(Mark One)
For the transition period from _______ to _________
Commission file number 0-28584
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: 248,217,798 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 o
Indicate by check mark which financial statement item the registrant has elected to follow:
Item 17 o Item 18 x
2
Not applicable.
3
The following selected consolidated statement of income data for the years ended December 31, 2002, 2003 and 2004, and the selected consolidated balance sheet data as of December 31, 2003 and 2004, 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, 2000 and 2001 and the selected consolidated balance sheet data as of December 31, 2000, 2001 and 2002 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 data set forth below should be read in conjunction with and is 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 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 amounts herein reflect adjustments resulting from these stock splits.
(1) Including the following significant pre-tax charges: acquisition related in-process R&D of $23.1 million, stock-based compensation of $4.6 million and amortization of intangible assets of $4.2 million.
(2) See Note 2r of the Notes to the Consolidated Financial Statements for an explanation of the determination of the number of shares used in computing net earnings per share.
4
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 others, 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 Internet 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, 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.
In March 2004 the Company completed the acquisition of Zone Labs, Inc. (“Zone Labs”). The acquisition of Zone Labs involved the integration of two companies that had previously operated independently. The difficulties of combining the companies’ operations included, and continue to be, but are not limited to: the necessity of coordinating geographically separate organizations and integrating personnel with diverse business backgrounds, potential difficulties in retaining employees and the associated adverse effects on relationships with existing partners. The integration may interrupt the activities of one or more of the combined company’s businesses and may result in the loss of key personnel. This could have an adverse effect on the business, results of operations, financial condition or prospects of the Company.
The Financial Accounting Standards Board (“FASB”) has recently adopted an accounting standard (“SFAS No. 123(R)”) that requires the fair value of all equity-based awards granted to employees be recognized in the statement of operations as compensation expense, beginning in the third quarter of 2005.
The various methods for determining the fair value of stock options are based on, among other things, the volatility of the underlying stock. The Company’s stock price has historically been volatile. The adoption of SFAS No. 123(R) will negatively affect the Company’s profitability and may adversely affect the Company’s stock price. Such adoption may also affect the Company’s management discretion to continue to use stock options as an incentive and retention tool, which could, in turn, hurt the Company’s ability to recruit employees and retain existing employees. See Notes 2s and 2v of the Notes to the Consolidated Financial Statements for a description of SFAS No. 123(R) and its possible effects on the Company’s earnings and earnings per share.
The market for Internet security solutions is intensely competitive and the Company expects competition to increase in the future. The Company’s principal competitors include Cisco Systems, Inc., Juniper Networks, McAfee, Inc., Microsoft 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, consolidation in the Internet security market may affect the Company’s competitive position. 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, reduced gross margins and loss of market share, any of which will materially adversely affect the Company’s business, operating results and financial condition.
5
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 Internet security functionality provided as standard features by operating systems software or networking hardware is more limited than that of the Company’s solutions, there can be no assurance that a significant number of customers would not elect to accept more limited functionality in lieu of purchasing additional solutions. 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.”
The Internet security 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 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.”
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 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 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.
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.”
6
The Company may experience a decline in operating margins due to the following reasons: 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 and additional expansion of the research and development organization. The amount and timing of the above-mentioned additional expenses are likely to result in fluctuations in operating margins. In addition, if revenue levels are below expectations, operating margins are likely to be adversely affected, since most of the Company’s expenses are not variable. See “Item 5 – Operating and Financial Review and Prospects.”
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” and “Competition” in this “Item 3.”
In 2004, sales to the Company’s five largest distributors and resellers 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 and resellers for a significant portion of its revenues. If anticipated orders from these distributors and 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 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, training and consulting. 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.”
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.”
The Company’s products incorporate certain technologies that are licensed by the Company from others. There can be no assurance that the Company will be able to continue to license such technologies or enter into new license agreements with respect to new technologies that it may wish to license and incorporate in its products, either on acceptable terms or at all. If the Company is unable to continue to license these technologies or enter into new license agreements for new technologies, it will not be able to incorporate such technologies into its products, thereby adversely affecting the Company’s ability to compete with competitors utilizing such technologies in their products.
7
The Company is and has been a party to various lawsuits, including employment claims, and other legal proceedings in the normal course of its business. In addition, the Company has received a number of class action complaints, which were later consolidated by the court into one action, 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.
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 and resellers 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 business with Israeli companies. In addition, many of the Company’s male officers and employees are subject to being called for military reserve duty, and for active military 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.
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, the Company needs to establish additional operations, hire additional personnel and recruit additional distributors and resellers 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.”
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 Internet 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 and hardware 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.”
8
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 United States and some other countries, as well as pending patent applications. 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.
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 regular statutory rate, and could be required to refund the tax benefits already received, together with linkage adjustment to the Israeli consumer price index and interest. In recent years, the Israeli government has reduced the benefits available under these programs and Israeli governmental authorities have indicated that the government may in the future reduce or eliminate the benefits of those programs. There can be no assurance that new benefits will be available, 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), a requirement to refund the tax benefits already received or changes in legislation, could 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.”
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. Under the Company’s Articles of Association, the required shareholder vote is a supermajority of at least 75% of the shares voting in person or by proxy on the matter. 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 30 days have passed from the shareholders’ approval of each of the merging companies and all approvals have been submitted to the Israeli Registrar of Companies and 50 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, unless 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 45% of the voting power of the company. These rules do not apply if the acquisition is made by way of a merger.
9
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:
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.
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.
As of February 28, 2005, the directors and executive officers of the Company beneficially owned approximately 24% of the outstanding ordinary shares of the Company. The percentage of ownership is calculated based on the number of ordinary shares owned, directly or indirectly, and the number of options immediately exercisable or that are exercisable within 60 days from February 28, 2005. 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.”
The Company has agreements with its directors and senior officers which provide, subject to Israeli law, for the Company to indemnify each such director and senior officer for any of the following obligations or expenses incurred in connection with the acts or omissions of such person in his or her capacity as a director or officer of the Company:
10
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 restricts in any way the ownership or voting of ordinary shares by non-residents of Israel, except with respect to citizens of those countries, which are in a state of war with Israel.
Check Point develops markets and supports Internet security 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 aims to provide intelligent security solutions that protect business communications and resources for corporate networks and applications, remote employees, branch offices and partner extranets, in three distinct areas: perimeter, Web and internal networks. The Company also provides endpoint security solutions that protect personal computers from hackers, spyware and data theft. The capabilities of Check Point products can be extended with the Company’s Open Platform for Security (“OPSEC”) framework, enabling integration with leading hardware appliances and third-party security software applications.
Check Point was incorporated in 1993. Its registered office and principal place of business 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).
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 expanding 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 dispersed client/server environments. The ability to access and share information through client/server technology has expanded the need for connectivity beyond workgroup Local Area Networks (“LANs”) to enterprise-wide networks spanning multiple LANs and Wide Area Networks (WANs). The second major transition has been the widespread adoption of the Internet for 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, supply chain automation, 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 (“VPNs”) 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.
11
The need for security
The growth of Internet connectivity among organizations of all sizes has increased the risk that an organization’s 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 organizational confidential information from unauthorized access.
The primary means of controlling access to organizational networks and protecting against attacks is the deployment of Internet firewalls. Firewalls are typically deployed at the demarcation of an organization’s LAN and the Internet, and are used to strictly control traffic into and out of the organizational 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. Increasing numbers of organizations are deploying an additional layer of security by applying endpoint security. Endpoint security includes personal firewall, security and policy enforcement features specifically designed for internal and remote personal computing devices.
In addition to protecting an organization’s IT assets from attack, organizations take steps to guard sensitive organizational information traversing untrusted networks, such as the Internet. Securing organizational 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, an increasing number of organizations are deploying VPNs to encrypt and authenticate their Internet-bound traffic. Leveraging standards-based VPN technology enables organizations to connect offices and remote employees via the Internet, while maintaining the privacy and integrity of communications.
Frequently, firewalls and VPNs are provided in an integrated manner or as a single product. Integrating firewall and VPN functionality delivers greater security for all traffic and eases the management burden on the security and network administrators.
IT security administrators within organizations 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.
Check Point’s Internet security solutions include various technologies that enable its customers to define their network and application security policies, enforce these policies across their networks, collect and correlate information, monitor the security and traffic flow and analyze and update configurations to reflect changes in the Internet security policies. The Company’s products are packaged and marketed under different names and address security tasks in various environments at a variety of price points.
Stateful Inspection technologies
Check Point’s VPN-1 product offerings are based upon the Company’s patented 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, Connectra and InterSpect scale effectively with increasing network bandwidth. In addition, Check Point’s proprietary implementation of Stateful Inspection in a “virtual machine” enables it to be adapted to new protocols and applications and has proved to be adaptable to many security threats. The Company’s implementation also provides upgradeability and enables the Company’s products to be 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.
12
Security and network traffic enforcement technologies (based on Stateful Inspection)
Check Point’s enforcement points are typically installed at the network perimeter as security gateways, on critical servers, on client platforms, as well as internally, to segment the corporate network. These varying enforcement points implement different patented technologies including the Company’s INSPECT engine. The INSPECT engine scans all incoming and outgoing internet traffic against a customizable security policy. The INSPECT engine can be further enhanced by partners or customers by using the INSPECT programming language.
Network traffic can be dropped when the security policy has been violated, encrypt to create a secured VPN, prioritize for Quality of Service (“QoS”) purposes or sent for further analysis to perform specific security functions such as authentication, URL filtering or content inspection using Anti-Virus. Many of these security technologies are provided by third party vendors and are integrated with the various Check Point solutions through the OPSEC framework. In addition, technologies like Check Point’s SecureXL allow third party accelerators and platforms to create Check Point based appliances and other solutions such as acceleration cards that further accelerate the performance of security and network operations.
Application Intelligence
Check Point’s Application Intelligence is a set of advanced capabilities, integrated into the VPN-1, InterSpect, Connectra and Integrity product offerings, which detect and prevent application-level attacks. Some of the most serious threats in today’s Internet environment originate 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 Security Management Architecture (“SMART”), 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 maximize interoperability and improve the manageability of the system.
SecurePlatform
SecurePlatform enables easy deployment of Check Point’s products on a variety of open systems. SecurePlatform bundles certain Check Point products with a hardened and optimized version of the Linux operating system, with a set of tools in order to ease setup and network configuration. SecurePlatform allows improved cost/performance and reduced total cost of ownership for security servers.
SecureXL
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-1 and VPN-1 gateways by off-loading simple, though computationally intensive, functions to third-party packet processors. Using SecureXL different hardware appliance vendors can accelerate the performance of “Secured by Check Point” appliances and provide greater value to their customers that are benefiting from wire-speed advanced security.
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Open Platform for Security (OPSEC)
The OPSEC framework provides a single platform that manages various aspects of Internet security through an open, extensible management framework. Various third-party security applications plug into the OPSEC framework through published application programming interfaces, such as the Content Vectoring Protocol which integrates virus scanning software and other content inspection programs, URL Filtering Protocol which integrates URL list services, and Suspicious Activity Monitoring Protocol which integrates suspicious activity monitoring programs. The OPSEC framework 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’s SmartDefense is a proactive 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 offers 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.
Malicious Code Protector
Check Point’s Malicious Code Protector is a patent pending technology, providing breakthrough protection capabilities against different types of buffer overflow attacks that are targeted to provide attackers remote access to a victim’s system. The Malicious Code Protector is designed to provide extreme defense without the use of signatures, thus creating critical protection from zero day type attacks.
Cooperative Enforcement
The patented Cooperative Enforcement technology enables integration with network gateway products, from VPNs and switches to Web applications and wireless access points, in order to ensure that every endpoint is compliant with the designated security policy before it is allowed access to network resources.
TrueVector Technology
TrueVector technology is a patented, flexible and efficient software platform for enabling high-performance, scalable and robust Internet security. TrueVector monitors all applications running on the protected computer and applies various network security policies to individual applications and processes. Depending on the policy, TrueVector may explicitly allow certain applications, or individual application modules, to communicate over a specific set of network protocols, ports, and destinations, denying all other communications. It also may be configured to make the protected computer invisible to external attackers. TrueVector is capable of enforcing centrally created and managed security policies, standalone security policies, and combinations of these.
Total Access Protection
Total Access Protection (“TAP”) endpoint security initiative provides a security policy enforcement framework for heterogeneous networks to provide all network-connected personal computers with unified endpoint security.
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Check Point’s products are packaged in different ways and address various customer needs and deployment scenarios. Most products operate on a broad range of hardware platforms, running primarily on the following operating systems: Nokia IPSO, Microsoft Windows, Sun 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 access between a customer’s internal network or computers and an external network such as the Internet. Check Point historically has focused mainly on VPN-1 and FireWall-1 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:
Enterprise products:
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Products for medium businesses, small businesses and consumers:
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Products for service providers, data centers and large enterprises:
Product for wireless carriers:
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Check Point’s 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 (also referred to as channel partners), including distributors, resellers and value added resellers (“VARs”), system integrators and MSPs. Substantially all of the Company’s products are sold to end-user customers through resellers and distributors worldwide. Products for the consumer market are primarily sold through the Company’s Web site and through certain retail stores. The Company expects that it will continue to be dependent upon a limited number of distributors and resellers for a significant portion of its revenues. In 2004, sales to the Company’s five largest distributors and resellers 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, on-line advertising and time limited software evaluations.
The Company has relationships with server and workstation vendors and appliance manufacturers, such as Nokia Corporation, International Business Machines Corporation (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 Internet security products, packaged and marketed mostly under the VPN-1 product family (which includes the FireWall-1 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 framework 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 350) include appliance manufacturers like Nokia Corporation, Sun Microsystems, Inc. and Nortel Networks Corp. and application developers like Computer Associates International, Inc., Trend Micro, Inc., RSA Security, Inc. and VeriSign, Inc. In addition, the Company maintains marketing relationships with other companies to promote integrated products.
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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.
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 offer lower cost to the customer and greater account coverage. In 2004 most subscription and support contracts were based on the new method.
The Company’s technical assistance centers in the United States and Israel offer worldwide 24-hour, 7-day per week service. There are additional locations supporting the call centers, as well as a call center operated by a third party.
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 2002, 2003 and 2004 were $28.7 million, $29.3 million and $43.2 million, respectively. At December 31, 2004, the Company had 439 employees dedicated to research and development activities and quality assurance, mostly located in Israel. As of February 28, 2005 the Company had 465 such employees.
See “Risk Factors – Competition” in “Item 3 – Key Information.”
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 18 patents pending, four U.S. patents and additional pending applications worldwide. 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.
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The Company is organized under the laws of the State of Israel. Except as set forth in the footnotes below, the Company wholly owns, directly or indirectly, the subsidiaries specified below:
(1) Branch of Check Point Software Technologies Ltd.
(2) Branch of Check Point Holding (Singapore) PTE Ltd.
(3) Wholly owned by Check Point Software Technologies, Inc.
(4) Wholly owned by Check Point Software Technologies, Inc. Currently in the process of merger into the respective Check Point subsidiary in the relevant jurisdiction.
(5) Wholly owned by Zone Labs LLC. Currently in the process of merger into the respective Check Point subsidiary in the relevant jurisdiction.
(6) Check Point had provided convertible loans to SofaWare Technologies Ltd (“SofaWare”), which were converted into 65% of the equity of SofaWare on June 29, 2004 (without giving effect to the exercise of any outstanding options or warrants to purchase equity securities of SofaWare). Check Point beneficially owns 74% of the equity of SofaWare (based on the shares of SofaWare currently held by Check Point, and assuming the exercise by Check Point of all of its warrants to acquire shares of SofaWare). Accordingly, Check Point consolidates the results of SofaWare’s operations into Check Point’s financial statements.
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Check Point Software Technologies (Netherlands) B.V. acts as a holding company and wholly owns the following principal operating subsidiaries specified below:
(1) 97% owned by Check Point Software Technologies (Netherlands) B.V. and 3% owned by Check Point Software Technologies Ltd.
(2) 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.
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 have leases that expire between 2005 and 2007, or 2011 if renewal options are exercised. The Company also leases approximately a total of 170,000 square feet of office space in the United States. Of that, approximately 48,000 square feet is in Redwood City, California, approximately 70,000 square feet is in San Francisco, California and approximately 31,000 square feet is in Dallas, Texas. These facilities are leased for periods of up to five years. In addition, the Company leases regional office space in the United States, Canada, Europe and Asia.
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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.”
Check Point develops, markets and supports Internet security 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 aims to provide intelligent security solutions that protect business communications and resources for corporate networks and applications, remote employees, branch offices and partner extranets, in three distinct areas: perimeter, Web and internal networks. The Company also provides endpoint security solutions that protect personal computers from hackers, spyware and data theft. The capabilities of Check Point products can be extended with the OPSEC framework, 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 product family, including related software subscriptions, support, training and consulting.
During 2002, 2003 and 2004 approximately 13% of the Company’s revenues derived from a single distributor.
On March 26, 2004, the Company completed the purchase of 100% of the share capital of Zone Labs Inc. The Company paid $114.5 million in cash, $92.2 million in ordinary shares and $50.4 million in options assumed. The acquisition was accounted for as a purchase and, accordingly, the purchase price for the acquisition was allocated to the assets acquired and liabilities assumed based on their respective fair values. Zone Labs’ results of operations are included in Check Point consolidated statement of income from the date of acquisition.
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:
For information with respect to the impact of foreign currency fluctuations, see Item 11, “Quantitative and Qualitative Disclosures about Market Risk–Foreign Currency Risk.”
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The Company’s consolidated financial statements are prepared in accordance with U.S. 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 U.S. 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 U.S. GAAP.
Management believes the critical 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
The Company derives its revenues from three primary sources: (1) new software licenses (2) software subscriptions and (3) services revenues, which include support, training and consulting. 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) the price 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 not to be 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 and support 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, training and consulting) is generally determined based on the price charged for the undelivered element when sold separately or renewed.
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.
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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 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.
Marketable securities
Marketable securities consist of held-to-maturity securities, which are debt securities in which the Company has invested with the intention of holding until the maturity dates of the securities. If it is determined, based on valuations, that a decline in the fair value of any of the investments is other than temporary, an impairment loss is recorded and included in the consolidated statements of income as financial expenses.
Legal contingencies
The Company is and has been a party to various lawsuits, including employment claims, and other legal proceedings in the normal course of its business. In addition, the Company has received a number of class action complaints, which were later consolidated by the court into one action, alleging violations of the federal securities laws. In determining whether provisions should be recorded for pending litigation claims, the Company assesses the allegations made and the likelihood that it will successfully defend itself. When the Company’s management believes that it is probable that it will not prevail in a particular matter, it then estimates the amount of the provision based in part on advice of legal counsel.
Income taxes and valuation allowance
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.
Deferred taxes are determined utilizing the asset and liability method based on the estimated future tax effects of differences between the financial accounting and tax bases of assets and liabilities under the applicable tax laws. Valuation allowances are provided if based upon the weight of available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized. Taxes, which would apply in the event of disposal of investments in subsidiaries, have not been taken into account in computing deferred taxes, as it is Check Point’s intention to hold these investments, rather than realize them.
Goodwill and other intangible assets
The Company applies SFAS No. 142, ‘Goodwill and Other Intangible Assets’. SFAS No. 142 requires that goodwill and intangible assets with an indefinite life be tested for impairment at least annually rather than amortized. Goodwill and intangible assets with an indefinite life are tested for impairment by comparing the fair value of the reporting unit or the asset with its carrying value. Fair value is generally determined using discounted cash flows, market multiples and market capitalization. Significant estimates used in the fair value methodologies include estimates of future cash flows, future short-term and long-term growth rates, weighted average cost of capital and estimates of market multiples of the reportable unit. Other factors considered are the brand awareness and the market position of the acquired products and assumptions about the period of time the brand will continue to be used in the combined companies’ product portfolio. If these estimates or their related assumptions change in the future, the Company may be required to record impairment charges for its goodwill and intangible assets with an indefinite life.
The Company selected December 31st as the date on which it will perform its annual impairment tests for goodwill and intangible assets with an indefinite life. As of December 31, 2004, no impairment charges were required. The Company allocated the purchase price of Zone Labs to the tangible and intangible assets acquired and liabilities assumed, based on their estimated fair values. As described above, such valuations require management to make significant estimates and assumptions, especially with respect to intangible assets.
If the Company does not appropriately allocate these components or incorrectly estimates the useful lives of these components, the computation of depreciation and amortization expense may not appropriately reflect the actual impact of these costs over future periods, which will affect net income.
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The following table presents, for the periods indicated, information concerning the Company’s results of operations:
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The following table presents, for the periods indicated, information concerning the Company’s results of operations as a percentage of the Company’s revenues:
Revenues
The Company’s revenues are derived from the sale of products and licenses and related software subscriptions, support, training and consulting. The Company’s revenues were $427.0 million, $432.6 million and $515.4 million in 2002, 2003 and 2004, respectively. In 2003, the Company experienced 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 the Company’s installed base. The increase in revenues in 2004 was attributable both to organic growth and to the acquisition of Zone Labs. The organic growth was evident both in the Company’s core products and in various emerging products which were introduced during the year. Management anticipates that revenues in 2005 will increase mainly due to internal growth. However, there can be no assurance that revenues will grow in 2005 due to several factors, any of which could have a material adverse affect on revenues, including the uncertainty of the global economic conditions, 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 $20.7 million, $18.9 million and $23.6 million (excluded amortization of intangible assets related to the Zone Labs acquisition in the amount of $4.2 million) for 2002, 2003 and 2004, respectively. The acquired intangible assets are amortized on a straight-line basis over their useful lives which best represents the distribution of their economic value. In 2003, cost of revenues decreased due to improvement of operational efficiencies. In 2004, the increase in cost of revenues was mainly attributable to the inclusion of Zone Labs’ operations starting in the second quarter of 2004 and to the increase in sales of hardware based products. Management anticipates that cost of revenues will increase in 2005 in line with an expected growth in revenues derived from products incorporating hardware.
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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 $28.7 million, $29.3 million and $43.2 million in 2002, 2003 and 2004, respectively, representing 7%, 7% and 8% of revenues, respectively. The increase in 2003 related mainly to the increase in the number of research and development personnel employed by the Company. In 2004, the significant increase was mainly attributable to the increase in the number of research and development employees, resulting from the acquisition of Zone Labs. Management anticipates that research and development expenses in 2005 will increase due to additional recruiting of employees and expected increase in payroll and related 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 $104.6 million, $111.0 million and $132.8 million in 2002, 2003 and 2004, respectively, representing 24%, 26% and 26% of revenues, respectively. In 2003, the increase resulted mostly from higher compensation related expenses and the effect of the strong position of the Euro against the U.S. Dollar. In 2004, the selling and marketing expenses increased mainly due to the inclusion of Zone Labs’ operations, the increase in compensation expenses – in line with the increase of revenues, increase in marketing activities and the continued strengthening of the Euro. Management anticipates that selling and marketing expenses in 2005 will increase due to increased marketing activities and an expected increase in payroll and related 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 $18.0 million, $17.6 million and $23.7 million in 2002, 2003 and 2004, respectively, representing 4%, 4% and 5% of revenues, respectively. The increase in 2004 compared to 2002 and 2003 was mainly due to the inclusion of Zone Labs’ operations and market increase in insurance costs. Management anticipates that in 2005, general and administrative expenses will increase due to additional recruiting of employees and expected increase in payroll and related expense.
In-process research and development
At the acquisition date of Zone Labs, the Company recorded a $23.1 million charge for acquired in-process research and development (“IPR&D”) in conjunction with projects which qualified as not yet having reached technological feasibility and have no alternative future use. The value of IPR&D was determined using the discounted cash flow approach. The expected future cash flow attributable to IPR&D was discounted at 25%. At the time of the acquisition of Zone Labs, it was estimated that these IPR&D projects were 32% complete and would be completed over the next 3 years.
Deferred stock-based compensation
In conjunction with the acquisition of Zone Labs, the Company recorded deferred stock-based compensation in the amount of $16.6 million, which represents the intrinsic value of approximately $2.8 million options to purchase the Company’s ordinary shares that the Company issued in exchange for Zone Labs unvested stock options. This amount is included in the total fair value of Zone Labs’ options assumed of $50.4 million. Deferred stock-based compensation is recognized over the remaining vesting period of the related options on a straight-line basis. During the year ended December 31, 2004, stock-based compensation associated with these options amounted to $4.6 million. Management anticipates that in 2005, stock-based compensation expenses will increase due to adoption of SFAS No. 123(R).
Operating margin
The Company may experience future decline in operating margins from historical levels due to the following reasons: 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; adoption of SFAS No. 123(R) and the expected growth in revenues derived from products incorporating hardware. The amount and timing of the above-mentioned additional expenses are likely to result in fluctuations in operating margins.
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Financial income, net
Financial income, net consists primarily of interest earned on cash equivalents and marketable securities. Financial income, net was $49.3 million, $43.5 million, and $44.8 million in 2002, 2003 and 2004, respectively. 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. Financial income has slightly increased in 2004. This increase is a result of rising interest rates despite the decrease in the Company’s average cash levels in 2004 attributable to the Zone Labs acquisition and the share repurchase programs executed in 2004.
Taxes on income
The Company’s effective tax rate was 16.2%, 18.5% and 18.6% in 2002, 2003 and 2004, respectively. These relatively low tax rates were mainly achieved as a result of the Approved Enterprise status granted to the production facilities in Israel. The Company expects that its effective tax rate in 2005 will not increase significantly compared to its 2004 effective tax rate.
Under the provisions of the Israeli law, the Company has elected the alternative package of tax benefits relating to its production facilities, which grant tax exemptions and reduced tax rates. Accordingly, income derived from its Approved Enterprises is generally entitled to a tax-exemption period of two years and 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 in the Company. 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 of $1,515 million as of December 31, 2004, approximately $568 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 $ 142 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 regularly statutory Israeli corporate tax rate and could be required to refund tax benefits already received plus linkage adjustment to the Israeli consumer price index and interest. New legislation to replace the law prescribing the benefits is currently pending final approval of the Israeli Parliament. The proposed new legislation imposes additional eligibility criteria for Approved Enterprise benefits. The proposed new legislation would also offer additional forms of alternative benefits. The Company’s management does not believe that the new legislation, if adopted in accordance with the current proposal, would have a material effect on the Company in 2005.
See “Israeli Taxation, Foreign Exchange Regulation and Investment Programs” in “Item 10 – Additional Information.”
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The following table sets forth certain unaudited consolidated statements of income data for each of the quarters in 2003 and 2004, 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.
(1) Including pre-tax charge of acquisition related IPR&D of $23.1 million.
(2) Including pre-tax charges of amortization of intangible assets and deferred stock-based compensation of $3.1 million.
(3) Including pre-tax charges of amortization of intangible assets and deferred stock-based compensation of $2.9 million.
(4) Including pre-tax charges of amortization of intangible assets and deferred stock-based compensation of $2.8 million.
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As a Percentage of Revenues:
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.
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.
On December 16, 2004, the Financial Accounting Standards Board issued SFAS No. 123(R), which is a revision of FASB Statement No. 123, Accounting for Stock-Based Compensation (“SFAS No. 123”). SFAS No. 123(R) supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees” and amends FASB statement No. 95 “Statement of Cash Flows”. Generally, the approach in SFAS No. 123(R) is similar to the approach described in SFAS No. 123. However, SFAS No. 123 permits, but does not require, share-based payments to employees to be recognized based on their fair values, while SFAS No. 123(R) requires all share-based payments to employees to be recognized based on their fair values. Pro forma disclosure is no longer an alternative.
SFAS No. 123(R) must be adopted no later than July 1, 2005. The Company expects to adopt this statement on July 1, 2005. The Company plans to adopt SFAS No. 123(R) using the modified prospective method.
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The adoption of SFAS No. 123(R)‘s fair value method will have a significant impact on the Company’s results of operations, although it will have no impact on the company’s overall financial position. The impact of adoption of SFAS No. 123(R) cannot be predicted at this time because it will depend on levels of share-based payments granted in the future. However, had the Company adopted SFAS 123(R) in prior periods, the impact of that standard would have approximated the impact of SFAS 123 as described in the disclosure of pro forma net income and earnings per share in Note 2s of the Notes to the Consolidated Financial Statements.
The Company has financed its operations through cash generated from operations. Cash and cash equivalents and short-term investments were $954.2 million and long-term interest bearing investments were $623.1 million, totaling $ 1,577.3 million as of December 31, 2004, as compared with cash and cash equivalents and short-term investments of $1,136.3 million and long-term interest bearing investments of $466.4 million totaling $1,602.7 million as of December 31, 2003. 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 $283.9 million, $290.9 million and $302.0 million in 2002, 2003 and 2004, respectively. Net cash from operations for 2002 and 2003 consisted primarily of net income, 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 2004 consisted primarily of net income, plus increases in deferred revenue, employees and payroll accruals, depreciation and amortization of marketable securities, IPR&D, intangible assets and deferred stock based compensation related to the acquisition of Zone Labs offset by decreases in accrued expenses and other liabilities and increases in trade receivables.
Net cash used in investing activities was $73.3 million, $425.9 million and $261.5 million in 2002, 2003 and 2004, respectively. In 2002 and 2003 net cash used in investing activities consists primarily of investing in marketable securities and bank deposits of varying maturities offset by proceeds from marketable securities and bank deposits. Excess cash is invested depending on projected cash needs for operations, capital purchases and other business purposes. In 2004, net cash used in investing activities included, in addition to the above, net cash paid in conjunction with the acquisition of Zone Labs of $ 95.3 million. The Company’s capital expenditures amounted to approximately $4.6 million, $3.0 million, and $4.5 million in 2002, 2003 and 2004, 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, 2004, the Company had no material commitments for capital expenditures.
Net cash provided by (used in) financing activities was approximately $14.7 million, $17.7 million and $(210.1) million in 2002, 2003 and 2004, respectively. Net cash from financing activities in 2002 and 2003 was primarily as a result of proceeds derived from exercise of stock options. In 2004, net cash used in financing activities was attributed primarily to the purchase of treasury shares. 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. In October 2004, after the Company has completed the repurchase of its ordinary shares in the amount of $200 million under the repurchase program, the Company announced that its Board of Directors has authorized an additional repurchase of up to $200 million of its outstanding ordinary shares in the open market or through privately negotiated transactions. Under the repurchase programs, 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 programs have no time limit and may be suspended from time to time or discontinued. Under the above programs, the Company purchased during 2004 a total of 12 million shares at a total cost of $245 million at an average price of $20.4.
The Company’s principal sources of liquidity consist of its current assets and long-term investments (which aggregated $1,577.3 million as of December 31, 2004), 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.
The Company is not a party to any material off-balance sheet arrangements. In addition, the Company has no unconsolidated special purpose financing or partnership entities that are likely to create material contingent obligations.
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As of December 31, 2004 the Company does not have material contractual obligations and commercial commitments except for leases of its facilities. The lease commitments due within one year amount to $6.4 million. Lease commitments due between one to five years amount to $4.2 million (see also Note 7a to the financial statements).
The directors and executive officers of the Company as of December 31, 2004 were as follows:
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 has received numerous prestigious accolades for his individual achievements and industry contributions, including an honorary Doctor of Science from Technion, Israel Institute of Technology, the World Economic Forum’s Global Leader for Tomorrow for his commitment to public affairs and leadership in areas beyond immediate professional interests, and the Academy of Achievement’s Golden Plate Award for his innovative contribution to business and technology.
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. Nacht earned a B.S. Cum Laude in Physics and Mathematics from the Hebrew University of Jerusalem, through an elite project of the Israeli Air Force in 1983 and an M.S. in Electrical Engineering and Communication Systems from Tel Aviv University in 1987.
Jerry Ungerman was appointed Vice Chairman of the Board in 2005 and he is responsible for leading the Company’s partner and customer relations. He served as President of the Company from 2001 until 2005 and as Executive Vice President of the Company from 1998 until 2000. Prior to joining the Company, Mr. Ungerman accumulated more than 30 years of high-tech sales, marketing and management experience at Hitachi Data Systems (HDS). He began his career with IBM after earning a bachelor’s degree in business administration from the University of Minnesota.
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Eyal Desheh has been Chief Financial Officer of the Company since 2000. As chief financial officer, he is responsible for all Worldwide financial management including investor relations, financial and risk management, planning, reporting, legal and operations. From 1996 until 2000 he was Chief Financial Officer for Scitex Corporation Ltd., a world leader in digital imaging solutions for graphics communications, where he managed all major finance functions. Before joining Scitex, he served in numerous financial management and business development roles including Vice President for business development and strategy at Bezeq, The Israeli Telecommunications Corp. Ltd., Deputy Chief Financial Officer of Teva Pharmaceuticals Ltd., President of H.L. Financial Services Ltd. and Vice President of Bank Hapoalim New York. Mr. Desheh earned a bachelor’s degree in Economics and MBA in Finance, both from the 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 and he was a recipient of the Industry Prize in 1995. Mr. Rubner serves on the boards of directors of Koor Industries, Lipman Transaction Solutions Ltd. and Elbit Imaging Ltd., and is a member of the Board of Trustees of Bar-Ilan University and Shaare Zedek hospital.
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 Gil Shwed and Marius Nacht, as of December 31, 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 Gil Shwed and Marius Nacht, see “Item 7 – Major Shareholders and Related Party Transactions.”
The term of each director will expire at the annual general meeting of shareholders to be held in 2005, except for Ray Rothrock and Irwin Federman, whose terms will expire at the annual general meeting of shareholders to be held in 2006.
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 or her 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 eligible to serve as a director, 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.
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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 an Audit Committee and a Compensation Committee.
Outside directors
In accordance with the Israeli Companies Law and the relevant regulations, 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.
Independent directors
Under the rules promulgated by the Securities and Exchange Commission (the “SEC”) and under the NASDAQ National Market regulations applicable to foreign private issuers such as the Company, on or before July 31, 2005, the Company is required to have at least three “independent” directors as that term is defined under the applicable NASDAQ National Market regulations. The current directors of the Company determined to be independent under the applicable NASDAQ National Market regulations are Irwin Federman, Ray Rothrock and David Rubner.
The Israeli Companies Law requires public companies to establish an audit committee. Under the Israeli Companies Law, an audit committee must consist of at least three directors, two of which must be 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 members of the audit committee. The 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 the approval was granted. In addition, under the rules promulgated by the SEC and under the NASDAQ National Market regulations applicable to foreign private issuers such as the Company, on or before July 31, 2005, the audit committee must consist solely of “independent directors” as that term is defined under the applicable NASDAQ National Market regulations. Currently, the audit committee consists of three members: Irwin Federman, Ray Rothrock and David Rubner. The Company’s audit committee composition satisfies both the Israeli Companies Law and the SEC and NASDAQ National Market requirements. The audit committee’s responsibilities include identifying irregularities in the management of the Company’s business and approving related party transactions as required by the Israeli Companies Law. In addition, the audit committee reviews all subjects of an accounting or financial nature (including closing of the financial statements, relevance of accounting methods and review of internal audit procedures and plans) and issues opinions on the renewal or appointment of auditors. For more information regarding the audit committee’s policies and procedures for the appointment of outside auditors, see “Item 16C-Principal Accounting Fees and Services.” In 2003 the Audit Committee has adopted an Audit Committee Charter as required by the NASD.
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. In 2004 the Compensation Committee has adopted a Compensation Committee Charter.
The aggregate accrued compensation of all persons as a group who served in the capacity of director or executive officer during the years ended December 31, 2003 and 2004 was approximately $3.3 and $3.2 million, respectively. 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 2005; the Company’s directors who are not officers will receive compensation for serving as directors in 2005. From time to time, the Company grants options under its stock option plans (described below) to its executive officers and directors. As of February 28, 2005, the Company’s executive officers and directors held options to purchase an aggregate of 13,126,996 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 October 2005 and July 2011. Other than as set forth in the share ownership table under Item 7 – “Major Shareholders and Related Party Transactions,” none of the Company’s directors and officers holds more than 1% of the outstanding shares of the Company.
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Number of shares reserved for future grants
Effective as of January 2000, the Company’s Board of Directors approved a plan for automatic annual increases in the number of shares authorized for issuance under the Company’s stock option plans in an aggregate amount equal to five percent (5%) of the then outstanding ordinary shares. The total annual increase is allocated 40% to the Company’s 1996 Israel Stock Option Plan (the “1996 Israel Plan”) and 60% to the Company’s 1996 United States Stock Option Plan (the “1996 U.S. Plan”), unless the Board of Directors determines a different allocation.
On May 6, 2004, the Company’s Board of Directors reviewed the appropriateness of the number of ordinary shares reserved for issuance under the Company’s stock option plans. The review concluded that the number of shares reserved for issuance under the Company’s stock option plans exceeds the number of shares necessary for the expected net grants to employees, consultants and service providers in the foreseeable future. The Company’s Board of Directors therefore determined to reduce the number of shares reserved for future grants under the Company’s stock option plans by an aggregate of 60,000,000 ordinary shares.
As of February 28, 2005, the aggregate number of shares reserved for future grants under the Company’s stock option plans was 54,001,156 ordinary shares.
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 May 2004. The 1996 Israel Plan authorizes the issuance of up to 76,433,142 ordinary shares. As of February 28, 2005, 15,203,696 ordinary shares had been issued under the 1996 Israel Plan, options to purchase 23,219,264 ordinary shares were outstanding (including options incorporated from previous grants to employees in Israel prior to the adoption of the 1996 Israel Plan) and 38,010,182 ordinary shares remained available for future grants. The options exercise prices range between $2.65 and $86.54. The 1996 Israel Plan is administered by the Board of Directors. The 1996 Israel Plan provides that options granted thereunder 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 which expire or terminate prior to exercise, are available for future issuance.
The Board of Directors 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. The subsidiary plans are tailored for various jurisdictions worldwide, except for the United States, to employees of the Company’s subsidiaries. In accordance with the terms and conditions imposed by Section 102 of the Israel Income Tax Ordinance, optionees that receive options under the 1996 Israel Plan are afforded certain tax benefits, excluding optionees who previously received options that were incorporated upon the adoption of the 1996 Israel Plan, and further excluding controlling shareholders of the Company or optionees who are not employees or directors of the Company. The Company has elected the benefits available pursuant to the “capital gains” alternative under the Income Tax Ordinance. 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 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 terminates by its terms on April 11, 2006.
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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 was restated, most recently in May 2004. The 1996 U.S. Plan authorizes the issuance of up to 60,278,415 ordinary shares. As of February 28, 2005, 37,359,271 ordinary shares have been issued under the 1996 U.S. Plan, options to purchase 6,928,169 ordinary shares were outstanding (including options incorporated from the 1995 Plan) and options to purchase 15,990,974 ordinary shares remained available for future grant. The option 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. 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 may cancel outstanding options under the 1996 U.S. Plan, in return for the grant of new options with an exercise price per share based upon the fair market value of 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 terminates by its terms on April 11, 2006.
Stock option grants to board members
Under the Board of Directors Option Grant Program, each non-employee director who is first elected or appointed to the Board of Directors shall automatically be granted an option to purchase up to 50,000 ordinary shares on the date of such initial election or appointment, vesting over a four-year period. In addition, on the date of each annual general meeting of shareholders, each non-employee director who is to continue to serve as a non-employee director after such annual meeting shall be granted an option to purchase up to an additional 25,000 ordinary shares, vesting in equal monthly installments over a one-year period, 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 the annual meeting. All options granted at an exercise price equal to 100% of the closing price of the ordinary shares on the NASDAQ Stock Market on the date of grant. The options have a maximum term of seven years, subject to earlier termination following the optionee’s cessation of Board service. The Board of Directors Option Grant Program was restated, most recently in the annual meeting of the Company’s shareholders held on June 30, 2004.
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Zone Labs 1998 stock option plan
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 approximately 2.8 million shares of the Company’s ordinary shares. The Zone Labs Plan authorizes the issuance of up to 2,818,615 ordinary shares. As of February 28, 2005, 1,930,161 ordinary shares had been issued under the Zone Labs Plan and options to purchase 728,339 ordinary shares were outstanding. The options exercise prices range between $1.66 and $6.08. No further stock options can be granted under the Zone Labs Plan. The stock options generally have terms of between five and ten years and generally vest over a four-year period.
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 28, 2005, 1,601,362 ordinary shares have been issued under the Purchase Plan. The Purchase Plan, which is intended to qualify under Section 423 of the U.S. 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 of Directors administers the Purchase Plan. Employees of the Company and some of its subsidiaries are eligible to participate if they are employed full time. 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 shareholder 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 on July 31, 2006.
The Compensation Committee of the Board of Directors, as administrator of the 1996 U.S. 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, 2004, the Company had 1,344 employees, of whom 439 were engaged in research, development, and quality assurance, 568 were engaged in marketing, sales and business development, 124 were engaged in customer support, and 213 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, 2004, the Company had 88 people of the above-mentioned nature.
As of December 31, 2004, the Company employed 538 people in Israel, 612 people in the United States and 194 people in the rest of the world. The Company’s relations with its employees in Israel are governed by Israeli labor laws. These laws differ in material respects from U.S. labor laws and, in some cases, impose material obligations on the Company (such as severance pay and mandatory cost of living increases). The Company believes that it has sufficient provisions in respect of these obligations. The Company is subject to the labor laws and regulations of other jurisdictions in the world where it has employees.
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The following table sets forth certain information regarding ownership of the Company’s ordinary shares as of December 31, 2004 for each person who is known by the Company to own beneficially more than five percent of the Company’s outstanding ordinary shares:
According to the Company’s transfer agent, as of March 31, 2005 there were 293 holders of record of the Company’s ordinary shares residing in the United States, holding 204,019,216 ordinary shares, or 83% 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.
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.
Out of the Company’s retained earnings of $1,515 million as of December 31, 2004, approximately $568 million were tax-exempt. 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.
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 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 a 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 retained counsels and filed a motion 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. On March 7, 2005 Check Point’s motion to dismiss was granted by the District Court. The issued Order permits the plaintiffs to file an amended complaint to cure the defects in the dismissed complaint by April 22, 2005. Further analysis cannot be provided until the submission of an amended complaint. Check Point continues to dispute the allegations of wrongdoing and intends to defend the matter vigorously. Check Point maintains applicable insurance as well as a financial reserve in its financial statements as of December 31, 2004.
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On November 16, 2004, Etay Bogner, a shareholder of SofaWare, filed a motion in the Tel-Aviv District Court asking that the court authorize him to conduct a shareholders derivative suit against the Company on behalf of SofaWare in the amount of NIS 22.7 million ($5.1 million), not including linkage and interest. The suit relates to discounts, sales commissions and royalties that the plaintiff alleges the Company owes to SofaWare, with respect to products that were sold by or through the Company. The matter is at a preliminary stage and the Company’s management is therefore unable to estimate its effect on the Company’s financial results.
On December 14, 2004, Adi Ruppin, a shareholder and director of SofaWare, filed an initiating motion in the Tel-Aviv District Court against the Company. The motion alleges that the Company is oppressing the plaintiff, who is a minority shareholder of SofaWare. Therefore, the plaintiff is asking the court to compel the Company to purchase the plaintiff’s shares in SofaWare, based upon a valuation to be determined by an independent expert. The plaintiff is also seeking disclosure of information and documents relating to the business plans of the Company and SofaWare, and to the inter-company balances between the two companies. The matter is at a preliminary stage and the Company’s management is therefore unable to estimate its effect on the Company’s financial results.
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 prices for the ordinary shares for the periods indicated as reported by the NASDAQ National Market:
On March 31, 2005, the last reported sale price of the Company’s ordinary shares on the NASDAQ National Market was $21.72 per share.
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 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.
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.
Description of ordinary shares
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 or approval of a winding-up of the Company or a merger involving the Company) 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.
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The Israeli Companies Law requires that the shareholders approve certain transactions, actions and arrangements. Such transactions, actions and arrangements include:
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 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 business combination includes:
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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 or her 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 or she may have and all related material information known to him or her, 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 or she 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.
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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 or her power in the company, including, among other things, voting in the general meeting of shareholders on the following matters:
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. A recent amendment to the Israeli Companies Law provides that a breach of the duty of fairness will be governed by the laws governing breach of contract. 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 or her as a result of an act or omission in the capacity of an office holder for:
Moreover, a company can indemnify an office holder for any of the following obligations or expenses incurred in connection with the acts or omissions of such person in his or her capacity as an office holder:
Furthermore, a company can, with a limited exception, exculpate an office holder in advance, in whole or in part, from liability for damages sustained by a breach of duty of care to the company.
The Company’s Articles of Association allow for insurance, exculpation 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.
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In accordance with Rule 4350(a)(1) of the Rules of Corporate Governance of the NASDAQ Stock 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 on Form 20-F with the Securities and Exchange Commission.
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, the Law for Amendment of the Income Tax Ordinance (amendment No.132), 2002, commonly referred to as the Tax Reform, came into effect, following its enactment by the Israeli Parliament on July 24, 2002. On December 17, 2002, the Israeli Parliament approved a number of amendments to the Tax Reform, which came into effect on January 1, 2003. Other regulations and decrees relating to the Tax Reform were executed as well.
The Tax Reform, aimed at broadening the categories of taxable income and reducing the tax rates imposed on employment income, introduced the following, among other things:
Statutory corporate tax rate
Israeli companies are subject to corporate tax on their taxable income. The applicable rate is 35% in 2004, 34% in 2005, 32% in 2006 and 30% in 2007 and thereafter. However in the Company’s case, the rate is currently effectively reduced, as described below.
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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, commonly referred to as 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 to ten 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 12 years from completion of the investment under the approved plan or 14 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 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 12 years thereafter. The 12-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.
New legislation to replace the Investment Law is currently pending final approval of the Israeli Parliament. The proposed new legislation imposes additional eligibility criteria for Approved Enterprise benefits. The proposed new legislation would also offer additional forms of alternative benefits. The Company’s management does not believe that the new legislation, if adopted in accordance with the current proposal, would have a material effect on the Company in 2005.
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Tax benefits under the Law for the Encouragement of Industry (Taxation), 1969
According to the Law for the Encouragement of Industry (Taxation), 1969, commonly referred to as 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:
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 the Company does 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, commonly referred to as 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.
Stamp tax
Under Israel’s Stamp Tax on Documents Law, certain documents are subject to stamp tax. Recently promulgated regulations provide for a gradual phase-out of the stamp tax by 2008. In 2004, however, the tax authorities began an enforcement campaign involving extensive audits of companies’ compliance with the stamp tax obligation with respect to all agreements which had been signed since June 2003. The Company has recently received from the tax authorities a request to list all agreements signed since June 2003.
The Company has received legal advice that there are a variety of defenses relating to its obligation to pay stamp tax or to the amount to be paid. The Company’s management believes that the applicable provision in its financial statements as of December 31, 2004, is adequate to cover probable costs arising from this law.
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 partial 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.
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On January 1, 2003, 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:
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 the NASDAQ National Market, provided such shareholders did not acquire their shares prior to an initial public offering and do not have a permanent establishment in Israel. 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, commonly referred to as 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; 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.
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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. 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 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 or her tax advisor to determine whether and if he or she would be entitled to this credit.
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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. 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.
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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). 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.
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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 interest rates and 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, 2004.
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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 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 Euro 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 through earnings or recognized in other comprehensive income for firm commitments 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, 2004, 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 $25.6 million. The above transactions were for a period of up to twelve months. As of December 31 2004, the Company expects to reclassify during the following year an insignificant amount of unrealized losses from accumulated other comprehensive loss to expenses.
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., European and other 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, 2004.
In 2003, the Company has entered into forward rate agreements in the amount of $25 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 settled in August 2004, resulting in an immaterial gain presented in the statement of income as financial income. During 2004, the Company has entered into additional forward rate agreements in the amount of $125 million for a 12 month period beginning one year after the date of the agreement. As of December 31, 2004, the Company incurred an immaterial unrealized gain in respect of these agreements.
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There are no defaults, dividend arrearages or delinquencies that are required to be disclosed.
There are no material modifications to, or qualifications of, the rights of security holders that are required to be disclosed.
(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 SEC is recorded, processed, summarized and reported timely. Based on the Company’s evaluation, the Company’s management, including the Chief Executive Officer and Chief Financial Officer, has concluded that the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) 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 the 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 were taken with regard to significant deficiencies and material weaknesses.
The Company’s Board of Directors has determined that Mr. Irwin Federman is an “audit committee financial expert” and that he is independent under the applicable rules promulgated by the SEC and the NASDAQ National Market.
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).
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The table below summarizes the audit fees paid by the Company and its consolidated subsidiaries during 2003 and 2004.
(1) “Audit-related fees” are fees related to due diligence investigations and to other assignments relating to internal control and procedures over financial reporting.
(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 benefits.
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. The policy was last amended in October 2004. 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 pre-approval 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.
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Set forth below is information concerning repurchases of ordinary shares that the Company effected during the year ended December 31, 2004.
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The Company has responded to Item 18.
See pages F-1 to F-33 incorporated herein.
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We have audited the accompanying consolidated balance sheets of Check Point Software Technologies Ltd. (the “Company”) and its subsidiaries as of December 31, 2003 and 2004, 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, 2004. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform audits of the Company’s internal control over financial reporting. An audit includes consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above, present fairly, in all material respects, the consolidated financial position of the Company and its subsidiaries as of December 31, 2003 and 2004, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2004, in conformity with U.S. generally accepted accounting principles.
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The accompanying notes are an integral part of the consolidated financial statements.
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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.
Date: April 04, 2005