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UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Form 10-K

Commission File Number 0-26241

BackWeb Technologies Ltd.

(972) 3-6118800

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act:

Ordinary Shares, NIS 0.03 par 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 þ          No o

      Indicate by check mark if the disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. þ

      Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2).     Yes o          No þ

      The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant as of June 28, 2002, which was the last business day of the registrant’s most recently completed second fiscal quarter, was approximately $14,502,269.

      As of March 3, 2003, there were 39,818,628 shares of the registrant’s Ordinary Shares outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

      None.

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BACKWEB TECHNOLOGIES LTD.

ANNUAL REPORT ON FORM 10-K

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      BackWeb Technologies Ltd. was incorporated in the State of Israel in 1995. The principal executive offices of the Company are located at 3 Abba Hillel Street, Ramat Gan, Israel 52136. In the United States, the Company’s principal offices are located at 2077 Gateway Place, Suite 500, San Jose, California 95110. The Company’s website may be accessed at www.backweb.com; however, the information in, or that can be accessed through, our website is not part of this report.

      We are subject to the informational requirements of the Securities Exchange Act of 1934. Therefore, we file periodic reports, proxy statements and other information with the Securities and Exchange Commission. All our periodic reports and proxy statements, including our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K, and any amendments to those reports, are available, free of charge, through our website. These reports and amendments are available through our website as soon as reasonably practicable after we electronically file such report or amendment.

      BackWeb, the BackWeb logo, ProactivePortal, Polite, Polite Agent, Polite Neighborcast, Polite Proxy, and Polite Upstream are our registered trademarks and e-Accelerator and Foundation are trademarks of ours

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      The terms “BackWeb,” “Company,” “we,” “us” and “our” as used in this Annual Report on Form 10-K refer to BackWeb Technologies Ltd. and its subsidiaries as a combined entity, except where it is made clear that such term means only the parent company.

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Cautionary Statement Regarding Forward-Looking Statements

      This Annual Report on Form 10-K contains express or implied forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements are those that predict or describe future events or trends and that do not relate solely to historical matters. The words “believes,” “expects,” “anticipates,” “intends,” “forecasts,” “projects,” “plans,” “estimates” or “anticipates” or similar expressions identify forward-looking statements, although not all forward-looking statements contain these identifying words. All statements in this Annual Report regarding our future strategy, future operations, projected financial position, estimated future revenue, projected costs, our ability to achieve cost reductions in the amounts and in the timeframes anticipated, our ability to transition new product introductions effectively, future prospects and results that might be obtained by pursuing management’s current plans and objectives are forward-looking statements. These forward-looking statements involve risks and uncertainties and readers are cautioned not to place undue reliance on forward-looking statements, as we cannot assure you that the events or circumstances reflected in these statements will be achieved or will occur. The Company’s actual results may differ materially from such statements. Factors that may cause or contribute to such differences include those discussed elsewhere in this Annual Report, including materials set forth under the caption “Risk Factors” and elsewhere in this Annual Report, or detailed in our other SEC reports and filings. Although the Company believes that the assumptions underlying its forward-looking statements are reasonable, any of the assumptions could prove inaccurate and, therefore, we cannot assure you that the results contemplated in such forward-looking statements will be realized. The inclusion of such forward-looking information should not be regarded as a representation by the Company or any other person that the future events, plans or expectations contemplated by the Company will be achieved. Forward-looking statements reflect the Company’s current views with respect to future events and financial performance or operations and speak only as of the date the statements are made. The Company undertakes no obligation to issue any updates or revisions to any forward-looking statements to reflect any change in the Company’s expectations with regard thereto or any change in events, conditions or circumstances on which any such statements are based.

PART I

Overview

      BackWeb provides offline Web infrastructure software and application-specific software that enable companies to extend the reach of their Web assets to the mobile community of their customers, partners and employees. The Company’s products address the need of mobile users who are disconnected from a network to access and transact with critical enterprise Web content and applications, such as sales tools, forecast management, contact lists, service repair guides, expense report updates, pricing data, time sheets, collaboration sessions, work orders and other essential documents and applications. Our products have been licensed by companies worldwide in such industries as high technology manufacturing, financial services and insurance, telecommunications, entertainment and media, and government.

      Our BackWeb® ProactivePortal® infrastructure software enables mobile users to access online portals, websites and Web applications when they are doing offline work and disconnected from the network. Our BackWeb e-Accelerator™ Web application provides an extended enterprise with a complete stand-alone solution to manage, publish and deliver pertinent information and alerts to both online and offline users. Our ProactivePortal and e-Accelerator products were developed on top of BackWeb Foundation,^TM our core Polite® delivery and synchronization software. BackWeb Foundation is also a stand-alone development platform that allows organizations to develop applications that efficiently gather, target, synchronize and deliver digital data in any format to users’ desktops throughout an extended enterprise.

      Our objective is to establish BackWeb as the leading provider of offline Web infrastructure software and become the standard infrastructure for offline Web access. Our initial penetration into the offline Web access market is through the enterprise portal market. We intend to establish BackWeb ProactivePortal technology

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	•	Expanding our distribution and market reach through strategic partnerships, such as those we have established with SAP, IBM and Plumtree. We intend to continue to establish multiple indirect distribution channels worldwide through resellers, OEMs and large applications vendors.
	•	Continuing to enhance our products and technology by dedicating substantial resources to the development of new and innovative software products and technologies. We believe that our early entry into the market for offline access for the enterprise portal has allowed us to establish technological leadership and a time-to-market advantage. We intend to continue to focus our development efforts on increasing the functionality and flexibility of the BackWeb ProactivePortal technology to facilitate its adoption and to increase technological barriers to entry.
	•	Leveraging the emergence of the market for wireless technology by extending our current product offerings to include multi-channel access by non-laptop devices. We believe that laptop devices provide the immediate opportunity for offline Web access. However, in the mid- to long-term future, we expect other offline devices, such as personal digital assistants, or PDAs, to be increasingly used within companies and that the need for a Web synchronization infrastructure will grow with the proliferation of wireless technology. We believe wireless technology will significantly reduce online Web access response time and the acceptance of wireless devices and technology within enterprises will significantly depend on the user experience and network responsiveness. We believe our offline infrastructure can help accelerate this acceptance, and we intend to extend our offline Web infrastructure offerings, specifically for wireless technology and other offline devices, over the course of the next several years.

Industry Background

      The Internet has changed the nature of business operations and competition. Companies, as well as their suppliers, customers and employees, now commonly conduct business electronically. To compete effectively, market forces are pushing companies and application vendors to move their information technology, or IT, investments to the Web to enable them to stay in closer contact with employees, partners and customers.

      As a result, the Web is increasingly becoming the single point of interaction for the workplace, and the requirements for Web-based portals have grown to include aggregation and integration of applications, processes and content. Enterprise portals, in particular, serve as a key to unified applications access and information and knowledge management across the enterprise and can improve worker productivity, increase customer satisfaction and accelerate the pace at which companies do business. Maximizing usage of enterprise portals by employees, partners and customers has therefore become a critical factor in enabling companies to derive maximum business value from their portals. Similar to e-mail systems, portals need to go beyond online only access to allow a company’s high-value, revenue generating users, such as sales and services field personnel, to do work and interact with the portal when they are on the road and disconnected from the network.

      We believe that in order for the Web to be used efficiently as an effective communication medium across the extended enterprise, a complementary offline Web infrastructure must be utilized. This offline infrastructure must:

	•	Provide offline Web access with user experience unification so that whether the viewer is interacting from the online mode or from the offline mode, the look and feel is the same;
	•	Efficiently synchronize large amounts of data with a minimal impact on the user experience, while protecting the network of a company and its extended enterprise from overload disruptions;

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	•	Permit offline interaction tracking and reporting; and
	•	Enable quick and non-intrusive Web integration, preventing the need to re-engineer Web application code.

BackWeb Technology and Products

      We develop, market and support offline Web access software that enables companies to extend the reach of their Web assets to their mobile community of customers, partners and employees. Our software enables mobile users to access and transact with a company’s critical Web content and applications by enabling offline access to the corporate website or portal. Mobile users can then take their website or enterprise portal wherever they go and perform transactions when disconnected from the network.

      Our products and technology provide the benefits of:

	•	Improved on-the-road productivity by adapting the online Web to offline usage by mobile users, enabling them to access and transact with Web content and applications while offline;
	•	Acceleration of business processes by allowing offline data entry submission for items, such as service orders, expense reports, sales forecasts, time sheets and collaboration sessions, enabling users to productively use “forced down time” while traveling;
	•	Increased customer satisfaction by providing our customers’ field workforce access to important business information when servicing a customer in the field, enabling them to respond to their customers more quickly and effectively;
	•	Decreased costs through the reduction of the costs incurred in manually distributing information, and the costs associated with unnecessary repeat service calls resulting from the inability of users to access the latest service data;
	•	Improved Web and portal effectiveness through tracking and reporting offline interactions which makes apparent what content, information, and applications mobile users most often utilize or need to access to;
	•	Increased end user productivity by enabling offline synchronization to be done in the background, taking advantage of unused bandwidth, without degrading the end user experience when remotely connected; and
	•	Leveraging current IT investments and lower total cost of ownership by deploying in a matter of weeks, and integrating with a customer’s existing portal environment to maintain the existing Web user interface and eliminate the need to rewrite code.

     Technology:

      Our infrastructure software platform is powered by three core technologies that we have developed: Polite Synchronization, OTML Offline Web Integration and Attention Management.

     Polite Synchronization

      Polite Synchronization enables the transmission of significant volumes of digital data from BackWeb Polite Communication Servers to BackWeb plug-ins on personal computers through existing networks without interfering with normal network applications and traffic. Polite Synchronization enables companies to provide any user with rapid communication of bandwidth-intensive data, regardless of whether they utilize high-speed or low-speed data access services. Polite Synchronization is designed to improve the efficiency of transmission by reducing the amount of data to be transmitted through various techniques, including the compression of data, updating only the information which has changed since the user’s previous download and by eliminating the need to re-send an interrupted transmission by progressively resuming the transmission at the point where

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	•	Polite Agent® monitors the network activity of the plug-in and communicates with BackWeb Polite Communication Servers only when the connection is idle. It is able to interrupt BackWeb communications when other applications request use of the user’s network connection.
	•	Polite Proxy® allows communication between the BackWeb proxy server and BackWeb Polite Communication Servers only when wide area network, or WAN, bandwidth utilization is below a specified threshold. It achieves this by monitoring the WAN.
	•	Polite Neighborcast® enables the automatic transmission of digital data from one BackWeb plug-in to others on the same local area network, or LAN, obviating the need for transmission of the data from the server to each BackWeb plug-in. The transmission from BackWeb plug-in to BackWeb plug-in on the same LAN enables fast, efficient and cost-effective transmission of data.
	•	Polite Upstream® enables the automatic transmission of digital data from BackWeb plug-ins to the BackWeb Polite Communication Server when the network connection is idle.

     OTML Offline Web Integration

      BackWeb has developed a set of Hyper Text Markup Language (HTML) tags referred to as OTML, or Offline Tagging Markup Language, that extends HTML to support offline browsing. OTML tags embedded within online HTML pages control the transformation of the online HTML pages into pages that a browser, enhanced with the BackWeb Plug-in, can display offline. OTML is designed to preserve the personalization of the website or portal, including layout and data preferences. OTML tags also control the transformation of HTML data entry forms, allowing end users to perform transactions while offline. Offline transactions are queued while the user is offline and sent to the server when the user connects to the network. The server applies the transaction to the online Web environment and reports back to the plug-in the results of the submission. A Content Acquisition Server, or CAS, is a high performance OTML processor that retrieves content from the target portal or website and processes content for offline use. The CAS transforms online HTML pages into their offline equivalent based on OTML tags and can process OTML tags that are applied to the HTML in run time (known as “scripted OTML”) or can process OTML tags that already exist in the HTML (known as “embedded OTML”). The CAS can be clustered to increase scalability and is responsible for content acquisition scheduling through automated or on-demand synchronization.

     Attention Management

      BackWeb products are often used by customers to deliver time-sensitive or otherwise critical information. Attention Management is an automatic notification system supported by BackWeb plug-in software on personal computers. When content items are transmitted to the personal computer, the BackWeb Attention Management capability alerts users with the appropriate information for that user and content item. Attention Management alerts users to the delivery of business-critical information through a variety of display techniques, including Flash Alerts. Flash Alerts are a particular display technique that can be customized to notify users and, if desired, can allow management to track the usage of the delivered information. For example, the recipient can be required to acknowledge its receipt of the information or to immediately launch and interact with a designated application. In addition, Attention Management displays can be programmed to play automatically according to specific scheduling and expiration parameters, after which the information and associated data can be automatically purged. These features enable companies to attract immediate attention to, and ensure interaction with, time-sensitive information.

     Products:

          BackWeb ProactivePortal Server

      In September 2001, we introduced the BackWeb ProactivePortal Server, which enables mobile users to access Web applications and content, including portal environments, when a user is disconnected or poorly

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	•	The Portal Integration System is a new component of the ProactivePortal Server that is designed for highly scalable Web content acquisition from corporate portals. The Portal Integration System includes: Content Retrieval, Content Transformation, Content Consolidation and Differencing, and Content Packaging.

	•	Content Retrieval. On an on-going basis, the BackWeb ProactivePortal Server logs in as individual portal users and retrieves HTML pages from the portal by using standard HTTP or HTTPS protocols (either secure or non-secure). Each portal page links to more Web pages or documents that are retrieved once the links are identified.
	•	Content Transformation and OTML Tags. Content transformation and OTML tags parse the portal HTML pages and create an offline equivalent of the page that is sent to users. The Content Acquisition Manager retrieves additional pages when it identifies links to more portal pages, external documents or Web pages. Since the presentation of portal content sometimes changes, it is necessary to keep the content transformation correct regardless of visual presentation changes. Content transformation is accomplished by embedding OTML tags in the portal page, which tags control the optimized transformation of the pages for offline viewing. OTML is an extension to HTML and applications other than ProactivePortal software, such as the browser, will ignore the HTML tags.
	•	Content Consolidation and Differencing. Although portals include both personalized and non-personalized content, our ProactivePortal Server acquires content in the context of individual users and creates a single personalized information package for each user. Because a large portion of the content is shared among many users and because that content may be very large, it is necessary to consolidate shared information so that it can be retrieved and stored once for all targeted users. The ProactivePortal Server stores content, including documents and Web pages, in separate information packages that are sent to more than one user.
	•	Content Packaging. Once content has been acquired, transformed and consolidated, it is packaged for offline delivery into units called InfoPaks. Such packaging includes the creation of database records for targeting, delivery tracking, user interaction reporting and version control of the content; calculating byte-level differences between versions of the content, critical when only a small portion of a document is modified; and optimized storage and communication with users’ plug-ins.

	•	The BackWeb Portal Management Server is a management engine that manages the delivery of the content packages to the end users/ subscribers. The Portal Management Server contains:

	•	A Content Targeting Manager stores targeting information about acquired content in the database and dispatches the content for delivery to the end users.
	•	A BackWeb Subscription Manager that manages users’ subscriptions to portal content, enabling portal developers and administrators to define which portal components (or portlets) should be made available offline. Users can then subscribe to portlets for offline access and for notification of critical content. The subscription manger stores all users subscription information.
	•	A Content Tracking Manager that tracks who received what content and how they interacted with it. When a user clicks on a link that refers to a document in the offline view or on a notification, the interaction information is recorded by the plug-in and then forwarded to the server when the plug-in reconnects to the server. This information is stored in the server database and can be queried to create offline interaction reports, which can be viewed and exported to the portal’s reporting system and merged with online portal click-through reports.

	•	The BackWeb Polite Communication System is a highly scalable content delivery engine for desktops and laptops that enables offline access to portal content via BackWeb plug-ins and the BackWeb Polite Communication Server. The BackWeb Polite Communications System is designed to manage the

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		delivery of thousands of gigabytes of data every day to end users. The server consults the BackWeb ProactivePortal Server database to find out whether there is new content relevant to the corresponding user. The BackWeb plug-in then begins downloading InfoPaks incrementally via the Polite Communications Server to ensure scalable content delivery. The Polite Communication System includes several key features:

	•	Interruptible content delivery that activates only when the network connection is idle;
	•	Byte-level differentiation that determines which content has been modified based on the content already stored on the user’s computer and ensures the delivery of only the changes rather than the entire content item; and
	•	Polite Neighborcast which distributes content over a LAN using the distributed client-based caching system, thereby reducing the amount of WAN traffic.

          BackWeb e-Accelerator

      In December 1998, we introduced BackWeb Sales Accelerator, which we now refer to as BackWeb e-Accelerator, our first packaged application built on BackWeb Foundation. The BackWeb e-Accelerator application allows companies to equip their extended enterprise with the most up-to-date documents, market information and management announcements by automating the collection, delivery and dissemination of business critical information. This application is targeted at companies that need to communicate to geographically dispersed employees, resellers, partners and customers to accelerate their business execution and response time to critical changes affecting their business. The application contains several modules that a customer may select:

	•	The Enterprise Video Communications Module leverages existing IT infrastructure investments in streaming media, Webcasting and network upgrades, extending its reach with a broad application framework for managing rich content distribution.
	•	The Market Intelligence Module automatically monitors, collects and organizes information from Internet or intranet sites to keep users abreast of the latest industry news, competitive announcements and customer information.
	•	The Priority Publishing Module, which we previously referred to as Strategic Publishing, enables users to publish and direct the immediate attention of their constituents to time-sensitive and business-critical information. Editorial rights, publishing and access rights are centrally controlled. The published information can be disseminated to users’ desktops using our Flash Alert technology.
	•	The Rapid Survey Module enables companies to acquire feedback from its users through interactive surveys that collect and analyze information. Companies can publish these surveys through a Web-based interface and create questions that have one response, multiple responses or text answers. Users can respond to these surveys quickly, even when they are offline, generally increasing the response rate and decreasing the response time as compared to other survey techniques.
	•	The Automated Encyclopedia Module enables a company to create a library of documents or files to which extended enterprise users can subscribe. These documents and files, and all subsequent updates, are automatically delivered to users once they have subscribed to the service.

      Our infrastructure software platform, BackWeb Foundation, is based on a set of flexible components that enable an organization to capture information from most data sources, including websites, file servers, databases, applications and legacy systems, and efficiently and reliably deliver the information throughout its extended enterprise. One of the major components to Foundation is the BackWeb Polite Communication Server that communicates with BackWeb plug-ins, is capable of receiving digital data from various sources, such as the Internet, intranet sites, databases, applications and legacy systems, and automatically distributes that data to BackWeb plug-ins. The BackWeb Polite Communication Server is highly scalable and designed

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      BackWeb Foundation also includes add-on components:

	•	The BackWeb Enhanced Security Module provides encrypted communications between the BackWeb Polite Communication Server and BackWeb plug-in and certificate authentication of data packages. This module incorporates industry standard technologies from RSA Data Security and VeriSign, Inc.
	•	The BackWeb AutoFile Update Manager enables the automatic replication of files or file directories from any directory accessible to the BackWeb Polite Communication Server, and allows the placement of the replicated files in any location on the user’s system. The BackWeb AutoFile Update Manager also allows management to have greater flexibility over the organization of information on the user’s desktop.
	•	The BackWeb Polite Upstream enables BackWeb plug-ins to deliver digital data to BackWeb Polite Communication Servers, such as completed questionnaires or surveys.

Customers

      We sell our products to customers from a variety of industries. Our customers include industry leaders, such as A.C. Nielsen Co., British Telecommunications plc, Check Point Software Technologies Ltd., Cisco Systems, Inc., Eastman Kodak Company, Fidelity Investments Institutional Services, General Inc., Guidant Corporation, Hewlett-Packard Company, Information Services International Inc. (M&M Mars), International Business Machines Corporation, or IBM, International Monetary Fund, Lam Research Corp., Logitech, National Broadcasting Company, or NBC, Owens-Illinois and Siemens AG, as well as the United States Social Security Administration.

      SAP AG accounted for 20% and Hewlett-Packard Company for 11% of our revenue in 2002. Our OEM contract with SAP AG expired in 2002. We have signed a new reseller agreement with SAP AG, but the agreement does not require SAP AG to purchase any product from us. As a result, we cannot assure you that we will derive revenue from this reseller agreement in the future.

      For a more complete discussion of customer transactions by geography, please refer to Note 14 to Consolidated Financial Statements appearing elsewhere in this Annual Report. For a more complete discussion of related party transactions and their effect on the Company, please refer to Note 8 to Consolidated Financial Statements.

Alliances with Business Partners

      In order to accelerate the acceptance of our products, we have developed cooperative alliances with leading portal framework vendors, technology vendors, OEMs, applications vendors and Internet-based solutions providers. During 2002, we signed new agreements for business alliances with SAP, IBM and Plumtree. We believe that these alliances can provide additional marketing and sales channels for our products, help enable us to position position BackWeb as the offline vendor of choice, and help facilitate broad market acceptance for BackWeb’s products.

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Marketing and Sales

     Marketing

      In 2002, BackWeb’s marketing efforts focused on the portal market with the goal of establishing itself as the leading provider of offline Web infrastructure software. During this time, BackWeb has worked to educate industry analysts, portal framework vendors and integrators, and portal customers about our ProactivePortal technology.

      BackWeb’s marketing strategy is designed to promote offline access as a “must-have” technology for portal implementations and to position BackWeb as the leading offline access vendor of choice. Our marketing efforts are directed at creating market awareness and generating leads for our ProactivePortal technology. Marketing activities include: Web seminars, e-mail campaigns, telemarketing, and attendance at industry trade show events and conferences. In addition, our public relations programs are designed to build market awareness by establishing and maintaining relationships with key trade press, business press and industry analysts.

     Sales

      In 2002, we began to shift our sales strategy to pursue opportunities with large accounts and industry leaders and to penetrate various targeted market segments through indirect distribution channels and strategic partnerships. We partner and actively seek relationships with large applications vendors, portal framework vendors and systems integrators that serve our target markets. Through these strategic partnerships, we believe that we will be able to expand our installed base as our products are incorporated into the vendor’s products and systems integrator’s custom-developed applications. This installed base can, in turn, be leveraged by us and our partners to develop and market BackWeb ProactivePortal technology and other additional BackWeb-based applications and products. We are building these channels and currently have entered into written agreements with a number of companies. However, we cannot assure you that such distribution and strategic partners will devote adequate resources to selling our products. We also may not be able to enter into additional agreements or establish relationships with additional desired strategic and distribution partners on a timely basis or at all.

      We also maintain sales personnel in the United States, the United Kingdom and Germany. Our sales force consists of sales representatives and sales engineers.

      We typically have very little backlog and, accordingly, generate substantially all of our revenue for a given quarter in that quarter.

Customer Service and Support

      We have a comprehensive service and support organization designed to ensure that customers receive the highest quality of service. Our services are primarily comprised of maintenance, consulting and training. Our technical support group provides post-sales support through renewable annual maintenance contracts. Our support contracts provide for technical and emergency support as well as software upgrades, on an “if and when available” basis. When our technical support organization is unable to solve a problem, our engineers and product developers work with the support personnel to resolve the problem. We believe that strong customer support organization is crucial to both the initial marketing of our products and maintaining customer satisfaction, which in turn can enhance our reputation and generate repeat orders. In addition, we believe that the customer interaction and feedback involved in our ongoing support functions provide us with information on market trends and customer requirements that is critical to future product development efforts

      Our professional services organization provides consulting, training and on-site implementation services, offering our customers the expertise, knowledge, and practices to help implement successfully an enterprise-wide IT strategy. We expect to expand our range of services, both directly and through third-party relationships, in order to meet the growing needs of our customers.

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Research and Development

      Since our inception in 1995, we have made substantial investments in research and product development. We believe that strong product development capabilities are essential to enhancing our core technology, developing additional applications, and maintaining the competitiveness of our product and service offerings. We have invested significant time and resources in creating a structured process for undertaking all product development projects.

      Our research and development group is located in Ramat Gan, Israel. We believe that performing research and development in Israel offers a number of strategic advantages because Israel offers a pool of highly qualified technology engineers, as well as a lower cost structure than the U.S. Operating in Israel has also allowed us to enjoy tax incentives from the government of Israel. Our Israeli engineers typically hold advanced degrees in computer-related disciplines.

      In addition, we have actively recruited computer scientists, engineers and software developers and have complemented these individuals by hiring senior management with backgrounds in the commercial software development industries. Our research and development expenses, net totaled $6.1 million for the year ended December 31, 2002, $9.2 million for the year ended December 31, 2001 and $8.7 million for the year ended December 31, 2000.

Competitive Landscape

      We compete in markets that are new, intensely competitive, highly fragmented and rapidly changing. We have experienced, and expect to continue to experience, increased competition from current and potential competitors. Many of our competitors have greater name recognition, longer operating histories, larger customer bases and significantly greater financial, technical, marketing, public relations, sales, distribution and other resources. In addition, some of our potential competitors are among the largest and most well capitalized software companies in the world. We expect to face competition from these and other competitors, including:

	•	companies attempting to address the needs of mobile or disconnected Web users such as Lotus Domino, iOra and Covigo;
	•	companies addressing certain other segments of our BackWeb Foundation market, such as Marimba and Tibco;
	•	sales force automation and enterprise resource planning, or ERP, vendors that may introduce products competitive to our packaged applications; and
	•	communications and information management platform companies.

      Additional competition could come from operating system vendors, online service providers, plug-in or server applications and tools vendors, multimedia companies, document management companies and network management vendors. If any of our competitors were to become the industry standard or were to enter into or expand relationships with significantly larger companies through mergers, acquisitions or otherwise, our business and operating results could be seriously harmed. In addition, potential competitors may bundle their products or incorporate functionality into existing products in a manner that discourages users from purchasing our products.

      Many of our existing and potential customers evaluate on an on-going basis whether to develop their own software or purchase it from outside suppliers. In addition, our partners have significant research and development capabilities and are continually evaluating the efficacy of internal software development. As a result, we must, on an on-going basis, educate existing and potential customers on the advantages of our software over internally developed software, as well as our competitors’ products. However, we cannot assure you that our existing or potential customers or partners will not internally develop products similar to our own.

      Our existing and potential customers often have a pre-set budget for which we compete. We currently compete primarily on the basis of the following factors: functionality; product features and effectiveness; ease of installation and use; and price. We believe that we currently compete favorably with respect to each of these

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      In addition, emerging technologies, such as wireless fidelity or WiFi, that take a different approach to offline Web access by, for example, re-engineering platforms and applications, may pose a competitive challenge.

      We expect that competition will increase in the near term and that our primary long-term competitors may not have entered the market yet. Increased competition could result in price reductions, fewer customer orders, reduced gross margin and loss of market share, any of which could cause our business to suffer.

Intellectual Property and Proprietary Rights

      Our success and ability to compete are dependent on our ability to develop, maintain and protect the proprietary aspects of our technology. We rely on a combination of patent, trademark, trade secret and copyright laws and contractual restrictions to protect the proprietary aspects of our technology.

      We have been issued several U.S. patents with respect to certain aspects of our products. In addition, we have filed other U.S. and foreign patent applications on various elements of our products. Our policy is to apply for patents or for other appropriate statutory protection when we develop valuable new or improved technology. The status of any patent involves complex legal and factual questions, and the breadth of claims that may be allowed is uncertain. Accordingly, we cannot assure you that any patent application filed by us will result in a patent being issued, or that our patents, and any patents that may be issued in the future, will afford adequate protection against competitors with similar technology, nor can we assure you that patents issued to us will not be infringed or designed around by others.

      We have been issued registered trademarks in the U.S. covering certain goods or services for “BackWeb,” the BackWeb logo design, “Polite,” “Polite Agent,” “Polite Neighborcast,” Polite Proxy,” “Polite Upstream,” and “ProactivePortal.” In addition, the trademark “BackWeb” is registered in Australia, the European Community and Japan.

      We seek to protect our source code for our software, documentation and other written materials under trade secret and copyright law. We license our software to our customers under signed license agreements and under electronic (shrink-wrap) agreements that restrict the customer’s use of our software to its own business operations and prohibit disclosure to third parties. The enforceability of shrink-wrap licenses is unproven in certain jurisdictions. Finally, we seek to avoid disclosure of our intellectual property by requiring employees and consultants with access to our proprietary information to execute confidentiality and assignment of invention agreements with us and by restricting access to our source code. However, we have not signed confidentiality agreements in every case.

      Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy or otherwise obtain and use our products or technology. Policing unauthorized use of our products is difficult, and the steps we have taken might not prevent misappropriation of our technology, particularly in foreign countries where the laws may not protect our proprietary rights as fully as do the laws of the U.S.

      Thus, while we rely on patent, copyright, trade secret and trademark law to protect our technology, we believe that factors such as the technological and creative skills of our personnel, new product developments, frequent product enhancements and reliable product maintenance are more essential to establishing and maintaining a technology leadership position. Others may develop technologies that are similar or superior to our technology.

      Our products and services operate in part by making copies of material available on the Internet and other networks and making this material available to end-users from a central location. This creates the potential for claims to be made against us, either directly or through contractual indemnification provisions with customers, including defamation, negligence, copyright or trademark infringement, personal injury, invasion of privacy or other legal theories based on the nature, content or copying of such materials. In the past, these claims have been brought, and sometimes successfully pressed against, companies such as online service providers in the

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      Substantial litigation regarding intellectual property rights exists in the software industry. We expect that software products may be increasingly subject to third-party infringement claims as the number of competitors in our industry segments grows and the functionality of products in different industry segments overlaps. We believe that many of our competitors have filed or intend to file patent applications covering aspects of their technology that they may claim our technology infringes. Third parties may claim infringement by us with respect to our products and technology. Any such claims, with or without merit, could:

	•	be time-consuming to defend;
	•	result in costly litigation;
	•	divert management’s attention and resources;
	•	cause product shipment delays; or
	•	require us to enter into royalty or licensing agreements.

      Royalty or licensing agreements, if required, may not be available on acceptable terms, if at all. A successful claim of product infringement against us and our failure or inability to license the infringed or similar technology could harm our business.

Employees

      As of December 31, 2002, we had a total of 84 employees, of which 36 were engaged in research and development, 15 in sales, marketing and business development, 15 in professional services and technical support and 18 in finance, administration and operations. Our future performance depends in part upon the continued service of our key technical, sales and senior management personnel, none of whom is bound by an employment agreement requiring service for any defined period of time. The loss of the services of one or more of our key employees could have a material adverse effect on our business, financial condition and results of operations. Our future success also depends on our continuing ability to attract, train and retain highly qualified technical, sales and managerial personnel. Competition for such personnel is intense, and we may not be able to retain our key personnel in the future. None of our employees is represented by a labor union. We have not experienced any work stoppages and consider our overall relations with our employees to be good.

      We have 45 of our 84 employees located in Israel. Israeli law and certain provisions of the nationwide collective bargaining agreements between the Histadrut, which is the General Federation of Labor in Israel, and the Coordinating Bureau of Economic Organization, which is the Israeli federation of employers’ organizations, apply to our Israeli employees. These provisions principally concern the maximum length of the work day and the work week, minimum wages, contributions to a pension fund, insurance for work-related accidents, procedures for dismissing employees, determination of severance pay and other conditions of employment. Furthermore, pursuant to such provisions, the wages of most of our employees are subject to cost of living adjustments, based on changes in the Israeli Consumer Price Index. The amounts and frequency of such adjustments are modified from time to time. Israeli law generally requires the payment of severance pay upon the retirement or death of an employee or upon termination of employment by the employer or, in certain circumstances, by the employee. We currently fund our ongoing severance obligations for our Israeli employees by making monthly payments for insurance policies to cover these obligations.

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RISK FACTORS

      You should consider the following factors, as well as other information set forth in this Annual Report, in connection with any investment in our Ordinary Shares. If any of the risks described below occurs, our business, results of operations and financial condition could be adversely affected. In such cases, the price of our Ordinary Shares could decline, and you could lose part or all of your investment.

Risks Relating to Our Business

      Current predictions for the general economy indicate continued uncertain economic conditions. Weak economic conditions may continue to cause a reduction in information technology spending generally. In addition, some of our customers continue to operate based on Internet-centric business models, and these companies have been more acutely affected by the continuing economic slowdown and have encountered significant difficulties in raising additional capital. If our customers experience financial difficulties, it could have an adverse impact on the demand for our products, which would adversely affect our results of operations. In addition, predictions regarding economic conditions have a low degree of certainty, and further predicting the effects of the changing economy is even more difficult. We may not accurately gauge the effect of the general economy on our business. As a result, we may not react to changing conditions in a timely manner, which could adversely impact our business and results of operations and cause the price of our Ordinary Shares to decline.

      We have a limited operating history generally and an even more limited history operating our business as currently conducted. We cannot be certain that our business strategy will be successful. We were incorporated on August 31, 1995, and did not begin generating revenue until December 1996. In early 1998, we changed our strategic focus from a consumer-oriented to an enterprise-oriented Internet communications company. In 2001, we re-positioned our products to focus on the portal market. These changes required us to adjust our business processes and make a number of significant personnel changes. We do not know if our new strategic and product focus will be successful, and, to date, we have only generated very limited revenue from such business. To the extent we do not succeed in generating revenue from licensing our new products, particularly ProactivePortal Server, our business, operating results and financial conditions will suffer.

      We have not achieved profitability and expect to continue to incur net losses for at least the fiscal year 2003. We incurred net losses of $24.9 million for the year ended December 31, 2002, $34.7 million for the year ended December 31, 2001, and $19.2 million for the year ended December 31, 2000. As of December 31, 2002, we had an accumulated deficit of $127.8 million. We expect to continue to incur significant sales and marketing, product development and administrative expenses during 2003. As a result, we will need to generate significant revenue to achieve and maintain profitability.

      Our operating results are difficult to predict. Our revenue and operating results have fluctuated in the past and may, in the future, vary significantly from quarter to quarter due to a number of factors, including:

	•	demand for our products and services;
	•	internal budget constraints and approval processes of our current and prospective customers;
	•	the timing and mix of revenue generated by product licenses and professional services;
	•	the length and unpredictability of our sales cycle;

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	•	loss of customers;
	•	delays in introducing new products and services;
	•	new product introductions by competitors;
	•	changes in our pricing policies or the pricing policies of our competitors;
	•	costs related to acquisitions of technology or businesses; and
	•	economic conditions generally, as well as those specific to the Internet and related industries.

      Due to the foregoing factors, we believe that quarter-to-quarter comparisons of our operating results are not a good indication of our future performance. We incur expenses based predominantly on operating plans and estimates of future revenue. Our expenses are to a large extent fixed and we may not be able to adjust them quickly to meet a shortfall in revenue during any particular quarter. Any significant shortfall in revenue in relation to our expenses would decrease our net income or increase our operating losses and would also harm our financial condition. In some recent quarters our operating results have been below the expectations of public market analysts and investors. It is likely that in some future quarters, our operating results may also be below such expectations, which would likely cause our stock price to decline.

      We believe that our success in penetrating our target markets depends significantly on our ability to develop and maintain strategic relationships with portal framework vendors, key independent software vendors, resellers, distribution partners and customers. Because we expect to generate a large portion of our revenue from sales through these relationships, if we fail to develop these strategic partnerships, our growth would likely be limited. As of December 31, 2002, we had entered into various alliances, remarketing and partnership agreements with certain portal framework vendors, which we consider key to our success, and seek to expand the number of such relationships in 2003. We do not know if these will prove to be successful relationships in the future or if we will derive material revenue from them.

      We depend on strategic relationships, partnerships and business alliances for the continued growth of our business. If we fail to continue developing these relationships, our growth could be limited. These business relationships often consist of cooperative marketing programs, joint customer seminars, lead referrals and cooperation in product development. Some of these relationships are not contractual and depend on the continued voluntary cooperation of each party with us. Even where there are written agreements in place, divergence in strategy or change in focus by, or competitive product offerings developed or acquired by, any of these companies may interfere with our ability to develop, market, sell or support our products, which in turn could harm our business. Further, if these companies enter into strategic alliances with other companies or are acquired, they could reduce their support of our products. Our existing relationships may be jeopardized if we enter into alliances with competitors of our strategic partners. In addition, one or more of these companies may use the information they gain from their relationship with us to develop or market competing products.

      We typically derive a significant portion of our product license revenue in each quarter from a small number of relatively large orders. Our operating results for a particular fiscal quarter could be materially are adversely affected if we are unable to complete one or more substantial license sales forecasted for that quarter. Additionally, we also offer volume-based pricing, which may adversely affect our operating margins. We typically have very little backlog and, accordingly, generate substantially all of our revenue for a given quarter in that quarter.

      We have historically generated a substantial portion of our revenue from a limited number of customers, and we expect this to continue for the foreseeable future. As a result, if we lose a major customer, or if there is a decline in end-users in any of our customers’ licenses, our revenue would be adversely affected. In 2002, our

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      Our business model generally depends on the sale of our products to new customers as well as expanded use of our products within our existing customers’ organizations. If we fail to grow our customer base or to generate repeat and expanded business from our current and future customers, our business and operating results will be seriously harmed. In some cases, our customers initially make a limited purchase of our products and services for trials, pilot or proof of concept programs. These customers might not choose to acquire additional licenses to expand their use of our products.

      In addition, as we have introduced new versions of our products or new products, such as our ProactivePortal Server, we have experienced a decline in licensing revenue generated from our older products, such as Foundation and e-Accelerator, and we anticipate future declines in licensing revenue from these products. However, it is also possible that our current customers might not require the functionality of our new products and might not ultimately license these products. Because the total amount of maintenance and support fees we receive in any period depends, in large part, on the size and number of licenses that we have previously sold, any downturn in our software license revenue would negatively affect our future maintenance and support revenue. In addition, if customers elect not to renew their maintenance agreements, our services revenue could decline significantly. Further, some of our customers are telecom or information technology companies, which have been forced to significantly reduce their operations in light of limited access to sources of financing and the current national and global economic slowdown. If customers are unable to pay for their current products or are unwilling to purchase additional products, our revenue will decline, which would likely materially and adversely affect our revenue, operating results and stock price.

      Our future revenue and profits, if any, depend upon the widespread acceptance and use of the Internet as an effective medium of business and communication by our customers. Rapid growth in the use of, and interest in, the Internet has occurred only recently. As a result, acceptance and use may not continue to develop at historical rates, and a sufficiently broad base of consumers may not adopt, and continue to use, the Internet and other online services as a medium of commerce and communication. Our success will depend, in large part, on the acceptance of the Internet in the commercial marketplace and on the ability of third parties to provide a reliable Internet infrastructure network with the speed, data capacity, security and hardware necessary for reliable Internet access and services. To the extent that the Internet continues to experience increased numbers of users, increased frequency of use or increased bandwidth requirements, the Internet infrastructure may not be able to support the demands placed on it and the performance or reliability of the Internet could suffer.

      The Internet communications market is characterized by rapid technological change, frequent new product introductions, changes in customer requirements and evolving industry standards. If we are unable to develop and introduce products or enhancements in a timely manner to meet these technological changes, we may not be able to successfully compete. In addition, our products may become obsolete, in which event we may not be a viable business.

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      Our market is susceptible to rapid changes due to technology innovation, evolving industry standards, and frequent new service and product introductions. New services and products based on new technologies or new industry standards expose us to risks of technical or product obsolescence. If we do not use leading technologies effectively, continue to develop our technical expertise and enhance our existing products on a timely basis, we may be unable to compete successfully in this industry, which would adversely affect our business and results of operations.

      Our ability to compete successfully depends on the continued compatibility and interoperability of our products with products and systems sold by various third parties, such as portal framework vendors. Currently, these vendors have open applications program interfaces, which facilitate our ability to integrate with their systems. These vendors have also been willing to license to us rights to build integrations to their products and use their development tools. If any one of them were to close their programs’ interface or fail to grant us necessary licenses, our ability to provide a close integration of our products could become more difficult and could delay or prevent our products’ integration with future systems.

      Many of our products run on the Microsoft Windows NT, Microsoft Windows 2000 or certain versions of the Sun Solaris Unix operating systems, and some require the use of third party software. Any change to our customers’ operating systems could require us to modify our products and could cause us to delay product releases. In addition, any decline in the market acceptance of these operating systems we support may require us to ensure that all of our products and services are compatible with other operating systems to meet the demands of our customers. If potential customers do not want to use the Microsoft or Sun Solaris operating systems we support, we will need to develop more products that run on other operating systems adopted by our customers. If we cannot successfully develop these products in response to customer demands, our business could be adversely impacted. The development of new products in response to these risks would require us to commit a substantial investment of resources, and we might not be able to develop or introduce new products on a timely or cost-effective basis, or at all, which could lead potential customers to choose alternative products.

      In addition, our products may face competition from operating system software providers that may elect to incorporate similar technology into their own products.

      In the future, we might need to raise additional capital to fund expansion, product development, acquisitions or working capital. This need may arise sooner than we anticipate if our revenue does not grow in line with our expectations, if our costs are higher than we expect or if we change our strategic plans. If we were required to raise additional funds, it could be difficult to obtain additional financing on favorable terms, or at all. In the event that we obtain additional financing by issuing Ordinary Shares or equity or debt securities that are convertible into Ordinary Shares, the interests of existing stockholders would be diluted. If we cannot raise needed funds on acceptable terms, or at all, we may not be able to develop or enhance our products, respond to competitive pressures or grow our business.

      The Internet communications market is intensely competitive and rapidly changing. We expect that competition will intensify in the near-term because there are very limited barriers to entry. Our primary long-term competitors may not have entered the market yet because the Internet communications market is relatively new. Competition could impact us through price reductions, fewer customer orders, reduced gross

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      We license technology that is incorporated into our products from third parties, including security and encryption software. Any interruption in the supply or support of any licensed software could disrupt our operations and delay our sales, unless and until we can replace the functionality provided by this licensed software. Because our products incorporate software developed and maintained by third parties, we depend on these third parties to deliver and support reliable products, enhance their current products, develop new products on a timely and cost-effective basis and respond effectively to emerging industry standards and other technological changes.

      The use of our products by our customers often requires implementation services. Although we currently provide implementation services sufficient to meet our current business level, our growth will be limited in the event we are unable to expand our implementation services personnel or subcontract these services to qualified third parties. In addition, customers could delay product implementations. Implementation typically involves working with sophisticated software, computers and communications systems. If we experience difficulties with implementation or do not meet project milestones in a timely manner, we could be obligated to devote more customer support, engineering and other resources to a particular project.

      We generally recognize revenue from a customer sale when persuasive evidence of an agreement exists, the product has been delivered, the arrangement does not involve significant customization of the software, the license fee is fixed or determinable and collection of the fee is probable. If an arrangement requires acceptance testing or customization services, recognition of the associated license and service revenue would be delayed. The timing of the commencement and completion of the these services is subject to factors that may be beyond our control, such as access to the customer’s facilities and coordination with the customer’s personnel after delivery of the software. If new or existing customers have difficulty deploying our products or require significant amounts of our professional services support for customized features, our revenue recognition could be further delayed and our costs could increase, causing increased variability in our operating results.

      To date, our customers have taken a long time to evaluate our products before making their purchase decisions. The long, and often unpredictable, sales and implementation cycles for our products may cause our license revenue and operating results to vary significantly from period to period. Sales of licenses and implementation schedules are subject to a number of risks over which we have little or no control, including customer budgetary constraints, customer internal acceptance reviews, the success and continued internal support of customers’ own development efforts, the sales and implementation efforts of businesses with which we have relationships, the nature, size and specific needs of a customer and the possibility of cancellation of projects by customers. Along with our distributors, we spend significant time educating and providing information to our prospective customers regarding the use and benefits of our products. In addition, our customers often begin by purchasing our products on a pilot basis before they decide whether or not to purchase additional licenses for full deployment. For example, even after purchase, our customers tend to deploy our ProactivePortal solution slowly, depending upon the skill set of the customer, the size of the

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      If we fail to substantially expand our direct sales and marketing operations in our existing markets, we will have difficulties in growing our revenue. We are currently constrained from expanding our sales and marketing organization by budget and cost considerations. Moreover, even though we expect to expand our sales and marketing organization, we might not be able to hire or retain the kind and number of sales and marketing personnel that could be required because competition for qualified sales and marketing personnel is intense.

      As a result of the economic slowdown, in the third quarter of 2002, we announced a restructuring plan to reduce our operating costs to match the current business environment, which plan was implemented in the fourth quarter of 2002. We also previously implemented a restructuring plan in July 2001. If we do not meet our restructuring objectives or if the economic slowdown continues, we may have to implement additional plans to reduce our operating costs, which could cause us to incur additional restructuring charges. Further, these plans may not achieve our desired goals due to such factors as significant costs or restrictions that may be imposed in some international locales on workforce reductions and a potential adverse affect on employee morale that could harm our efficiency and our ability to act quickly and effectively in the rapidly changing technology markets in which we sell our products. Moreover, as a result of the restructuring, we have excess office space and are negotiating to restructure our leases for our main offices in San Jose, California and Ramat Gan, Israel. If these negotiations are not successful, continuing lease obligations could have an adverse effect on our ongoing efforts to reduce costs.

We may experience tax liabilities in connection with the liquidation of wholly owned subsidiaries that have ceased trading

      As a result of the restructuring plans we announced on July 1, 2001 and September 30, 2002, we ceased commercial operations of the following wholly owned subsidiaries: BackWeb Technologies B.V., BackWeb Technologies (U.K.) Ltd., BackWeb Technologies G.m.b.H., BackWeb Technologies S.a.r.l., BackWeb Technologies A.B., BackWeb Canada Inc. and BackWeb K.K. Ltd. We have decided to further streamline our operations and to simplify the legal entity structure of the BackWeb group to liquidate these companies. We do not anticipate any issues upon the liquidation of these companies, but we cannot assure you that we will not have any termination liability issues with the appropriate tax authorities in each jurisdiction. If such termination liability issues were to arise and we did not prevail, we might experience a material adverse effect on our cash and earnings. We cannot assure you that we would prevail with respect to any such issue(s).

      Our ability to successfully offer products and services and to implement our business plan in the rapidly evolving Internet communications market requires an effective planning and management process. These factors, together with our anticipated future operations and geographic dispersion, will continue to place a significant strain on our management systems and resources. We expect that we will need to continue to improve our financial and managerial controls and reporting systems and procedures, and expand, train and manage our work force worldwide.

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      Revenue from customers outside the United States represented approximately $2.9 million, or 46% of our total revenue, for the year ended December 31, 2002. Our international operations will continue to be subject to a number of risks, including, but not limited to:

	•	laws and business practices favoring local competition;
	•	compliance with multiple, conflicting and changing laws and regulations;
	•	longer sales cycles;
	•	greater difficulty or delay in accounts receivable collection;
	•	import and export restrictions and tariffs;
	•	difficulties in staffing and managing foreign operations;
	•	difficulties in investing in foreign operations at appropriate levels to compete effectively; and
	•	political and economic instability.

      Our international operations also face foreign-currency-related risks. To date, substantially all of our revenue has been denominated in U.S. dollars, but we believe that in the future, an increasing portion of our revenue may be denominated in foreign currencies, including the NIS, Euro Dollar and British Pound. Fluctuations in the value of foreign currencies may cause further volatility in our operating results, reduce the accuracy of our financial forecasts and could have a material adverse effect on our business, operating results and financial condition.

      To protect our proprietary rights, we rely primarily on a combination of patent, copyright, trade secret and trademark laws, confidentiality agreements with employees and third parties, and protective contractual provisions such as those contained in license agreements with customers, consultants and vendors. However, these parties could breach such confidentiality agreements and other protective contracts. In addition, we have not signed confidentiality agreements in every case. Despite our efforts to protect our proprietary rights, unauthorized parties may copy aspects of our products and obtain and use information that we regard as proprietary. We may not become aware of, or have adequate remedies in the event of, such breaches.

      We pursue the registration of some of our trademarks and service marks in the United States and in certain other countries, but we have not secured registration of all our marks. We license certain trademark rights to third parties. Such licensees may not abide by compliance and quality control guidelines with respect to such trademark rights and may take actions that would adversely affect our trademarks.

      We do not conduct comprehensive patent searches to determine whether the technology used in our products infringes patents held by third parties. Product development is inherently uncertain in a rapidly evolving technological environment in which there may be numerous patent applications pending, which are confidential when filed, with regard to potentially similar technologies. We expect that software products may be increasingly subject to third-party infringement claims as the number of competitors in our industry segment grows and the functionality of products in different industry segments overlaps. Although we believe that our products do not infringe the proprietary rights of any third parties, third parties could assert infringement claims against us in the future. The defense of any such claims would require us to incur substantial costs and would divert management’s attention and resources, which could materially and adversely affect our financial condition and operations. If a party succeeded in making such a claim we could be liable for substantial damages, as well as injunctive or equitable relief that could effectively block our ability to sell our products and services. Royalty or licensing agreements, if required, may not be available on acceptable terms, if at all. Any such outcome could have a material adverse effect on our business, financial condition, operating results and stock price.

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      Our products are used to transmit information through the Internet. Our products could be used to transmit harmful applications, negative messages, unauthorized reproduction of copyrighted material, inaccurate data or computer viruses to end-users in the course of delivery. Any such transmission could damage our reputation or could give rise to legal claims against us. We could spend a significant amount of time and money defending against these legal claims.

      Our products are integrated into our customers’ networks. The sale and support of our products may entail the risk of product liability or warranty claims based on damage to these networks. In addition, the failure of our products to perform to customer expectations could give rise to warranty claims. Although we carry general liability and errors and omissions insurance, our insurance may not cover potential claims of this type or may not be adequate to protect us from all liability that may be imposed.

      Our D&O insurance may not cover all potential claims against our directors and officers. Our D&O insurance policy expires August 1, 2003, and we cannot assure you that we will be able to renew our D&O policy after this time at a reasonable rate or at all. As a result, it may be difficult to retain or attract qualified directors or officers.

      If we fail to attract qualified personnel for our open positions or retain current employees, including, our executive officers and other key employees, our revenue may not increase and could decline and our operations in general could be impacted. None of our officers or key employees is bound by an employment agreement for any specific term. Our relationships with these officers and key employees are at will. Moreover, we do not have “key person” life insurance policies covering any of our employees.

Risks Relating to Our Location in Israel

      We are incorporated under the laws of the State of Israel. Our research and development facilities, as well as one of our executive offices, are located in Israel. Although substantial portions of our sales are currently made to customers outside of Israel, any major hostilities involving Israel or the interruption or curtailment of trade between Israel and its present trading partners could significantly harm our business. Since September 2000, a continuous armed conflict with the Palestinian Authority has been taking place. We cannot predict the effect on BackWeb of the increase in the degree of violence by Palestinians against Israel or of any possible military action elsewhere in the Middle East, such as the war in Iraq. If Israel’s economy is impaired by a high inflation rate or if the timing of the devaluation of the NIS against the U.S. dollar were to lag considerably behind inflation, our operations and financial condition may be negatively impacted to the extent that the inflation rate exceeds the rate of devaluation of the NIS against the U.S. dollar.

      Pursuant to the Law for the Encouragement of Capital Investments, the Israeli Government has granted “Approved Enterprise” status to our existing capital investment programs. Consequently, we are eligible for tax benefits for the first several years in which we generate taxable income. Our future profitability may be diminished if all or portions of these tax benefits are reduced or eliminated. These tax benefits may be cancelled if we fail to comply with requisite conditions and criteria. Currently the most significant conditions

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      Under Israeli law, we are required to obtain an Israeli government license to engage in research and development and the export of the encryption technology incorporated in our products. Our current government license to engage in these activities expires in May 2003. Our research and development activities in Israel, together with our ability to export our products out of Israel, would be limited if the Israeli government revokes our current license, our current license is not renewed, our license fails to cover the scope of the technology in our products, or Israeli law regarding research and development or export of encryption technologies were to change.

      Some of our directors and executive officers are not residents of the United States and some of their assets and our assets are located outside the United States. Service of process upon these directors and executive officers, and enforcement of judgments obtained in the United States against us, and these directors and executive officers, may be difficult to obtain within the United States. BackWeb Technologies, Inc., our U.S. subsidiary, is the U.S. agent authorized to receive service of process in any action against us in any federal or state court arising out of our initial public offering or any related purchase or sale of securities. We have not given consent for this agent to accept service of process in connection with any other claim.

      We have been informed by our legal counsel in Israel, Naschitz, Brandes & Co., that there is doubt as to the enforceability of civil liabilities under U.S. securities laws in original actions instituted in Israel. However, subject to certain time limitations, an Israeli court may declare a foreign civil judgment enforceable if it finds that:

	•	the judgment was rendered by a court which was, according to the laws of the state of the court, competent to render the judgment;
	•	the judgment is no longer appealable;
	•	the obligation imposed by the judgment is enforceable according to the rules relating to the enforceability of judgments in Israel and the substance of the judgment is not contrary to public policy; and
	•	the judgment is executory in the state in which it was given.

      Even if the above conditions are satisfied, an Israeli court will not enforce a foreign judgment if it was given in a state whose laws do not provide for the enforcement of judgments of Israeli courts (subject to exceptional cases) or if its enforcement is likely to prejudice the sovereignty or security of the State of Israel. An Israeli court also will not declare a foreign judgment enforceable if:

	•	the judgment was obtained by fraud;
	•	there was no due process;
	•	the judgment was rendered by a court not competent to render it according to the laws of private international law in Israel;

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	•	the judgment is at variance with another judgment that was given in the same matter between the same parties and which is still valid; or
	•	at the time the action was brought in the foreign court a suit in the same matter and between the same parties was pending before a court or tribunal in Israel.

      Provisions of Israel corporate and tax law and of our articles of association may have the effect of delaying, preventing or making more difficult a merger or other acquisition of BackWeb, even if an acquisition would be beneficial to our shareholders.

      Israeli corporate law regulates acquisitions of shares through tender offers, requires special approvals for transactions involving significant shareholders and regulates other matters that may be relevant to these types of transactions. Furthermore, Israeli tax considerations may make potential transactions unappealing to us or to some of our shareholders. In addition, our articles of association provide for a staggered board of directors.

      On January 1, 2003, a comprehensive tax reform took effect in Israel. We have performed an initial analysis of the likely implications of the new tax reform legislation on our results and operations. Our initial evaluation concludes that the impact of the tax reform on both the corporate and income tax framework of the Company is not expected to have a material effect on the results and operations of the Company. This initial evaluation is in part based on the assumptions that there will no expansion of the BackWeb group of companies beyond the countries in which we already operate and that the Company will remain in a net operating loss for tax purposes for at least the next three years. We cannot provide assurances that these assumptions will be met, and the tax reform will not materially and adversely affect our results and operations.

      Certain of our officers and employees are currently obligated to perform annual reserve duty in the Israel Defense Forces and are subject to being called for active military duty at any time. Although we have operated effectively under these requirements since our inception, we cannot predict the effect of these obligations on the Company in the future. Our operations could be disrupted by the absence, for a significant period, of one or more of our officers or key employees due to military service. Such military requirement could be increased in the event of war or military action involving Israel, which may be more likely in light of the United States’ initiation of military action against Iraq.

Risks Relating to Our Ordinary Shares

      The market price of our Ordinary Shares has been volatile. We expect our stock price to continue to fluctuate:

	•	in response to quarterly variations in operating results;
	•	in response to announcements of technological innovations or new products by us or our competitors or partners;
	•	because of market conditions in the enterprise software or portal industry;
	•	in reaction to changes in financial estimates by securities analysts, and our failure to meet or exceed the expectations of analysts or investors;

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	•	in response to our announcements of strategic relationships or joint ventures; and
	•	in response to sales of our Ordinary Shares

      In the past, following periods of volatility in the market price of a particular company’s securities, securities class action litigation has often been brought against that company. We are currently subject to a securities class action described in Part I, Item 3 “Legal Proceedings” of this Annual Report, and the volatility of our stock price could make us a target for additional suits. Securities class action litigation could result in substantial costs and a diversion of our management’s attention and resources.

      On August 13, 2002, we received a letter from The Nasdaq Listing Qualifications Staff, advising us that our Ordinary Shares had been trading below the $1.00 per share requirement for continued inclusion on The Nasdaq National Market and that we had not regained compliance with this requirement during the previous ninety days. As a result, the Staff advised us that it would delist our Ordinary Shares from The Nasdaq National Market at the opening of business on August 21, 2002, unless we applied to transfer our securities to The Nasdaq SmallCap Market or requested a hearing to appeal the Staff’s determination to a Listing Qualification Panel. We initially requested a hearing to appeal the Staff’s determination to a Listing Qualifications Panel. Subsequently, the Company applied to transfer its Ordinary Shares to The Nasdaq SmallCap Market. That application was approved and the Company’s Ordinary Shares began trading on The Nasdaq SmallCap Market on September 23, 2002. We have met the initial and continued listing criteria for The Nasdaq SmallCap Market as a foreign company and will remain eligible to be quoted on The Nasdaq SmallCap Market, subject to our compliance with the continued listing requirements. However, we cannot assure you that we will be able to maintain the continued listing requirements, and, as a result, may be delisted from trading on The Nasdaq SmallCap Market. Delisting could reduce the ability of our shareholders to purchase or sell shares as quickly and as inexpensively as they have done historically. This situation would be exacerbated if we were unable to obtain listing on another market or exchange, as this would likely make it more difficult for traders to sell our securities. Broker-dealers may be less willing or able to sell or make a market in our Ordinary Shares. Not maintaining a listing on a major stock market may:

	•	result in a decrease in the trading price of our Ordinary Shares;
	•	lessen interest by institutions and individuals in investing in our Ordinary Shares;
	•	make it more difficult to obtain analyst coverage; and
	•	make it more difficult for us to raise capital in the future.

In addition, current and prospective customers and strategic partners may limit or cease their business relationships with us because of concerns or perceptions regarding our listing status and future liquidity.

      We believe that we will be classified as a passive foreign investment company, or PFIC, for U.S. federal income tax purposes. Our treatment as a PFIC could result in a reduction in the after-tax return to the holders of our Ordinary Shares and may cause a reduction in the value of such shares. For U.S. federal income tax purposes, we will be classified as a PFIC for any taxable year in which either (i) 75% or more of our gross income is passive income, or (ii) at least 50% of the average value of all of our assets for the taxable year produce or are held for the production of passive income. For this purpose, cash is considered to be an asset, which produces passive income. Passive income also includes dividends, interest, royalties, rents, annuities and the excess of gains over losses from the disposition of assets, which produce passive income. As a result of our substantial cash position and the decline in the value of our stock, we might be considered a PFIC under a literal application of the asset test that looks solely to market value. If we are a PFIC for U.S. federal income tax purposes, holders of our Ordinary Shares who are residents of the United States (“U.S. Holders”) would be required, in certain circumstances, to pay an interest charge together with tax calculated at maximum rates on certain “excess distributions,” including any gain on the sale of Ordinary Shares.

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      The consequences described above can be mitigated if the U.S. Holder makes an election to treat us as a qualified electing fund, or QEF. A shareholder making the QEF election is required for each taxable year to include in income a pro rata share of the net capital gain of the QEF as long-term capital gain, subject to a separate election to defer payment of taxes, which deferral is subject to an interest charge. We have agreed to supply U.S. Holders with the information needed to report income and gain pursuant to a QEF election. The QEF election is made on a shareholder-by-shareholder basis and can be revoked only with the consent of the Internal Revenue Service, or IRS.

      As an alternative to making the QEF election, the U.S. Holder of PFIC stock which is publicly traded could mitigate the consequences of the PFIC rules by electing to mark the stock to market annually, recognizing as ordinary income or loss each year an amount equal to the difference as of the close of the taxable year between the fair market value of the PFIC stock and the U.S. Holder’s adjusted tax basis in the PFIC stock. Losses would be allowed only to the extent of net mark-to-market gain previously included by the U.S. Holder under the election for prior taxable years.

      All U.S. Holders are advised to consult their own tax advisers about the PFIC rules generally and about the advisability, procedures and timing of their making any of the available tax elections, including the QEF or mark-to-market elections.

      Our executive officers, directors and entities affiliated with them, in the aggregate, beneficially own approximately 37.8% of our outstanding Ordinary Shares as of December 31, 2002. These shareholders, if acting together, would be able to significantly influence all matters requiring approval by our shareholders, including the election of directors and the approval of mergers or other business combination transactions.

Item 2.  Properties

      As of December 31, 2002, BackWeb leased approximately 8,500 square feet in a single office building located in Ramat Gan, Israel; approximately 34,000 square feet in a single office building located in San Jose, California; and approximately 10,000 square feet in a single office building in Toronto, Canada. The office space in Ramat Gan, Israel is leased pursuant to a lease that terminates in May 2004. The office space in San Jose, California is leased pursuant to a lease that expires in March 2007. The office space in Toronto, Canada is leased pursuant to a lease that expires in August 2006. In addition to these facilities, BackWeb also rents a small office in Hamburg, Germany with a lease that expires in October 2003.

      As part of the restructuring that began in the third and fourth quarter 2002, the Company entered into negotiations with its various landlords to renegotiate its lease obligations in San Jose, California, Ramat Gan, Israel and Toronto, Canada. The Company has reached agreements in principle with the landlords in San Jose, California and Ramat Gan, Israel, whereby it may be able to mitigate its lease obligations by, among other things, buying out certain of its obligations, subletting space or reducing rent, or a combination of these. However, there can be no assurance that the Company will be successful in entering into written agreements reflecting these various agreements in principle or that it will be able to mitigate its lease obligations. For a more complete discussion of the Company’s lease obligations, please refer to Note 9 to Notes of Consolidated Financial Statements elsewhere in this Annual Report.

      As part of the restructuring, BackWeb has also relinquished other office space it had acquired through short-term leases or on a month-to-month basis in various parts of the United States. We believe that our remaining facilities will be adequate to meet our needs for the foreseeable future.

Item 3.  Legal Proceedings

      BackWeb, six of its officers and directors, and various underwriters for BackWeb’s initial public offering were named as defendants in a consolidated action captioned In re BackWeb Technologies Ltd. Initial Public Offering Securities Litigation, Case No. 01-CV-10000, a purported securities class action lawsuit filed in the

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      We believe we have meritorious defenses and intend to defend this action vigorously; however, the results of any litigation are inherently uncertain and can require significant management attention, and we could be forced to incur substantial expenditures, even if we ultimately prevail. In the event there were an adverse outcome, our business could be harmed. Thus, we cannot assure you that this lawsuit will not materially and adversely affect our business, results of operations or our share price.

      From time to time we are involved in litigation incidental to the conduct of our business. Apart from the litigation described above, we are not party to any lawsuit or proceeding that, in our opinion, is likely to seriously harm our business.

Item 4.  Submission of Matters to a Vote of Security Holders

      There were no matters submitted to a vote of the shareholders during the fourth quarter of the fiscal year ended December 31, 2002.

PART II

      Our Ordinary Shares are traded on The Nasdaq SmallCap Market under the symbol “BWEB.” We transferred the trading in our Ordinary Shares to The Nasdaq SmallCap Market as of September 23, 2002. Prior to this time, and since our initial public offering on June 8, 1999, our Ordinary Shares had been traded on The Nasdaq National Market. Prior to that, there was no public market for our Ordinary Shares. The following table sets forth The Nasdaq National or SmallCap Market (as applicable) low and high sales price of our Ordinary Shares for the periods indicated below:

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      Our transfer agent is American Stock Transfer & Trust Company (AST), 59 Maiden Lane, New York, NY 10038. AST’s telephone number for shareholder services is 1-800-937-5449.

      According to the records of AST, we had approximately 184 shareholders of record as of March 3, 2003. Because many of our Ordinary Shares are held by brokers and other institutions on behalf of shareholders, we are unable to estimate the total number of shareholders represented by these record holders.

      Our policy is to reinvest earnings to fund future growth. Accordingly, we have not paid dividends and do not anticipate declaring dividends on our Ordinary Shares in the foreseeable future.

      If we were to distribute cash dividends out of income that had been exempt from tax because of our investment program’s Approved Enterprise status (for description of such status please refer to the section entitled “Effective Corporate Tax Rate” in the Management’s Discussion and Analysis of Financial Condition and Results of Operations or “MD&A” section below) such income would become subject to Israeli corporate tax.

      If we were to declare dividends in the future, we would declare those dividends in NIS but pay those dividends to our non-Israeli shareholders in U.S. dollars. Because exchange rates between NIS and the dollar fluctuate continuously, a U.S. shareholder would be subject to currency fluctuation between the date when the dividends were declared and the date the dividends were paid.

      In 1998, the Israeli currency control regulations were liberalized significantly, and since January 1, 2003, all exchange control restrictions have been removed, although there are still reporting requirements for foreign currency transactions. There are no longer Israeli currency control restrictions on remittances of dividends on the Ordinary Shares (after deduction of withholding tax) or the proceeds from the sale of the Ordinary Shares, and shareholders may freely convert these amounts into non-Israeli currencies and remit these amounts abroad. However, legislation remains in effect, pursuant to which currency controls can be imposed by administrative action at any time.

      The selected consolidated financial data set forth below should be read in conjunction with “Management’s Discussion and Analysis of Financial Conditions and Results of Operations,” the Consolidated Financial Statements of the Company and Notes thereto, and other financial information included elsewhere in this Report. Historical results are not necessarily indicative of the results to be expected in the future.

BackWeb Technologies Ltd.

Consolidated Statements of Operations

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(1)	For the calculation of the number of shares, please see Note 2 of the Notes to Consolidated Financial Statements, “Net Loss Per Share.”

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      The following discussion and analysis should be read in conjunction with, and is qualified by, the “Selected Consolidated Financial Data” and our Consolidated Financial Statements and Notes thereto included elsewhere in this Annual Report, as well as the section on “Risk Factors” that is set forth in Item 1 of Part I of this Form 10-K. In addition, this discussion contains forward-looking statements and is, therefore, subject to the overall qualification on forward-looking statements that appears at the beginning of this Form 10-K.

Overview

      BackWeb provides offline Web infrastructure software and application-specific software that enable companies to extend the reach of their Web assets to the mobile community of their customers, partners and employees. The Company’s products address the need of mobile users who are disconnected from a network to access and transact with critical enterprise Web content and applications, such as sales tools, forecast management, contact lists, service repair guides, expense report updates, pricing data, time sheets, collaboration sessions, work orders and other essential documents and applications.

      BackWeb ProactivePortal^TM is designed to extend the reach of corporate portals to mobile or disconnected users and users who need to be notified of critical new content, which helps increase usage of the portal and critical communications, which can increase companies’ return on investment from their enterprise portals. Our BackWeb e-Accelerator^TM application allows an extended enterprise or geographically dispersed organization to manage and deliver pertinent information and alerts without the use of a portal. This enables sales and service organizations, partners and resellers, and call centers using our products to collect and distribute up-to-date, key data to customers, partners, and employees, enabling users to interact with the data through alerts and notification features. Our core infrastructure software, BackWeb Foundation^TM, is a platform that allows organizations to efficiently target and deliver sizeable digital data of any format to users’ desktops throughout the extended enterprise.

      Since our inception, we have derived revenue primarily from licensing our products and, to a lesser extent, from maintenance, consulting and training services. The rate of growth of our service revenue is not commensurate with the costs of service revenue such as salaries and related expenses of our customer support and consulting organizations and the cost of third party contractors to provide consulting services. Accordingly, our gross margins on service revenue are significantly lower than our gross margins on license revenue. Our products are marketed worldwide through a combination of the direct sales force, reseller channel and OEMs.

Critical Accounting Policies

      Our critical accounting policies are as follows:

	•	Revenue recognition;
	•	Estimating valuation allowances and accrued liabilities, specifically the trade receivable allowances for doubtful debts;
	•	Reviewing goodwill, intellectual property and other intangible assets arising on capitalized purchased technology for impairment;
	•	Review of equity investments for impairment; and
	•	Forward exchange contracts

      We derive our revenue from licensing of our products, and by providing maintenance service, customer training and consulting services. We generally sell our products through our direct sales force and, indirectly,

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      We recognize software license revenue in accordance with Statement of Position 97-2 “Software Revenue Recognition” (“SOP 97-2”), as amended. SOP 97-2 generally requires revenue earned on software arrangements involving multiple elements to be allocated to each element based on the relative fair value of the elements. We have also adopted SOP 98-9, “Modification of SOP 97-2, Software Revenue Recognition with Respect to Certain Transactions” (“SOP 98-9”), for all transactions entered into after January 1, 2000. SOP 98-9 requires that revenue be recognized under the “Residual Method” when vendor specific objective evidence (“VSOE”) of fair value exists for all undelivered elements and no VSOE exists for the delivered elements.

      We license our products on a perpetual and on a term basis. We recognize license revenue arising from the sale of perpetual licenses and multi-year term licenses in the accounting period that the official order form and sale occurs. For term licenses with a contract period of less than one year, revenue arising is recognized on a monthly basis.

      A license sale is deemed to have occurred when persuasive evidence exists of an agreement exists, delivery has occurred, the fee is fixed and determinable and the collection of the resulting receivable is reasonably assured. Delivery generally occurs when the product is delivered to a common carrier.

      At the time of the transaction, we assess whether the fee associated with our license sale is fixed and determinable. If the fee is not fixed or determinable, we recognize revenue as payments become due from the customer provided that all other revenue recognition criteria have been met. We determine the fee associated with a license sale by reference to a price list, and if a discount from the price list is applicable, we assess whether the discount is in accordance with what management believes to be generally acceptable discount. The principal factors we take into account when giving a discount are the volume of licenses in the transaction, the strategic nature of the deal and customer and the future likelihood of further transactions with the same customer. In addition, we assess whether or not collection is reasonably assured. Our license agreements generally provide for payment within 30 to 90 days from the official order form date. In cases where we do not establish reasonable assurance of collection, revenue is recognized only on the receipt of payment. If we agree to payment terms that are outside of these parameters, we generally recognize revenue as the fees become due.

      We assess the likelihood of collection based on a number of factors, including past transaction history, the credit worthiness of the customer and, in some instances, a review of the customer’s financial statements. We do not request collateral from our customers. If credit worthiness cannot be established at the time the official order form is signed, we defer the fee and recognize revenue at the time collection is made, which is generally upon the receipt of cash.

      For all sales made through our direct sales force, we use a “Software License Service Agreement” (“SLSA”) and an official order form. For sales made through a reseller, we enter into a standard reseller agreement and evidence of orders from customers must be supplied before we recognize revenue.

      We recognize maintenance revenue over the contractual period for the maintenance, which is generally one year. We provide maintenance at multiple levels of support, and we price this service as a percentage of the related license revenue. For those agreements where the maintenance and license is quoted as one fee, we value the maintenance as an undelivered element at standard rates and defer this revenue over the contractual maintenance period. A customer may elect whether to buy a maintenance contract.

      Our arrangements do not generally include acceptance. However if such an acceptance provision exists, then we defer revenue recognition until we receive written acceptance of the product from the customer. All agreements we enter into are non-refundable and non-cancelable.

      We also recognize revenue from consulting activities, which is generally evidenced by a signed Statement of Work (“SOW”). We generally charge for our consulting activities on a time and materials basis, and, in such cases, recognize revenue when we invoice the customer. If an acceptance clause is contained in the SOW, we defer revenue until we obtain written acceptance from the customer. We also sometimes charge a

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      We determine the appropriate revenue recognition for training to customers when we provide the customer with the training

      Deferred revenue includes amounts billed to customers and cash received from customers for which revenue has not been recognized.

      Management continually reviews the collectibility of trade accounts receivable and the adequacy of the allowance for doubtful debts against the trade accounts receivable. Management specifically analyzes customer accounts, account receivable aging reports, history of bad debts and the business or industry sector to which they belong, customer concentrations, customer credit-worthiness, current economic trends and any other pertinent factors. Generally, we make a provision for doubtful accounts when a trade receivable becomes 90 days past due. In exceptional cases, we will waive a provision after a trade receivable is 90 days or more past due when in the judgment of management, after conducting due diligence with the management of the customer, the receivable is still collectible and the customer has demonstrated that payment is forthcoming. During 2002 and 2001, management provided for approximately $205,000 and $2.9 million, respectively, of doubtful debts arising primarily from “Internet-centric” businesses in the “business to consumer” market that arose primarily as a result of certain customers no longer being able to continue business due to the prevailing economic conditions. Management is able to make reasonably objective judgments on the adequacy of other provisions relating to trade accruals. We have not made any provision for contingent liabilities, which has involved significant management judgment that either we will prevail in the case of material litigation or that we have sufficient insurance to cover any adverse outcome. In these cases management has accrued for the appropriate deductible in respect of the legal expenses in the financial statements. A discussion of our outstanding material litigation is contained in Part I, Item 3 “Legal Proceedings” of this Form 10-K.

      We assess the impairment of long-lived assets and related goodwill, intellectual property and other intangibles whenever an event occurs that indicates that the carrying value of these assets may not be recoverable. The factors we consider important in this assessment include, but are not limited to, the following:

	•	Significant changes in the manner of our use of the acquired assets or the strategy of our company;
	•	Significant negative industry or economic trends.

      The determination that the carrying value of intangibles, long-lived assets and goodwill arising on the purchase of intellectual property may not be recoverable is based upon the existence of one or more of the above factors. We assess whether impairment exists by conducting an impairment review in which we compare the carrying value of the assets to their fair value in accordance with SFAS 142.

      As discussed in Note 2 to the Consolidated Financial Statements, the Company adopted SFAS 144 in January 2002. In conjunction with the restructuring we implemented during the third quarter of 2002, which included a reduction-in-force of 61 employees (see Note 9 of the Notes to the Consolidated Financial Statements), the Company changed its internal allocation of resources. The Company now believes that it is unlikely that any future value will be realized from the wireless technology that was acquired from Mobix. As of June 30, 2002, the carrying value of the wireless technology, which was recorded as intangibles, was $1.8 million. Based on SFAS No. 144, the Company’s intangible assets carrying value of $1.8 million was in excess of its fair value of zero. Therefore, the Company wrote-off the $1.8 million remaining carrying value of

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      We have made equity investments in other companies that we believed were in the best interests of the Company and its strategic objectives. Before an investment is executed, the Company’s executive management and Board of Directors approve them. Generally, management designates an executive staff member to either serve on the Board of Directors of the company in which we invested as a voting member or as an observer. This process serves management to monitor the investment and to determine when an impairment review of the investment may be needed. Management performs a review of equity investments on a quarterly basis to determine if a provision for impairment is required. This process, while based on reasonably objective evidence supplied by the company in which we invested, is combined with analysis of general economic trends and indicators. During 2001, management carried out such reviews and accounted for an impairment charge against one of its equity investments for the full $2.5 million amount of the equity investment. Management reviews during 2002 demonstrated that no further impairment provisions were required against other equity investments. Significant management judgment is involved in conducting these reviews and future developments to this company may result in the impairment provision becoming a write-off.

      We participate in hedging certain forecasted committed expenses that are payable in New Israeli Shekels, or NIS to minimize the company’s exposure to fluctuations in the exchange rate between the NIS and the US $. We compare budgeted NIS exchange rates to the forward contract rates for the NIS for various periods of time into the future where we are reasonable confident that we can forecast a stable stream of expenses payable in NIS. Taking all industry specific and macro economic indicators into account, in order to protect ourselves from fluctuating exchange rates we enter into forward contacts. The contracts are generally monthly and timed in the month to mature when we incur most of our expenses in NIS, which are the payroll and related expenses. We take out a number of forward contracts at a time for future months, depending on how confident we feel about both our forecasted NIS expenses and our visibility into future exchange rate movement.

      Statement of Financial Accounting Standard No. 133 “Accounting for Derivative Instruments and Hedging Activities” (“SFAS No. 133”) requires that all derivatives be recorded on the balance sheet at fair value and such anticipated transactions are designated and documented at inception as “cash flow hedges” and are evaluated for effectiveness, at least quarterly. If the derivative meets the definition of a hedge and is so designated, changes in the fair value of the derivatives will either be offset against the change in fair value of the hedged assets, liabilities or firm commitments through earnings or recognized in other comprehensive income until the hedged item is recognized in earnings. Changes in the fair value of derivatives that are not designated, or are not effective as hedges, must be recognized in earnings. All amounts accumulated in Other Comprehensive Income at year-end will be reclassified to earnings when the forecasted expense underlying the forward contract has been made.

Results of Operations

      We derive revenue from license, maintenance, consulting and training services for BackWeb Foundation, BackWeb e-Accelerator Suite and BackWeb Proactive Portal. Total revenue for the twelve months ended December 31, 2002 was $6.3 million, a decrease of approximately $14.3 million, or 69.2%, from $20.6 million in the twelve months ended December 31, 2001. Total revenue decreased approximately $17.7 million, or 46.2%, during 2001 as compared to 2000. The decrease in 2002 was due primarily to a $9.4 million decrease in revenue from one OEM customer, whose contract ended during 2002. We have negotiated a new reseller agreement with this customer and we are still in the business objective and strategy setting process. We are not able to quantify the amount of revenue that may be generated in future periods from the new agreement. The

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      License revenue was $2.1 million, or 33.4% of total revenue, in the twelve months ended December 31, 2002 compared to $13.8 million, or 66.9% of total revenue, and $29.3 million, or 76.4% of total revenue, in the twelve months ended December 31, 2001 and 2000, respectively. The $11.7 million decrease in license revenue in 2002 as compared with 2001 was primarily due to the $9.0 million decrease of license revenue from the OEM customer whose contract terminated during 2002, and the remaining $2.7 million decrease was due to a decrease in the volume and average size of our license deals. The $15.5 million decrease in license revenue in 2001 as compared with 2000 was primarily due to a decrease in the volume and average size of our license deals. During 2002 we have been transitioning to our new product, the BackWeb Proactive Portal. Our license revenue during 2002 has been largely dependent on our older products, especially the BackWeb Foundation product. During 2003 we expect the revenue from the BackWeb Proactive Portal to increase both in absolute terms and as a percentage of the overall product portfolio. We expect too continue to generate license revenue from our older products, in particular the BackWeb Foundation product but we expect this to decrease as a percentage of the overall product mix portfolio.

      Service revenue, which includes maintenance, consulting and training services, was $4.2 million, or 66.6% of total revenue, in the twelve months ended December 31, 2002 compared to $6.8 million, or 33.1% of total revenue, and $9.1 million, or 23.6% of total revenue, in the twelve months ended December 31, 2001 and 2000, respectively. The decrease in service revenue was primarily related to the decrease in our maintenance revenue, which was directly attributable to the reduction in our license revenue, a decrease in professional consulting services revenue directly related to the volume reduction of license revenue deals and to a lesser extent a decrease in maintenance renewals due to global economic conditions.

      In 2002, 2001 and 2000, one OEM customer accounted for $1.3 million, or 20% of total revenue, $10.7 million, or 52% of total revenue, and $10.4 million, or 27% of total revenue, respectively. In addition, two customers accounted for an aggregate of 20% of total revenue in 2002, and two customers accounted for an aggregate of 11% of total revenue in 2001. We expect that a small number of customers will continue to account for a substantial portion of our total revenue for the foreseeable future and revenue from one or more of these customers may represent more than 10% of our total revenue in future years.

      Customers outside of the United States accounted for 46.3%, 70.1% and 48.8% of our total revenue in the twelve months ended December 31, 2002, 2001 and 2000, respectively. The variations in the mix of revenue generated in the United States as compared to the revenue generated outside of the United States fluctuates significantly due to the reduced number of deals closed in these periods, as each individual deal had a greater impact on the composition of our revenue and the significant variability in the value of these deals. To a lesser extent the overall increase from 2000 to 2001 and the decline from 2001 to 2002 of revenue generated outside of the United States was also attributable to the geographical distribution of revenue that was associated with the OEM agreement that ended during 2002.

Cost of Revenue

      Cost of revenue was $3.3 million, or 51.4% of total revenue, for the twelve months ended December 31, 2002 compared to $5.7 million, or 27.5% of total revenue, and $6.3 million, or 16.4% of total revenue, for the twelve months ended December 31, 2001 and 2000, respectively. In 2002 and 2001, the increase in cost of revenue was due to a shift in the revenue produced from the higher gross margin license deals to the lower gross margin service revenue deals. The decrease in cost of revenue in absolute dollars was primarily due to the reduction in run-rate expenses as a result of both the 2001 and 2002 restructuring that was undertaken. The

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      Cost of license revenue consists primarily of expenses related to media duplication, packaging of products and royalty payables to OEM vendors. Cost of license revenue was $213,000, or 10.1% of license revenue, for the twelve months ended December 31, 2002 compared to $443,000, or 3.2% of license revenue, for the twelve months ended December 31, 2001 and $249,000, or 0.9% of license revenue, for the twelve months ended December 31, 2000. The cost of license revenue is higher in percentage terms in the twelve months ended December 2002 compared to the twelve months ended December 31, 2001 and 2000 due to the fixed cost elements of the royalty payables for embedded third party software.

      Cost of service revenue consists primarily of expenses related to salaries and the overhead of our customer support and professional service organizations, including related expenses of BackWeb consultants, third party consultants and contractors. Cost of service revenue was $3.1 million, or 72.1% of service revenue, in the twelve months ended December 31, 2002 compared to $5.2 million, or 76.7% of service revenue, in the twelve months ended December 31, 2001 and $6.1 million, or 66.8% of service revenue, in the twelve months ended December 31, 2000. The decrease in cost of service revenue in 2002 and 2001 was primarily due to the reduced level of payroll and related expenses together with overhead expenses that resulted from the reorganizations that occurred in both 2002 and 2001. We expect the cost of service revenue to increase marginally in line with service revenues; the increase is not directly variable due to the relative fixed cost of the customer technical support operation.

Operating Expenses

      Research and development expenses, net consist of personnel costs, equipment and supply costs for our development efforts. We charge these expenses to operations as they are incurred. We have research and development facilities in Israel. Research and development expenses, net were $6.1 million, $9.2 million and $8.7 million for the twelve months ended December 31, 2002, 2001 and 2000, respectively. The decrease in research and development expenses, net during 2002 was primarily due to the reduction in our headcount from 60 to 37 full-time employees that resulted from the reduction-in-force we implemented on October 1, 2002. Our research and development expenses, net also decreased in 2002 due to more effective cost management and the restructuring of the underlying fixed cost element, principally the office lease costs in Israel, following the reorganization. Other influential factors are the devaluation of the NIS against the U.S. dollar and the credit resulting from cash flow hedging under forward exchange contracts of approximately $131,000. The increase in research and development expenses, net during 2001 was partly due to a $150,000 research and development grant that we received in 2000 which was credited against operational expenses and substantial investment in research and development personnel and related costs towards the end of 2000, which peaked during the first six months of 2001. We were not entitled to receive any research and development grant in 2001. This was partially offset by the reduction in research and development costs following the reduction-in-force we implemented on July 1, 2001,although there was some underlying investment and growth remaining after the reorganization. Research and development expenses, net were 95.5%, 44.7% and 22.6% of total revenue in the twelve months ended December 31, 2002, 2001 and 2000, respectively. The increase in research and development expenses, net as a percentage of revenue during each of the last two years was due to a larger percentage decrease in total revenue as compared with research and development, net expenses. We expect our research and development, net expenses will decrease on an absolute basis in 2003 due to the restructuring that we carried out in 2002 and more effective cost management.

      Sales and marketing expenses consist of personnel and related costs for our direct sales force, product management, marketing, business development and operations management employees, together with the costs of marketing programs, including trade shows and other related direct expense and general overhead. As of December 31, 2002, we had sales personnel in offices located in the United States and Europe. Sales and

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      General and administrative expenses consist primarily of personnel and related costs and outside services for general corporate functions, including finance, accounting, general management, human resources, information services, legal and the provision for bad and doubtful debts. General and administrative expenses were $4.6 million; $10.5 million and $7.6 million in the twelve months ended December 31, 2002, 2001, and 2000, respectively. Excluding the provision for bad and doubtful debt of $205,000, $2.9 million and $731,000 in the twelve months ended December 31, 2002, 2001 and 2000, respectively; general and administrative expenses were $4.4 million, $7.5 million, and $6.8 million. The decrease in general and administrative expenses during 2002, excluding the provision for bad and doubtful debts, was primarily decreased payroll and related expense as well as reductions in underlying fixed overhead following the reduction in our headcount from 29 to 16 full-time employees, resulting from the reorganization in 2002. We expect general and administrative expenses, excluding the provision for bad and doubtful debts, will decrease on an absolute basis over the next year due to the 2002 reorganization and more effective cost management.

      During 2002 and 2001, our provision for bad and doubtful debts were primarily attributable to “Internet-centric” businesses in the “business to consumer” market, as worsening economic conditions caused certain customers to no longer be able to continue business. We do not expect to have increased provisions for bad and doubtful debt during 2003.

      During the three months ended September 30, 2002, the Company announced a restructuring plan, which it implemented in the three months ended December 31, 2002. The restructuring plan included reducing the workforce by 61 employees, vacating some facilities, canceling office service leases and writing-down fixed assets as a result of employee terminations and office consolidation. During the three-month period ended September 30, 2002, we recorded a restructuring charge of $4.7 million, which included $1.6 million of severance and benefit costs, $2.7 million of facility costs, $200,000 related to the write-down of fixed assets and $200,000 related to other restructuring costs. For further information related to this restructuring, see Note 9 of the Notes to the Consolidated Financial Statements.

      During the three months ended September 30, 2001, the Company approved a restructuring plan to reduce its workforce by 63 employees, vacate certain facilities, canceling office service leases and writing-down fixed assets. We recorded a restructuring charge of $2.8 million, which included $1.3 million related to severance and benefits costs, $1.4 million related to facility costs, and $100,000 of other related restructuring costs. For further information related to this restructuring, see Note 9 of the Notes to the Consolidated Financial Statements.

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      In conjunction with the Company’s restructuring that it implemented during 2002, the Company changed its internal allocation of resources. As of June 30, 2002, the Company believed that it was unlikely that any future value would be realized from the wireless technology that it acquired from Mobix Communications Ltd. This wireless technology was recorded as intangibles on June 27, 2000 and had a carrying value of $1.8 million as of June 30, 2002. Based on SFAS 144 in the Critical Accounting Policies, the Company’s intangible assets carrying value of $1.8 million was in excess of its fair value of zero. Therefore, the Company wrote-off the $1.8 million remaining carrying value of these intangibles during the three months ended September 30, 2002.

      Amortization of goodwill, intellectual property, other intangible assets and deferred stock compensation consists of amortization of goodwill and other intangibles associated with our acquisition of Lanacom in August 1997, deferred stock compensation in 1999, the initial write-off of the acquisition of intellectual property from Mobix Communications Ltd. in June 2000 and amortization of intellectual property and other intangibles associated with the acquisition of intellectual property from Mobix. Deferred stock compensation represents the aggregate differences between the respective exercise price of options at their dates of grant and the deemed fair market value of our Ordinary Shares for accounting purposes. Goodwill, intellectual property and other intangibles are being amortized on a straight-line basis over the estimated useful life, generally two to three years. Deferred stock compensation is presented as a reduction of shareholders’ equity and is amortized over the vesting period of the underlying options based on an accelerated vesting method. The total amortization expense related to a one-time write-off of in-process research and development in June 2000 was $8.4 million. Amortization expense was $1.8 million for the twelve months ended December 31, 2002 compared to $3.8 million and $11.4 million in the twelve months ended December 31, 2001 and 2000, respectively.

      Finance and other income, net includes interest income earned on our cash, cash equivalents and short-term investments offset by interest expense and the effects of exchange gains and losses arising from the re-measurement of transactions in foreign currencies. For the twelve months ended December 31, 2002, finance and other income and expenses, net was $1.2 million compared to $2.0 million and $4.7 million in the twelve months ended December 31, 2001 and 2000, respectively. The decrease in finance and other income, net during 2002 and 2001 was due to the decrease in our cash, cash equivalents and short-term investments due to our operating losses and reduced interest rates. The increase in finance and other income during 2000 was due to interest income generated from the proceeds of our initial public offering in July 1999. We expect finance and other income, net to continue to decrease during 2003 as the Company forecasts that it will continue to use cash during 2003 and, as a result, the Company expects to earn less investment and interest income.

      In 2000, the Company invested an aggregate of $3.0 million in certain development-stage companies operating Internet-centric businesses in which the Company believed it had a significant strategic interest. However, due to the economic slowdown and the significant decline in capital available to, and in the valuations of, the privately funded Internet-centric businesses, the Company determined that its investment in 3Path, Inc. had become impaired. Accordingly, in the three months ended June 30, 2001, the Company recorded a charge of $2.5 million to reflect impairment of these assets below their recorded cost to represent what the Company’s management considered to be fair value. No impairment charge was recorded during the year ended December 31, 2002.

      As of December 31, 2002, we had approximately $82.0 million of Israeli net operating loss carry forwards and $5.0 million of U.S. federal net operating losses carry forwards available to offset future taxable income.

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      As of December 31, 2002, the Company had $23.8 million of cash, cash equivalents and short-term investments as compared to $41.8 million as of December 31, 2001.

      Net cash used in operating activities was $18.4 million and $22.2 million for the twelve months ended December 31, 2002 and 2001, respectively. Cash provided by investing activities was $18.6 million for the twelve months ended December 31, 2002, and primarily represents the net proceeds from the purchases and sales of short-term investments. Cash provided by investing activities was $17.1 million for the twelve months ended December 31, 2001, and primarily represents the net proceeds from the purchases and sales of short-term investments, partially offset by the purchase of property and equipment. Cash provided by financing activities was $807,000 and $1.2 million for the twelve months ended December 31, 2002 and 2001, respectively, and consisted primarily of proceeds from the issuance of Ordinary Shares and proceeds from shareholders’ note receivables.

      As of December 31, 2002, the Company had no material commitments for capital expenditures. Our capital requirements depend on numerous factors, including market acceptance of our products, the resources we devote to developing, marketing, selling and supporting our products and the timing and extent of establishing additional operations. We believe that our current cash balances will be sufficient to fund our operations for at least the next 12 months from the date of this report. However, we might need to raise additional funds prior to the expiration of this period if we are not successful in generating significant revenue from our products, particularly from licensing the ProactivePortal Server, if we fail to develop key strategic relationships or if our operating expenses exceed our expectations. If we were required to raise additional funds, it could be difficult to obtain additional financing on favorable terms, if at all. We may try to obtain additional financing by issuing Ordinary Shares or debt securities, which could dilute our existing shareholders. If we cannot raise needed funds on acceptable terms, or at all, we may not be able to develop or enhance our products, respond to competitive pressures or grow our business.

      BackWeb leases its office facilities under cancelable and non-cancelable operating leases. Future rental payments on a fiscal year basis under non-cancelable operating leases with initial terms in excess of one year are as follows (in thousands):

As part of the restructuring plan that began in the three months ended September 30, 2002, the Company entered into negotiations with its various landlords to renegotiate its lease obligations. The Company has reached agreement in principle with its landlords in San Jose, CA and Ramat Gan, Israel whereby it may be able to mitigate its lease obligations by, among other things buying out certain of its obligations, subletting space or reducing rent or a combination of these. The amounts reflected in the table above assume that the agreements in principle are reflective of the final executed agreements.

Effective Corporate Tax Rates

      Our tax rate reflects a mix of the U.S. statutory tax rate on our U.S. income, versus European country tax rates on our individual European country income and the Israeli tax rate discussed below. We expect that most of our taxable income will be generated in Israel. Israeli companies are generally subject to income tax at a rate of 36% of taxable income. The majority of our income, however, is derived from our capital investment

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      All of these tax benefits are subject to various conditions and restrictions. See “Note 13 — Income Taxes — Israeli Income Taxes — Tax Benefits under the Law for the Encouragement of Capital Investments, 1959.” We cannot assure you that we will obtain approval for additional Approved Enterprise Programs, or that the provisions of the law will not change.

      Since we have incurred tax losses through December 31, 2002, we have not yet used the tax benefits for which we are eligible. See Item 1, “Business — Risk Factors.”

Impact of Inflation and Currency Fluctuations

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

      The annual rate of inflation in Israel was 6.5%, in 2002, 1.0% in 2001 and 0% in 2000. The NIS was devalued against the U.S. dollar by approximately 7.3% in 2002, 9.3% in 2001 and (2.7)% in 2000. The representative dollar exchange rate for converting the NIS to U.S. dollars, as reported by the Bank of Israel, was NIS 4.737 for one U.S. dollar on December 31, 2002.

Recently Issued Accounting Pronouncements

      The FASB recently issued SFAS No. 146 “Accounting for Costs Associated with Exit or Disposal Activities” (“SFAS 146”). SFAS 146 addresses financial accounting and reporting for costs associated with exit or disposal activities and replaces Emerging Issues Task Force (EITF) Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)”. SFAS 146 improves financial reporting by requiring that a liability for a cost associated with an exit or disposal activity be recognized and measured initially at fair value only when the liability is incurred. The provisions of SFAS 146 are effective for exit or disposal activities that are initiated after December 31, 2002. Adoption of SFAS 146 is not expected to have a material effect on the Company’s financial position or operating results.

      In December 2002, the FASB issued SFAS 148, “Accounting for Stock Based Compensation Transmission and Disclosure,” which amended FASB Statement No. 123 (“SFAS 148”). The transition guidance and annual disclosure provisions of SFAS 148 are effective for fiscal years ending after December 15, 2002. SFAS 148 has been adopted and the additional disclosure requirements have been reflected in Note 2 of the Notes to the Consolidated Financial Statements.

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      We develop products in Israel and sell them in U.S., Canada, Europe and Israel. As a result, our financial results could be affected by factors such as changes in foreign currency exchange rates or weak economic conditions in foreign markets. As most of our sales are currently made in U.S. dollars, a strengthening of the dollar could make our products less competitive in foreign markets. Our interest income is sensitive to changes in the general level of U.S. interest rates, particularly since the majority of our investments are in short-term instruments. We regularly assess these risks and have established policies and business practices to protect against the adverse effects of these and other potential exposures. As a result, the Company does not anticipate material losses in these areas. Due to the nature of our short-term investments, we have concluded that there is no material market risk exposure. Therefore, no quantitative tabular disclosures are required.

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Unaudited Quarterly Financial Data for 2002 and 2001

      The following are summaries of quarterly financial data for the years ended December 31, 2002 and 2001 as reported by the Company:

      The following consolidated financial statements and the related notes thereto of BackWeb Technologies Ltd. and the Report of Independent Auditors are filed as a part of this Form 10-K.

      Report of Kost Forer & Gabbay, a member of Ernst & Young Global, Independent Auditors

      Consolidated Balance Sheets

      Consolidated Statements of Operations

      Consolidated Statements of Shareholders’ Equity

      Consolidated Statements of Cash Flows

      Notes to the Consolidated Financial Statements

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REPORT OF INDEPENDENT AUDITORS

To the Shareholders’ of

      We have audited the accompanying consolidated balance sheets of BackWeb Technologies Ltd. (the “Company”) and its subsidiaries as of December 31, 2002 and 2001, and the related consolidated statements of operations, changes in shareholders’ equity and cash flows for each of the three years in the period ended December 31, 2002. Our audits also included the financial statement schedules listed at Item 15(a)2. These financial statements and schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.

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

      In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of BackWeb Technologies Ltd. and its subsidiaries as of December 31, 2002 and 2001 and the consolidated results of their operations and cash flows for each of the three years in the period ended December 31, 2002, in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.

	KOST FORER & GABBAY
	A Member of Ernst & Young Global

Tel-Aviv, Israel

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BACKWEB TECHNOLOGIES LTD.

CONSOLIDATED BALANCE SHEETS

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

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BACKWEB TECHNOLOGIES LTD.

CONSOLIDATED STATEMENTS OF OPERATIONS