of the 1996 Plan, has the authority to provide
for accelerated vesting of the ordinary shares subject to outstanding options held by the executive officers in connection with
certain changes in control of the Company or the subsequent termination of the officer’s employment following the change in
control event.
## Employees
As of December 31, 2003, the Company had 1,145 employees, of whom 321 were engaged in research, development, and
quality assurance, 486 were engaged in marketing, sales and business development, 163 were engaged in customer support, and
175 were engaged in Information systems, administration and finance. From time to time, the Company also engages a limited
number of consultants, subcontractors and temporary help. As of December 31, 2003, the Company had 50 people of the
abovementioned nature. The Company believes that its relations with its employees are satisfactory.
As of December 31, 2003, the Company employed 500 people in Israel, 463 people in the United States and 182 people in
the rest of the world. With respect to its employees in Israel, the Company is subject to various Israeli labor laws and labor practices,
and to administrative orders extending certain provisions of collective bargaining agreements between the Histadrut (Israel’s General
Federation of Labor) and the Coordinating Bureau of Economic Organizations (the Israeli federation of employers’ organizations) to
all private sector employees. For example, mandatory cost of living adjustments, which compensate Israeli employees for a portion
of the increase in the Israeli consumer price index, are determined on a nationwide basis. Israeli law also requires the payment of
severance benefits upon the termination, retirement or death of an employee. The Company meets this requirement by contributing
on an ongoing basis towards “managers’ insurance” funds that combine pension, insurance and, if applicable, severance pay benefits.
In addition, Israeli employers and employees are required to pay specified percentages of wages to the National Insurance Institute,
which is similar to the United States Social Security Administration. Other provisions of Israeli law or regulation govern matters
such as the length of the workday, minimum wages, other terms of employment and restrictions on discrimination. The Company is
subject to the labor laws and regulations of other jurisdictions in the world where it has employees.
---
## ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS
The following table sets forth certain information regarding ownership of the Company’s ordinary shares as of February
16, 2004 for each person who is known by the Company to own beneficially more than five percent of the Company’s outstanding
ordinary shares:
| Name of Five Percent Shareholders | Amount Beneficially Owned | Percentage of Class(3) |
| --- | --- | --- |
| Gil Shwed | 29,751,494(1) | 11.7% |
| Franklin Resources,Inc. | 27,306,935(2) | 11.0% |
| Marius Nacht | 27,311,794(1) | 10.8% |
| Janus Capital Management LLC | 17,335,164(2) | 7.0% |
| Shlomo Kramer | 13,746,900(1) | 5.5% |
(1) The amount includes ordinary shares owned by each of the above, directly or indirectly and options immediately exercisable
or that are exercisable within 60 days from December 31, 2003. The exercise price of some of these options is higher than
the current Check Point’s share market price.
(2) Based on the most recent 13G filing.
(3) The percentage is calculated using the amount beneficially owned, divided by the sum of total outstanding ordinary shares
and options exercisable within 60 days from December 31, 2003, if applicable.
According to the Company’s transfer agent, as of March 22, 2004 there were 281 holders of record of the Company’s
ordinary shares residing in the United States holding 202,596,715 ordinary shares, or 80.78% of the aggregate number of ordinary
shares outstanding.
The Company is not directly or indirectly controlled by another corporation or by any foreign government. The Company’s
major shareholders do not have different voting rights with respect to their shares.
## ITEM 8. FINANCIAL INFORMATION
## Consolidated Financial Statements
The Company’s Consolidated Financial Statements included in this Annual Report on Form 20-F beginning on page F-1
are hereby incorporated into this Annual Report by reference.
## Dividend Policy
The Company anticipates that it will retain any future earnings to support operations and to finance the growth and
development of its business. In addition, tax-exempt income attributable to the Company’s status as an Approved Enterprise
under Israeli tax law can be distributed to shareholders without subjecting the Company to taxes only upon the complete
liquidation of the Company. Tax will be levied if the Company decides to distribute such income in the future. Currently, the
Company intends to reinvest the amount of its tax-exempt income.
## Legal Proceedings
In 1996, Checkpoint Systems, Inc. (“CSI”) a manufacturer of theft prevention devices for retail stores has taken legal
actions in respect of trademark infringement and unfair competition against the Company. In 2002 a trademark opposition was
filed by CSI with the Patent and Trademark Office. In February 2003 the parties entered into an agreement that settled all of the
disputes by definitively setting forth each company's trademark description. The agreement permits both parties to use the mark
“Check Point” and to seek registration consistent with the descriptive aspects of their respective businesses.
Beginning on August 29, 2003, Check Point received a number of class action complaints filed in the United States District
Court for the Southern District of New York by holders of Check Point ordinary shares, alleging violations of Section 10(b) of the
Securities Exchange Act of 1934 (the “Exchange Act”), Rule 10b-5 promulgated thereunder, and Section 20(a) of the Exchange Act.
On November 20, 2003, the court consolidated all of the complaints into one action and appointed lead plaintiff. On January 14,
2004, the lead plaintiff filed a Consolidated Amended Complaint, purporting to represent a putative class of all purchasers of ordinary
shares between July 10, 2001 and April 4, 2002. The complaint generally alleges that Check Point and certain of its senior officers
made misrepresentations and omissions regarding, among other things, Check Point’s sales, revenue, and future prospects. Check
Point has retained experienced counsel and is currently moving to dismiss the complaint pursuant to Rule 12(b)(6) and Rule 9(b) of
the Federal Rules of Civil Procedure and Section 21D(b)(3) of the Exchange Act. Further analysis cannot be provided until the
resolution of the motion to dismiss. Check Point disputes the allegations of wrongdoing and intends to defend the matter vigorously.
---
## ITEM 9. THE OFFER AND LISTING
The Company’s ordinary shares are traded publicly on the NASDAQ National Market under the symbol “CHKP.”
The following table lists the high and low closing sale prices for the ordinary shares for the periods indicated as reported
by the NASDAQ National Market:
| | High | Low |
| --- | --- | --- |
| 1999 | 34.85 | 4.46 |
| 2000 | 113.33 | 30.54 |
| 2001 | 110.58 | 20.70 |
| 2002 | 47.20 | 12.11 |
| 2003 | 21.27 | 13.82 |
| 2002 | | |
| First Quarter | 47.20 | 27.48 |
| Second Quarter | 29.50 | 13.00 |
| Third Quarter | 18.71 | 12.11 |
| Forth Quarter | 17.46 | 12.97 |
| 2003 | | |
| First Quarter | 16.32 | 13.82 |
| Second Quarter | 21.17 | 14.61 |
| Third Quarter | 21.27 | 15.89 |
| Forth Quarter | 18.36 | 16.33 |
| Most recent six months | | |
| September 2003 | 20.39 | 16.65 |
| October 2003 | 18.22 | 16.33 |
| November 2003 | 18.36 | 16.55 |
| December 2003 | 18.06 | 16.54 |
| January 2004 | 21.61 | 16.87 |
| February 2004 | 24.07 | 20.50 |
On March 29, 2004, the last reported sale price of the Company’s ordinary shares on the NASDAQ National Market was
$23.20 per share.
## ITEM 10. ADDITIONAL INFORMATION
The objectives and purposes of the Company are to engage in any lawful activity everywhere in the world. In connection
therewith, Check Point develops, markets and supports Internet security and VPN brand solutions for enterprise and high-end
networks, service providers, small businesses and consumers. The Company delivers solutions that enable secure, reliable and
manageable communications over Internet Protocol networks including the Internet, intranets and extranets. Articles of
Association
The following is a summary of the material provisions of the Company’s Articles of Association and related provisions
of Israeli corporate law. This summary is qualified in its entirety by reference to the complete text of the Articles of Association;
see “Item 4 – Information on the Company – General” and “Item 19 - Exhibits.”
## Description of Shares
The Company’s authorized share capital consists of 500,000,000 ordinary shares, NIS 0.01 nominal value, 5,000,000
Preferred Shares, NIS 0.01 nominal value, and 10 deferred shares, NIS 1 nominal value. The deferred shares are not entitled to any
rights other than the right to receive their nominal value upon liquidation of the Company.
---
All issued and outstanding ordinary shares are validly issued, fully paid and non-assessable. The ordinary shares do not
have pre-emptive rights. Neither the Memorandum of Association and the Articles of Association of the Company nor the laws of
Israel restrict in any way the ownership or voting of ordinary shares by non-residents of Israel, except with respect to subjects of
counties, which are in a state of war with Israel.
## Dividend and Liquidation Rights
Subject to the rights of the holders of shares with preferential or other special rights which may be authorized in the
future, holders of ordinary shares are entitled to receive dividends out of assets legally available therefore and, in the event of the
winding up of the Company, to share ratably in all assets remaining after payment of liabilities, subject to applicable law.
## Voting, Shareholder Meetings and Resolutions
Holders of ordinary shares have one vote for each ordinary share held on all matters submitted to a vote of shareholders.
Such voting rights may be affected by the grant of any special voting rights to the holders of a class of shares with preferential
rights that may be authorized in the future.
An annual general meeting is to be held once every calendar year at such time (within a period of not more than 15
months after the last preceding annual general meeting) and at such place, either within or outside of Israel, as may be determined
by the Board of Directors. The quorum required for a general meeting of shareholders consists of at least two shareholders
present in person or by proxy and holding more than 50% of the voting power of the Company. A meeting adjourned for lack of
quorum shall be adjourned to the same day in the next week at the same time and place, or to such time and place as the chairman
of the Board may determine with the consent of the holders of a majority of the voting power represented at the meeting in person
or by proxy and voting on the question of adjournment. If at such adjourned meeting a quorum is not present within one half hour
from the time appointed for holding the meeting, any two shareholders present in person or by proxy will constitute a quorum,
regardless of the number of shares represented.
An ordinary resolution (such as resolution for the election of directors and the appointment of auditors) shall be deemed
adopted if approved by the holders of a majority of the voting power represented at the meeting, in person or by proxy, and voting
thereon. A special or extraordinary resolution (such as a resolution amending the Memorandum of Association or Articles of
Association) shall be deemed adopted if approved by the holders of not less than 75% of the voting power represented at the
meeting, in person or by proxy, and voting thereon.
The Israeli Companies Law requires that the shareholders approve certain transactions, actions and arrangements. Such
transactions, actions and arrangements include: (i) arrangements with a director as to the terms of office or compensation; (ii)
certain extraordinary transactions (as defined in the Companies Law); and (iii) any action or extraordinary transaction involving a
director or officer in which a majority of the Board or the statutory audit committee has a personal interest. See “Approval of
Certain Transactions; Obligations of Directors, Officers and Shareholders” below in this Item 10.
## Transfer of Shares and Notices
Fully paid ordinary shares are issued in registered form and, subject to applicable securities laws, may be transferred
freely. Each shareholder of record is entitled to receive at least 21 days’ prior notice of shareholder meetings. For purposes of
determining the shareholders entitled to notice and to vote at such meeting, the Board of Directors may fix the record date which
shall be not more than forty nor less than four days prior to the date of the meeting.
## Election of Directors
The ordinary shares do not have cumulative voting rights in the election of directors. Thus, the holders of ordinary
shares conferring more than 50% of the voting power have the power to elect all the directors, to the exclusion of the remaining
shareholders.
## Transfer Agent and Registrar
American Stock Transfer & Trust Company is the Transfer Agent and Registrar for the ordinary shares.
## Description of Preferred Shares
The Company has 5,000,000 preferred shares authorized. The Company’s Articles of Association provide that the Board
of Directors has the authority to issue the preferred shares in one or more series and to fix the rights, preferences, privileges and
restrictions of such shares, including dividend rights, dividend rates, conversion rights, voting rights, terms of redemption,
redemption prices, liquidation preferences and the number of shares constituting any series, without further vote or action by the
shareholders. If this provision withstands judicial scrutiny under the Israeli Companies Law, the issuance of preferred shares may
33 have the effect of delaying, deferring or preventing a change in control of the Company without further action by the shareholders.
For example, the Board of Directors could issue preferred shares with voting and conversion rights, which may adversely affect
the voting power of the holders of ordinary shares, including the loss of voting control to others. The Company currently has no
plans to issue any preferred shares.
## Provisions Affecting a Potential Change of Control
The Company’s Articles of Association provide that the Company may not engage in any business combination with an
interested shareholder for a period of three years following the date that such shareholder became an interested shareholder,
unless: (a) prior to such date, the Board of Directors approved either the business combination or the transaction that resulted in
the shareholder’s becoming an interested shareholder; or (b) upon consummation of the transaction that resulted in the
shareholder’s becoming an interested shareholder, the interested shareholder owned at least 75% of the voting shares of the
Company outstanding at the time the transaction commenced. A business combination includes: (i) any merger or consolidation
involving the Company and the interested shareholder; (ii) any sale, transfer, pledge or other disposition of 10% or more of the
assets of the Company in a transaction involving the interested shareholder; (iii) subject to certain exceptions, any transaction that
results in the issuance or transfer by the Company of any shares of the Company to the interested shareholder; (iv) any transaction
involving the Company that has an effect of increasing the proportionate share of the shares of any class or series of the Company
beneficially owned by the interested shareholder; or (v) the receipt by the interested shareholder of the benefit of any loans,
advances, guarantees, pledges or other financial benefits provided by or through the Company. In general, the Articles of
Association define an interested shareholder as any entity or person beneficially owning 15% or more of the outstanding voting
shares of the Company and any entity or person affiliated with, controlling or controlled by such entity or person.
## 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 care generally
requires an office holder to act with the level of care, which a reasonable office holder in the same position would have acted
under the same circumstances. 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 position as an office
holder. Each person listed in the table that appears at the beginning of “Item 6 – Directors, Senior Management and Employees”
is an office holder of the Company.
Under the Israeli Companies Law, generally 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 may have and all related material information known to him, in
connection with any existing or proposed transaction with the company. In addition, the office holder must also generally disclose
any personal interest held by the office holder’s specified relatives, or by any corporation in which the office holder or the office
holder’s relative is a five percent or greater shareholder, director or general manager or in which he has the right to appoint at least
one director or the general manager.
In the case of a transaction that is not an extraordinary transaction, after the office holder complies with the above
disclosure requirements, only board of directors’ 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 of directors 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 extraordinary transaction is 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. 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 or employee, require the
approval of the audit committee, the board of directors and the shareholders of the company. Shareholders approval must either
include at least one-third of the votes of disinterested shareholders who are present, in person or by proxy, at the meeting or,
alternatively, the total shareholdings of the disinterested shareholders who vote against the transaction must not represent more
than one percent of the voting rights in the company.
---
Under the Israeli Companies Law, a shareholder has a duty to act in good faith toward the company and other
shareholders and refrain from abusing his power in the company, including, among other things, voting in the general meeting of
shareholders on the following matters:
- any amendment to the articles of association;
- an increase of the company's authorized share capital;
- a merger; or
- approval of interested party transactions that require shareholder approval.
In addition, any controlling shareholder, any shareholder who can determine the outcome of a shareholder vote and any
shareholder who, under the company’s articles of association, can appoint or prevent the appointment of an office holder, is under
a duty to act with fairness towards the company. The Israeli Companies Law does not describe the substance of this duty.
## 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 as a result of the breach
of his duty of care to the company or to another person, or as a result of the breach of his fiduciary duty to the company, to the
extent that he 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 committed in connection with his
serving as an office holder. Moreover, a company can indemnify an office holder for (a) monetary liability imposed upon him in
favor of other persons pursuant to a court judgment, including a settlement or an arbitrator’s decision approved by a court, and (b)
reasonable litigation expenses, including attorneys’ fees, actually incurred by him or imposed upon him by a court, in an action,
suit or proceeding brought against him by or on behalf of the company or other persons, or in a criminal action in which he was
acquitted, or in a criminal action which does not require criminal intent in which he was convicted, in each case in connection
with his activities as an office holder. The Company’s Articles of Association allow for insurance and indemnification of office
holders to the fullest extent permitted by law. The Company has entered into indemnification, insurance and exculpation
agreements with its directors and senior officers, following shareholder approval of these agreements. The Company has
directors’ and officers’ liability insurance covering the officers and directors of the Company and its subsidiaries for certain
claims.
## Borrowing Power: Amendment of Rights of Ordinary Shares
The Company’s Articles of Association grant broad powers to the Board of Directors to authorize the Company to
borrow funds, repay borrowings, make guarantees and grant security interests in borrowings. The rights and provisions of the
ordinary shares may be cancelled, added to, restricted, amended or otherwise altered with a vote of the holders of at least 75% of
the outstanding ordinary shares voting at a duly convened shareholders’ meeting.
## NASDAQ National Market Corporate Governance Rules
In accordance with Rule 4350(a)(1) of the Rules of Corporate Governance of The NASDAQ National Market, Inc., the
Company has received an exemption from the requirement to distribute an annual report to its shareholders prior to the Company's
annual general meeting of shareholders. The basis for the exemption is the fact that the generally accepted business practice
in Israel, where the Company is incorporated, is not to distribute an annual report to shareholders. The Company posts its Annual
Report on Form 20-F on its Website (www.checkpoint.com) promptly following the filing of the Annual Report with the
Securities and Exchange Commission.
## Israeli Taxation, Foreign Exchange Regulation and Investment Programs
The following is a summary of the material Israeli tax consequences, Israeli foreign exchange regulations and certain
Israeli government programs affecting the Company.
**To the extent that the discussion is based on new tax or other legislation that has not been subject to judicial or**
**administrative interpretation, there can be no assurance that the views expressed in the discussion will be accepted by the**
**tax or other authorities in question. The discussion is not intended, and should not be construed, as legal or professional**
**tax advice and is not exhaustive of all possible tax considerations.**
## Tax Reform
On January 1, 2003 a comprehensive tax reform took effect in Israel. Pursuant to the reform, resident companies are
subject to Israeli tax on income accrued or derived in Israel or abroad. In addition, the concept of “controlled foreign corporation”
was introduced according to which an Israeli company may become subject to Israeli taxes on certain income of a non-Israeli
subsidiary if the subsidiary's primary source of income is passive income (such as interest, dividends, royalties, rental income or
capital gains). The tax reform also substantially changed the system of taxation of capital gains.
---
Israeli companies are generally subject to corporate tax at the rate of 36% of their taxable income. However in the
Company's case, the rate is currently effectively reduced, as described below.
*Tax benefits under the Law for the Encouragement of Capital Investments, 1959*
The Company’s facilities have been granted Approved Enterprise status pursuant to the Law for the Encouragement of
Capital Investments, 1959 (the “Investment Law”), which provides certain tax and financial benefits to investment programs that
have been granted such status.
The Investment Law provides that a proposed capital investment in eligible facilities may, upon application to the
Investment Center of the Ministry of Industry, Trade and Labor of the State of Israel, be designated as an Approved Enterprise.
Each certificate of approval for an Approved Enterprise relates to a specific investment program delineated both by its financial
scope, including its capital sources, and by its physical characteristics, such as the equipment to be purchased and utilized
pursuant to the program. The tax benefits under the Investment Law are not available for income derived from products
manufactured outside of Israel.
A company owning an Approved Enterprise may elect to receive either governmental grants or an alternative package of
tax benefits. Under the alternative package a company's undistributed income derived from an Approved Enterprise will be
exempt from corporate tax for a period of two years (depending on the geographic location of the Approved Enterprise within
Israel). The exemption commences in the first year of taxable income, and taxed at a reduced corporate tax of 10% to 25% for the
following five to eight years, depending on the extent of foreign investment in the Company. The benefits period is limited to
twelve years from completion of the investment under the approved plan or fourteen years from the date of approval, whichever is
earlier. A Foreign Investors Company (“FIC”), as defined in the Investment Law, may enjoy benefits for an extended period of up
to ten years. A FIC is a company of which more than 25% of its shareholders are non-Israeli residents.
The tax benefits derived from any certificate of approval relate only to taxable income attributable to the specific
Approved Enterprise. If a company has more than one approval or only a portion of its capital investments are approved, its
effective tax rate is the result of a weighted combination of the applicable rates.
Distribution of earnings derived from Approved Enterprise which were previously taxed at reduced tax rates, would not
result in additional tax consequences to the Company. However, if retained tax-exempt income is distributed in a manner other
than upon the complete liquidation of the Company, the Company would be taxed at the reduced corporate tax rate applicable to
such profits (between 10%-25%). The Company is not obliged to distribute exempt retained profits under the alternative package
of benefits, and may generally decide from which source of income to declare dividends. The Company currently intends to
reinvest the amount of its tax-exempt income and not to distribute such income as a dividend. Dividends from Approved
Enterprises are generally taxed at a rate of 15% (which is withheld and paid by the Company paying the dividend) if such
dividend is distributed during the benefits period or within twelve years thereafter. The twelve-year limitation does not apply to
an FIC.
The Company’s production facilities have been granted the status of Approved Enterprises. Income arising from the
Company’s Approved Enterprise facilities is tax-free under the alternative package of benefits described above and entitled to
reduced tax rates based on the level of foreign ownership for specified periods. The Company has derived, and expects to
continue to derive, a substantial portion of its operating income from its Approved Enterprise facilities. The tax benefits
attributable to the Company’s current Approved Enterprises are scheduled to expire gradually from 2005 to 2013.
The Investment Center bases its decision as to whether to approve or reject an application for designation as an Approved
Enterprise, on the criteria set forth in the Investment Law and regulations, the then prevailing policy of the Investment Center, and
the specific objectives and financial criteria of the applicant. Accordingly, there can be no assurance that any such application
will be approved. In addition, the benefits available to an Approved Enterprise are conditional upon the fulfillment of conditions
stipulated in the Investment Law and related regulations and the criteria set forth in the specific certificate of approval. In the
event that a company does not meet these conditions, it would be required to refund a portion of the benefits already received, plus
a linkage adjustment to the Israeli consumer price index and interest.
The Investment Law and regulations prescribing the benefits provide for an expiration date for the grant of new benefits.
The expiration date has been extended several times in the past. The expiration date currently in effect is June 30, 2004 (which
may be extended by ministerial decision until December 31, 2004), and no new benefits will be granted after that date unless the
expiration date is extended again. There can be no assurance that new benefits will be available after June 30, 2004 or that
existing benefits will be continued in the future at their current level or at any level.
---
According to the Law for the Encouragement of Industry (Taxation), 1969 (the “Industry Encouragement Law”), an
Industrial Company is a company resident in Israel, that at least 90% of its income in any tax year (determined in Israeli currency,
exclusive of income from certain government loans, capital gains, interest and dividends), is derived from an Industrial Enterprise
owned by it. An Industrial Enterprise is defined as an enterprise whose major activity in a given tax year is industrial production
activity. The Company believes it currently qualifies as an Industrial Company within the definition of the Industry
Encouragement Law. Under the Industry Encouragement Law, Industrial Companies are entitled to the following preferred
corporate tax benefits:
- Deduction of purchases of know-how and patents over an eight-year period for tax purposes;
- Right to elect, under specified conditions, to file a consolidated tax return with related Israeli Industrial Companies; and
- Accelerated depreciation rates on equipment and buildings.
Eligibility for the benefits under the Industry Encouragement Law is not subject to receipt of prior approval from any
governmental authority. The Israeli tax authorities may determine that we do not qualify as an Industrial Company, which would
entail the loss of the benefits that relate to this status. In addition, no assurance can be given that the Company will continue to
qualify as an Industrial Company, in which case the benefits described above will not be available in the future.
## Special Provisions Relating to measurement of taxable income
Until December 31, 2001, the Company measured its taxable income in accordance with the Income Tax Law
(Inflationary Adjustments), 1985 (the “Inflationary Adjustments Law”) which represents an attempt to overcome the problems
presented to a traditional tax system by an economy undergoing rapid inflation. The Inflationary Adjustments Law is highly
complex. Since January 1, 2002, the Company elected to measure its taxable income based on the changes in the exchange rate of
the U.S. dollar rather than on the basis of inflation.
## Capital Gains Tax applicable to Shareholders
Israeli law generally imposes a capital gains tax on the sale of capital assets located in Israel, including shares in Israeli
resident companies, by both residents and non-residents of Israel, unless a specific exemption is available or unless a treaty
between Israel and the country of the non-resident provides otherwise. Regulations promulgated under the Israeli Income Tax
Ordinance provided for an exemption from Israeli capital gains tax for gains accrued before January 1, 2003 and derived from the
sale of shares of an Industrial Company, as defined by the Industry Encouragement Law, that are traded on specified non-Israeli
markets, including The NASDAQ National Market, provided that the sellers purchased their shares either in the company's initial
public offering or in public market transactions thereafter. This exemption does not apply to shareholders who are in the business
of trading securities, or to shareholders that are Israeli resident companies subject to the Inflationary Adjustments Law. The
Company believes that it is currently an Industrial Company, as defined by the Industry Encouragement Law. The status of a
company as an Industrial Company may be reviewed by the tax authorities from time to time. There can be no assurance that the
Israeli tax authorities will not deny the Company’s status as an Industrial Company, possibly with retroactive effect.
On January 1, 2003, the Law for Amendment of the Income Tax Ordinance (Amendment No.132), 2002, known as the
tax reform, came into effect thus imposing capital gains tax at a rate of 15% on gains derived on or after January 1, 2003 from the
sale of shares in Israeli companies publicly traded on a recognized stock exchange outside of Israel. This tax rate does not apply
to:(1) dealers in securities;(2) shareholders that report in accordance with the Inflationary Adjustments Law; or (3) shareholders
who acquired their shares prior to an initial public offering. The tax basis of shares acquired prior to January 1, 2003 will be
determined as the higher between the original price paid for the share and the average closing share price in the three trading days
preceding January 1, 2003. Non-Israeli residents shall be exempt from Israeli capital gains tax on any gains derived from the sale
of shares publicly traded on a stock exchange recognized by the Israeli Ministry of Finance, provided such shareholders did not
acquire their shares prior to an initial public offering. Although it is generally believed that the NASDAQ National Market will be
included in the list of recognized stock exchanges, the Israeli Minister of Finance has not yet issued a decree determining the list
of such stock exchanges. In any event, the provisions of the tax reform shall not affect the exemption from capital gains tax for
gains accrued before January 1, 2003, as described in the previous paragraph.
In addition, pursuant to the Convention Between the Government of the United States of America and the Government of
Israel with respect to Taxes on Income, as amended (the “United States-Israel Tax Treaty”), the sale, exchange or disposition of
ordinary shares by a person who qualifies as a resident of the United States within the meaning of the United States-Israel Tax
Treaty and who is entitled to claim the benefits afforded to such person by the United States- Israel Tax Treaty (a “Treaty United
States Resident”) generally will not be subject to the Israeli capital gains tax unless such Treaty United States Resident holds,
directly or indirectly, shares representing 10% or more of the Company’s voting power during any part of the twelve-month
period preceding such sale, exchange or disposition, subject to certain conditions. A sale, exchange or disposition of ordinary
shares by a Treaty United States Resident who holds, directly or indirectly, shares representing 10% or more of the Company’s
voting power at any time during such preceding twelve-month period would be subject to such Israeli tax, to the extent applicable;
37 however, under the United States-Israel Tax Treaty, such Treaty United States Resident would be permitted to claim a credit for
such taxes against the United States federal income tax imposed with respect to such sale, exchange or disposition, subject to the
limitations in United States laws applicable to foreign tax credits. The United States-Israel Tax Treaty does not relate to United
States state or local taxes.
## Taxation of Non-Resident Shareholders
Non-residents of Israel are subject to Israeli income tax on income accrued or derived from sources in Israel, including
passive income such as dividends, royalties and interest. On distributions of dividends, other than bonus shares and stock
dividends, income tax at the rate of 25% is withheld at the source, unless a different rate is provided in a treaty between Israel and
the shareholder's country of residence. If the dividends are distributed out of Approved Enterprise earnings, the applicable tax rate
would be 15%. Under the United States- Israel Tax Treaty, the maximum tax on dividends paid to a holder of ordinary shares
who is a Treaty United States Resident will be 25%, however the tax rate is reduced to12.5% for dividends not generated by an
Approved Enterprise to a corporation which holds 10% or more of the Company’s voting power during a certain period preceding
the distribution of the dividend. Dividends derived from an Approved Enterprise will still be subject to 15% tax withholding.
## Foreign Exchange Regulations
Dividends, if any, paid to the holders of the ordinary shares, and any amounts payable upon dissolution, liquidation or
winding up, as well as the proceeds of any sale in Israel of the ordinary shares to an Israeli resident, may be paid in non-Israeli
currency or, if paid in Israeli currency, may be converted into freely repatriable U.S. dollars at the rate of exchange prevailing at
the time of conversion, however, Israeli income tax is required to have been paid or withheld on these amounts. In addition, the
statutory framework for the potential imposition of exchange controls has not been eliminated, and may be restored at any time by
administrative action.
## United States Federal Income Taxes
The following summary sets forth the material United States federal income tax consequences applicable to the following
persons who purchase, hold or dispose of the ordinary shares (“U.S. Shareholders”); (i) citizens or residents (as defined for U.S.
federal income tax purposes) of the United States; (ii) corporations or other entities taxable as corporations created or organized in or
under the laws of the United States or any state thereof; (iii) estates, the income of which is subject to United States federal income
taxation regardless of its source; and (iv) trusts, if (a) a U.S. court is able to exercise primary supervision over its administration and
(b) one or more U.S. persons have the authority to control all of its substantial decisions. This discussion is based on the provisions
of the Internal Revenue Code of 1986, as amended (the “Code”), United States Treasury Regulations promulgated thereunder and
administrative and judicial interpretations thereof, all as in effect as of the date of this Annual Report on Form 20-F. This discussion
generally considers only U.S. Shareholders that will hold the ordinary shares as capital assets and does not consider (a) all aspects of
U.S. federal income taxation that may be relevant to particular U.S. Shareholders by reason of their particular circumstances
(including potential application of the alternative minimum tax), (b) U.S. Shareholders subject to special treatment under the U.S.
federal income tax laws, such as financial institutions, insurance companies, broker-dealers, tax-exempt organizations and foreign
individuals or entities, (c) U.S. Shareholders owning directly or by attribution 10% or more of the Company's outstanding voting
shares, (d) U.S. Shareholders who hold the ordinary shares as part of a hedging, straddle or conversion transaction, (e) U.S.
Shareholders who acquire their ordinary shares in a compensatory transaction, (f) U.S. Shareholders whose functional currency is not
the U.S. dollar, or (g) any aspect of state, local or non-United States tax law.
**The following summary does not address the impact of an investor's individual tax circumstances. Accordingly, each**
**investor should consult his or her own tax advisor as to the particular tax consequences to him or her of an investment in the**
**ordinary shares, including the effects of applicable state, local or non-United States tax laws and possible changes in the tax**
**laws.**
## Dividends Paid on the Ordinary Shares
A U.S. Shareholder generally will be required to include in gross income the amount of any distributions paid in respect of
the ordinary shares (including the amount of any Israeli taxes withheld therefrom) to the extent that such distributions are paid out of
the Company's current or accumulated earnings and profits as determined for U.S. federal income tax purposes. Under U.S.
legislation enacted in 2003, which is generally effective for tax years beginning after December 31, 2002 and before January 1, 2009,
a maximum U.S. federal income tax rate of 15% (rather than the higher rates of tax generally applicable to items of ordinary income)
will apply to “qualified dividend income” received by an individual (as well as certain trusts and estates) provided certain holding
period requirements are met. Qualified dividend income generally includes dividends paid by a U.S. corporation or a “qualified
foreign corporation.” A non-U.S. corporation (other than a foreign personal holding corporation, foreign investment company, or
passive foreign investment company) generally will be considered to be a qualified foreign corporation if (i) the shares of the non-
U.S. corporation are readily tradable on an established securities market in the United States, or (ii) the non-U.S. corporation is
eligible for the benefits of a comprehensive U.S. income tax treaty determined to be satisfactory to the United States Department of
the Treasury. The United States Department of the Treasury and the Internal Revenue Service have determined that the United
States-Israel Tax Treaty is satisfactory for this purpose. In addition, the United States Department of the Treasury and the Internal
Revenue Service have determined that ordinary shares are considered readily tradable on an established securities market if such
38 shares are listed on an established securities market in the United States such as the NASDAQ National Market. Information returns
reporting dividends paid to U.S. Shareholders will identify the amount of dividends eligible for the reduced rates. Distributions in
excess of such earnings and profits will be treated first as non-taxable return of capital reducing the U.S. Shareholder's tax basis in the
ordinary shares to the extent of the distributions, and then as capital gain from a sale or exchange of such ordinary shares. Such
dividends will generally not qualify for the dividends received deduction available to corporations. The amount of any cash
distribution paid in Israeli shekels will equal the U.S. dollar value of the distribution, calculated by reference to the spot exchange rate
in effect on the date of the distribution.
## Credit for Israeli Taxes Withheld
Subject to certain conditions and limitations, any Israeli tax withheld or paid with respect to dividends on the ordinary shares
will generally be eligible for credit against a U.S. Shareholder's United States federal income tax liability at such U.S. Shareholder's
election. The Code provides limitations on the amount of foreign tax credits that a U.S. Shareholder may claim, including extensive
separate computation rules under which foreign tax credits allowable with respect to specific categories of income cannot exceed the
United States federal income taxes otherwise payable with respect to each such category of income. U.S. Shareholders that do not
elect to claim a foreign tax credit may instead claim a deduction for Israeli income tax withheld or paid, but only for a year in which
these U.S. Shareholders elect to do so for all foreign income taxes. Special rules for determining a U.S. Shareholder’s foreign tax
credit limitation shall apply in the case of qualified dividend income. Rules similar to those concerning adjustments to the foreign tax
credit limitation to reflect any capital gain rate differential shall also apply to any qualified dividend income. The rules relating to
foreign tax credits are complex, and each investor should consult his of her tax advisor to determine whether and if he or her would
be entitled to this credit.
## Disposition of the Ordinary Shares
The sale or exchange of ordinary shares will generally result in the recognition of capital gain or loss in an amount equal to
the difference between the amount realized on the sale or exchange and the U.S. Shareholder's tax basis in the ordinary shares. Such
gain or loss generally will be long-term capital gain or loss if the U.S. Shareholder's holding period of the ordinary shares exceeds
one year at the time of the disposition. Under recently enacted U.S. legislation, long-term capital gains realized upon a sale or
exchange of ordinary shares after May 5, 2003 and before the end of a taxable year which begins before January 1, 2009 generally
will be subject to a maximum U.S. federal income tax rate of 15%. Gain or loss recognized by a U.S. Shareholder on a sale or
exchange of ordinary shares generally will be treated as U.S. source income or loss for U.S. foreign tax credit purposes. Under the
United States-Israel Tax Treaty gain derived from the sale, exchange or other disposition of ordinary shares by a holder who is a
resident of the United States for purposes of the treaty and who sells the ordinary shares within Israel may be treated as foreign source
income for U.S. foreign tax credit purposes.
## Passive Foreign Investment Company Status
Based upon its current income, assets and activities, the Company believes that it is currently not a passive foreign
investment company (a “PFIC”) for U.S. federal income tax purposes and currently does not anticipate that it will be a PFIC for
any subsequent year. The Company would be classified as a PFIC if, for any taxable year, either (i) 75% or more of its gross
income in the taxable year is passive income, or (ii) 50% or more of the average value of its gross assets in the taxable year,
calculated quarterly by value, produce or are held for the production of passive income. For this purpose, passive income
includes dividends, interest, royalties, rents, annuities and the excess of gain over losses from the disposition of assets, which
produce passive income. If the Company were a PFIC for any taxable year during a U.S. Shareholder’s holding period and the
U.S. Shareholder does not timely elect to treat the Company as a “qualified electing fund” under Section 1295 of the Code or elect
to mark the ordinary shares to market, a U.S. Shareholder would be subject to special tax rules on the receipt of an “excess
distribution” on the ordinary shares (generally, a distribution to the extent it exceeds 125% of the average annual distributions in
the prior three years) and on gain from the disposition of the ordinary shares. Under these rules, the excess distribution and any
gain would be allocated ratably over the U.S. Shareholder’s holding period for the ordinary shares, the amount allocated to the
current taxable year and any taxable year prior to the first taxable year in which the Company is a PFIC would be taxed as
ordinary income, the amount allocated to each of the other taxable years would be subject to tax at the highest marginal rate in
effect for the applicable class of taxpayer for that year, and an interest charge for the deemed deferral benefit would be imposed
on the resulting tax allocated to such other taxable years. The tax liability with respect to amounts allocated to years prior to the
year of the disposition or “excess distribution” cannot be offset by any net operating losses. Additionally, if the Company is
deemed to be a PFIC, a U.S. Shareholder who acquires ordinary shares in the Company from a decedent will be denied the
normally available step-up in tax basis to fair market value for the ordinary shares at the date of the death, and instead will have a
tax basis equal to the decedent’s tax basis if lower than fair market value.
U.S. Shareholders may avoid taxation under the rules described above by making (i) a “qualified electing fund” election
for the first taxable year in which the Company is a PFIC to include such holder’s share of the Company’s ordinary earnings and
net capital gain on a current basis or (ii) a “deemed sale” election in a subsequent year, along with a qualified electing fund
election, if the Company is still classified as a PFIC. However, a U.S. Shareholder may make a qualified electing fund election
only if the Company agrees to furnish the U.S. Shareholder annually with certain tax information. The Company does not
presently prepare or provide such information, and such information may not be available to U.S. Shareholders if the Company is
subsequently determined to be a PFIC.
---
U.S. Shareholders holding “marketable shares” (which the Company considers the ordinary shares to be) in a PFIC may
make an election to “mark-to-market” the ordinary shares annually, rather than be subject to the above-described rules. Under
such election, the U.S. Shareholder will include in income each year any excess of the fair market value of the PFIC stock at the
close of each taxable year over the U.S. Shareholder’s adjusted basis in such stock. The U.S. Shareholder will generally be
allowed an ordinary deduction for the excess, if any, of the adjusted basis of the PFIC stock over its fair market value as of the
close of the taxable year, or the amount of any net mark-to-market gains recognized for prior taxable years, whichever is less. A
U.S. Shareholder’s adjusted tax basis in the ordinary shares will generally be adjusted to reflect the amounts included or deducted
under the mark-to-market election. Additionally, any amounts included in income pursuant to a mark-to-market election, as well
as gain on the actual sale or other disposition of the PFIC stock, are treated as ordinary income. Ordinary loss treatment also
applies to any loss recognized on the actual sale or disposition of PFIC stock to the extent that the amount of such loss does not
exceed the net mark-to-market gains previously included with respect to such stock. An election to mark-to-market generally will
apply to the taxable year in which the election is made and all subsequent taxable years.
If a U.S. Shareholder makes one of these two elections, distributions and gain will not be recognized ratably over the
U.S. Shareholder’s holding period or be subject to an interest charge as described above. Further, the denial of basis step-up at
death described above will not apply. A U.S. Shareholder making one of these two elections may experience current income
recognition, even if no cash is distributed by the Company.
A U.S. Shareholder who beneficially owns shares in a PFIC must file an annual return with the IRS on IRS Form 8621
that describes any distributions received with respect to such shares and any gain realized on the disposition of such shares.
A number of specific rules and requirements apply to both of these elections available to owners of a PFIC and a U.S.
Shareholder is urged to consult his or her tax advisor concerning these elections.
## Information Reporting and Back up Withholding
Dividend payments and proceeds from the sale or disposal of ordinary shares may be subject to information reporting to
the Internal Revenue Service and possible U.S. federal backup withholding at the current rate of 28% (increased to 31% for
taxable years 2011 and thereafter). Backup withholding will not apply, however, to a holder who furnishes a correct taxpayer
identification number or certificate of foreign status and makes any other required certification or who is otherwise exempt from
backup withholding (for example, a corporation). Any U.S. Shareholder who is required to establish exempt status generally must
file IRS Form W-9 (“Request for Taxpayer Identification Number and Certification”). Finalized Treasury Regulations which are
applicable to payments made after December 31, 2000 have generally expanded the circumstances under which information
reporting and backup withholding may apply. Amounts withheld as backup withholding may be credited against a U.S.
Shareholder’s federal income tax liability. A U.S. Shareholder may obtain a refund of any excess amounts withheld under the
backup withholding rules by filing the appropriate claim for refund with the Internal Revenue Service and furnishing any required
information.
## ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risks relating to the Company’s operations result primarily from weak economic conditions in the markets in which
the Company sells its products and from changes in exchange rates or in interest rates. Other than forward exchange currency
contracts and forward rate agreements described below which are used for hedging cash flow in transactions not denominated in U.S.
dollars, the Company does not use derivative financial instruments in its investment portfolio.
---
The table below presents principal amounts and related weighted average rates by date of maturity for the Company’s
investments in cash and cash equivalents, deposits and marketable securities held as of December 31, 2003.
| | | Maturity | | | | | Total Book Value | Fair Value at Dec.31, 2003 |
| --- | --- | --- | --- | --- | --- | --- | --- | --- |
| | | 2004 | 2005 | 2006 | 2007 | 2008 onwards | | |
| (In thousands, except percentages) | | | | | | | | |
| Government and Corporate Securities-Fixed interest rates | Book Value | $414,558 | $262,479 | $61,473 | $10,918 | $1,010 | $750,438 | $758,527 |
| Government and Corporate Securities-Fixed interest rates | WAIR* | 3.14% | 3.66% | 3.45% | 3.00% | - | 3.34% | |
| Structured Products*** | Book Value | $202,646 | - | - | - | - | $202,646 | $204,887 |
| Structured Products*** | WAIR* | 5.15% | - | - | - | - | 5.15% | |
| Mortgage and Asset Backed Securities | Book Value | $49,871 | $53,982 | $29,695 | $10,623 | $8,945 | $153,116 | $151,075 |
| Mortgage and Asset Backed Securities | WAIR* | 2.40% | 1.89% | 2.29% | 2.25% | 1.29% | 2.12% | |
| Auction Rate Securities | Book Value | $92,550 | - | - | - | - | $92,550 | $92,881 |
| Auction Rate Securities | WAIR* | 1.61% | - | - | - | - | 1.61% | |
| Government and Corporate Securities-Floating interest rates** | Book Value | $24,049 | $12,653 | $14,600 | - | - | $51,302 | $51,226 |
| Government and Corporate Securities-Floating interest rates** | WAIR* | 2.61% | 1.32% | 1.30% | - | - | 1.92% | |
| Money Market instruments | Book Value | $8,596 | - | - | - | - | $8,596 | $8,595 |
| Money Market instruments | WAIR* | 1.03% | - | - | - | - | 1.03% | |
| Money market Fund | Book Value | $327,188 | - | - | - | - | $327,188 | $327,188 |
| Money market Fund | WAIR* | 1.10% | - | - | - | - | 1.10% | |
| Deposits | Book Value | $16,888 | - | - | - | - | $16,888 | $16,888 |
| Deposits | WAIR* | 3.61% | - | - | - | - | 3.61% | |
| Total | Book Value | $1,136,346 | $329,114 | $105,768 | $21,541 | $9,955 | $1,602,724 | $1,611,267 |
| Total | WAIR* | 2.73% | 3.28% | 2.83% | 2.63% | 1.16% | 2.84% | |
* WAIR – Weighted Average Interest Rate
** Based upon LIBOR as of December 31, 2003
*** Composed of callable range accrual notes and inverse floaters (see also Note 3 of the financial statements) and bears an
interest rate related to the LIBOR. There is no assurance that this WAIR could be maintained in the future due to the
nature of these products
---
## Foreign Currency Risk
Most of the Company’s sales are denominated in U.S. dollars. In addition, a substantial portion of the Company’s
expenses is incurred in U.S. dollars. The Company’s management believes that the U.S. dollar is the primary currency of the
economic environment in which the Company and its subsidiaries operate, and thus the U.S. dollar is their functional and
reporting currency. Accordingly, monetary accounts maintained in currencies other than the U.S. dollar (principally cash and cash
equivalents, short-term deposits and liabilities) are remeasured into U.S. dollars 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. All transaction gains and losses of the remeasurement of monetary balance sheet items are reflected in the
statement of income as financial income or expenses, as appropriate.
The Company hedges the exposure of assets and anticipated revenues denominated in the Japanese Yen as well as
anticipated expenses denominated in Euros with forward and option contracts. The Company monitors its foreign currency
exposures periodically to maximize the overall effectiveness of its foreign currency hedge positions. If these derivatives meet the
definition of a hedge and are so designated, depending on the nature of the hedge, changes in the fair value of derivatives will either
be offset against the change in fair value of the hedged assets, liabilities or firm commitments through earnings or recognized in other
comprehensive income until the hedged item is recognized in earnings. The ineffective portion of a derivative’s change in fair value
is recognized in earnings.
As of December 31, 2003, the Company's management believes that because the above transactions are carried out with
well-established institutions, liabilities owing to the Company will be fulfilled. Total outstanding zero cost collar contracts and
forward contracts to hedge customers’ balances to sell/purchase U.S. dollars in exchange for Japanese Yen were in the amount of
$ 9.3 million. Total outstanding transactions to sell/purchase Euro in exchange for U.S. dollars were in the amount of $4.0
million. The above transactions were for a period of up to three months. As of December 31 2003, the Company expects to
reclassify during the following three months an insignificant amount of unrealized losses from accumulated other comprehensive
loss to expenses.
## Interest Rate Risk
The Company’s exposure to market risk for changes in interest rates relates primarily to the Company’s investment in
marketable securities. The Company’s marketable securities are comprised of U.S. and European government and corporate debt
instruments. The fair value of the Company’s long and short-term securities is based upon their market values as of December 31,
2003.
In 2001, the Company has entered into forward rate agreements (“FRA”,) in the amount of $125 million that effectively
convert a portion of its floating rate investments to a fixed rate basis for a 12 month period beginning one year after the date of the
agreements, thus reducing the impact of the interest rate changes on future interest income. The agreements were executed in
November 2002, resulting in a total gain of approximately $3.4 million presented in the statement of income as financial income. In
August 2003, the company has entered into an additional FRA agreement in the amount of $25 million for a 12 month period
beginning one year after the date of the agreement. As of December 31, 2003, the unrealized gain in respect of this agreement
amounted to $0.2 million.
## ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES
Not applicable.
---
## ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES
There are no defaults, dividend arrearages or delinquencies that are required to be disclosed.
## ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS
There are no material modifications to, or qualifications of, the rights of security holders that are required to be disclosed.
## ITEM 15. CONTROLS AND PROCEDURES
(a) The Company performed an evaluation of the effectiveness of its disclosure controls and procedures that are designed
to ensure that the material financial and non-financial information required to be disclosed on Form 20-F and filed with the
Securities and Exchange Commission is recorded, processed, summarized and reported timely. Based on the Company’s
evaluation, the Company’s management, including the CEO and CFO, has concluded that the Company’s disclosure controls and
procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended) as of the end of the
period covered by this report are effective. Notwithstanding the foregoing, there can be no assurance that the Company’s
disclosure controls and procedures will detect or uncover all failures of persons within Check Point to disclose material
information otherwise required to be set forth in the Company’s reports.
(b) There have been no significant changes in Company’s internal controls or in other factors that could significantly
affect these controls subsequent to the date of the evaluation thereof. Therefore, no corrective actions with regard to significant
deficiencies and material weaknesses were taken.
## ITEM 16. Reserved.
## ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT
The Company’s board of directors has determined that Mr. Irwin Federman is an “audit committee financial expert.”
## ITEM 16B. CODE OF ETHICS
In March 2004, the Company’s board of directors adopted a Code of Ethics that applies to all employees, directors and
officers of the Company, including the chief executive officer, chief financial officer, principal accounting officer and other
individuals performing similar functions. A copy of the Company’s Code of Ethics may be obtained, without charge, upon a
written request addressed to the Company’s investor relations department, 800 Bridge Parkway, Redwood City, California 94065
(telephone no. 650-628-2000).
---
## ITEM 16C. PRINCIPAL ACCOUNTING FEES AND SERVICES
## Fees and Services
The table below summarizes the audit fees paid by the Company and its consolidated subsidiaries during each of 2002
and 2003.
| | Year Ended December 31,2002 | | Year Ended December 31,2003 | |
| --- | --- | --- | --- | --- |
| | Amount | Percentage | Amount | Percentage |
| | (in thousands,except percentage) | | | |
| Audit Fees | $380 | 36% | $343 | 36% |
| Audit-Related Fees(1) | 77 | 7 | 75 | 8 |
| Tax Fees(2) | 602 | 57 | 544 | 56 |
| Total | 1,059 | 100 | 962 | 100 |
(1) “Audit-related fees” are fees related to due diligence investigations and to other assignments relating to internal
accounting functions and procedures.
(2) “Tax fees” are fees for professional services rendered by the Company’s auditors for tax compliance, tax advice on
actual or contemplated transactions, tax consulting associated with international transfer prices and employee tax
services.
## Audit Committee’s pre-approval policies and procedures
The audit committee of the Company’s board of directors chooses and engages the Company’s independent auditors to
audit the Company’s financial statements. In March 2004, the Company’s audit committee adopted a policy requiring
management to obtain the audit committee’s approval before engaging the Company’s independent auditors to provide any audit
or permitted non-audit services to the Company or its subsidiaries. This policy, which is designed to assure that such
engagements do not impair the independence or the Company’s auditors, requires the audit committee to pre-approve annually
various audit and non-audit services that may be performed by the Company’s auditors. In addition, the audit committee limited
the aggregate amount of fees the Company’s auditors may receive during 2004 for non-audit services in certain categories.
The Company’s Controller reviews all management requests to engage the Company’s auditors to provide services and
approves the request if the requested services are of the type pre-approved by the audit committee. The Company informs the
audit committee of these approvals at least quarterly. Services of the type not pre-approved by the audit committee require preapproval by the audit committee on a case-by-case basis. The audit committee is not permitted to approve the engagement of the
Company’s auditors for any services that fall into a category of services that is not permitted by applicable law or if the services
would be inconsistent with maintaining the auditor’s independence.
---
## PART III
## ITEM 17. FINANCIAL STATEMENTS
The Company has responded to Item 18.
## ITEM 18. FINANCIAL STATEMENTS
See pages F-1 to F-28 incorporated herein.
## ITEM 19. EXHIBITS
| 1 | Articles of Association (incorporated by reference to Exhibit 2.5 of the Company's annual report on Form 20-F for the year ended December 31, 2000) |
| --- | --- |
| 4.1 | Form of Indemnification Agreement between the Company and its officers and directors (Incorporated by reference to exhibit 4.1 of the Company's annual report on Form 20-F for the year ended December 31, 2001) |
| 4.2 | Agreement and Plan of Merger by and among Check Point Software Technologies Ltd., Check Point Software Technologies, Inc., Zanzibar Acquisition, L.L.C., and Zone Labs, Inc., dated as of December 15, 2003 |
| 8 | List of subsidiaries (incorporated by reference to "Item 4-Information on the Company-Organizational Structure" in this Annual Report on Form 20-F) |
| 10 | Consent of Kost Forer Gabbay & Kasierer, a member of Ernst & Young Global |
| 12.1 | Certification of the Chief Executive Officer pursuant to§302 of the Sarbanes-Oxley Act of 2002 |
| 12.2 | Certification of the Chief Financial Officer pursuant to§302 of the Sarbanes-Oxley Act of 2002 |
| 13 | Certification pursuant to section906 of the Sarbanes-Oxley Act of 2002 |
---
## CHECK POINT SOFTWARE TECHNOLOGIES LTD. AND ITS SUBSIDIARIES
## CONSOLIDATED FINANCIAL STATEMENTS
## AS OF DECEMBER 31, 2003
## IN U.S. DOLLARS
## INDEX
| | Page |
| --- | --- |
| Report of Independent Auditors | F-2 |
| Consolidated Balance Sheets | F-3 |
| Consolidated Statements of Income | F-4 |
| Statements of Changes in Shareholders' Equity | F-5 |
| Consolidated Statements of Cash Flows | F-6 |
| Notes to Consolidated Financial Statements | F-7-F-28 |
**- - - - - - - -**
---
# REPORT OF INDEPENDENT AUDITORS To the Shareholders of CHECK POINT SOFTWARE TECHNOLOGIES LTD.
We have audited the accompanying consolidated balance sheets of Check Point Software Technologies
Ltd. and its subsidiaries as of December 31, 2002 and 2003, and the related consolidated statements of income,
changes in shareholders' equity and cash flows for each of the three years in the period ended December 31,
2003. These financial statements are the responsibility of Check Point Software Technologies Ltd.'s
management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted 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 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 Check Point Software Technologies Ltd. and its subsidiaries as of
December 31, 2002 and 2003, and the consolidated results of their operations and cash flows for each of the
three years in the period ended December 31, 2003, in conformity with accounting principles generally accepted
in the United States.
Tel-Aviv, Israel
January 20, 2004
KOST FORER GABBAY & KASIERER
A Member of Ernst & Young Global
---
CONSOLIDATED BALANCE SHEETS
| | December 31, | |
| --- | --- | --- |
| | 2002 | 2003 |
| ASSETS | | |
| Current assets: | | |
| Cash and cash equivalents | $444,449 | $327,188 |
| Short-term bank deposits | 24,279 | 16,888 |
| Marketable securities | 317,169 | 792,270 |
| Trade receivables (net of allowances for doubtful accounts and product returns of $8,722 and $7,400 for the years 2002 and 2003, respectively) | 73,165 | 72,754 |
| Other accounts receivable | 17,045 | 19,667 |
| Total current assets | 876,107 | 1,228,767 |
| Long-term assets: | | |
| Long-term investments | 529,407 | 466,847 |
| Other long-term assets | 757 | 417 |
| Property and equipment, net | 10,453 | 7,394 |
| Severance pay fund | 3,924 | 4,721 |
| Deferred tax asset | 4,963 | 5,519 |
| | 549,504 | 484,898 |
| Total assets | $1,425,611 | $1,713,665 |
| LIABILITIES AND SHAREHOLDERS' EQUITY | | |
| Current liabilities: | | |
| Trade payables | $4,921 | $4,556 |
| Employees and payroll accruals | 29,750 | 31,049 |
| Deferred revenues | 99,227 | 105,889 |
| Accrued expenses and other liabilities | 98,891 | 103,740 |
| Total current liabilities | 232,789 | 245,234 |
| Accrued severance pay | 5,780 | 6,886 |
| Shareholders' equity: | | |
| Share capital - Authorized: 500,000,000 Ordinary shares of NIS 0.01 par value; 10 Deferred shares of NIS 1 par value; 5,000,000 Preferred shares of NIS 0.01 par value as of December 31, 2002 and 2003; Issued and outstanding: 245,908,827 and 249,276,058 Ordinary shares as of December 31, 2002 and 2003, respectively; 1 Deferred share and no Preferred shares as of December 31, 2002 and 2003 | 740 | 747 |
| Additional paid-in capital | 163,235 | 193,504 |
| Accumulated other comprehensive income (loss) | (190) | 158 |
| Retained earnings | 1,023,257 | 1,267,136 |
| Total shareholders' equity | 1,187,042 | 1,461,545 |
| Total liabilities and shareholders' equity | $1,425,611 | $1,713,665 |
The accompanying notes are an integral part of the consolidated financial statements.
---
CONSOLIDATED STATEMENTS OF INCOME
**U.S. dollars in thousands (except per share data)**
| | Year ended December 31, | | |
| --- | --- | --- | --- |
| | 2001 | 2002 | 2003 |
| Revenues: | | | |
| Product and licenses | $374,026 | $256,113 | $230,096 |
| Software subscriptions | 110,236 | 130,879 | 161,690 |
| Support, training and consulting | 43,381 | 39,997 | 40,786 |
| Total revenues | 527,643 | 426,989 | 432,572 |
| Operating expenses: | | | |
| Cost of revenues | 26,571 | 20,693 | 18,923 |
| Research and development | 33,221 | 28,709 | 29,314 |
| Selling and marketing | 109,086 | 104,606 | 111,007 |
| General and administrative | 22,002 | 17,969 | 17,644 |
| Total operating expenses | 190,880 | 171,977 | 176,888 |
| Operating income | 336,763 | 255,012 | 255,684 |
| Financial income, net | 44,760 | 49,314 | 43,506 |
| Income before taxes on income | 381,523 | 304,326 | 299,190 |
| Taxes on income | 59,603 | 49,246 | 55,311 |
| Net income | $321,920 | $255,080 | $243,879 |
| Net earnings per share: | | | |
| Basic net earnings per Ordinary share | $1.34 | $1.04 | $0.98 |
| Diluted net earnings per Ordinary share | $1.25 | $1.00 | $0.96 |
The accompanying notes are an integral part of the consolidated financial statements.
---
STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
U.S. dollars in thousands (except share data)
| | Share capital | Additional paid-in capital | Accumulated other comprehensive income (loss) | Retained earnings | Total comprehensive income | Total shareholders' equity |
| --- | --- | --- | --- | --- | --- | --- |
| Balance as of January 1, 2001 | $723 | $102,303 | $- | $446,257 | | $549,283 |
| Tax benefit related to exercise of stock options | - | 5,345 | - | - | | 5,345 |
| Issuance of shares upon exercise of options and stock purchase plan(7,395,667 Ordinary shares), net | 12 | 37,724(1,465) | - | - | | 37,736(1,465) |
| Purchase of stock dividend fractional shares | - | - | - | - | | |
| Comprehensive income-Unrealized gains on hedging derivative instrumentsNet income | - | - | 2,909 | -321,920 | $2,909321,920 | 2,909321,920 |
| Total comprehensive income | - | - | - | 321,920 | $324,829 | |
| Balance as of December 31, 2001 | 735 | 143,907 | 2,909 | 768,177 | | 915,728 |
| Tax benefit related to exercise of stock options | - | 4,597 | - | - | | 4,597 |
| Issuance of shares upon exercise of options and stock purchase plan(3,084,806 Ordinary shares), net | 5 | 14,731 | - | - | | 14,736 |
| Comprehensive income(loss)-Realized loss on hedging derivative instrumentsUnrealized loss on hedging derivative instrumentsNet income | - | - | (2,909)(190) | -255,080 | $(2,909)(190)255,080 | (2,909)(190)255,080 |
| Total comprehensive income | - | - | - | 255,080 | $251,981 | |
| Balance as of December 31, 2002 | 740 | 163,235(190) | 1,023,257 | | | 1,187,042 |
| Tax benefit related to exercise of stock options | - | 12,566 | - | - | | 12,566 |
| Issuance of shares upon exercise of options and stock purchase plan(3,367,231 Ordinary shares), net | 7 | 17,703 | - | - | | 17,710 |
| Comprehensive income-Realized gain on hedging derivative instrumentsUnrealized gain on hedging derivative instrumentsNet income | - | - | 190158 | -158243,879 | $190158243,879 | 190158243,879 |
| Total comprehensive income | - | - | - | 243,879 | $244,227 | |
| Balance as of December 31, 2003 | $747 | $193,504 | $158 | $1,267,136 | | $1,461,545 |
| The accompanying notes are an integral part of the consolidated financial statements. | | | | | | |
---
CONSOLIDATED STATEMENTS OF CASH FLOWS
**U.S. dollars in thousands**
| | Year ended December 31, | | |
| --- | --- | --- | --- |
| | 2001 | 2002 | 2003 |
| Cash flows from operating activities: | | | |
| Net income | $321,920 | $255,080 | $243,879 |
| Adjustments required to reconcile net income to net cash provided by operating activities: | | | |
| Depreciation and amortization | 8,949 | 7,390 | 6,030 |
| Amortization of marketable securities premium and accretion of discount, net | 1,405 | 7,565 | 17,652 |
| Deferred income taxes, net | (240) | 796 | (556) |
| Decrease in trade receivables, net | 10,087 | 1,129 | 411 |
| Decrease (increase) in other accounts receivable and long-term assets | 939 | (527) | (1,935) |
| Increase (decrease) in trade payables | 1,301 | (24) | (365) |
| Increase (decrease) in employees and payroll accruals | (7,090) | 3,597 | 1,299 |
| Increase in accrued expenses and other liabilities | 29,482 | 635 | 4,849 |
| Increase (decrease) in deferred revenues | (25,499) | 3,524 | 6,662 |
| Tax benefit related to exercise of stock options | 5,345 | 4,597 | 12,566 |
| Increase in accrued severance pay, net | 630 | 60 | 309 |
| Others | (54) | 105 | 84 |
| Net cash provided by operating activities | 347,175 | 283,927 | 290,885 |
| Cash flows from investing activities: | | | |
| Proceeds from short-term bank deposits | 216,980 | 125,884 | 24,279 |
| Investment in short-term bank deposits | (103,749) | (20,841) | - |
| Proceeds from held-to maturity marketable securities | 186,620 | 803,903 | 736,159 |
| Investment in held-to-maturity marketable securities | (603,119) | (955,244) | (1,183,323) |
| Investment in long-term bank deposits | (8,635) | (22,388) | - |
| Purchase of property and equipment | (9,678) | (4,596) | (2,971) |
| Net cash used in investing activities | (321,581) | (73,282) | (425,856) |
| Cash flows from financing activities: | | | |
| Proceeds from issuance of shares upon exercise of options and stock purchase plan, net of expenses | 37,736 | 14,736 | 17,710 |
| Purchase of stock dividend fractional shares | (1,465) | - | - |
| Net cash provided by financing activities | 36,271 | 14,736 | 17,710 |
| Increase (decrease) in cash and cash equivalents | 61,865 | 225,381 | (117,261) |
| Cash and cash equivalents at the beginning of the year | 157,203 | 219,068 | 444,449 |
| Cash and cash equivalents at the end of the year | $219,068 | $444,449 | $327,188 |
| Supplemental disclosure of cash flow information: | | | |
| Cash paid during the year for income taxes | $20,770 | $25,570 | $31,913 |
The accompanying notes are an integral part of the consolidated financial statements.
---
# NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
## In U.S. dollars
## NOTE 1:- GENERAL
Check Point Software Technologies Ltd. ("Check Point Ltd."), an Israeli corporation, and its
subsidiaries (collectively "the Company" or "Check Point"), are engaged in developing, marketing
and supporting Internet security solutions for enterprise networks and service providers.
In December 2002, a wholly owned subsidiary was established in Singapore in order to manage the
Company's financial assets.
The Company operates in one reportable segment and its revenues are mainly derived from the sales
of its network security products, packaged and marketed mostly under the VPN-1 product family
and related software subscription, support technical services and training program. The Company
sells its software products worldwide through multiple distribution channels ("channel partners")
including distributors, resellers, system integrators, Original Equipment Manufacturers ("OEMs")
and Managed Security service Providers ("MSPs").
During 2002 and 2003, approximately 13% of revenues in each year were derived from a single
channel partner, the Company's largest distributor. No channel partner exceeded 10% of the
Company's revenues in 2001.
In October 2003, the Company announced its plan to buy back its shares for a total amount of up to
$ 200 million. As of December 31, 2003, the plan has not yet been executed.
## NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES
The consolidated financial statements are prepared according to United States generally accepted
accounting principles ("U.S. GAAP").
## a. Use of estimates:
The consolidated financial statements are prepared in accordance with accounting principles
generally accepted in the United States. These accounting principles require management to
make certain estimates, judgments and assumptions. Management believes that the estimates,
judgments and assumptions upon which it relies, are reasonable based upon information
available at the time that these estimates, judgments and assumptions were made. To the
extent that there are material differences between these estimates and actual results, the
financial statements may be affected.
---
## NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
## U.S. dollars in thousands
## NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.)
## b. Financial statements in United States dollars:
Most of the Company's revenues are denominated in United States dollars ("dollars"). In
addition, a substantial portion of the Company's costs is incurred in dollars. The Company's
management believes that the dollar is the primary currency of the economic environment in
which Check Point Ltd. and each of its subsidiaries operate. Thus, the dollar is their
functional and reporting currency. Accordingly, monetary accounts maintained in currencies
other than the dollar are remeasured into dollars in accordance with Statement of Financial
Accounting Standard No. 52 "Foreign Currency Translation ("SFAS No. 52"). All transaction
gains and losses of the remeasurement of monetary balance sheet items are reflected in the
statements of income as financial income or expenses, as appropriate.
## c. Principles of consolidation:
The consolidated financial statements include the accounts of Check Point Ltd. and its
subsidiaries. Intercompany transactions and balances have been eliminated upon
consolidation.
## d. Cash equivalents:
Cash equivalents are short-term highly liquid investments that are readily convertible to cash
with maturities of three months or less, at the date acquired.
## e. Short and long-term bank deposits:
Bank deposits with maturities of more than three months but less than one year are included
in short-term bank deposits. Bank deposits with maturities of more than one year are included
in long-term investments. Deposits are presented at cost, while related accrued interest is
included in other receivables. The deposits are in U.S. dollars and bear annual interest at rates
ranging from 3%-3.6%.
## f. Investments in marketable securities:
The Company accounts for investments in marketable securities in accordance with
Statement of Financial Accounting Standard No. 115, "Accounting for Certain Investments in
Debt and Equity Securities ("SFAS No. 115").
---
# NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
## U.S. dollars in thousands
## NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.)
Management determines the appropriate classification of its investments in government and
corporate marketable debt securities at the time of purchase and reevaluates such
determinations at each balance sheet date. Debt securities are classified as held-to-maturity as
the Company has the positive intent and ability to hold the securities to maturity and are
stated at amortized cost. The amortized cost of held-to-maturity securities is adjusted for
amortization of premiums and accretion of discounts to maturity. Such amortization, interest
and declines in value determined to be other than temporary are included in financial income,
net. Interest income resulting from investments in structured notes that are classified as held
to maturity is accounted for under the provision of Emerging Issue Task Force No. 96-12,
"Recognition of Interest Income and Balance Sheet Classification of Structured Notes"
("EITF No. 96-12"). Under EITF No. 96-12, the retrospective interest method should be used
for recognizing interest income.
## g. Property and equipment, net:
Property and equipment are stated at cost less accumulated depreciation using the straightline method over the estimated useful lives of the assets, ranging from two to ten years.
Leasehold improvements are amortized by the straight-line method over the term of the lease.
The Company's long-lived assets are reviewed for impairment in accordance with Statement
of Financial Accounting Standard No. 144 "Accounting for the Impairment or Disposal of
Long-Lived Assets" ("SFAS No. 144") whenever events or changes in circumstances indicate
that the carrying amount of an asset may not be recoverable. Recoverability of an asset to be
held and used is measured by a comparison of the carrying amount of an asset to the future
undiscounted cash flows expected to be generated by the asset. If such asset is considered to
be impaired, the impairment to be recognized is measured by the amount by which the
carrying amount of the asset exceeds its fair value. During 2003, impairment in the amount of
$ 440 with respect to the relocation of the U.S. subsidiary's offices, was noted.
## h. Research and development costs:
Research and development costs, are charged to the statement of income as incurred.
Statement of Financial Accounting Standard No. 86 "Accounting for the Costs of Computer
Software to be Sold, Leased or Otherwise Marketed" ("SFAS No. 86"), requires
capitalization of certain software development costs subsequent to the establishment of
technological feasibility.
Based on the Company's product development process, technological feasibility is established
upon completion of a working model. Costs incurred by the Company between completion of
the working models and the point at which the products are ready for general release have
been insignificant. Therefore, all research and development costs have been expensed.
---
## U.S. dollars in thousands
## NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.)
i. Revenue recognition:
The Company derives its revenues from license fees for its products, software subscriptions,
support, consulting and training programs. The Company sells its products primarily through
distributors, resellers, OEMs, system integrators and MSPs, all of whom are considered endusers.
The Company accounts for software sales in accordance with Statement of Position No. 97-2,
"Software Revenue Recognition ("SOP No. 97-2"), as amended. In addition, the Company
has adopted Statement of Position No. 98-9, "Modification of SOP No. 97-2, Software
Revenue Recognition with Respect to Certain Transactions, "("SOP No. 98-9"). SOP No. 98-
9 requires that revenue be recognized under the "residual method" when Vendor Specific
Objective Evidence ("VSOE") of Fair Value exists for all undelivered elements and VSOE
does not exist for all of the delivered elements.
Revenue from license fees is recognized when persuasive evidence of an arrangement exists,
delivery of the product has occurred, the fee is fixed or determinable, and collectability is
probable.
Software subscription, support, consulting and training program revenues included in
multiple-element arrangements are deferred and either recognized on a straight-line basis over
the term of the software subscription and support agreement or when services are performed.
Revenues earned on software arrangements involving multiple-elements are allocated to each
element based on the its VSOE of fair value. The VSOE of fair value of the undelivered
elements (software subscription, support, consulting services and training) is generally
determined based on the price charged for the undelivered element when sold separately or
renewed.
The Company maintains certain provisions for product returns, in accordance with Statement
of Financial Accounting Standard No. 48, "Revenue Recognition When Right of Return
Exists", based on its experience with historical sales returns, analysis of credit memo data and
other known factors. Such provisions amounted to $ 3,598 and $ 2,098 as of December 31,
2002 and 2003, respectively.
The Company considers arrangements regarding certain channel partners with payment terms
extending beyond customary payment terms not to be fixed or determinable. If the fee is
considered to be not fixed or determinable, revenue is deferred and recognized when
payments become due from the customer or are actually collected, providing that all other
revenue recognition criteria have been met.
Deferred revenue includes unearned amounts received under software subscription and
support contracts, and amounts received from customers but not yet recognized as revenues.
---
# NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
## U.S. dollars in thousands
## NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.)
## j. 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. The Company records as expenses the net increase
in its funded or unfunded severance liability. Employees are entitled to one month's salary for
each year of employment, or a portion thereof. The Company's liability is fully provided by
monthly payments deposited with insurers and by a reserve established by the Company to
cover the portion of this liability not covered by the Company's deposits.
The deposited funds include profits accumulated up to the balance sheet date. The deposited
funds may be withdrawn only upon the fulfillment of the obligation pursuant to Israeli
severance pay law or labor agreements. The value of the deposited funds is based on the cash
surrendered value of these policies, and includes immaterial profits.
Severance expenses for the years ended December 31, 2001, 2002 and 2003, were $ 1,997,
$ 1,741 and $ 1,437, respectively.
## k. Employee benefit plan:
The Company has a 401(K) defined contribution plan covering certain employees in the U.S.
All eligible employees may elect to contribute up to 50%, but no greater than $ 12 per year,
of their annual compensation to the plan through salary deferrals, subject to IRS limits. From
January 1, 1996 (inception) to December 31, 2003, the Company made no matching
contributions to the plan.
## l. Income taxes:
The Company accounts for income taxes in accordance with Statement of Financial
Accounting Standard No. 109, "Accounting for Income Taxes" ("SFAS No. 109"). SFAS No.
109 prescribes the use of the liability method whereby deferred tax asset and liability account
balances are determined based on differences between financial reporting and tax bases of
assets and liabilities and are measured using the enacted tax rates and laws that will be in
effect when the differences are expected to reverse. The Company provides a valuation
allowance, if necessary, to reduce deferred tax assets to their estimated realizable value.
## m. Advertising expenses:
Advertising costs are expensed as incurred. Advertising expenses for the years ended 2001,
2002 and 2003, were $ 15,516, $ 11,502 and $ 8,371, respectively.
---
# NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
**U.S. dollars in thousands**
## NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.)
n. Concentrations of credit risk:
Financial instruments that potentially subject the Company to concentrations of credit risk
consist principally of cash and cash equivalents, short-term bank deposits, marketable
securities, trade receivables and long-term bank deposits. The majority of the Company's cash
and cash equivalents, short-term bank deposits and the long-term bank deposits are invested
in dollar and dollar-linked investments, and are deposited in major banks in the U.S. and
Europe. Such deposits in the U.S may be in excess of insured limits and are not insured in
other jurisdictions. Management believes that the financial institutions that hold the
Company's investments are financially sound and, accordingly, minimal credit risk exists
with respect to these investments.
The Company's marketable securities include investments in government and corporate
debentures and structured notes of issuers that are considered by management to be
financially sound. The Company's investments in debt securities are diversified among highquality credit securities.
The Company's trade receivables are geographically diversified and derived from sales to
channel partners mainly in the United States, Europe and Asia. The Company performs
ongoing credit evaluations of its partners. The allowance for doubtful accounts is mainly
composed of specific debts that are doubtful of collection amounting to $ 5,124 and $ 5,302
as of December 31, 2002 and 2003, respectively.
## o. Derivatives and hedging:
The Company accounts for derivatives and hedging based on Statement of Financial
Accounting Standard No. 133, "Accounting for Derivative Instruments and Hedging
Activities" ("SFAS No. 133"). SFAS No. 133 requires the Company to recognize all
derivatives on the balance sheet at fair value. If the derivatives meet the definition of a hedge
and is so designated, depending on the nature of the hedge, changes in the fair value of
derivatives will either be offset against the change in fair value of the hedged assets,
liabilities, or firm commitments through earnings, or recognized in other comprehensive
income until the hedged item is recognized in earnings. The ineffective portion of a
derivative's change in fair value is recognized in earnings. During 2001, 2002 and 2003 there
were no gains or losses recognized in earning for hedge ineffectiveness.
---
# NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
## U.S. dollars in thousands (except share and per share data)
## NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.)
The Company hedges the exposure of assets and anticipated revenues denominated in the
Japanese Yen as well as anticipated expenses denominated in Euros with forward and option
contracts. To protect against the risk of overall changes in cash flows resulting from export
sales over the next year, the Company has instituted a foreign currency cash flow hedging
program with zero-cost collar contracts. The net gains (losses) recognized in revenues during
2001, 2002 and 2003 were $ 1,484, $ 1,369 and $ (173), respectively. As of December 31,
2003, the Company expects to reclassify during the first quarter of 2004 an amount of $10 of
unrealized losses on hedging derivative instruments from accumulated other comprehensive
loss to revenues. During 2003, the Company entered into a foreign currency cash flow
hedging program with option contracts designated to hedge expenses in Euro. The net gain
which offset expenses during 2003 amounted to $ 655. Also, the Company entered into
forward exchange contracts designated to hedge the fair value of certain foreign currency
denominated partner balances and accrued liabilities. The net gains (losses) recognized in
earnings during 2001, 2002 and 2003, representing the foreign exchange forward contract
gains (losses), were $ 1,403, $ (451) and $ 166, respectively. Those gains (losses) were
presented within financial income (expenses).
As of December 31, 2003, the Company's management believed that since the
abovementioned activities were transacted with well-established institutions, the liabilities
owed to the Company will be fulfilled.
## p. Basic and diluted net earnings per share:
Basic net earnings per share is computed based on the weighted average number of Ordinary
shares outstanding during each year. Diluted net earnings per share is computed based on the
weighted average number of Ordinary shares outstanding during each year, plus dilutive
potential Ordinary shares considered outstanding during the year, in accordance with
Statement of Financial Accounting Standard No. 128, "Earnings Per Share" ("SFAS No.
128").
The total weighted average number of shares related to the outstanding options excluded
from the calculations of diluted net earnings per share, since they would have an anti-dilutive
effect, were 2,658,141, 7,448,419 and 8,859,208 for 2001, 2002 and 2003, respectively.
---
## NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
## U.S. dollars in thousands (except share and per share data)
## NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.)
## q. Accounting for stock-based compensation:
The Company has elected to follow Accounting Principles Board Opinion No. 25
"Accounting for Stock Issued to Employees" ("APB No. 25") and FASB. Interpretation No.
44 "Accounting for Certain Transactions Involving Stock Compensation" ("FIN No. 44") in
accounting for its employee stock option plans. Under APB No. 25, when the exercise price
of the Company's stock options is less than the market price of the underlying shares on the
date of grant, compensation expense is recognized.
The Company adopted the disclosure provisions of Statement of Financial Accounting
Standards No. 148, "Accounting for Stock-Based Compensation - transition and disclosure"
("SFAS No. 148"), which amended certain provision of Statement of Accounting Standards
No. 123, "Accounting for Stock-Based Compensation” (SFAS No. 123”) to provide
alternative methods of transition for an entity that voluntarily changes to the fair value based
method of accounting for stock-based employee compensation, effective as of the beginning
of 2003. The Company continues to apply the provisions of APB No. 25, in accounting for
stock-based compensation.
Pro forma information regarding the Company's net income and net earnings per share is
required by SFAS No 123 and has been determined as if the Company had accounted for its
employee stock options under the fair value method prescribed by SFAS No. 123.
The fair value for options granted in 2001, 2002 and 2003 is amortized over their vesting
period and is estimated at the date of grant using a Black-Scholes options pricing model with
the following weighted average assumptions:
| Employee Stock Options | 2001 | 2002 | 2003 |
| --- | --- | --- | --- |
| Expected volatility | 100.0% | 76.0% | 44.0% |
| Risk-free interest | 3.7% | 3.7% | 2.5% |
| Dividend yield | 0.0% | 0.0% | 0.0% |
| Expected life after the option is vested(years) | 0.5 | 0.5 | 0.7 |
| Employee Stock Purchase Plan | | | |
| Expected volatility | 100.0% | 76.0% | 44.0% |
| Risk-free interest | 1.8% | 1.2% | 1.0% |
| Dividend yield | 0.0% | 0.0% | 0.0% |
| Expected life from vesting date(years) | 0.5 | 0.5 | 0.5 |
---
## NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
## U.S. dollars in thousands (except per share data)
## NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.)
The following table illustrates the effect on net income and net earnings per share, assuming
that the Company had applied the fair value recognition provision of SFAS No. 123 on its
stock-based employee compensation:
**December 31,**
| | December 31, | | |
| --- | --- | --- | --- |
| | 2001 | 2002 | 2003 |
| Net income as reported | $321,920 | $255,080 | $243,879 |
| Deduct: Stock-based compensation expense determined under fair value method for all awards, net of related tax effects | $71,848 | $61,490 | $37,262 |
| Pro forma net income | $250,072 | $193,590 | $206,617 |
| Net earnings per share:
Basic net earnings per Ordinary shares, as reported | $1.34 | $1.04 | $0.98 |
| Diluted net earnings per Ordinary shares, as reported | $1.25 | $1.00 | $0.96 |
| Basic pro forma net earning per Ordinary shares | $1.04 | $0.79 | $0.83 |
| Diluted pro forma net earning per Ordinary shares | $0.97 | $0.76 | $0.82 |
## r. Fair value of financial instruments:
The following methods and assumptions were used by the Company in estimating its fair
value disclosures for financial instruments:
1. The carrying amount of cash and cash equivalents, short-term bank deposits, trade
receivables and trade payables approximates their fair values due to the short-term
maturities of these instruments.
2. The fair value of short and long term marketable securities structured notes and bank
deposits with quoted market prices is based on quoted market prices (see Notes 3 and
4).
3. The carrying amount of the Company's long-term bank deposits is estimated by
discounting the future cash flows using the interest rates for deposits of similar terms
and maturities (see Note 4).
4. The fair value of derivative instruments is estimated by obtaining quotes from brokers.
---
## U.S. dollars in thousands
## NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.)
s. Reclassification:
The Company has reclassified certain amounts from 2002 to conform to the 2003
presentation. The reclassification had no effect on previously reported net loss, shareholders'
equity or cash flows.
t. Impact of recently issued accounting standards:
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of Variable Interest
Entities" ("FIN 46"). The objective of FIN 46 is to improve financial reporting by companies
involved with variable interest entities. A variable interest entity is a corporation, partnership,
trust, or any other legal structure used for business purposes that either (a) does not have
equity investors with voting rights or (b) has equity investors that do not provide sufficient
financial resources for the entity to support its activities.
FIN 46 requires a variable interest entity to be consolidated by a company if that company is
subject to a majority of the risk of loss from the variable interest entity's activities or entitled
to receive a majority of the entity's residual returns or both. FIN 46 also requires disclosures
about variable interest entities that the company is not required to consolidate, but in which it
has a significant variable interest. The consolidation requirements of FIN 46 apply in the first
fiscal year or interim period ending after March 15, 2004. Certain of the disclosure
requirements apply in all financial statements issued after January 31, 2003, regardless of
when the variable interest entity was established. As of December 31, 2003, the Company
does not expect the adoption of FIN 46 to have a material impact on its consolidated financial
statements.
---
# NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
## U.S. dollars in thousands
## NOTE 3:- MARKETABLE SECURITIES
**December 31,**
| | 2002 | | | | 2003 | | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- |
| | Amortized cost | Gross unrealized gains | Gross unrealized losses | Market value | Amortized cost | Gross unrealized gains | Gross unrealized losses | Market value |
| Government and corporate debentures-Fixed interest rate | $225,617 | $2,750 | $(152) | $228,215 | $414,558 | $2,813 | $(1,017) | $416,354 |
| Government and corporate debentures-Floating interest rate(**) | 58,700 | 1,863 | (6) | 60,557 | 226,695 | 4,351 | (2,192) | 228,854 |
| Mortgage and Asset Backed Securities(*) | 12,855 | 6 | (72) | 12,789 | 49,871 | 304 | (2,108) | 48,067 |
| Auction rate securities | 19,997 | 3 | - | 20,000 | 92,550 | 342 | (11) | 92,881 |
| Money Market Instruments | - | - | - | - | 8,596 | - | (1) | 8,595 |
| | $317,169 | $4,622 | $(230) | $321,561 | $792,270 | $7,810 | $(5,329) | $794,751 |
(*) The expected maturities dates may differ from the contractual maturities because debtors may
have the right to call or prepay obligations without penalties.
(**) As of December 31, 2003, the Company holds investments in structured notes in the amount
of $202,646. The structured notes include mainly inverse floaters and range accruals.
Ranges accruals are bonds where the coupon is paid only if a specified interest rate stays
within a pre-established range, otherwise the bond pays 0%. Inverse floaters are bonds where
the coupon varies in accordance with changes in specified interest rates or indices (for
example, LIBOR).
The unrealized gains on structured notes amounted to $ 2,241.
## NOTE 4:- LONG-TERM INVESTMENTS
Long-term investments due within one to five years, are as follows:
**December 31,**
| | December 31, | |
| --- | --- | --- |
| | 2002 | 2003 |
| Government and corporate debentures(a) | $511,967 | $466,378 |
| Bank deposits(a) | 16,888 | - |
| Investments in a privately-held company(b) | 552 | 469 |
| | $529,407 | $466,847 |
2002 2003
---
# NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
## U.S. dollars in thousands
## NOTE 4:- LONG-TERM INVESTMENTS (Cont.)
## (a) Composed as follows:
December 31,
| | 2002 | | | | 2003 | | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- |
| | Amortized cost | Gross unrealized gains | Gross unrealized losses | Market value | Amortized cost | Gross unrealized gains | Gross unrealized losses | Market value |
| Government and corporate debentures-Fixed interest rate | $427,051 | $19,077 | $(2,747) | $443,381 | $335,880 | $7,917 | $(1,624) | $342,173 |
| Government and corporate debentures-Floating interest rate | 47,786 | 142 | (13) | 47,915 | 27,253 | 23 | (17) | 27,259 |
| Mortgage and Asset Backed Securities(*) | 37,130 | 174 | - | 37,304 | 103,245 | 207 | (444) | 103,008 |
| Deposits | 16,888 | 334 | - | 17,222 | - | - | - | - |
| | $528,855 | $19,727 | $(2,760) | $545,822 | $466,378 | $8,147 | $(2,085) | $472,440 |
(*) The expected maturities may differ from the contractual maturities because debtors may have
the right to call or prepay obligations without penalties.
(b) The investment in a privately held company is stated at cost since the Company does not
have a significant influence over that private company.
## NOTE 5:- PROPERTY AND EQUIPMENT, NET
| | December 31, | |
| --- | --- | --- |
| | 2002 | 2003 |
| Cost: | | |
| Computers and peripheral equipment | $28,852 | $28,581 |
| Office furniture and equipment | 5,555 | 4,896 |
| Leasehold improvement and other | 3,275 | 3,139 |
| | 37,682 | 36,616 |
| Accumulated depreciation | 27,229 | 29,222 |
| Depreciated cost | $10,453 | $7,394 |
Depreciation and amortization expenses amounted to approximately $ 8,949, $ 7,390 and $ 6,030
for 2001, 2002 and 2003, respectively.
During 2003, the US subsidiary of the Company recorded a reduction of approximately $ 4,000 to
the cost and accumulated depreciation of fully depreciated equipment no longer in use, primarily
due to the relocation of facilities.
---
## U.S. dollars in thousands
**NOTE 6:- ACCRUED EXPENSES AND OTHER LIABILITIES**
**December 31,**
| | December 31, | |
| --- | --- | --- |
| | 2002 | 2003 |
| Income taxes payable | $72,898 | $83,783 |
| Marketing expenses payable | 11,672 | 8,195 |
| Others | 14,321 | 11,762 |
| | $98,891 | $103,740 |
## NOTE 7:- COMMITMENTS AND CONTINGENT LIABILITIES
## a. Lease commitments:
The facilities of the Company are rented under operating lease agreements that expire on
various dates.
Aggregate minimum lease commitments under non-cancelable operating leases as of
December 31, are as follows:
| 2004 | $ 258 |
| --- | --- |
| 2005 | 3,733 |
| 2006 | 2,020 |
| 2007 | 317 |
| 2008 | 168 |
| | $ 11,496 |
Rent expenses for the years ended December 31, 2001, 2002 and 2003, were $ 6,842, $ 7,289
and $ 5,587, respectively.
b. Litigation:
In 1996, Checkpoint Systems, Inc. (“CSI”) a manufacturer of theft prevention devices for
retail stores has taken legal actions in respect of trademark infringement and unfair
competition against the Company. In 2002 a trademark opposition was filed by CSI with the
Patent and Trademark Office. In February 2003 the respective parties entered into an
agreement that settled all of the disputes by definitively setting forth each company's
trademark description. The agreement permits both parties to use the mark “Check Point”
and to seek registration consistent with the descriptive aspects of their respective businesses.
As a result, the Company reversed the related provision.
---
# NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
## U.S. dollars in thousands
## NOTE 7:- COMMITMENTS AND CONTINGENT LIABILITIES (Cont.)
Beginning on August 29, 2003, the Company received a number of class action complaints
filed in the United States District Court for the Southern District of New York by holders of
the Company Ordinary shares, alleging violations of Section 10(b) of the Securities Exchange
Act of 1934 (the "Exchange Act"), Rule 10b-5 promulgated thereunder, and Section 20(a) of
the Exchange Act. On November 20, 2003, the court consolidated all of the complaints into
one action and appointed lead plaintiff. On January 14, 2004, lead plaintiff filed a
Consolidated Amended Complaint, purporting to represent a putative class of all purchasers
of the Company Ordinary shares between July 10, 2001 and April 4, 2002. The complaint
generally alleges that Check Point and certain of its senior officers made misrepresentations
and omissions regarding, among other things, the Company’s sales, revenue, and future
prospects. The Company has retained experienced counsel and is currently moving to dismiss
the complaint pursuant to Rule 12(b)(6) and Rule 9(b) of the Federal Rules of Civil
Procedure and Section 21D(b)(3) of the Exchange Act. The Company disputes the allegations
of wrongdoing and intends to defend the matter vigorously. Accordingly, the Company’s
management believes that applicable insurance as well as a provision in the financial
statements as of December 31, 2003, are adequate to cover probable costs arising from this
matter.
## NOTE 8:- TAXES ON INCOME
## a. Israeli taxation:
1. Measurement of taxable income under the Income Tax (Inflationary Adjustments)
Law, 1985 ("the Israeli law"):
Under the Israeli law, results for tax purposes are measured in real terms, in accordance
with the changes in the Israeli Consumer Price Index ("Israeli CPI"), or in the
exchange rate of the dollar for a "foreign investors' company". Until 2001, results for
tax purposes were measured in terms of earnings in NIS after certain adjustments for
increases in the Israeli CPI. Beginning January 1, 2002, the basis for remeasurment is
the changes in the exchange rate of the U.S. dollar.
2. Tax benefits under the Law for the Encouragement of Capital Investments, 1959 (the
"Law"):
Practically all of Check Point Ltd.'s production facilities have been granted the status
of "Approved Enterprise", under the Law, in five investment programs (the
"Programs").
In accordance with the Law, Check Point Ltd. has chosen to enjoy "Alternative plan
benefits". Accordingly, Check Point Ltd.'s income attributed to the "Approved
Enterprise" is tax exempt for a period of two years and is subject to a reduced corporate
tax rate of 10% - 25% for an additional period of eight years, based on the percentage of
foreign investment in Check Point Ltd. The abovementioned tax benefits are scheduled to
gradually expire from 2005 through 2013.
---
# NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
## U.S. dollars in thousands
**NOTE 8:- TAXES ON INCOME (Cont.)**
The duration of tax benefits, for each of the Programs is subject to limitations of the
earlier of 12 years from commencement of investment, or 14 years from receipt of
approval, as an "Approved Enterprise" under the Law.
Tax-exempt income attributable to the "Approved Enterprise" cannot be distributed to
shareholders without subjecting the Company to taxes except upon complete
liquidation of the Company. Out of the Company’s retained earnings as of December
31, 2003 approximately $ 461,000 are tax-exempt. If such retained tax-exempt income
is distributed in a manner other than upon the complete liquidation of the Company, it
would be taxed at the reduced corporate tax rate applicable to such profits (between
10%-25%) and an income tax liability of up to approximately $ 115,000 would be
incurred as of December 31, 2003. The Company currently intends to reinvest the
amount of its tax-exempt income and not to distribute such income as a dividend.
Accordingly, no deferred income taxes have been provided on income attributable to
the Company’s "Approved Enterprise".
The entitlement to the above benefits is conditional upon the Company's fulfilling the
conditions stipulated by the Law, regulations published thereunder and the certificates
of approval for the specific investments in approved enterprises.
Should Check Point Ltd. fail to meet such requirements in the future, income
attributable to its "Approved Enterprise" programs could be subject to the statutory
Israeli corporate tax rate of 36%, and the Company could be required to refund a
portion of the tax benefits already received, with respect to such programs.
3. The Israeli company has final tax assessments through the year 2001.
Income from sources other than the "Approved Enterprise" is subject to tax at regular
Israeli corporate tax rate of 36%.
4. On January 1, 2003, a comprehensive tax reform took effect in Israel. Pursuant to the
reform, resident companies are subject to Israeli tax on income accrued or derived in
Israel or abroad. In addition, the concept of "controlled foreign corporation" was
introduced, according to which an Israeli company may become subject to Israeli taxes
on certain income of a non-Israeli subsidiary if the subsidiary's primary source of
income is passive income (such as interest, dividends, royalties, rental income or
capital gains). The tax reform also substantially changed the system of taxation of
capital gains.
---
# NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
## U.S. dollars in thousands
## NOTE 8:- TAXES ON INCOME (Cont.)
## b. Deferred tax assets:
Deferred tax assets reflect the net tax effects of temporary differences between the carrying
amounts of assets and liabilities for financial reporting purposes and the amounts used for
income tax purposes. As of December 31, 2002 and 2003, the Company's deferred taxes were
in respect of the following:
**December 31,**
December 31,
| | December 31, | |
| --- | --- | --- |
| | 2002 | 2003 |
| U.S. carryforward tax deductions | $231,000 | $251,125 |
| Accrued vacation, severance pay and property and equipment | 4,963 | 5,519 |
| Net deferred tax assets before valuation allowance | 235,963 | 256,644 |
| Valuation allowance | (231,000) | (251,125) |
| Net deferred tax assets (presented in other long term assets) | $4,963 | $5,519 |
| Domestic | $694 | $1,313 |
| Foreign | 4,269 | 4,206 |
| | $4,963 | $5,519 |
The subsidiary in the U.S. has provided valuation allowances in respect of deferred tax assets
resulting from tax benefits related to employee stock option exercises, which will be credited
to additional paid-in capital when realized. Management currently believes that it is more
likely than not that those deferred tax deductions will not be realized in the foreseeable
future.
Through December 31, 2003, the U.S. subsidiary had a U.S. federal loss carryforward of
approximately $ 690,000 resulting from tax benefits related to employees stock option
exercises that can be carried forward and offset against taxable income for 15 to 20 years,
expiring between 2010 - 2023.
Utilization of U.S. loss carryforwards may be subject to substantial annual limitation due to
the "change in ownership" provisions of the Internal Revenue Code of 1986 and similar state
provisions. The annual limitations may result in the expiration of losses before utilization.
---
## U.S. dollars in thousands
## NOTE 8:- TAXES ON INCOME (Cont.)
c. Income before taxes on income is comprised as follows:
| | Year ended December 31, | | |
| --- | --- | --- | --- |
| | 2001 | 2002 | 2003 |
| Domestic | $366,237 | $289,116 | $255,282 |
| Foreign | 15,286 | 15,210 | 43,908 |
| | $381,523 | $304,326 | $299,190 |
d. Income tax expenses are comprised as follows:
**Year ended December 31,**
**2001 2002** 2003
| | 2001 | | 2002 | | 2003 | |
| --- | --- | --- | --- | --- | --- | --- |
| Current Deferred | $59,843(240) | | $48,450796 | | $55,867(556) | |
| | $59,603 | | $49,246 | | $55,311 | |
| Domestic Foreign | $52,8846,719 | | $43,7005,546 | | $49,6385,673 | |
| | $59,603 | | $49,246 | | $55,311 | |
## e. Reconciliation of the theoretical tax expenses:
A reconciliation between the theoretical tax expenses, assuming all income is taxed at the
statutory rate applicable and the actual income tax as reported in the statements of income, is
as follows:
**Year ended December 31,**
**2001 2002** 2003
| | 2001 | 2002 | 2003 |
| --- | --- | --- | --- |
| Income before taxes as reported in the statements of income | $381,523 | $304,326 | $299,190 |
| Statutory tax rate in Israel | 36% | 36% | 36% |
| Increase (decrease) in taxes resulting from:Effect of"Approved Enterprise"status(*)Others,net | (17%) (3%) | (22%) 2% | (17%) (1%) |
| Effective tax rate | 16% | 16% | 18% |
| (*)Basic net earnings per share amounts of the benefit resulting from the"Approved Enterprise"status | $0.27 | $0.27 | $0.20 |
| (*)Diluted net earnings per share amounts of the benefit resulting from the"Approved Enterprise"status | $0.25 | $0.26 | $0.20 |
---
# NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
## U.S. dollars in thousands
## NOTE 9:- SHARE CAPITAL
a. General:
Ordinary shares confer upon their holders the right to receive notice to participate and vote in
general meetings of the Company, and the right to receive dividends if declared.
Dividends declared on Ordinary shares will be paid in NIS. Dividends paid to shareholders
outside Israel will be converted into U.S. dollars, on the basis of the exchange rate prevailing
at the date of payment.
On January 18, 2001, the Company's Board of Directors approved a three-for-two stock split
in the form of a stock dividend, effective February 1, 2001. This stock split has been reflected
in the statement of changes in shareholders equity in 2000.
Shareholders otherwise entitled to receive fractional shares because they held a number of old
Ordinary shares that are not evenly divisible by the split number, were paid by cash.
All shares, options and earnings per share amounts have been retroactively adjusted for all
periods presented to reflect the stock splits effected as a stock dividend.
## b. Deferred share:
The Deferred share is not entitled to any rights other than the right to receive its nominal
value upon liquidation of the Company.
## c. Employee Stock Purchase Plan ("ESPP"):
The Company reserved a total of 6,000,000 shares for issuance under the ESPP. Eligible
employees use up to 15% of their salaries to purchase Ordinary shares but no more than
1,250 shares per participant on any purchase date. The purchase plan is being implemented
by effecting an offering every six months. The price of an Ordinary share purchased under
the purchase plan is equal to 85% of the lower of the fair market value of the Ordinary share
on the subscription date of each offering period, or on the purchase date.
During 2001, 2002 and 2003, employees purchased 81,265, 146,291 and 254,889 Ordinary
shares at average prices of $ 46.90, $ 21.08 and $12.29 per share, respectively.
As of December 31, 2003, 4,833,527 Ordinary shares were available for future issuance.
## d. Stock options:
Under the Company's 1996 International and U.S. Incentive Employee Stock Option Plans
("the Plan"), options are granted to employees, officers and directors at an exercise price
equal to at least the fair market value at the date of grant and are granted for periods not to
exceed seven years. Options granted under this plan, generally vest over a period of four to
five years of employment. Any options that are cancelled or forfeited before expiration
become available for future grants.
---
# NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
## U.S. dollars in thousands
## NOTE 9:- SHARE CAPITAL (Cont.)
Under the terms of the Plan, options to purchase 171,210,000 Ordinary shares were reserved
for issuance for the plan.
As of December 31, 2003, 93,343,000 options were available for future grant under the plan.
A summary of the Company's stock option activity, and related information, is as follows:
| | Options(in thousands) | | | Weighted average exercise price | | |
| --- | --- | --- | --- | --- | --- | --- |
| | 2001 | 2002 | 2003 | 2001 | 2002 | 2003 |
| Outstanding at beginning of year | 33,428 | 26,477 | 28,769 | $11.57 | $16.14 | $17.34 |
| Granted | 2,607 | 6,954 | 5,370 | 41.65 | 17.84 | 17.14 |
| Exercised | (7,314) | (2,939) | (3,112) | 4.75 | 4.16 | 4.73 |
| Cancelled | (2,244) | (1,723) | (1,590) | 14.84 | 23.71 | 31.28 |
| Outstanding as of December 31, | 26,477 | 28,769 | 29,437 | $16.14 | $17.34 | $17.88 |
| Exercisable as of December 31, | 9,611 | 14,454 | 17,710 | $10.74 | $13.04 | $15.36 |
The options outstanding as of December 31, 2003, have been separated into ranges of
exercise price, as follows:
| Exercise price | Options outstanding at December 31,2003(in thousands) | Weighted average remaining contractual life(years) | Weighted average exercise price | Options exercisable at December 31,2003(in thousands) | Weighted average exercise price of exercisable options |
| --- | --- | --- | --- | --- | --- |
| $ | | | $ | | $ |
| 2.65-3.19 | 3,031 | 1.71 | 2.82 | 2,992 | 2.83 |
| 3.77-4.46 | 1,445 | 1.95 | 4.25 | 1,157 | 4.21 |
| 4.56-9.38 | 699 | 2.18 | 6.95 | 522 | 6.80 |
| 9.83-13.02 | 9,958 | 3.62 | 10.94 | 7,351 | 10.23 |
| 13.33-17.64 | 8,378 | 5.65 | 16.80 | 2,745 | 16.54 |
| 20.36-23.60 | 153 | 2.87 | 20.43 | 128 | 20.44 |
| 27.22-30.54 | 1,816 | 4.69 | 28.08 | 534 | 28.97 |
| 31.75-36.72 | 250 | 3.53 | 34.04 | 216 | 34.19 |
| 40.09-44.42 | 2,100 | 4.45 | 42.30 | 1,055 | 42.30 |
| 44.96-51.21 | 594 | 3.33 | 47.17 | 401 | 47.09 |
| 57.59-65.58 | 28 | 3.66 | 63.27 | 16 | 64.54 |
| 68.42-70.02 | 398 | 3.75 | 69.04 | 276 | 69.11 |
| 70.19-75.08 | 127 | 3.54 | 71.44 | 85 | 71.33 |
| 79.79-86.54 | 460 | 4.18 | 85.08 | 232 | 83.78 |
| 2.65-86.54 | 29,437 | 4.01 | 17.88 | 17,710 | 15.36 |
The weighted average fair values at grant date of options granted for the years ended
December 31, 2001, 2002 and 2003, were $ 28.29, $ 9.44 and $ 5.44, respectively. All
options are granted with an exercise price equal to the market value at the date of grant.
---
## NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
## U.S. dollars in thousands
## NOTE 10:- EARNINGS PER SHARE
The following table sets forth the computation of historical basic and diluted net earnings per share:
| | Year ended December 31, | | |
| --- | --- | --- | --- |
| | 2001 | 2002 | 2003 |
| Net income | $321,920 | $255,080 | $243,879 |
| Weighted average Ordinary shares outstanding | 240,008 | 244,097 | 247,691 |
| Dilutive effect:Employee stock options | 18,067 | 10,675 | 7,392 |
| Diluted weighted average Ordinary shares outstanding | 258,075 | 254,772 | 255,083 |
| Basic net earnings per Ordinary share | $1.34 | $1.04 | $0.98 |
| Diluted net earnings per Ordinary share | $1.25 | $1.00 | $0.96 |
---
## U.S. dollars in thousands
## NOTE 11:- GEOGRAPHIC INFORMATION AND SELECTED STATEMENTS OF INCOME DATA
## a. Summary information about geographical areas:
The Company adopted Statement of Financial Accounting Standard No. 131, "Disclosures
About Segments of an Enterprise and Related Information", ("SFAS No. 131"). The
Company operates in one reportable segment (see Note 1 for a brief description of the
Company's business). The total revenues are attributed to geographic areas based on the
location of the end customer.
The following present total revenues for the years ended December 31, 2001, 2002 and 2003
and long-lived assets as of December 31, 2001, 2002 and 2003:
## 1. Revenues based on the channel partners' location:
| | Year ended December 31, | | |
| --- | --- | --- | --- |
| | 2001 | 2002 | 2003 |
| Americas | $235,360 | $184,823 | $185,186 |
| Europe,Middle East and Africa | 199,303 | 173,369 | 175,887 |
| Japan | 52,827 | 40,068 | 39,622 |
| Asia Pacific | 40,153 | 28,729 | 31,877 |
| | $527,643 | $426,989 | $432,572 |
| 2. Long-lived assets: | | | |
| | December 31, | | |
| | 2001 | 2002 | 2003 |
| Israel | $7,772 | $134 | $4,372 |
| Americas | 4,356 | 499 | 2,452 |
| Other | 1,120 | 820 | 570 |
| | $13,248 | $10,453 | $7,394 |
| Financial income,net: | | | |
| Financial income: | | | |
| Interest income | $42,537 | $46,098 | $42,852 |
| Foreign currency translation adjustmentsand others | 2,523 | 3,521 | 1,006 |
| | 45,060 | 49,619 | 43,858 |
| Financial expense: | | | |
| Others | 300 | 305 | 352 |
| | 300 | 305 | 352 |
| | $44,760 | $49,314 | $43,506 |
---
# NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
## U.S. dollars
## NOTE 12:- SUBSEQUEENT EVENT (UNAUDITED)
In March 2004, the Company completed the acquisition 100% of the outstanding shares of privately
held Zone Labs for approximately $114 million in cash and 5.3 million ordinary shares. The
Company also assumed Zone Labs’ outstanding employee stock options which could convert to
approximately 2.8 million of the Company’s Ordinary shares.
Zone Labs' endpoint security solutions for enterprises, small businesses and consumers which
include the Integrity, ZoneAlarm and IM secure product lines, are expected to further strengthen the
Company’s perimeter, internal and Web security portfolio, enabling the Company to deliver a
comprehensive end-to-end Internet security to all types of customers.
- - - - - - - - - -
---
## SIGNATURES
The registrant hereby certifies that it meets all of the requirements for filing on Form 20-F and that it has duly caused and
authorized the undersigned to sign this annual report on its behalf.
# CHECK POINT SOFTWARE TECHNOLOGIES LTD.
By: /s/ Gil Shwed________________________________
Gil Shwed
Chief Executive Officer and Chairman of the Board
By: /s/ Eyal Desheh______________________________
Eyal Desheh
Chief Financial Officer
Date: March 29, 2004
---
## Consent of Independent Auditors
We hereby consent to the incorporation by reference in the Registration Statements on Form S-8 (Registration
Nos.333-6032, 333-7260, 333-9136 and 333-9508) of Check Point Software Technologies Ltd. of our report
dated January 20, 2004, with respect to the consolidated financial statements of Check Point Software
Technologies Ltd. included in this Annual Report on Form 20-F for the year ended December 31, 2003.
March 29, 2004
Tel-Aviv, Israel
KOST, FORER, GABBAY & KASIERER
A Member of Ernst & Young Global
---
## Exhibit 12.1
## CERTIFICATION
I, Gil Shwed, certify that:
1. I have reviewed this annual report on Form 20-F of Check Point Software Technologies Ltd.;
2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances under which such statements were made, not
misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in
all material respects the financial condition, results of operations and cash flows of the company as of, and for, the periods
presented in this report;
4. The company’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and
procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e) for the company and have:
(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed
under our supervision, to ensure that material information relating to the company, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is
being prepared;
(b) Evaluated the effectiveness of the company’s disclosure controls and procedures and presented in this report our
conclusions about the effectiveness of the disclosure controls and procedures, as of the period covered by this report
based on such evaluation; and
(c) Disclosed in this report any change in the company’s internal control over financial reporting that occurred during the
period covered by the annual report that has materially affected, or is reasonably likely to materially affect, the
company’s internal control over financial reporting.
5. The company’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over
financial reporting, to the company’s auditors and the audit committee of the company’s board of directors (or persons
performing the equivalent functions):
(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial
reporting which are reasonably likely to adversely affect the company’s ability to record, process, summarize and
report financial information; and
(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the
company’s internal controls over financial reporting.
---
## Exhibit 12.2
## CERTIFICATION
I, Eyal Desheh, certify that:
1. I have reviewed this annual report on Form 20-F of Check Point Software Technologies Ltd.;
---
# CERTIFICATION
## PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
## (SUBSECTIONS (a) AND (b) OF SECTION 1350, CHAPTER 63 OF TITLE 18, UNITED STATES CODE)
Pursuant to section 906 of the Sarbanes-Oxley Act of 2002 (subsections (a) and (b) of section 1350, chapter 63 of title 18,
United States Code), each of the undersigned officers of Check Point Software Technologies Ltd., an Israeli corporation (the
“Company”), does hereby certify, to the best of such officer’s knowledge, information and belief, that
The Annual Report on Form 20-F for the year ended December 31, 2003 (the “Form 20-F”) of the Company fully complies
with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934 and the information contained in the Form 20-
F fairly presents, in all material respects, the financial condition and results of operations of the Company.
Date: March 29, 2004
By: /s/ Gil Shwed________________________________
Gil Shwed
Chief Executive Officer and Chairman of the Board
By: /s/ Eyal Desheh______________________________
Eyal Desheh
Chief Financial Officer