By Mary Sagi-Maydan

PALO ALTO - The problems of

CommTouch Software

(Nasdaq:CTCH) begin with parking. Namely, it's available.

A year ago you couldn't squeeze a scooter into the parking lot by its Palo Alto, California facility. Now you can pick your spot. "About 1,000 people from our building and the ones nearby have been fired," explains CommTouch CEO Gideon Mantel.

CommTouch supplies Web-based email services for enterprises. Times are tough. About 180 people have been sent packing and shareholders have filed a class action against the company and its executives, claiming they had been misled with fraudulently rosy forecasts.

In 2000, CommTouch wanted to raise $80 million in a secondary offering on the market. Its share price was down to $40, from a peak of $60. Its investment bankers advised CommTouch to wait. Since then, CommTouch stock has plunged to 53 cents.

Still optimistic

Mantel says he checks CommTouch's share price on Nasdaq twice a day, when he comes to work and when trade closes.

"These aren't the days when its share price can rise or fall by $10 a day," says Isabel Maxwell, CommTouch's president. "We track the stock exchange more as a gauge of mood."

Everything considered, Mantel and Maxwell are looking chirpy. CommTouch is trying to make lemonade with the lemons God gave it. Maxwell says she's an optimist by nature, but she believes the mood is improving. The press reports dismissals, not efforts to rally, she points out. Deals are being signed. Maxwell spends a great deal of effort lifting the mood in the company's corridors and listening to what the employees think. At some point she had to make the point that the class action is no big deal.

"It's like a blister," she says. "It isn't malignant, it's the price that has to be paid for doing business in the present climate. When a share price dives, lawyers pounce."

Mantel chimes in: "We run the company according to the highest possible standards. The claims are baseless," he adds, and says he's confident they will be rejected.

The lawsuits were born when CommTouch restated its results for the last quarters of 2000. The whole problem was that 2000 was such a flaming good year, at least until March-April. Between March to August, the world corrected, the exchange fell from 5,000 points to 3,500 and seemed to be stabilizing. From September to October, the entire world economy went into free-fall.

"These are vast changes to take place in a single year, and it shows up in the books too," says Mantel. For instance, a deal done in the first quarter of 2000 that was expected to generate revenue the year through, wound up developing quite differently.

The nine lives of CommTouch

TheStreet Recommends

Could CommTouch be closed down? "Certainly, if the market completely crashes, if Nasdaq reaches 1,200 points. If nobody buys anything from anybody and we're one of the companies selling nothing," Mantel says.

"But assuming the market condition stays as is, CommTouch can pull through for sure. We have breathing room for about a year, with no income. I got an email from a former employee, saying that like a cat, CommTouch has nine lives. He wrote that we've used up five, but have four to go."

CommTouch may have more lives to squander, but meanwhile its investors are pretty blue. They lost a fortune. "We're committed to restoring growth," Mantel promises. He said the management has the full support of the board.

"Eight months ago we decided on a strategic shift to the enterprise market. The contracts are more complicated. They are longer-term, three to five years, and more complex. Since everything is happening in a slower market, big enterprises are also making decisions more slowly. Things scheduled for March happened in October.

"The toughest part is adapting an organization to change Enterprises are losing confidence, from

Cisco Systems

(Nasdaq:CSCO) to

Nortel

(NYSE:NT) to CommTouch." It's up to the manager, Mantel says, to demonstrate that he knows what he is doing, even if he is navigating in the dark. He has to radiate confidence, however hard that may be."People don't expect perfection, but they want to know you learned from mistakes," he says.

Such as? "Looking back, we began developing a product for enterprises in time. In September we thought the weak players were being weeded out and the market would be strengthened. We did not expect a total crash. I think we reacted fast and aggressively. We trimmed the company by 60% and now focus tightly on enterprises, while back in September we thought we could sustain the consumer segment too, including the dot.com customers."

It's tough for the workers too, some of whom have never experienced a bear market and are terrified, says Maxwell. They need to see the management standing strong under pressure. To use the analogy of California's power companies, sometimes there's a blackout, so you use emergency generators, but the business lives on.

How about motivation, when stock options are out of the money? Youngsters who thought they'd be instant millionaires have to rethink, Maxwell says. Nor are there about to be 30% pay raises for CommTouch's remaining workers, Mantel refutes recent rumors. But Mantel proudly notes that nobody quit, compared with expectations in February that about 25% would jump ship. "We took it as a sign that we run a healthy operation, and that to be realistic, the situation in the market isn't good."

One very bad move

Things at CommTouch might have looked very different but for one mistake. A big one. Gideon Mantel and Isabel Maxwell scorned to raise more capital at a company value of $600 million, although the company's sales were all of $5 million a quarter. Bad move.

Without alternative sources of financing, without a new source or profit and a strong back-wind from the U.S. economy, CommTouch could go broke in two or three quarters. Its market cap is down to $8 million, about a third of its cash at the end of March 2001.

The company bet all on growth and spent hugely on recruitment, sprouting from 180 workers in early 2000 to 500 people by year-end. But that's when it stopped spending money like water, started issuing profit warnings and began to cut staff. In January CommTouch announced it had secured financing from Torneaux, but only $2 million. Now it has to his the banks, who may not rush to finance a company that has nothing to mortgage and can't prove its business model will work. Maxwell and Mantel may be very right about one thing: The class action is the last of their worries.