**UNITED
STATES**


**SECURITIES
AND EXCHANGE COMMISSION**


**Washington,
D.C. 20549**




**FORM
20-F**




o
    **REGISTRATION
      STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES EXCHANGE ACT
      OF 1934**




**OR**




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


**For
the fiscal year ended** December 31,
2004




**OR**




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


**For
the transition period from __________ to __________**




**Commission
file number 0-29452**




**RADCOM
Ltd.**


**(Exact
name of Registrant as specified in its charter)**




**Israel**


**(Jurisdiction
of incorporation or organization)**




**24
Raoul Wallenberg Street, Tel Aviv 69719, Israel**


**(Address
of principal executive offices)**




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


**Title
      of each class**
    
    **Name
      of each exchange on which registered****None**
    
    **None**


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


**Ordinary
Shares, NIS 0.05 par value per share**


**(Title
of Class)**




**Securities
for which there is a reporting obligation pursuant to Section 15(d) of the
Act:**


**None**


**(Title
of Class)**




Indicate
the number of outstanding shares of each of the issuer’s classes of capital or
common stock as of the close of the period covered by the annual
report:




**14,438,348
Ordinary Shares, NIS 0.05 par value per share**




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.


x  Yes   o No




Indicate
by check mark which financial statement item the registrant has elected to
follow.


o Item 17   x Item
18





Table of Contents





INTRODUCTION




RADCOM
Ltd. develops, manufactures, markets and supports innovative, high-performance
internetworking test and analysis equipment and quality management for data
communications and telecommunications networks. We were incorporated in 1985
under the laws of the State of Israel and commenced operations in
1991.




Except
for the historical information contained herein, the statements contained in
this annual report are forward-looking statements, within the meaning of the
Private Securities Litigation Reform Act of 1995, with respect to our business,
financial condition and results of operations. Actual results could differ
materially from those anticipated in these forward-looking statements as a
result of various factors, including all the risks discussed in “Item 3-Key
Information-Risk Factors” and elsewhere in this annual report.




We urge
you to consider that statements which use the terms “believe,” “do not believe,”
“expect,” “plan,” “intend,” “estimate,” “anticipate,” and similar expressions
are intended to identify forward-looking statements. These statements reflect
our current views with respect to future events and are based on assumptions and
are subject to risks and uncertainties. Except as required by applicable law,
including the securities laws of the United States, we do not intend to update
or revise any forward-looking statements, whether as a result of new
information, future events or otherwise.




As used
in this annual report, the terms “we,” “us,” “our,” and “RADCOM” mean RADCOM
Ltd. and its subsidiaries, unless otherwise indicated.




PrismLiteTM,
Omni-QTM, MediaProTM and WirespeedTM are our trademarks. All other trademarks and
trade names appearing in this annual report are owned by their respective
holders.




Table of Contents




.PART I
    
    
    1ITEM 1.
    IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND
      ADVISORS
    1ITEM 2.
    OFFER STATISTICS AND EXPECTED TIMETABLE
    1ITEM 3.
    KEY INFORMATION
    1A.
    SELECTED FINANCIAL DATA
    1B.
    CAPITALIZATION AND INDEBTEDNESS
    2C.
    REASONS FOR THE OFFER AND USE OF
    PROCEEDS
    2D.
    RISK FACTORS
    2ITEM 4.
    INFORMATION ON THE COMPANY
    14A.
    HISTORY AND DEVELOPMENT OF THE COMPANY
    14B.
    BUSINESS OVERVIEW
    15C.
    ORGANIZATIONAL STRUCTURE
    26D.
    PROPERTY, PLANTS AND EQUIPMENT
    27ITEM 5.
    OPERATING AND FINANCIAL REVIEW AND
    PROSPECTS
    27A.
    RESULTS OF OPERATIONS
    30B.
    LIQUIDITY AND CAPITAL RESOURCES
    34C.
    RESEARCH AND DEVELOPMENT, PATENTS AND
      LICENSES
    40D.
    TREND INFORMATION
    40E.
    OFF BALANCE SHEET ARRANGEMENTS
    41F.
    TABULAR DISCLOSURE OF CONTRACTUAL
      OBLIGATIONS
    41ITEM 6.
    DIRECTORS, SENIOR MANAGEMENT AND
    EMPLOYEES
    42A.
    DIRECTORS AND SENIOR MANAGEMENT
    42B.
    COMPENSATION
    44C.
    BOARD PRACTICES
    45D.
    EMPLOYEES
    47E.
    SHARE OWNERSHIP
    48ITEM 7.
    MAJOR SHAREHOLDERS AND RELATED PARTY
      TRANSACTIONS
    49A.
    MAJOR SHAREHOLDERS
    49B.
    RELATED PARTY TRANSACTIONS
    50C.
    INTERESTS OF EXPERTS AND COUNSEL
    52ITEM 8.
    FINANCIAL INFORMATION
    52
  Pg i
 Table of Contents
 A.
    CONSOLIDATED STATEMENTS AND OTHER FINANCIAL
      INFORMATION
    52B.
    SIGNIFICANT CHANGES
    52ITEM 9.
    THE OFFER AND LISTING
    52A.
    OFFER AND LISTING DETAILS
    52B.
    PLAN OF DISTRIBUTION
    53C.
    MARKETS
    53D.
    SELLING SHAREHOLDERS
    53E.
    DILUTION
    54F.
    EXPENSES OF THE ISSUE
    54ITEM 10.
    ADDITIONAL INFORMATION
    54A.
    SHARE CAPITAL
    54B.
    MEMORANDUM AND ARTICLES OF ASSOCIATION
    54C.
    MATERIAL CONTRACTS
    60D.
    EXCHANGE CONTROLS
    60E.
    TAXATION
    60F.
    DIVIDENDS AND PAYING AGENTS
    71G.
    STATEMENTS BY EXPERTS
    71H.
    DOCUMENTS ON DISPLAY
    71I.
    SUBSIDIARY INFORMATION
    72ITEM 11.
    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
      RISK
    72ITEM 12.
    DESCRIPTION OF SECURITIES OTHER THAN EQUITY
      SECURITIES
    72PART II
    72ITEM 13.
    DEFAULTS, DIVIDEND AVERAGES AND
      DELINQUENCIES
    72ITEM 14.
    MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS
      AND USE OF PROCEEDS
    72ITEM 15.
    CONTROLS AND PROCEDURES
    73ITEM 16A.
    AUDIT COMMITTEE FINANCIAL EXPERT
    73ITEM 16B.
    CODE OF ETHICS
    73ITEM 16C.
    PRINCIPAL ACCOUNTANT FEES AND SERVICES
    73ITEM 16D.
    EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT
      COMMITTEES.
    74ITEM 16E.
    PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND
      AFFILIATED PURCHASERS.
    74
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 PART III
    74ITEM 17.
    FINANCIAL STATEMENTS
    74ITEM 18.
    FINANCIAL STATEMENTS
    74ITEM 19.
    EXHIBITS
    74
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****


**PART I**





**ITEM
1.** **IDENTITY
OF DIRECTORS, SENIOR MANAGEMENT AND ADVISORS**




Not
applicable.




**ITEM
2.** **OFFER
STATISTICS AND EXPECTED TIMETABLE**




Not
applicable.




**ITEM
3.** **KEY
INFORMATION**




**A.** **SELECTED
FINANCIAL DATA**




We have
derived the following selected consolidated financial data as of
December 31, 2003 and 2004 and for each of the years ended
December 31, 2002, 2003, and 2004 from our consolidated financial
statements and notes included in this annual report. The selected consolidated
financial data as of December 31, 2000, 2001 and 2002 and for the years
ended December 31, 2000 and 2001 have been derived from audited
consolidated financial statements not included in this annual report. Based on
the International Financial Reporting and Disclosure Issues issued on May 1,
2001, beginning with the year 2001 we have reclassified royalties paid to the
Israeli Ministry of Industry and Trade, Office of the Chief Scientist of the
State of Israel, and have begun reporting them as “Cost of sales” rather than as
“Sales and marketing, net”. For comparison purposes, all previous-period
information has been restated.




You
should read the selected consolidated financial data together with “Item
5—Operating and Financial Review and Prospects” and our consolidated financial
statements included elsewhere in this annual report.




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Year
      Ended December 31,In
      Thousands of U.S. dollars (except weighted average number of
      ordinaryshares, basic and diluted loss per ordinary
    share)2000
    
    2001
    
    2002
    
    2003
    
    2004Statement
      of Operations Data:Sales
    
    
    30,583
    
    
    18,676
    
    
    14,591
    
    
    11,203
    
    
    16,055Cost
      of sales
    
    
    10,095
    
    
    8,811
    
    
    5,047
    
    
    4,894
    
    
    5,127Gross
      profit
    
    
    20,488
    
    
    9,865
    
    
    9,544
    
    
    6,309
    
    
    10,928Operating
      expenses:Research
      and development, gross
    
    
    9,693
    
    
    9,380
    
    
    6,481
    
    
    5,593
    
    
    5,232Less
      royalty bearing participation
    
    
    2,622
    
    
    1,976
    
    
    2,328
    
    
    1,997
    
    
    1,722Research
      and development, net
    
    
    7,071
    
    
    7,404
    
    
    4,153
    
    
    3,596
    
    
    3,510Sales
      and marketing, net
    
    
    15,393
    
    
    11,513
    
    
    8,306
    
    
    7,411
    
    
    6,983General
      and administrative
    
    
    2,102
    
    
    2,437
    
    
    2,018
    
    
    1,620
    
    
    2,191Total
      operating expenses
    
    
    24,566
    
    
    21,354
    
    
    14,477
    
    
    12,627
    
    
    12,684Operating
      loss
    
    
    (4,078
    )
    
    (11,489
    )
    
    (4,933
    )
    
    (6,318
    )
    
    (1,756
    )Financing
      income, net
    
    
    1,051
    
    
    41
    
    
    217
    
    
    93
    
    
    78Net
      loss for the year
    
    
    (3,027
    )
    
    (11,448
    )
    
    (4,716
    )
    
    (6,225
    )
    
    (1,678
    )Basic
      loss per ordinary share
    
    $
    (0.29
    )
    $
    (1.09
    )
    $
    (0.45
    )
    $
    (0.59
    )
    $
    (0.12
    )Weighted
      average number of ordinary shares used to compute basic loss per ordinary
      share
    
    
    10,337,275
    
    
    10,511,789
    
    
    10,492,050
    
    
    10,493,184
    
    
    13,453,509Diluted
      loss per ordinary share
    
    $
    (0.29
    )
    $
    (1.09
    )
    $
    (0.45
    )
    $
    (0.59
    )
    $
    (0.12
    )Weighted
      average number of ordinary shares used to compute diluted loss per
      ordinary share
    
    
    10,337,275
    
    
    10,511,789
    
    
    10,492,050
    
    
    10,493,184
    
    
    13,453,509Balance
      Sheet Data:Working
      capital
    
    
    24,608
    
    
    14,444
    
    
    10,707
    
    
    5,702
    
    
    10,051Total
      assets
    
    
    38,078
    
    
    24,306
    
    
    19,429
    
    
    14,403
    
    
    20,129Short-term
      credits, including current maturities of long-term debt
    
    
    20
    
    
    -
    
    
    -
    
    
    -
    
    
    -Shareholders’
      equity
    
    
    28,050
    
    
    16,926
    
    
    12,344
    
    
    6,246
    
    
    10,024


**B.CAPITALIZATION AND INDEBTEDNESS**




Not
applicable.




**C.** **REASONS
FOR THE OFFER AND USE OF PROCEEDS**




Not
applicable.




**D.** **RISK
FACTORS** ****




*Our
business, operating results and financial condition could be seriously harmed
due to any of the following risks, among others. If we do not successfully
address the risks to which we are subject, we could experience a material
adverse effect on our business, results of operations and financial condition
and our share price may decline. We cannot assure you that we will successfully
address any of these risks.*


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***Risks
Related to our Business and our Industry***




**We
incurred losses for the years ended December 31, 2002, 2003 and 2004, and we may
continue to incur losses in the future.**




In each
of the fiscal years ended December 31, 2002, 2003 and 2004, we incurred losses
of approximately $4.7 million, $6.2 million, and $1.7 million, respectively. We
may continue to incur losses in the future, which could materially affect our
cash and adversely affect the value and market price of our shares.




**From
time to time we may need to raise financing. If adequate funds are not available
on terms favorable to us, our operations and growth strategy will be materially
adversely affected.**




As a
result of the net losses during the year ended December 31, 2004, we used
approximately $2.2 million in cash during that period. We continue to streamline
our operations with the objective of aligning our business and cost structure
with the changing marketplace. Nevertheless, from time to time we are required
to raise financing in connection with our operations and growth strategy. In
March 2004, we raised $5.5 million in a private placement of
3,851,540  of our
ordinary shares and warrants to purchase 962,887  of our
ordinary shares. This equity financing enabled us, among other things, to
sustain near-term compliance with certain continued listing requirements of the
Nasdaq National Market. Depending upon our level of revenues in the future and
the strategies which we adopt, we may need to raise additional debt or equity
capital to meet our working capital needs in the future. We do not know whether
additional financing will be available when needed, or whether it will be
available on terms favorable to us. If adequate funds are not available on terms
favorable to us, our operations and growth strategy will be materially adversely
affected. ******




**We
have a history of quarterly fluctuations in our results of operations and expect
these fluctuations to continue. This may cause our stock price to decline.**




We have
experienced and expect to experience in the future significant fluctuations in
our quarterly results of operations. Factors that may contribute to fluctuations
in our quarterly results of operations include:




·  the size,
timing and shipment of orders;




·  customer
deferral of orders in anticipation of new products, product upgrades or price
enhancements;




·  the
purchasing patterns and budget cycles of our customers;




·  seasonality,
including the relatively low level of general business activity during the
summer months in Europe;




·  lengthening
sales cycles and sales and marketing expenses associated with any deferred or
lost sales;




·  the mix
of product sales;




·  expenses,
such as rent and salaries, that are largely fixed in nature constituting a
significant portion of our operating expenses; and




·  the size
and timing of approval of grants from the Government of Israel.




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Our
customers ordinarily require the delivery of products promptly after we accept
their orders. We usually do not have a significant backlog of accepted orders.
Consequently, revenues in any quarter depend on orders received and accepted in
that quarter. The deferral of the placing and acceptance of any large order from
one quarter to another could materially adversely affect results of operations
for a given quarter. If our revenues in any quarter remain level or decline in
comparison to any prior quarter, our financial results could be materially
adversely affected. In addition, if we do not reduce our expenses in a timely
manner in response to level or declining revenues, our financial results for
that quarter could be materially adversely affected.




**Our
quarterly revenues and operating results are difficult to predict and may
fluctuate significantly from quarter to quarter.**




Our
quarterly revenue and earnings per share guidance is our best estimate at the
time we provide guidance. Delays in generating or recognizing forecasted
revenues could cause our quarterly operating results to be below our
expectations and those of public market analysts or investors, which could cause
the price of our common stock to fall.




We may
experience a delay in generating or recognizing revenue for a number of reasons.
Unfulfilled orders at the beginning of each quarter are typically substantially
less than our expected revenue for that quarter. Therefore, we depend on
obtaining orders in a quarter for shipment in that quarter to achieve our
revenue objectives. Moreover, demand for our products may fluctuate as a result
of seasonality.




Our
revenues for a particular period may also be difficult to predict and may be
adversely affected if we experience a non-linear (back-end loaded) sales pattern
during the period. We sometimes experience significantly higher levels of sales
towards the end of a period as a result of customers submitting their orders
late in the period or as a result of manufacturing issues or component shortages
which may delay shipments. Such non-linearity in shipments can increase costs,
as irregular shipment patterns result in periods of underutilized capacity and
periods when overtime expenses may be incurred, as well as leading to additional
costs associated with inventory planning and management. Furthermore, orders
received towards the end of the period may not ship within the period due to our
manufacturing lead times.




In
addition, we may incur increased costs and expenses related to sales and
marketing, including expansion of our direct sales operations and distribution
channels, product marketing, customer support, expansion of our corporate
infrastructure, legal matters, and facilities expansion. We base our operating
expenses on anticipated revenue levels, and a high percentage of our expenses
are fixed in the short-term. As a result, any significant shortfall in revenue
relative to our expectations could cause a significant decline in our quarterly
operating results.




Because
of the uncertain nature of the economic environment and rapidly changing market
we serve, period-to-period comparisons of operating results may not be
meaningful. In addition, you may not be able to rely on the results for any
period as an indication of future performance. In the future, our revenue may
remain the same, decrease or increase, and we may not be able to sustain or
increase profitability on a quarterly or annual basis. As a consequence,
operating results for a particular quarter are extremely difficult to predict. Any
quarterly fluctuations in our results of operations may have a material adverse
effect on the market price of our ordinary shares.




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****


**We
might not satisfy all the requirements for continued listing on the Nasdaq
National Market, and our shares may be delisted.**




The
Nasdaq Stock Market has a number of requirements for the continued listing of
shares on the Nasdaq National Market. For example, the company is required to
maintain minimum shareholders’ equity of $10 million, a minimum market value of
publicly held shares of $5 million and the company’s shares must have a minimum
bid price of $1.00 per share. From time to time during 2003, our share price
decreased below the required minimum bid price, and we did not maintain the
required minimum market value of publicly held shares. In addition, in 2003, we
fell below the minimum $10 million shareholders’ equity requirement




In March
2004 we completed a $5.5 million private placement of ordinary shares and
warrants. As a result of the private placement, we are in compliance with the
$10 million shareholders’ equity requirement. We cannot assure you, however,
that we will maintain such compliance over the long term or that we will be able
to maintain compliance with all of the continued listing requirements for the
Nasdaq National Market. If we fail to comply with any of the continued listing
requirements, we could be delisted from the Nasdaq National Market. Our shares
would then be quoted on the Nasdaq SmallCap Market (if we satisfy the continued
listing requirements for that market) or the Over-The-Counter Bulletin Board.
For additional information on the Nasdaq National Market continued listing
requirements and the private placement, please see the section entitled “Item
5--Liquidity and Capital Resources--Private Placement . ”




**A
slowdown in the telecommunications industry could materially adversely affect
our revenues and results of operations.**




Telecommunications
and data communications equipment developers, manufacturers and carriers are the
principal end-users of a large percentage of our products. From 2001 through the
first half of 2003, the telecommunications industry in much of the world,
including in our principal geographic markets, experienced a slowdown, resulting
in decreases and delays in the procurement and deployment of new
telecommunications equipment. Since the second half of 2003 we perceived an
improvement in the general market for telecommunications equipment, particularly
in the cellular segment of the market. However, we are unable to predict the
duration of this trend or the extent of any impact that it may have on our
revenues or results of operations. Any return to a prolonged and substantial
curtailment of growth in the telecommunications industry will likely have a
material adverse effect upon us, and may result from circumstances unrelated to
us or our product offerings.




**The
market for our products is characterized by changing technology, requirements,
standards and products, and we may be materially adversely affected if we do not
respond promptly and effectively to such changes.**




The
market for our products is characterized by rapidly changing technology,
changing customer requirements, evolving industry standards and frequent new
product introductions, certain of which changes could reduce the market for our
products or require us to develop new products. For example, the sharp reduction
in demand for our ATM and frame relay products during 2003 resulted in
significantly reduced revenues for the year.




New or
enhanced telecommunications and data communications-related products developed
by other companies could be incompatible with our products. Therefore, our
timely access to information concerning, and our ability to anticipate, changes
in technology and customer requirements and the emergence of new industry
standards, as well as our ability to develop, manufacture and market new and
enhanced products successfully and on a timely basis, will be significant
factors in our ability to remain competitive.




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In
addition, as a result of the need to develop new and enhanced products, we
expect to continue making investments in research and development before or
after product introductions. Some of our research and development activities
relate to long-term projects, and these activities may fail to achieve their
technical or business targets and may be terminated at any point, and revenues
expected from these activities may not be received for a substantial time, if at
all.




**Our
inventory may become obsolete or unusable.**




We make
advance purchases of various component parts in relatively large quantities to
ensure that we have an adequate and readily available supply. Our failure to
accurately project our needs for these components and the demand for our
products that incorporate them, or changes in our business strategy or
technology that reduce our need for these components, could result in these
components becoming obsolete prior to their intended use or otherwise unusable
in our business. For example, in 2003 we wrote-off $960,000 of inventory which
we determined to be obsolete.




**We
are dependent on our key personnel, in particular Arnon Toussia-Cohen, our
President and Chief Executive Officer, the loss of whom could negatively affect
our business.**




Our
future success depends in large part on the continued services of our senior
management and key personnel. In particular, we are highly dependent on the
services of Arnon Toussia-Cohen, our President and Chief Executive Officer. Any
loss of the services of Arnon Toussia-Cohen, other members of senior management
or other key personnel could negatively affect our business.




**We
may lose significant market share as a result of intense competition in the
markets for our existing and future products.**




Many
companies compete with us in the market for network testing and service
monitoring solutions. We expect that competition will increase in the future,
both with respect to products that we currently offer and products that we are
developing. Moreover, manufacturers of data communications and
telecommunications equipment, which are current and potential customers of ours,
may in the future incorporate into their products capabilities similar to ours,
which would reduce the demand for our products. In addition, affiliates of ours
that currently provide services to us may, in the future, compete with us.




Many of
our existing and potential competitors have substantially greater resources
including financial, technological, engineering, manufacturing and marketing and
distribution capabilities, and several of them may enjoy greater market
recognition than us. We may not be able to compete effectively with our
competitors. A failure to do so could adversely affect our revenues and
profitability.




**We
are dependent upon the success of distributors and manufacturer’s
representatives who are under no obligation to distribute our
products.**




We are
highly dependent upon our distributors and manufacturer’s representatives for
their active marketing and sales efforts and for the distribution of our
products. Many of our manufacturer’s representatives in North America and
several of our distributors outside of North America are the only entities
engaged in the distribution of our products in their respective geographical
areas. Typically, our arrangements with them do not prevent our distributors
from distributing competitive products, or require them to distribute our
products in the future. Our distributors may not give a high priority to
marketing and supporting our products. Our results of operations could be
materially adversely affected by changes in the financial condition, business or
marketing strategies of our distributors. Any such changes could occur suddenly
and rapidly.




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****


**We
may lose distributors or manufacturer’s representatives on which we currently
depend and we may not succeed in developing new distribution channels.**




Our seven
largest distributors in Europe and Asia accounted for a total of approximately
22.4% of our sales in 2002, 30.1% of our sales in 2003, and 47.2% of our sales
in 2004. Two of our largest distributors in Europe each accounted for more than
10% of our sales in 2004. Our six largest manufacturer’s representatives in
North America accounted for a total of approximately 30.5% of our sales in 2002,
34.7% of our sales in 2003, and 17.4% of our sales in 2004. If we
terminate or lose any of our distributors or manufacturer’s representatives, or
if they downsize significantly, we may not be successful in replacing them on a
timely basis, or at all. Any changes in our distribution and sales channels,
particularly the loss of a major distributor or our inability to establish
effective distribution and sales channels for new products, will impact our
ability to sell our products and result in a loss of revenues.




**We
could be subject to warranty claims and product recalls, which could be very
expensive and harm our financial condition.**




Products
as complex as ours sometimes contain undetected errors. These errors can cause
delays in product introductions or require design modifications. In addition, we
are dependent on other suppliers for key components incorporated in our
products. Defects in systems in which our products are deployed, whether
resulting from faults in our products or products supplied by others, from
faulty installation or from any other cause may result in customer
dissatisfaction, product return and, potentially, product liability claims filed
against us. Our warranties permit customers to return defective products for
repair. The warranty period is typically one to two years. Any failure of a
system in which our products are deployed (whether or not our products are the
cause), product recall, product liability claim and any associated negative
publicity could result in the loss of, or delay in, market acceptance of our
products and harm our business.




**We
depend on limited sources for key components and if we are unable to obtain
these components when needed we will experience delays in manufacturing our
products.**




We
currently obtain key components for our products from either a single supplier
or a limited number of suppliers. We do not have long-term supply contracts with
any of our existing suppliers. This presents the following risks:




·
    Delays
      in delivery or shortages in components could interrupt and delay
      manufacturing and result in cancellations of orders for our
      products.
 
 ·
    Suppliers could increase component
      prices significantly and with immediate effect.
 
 ·
    We may not be able to develop
      alternative sources for product components.
 
 ·
    Suppliers could discontinue the
      manufacture or supply of components used in our products. This may require
      us to modify our products, which may cause delays in product shipments,
      increased manufacturing costs and increased product
prices.
 
 ·
    We may be required to hold more
      inventory than would be immediately required in order to avoid problems
      from shortages or discontinuance.




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We have
experienced delays and shortages in the supply of components on more than one
occasion in the past. This resulted in delays in our delivering products to our
customers.




**Our
proprietary technology is difficult to protect and unauthorized use of our
proprietary technology by third parties may impair our ability to compete
effectively.**




Our
success and ability to compete depend in large part upon protecting our
proprietary technology. We rely upon a combination of contractual rights,
software licenses, trade secrets, copyrights, nondisclosure agreements and
technical measures to establish and protect our intellectual property rights in
our products and technologies. In addition, we sometimes enter into
non-disclosure and confidentiality agreements with our employees, distributors
and manufacturers representatives and with certain suppliers with access to
sensitive information. However, we have no registered patents, and these
measures may not be adequate to protect our technology from third-party
infringement. Moreover, pursuant to current U.S. and Israeli laws, we may not be
able to enforce existing non-competition agreements. Additionally, effective
trademark, patent and trade secret protection may not be available in every
country in which we offer, or intend to offer, our products.




**We
are subject to litigation regarding intellectual property rights which could
seriously harm our business.**




Third
parties may from time to time assert against us infringement claims or claims
that we have violated a patent or infringed a copyright, trademark or other
proprietary right belonging to them. If such infringement were found to exist,
we may be required to modify our products or intellectual property or obtain a
license or right to use such technology or intellectual property. Any
infringement claim, even if not meritorious, could result in the expenditure of
significant financial and managerial resources.




For
example on January 13, 2004, we were served with a complaint, in the United
States District Court for the District of New Jersey, by Acterna, LLC, alleging
that certain of our products infringed one or more claims of a patent allegedly
owned by Acterna. Although we have not and do not acknowledge infringing such
patent, we decided to reach a settlement with Acterna in order to save
management’s time and litigation costs.




**Yehuda
Zisapel and Zohar Zisapel, beneficially own approximately 34.0% of our ordinary
shares and therefore have significant influence over the outcome of matters
requiring shareholder approval, including the election of
directors.**




As of
February 28, 2005, Yehuda Zisapel and Zohar Zisapel (our Chairman of the Board
of Directors), who are brothers, beneficially owned an aggregate of
5,151,562 ordinary
shares, representing approximately 34.0% of the ordinary shares. As a result,
Yehuda Zisapel and Zohar Zisapel have significant influence over the outcome of
various actions that require shareholder approval, including the election of our
directors. In addition, Yehuda Zisapel and Zohar Zisapel may be able to delay or
prevent a transaction in which shareholders might receive a premium over the
prevailing market price for their shares and prevent changes in control of
management.




**We
engage in transactions with companies controlled by Yehuda Zisapel and Zohar
Zisapel, which may result in potential conflicts.**




As more
fully described below, we are engaged in and expect to continue to be engaged in
numerous transactions with companies controlled by Yehuda Zisapel and Zohar
Zisapel. We believe that such transactions are beneficial to us and are
generally conducted upon terms which are no less favorable to us than would be
available from unaffiliated third parties. Several products of such affiliated
companies may be used in place of our products, and it is possible that direct
competition between us and one or more of such affiliated companies may develop
in the future. Moreover, opportunities to develop, manufacture, or sell new
products (or otherwise enter new fields) may arise in the future and be pursued
by one or more affiliated companies instead of or in competition with us. This
could materially adversely affect our business and results of
operations.




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****


**We
may encounter difficulties with our international operations and sales which
could affect our results of operations.**




While we
are headquartered in Israel, approximately 99.2% of our sales in 2003 and 96.9%
of our sales in 2004 were generated outside of Israel, including in North
America, Europe, Asia, South America and Australia. This subjects us to many
risks inherent in international business activities, including:




·  national
standardization and certification requirements and changes in tax law and
regulatory requirements;




·  longer
sales cycles, especially upon entry into a new geographical market;




·  export
license requirements;




·  trade
restrictions;




·  changes
in tariffs;




·  currency
fluctuations;




·  economic
or political instability;




·  greater
difficulty in safeguarding intellectual property; and




·  difficulties
in managing overseas subsidiaries and international operations.




We may
encounter significant difficulties in connection with the sale of our products
in international markets as a result of one or more of these
factors.




**The
ordinary shares issued to investors in the PIPE transaction, ordinary shares
underlying the warrants issued in the PIPE transaction, and ordinary shares
underlying our options, may be sold in the public market, which could materially
adversely affect the market price of our ordinary shares and our ability to
raise capital through an offering of securities.**




In
connection with the PIPE investment, we issued 3,851,540 ordinary shares and
warrants to purchase 962,887 ordinary shares. The ordinary shares, and the
shares issuable upon the exercise of the warrants, were registered, and we are
required to keep the registration statement effective for a period of two (2)
years from
December 10, 2004 . In
addition, as of February 28, 2005, options to purchase a total of 3,214,269
ordinary shares were outstanding, and an additional 820,543 ordinary shares
issuable pursuant to options which may be granted under our stock option plans
were reserved for issuance. All shares issued upon the exercise of these options
will be immediately available for sale in the public market, subject to the
terms of grant of the options. Sales of the ordinary shares issued in the PIPE,
sales of the ordinary shares issuable upon exercise of the warrants or options,
or even the prospect of such sales, could materially adversely affect the market
price of our ordinary shares and our ability to raise capital through our
offering of securities.




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****


**We
expect to comply with Section 404 of the Sarbanes-Oxley Act of 2002 regarding
internal control attestation and any inability to do so may negatively impact
the report on our financial statements to be provided by our independent
auditors.**




We are in
the process of implementing the requirements of Section 404 of the
Sarbanes-Oxley Act of 2002 which requires our management to assess the
effectiveness of our internal controls over financial reporting and include an
assertion in our annual report as to the effectiveness of our controls.
Subsequently, our independent auditors, Somekh Chaikin, a registered public
accounting firm, a member of KPMG, will be required to attest to whether our
assessment of the effectiveness of our internal controls over financial
reporting is fairly stated in all material respects and separately report on
whether it believes we maintained, in all material respects, effective internal
controls over financial reporting as of December 31, 2006. We are in the process
of performing the system and process documentation, evaluation and testing
required for management to make this assessment and for the auditors to provide
their attestation report. We have not completed this process or its assessment,
and this process will require significant amounts of management time and
resources.




We are
required to comply with the reporting disclosure requirements of Section 404 by
our year ending December 31, 2006, including remediation of any deficiencies
identified in our existing internal controls. However, if we are not able to
remediate any identified deficiencies in a timely fashion or to otherwise comply
with the Section 404 requirements for the year ending December 31, 2006, we will
not be able to give assurances regarding the effectiveness of our internal
controls and the attestation report on our evaluation of our internal controls
provided by our independent auditors may be negatively affected. ]




**We
will be required to record a compensation expense in connection with stock
option grants, and, as a result, our profitability may be reduced significantly.**




The
Financial Accounting Standards Board (“FASB”) has recently issued an accounting
standard that will require that the fair value of all equity-based awards
granted to employees be recognized in the statement of operations as a
compensation expense, beginning in the third quarter of 2005. The various
methods for determining the fair value of stock options are based on, among
other things, the volatility of the underlying stock. The
impact of the adoption of this standard cannot be predicted at this time because
it will depend also on levels of shares-based compensation granted in the
future. Had we adopted this standard in prior periods, however, the impact would
have had a material adverse effect on our results.Therefore, the
adoption of an accounting standard requiring companies to expense stock options
could materially
adversely affect our
profitability in the future and may adversely affect our stock price. Such
adoption could also limit our ability to continue to use stock options as an
incentive and retention tool in the future, which could, in turn, hurt our
ability to recruit employees and retain existing employees.




**If
we are characterized as a passive foreign investment company, our U.S.
shareholders may suffer adverse tax consequences.**




As more
fully described below in “Item 10-Taxation-United States Federal Income Tax
Considerations-Passive Foreign Investment Company Status,” if for any taxable
year our passive income, or our assets which produce (or are held for the
production of) passive income, exceed specified levels, we may be characterized
as a passive foreign investment company for U.S. federal income tax purposes.
This characterization could result in adverse U.S. tax consequences to our U.S.
shareholders. U.S. shareholders should consult with their own U.S. tax advisors
with respect to the U.S. tax consequences of investing in our ordinary shares.




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****


**Volatility
of the market price of our ordinary shares could adversely affect us and our
shareholders.**




The
market price of our ordinary shares has been and is likely to continue to be
highly volatile and could be subject to wide fluctuations in response to
numerous factors, including the following:




·  market
conditions or trends in our industry;




·  political,
economic and other developments in the State of Israel and
world-wide;




·  actual or
anticipated variations in our quarterly operating results or those of our
competitors;




·  announcements
by us or our competitors of technological innovations or new and enhanced
products;




·  changes
in the market valuations of our competitors;




·  announcements
by us or our competitors of significant acquisitions;




·  entry
into strategic partnerships or joint ventures by us or our competitors;
and




·  additions
or departures of key personnel.




In
addition, the stock market in general, and the market for Israeli and technology
companies in particular, has been highly volatile. Many of these factors are
beyond our control and may materially adversely affect the market price of our
ordinary shares, regardless of our performance. Shareholders may not be able to
resell their ordinary shares following periods of volatility because of the
market’s adverse reaction to such volatility and we may not be able to raise
capital through an offering of securities.




**Any
reversal or slowdown in deregulation of telecommunications markets could
materially harm the markets for our products.**




Future
growth in the markets for our products will depend, in part, on the continued
privatization, deregulation and the restructuring of telecommunications markets
worldwide, as the demand for our products is generally higher when a competitive
environment exists. Any reversal or slowdown in the pace of this privatization,
deregulation or restructuring could materially harm the markets for our
products. Moreover, the consequences of deregulation are subject to many
uncertainties, including judicial and administrative proceedings that affect the
pace at which the changes contemplated by deregulation occur, and other
regulatory, economic and political factors. Furthermore, the uncertainties
associated with deregulation have in the past, and could in the future, cause
our customers to delay purchasing decisions pending the resolution of these
uncertainties.




**We
do not intend to pay dividends.**




We have
never declared or paid any cash dividends on our ordinary shares. We currently
intend to retain any future earnings to finance operations and to expand our
business and, therefore, do not expect to pay any cash dividends in the
foreseeable future.




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******


***Risks
Relating to Our Location in Israel***


****


**Conditions
in Israel affect our operations and may limit our ability to produce and sell
our products.**




We are
incorporated under Israeli law and our principal offices and manufacturing and
research and development facilities are located in the State of Israel.
Political, economic and military conditions in Israel directly affect our
operations. Since the establishment of the State of Israel in 1948, a number of
armed conflicts have taken place between Israel and its Arab neighbors and a
state of hostility, varying in degree and intensity, has led to security and
economic problems for Israel. We could be adversely affected by hostilities
involving Israel, the interruption or curtailment of trade between Israel and
its trading partners, a significant increase in inflation, or a significant
downturn in the economic or financial condition of Israel. Since
October 2000, there has been a marked increase in hostilities between
Israel and the Palestinians, which has adversely affected the peace process and
has negatively influenced Israel’s relationship with several Arab countries.
Furthermore, certain parties with whom we do business have declined to travel to
Israel during this period, forcing us to make alternative arrangements where
necessary, and the United States Department of State and other countries have at
times issued an advisory regarding travel to Israel, impeding the ability of
travelers to attain travel insurance. Also, the political and security situation
in Israel may result in certain parties with whom we have contracts claiming
that they are not obligated to perform their commitments pursuant to force
majeure provisions of those contracts.




Since our
manufacturing facilities are located exclusively in Israel, we could experience
disruption of our manufacturing due to acts of terrorism or any other
hostilities involving or threatening Israel. If an attack were to occur, any
Israeli military response that results in the call to duty of the country’s
reservists (as further discussed below) could affect the performance of our
Israeli facilities for the short term. Our business interruption insurance may
not adequately compensate us for losses that may occur and any losses or damages
incurred by us could have a material adverse effect on our business. We do not
believe that the political and security situation has had any material impact on
our business to date; however, we can give no assurance that it will have no
such effect in the future.




Some
neighboring countries, as well as certain companies and organizations, continue
to participate in a boycott of Israeli firms and others doing business with
Israel or with Israeli companies. We are also precluded from marketing our
products to certain of these countries due to U.S. and Israeli regulatory
restrictions. Because none of our revenue is currently derived from sales to
these countries, we believe that the boycott has not had a material adverse
effect on us. However, restrictive laws, policies or practices directed towards
Israel or Israeli businesses could have an adverse impact on the expansion of
our business.




All male
adult citizens and permanent residents of Israel under the age of 51 are, unless
exempt, obligated to perform up to approximately 31 days of military reserve
duty annually. Additionally, these residents are subject to being called to
active duty at any time under emergency circumstances. Many of our officers and
employees are currently obligated to perform annual reserve duty. While we
believe that we have operated relatively efficiently given these requirements
since we began operations and during the period of the increase in hostilities
with the Palestinians since October 2000, we cannot assess what the full
impact of these requirements on our workforce or business would be if the
situation with the Palestinians would change, and we cannot predict the effect
on our business operations of any expansion or reduction of these
requirements.




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****


**We
may be adversely affected if the rate of inflation in Israel exceeds the rate of
devaluation of the New Israeli Shekel against the dollar, and by the
strengthening of the value of the New Israeli Shekel against the
dollar.**




A portion
of our expenses, primarily labor expenses, is incurred in New Israeli Shekels,
or NIS. As a result, we are exposed to the risk that the rate of inflation in
Israel will exceed the rate of devaluation of the NIS in relation to the dollar
or that the timing of this devaluation will lag behind inflation in Israel.
Although in recent years the rate of devaluation of the NIS against the dollar
exceeded the rate of inflation in Israel (a reversal from prior years, which
reversal benefited us), we cannot predict any future trends. In addition, during
the fourth quarter of 2004, the value of the NIS, expressed in dollar terms
increased significantly, raising our Israel-based costs as expressed in dollars.
Both of these conditions result in higher dollar costs for our operations in
Israel, adversely affecting our dollar-measured results of operations.




**We
currently benefit from government programs and tax benefits which may be
discontinued or reduced.**




We
currently receive grants and tax benefits under Government of Israel programs.
In order to maintain our eligibility for these programs and benefits, we must
continue to meet specified conditions, including making specified investments in
fixed assets and paying royalties with respect to grants received. In addition,
some of these programs restrict our ability to manufacture particular products
outside of Israel or transfer particular technology. If we fail to comply with
these conditions in the future, the benefits received could be canceled and we
could be required to refund any payments previously received under these
programs or pay increased taxes. The Government of Israel has reduced the
benefits available under these programs in recent years and these programs and
tax benefits may be discontinued or curtailed in the future. If we do not
receive these grants in the future, we will have to allocate other funds to
product development at the expense of other operational costs. The amount, if
any, by which our taxes will be increased depends upon the rate of any tax
increase, the amount of any tax benefit reduction and the amount of any taxable
income that we may earn in the future. If the Government of Israel ends these
programs and tax benefits, our business, financial condition and results of
operations could be materially adversely affected.




**We
may be required to pay stamp duty on agreements executed by us on or after June
1, 2003. This would increase our taxes.**




The
Israeli Stamp Duty on Documents Law, 1961 (the “Stamp Duty Law”), provides that
most documents signed by Israeli companies are subject to a stamp duty,
generally at a rate of between 0.4% and 1% of the value of the subject matter of
such document. De facto, it has been common practice in Israel not to pay such
stamp duty unless a document is filed with a governmental authority or with the
courts. As a result of an amendment to the Stamp Duty Law that came into effect
on June 1, 2003, the Israeli tax authorities have approached many companies in
Israel and requested the disclosure of all agreements signed by such companies
after June 1, 2003 with the aim of collecting the stamp duty on such agreements.
The legitimacy of the aforementioned amendment to the Stamp Duty Law and of
these actions by the Israeli tax authorities are currently under review by the
Israeli High Court of Justice. We believe that we may only be required to pay
stamp duty on documents signed on or after August 2004. However, we cannot
assure you that the tax authorities or the courts will accept such view.
Although at this stage it is not yet possible to evaluate the effect, if any, on
us of the amendment to the Stamp Duty Law, the same could adversely affect our
results of operations in the future.




In
January 2005, an order was signed which cancelled the requirement to pay the
stamp duty for agreements executed from January 1, 2008.




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****


**Provisions
of Israeli law may delay, prevent or make difficult a merger or acquisition of
us, which could prevent a change of control and depress the market price of our
shares.**




The
Israeli Companies Law generally requires that a merger be approved by a
company’s board of directors and by a majority of the shares voting on the
proposed merger. Unless a court rules otherwise, the statutory merger will not
be deemed approved if shares representing a majority of the voting power present
at the shareholders meeting, and which are not held by the potential merger
partner (or by any person who holds 25% or more of the shares of capital stock
or the right to appoint 25% or more of the directors of the potential merger
partner or its general manager) vote against the merger. Upon the request of any
creditor of a party to the proposed merger, a court may delay or prevent the
merger if it concludes that there is a reasonable concern that, as a result of
the merger, the surviving company will be unable to satisfy its obligations. In
addition, a merger may generally not be completed unless at least (i) 50 days
have passed since the filing of the merger proposal with the Israeli Registrar
of Companies by each of the merging companies and (ii) 30 days have passed since
the merger was approved by the shareholders of each of the parties to the
merger.




Finally,
Israeli tax law treats some acquisitions, such as stock-for-stock exchanges
between an Israeli company and a foreign company less favorably than U.S. tax
laws. For example, Israeli tax law may, under certain circumstances, subject a
shareholder who exchanges his ordinary shares for shares in another corporation
to taxation prior to the sale of the shares received in such stock-for-stock
swap.




These
provisions of Israeli corporate and tax law and the uncertainties surrounding
such law may have the effect of delaying, preventing or making more difficult a
merger with us or acquisition of us. This could prevent a change of control over
us and depress the market price of our ordinary shares which otherwise might
rise as a result of such a change of control.




**It
may be difficult to (i) effect service of process, (ii) assert U.S.
securities laws claims and (iii) enforce U.S. judgments in Israel against
directors, officers and experts named in this annual
report.**




We are
incorporated in Israel. All of our executive officers and directors named in
this annual report are nonresidents of the United States, and a substantial
portion of our assets and the assets of such persons are located outside the
United States. Therefore, it may be difficult to enforce a judgment obtained in
the United States against us or any of those persons or to effect service of
process upon those persons. It may also be difficult to enforce civil
liabilities under U.S. federal securities laws in original actions instituted in
Israel.




**ITEM
4.** **INFORMATION
ON THE COMPANY**




**A.**
    **HISTORY
      AND DEVELOPMENT OF THE COMPANY**




RADCOM
Ltd. was incorporated in 1985 under the laws of the State of Israel. Our
principal executive offices are located at 24 Raoul Wallenberg Street, Tel Aviv
69719, Israel, and our telephone and fax numbers are 972-3-645-5055 and
972-3-647-4681, respectively. Our website is www.radcom.com. Information on our
website and other information that can be accessed through it are not part of or
incorporated by reference into this annual report. In 1993, we established a
wholly-owned subsidiary in the United States, RADCOM
Equipment, Inc., a New Jersey corporation.  RADCOM
Equipment, Inc. is located at 6 Forest Avenue, Paramus, New Jersey 07652 and its
telephone number is (201) 518-0033. In 1996, we incorporated a wholly-owned
subsidiary in Israel, RADCOM Investments (1996) Ltd., located at our office in
Tel Aviv Israel. In 2001, we established a wholly-owned subsidiary in the United
Kingdom, RADCOM (UK) Ltd., a United Kingdom corporation. RADCOM (UK) Ltd. is
located at 2440 The Quadrant Aztec West, Almondsbury Bristol, BS32 4AQ England,
and its telephone number is 1454-878827.




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**B.**
    **BUSINESS
      OVERVIEW**




**Overview**




We
develop, manufacture, market and support innovative, network testing and service
monitoring solutions for data communications and telecommunications networks
mainly for cellular 2.5 generation, or 2.5 G, third
generation, or 3G, and Voice-over-IP, or VoIP ,
networks . Our
products are used in the development and manufacturing of network equipment, the
installation of networks, and the ongoing maintenance of operational networks to
facilitate fault management, performance monitoring and analysis,
troubleshooting and pre -mediation , which
provides call
detail records (CDR) to third-party operations support systems (OSS) or other
solution s . We
introduced our first test equipment solution in 1993 and currently offer the
following product lines:


·
    **The
      Performer family consists of solutions for both cellular and
      Voice-over****-********IP,
      or VoIP networks.******For
      cellular networks we provide monitoringsolutions for 2.5 and third generation networks, including the****Expert
      System. We also provide a comprehensive cellular network analyzer for 2.5
      and third generation networks. It is designed for vendor research and
      development, Quality Assurance (or QA) and integration labs, as well as
      for operators during network set-up and operation.For
      VoIP, we provide a comprehensive solution for pre/post-deployment stages,
      research and development verification, stress testing and recurring VoIP
      system performance testing.
  ·
    **Omni-Q.**A
      voice quality management system which service providers use to perform
      quality testing on their live VoIP networks, which better enables them to
      deliver reliable, high-quality packet telephony services and to optimize
      network resources.
  ·
    **Prism
      family of WAN/LAN/ATM protocol analyzers, consisting of the PrismLite and
      Prism UltraLite suite of high quality, integrated multitechnology test
      equipment.**These
      analyzers are also suited for cellular converged network testing and VoIP
      (e.g. ATM, IP), testing.
 
 Our
objective is to become a leader in the market for network test and service
monitoring solutions. We seek to achieve this position by delivering customer
oriented, technically advanced and cost-effective products together with
customer support. Key elements of our strategy include:




·
    capitalizing
      upon our technology position in the area of converged networks and our
      technology platforms to produce comprehensive testing and analysis
      solutions for Voice-over-IP, or VoIP, Multimedia over IP, and applications
      over cellular networks;




·
    capitalizing
      on the growth in the Cellular and VoIP markets, and the emerging need to
      monitor the services offered to their customers;




·
    capitalizing
      upon our customer base and distribution channels to gain access to the
      service providers who are offering these new technologies;
and




·
    continuing
      to enhance our distribution channels.




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Our sales
network includes sales in North America through our wholly-owned U.S.
subsidiary, RADCOM Equipment, Inc., a sales office in China and, in the rest of
the world, a network of more than 45 distributors selling in over
45 countries. RADCOM Equipment sells our products to end-users through a
direct sales force and through 11 independent manufacturer’s representatives.
Our testing and monitoring equipment has been sold to a number of international
companies and government agencies including AT&T, AT&T Wireless, British
Telecom, Telstra, Deutsche Telekom, Verizon, Vodafon, KPN, Nortel Networks,
Lucent, Siemens, Cisco NTT, NEC, Nokia, Alcatel and Ericsson.




**Industry
Background**




Unified
packet based, or VoIP, platforms, broadband and 3G technologies enhance the
value proposition of convergence networks. Services enabled by these
technologies, such as video calls, video streaming, IP Centrex and
messaging solutions, represent new opportunities for service providers to
enhance their offerings in developed countries. These technologies enable
service providers to offer basic low cost scalable telecommunication services.
Consequently, vendors are under increasing pressure to develop convergence
technology-based devices that support mission-critical applications, while
service providers need solutions that will allow them to evaluate different
vendors’ abilities, and guarantee consistent delivery of high quality service to
their customers. As such, a variety of new testing and monitoring needs are
growing in the marketplace.




**Products**




We
categorize our products into three primary lines: (i) the Performer series
of performance analyzers include monitoring solutions
for the Cellular networks (ii) the
Omni-QTM voice quality management solution, and (iii) the Prism series of
multitechnology analyzers.




**The
Performer Series of Performance Analyzers**




The
Performer series is an open platform that supports a wide range of test
applications over a variety of technologies. The Performer series is a PC-based
system, utilizing our generic analyzer processor, or GEAR-based, hardware. GEAR
is our proprietary silicon chip designed for testing high speed links in full
line rate, on-line, and is protocol independent. The Performer is unique for its
combination of strong hardware performance and flexible software use.




The
Performer’s innovative approach provides customers with real-time cell and
packet analysis and troubleshooting capabilities at all seven telecommunications
layers including, basic physical and link layer testing, complex tracing of NAS
layer voice, IP session signaling and data/voice quality of service validation.
This analyzer supports Ethernet, WAN, ATM and POS interfaces, and can decode
over 650 communication protocols. A fully distributed system, the Performer
Analyzer is an ideal solution for vendor research and development, quality
assurance and integration labs, as well as for use by operators during network
setup and operation for protocol verification, cell/frame-level analysis, voice
call and IP session analysis and streaming media and voice quality
testing.




With
simplified control from a central console, the Performer hardware and software
suite tests the quality and grade of service of a real-world network
environment. The Performer’s accurate measurements and accelerated data output
shorten time-to-market of network products, reduce research and development
costs and simplify the evaluation process, all critical to successful
deployment.




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·
    The
      Cellular Performer




The
Cellular Performer is an application that runs on our Performer series of
performance analyzers platform. Launched
in February 2003, the Cellular Performer is a versatile and powerful testing
solution for Next Generation cellular networks. It was designed to meet the
testing and analysis needs of the R&D, QA and integration labs of cellular
equipment vendors, as well as of operators who set
up and operate
these networks and monitor consistent delivery of high quality  service
to their customers. It
utilizes our proprietary Performer technology to comprehensively test and
analyze network performance at all cellular network layers, independent of
protocols and technologies. The product supports all major 2.5 and third
generation networks, including general packet radio service (GPRS), universal
mobile telecommunications service (UMTS), enhanced data rates for global
revolution standard (Edge), code division multiple access (CDMA2000) and time
division synchronous CDMA (TD-SCDMA).




The
Cellular Performer is differentiated mainly by our own hardware platform and its
whole-network, flexible analysis approach.




·
    The
      hardware platform takes advantage of our proprietary GEAR chip. It allows
      the system to perform full line-rate analysis at up to 2.5 gigabits per
      second, a rate which is currently faster than competing systems.




·
    The
      Cellular Performer’s analysis approach is also unique. It is able to
      analyze the complex interactions of the whole-network, not just each
      individual protocol and interface. While analyzing the high-level network
      picture, the user can drill down to investigate any particular trouble
      spot. This allows users to quickly pinpoint specific problems, and to
      smooth out the performance of highly complex
networks.




·
    TheCellular
      Monitoring solutionutilizesthe Cellular Performer asa
      probe to monitor consistent Key Performance Indicators (KPIs) and Key
      Quality Indicators (KQIs) as further described below:




o
    The
      Network Consultant is an advanced cellular network analysis application
      that enables mobile operators to quickly verify subscriber connectivity
      and proactively monitor end-to-end network performance. The Network
      Consultant gathers and processes data from multiple server links from the
      Radio access network, Core signaling, and Core IP. It provides end-to-end
      call detail records (CDRs) and enables full drill down analysis
      capabilities of the call session, voice calls and video calls. Using it,
      customers can zoom in and view the statistics and procedures on each
      interface separately, online and offline.




o
    The
      Cellular Performer Expert system is a fully distributed cellular network
      analysis solution with a strong database. It offers unique and powerful
      capabilities that can help service providers reducefault
      in mission-critical applicationsand increase customer satisfaction. It monitors and analyzes the
      performance of Radio Access, Core Signaling and Core IP components. It
      provides extensive and flexible KPIs (Key Performance Indicators) analyses
      with real-time alarms that allow operators to detect faults before their
      customers experience problems.




·
    The
      Voice-over-IP Performeris
      designedto
      support pre-deployment testing of current and emerging convergence
      technologies. The Voice-over-Data Performer is the first performance
      testing solution that we launched.




The
following are some of the highlights of the Voice-over-IP
Performer:




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·
    H.323Sim—voice-over-IP
      generator that generates over 2000 calls simultaneously, at the rate of
      over 100,000 calls per hour, emulating the functionality of an H.323
      terminal;




·
    MediaPro—voice-over-IP
      monitor that analyzes the media and signaling data generated from
      H.323/MGCP/SIP/Megaco protocols and provides voice quality
      measurements;




·
    QPro—circuit
      switch call quality - tool that features Mean Opinion Score voice quality
      measurement;




·
    SIPSim—voice-over
      IP generator that generates high volume SIP-based traffic and is capable
      of stressing SIP entities such as proxy servers, registration servers,
      redirect servers and application servers; and




·
    MasterScript—
      dynamic scripting capability that allows convergence developers and
      service providers to customize and automate testing of quality of service,
      jitter, packet loss, background noise, echo attenuation, and other
      application-specific performance measurements.




**Omni-QTM
Voice Quality Management Solution**




Omni-QTM,
our voice quality management solution, is used by IP telephony service providers
to help them deliver consistently high quality packet telephony services.
Omni-QTM proactively measures the end-to-end voice and signaling quality of
packet and circuit-switched networks. It gives service providers control over
voice quality by preemptively identifying network bottlenecks before they
adversely affect voice transmission. This solution for voice quality management
assists service providers in offering competitive service level
agreements.




The
Omni-QTM system consists of remote probes that support circuit-switched and
packet-switched interfaces. The cProbes and iProbes generate end-to-end circuit
calls and edge-to-edge packet calls, respectively, using standard-based
algorithms. In addition, passive vProbes monitor live traffic going through
voice-over-IP lines and conduct a set of call quality measurements. Together,
these probes are controlled by the QManager, which configures them, polls them
for results and stores the results in an Oracle database ready for the
production of a variety of reports.




**The
Prism Series of Multitechnology Analyzers**




Our Prism
series is designed primarily to address the increasingly complex needs of
networking equipment developers, field service engineers, and end-users of
network products using multiple technologies. Our PrismLite is designed to
address the needs of field service engineers and quality assurance and research
and development labs, both of equipment developers and service providers who may
need to test the operation of equipment using multiple technologies
simultaneously. The PrismLite is convenient for transporting to on-site
locations for the testing of internetworking problems.




The
market for our products is characterized by rapidly changing technology,
changing customer requirements, evolving industry standards and frequent new
product introductions. For
example, starting in the first quarter of 2003, sales of the Prism series
products for ATM and frame relay declined dramatically as our customers’
transitioned to our new Performer product line.




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**Other
Products**




RADCOM’s
PNNI simulation product is a software application used to test ATM switches
running the Private Network to Network Interface (PNNI) protocol. This
application runs on a standard PC platform and enables the user to graphically
design PNNI networks and simulate the existence of a multi-tiered network in its
interaction with the ATM switch.




The
following table shows the breakdown of our consolidated sales for the calendar
years 2002, 2003 and 2004 by product:




Year
      ended December 312002
    
    2003
    
    2004(in
      thousands)Performer
    
    $
    3,860
    
    $
    7,075
    
    $
    11,180Omni-QTM
    
    $
    536
    
    $
    518
    
    $
    2,394Prism
    
    $
    9,924
    
    $
    3,300
    
    $
    2,311Others
    
    $
    271
    
    $
    310
    
    $
    170Total
    
    $
    14,591
    
    $
    11,203
    
    $
    16,055





**Sales
and Marketing**




We sell
our products in North America through our wholly-owned U.S. subsidiary, RADCOM
Equipment, Inc., which sells our products to end-users directly or through
independent manufacturer’s representatives. Most of these manufacturer’s
representatives have exclusive rights of distribution of our products in their
respective geographical areas throughout North America (except some accounts
which we handle directly) and are compensated by us on a commission basis. The
activities of our manufacturer’s representatives and our other sales and
marketing efforts in North America are coordinated by RADCOM
Equipment, Inc.’s employees, who also provide product support to our North
American customers. These representatives do not hold any of our inventory, and
they do not buy products from us. Our representatives locate customers, provide
a demo if needed (in these cases they use our demo equipment), and in some cases
they provide training to the end-users. The customers submit orders directly to
our wholly owned subsidiary, RADCOM
Equipment, Inc. which invoices the end-user customers directly, collects payment
directly and then pays commissions to the manufacturer’s representative for the
sales in its territory. The commission is between 12% and 20%, depending on the
agreement RADCOM
EQUIPMENT Inc. has with the individual manufacturer’s
representative.




Outside
North America, we sell our products through a global network of distributors who
market data communications-related hardware and software products. We currently
have more than 45 independent distributors, some of which have exclusive rights
to sell our products in their respective geographical areas. We have opened
regional sales support offices in China and Spain. These offices support our
distributors in these regions. We continue to search for new distributors to
penetrate new geographical markets or to better serve our targeted
markets.




Our
distributors serve as an integral part of our marketing and service network
around the world. They offer technical support in the end user’s native
language, attend to customer needs during local business hours, organize user
programs and seminars and, in some cases, translate our manuals and product and
marketing literature into the local language. We have a
standard contract with our distributors. Based on this agreement, sales to
distributors are final, and distributors have no right of return or price
protection. In certain circumstances, we have granted limited rights of return
and in such situations, we report deferred revenue. The distributors do not need
to disclose to us their customers’ names, prices or date of order. To the best
of our knowledge, a distributor places an order with us after it receives an
order from its end-user, and does not hold our inventory for sale. Distributors
may hold products for a demo or as repair parts in order to keep their service
agreement with a customer. Usually, we are not a party to the agreements between
distributors and their customers. According to our agreement with the
distributors, a distributor generally should buy at least one demo unit in order
to present the equipment to their customers. This is a final sale, and there are
no rights of return. In practice, the distributors pay full price for the
hardware, and we give them a special discount for the software and allow
distributors to receive all new software packages as they are released. The
distributor cannot sell this equipment to the end-user; the license is only for
the distributor. We do not consider this a benefit to the distributors since we
sell only the demo systems with a special software discount.




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We focus
a significant amount of our sales and marketing resources on our distributors,
providing them with on-going communications and support, and our employees
regularly visit distributors’ sites. Annual distributors’ meetings are organized
by us to further our relationships with our distributors and familiarize them
with our products. In addition, in conjunction with our distributors we
participate in exhibitions of our products worldwide, place advertisements in
local publications, encourage exposure in the form of editorials in
communications journals and prepare direct mailings of flyers and
advertisements. The table below shows the sales breakdown by territory:




Year
      ended December 31,
    
    Year
      ended December 31,(approximate
      $ in millions)
    
    (in
      percentage)2002
    
    2003
    
    2004
    
    2002
    
    2003
    
    2004North
      America
    
    
    5.6
    
    
    4.6
    
    
    4.5
    
    
    38.0
    %
    
    41.0
    %
    
    27.7
    %Europe
    
    
    5.1
    
    
    4.1
    
    
    8.5
    
    
    34.9
    
    
    36.4
    
    
    53.1Asia
      Pacific
    
    
    3.1
    
    
    2.2
    
    
    2.3
    
    
    21.3
    
    
    20.0
    
    
    14.3Israel
    
    
    0.2
    
    
    0.1
    
    
    0.5
    
    
    1.6
    
    
    0.8
    
    
    3.1Others
    
    
    0.6
    
    
    0.2
    
    
    0.3
    
    
    4.2
    
    
    1.8
    
    
    1.8Total
      revenues
    
    
    14.6
    
    
    11.2
    
    
    16.1
    
    
    100.0
    %
    
    100.0
    %
    
    100.0
    %


**Customer
Service and Support**




We
believe that providing a high level of customer service and support to end-users
is essential to the acceptance of our products. We offer a toll-free technical
support help desk to our representatives in the United States and a technical
support help desk to our distributors worldwide. We also support our customers
via fax, e-mail and cellular phone service and provide additional technical
information on our Internet home page. We also offer an E-Learning system, which
provides technical courses to our distributors, representatives and sales and
technical support people at remote locations. These services are partially
available to end-users. We regularly produce a newsletter which is sent to
representatives and distributors, and we publish application notes and technical
briefs for representatives, distributors and end-users to assist in using our
products more efficiently.




In
addition to our direct service and support activities, our representatives in
North America and our distributors worldwide provide sales, service and
technical support functions for our products in their respective territories to
end-user customers. We organize annual technical seminars in Europe and the Far
East every year to increase the technical knowledge of distributors in the use
of our products.




Our
products are designed and manufactured to meet standards required by our
customers. We provide a free one-year software update for the Performer family
and a free two-year software update for the Prism family, which includes bug
fixing solutions and a hardware warranty on our products. After the initial
update period, our customers can purchase an extended warranty for one, two or
three year periods. Under the extended warranty, for each calendar year, our
customers are entitled to at least one official software release and software
updates. The extended warranty includes full software updates, which are
included in the software package dating from the customer’s initial purchase of
the products and full hardware repair of any faulty units. The cost of the
extended warranty for the Performer family is based on a percentage of the
overall cost of the product as an annual maintenance fee. For the Prism family
the cost is fixed. We also provide a customer “hot line.”




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**Manufacturing
and Suppliers**




Our
manufacturing facilities, which are located in Tel Aviv and Jerusalem, Israel,
consist primarily of final assembly, testing and quality control. Electronic
components and subassemblies are prepared by subcontractors according to our
designs and specifications. See Item
5 - “Operating and Financial Review and Prospects-Reducing Costs” beginning on
page 29. Certain
components used in our products are presently available from, or supplied by,
only one source and others are only available from limited sources. In addition,
some of the software packages which we include in our product line are being
developed by unaffiliated subcontractors. The manufacturing processes and
procedures are generally ISO 2000 certified.




**Markets
and Customers**




The
market for our products consists of the following types of
end-users:




*Data
Communications and Telecommunications Equipment Developers and
Manufacturers.* This
group of customers includes companies that develop, manufacture and market data
communications and telecommunications equipment. The primary objectives we
fulfill for these end-users are to (i) help reduce the time to market and
development costs of their products, (ii) increase the conformance of their
products with the networks in which the products will be used and
(iii) increase the reliability and conformance of their products to
relevant standards through stringent test procedures.




*Labs
of Telecommunication Service Providers.* This
group of customers includes companies that buy from manufacturers specific
equipment and networks and provide services to their customers. Our products may
be used by these customers to evaluate the quality and performance of this
equipment and networks and verify the conformance and interoperability between
vendors.




*Public
Telecommunications Service Providers (Cellular and VoIP* ) are organizations responsible
for providing telecommunications services. This
group of companies are using our product in four main areas:




·
    Fault
      detection - to detect when there is a
problem.




·
    Performance
      - to analyze the behavior of network components and customer network usage
      in order to understand trends, performance and optimization (to help
      identify faults before the customer
complains).




·
    Troubleshoot
      - to drill-down to resolve specific issues.




·
    Pre-Mediation
      - to provide call detail records or CDR information to third-party
      operations support systems (OSS) or other
solution.




In
addition, the Omni-QTM benefits global IP carriers, by providing end-to-end voice
quality monitoring and management. Omni-QTM enables existing and next-generation
service providers to proactively manage call quality on their production
networks, and facilitates network capacity planning, new service installation
and maintenance of high-availability, high-quality voice services over packet
telephony.




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**


*Large
Network Owners.* This
group of customers includes industrial corporations, store chains, universities,
financial institutions, telecommunications companies and government agencies
with networks incorporating LANs, WANs and ATM networks. These organizations
employ network managers who use our products to efficiently monitor network
activities, detect changes in network behavior, identify symptoms before they
become problems and plan network expansion, thereby reducing the time required
to resolve problems. This minimizes network downtime and maximizes existing
network resources. These users require constant analysis
capabilities.




**Research
and Development**




The
industry in which we compete is subject to rapid technological developments,
evolving industry standards, changes in customer requirements, and new product
introductions and enhancements. As a result, our success, in part, depends upon
our ability, on a cost-effective and timely basis, to continue to enhance our
existing products and to develop and introduce new products that improve
performance and reduce total cost of ownership. In order to achieve these
objectives, we work closely with current and potential end-users, distributors
and manufacturer’s representatives and leaders in certain data communications
and telecommunications industry segments to identify market needs and define
appropriate product specifications. We intend to continue developing products
that meet key industry standards and to support important protocol standards as
they emerge. Still, there can be no assurances that we will be able to
successfully develop products to address new customer requirements and
technological changes or that such products will achieve market
acceptance.




Our gross
research and development costs were approximately $6.5 million in 2002, $5.6
million in 2003, and $5.2 million in 2004, representing 44.4%, 49.9% and 32.6%
of sales, respectively. Aggregate research and development expenses funded by
the Office of the Chief Scientist were approximately $2.3 million in 2002, $2.0
million in 2003 and $1.7 million in 2004. We expect to continue to invest
significant resources in research and development. As part of our restructuring,
we scaled back our research and development teams over the last three years
primarily by reducing our research and development workforce.




As of
December 31, 2004, our research and development staff consisted of 58
employees. Research and development activities take place at our facilities in
Tel Aviv. We occasionally use independent subcontractors for portions of our
development projects.




**Israeli
Office of the Chief Scientist**




From time
to time we file applications for grants under programs of the Office of the
Chief Scientist of the Israeli Ministry of Industry, Trade and Labor, known as
the Chief Scientist. Grants received under such programs are repaid through a
mandatory royalty based on revenues from products incorporating know-how
developed with the grants. This government support is conditioned upon our
ability to comply with certain applicable requirements and conditions specified
in the Chief Scientist’s programs and with the provisions of the Law for the
Encouragement of Research and Development in Industry,- 1984, and the
regulations promulgated thereunder, or the R&D Law.




Under the
R&D Law, research and development programs that meet specified criteria and
are approved by the research committee of the Chief Scientist are eligible for
grants of up to 50% of certain approved expenditures of such programs, as
determined by said committee.




In
exchange, the recipient of such grants is required to pay the Chief Scientist
royalties from the revenues derived from products incorporating know-how
developed within the framework of each such program or derived from such program
(including ancillary services in connection with such program), usually up to an
aggregate of 100% of the dollar-linked value of the total grants received in
respect of such program, plus interest. As of 2004, the royalty rate is
3.5%.




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The
R&D Law generally requires that the product developed under a program be
manufactured in Israel. However, with the approval of the Chief Scientist, some
of the manufacturing volume may be performed outside of Israel, provided that
the grant recipient pays royalties at an increased rate, which may be
substantial, and the aggregate repayment amount is increased to 120%, 150% or
300% of the grant, depending on the portion of the total manufacturing volume
that is performed outside of Israel. Effective April 1, 2003, the R&D Law
also allows for the approval of grants in cases in which the applicant declares
that part of the manufacturing will be performed outside of Israel or by
non-Israeli residents and the research committee is convinced that doing so is
essential for the execution of the program. This declaration will be a
significant factor in the determination of the Office of the Chief Scientist as
to whether to approve a program and the amount and other terms of benefits to be
granted. For example, the increased royalty rate and repayment amount will be
required in such cases.




The
R&D Law also provides that know-how developed under an approved research and
development program may not be transferred to another person or entity in Israel
without the approval of the research committee. Such approval is not required
for the sale or export of any products resulting from such research or
development. The R&D Law further provides that the know-how developed under
an approved research and development program may not be transferred to another
person or entity outside Israel.




The
R&D Law imposes reporting requirements with respect to certain changes in
the ownership of a grant recipient. The law requires the grant recipient and its
controlling shareholders and interested parties to notify the Chief Scientist of
any change in control of the recipient or a change in the holdings of the means
of control of the recipient that results in a non-Israeli becoming an interested
party directly in the recipient and requires the new interested party to
undertake to the Chief Scientist to comply with the R&D Law. In addition,
the rules of the Chief Scientist may require prior approval of the Chief
Scientist or additional information or representations in respect of certain of
such events. For this purpose, “control” is defined as the ability to direct the
activities of a company other than any ability arising solely from serving as an
officer or director of the company. A person is presumed to have control if such
person holds 50% or more of the means of control of a company. “Means of
control” refers to voting rights or the right to appoint directors or the chief
executive officer. An “interested party” of a company includes a holder of 5% or
more of its outstanding share capital or voting rights, its chief executive
officer and directors, someone who has the right to appoint its chief executive
officer or at least one director, and a company with respect to which any of the
foregoing interested parties owns 25% or more of the outstanding share capital
or voting rights or has the right to appoint 25% or more of the directors.
Accordingly, any non-Israeli who acquires 5% or more of our ordinary shares will
be required to notify the Office of the Chief Scientist that it has become an
interested party and to sign an undertaking to comply with the R&D
Law.




Draft
legislation was submitted in December 2004 by the Israeli government proposing
an amendment to the R&D Law to make it more compatible with the global
business environment by, among other things, relaxing restrictions on the
transfer of manufacturing rights outside Israel and on the transfer of Chief
Scientist funded know-how outside of Israel. As described above, currently, the
R&D Law permits the Chief Scientist to approve the transfer of manufacturing
rights outside Israel, in consideration of payment of higher royalties. The
proposed amendments further permit the Chief Scientist, among other things, to
approve the transfer of manufacturing rights outside Israel in exchange for an
import of different manufacturing into Israel as a substitute, in lieu of the
increased royalties. The proposed amendment further enables, under certain
circumstances and subject to the Chief Scientist’s prior approval, the transfer
of Chief Scientist-funded know-how outside Israel, in consideration of payment
of a portion of the sale price (according to certain formulae calculated in
proportion to the Chief Scientist’s “investment” in the grantee minus
depreciation), or in exchange for know-how and cooperation in R&D with
non-Israeli companies, without any additional payment to the Chief Scientist.
Currently, the proposed amendment is pending, awaiting discussion in the Knesset
(Israeli parliament) Finance Committee and there can be no certainty as to if
and when such proposed draft legislation will actually be finalized into
law.




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The funds
available for Chief Scientist grants made out of the annual budget of the State
of Israel were reduced in 1998, and the Israeli authorities have indicated in
the past that the government may further reduce or abolish the Chief Scientist
grants in the future. Even if these grants are maintained, we cannot presently
predict what would be the amounts of future grants, if any, that we might
receive. In each
of the last ten fiscal years, we have received such royalty-bearing grants from
the Chief Scientist. At December 31, 2004, our contingent liability to the
Office of the Chief Scientist in respect of grants received was approximately
$17.9 million.




***Binational
Industrial Research and Development Fund***




We
received from the BIRD Foundation funding for the research and development of
products. At December 31, 2004, our contingent liability to the Bird
Foundation in respect of funding received was approximately $290,000. We have
not received grants from the BIRD Foundation since 1995.




**Proprietary
Rights**




To
protect our rights to our intellectual property, we rely upon a combination of
trademarks, contractual rights, trade secret law, copyrights, nondisclosure
agreements and technical measures to establish and protect our proprietary
rights in our products and technologies. We own registered trademarks for the
names PrismLite, Omni-Q, MediaPro and Wirespeed. In addition, we sometimes enter
into non-disclosure and confidentiality agreements with our employees,
distributors and manufacturer’s representatives and with certain suppliers with
access to sensitive information. However, we have no registered patents or
trademarks (except for those listed above) and these measures may not be
adequate to protect our technology from third-party infringement, and our
competitors may independently develop technologies that are substantially
equivalent or superior to ours.




Given the
rapid pace of technological development in the communications industry, there
also can be no assurance that certain aspects of our internetworking test
solutions do not or will not infringe on existing or future proprietary rights
of others. Although we believe that our technology has been independently
developed and that none of our technology or intellectual property infringes on
the rights of others, from time to time third parties may assert infringement
claims against us. If such infringement is found to exist, or if infringement is
found to exist on existing or future proprietary rights of others, we may be
required to modify our products or intellectual property or obtain the requisite
licenses or rights to use such technology or intellectual property. However,
there can be no assurance that such licenses or rights can be obtained or
obtained on terms that would not have a material adverse effect on
us.




On
January 13, 2004, we were served with a complaint, in the United States District
Court for the District of New Jersey, by Acterna, LLC, alleging that certain of
our products infringed one or more claims of a patent allegedly owned by
Acterna. In December 2004, although we have not and do not acknowledge
infringing this patent, we decided to reach a settlement with Acterna in order
to save management time and litigation costs. In connection with the settlement
agreement, we paid an undisclosed sum, as well as legal expenses, and Acterna
granted us a worldwide license to the patent and we acknowledged the patent’s
validity.




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**Competition**




The
markets for our products are very competitive and we expect that competition
will increase in the future, both with respect to products that we are currently
offering and products that we are developing. We believe that the principal
competitive factors in the market for internetworking test and analysis
equipment include:




·
    name
      recognition
 
 ·
    product
performance;
 
 ·
    supporting a combination of the right
      interfaces and protocols;
 
 ·
    supporting the right
  services;
 
 ·
    quality of the software and the
      hardware;
 
 ·
    technical
features;
 
 ·
    multitechnology
support;
 
 ·
    portability;
 
 ·
    price;
 
 ·
    customer service and
  support;
 
 ·
    ease of use;
and
 
 ·
    ability to export data to other
      information systems.





Our
competitors with respect to internetworking test and analysis equipment include:
NetTest, Agilent , Network Associates, Ixia, Tektronix, NetHawk, Acterna,
SPIRENT Communications, Catapult, Sunrise Telecom Inc., and Empirix. On the
quality management front our competitors include Agilent, Brix Networks, Minacom
SwissQual and SOTAS. In addition to such competitors, we expect substantial
competition from established and emerging computer, communications, network
management and test equipment companies. Many of these competitors have
substantially greater resources than we have including financial, technological,
engineering, manufacturing and market and distribution capabilities, and some of
them may enjoy greater market recognition than we do.




**Employees**




As of
December 31, 2004, we had 103 permanent employees and 10 temporary
employees located in Israel, 12 permanent employees of RADCOM Equipment,
Inc. located in the United States and 5 permanent employees located in Spain and
China collectively. Of the 113 employees located in Israel, 58 were employed in
research and development, 18 in operations (including manufacturing and
production), 25 in sales and marketing and 12 in administration and management.
Of the 12 employees located in the U.S., 10 were employed in sales and marketing
and 2 were employed in administration and management. Of the 5 employees located
in Spain and China, all were employed in sales and marketing. We consider our
relations with our employees to be good and have never experienced a labor
dispute, strike or work stoppage. Substantially all of our employees have
employment agreements and none of them is represented by a labor
union.




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Although
our Israeli employees are not parties to a collective bargaining agreement, we
are subject to certain provisions of general collective agreements between the
Histadrut (General Federation of Labor in Israel) and the Coordinating Bureau of
Economic Organizations (including the Industrialists’ Association) that are
applicable to our employees by virtue of expansion orders of the Israeli
Ministry of Labor and Welfare. In addition, Israeli labor laws are applicable to
all of our employees in Israel. These provisions and laws principally concern
the length of the work day, minimum daily wages for workers, procedures for
dismissing employees, determination of severance pay and other conditions of
employment.




In Israel
a general practice followed by us (although not legally required) is the
contribution of funds on behalf of most of our full-time employees to an
individual insurance policy known as “Managers’ Insurance”. This policy provides
a combination of savings plan, insurance and severance pay benefits to the
insured employee. It provides for payments to the employee upon retirement or
death and accumulates funds on account of severance pay, if any, to which the
employee may be legally entitled upon termination of employment. Each
participating employee contributes an amount equal to 5% of such employee’s base
salary, and we contribute between 13.3% and 15.8% of the employee’s base salary.
Full-time employees who are not insured in this way are entitled to a savings
account, to which each of the employee and the employer makes a monthly
contribution of 5% of the employee’s base salary. We also provide our employees
with an Education Fund, to which each participating employee contributes an
amount equal to 2.5% of such employee’s base salary and we contribute an amount
equal to 7.5% of the employee’s base salary. In the United States we provide
benefits, in the form of health, dental, vision and disability coverage, in an
amount equal to 14.49% of the employees base salary. All Israeli employers,
including us, are required to provide certain increases in wages as partial
compensation for increases in the consumer price index. The specific formula for
such increases varies according to the general collective agreements reached
among the Manufacturers’ Association and the Histadrut. Israeli employees and
employers also are required to pay pre-determined sums (which include a
contribution to national health insurance) to the Israel National Insurance
Institute, which provides a range of social security benefits.




**C.**  **ORGANIZATIONAL
STRUCTURE**




In
January 1993, we established our wholly-owned subsidiary in the United
States, RADCOM **** Equipment,
Inc., which conducts the sale and marketing of our products in North America. In
July 1996, we incorporated a wholly-owned subsidiary in Israel, Radcom
Investments (1996) Ltd., for the purpose of making various investments,
including the purchase of securities. As of December 31, 2004, Radcom
Investments holds some of our outstanding shares. In August 2001, we
established our wholly-owned subsidiary in the United Kingdom, RADCOM (UK) Ltd.,
which conducts the sales and marketing of our products in the United Kingdom. In
2002, we established our wholly-owned Representative Office in China, which
conducts the sales and marketing for our products in China. Our subsidiaries
include:




Name
      of Subsidiary
    Jurisdiction
      of IncorporationRADCOMEQUIPMENT,
      Inc.
    New
      JerseyRADCOM
      Investments (1996) Ltd.
    IsraelRADCOM
      (UK) Ltd.
    United
      Kingdom







Yehuda
Zisapel and Zohar Zisapel are co-founders and principal shareholders of our
company. Individually or together, they are also founders, directors and
principal shareholders of several other privately and publicly held high
technology and real estate companies which, together with us and the other
subsidiaries and affiliates, are known as the RAD-Bynet group. In addition to
engaging in other businesses, members of the RAD-Bynet Group are actively
engaged in designing, manufacturing, marketing and supporting data
communications and telecommunications products. We have limited competition with
RADVISION that supplies as part of their stack package a protocol simulation
that may serve some of the needs of our customers for test equipment. Some of
the products of members of the RAD-Bynet Group are complementary to, and have
been and are currently used in connection with, our products.




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****


**D.**  **PROPERTY,
PLANTS AND EQUIPMENT**




We do not
own any real property. We currently lease an aggregate of approximately 2,215
square meters of office premises in Tel Aviv, which includes 2,106 square meters
from affiliates of our principal shareholders. Our manufacturing facilities
consist primarily of final assembly, testing and quality control of materials,
wiring, subassemblies and systems. In 2004, aggregate annual lease and
maintenance payments for the Tel Aviv premises were approximately $611,000, of
which approximately $472,000 was paid to affiliates of our principal
shareholders. We may, in the future, lease additional space from an affiliated
party. We also lease approximately 8,946 square feet in Paramus, New Jersey,
from an affiliate. In 2004, aggregate annual lease payments for the premises
were approximately $156,000. We
sub-lease 2,815 square feet of the New Jersey premises to a third party, and in
2004 received aggregate rental payments of approximately $45,000. We also
sub-lease 276 square feet of the New Jersey premises to a related party, and in
2004, we received aggregate rental payments of approximately $5,000 for this
sub-lease. We also lease approximately 144 square meters in Beijing. In 2004,
our aggregate annual lease payments for the premises were approximately $31,000.




**ITEM
5.** **OPERATING
AND FINANCIAL REVIEW AND PROSPECTS**




The
following discussion of our financial condition and results of operations should
be read in conjunction with the consolidated financial statements and the
related notes included elsewhere in this annual report.




This
discussion contains forward-looking statements regarding future events and our
future results that are subject to the safe harbors created under the Securities
Act of 1933 and the Securities Exchange Act of 1934. These statements are based
on current expectations, estimates, forecasts, and projections about the
industries in which we operate and the beliefs and assumptions of our
management. Words such as “expects,” “anticipates,” “targets,” “goals,”
“projects,” “intends,” “plans,” “believes,” “seeks,” “estimates,” “continues,”
“may,” variations of such words, and similar expressions are intended to
identify such forward-looking statements. In addition, any statements that refer
to projections of our future financial performance, our anticipated growth and
trends in our businesses, and other characterizations of future events or
circumstances are forward-looking statements. Readers are cautioned that these
forward-looking statements are only predictions and are subject to risks,
uncertainties, and assumptions that are difficult to predict, including those
identified below, as well as certain factors, including, but not limited to,
those set forth in “Item 3-Key Information-Risk Factors.” Therefore, actual
results may differ materially and adversely from those expressed in any
forward-looking statements. We undertake no obligation to revise or update any
forward-looking statements for any reason.




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****


**Overview**





We
develop, manufacture, market and support innovative, network testing and service
monitoring solutions for data communications and telecommunications networks
mainly for cellular 2.5 generation, third generation and Voice-over IP networks.
Our products are used in the development and manufacturing of network equipment,
the installation of networks, and the ongoing maintenance of operational
networks to facilitate fault management, performance monitoring and analysis,
trouble shooting and pre-mediation which provides call detail records (CDR) to
third-party operations support systems (OSS) and other solutions. We introduced
our first test equipment solution in 1993. Our main lines today are the
Performer and the Omni-Q.




The
Performer, which is a PC-based system, utiliz es our
generic analyzer processor, GEAR. GEAR is our proprietary silicon chip designed
for protocol independent testing of high speed links on-line in full line rate.
During the first quarter of 2003, we launched the Cellular Performer, designed
to meet the testing and analysis needs of the R&D, QA and integration labs
of cellular equipment vendors, as well as of operators who must set up, and
operate these networks and monitor consistent delivery of measurably high
quality of service to their customers. It utilizes our proprietary Performer
technology to comprehensively test and analyze network performance at all
cellular network layers. The product supports all major 2.5 and third generation
networks, including general packet radio service (GPRS), universal mobile
telecommunications service (UMTS), enhanced data rates for global revolution
standard (Edge), and code division multiple access (CDMA2000) and time division
synchronous CDMA (TD-SCDMA).




Omni-QTM,
our voice quality management solution, is used by IP telephony service providers
to help them deliver consistently high quality packet telephony services.
Omni-QTM proactively measures the end-to-end voice and signaling quality of
packet and circuit-switched networks. It gives service providers control over
voice quality by preemptively identifying network bottlenecks before they
adversely affect voice transmission. This solution to voice quality management
assists service providers in offering competitive service level
agreements.




As we
entered 2004, we articulated long-term financial priorities for seeking revenue
growth while pursuing our profitability targets. Our results of operation for
fiscal 2004 indicate that we made substantial progress towards these goals. Net
sales were $16.1 million, compared with $11.2 million in fiscal 2003. Net loss
was $1.7 million, compared with $6.2 million in fiscal 2003. Net cash used in
operations was $2.2 million compared with $4.4 million for fiscal 2003.




Our
technology vision is based on an architectural evolution of networking from
simple connectivity of products to application systems, or as we refer to it,
the Application Provider. As such, many of our strategic initiatives and
investments are aimed at meeting the requirements of Application Providers of 3G
cellular and VoIP networks. If networking evolves toward greater emphasis on
Application Providers, we believe we have positioned ourselves well relative to
our key competitors. If it does not, however, our initiatives and investments in
this area may be of no or limited value. As a result we cannot quantify the
impact of new product introductions on our historical operations or anticipated
impact on future operations.




As we
evaluate our growth prospects and manage our operations for the future, we
continue to believe that the leading indicator of our growth will be the
deployment of 3G cellular and VoIP networks. During fiscal 2004, we steadily
shifted resources to this segment. While this potentially increases our exposure
to changes in telecommunications industry conditions, we feel that this is a
growing area and that we have the technology to capitalize on this market
growth.




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After
commencing sales of our Cellular Performer in the first quarter of 2003, our
revenues began to increase. The Cellular Performer line has been received well
in the marketplace and resulted in growing sales in each quarter since its
introduction. In 2004, we introduced our new application for the Cellular
Performer, the Cellular Expert product which increases our offering in this
product line, increases our average deal size and improves our visibility. With
the rise of VoIP deployments, we began to record higher sales of our
comprehensive Omni-Q solution. As a result of both these developments, we
enjoyed increased sales across all converged network product lines and the
average size of our deals began to rise. During the fourth quarter of 2004, our
sales reached $5.1 million for the first time since 2001, reflecting a
significant increase in deals from major operators and equipment vendors
throughout the world.




In order
to improve our sales performance in the strategic North American region,
appointed in the second quarter of 2004, a new president of our wholly owned
subsidiary in North America, RADCOM EQUIPMENT
Inc. In the fourth quarter we began to see indications that our efforts were
having an impact on our results of operations. China is also a strategic market
for us. In January 2005 we appointed a new general manager for our Chinese
branch in order to improve our sales performance.




In 2005,
we will continue to focus on our two major growth areas of 3G cellular and VoIP
networks, while maintaining our focus on profit contribution. Among the key
external factors that will influence our 2005 performance are the continued
improvement of the global telecommunications industry and our customers’
perspective regarding the prospects for improving conditions. Although we
believe that our products are unique fits for the needs of some of the
industry’s most rapidly growing segments, there can be no assurance that our
sales will continue to increase.




In 2004,
2003 and 2002, we recorded net losses in the respective amounts of approximately
$1.7 million, $6.2 million and $4.7 million. The loss es **** for 2004
included litigation
expenses and the settlement reached with Acterna LLC **** in the
amount of
approximately $697,000 **.** The decrease
in losses in 2004 is due primarily to the increase in our total revenues.  The
losses in 2002 and 2003 were primarily a result of the slowdown in the worldwide
telecommunications industry, which resulted in decreases and delays in the
procurement and deployment of new telecommunications equipment. In addition,
since 2002, we began facing decreased demand for our Prism product line, which
exacerbated the decrease in our revenues. The loss for 2003 included
an  inventory
write-off of $960,000 taken in the first quarter and recorded in cost of sales.
This write-off reflected the reduced value of some of the Prism series
components caused by changing market conditions and the launch of our Cellular
Performer.




During
the years 2001 through 2003, we took a number of cost-cutting measures that
enabled us to minimize our net loss. First, since
2001, we have increasingly shifted to a subcontracting model for the manufacture of our
products. The shift
from a manufacturing model to a subcontracting model has occurred mainly in the
Performer product line, and the bulk of the manufacturing of the Performer
products is subcontracted out. Prior to 2001 the functions performed by us and
subcontractors were divided as follows:




RADCOM
    SubcontractorPlanning
    AssemblyPurchase
      component partsTestingIntegration
 
 As part
of our plans to reduce product cost and improve manufacturing flexibility, we
began to subcontract additional functions. Currently, the functions performed by
us and subcontractors are divided as follows:




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RADCOM
    SubcontractorPlanning
    Purchase
      component partsIntegration
    AssemblyTesting




Our
subcontracting arrangements do not call for rolling forecasts. We provide a
non-binding forecast every 12 months, and submit binding purchase orders
quarterly for material needed in the next quarter. Purchase orders are generally
filled within a month of placing the order. We are charged by the unit, which
ensures that unnecessary charges for reimbursements are minimal. We are not
required to reimburse subcontractors for losses that are incurred in providing
services to us and there are no minimum purchase requirements in our
subcontracting arrangements. If we change components in our products, however,
and the manufacturer already bought components based on a purchase order, we
would reimburse the manufacturer for any losses incurred relating to the
manufacturer’s disposal of such components. The subcontracting arrangements are
governed by one-year contracts that are automatically renewable, and can be
terminated by either party upon ninety days’ written notice.




By
reducing fixed manufacturing costs, we seek to
ensure that our cost of goods sold fluctuates more directly in line with
revenues.




Second,
we reduced our research and development workforce. Since our future success will
depend upon our ability to introduce new products addressing the changing
demands of the telecommunications industry on a timely basis, we tried to
achieve a balance between the short-term and long-term challenges. Accordingly,
we scaled back our research and development teams in a manner that we believe
has not significantly affected our long-term development goals. Third, we
reduced our sales and marketing workforce and related expenses in line with our
reduced revenues. For example, we began focusing on specific conferences rather
than on general shows for marketing initiatives, taking advantage of the fact
that potential customers for the new Cellular Performer product line are larger
and more well-known and that, as a result, our marketing efforts can be more
focused.




Since the
third quarter of 2004 we have seen significant improvement in our booking and
sales. In order to support this growing activity, we may need to increase our
workforce and other expenses slightly in the areas of research and development
and sales and marketing.




**Organization
of Our Business**




The
Company’s management receives sales information by product groups and by
geographic regions. The cost of material and related gross profit for the
Performer is almost identical to that of our other products. Research and
development, sales and marketing, and general and administrative expenses are
reported on a combined basis only (i.e. are not allocated to product groups or
geographic regions). Because a measure of operating profit or loss by product
groups or geographic regions is not presented to the Company’s management, we
have concluded that we operate in one reportable segment.




**A.**  **RESULTS
OF OPERATIONS** ****




The
following table sets forth, for the periods indicated, certain financial data
expressed as a percentage of sales:




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Year
      Ended December 31,2002
    
    2003
    
    2004Sales
    
    
    100.0
    %
    
    100.0
    %
    
    100.0
    %Cost
      of sales
    
    
    34.6
    
    
    43.7
    
    
    31.9Gross
      profit
    
    
    65.4
    
    
    56.3
    
    
    68.1Operating
      expenses:Research
      and development, gross
    
    
    44.4
    
    
    49.9
    
    
    32.6Less
      royalty bearing participation
    
    
    15.9
    
    
    17.8
    
    
    10.7Research
      and development, net
    
    
    28.5
    
    
    32.1
    
    
    21.9Sales
      and marketing
    
    
    56.9
    
    
    66.1
    
    
    43.5General
      and administrative
    
    
    13.8
    
    
    14.5
    
    
    13.6Total
      operating expenses
    
    
    99.2
    
    
    112.7
    
    
    79.0Operating
      loss
    
    
    (33.8
    )
    
    (56.4
    )
    
    (10.9
    )Financial
      income, net
    
    
    1.5
    
    
    0.8
    
    
    0.5Tax
      on Income
    
    
    -
    
    
    -
    
    
    -Net
      loss
    
    
    (32.3
    )
    
    (55.6
    )
    
    (10.4
    )





**Financial
Data for Year Ended December 31, 2004 Compared with Year Ended December 31, 2003
and Year Ended December 31, 2002**





*Revenues*Year
      ended December 31,
    
    %
      Change
    
    %
      Change(approximate
      $ in millions)
    
    2003
      vs.
    
    2004
      vs.2002
    
    2003
    
    2004
    
    2002
    
    2003Performer
    
    
    3.9
    
    
    7.1
    
    
    11.2
    
    
    82.1
    
    
    57.7Omni-Q
    
    
    0.5
    
    
    0.5
    
    
    2.4
    
    
    0.0
    
    
    480.0Prism
    
    
    9.9
    
    
    3.3
    
    
    2.3
    
    
    (66.7
    )
    
    (30.3
    )Others
    
    
    0.3
    
    
    0.3
    
    
    0.2
    
    
    (0.0
    )
    
    (33.3
    )Total
      revenues
    
    
    14.6
    
    
    11.2
    
    
    16.1
    
    
    (23.3
    )
    
    43.8





*Revenues* .
Revenues consist of gross sales of products, less discounts, refunds and
returns. The increase in net sales in 2004 was due to a gradual recovery in the
global telecommunications environment coupled with increased capital spending by
service providers. The increase
in net sales in 2004 was primarily
the result of increased sales
of Cellular
Performer. With the increase in VoIP deployments, we experienced
increased sales of
our comprehensive Omni-Q solution. As a result of both these developments, we
experienced increased
sales across all converged network product lines, as reflected in the table
above. In
addition, our increase in sales resulted from an increase in service provider
customers. These customers purchased larger quantities of our products, and due
to the nature of their orders, the average size of our transactions began to
increase.




Our sales
network includes RADCOM
Equipment, Inc., our wholly-owned subsidiary in the United States, as well as
eleven independent manufacturers’ representatives, and more than 45 independent
distributors in over 50 other countries. The table below shows the sales
breakdown by territory:




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Year
      ended December 31,
    
    Year
      ended December 31,(approximate
      $ in millions)
    
    (in
      percentage)2002
    
    2003
    
    2004
    
    2002
    
    2003
    
    2004North
      America
    
    
    5.6
    
    
    4.6
    
    
    4.5
    
    
    38.0
    %
    
    41.0
    %
    
    27.7
    %Europe
    
    
    5.1
    
    
    4.1
    
    
    8.5
    
    
    34.9
    
    
    36.4
    
    
    53.1Asia
      Pacific
    
    
    3.1
    
    
    2.2
    
    
    2.3
    
    
    21.3
    
    
    20.0
    
    
    14.3Israel
    
    
    0.2
    
    
    0.1
    
    
    0.5
    
    
    1.6
    
    
    0.8
    
    
    3.1Others
    
    
    0.6
    
    
    0.2
    
    
    0.3
    
    
    4.2
    
    
    1.8
    
    
    1.8Total
      revenues
    
    
    14.6
    
    
    11.2
    
    
    16.1
    
    
    100.0
    %
    
    100.0
    %
    
    100.0
    %





The
increase in sales in Europe reflects mainly the deployment of 3G cellular and
VoIP networks. During 2004 we announced that we signed a universal mobile
telecommunications service, or UMTS, network and service monitoring solution
contract for over $1 million with a major 3G mobile operator in Europe. Two of
our distributors in Europe each accounted for more than 10% of our sales in
2004.




*Cost
of sales and Gross profit*




Year
      ended December 31,(approximate
      $ in millions)2002
    
    2003
    
    2004Cost
      of sales
    
    
    5.0
    
    
    4.9
    
    
    5.1Gross
      profit
    
    
    9.6
    
    
    6.3
    
    
    10.9





*Cost
of sales* . Cost of
sales consists primarily of our manufacturing costs, warranty expenses,
allocation of overhead expenses and royalties to the Chief Scientist. Since
2001, we increasingly shifted to a subcontracting model for the manufacture of
our products. As a result, cost of sales consisted of fixed costs of
approximately $1.4 million in 2004. We believe that the reduction of our fixed
manufacturing costs will ensure that our cost of sales fluctuates more directly
in line with revenues. Cost of
sales in 2003 included an inventory write-off of $960,000 taken during the first
quarter. This write-off was made to reflect the reduced value of some of the
Prism series components, caused by changing market conditions.




Our gross
profit is affected by several factors, including the introduction of new
products, price erosion due to increasing competition and product mix. The cost
of material and related gross profit for the Performer is almost identical to
that of our other products. As a result, the introduction of the Performer is
not expected to have a long-term impact on our gross margin. However, during the
initial launch and manufacturing ramp-up of a new product our gross profit is
generally lower as a result of manufacturing inefficiencies during that period.
As the difficulties in manufacturing new products are resolved and the volume of
sales of such products increased, our gross profit generally improves. For
example, in 2003, during the initial launch of the Performer, our gross profit
was lower and subsequently improved.




Most of
our products consist of a combination of hardware and software. Following an
initial purchase of a product, a customer can add additional functions by
purchasing software packages. These packages may add functions to the product
such as providing additional testing data or adding the ability to test
equipment based on different transmission technologies. Since there are no
incremental hardware costs associated with the sale of the add-on software, the
gross margins on these sales are higher. We also have higher gross profit on
sales in North America, where we sell primarily through manufacturers’
representatives, than on sales outside North America where we sell through
distributors.




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In
2004 the
variable costs of sales and fixed costs of
sales were
approximately the same as in 2003 .
Our gross
margin in 2004 improved because
of these stable costs and our increased revenues .




*Operating
      Costs and Expenses*Year
      ended December 31,
    
    %
      Change
    
    %
      Change(approximate
      $ in millions)
    
    2003
      vs.
    
    2004
      vs.2002
    
    2003
    
    2004
    
    2002
    
    2003Research
      and Development, gross
    
    
    6.5
    
    
    5.6
    
    
    5.2
    
    
    (13.8
    )
    
    (
      7.1
    )Less
      Royalty-bearing participation
    
    
    2.3
    
    
    2.0
    
    
    1.7
    
    
    (13.0
    )
    
    (15.0
    )Research
      and Development, net
    
    
    4.2
    
    
    3.6
    
    
    3.5
    
    
    (14.3
    )
    
    (
      2.8
    )Sales
      and Marketing
    
    
    8.3
    
    
    7.4
    
    
    7.0
    
    
    (10.8
    )
    
    (
      5.4
    )General
      and Administrative
    
    
    2.0
    
    
    1.6
    
    
    2.2
    
    
    (20.0
    )
    
    37.5Total
      Operating Expenses
    
    
    14.5
    
    
    12.6
    
    
    12.7
    
    
    (13.1
    )
    
    0.8




*Research
and Development* .
Research and development costs consist primarily of salaries and, to a lesser
extent, payments to subcontractors, the costs of raw materials and allocation of
overhead expenses. We use raw materials to build prototypes of our hardware and
software products. These prototypes have no value since they cannot be sold or
otherwise capitalized as inventory. The allocation of overhead expenses consists
of a variety of costs, including rent, office expenses (including
telecommunications expenses) and administrative costs, such as human resources
activities. The methodology for allocating these expenses depends on the nature
of the expense. Costs such as rent and associated costs are based on the square
meters used by the R&D department. Administrative costs such as human
resources activities are allocated based on the number of employees in the
department. There has been no change in methodology from year to year. These
expenses were partially offset by royalty-bearing grants from the Chief
Scientist. The decrease in gross research and development expenses from 2003 to
2004 reflects the results of our cost-cutting program, which was carried out in
a  manner
that we believe has not significantly affected our long-term development goals.




*Sales
and Marketing* . Sales
and marketing expenses consist primarily of salaries, commissions to
manufacturers’ representatives, advertising, public relations, trade shows,
promotional expenses and allocation of overhead expenses. Commencing in 2001, we
adjusted our sales and marketing expenses in line with reduced revenues. For
example, we are now focusing on specific conferences rather than on general
shows for marketing initiatives. In addition, potential customers for our new
Cellular Performer product line are larger and more well-known and, as a result,
our marketing efforts can be more focused. The decrease in sales and marketing
expenses from 2003 to 2004 also reflects a reduction in commissions paid to
sales representatives in the United States, which commissions are sales-based.
In 2004 we increased our presence in the United States by appointing a new
company president for our U.S. subsidiary. We started to sell our products in
some regions in North America to end-users directly which increased our salary and
other expenses, but was partially offset
by lower commissions paid to sales representatives.




*General
and Administrative* . General
and administrative expenses consist primarily of salaries, professional fees and
staffing recruitment. There was an increase in General and administrative
expenses in 2004 related to the litigation expenses and the settlement reached
with Acterna LLC. The total expenses for the litigation process and for the
settlement was approximately $697,000. General and administrative expenses
included a provision for bad debts and others totaling approximately $11,000 for
2004, $8,000 for 2003 and $338,000 for 2002.




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**


*Financial
Income, Net.* Financial income, net consists primarily of interest earned on bank deposits,
gains and losses from the exchange rate differences of monetary balance sheet
items denominated in non-dollar currencies and interest expense paid on bank
short-term loans. Financial income, net was approximately $217,000 in 2002,
$93,000 in 2003 and $78,000 in 2004. The decrease in financial income, net in
2004 compared to 2003 was a result of the exchange translation loss that
resulted from revaluation of the NIS against the US dollar. (See Impact of
Inflation and Currency Fluctuations below.)




**Discussion
of year 2003 compared 2002**




The
following discussion of 2003 compared with 2002 should be read in conjunction
with the section of this report entitled ”Financial Data for Year Ended December
31, 2004 Compared with Year Ended December 31, 2003 and Year Ended December 31,
2002”




*Revenue.* The
decrease in revenues in 2003 reflected the global communications industry
slowdown which began in 2001, together with a sharp reduction in demand for our
Prism product line. The principal factor in the decrease of our revenues was the
smaller number of Prism products sold and not price pressure.




*Cost
of sales and Gross profit.* The
decrease in gross profit reflected an inventory write-off of $960,000 taken
during the first quarter of 2003. This write-off was made to reflect the reduced
value of some of the Prism series components, caused by changing market
conditions. In 2003 and 2002 the fixed costs of sales were approximately the
same.




*Research
and Development* . The
decrease in gross research and development expenses from 2002 to 2003 reflects
the results of our cost-cutting program, which was carried out in a  manner
that we believe has not significantly affected our long-term development
goals.




*Sales
and Marketing* . The
decrease in sales and marketing expenses from 2002 to 2003 reflects the freeze
of our U.K. subsidiary’s operations and a reduction in commissions paid to sales
representatives in the U.S., which are sales- based and were therefore reduced
in line with the decline in sales.




*General
and Administrative* . The
decrease in general and administrative expenses from 2002 to 2003 reflects the
results of our cost-cutting program. In addition, general and administrative
expenses included a provision for bad debts of approximately $8,000 for 2003
compared $338,000 for 2002.




*Financial
Income, Net.*  The
decrease in financial income, net in 2003 compared to 2002 resulted from a
decrease in interest rates and a decrease in the balance of our cash and
short-term investments.




**B.**  **LIQUIDITY
AND CAPITAL RESOURCES** ****




We have
financed our operations through cash generated from operations, from the
proceeds of our 1997 initial public offering and from our 2004 private placement
transaction. Cash and cash equivalents, marketable securities and short-term
investments at December 31, 2002, 2003 and 2004 were approximately $10.2
million, $5.6 million and $8.6 million, respectively.




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**


*Net
Cash Used in Operating Activities.* Net cash
used in operating activities was approximately $1.7 million, $4.4 million and
$2.2 million in 2002, 2003 and 2004, respectively. In 2004, this was primarily
due to a net loss of approximately $1.7 million, an increase of approximately
$1,572,000 in trade receivables, an increase of approximately $892,000 in
inventories and an increase of approximately $534,000 in other current assets.
This was partially offset by an increase of approximately $892,000 in trade
payables, an increase approximately $413,000 in other payables and accruals, an
increase of approximately $414,000 in deferred revenues and approximately
$797,000 of depreciation and amortization.




The trade
receivables and days sales outstanding (DSO) are primarily impacted by shipment
linearity in the quarter and collections performance. The increase in trade
receivables is due primarily to the increase in our total revenue, a higher
concentration of shipments toward the end of the
fourth quarter
of 2004, which results in a shorter amount of time to collect the related
accounts receivable and increased DSO.




The
overall increase in inventory was due to the impact of managing targeted lead
times, changes in customer-specific requirements, and the increase in our total
revenue. Work-in-process
increased due to increased inventory levels of components
for subassembly needed
to manage targeted lead times on certain high-demand products. Our finished
goods increased primarily due to deferred cost of sales related
to unrecognized revenue on shipments to distributors and service provider
customers. Raw
material increased due to the GEAR chip subcontracting arrangement we
established. Since the amount of GEAR components that we
ordered was low compared to comparable orders in the industry, we agreed to
order and prepay for a minimum amount of silicon chips. All inventories are
accounted for at the lower of cost or market.




The
increase in other current assets is primarily a result of an increase in
receivables from the Office of the Chief Scientist and prepaid expenses. The
increase in trade payables is primarily due to the increase in purchases
of inventory to meet our increased orders . The
increase in payables and accruals is primarily a result of an increase in
commissions payable due to an increase in revenues and an increase of
customers ’ prepayments. The
increase in the deferred revenues was primary as a result of an increase in the
number of extended PCS warranties beyond the initial period in 2004, revenues
attributable to the extended PCS warranties are deferred at the time of the
initial sale, and recognized ratably over the contract period.




*Net
Cash Provided by/Used in Investing Activities.* Investing
activities have consisted of two components: purchases and sales of short-term
investments and purchases of equipment. We invest cash that is surplus to our
operating requirements in our short-term investment portfolio in order to get
better interest rates. Purchases and sales of short-term deposits and marketable
securities provided cash in the amount of $5.4 million in 2002 and $3.0 million
in 2003 as cash was withdrawn to assist with cash used in operating activities.
In 2004, we invested surplus cash in the amount of $2.0 million. Net cash
provided by investing activities in 2002, 2003 and 2004 was approximately $5.0
million, $2.8 million and $(2.3) million, respectively.




*Purchases
of equipment.*  P urchases
of equipment in 2002, 2003 and 2004 were approximately $434,000, $222,000 and
$292,000, respectively. These expenditures were principally for computers and
equipment purchases.




*Net
Cash Provided byFinancing Activities.* In 2002
we had no net change from financing activities, in 2003 net cash provided by
financing activities was $4,000 from the exercise of stock options. In 2004 net
cash provided by financing activities totalled approximately $5.4 million,
$64,000 from the exercise of stock options and approximately $5.3 million from
the private placement as described below.




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**


*Private
Placement.*As described in the “Risk Factors” section above, in 2003, we
fell below the minimum $10 million shareholders’ equity requirement of the
Nasdaq National Market. Our plan to achieve and maintain compliance with all of
the Nasdaq National Market continued listing requirements included, among other
things, the completion of a $5.5 million private placement, or PIPE, of ordinary
shares and warrants in March 2004. Under the PIPE transaction, we issued
3,851,540 of our ordinary shares at an aggregate purchase price of $5.5 million
or $1.428 per ordinary share. The investors in the PIPE included Star Ventures,
B.C.S. Group, Yehuda Zisapel, Zohar Zisapel, and others. We also issued to the
investors warrants to purchase up to 962,887 ordinary shares at an exercise
price of $2.253 per share. The warrants are exercisable for two years from the
closing of the PIPE. As part of the private placement, we filed a resale
registration statement covering the shares purchased in the private placement
(including the shares underlying the warrants). The registration was declared
effective by the SEC on December 10, 2004. We incurred expenses of approximately
$189,000 in connection with the offering. Our net proceeds from the offering
were approximately $5.3 million.





Although
we have been in compliance with the $10 million shareholders’ equity requirement
since completion of the private placement, we must continue to demonstrate an
ability to sustain this over the long term. We cannot assure you that we will
maintain such compliance over the long term or that we will be able to maintain
compliance with all of the continued listing requirements for the Nasdaq
National Market. If we fail to comply with any of the continued listing
requirements, we could be delisted from the Nasdaq National Market. Our shares
would then be quoted on the Nasdaq SmallCap Market (if we satisfy the continued
listing requirements for such market) or the Over-The-Counter Bulletin
Board *.*




**Impact
of Related Party Transactions**




We have
entered into a number of agreements with certain companies, of which Yehuda
Zisapel and Zohar Zisapel are co-founders, directors and/or principal
shareholders, collectively known as the RAD-Bynet Group. Of these agreements,
only the office space leases are material to our operations. The pricing of the
transactions was arrived at based on negotiations between the parties. Members
of our management reviewed the pricing of the lease agreements and confirmed
that they were not different than could have been obtained from unaffiliated
third parties. We believe, however, that due to the affiliation between us and
the RAD-Bynet Group, we have greater flexibility in certain terms than might be
available from unaffiliated third parties on certain issues. In the event that
the transactions with members of the RAD-Bynet Group are terminated and we enter
into similar transactions with unaffiliated third parties, that flexibility may
not be available to us.




**Impact
of Inflation and Currency Fluctuations**




Substantially
all of our sales and most of our expenses are denominated in U.S. dollars or are
dollar-linked. The currency of the primary economic environment in which our
operations are conducted is, therefore, the dollar, which is our functional
currency.




Since we
pay the salaries of our Israeli employees in NIS, the dollar cost of our
operations is influenced by the exchange rates between the NIS and the dollar.
While we incur some expenses in NIS, inflation in Israel will have a negative
affect on our profits for contracts under which we are to receive payment in
dollars or dollar-linked NIS, unless such inflation is offset on a timely basis
by a devaluation of the NIS in relation to the dollar.




From time
to time, inflation in Israel exceeds the devaluation of the NIS against the
dollar or we have faced the strengthening of the value of the NIS against the US
dollar. In the fourth quarter of 2004, for example, the value of the NIS,
expressed in dollar terms increased significantly, raising our Israeli-based
costs as expressed in dollars. Under these conditions, we experienced higher
dollar costs for our operations in Israel, adversely affecting our
dollar-measured results of operations.




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Because
exchange rates between the NIS and the dollar fluctuate continuously (albeit
with a historically declining trend in the value of the NIS) exchange rate
fluctuations will have an impact on our profitability and period-to-period
comparisons of our results. The effects of foreign currency re-measurements are
reported in our financial statements as financial income or
expense.




**Effective
Corporate Tax Rate**




Israeli
companies are generally subject to Corporate
Tax on their taxable income at the rate of 35% for the 2004 tax year, 34% for
the 2005 tax year, 32% for the 2006 tax year and 30% for the 2007 tax year and
thereafter. However,
our manufacturing facilities have been granted “Approved Enterprise” status
under the Law for the Encouragement of Capital Investments, 1959, as amended,
known as the Investments Law, and consequently are eligible, subject to
compliance with specified requirements, ****** for tax
benefits beginning when such facilities first generate taxable income. The tax
benefits under the Investment Law are not available with respect to income
derived from products manufactured outside of Israel. We have derived, and
expect to continue to derive, a substantial portion of our income from our
Approved Enterprise facilities. We are entitled to a tax exemption for a period
of two to four years (in respect of income derived from our Tel Aviv facility),
and up to ten years (in respect of income derived from our Jerusalem facility)
commencing in the first year in which such income is earned, subject to certain
time restrictions. These time periods have not yet commenced because we have
incurred net operating losses for Israeli tax purposes. At December 31,
2004, we had net operating loss carry forwards (unlimited in time) of
approximately $20.2 million.




Our
effective corporate tax rate may substantially exceed the Israeli tax rate. Our
U.S. subsidiary will generally be subject to applicable federal, state, local
and foreign taxation, and we may also be subject to taxation in the other
foreign jurisdictions in which we own assets, have employees or conduct
activities. Our U.S. subsidiary had net loss carry-forwards of approximately
$10.9 million available at December 31, 2004 for federal and state income
tax purposes. These carry-forwards will offset future taxable income and expire
in 2008 through 2024 for federal income tax purposes. Because of the complexity
of these local tax provisions, it is not possible to anticipate the actual
combined effective corporate tax rate which will apply to us. Our U.K.
subsidiary had net loss carry-forwards of approximately $366,000 for U.K. tax
purposes.




We
recorded a valuation allowance for all of our deferred tax assets. Based on the
weight of available evidence, it is more likely than not that all of the
deferred tax assets will not be realized.




**Government
Grants and Related Royalties**




The
Government of Israel, through the Office of the Chief Scientist, encourages
research and development projects pursuant to the Law for the Encouragement of
Industrial Research and Development, 1984, commonly referred to as the “R&D
Law”. We may receive from the Office of the Chief Scientist up to 50% of the
research and development expenditures for particular projects. We recorded
grants from the Office of the Chief Scientist totaling approximately $2.3
million in 2002, $2.0 million in 2003 and $1.7 million in 2004. Pursuant to the
terms of these grants, we are obligated to pay royalties of 3.5% of revenues
derived from sales of products funded with these grants. In the event that a
project funded by the Office of the Chief Scientist does not result in the
development of a product which generates revenues, we would not be obligated to
repay the grants we received for the product’s development. At December 31,
2004, our contingent liability to the Office of the Chief Scientist in respect
of grants received was approximately $17.9 million. For additional information,
see “Item 4B - Information on the Company - Israeli Office of Chief
Scientist”.




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We are
also obligated to pay royalties to the Israel-United States Binational
Industrial Research and Development Foundation, the BIRD Foundation, with
respect to sales of products based on technology resulting from research and
development funded by the BIRD Foundation. Royalties to the BIRD Foundation are
payable at the rate of 5% based on the sales revenues of such products, up to
150% of the grant received, linked to the United States Consumer Price Index. As
of December 31, 2004, we had a contingent obligation to pay the BIRD
Foundation aggregate royalties in the amount of approximately $290,000. Since
1995 we have not received grants from the BIRD Foundation.




**Critical
Accounting Policies and Estimates**




Our
significant accounting policies are more fully described in Note 2 to our
consolidated financial statements. However, certain of our accounting policies
are particularly important to the portrayal of our financial position and
results of operations. In applying these critical accounting policies, our
management uses its judgment to determine the appropriate assumptions to be used
in making certain estimates. Those estimates are based on our historical
experience, the terms of existing contracts, our observance of trends in the
industry, information provided by our customers and information available from
other outside sources, as appropriate. These estimates are subject to an
inherent degree of uncertainty. With respect to our policies on revenue
recognition, warranty costs and inventories, our historical experience is based
principally on our operations since we commenced selling. Our critical
accounting policies include:




*Revenue
recognition* . Revenue
from product sales is recognized, in accordance with Statement of Position (SOP)
97-2, “Software Revenue Recognition”, when the following criteria are met: (1)
persuasive evidence of an arrangement exists, (2) delivery has occurred, (3) the
vendor’s fee is fixed or determinable and (4) collectability is probable.
Amounts received from customers prior to product shipments are classified as
advances from customers. With certain of our products, we provide a one-year
free software update as part of the purchase price of our products, which
includes bug fixing solutions and a hardware warranty (“post customer support”
or “PCS”). In these cases, revenue from PCS during the first year is recognized
upon delivery of the product, since the following criteria are met: (1) the PCS
fee is included with the initial licensing fee, (2) the PCS included with the
initial license is for one year, (3) the estimated cost for providing PCS during
the arrangement is insignificant, (4) unspecified upgrades/enhancements offered
during PCS arrangements historically have been and are expected to continue to
be minimal and infrequent. For other products we provide PCS for two years. In
these cases, revenue attributable to the PCS component is determined utilizing
vendor specific objective evidence for such service and deferred at the time of
the initial sale and recognized ratably over the PCS period in accordance with
the provisions of SOP 97-2. During the PCS period we provide telephone support
and software maintenance releases, if and as developed. We do not commit to
provide any software or support services which are deemed significant vendor
obligations in accordance with SOP 97-2, “Software Revenue Recognition”. With
respect to the hardware warranty, we apply the provisions of SFAS 5, “Accounting
for Contingencies”, and recorded an appropriate provision. After the PCS period,
initially provided with our products, we sell extended PCS contracts, which
includes full software updates, new protocols included in the packages at time
of purchase, and full hardware repair of all faulty units. Revenues attributable
to the extended PCS are deferred at the time of the initial sale and recognized
ratably over the contract period. We generally do not grant rights of return
except for defective products for which a warranty allowance is recorded.
However, in certain circumstances, we have granted limited rights of return. In
these situations, we have deferred all the revenue until the right of return has
expired.




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Most of
our revenues are generated from sales to independent distributors. We have a
standard contract with our distributors. Based on this agreement, sales to
distributors are final and distributors have no rights of return or price
protection. We are not a party to the agreements between distributors and their
customers.




In
certain circumstances, we have granted limited rights of return and in such
situations, we report deferred revenue. The distributors do not need to disclose
to us their customers’ names, prices or date of order. To the best of our
knowledge, a distributor places an order with us after it receives an order from
its end-user, and does not hold our inventory for sale. Distributors may hold
products for a demo or as repair parts in order to keep their service agreement
with a customer. Usually, we are not a party to the agreements between
distributors and their customers. According to our agreement with the
distributors, a distributor generally should buy at least one demo unit in order
to present the equipment to their customers. This is a final sale, and there are
no rights of return. In practice, the distributors pay full price for the
hardware, and we give them a special discount for the software and allow
distributors to receive all new software packages as they are released. The
distributor cannot sell this equipment to the end-user; the license is only for
the distributor. We do not consider this a benefit to the distributors since we
sell only the demo systems with a special software discount.




We also
generate sales through independent manufacturer's representatives. These
representatives do not hold any of our inventories, and they do not buy products
from us. We invoice the end-user customers directly, collect payment directly
and then pay commissions to the manufacturer's representative for the sales in
its territory. We report sales through independent manufacturer's
representatives on a gross basis, based on the indicators of EITF 99-19,
Reporting Revenue Gross as a Principal versus Net as an Agent.




*Allowance
for product warranty* . Our
products sold are generally covered by a warranty for periods ranging from one
year to two years. In respect of contracts where the PCS was recognized upon
delivery, we recorded an appropriate provision. We accrue for warranty costs as
part of our cost of sales based on associated material costs, technical support
labor costs, and associated overhead. Material costs are estimated based
primarily upon historical trends. Technical support labor costs are estimated
based primarily upon historical trends in the rate of customer support cases and
the cost of support in the customer cases within the warranty period. Overhead
cost is applied based on estimated time to support warranty activities.




*Trade
receivables* . Trade
receivables are recorded less the related allowance for doubtful accounts
receivable. We consider accounts receivable to be doubtful when we think it is
probable that we will be unable to collect all amounts, after taking into
account current information regarding the customer’s ability to repay its
obligations. The balance sheet allowance for doubtful accounts for all periods
through December 31, 2004, is determined as a specific amount for those accounts
the collection of which is uncertain. If our customers’ ability to repay their
obligations diminishes in the future, the actual allowance for doubtful accounts
may not be adequate.




*Inventories* .
Inventories are stated at the lower of cost or market, cost being determined on
the basis of the average cost method for raw materials and on the basis of
actual manufacturing costs for work-in-progress and sub-contractors. Inventories
write-off and write-down provisions are provided to cover risks arising from
slow-moving items or technological obsolescence. Spare parts and raw materials
that are no longer used in producing our product are written down to their fair
market value. If changes in the market conditions or changes in the company’s
products occur in the future, it is possible that additional write-off will be
made at such time. In addition, we add to the cost of finished products and work
in process held in inventory the overhead from our manufacturing process. If
these estimates change in the future, the amount of overhead allocated to cost
of revenues would change.




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**


*Stock
option plans* . We
apply the intrinsic value-based method of accounting prescribed by Accounting
Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to
Employees", and related interpretations including FASB Interpretation No. 44,
"Accounting for Certain Transactions Involving Stock Compensation" of APB
Opinion No. 25 ("FIN 44"), in accounting for its stock option plans for
employees and directors. Under this method, compensation is recorded on the date
of grant only if the current market price of the underlying stock exceeded the
exercise price. SFAS No. 123, "Accounting for Stock-Based Compensation",
established accounting and disclosure requirements using a fair value-based
method of accounting for stock-based employee stock compensation plans and as a
measurement basis for transactions involving the acquisition of goods or
services from non-employees. As allowed by SFAS No. 123, we have elected to
continue to apply the intrinsic value-based method of accounting for employee
stock options and have adopted the disclosure requirements of SFAS No.
123.




*Stock
option plans - SFAS 123R.* In
December 2004, FASB issued SFAS No. 123 (Revision 2004), "Share-Based Payment",
(SFAS 123R), that addresses the accounting for share-based payment transactions
in which employee services are received in exchange for either equity
instruments of a company, liabilities that are based on the fair value of a
company's equity instruments or that may be settled by the issuance of such
equity instruments. SFAS 123R eliminates the ability to account for share-based
compensation transactions using the intrinsic value method as prescribed in APB
Opinion No. 25, "Accounting for Stock Issued to Employees". Instead, SFAS 123R
requires that such transactions be accounted for using a fair-value-based method
and that compensation expense be recognized in the statement of operations
rather than disclosing the pro forma impact of the stock based compensation as
we currently disclose in Note 7 to the financial statements. SFAS 123R provides
two tentative adoption methods. The first method is a modified prospective
transition method whereby a company would recognize share-based employee costs
from the beginning of the fiscal period in which the recognition provisions are
first applied as if the fair-value-based accounting method had been used to
account for all employee awards granted, modified, or settled after the
effective date and to any awards that were not fully vested as of the effective
date. Measurement and attribution of compensation cost for awards that are
unvested as of the effective date of SFAS 123R would be based on the same
estimate of the grant-date’s fair value and the same attribution method used
previously under SFAS No. 123, “Accounting for Stock-Based Compensation” (“SFAS
123”). The second adoption method is a modified retrospective transition method
whereby a company would recognize employee compensation cost for periods
presented prior to the adoption of SFAS 123R in accordance with the original
provisions of SFAS 123. Accordingly, an entity would recognize employee
compensation costs in the amounts reported in the pro forma disclosures provided
in accordance with SFAS 123. A company would not be permitted to make any
changes to those amounts upon adoption of SFAS 123R unless those changes
represent a correction of an error. The provisions of SFAS 123R are effective
for periods beginning after June 15, 2005, which will be our third quarter
beginning July 1, 2005.  We expect
that the adoption of this standard will reduce our net income in the second half
of 2005 by approximately $307,000. This estimate is based on the number of
options currently outstanding and exercisable and could change based on the
number of options granted or forfeited in fiscal 2005.




**C.** **RESEARCH
AND DEVELOPMENT, PATENTS AND LICENSES** ****




See “Item
4—Business Overview—Research and Development” and “Business Overview—Proprietary
Rights.”




**D.** **TREND
INFORMATION** **** ****




Telecommunications
and data communications equipment developers and manufacturers and carriers are
the principal end-users of a large percentage of our products. From 2001 through
the first half of 2003, the telecommunications industry in much of the world,
including in our principal geographic markets, has been experiencing a slowdown,
resulting in decreases and delays in the procurement and deployment of new
telecommunications equipment. Although some markets have stabilized, the level
of capital expenditures remains low, and many developers and manufacturers in
markets throughout the world continue to experience a low level of sales and
revenues. As a
result of the foregoing, we experienced a significant decline in demand for our
products in 2001, 2002 , and the
first half of 2003, resulting in a significant decline in sales and revenues. In
addition, we have been affected by reduced market demand for our Prism product
line. In the second half of 2003, we perceived an improvement in the general
market for telecommunications equipment, particularly in the cellular segment of
the market.




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Over the
course of the year 2004, there has been increasing evidence that the overall
decline in the telecommunications industry has ended, and that at least the
beginnings of a recovery are in evidence. This improvement in market conditions
has resulted in increased purchases and deployment of 3G cellular and VoIP
networks, which has resulted in an increase of our sales of products for these
networks.




**E.** **OFF
BALANCE SHEET ARRANGEMENTS** ****




Not
applicable.




**F.** **TABULAR
DISCLOSURE OF CONTRACTUAL OBLIGATIONS** ****




The
following table of our material contractual obligations as of December 31, 2004,
summarizes the aggregate effect that these obligations are expected to have on
our cash flows in the periods indicated:




Payments
      due by periodContractual
      Obligations
    
    Total
    
    Less
      than
      1
      year
    
    2-3
      years
    
    4-5
      years
    
    More
      than
      5
      years(in
      thousands US$)Property
      Leases
    
    $
    806
    
    $
    776
    
    $
    30
    
    $
    --
    
    $
    --Open
      purchase orders
    
    
    1,303
    
    
    1,303Operating
      Leases
    
    
    762
    
    
    303
    
    
    459
    
    
    --
    
    
    --Total
    
    $
    2,871
    
    $
    2,382
    
    $
    489
    
    $
    --
    
    $
    --





*Open
purchase orders* . We
purchase components from a variety of suppliers and use several contract
manufacturers to provide manufacturing services for our products. During the
normal course of business, in order to manage manufacturing lead times and help
assure adequate component supply, we enter into agreements with contract
manufacturers and suppliers that allow them to procure inventory based upon
criteria as defined by our requirements. In certain instances, we provide a
non-binding forecast every 12 months, and submit binding purchase orders
quarterly for material needed in the next quarter. These agreements allow us the
option to cancel, reschedule, and adjust our requirements based on our business
needs prior to firm orders being placed. There are no penalties incurred for not
taking delivery; however, if we change components in our products, when the
manufacturer has bought components based on a purchase order, we reimburse the
manufacturer for any losses incurred relating to the manufacturer’s disposal of
such components. Consequently, only a portion of our reported purchase
commitments arising
from these agreements are firm, non-cancelable, and unconditional
commitments and
included in the table above **.**




In
addition, we are required to pay royalties as percentages from the revenues
derived from products incorporating know-how developed within the framework of
each such program or derived from such program (including ancillary services in
connection with such program). As of December 31, 2004, our contingent
liability to the Office of the Chief Scientist in respect of grants received was
approximately $17.9 million and our contingent liability to the Bird Foundation
in respect of funding received was approximately $290,000. If we do not generate
revenues from products incorporating know-how developed within the framework of
these programs, we will not be obligated to pay royalties.




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Further,
we provided
a performance guarantee in favor of a customer from Bank Hapoalim in Israel
amounting to $204,000 as of December 31, 2004 .




**ITEM 6.**  **DIRECTORS,
SENIOR MANAGEMENT AND EMPLOYEES**




**A.** **DIRECTORS
AND SENIOR MANAGEMENT**




The
following table lists our current directors and executive officers:




Name
    Age
    PositionZohar
      Zisapel
    56
    Chairman
      of the Board of DirectorsArnon
      Toussia-Cohen
    50
    President,
      Chief Executive OfficerDavid
      Zigdon
    48
    Vice
      President Finance and Chief Financial OfficerHanan
      Klainer
    44
    Vice
      President Sales and MarketingDavid
      Ripstein
    38
    General
      Manager, Products and TechnologiesAvi
      Zamir
    48
    President
      ofRADCOM****EQUIPMENT
      Inc.Ilan
      Bar
    44
    Chief
      Technology OfficerRuth
      Koren
    48
    Vice
      President Human ResourcesMichael
      Shilinger
    50
    Vice
      President OperationsRony
      Ross
    55
    DirectorZohar
      Gilon
    57
    DirectorDan
      Barnea
    60
    Director


Mr. Zohar
Zisapel, a co-founder of our company, has served as our Chairman of the Board
since our inception. Mr. Zisapel is also a founder and a director of RAD
Data Communications Ltd., a worldwide data communications company headquartered
in Israel, for which he currently serves as Chairman of the Board and served as
President from 1982 to 1997. Mr. Zisapel is a director of other public companies
including: Verisity Ltd., RADVision Ltd., and Ceragon Ltd. Mr. Zisapel
previously served as Head of the Electronics Research Department in the Israeli
Ministry of Defense. Mr. Zisapel has a B.Sc. and an M.Sc. degree in
electrical engineering from the Technion and an M.B.A. degree from Tel Aviv
University.




Mr. Arnon
Toussia-Cohen, our President and Chief Executive Officer joined
us in September 1998, and served as
a director from September 1999 until January 2005. Mr. Toussia-Cohen also serves as a
Chairman of the Board of RADCOM
EQUIPMENT, Inc. and RADCOM (UK) Ltd. Prior to joining us, he worked for Telrad
Telecommunications Industries, a leading Israeli telecommunications equipment
manufacturer, in a number of capacities, including R&D Division Manager,
Vice President of Business Systems and finally as President of Telrad
Telecommunications Inc., the company’s subsidiary in North America.
Mr. Toussia-Cohen has a B.Sc. degree in electrical engineering from the
Technion and a diploma in Advanced Business Studies for Managers from the Open
University in Israel.




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Mr. David
Zigdon, our Vice President of Finance and Chief Financial Officer, joined us in
February 2000. Mr. Zigdon also serves as a director of RADCOM (UK) LTD
and RADCOM EQUIPMENT Inc. Prior to joining us, Mr. Zigdon was a manager in
the RAD-BYNET Group for 10 1/2 years, initially as Chief Financial Officer
and then for four years as Chief Executive Officer of Bynet Electronics Ltd.
which, as part of its business, distributes our products in Israel.
Mr. Zigdon has a B.A. degree in economics & accounting and a L.L.M
degree in business law from Bar Ilan University, and is a Certified Public
Accountant.




Mr. Hanan
Klainer, our Vice President of Sales, joined us in 1998 as Regional Marketing
Manager and was then promoted to the position of Vice President of Sales. Prior
to joining us, he worked with Tadiran Scopus where he was Marketing Manager.
Before that, he worked at Orbotech as Technical Marketing Manager for the
Japanese Market. Mr. Klainer has a B.Sc. degree in electronic engineering
from Tel Aviv University and an Executive M.B.A. from the Hebrew University in
Jerusalem.




Mr. David
Ripstein, our General Manager, Products and Technologies, joined us in 2000 as
General Manager, Quality Management Business Unit. Prior to joining us, he was
co-founder of Firebit, a company that targeted the ISP market with security
services solutions and one of the co-founders of Speedbit, a company that
focuses on increasing the speed of downloading from the Internet. Mr. Ripstein
served in the Intelligence Corps of the Israel Defense Forces, completing his
service with the rank of Major. Mr. Ripstein has a B.Sc. and an M.Sc.
degree in Electronic Engineering from the Technion.




Mr. Avi
Zamir, President of our wholly-owned U.S. subsidiary, RADCOM Equipment,
Inc., rejoined us in May 2004. Mr. Zamir also serves as a director of
RADCOM EQUIPMENT Inc. From 1999 to 2004, Mr. Zamir was co-founder of Business
Layers Inc., a company that focuses on eProvisioning solutions, which
allow organizations to transform business rules and changes into a set of
corresponding IT activities. Prior to
that, Mr. Zamir was the President of **** RADCOM EQUIPMENT
Inc. since its incorporation in February 1993 until 1999. Mr. Zamir has a
practical engineering qualification from Ort Yad-Singalovski, Tel Aviv.




Mr. Ilan
Bar, our Chief Technology Officer, joined us in 1993 as the WAN/LAN Project
Manager. Later he was promoted to the Head of Research and Development and in
2000 he was promoted again to the position of General Manager, Network Test
Solutions. Prior to joining us he was at Astronautics Ltd., an Israeli company
that manufactures and sells military products, where he held a number of
positions, including Systems Engineer and Research and Development Electronics
Engineer. Prior to that, he served in the Israeli Air Force. Mr. Bar has a
B.A. degree in Business Management from Ruppin Academic Center.




Ms. Ruth
Koren, our Vice President of Human Resources, joined us in March 2000. From
June 1997 to February 2000, she was Vice President of Human Resources
and Operations & Public Relations at SPL Worldgroup a global software
company. Ms. Koren has a B.A. degree in Psychology from Bar-Ilan
University.




Mr. Michael
Shilinger, our Vice President of Operations, joined us in June 1999. From
May 1997 to May 1999 he was Director of Purchasing and Logistics for
Tadiran - Telematics Ltd., an Israeli company involved in the marketing,
development and production of systems for the location of vehicles, cargo and
people. Prior to that Mr. Shilinger was a Director of Logistics at
Galtronics Ltd., one of the leading companies in the manufacture of portable
antennas for cellular systems. Prior to that Mr. Shilinger was the owner of
a Management Information Systems Consulting firm implementing ERP Systems.
Mr. Shilinger has a B.Sc. degree in Industry and Management from Ben-Gurion
University.




Ms. Rony
Ross has served as a Director since December 2000. She is the Executive Chairman
and founder of Panorama Software Ltd., a developer and marketer of Business
Intelligence and on-line analytical processing (OLAP) systems and has been its
Chief Executive Officer from 1993 until 2002. Ms. Ross has over 25 years
experience in the software and hi-tech industry. Ms. Ross is also a director of
Fundtech. She holds a B.Sc. degree in Mathematics and Statistics from Tel Aviv
University, an M.B.A. degree from the Recanati Management School of Tel Aviv
University and an M.Sc. degree in Computer Science from the Weizmann Institute
of Science.




Mr. Zohar
Gilon has served as a Director since June 1995. He serves as a General
Partner and Managing Director of Tamar Technologies Ventures, a venture capital
fund investing in Israel and the U.S. From 1993 until August 1995, he
served as President of W.S.P. Capital Holdings Ltd., which provides investment
banking and underwriting services in Israel and invests in real estate and
high-technology investments in Israel and abroad. Mr. Gilon serves as a director
of other public companies, namely Ceragon Ltd. and RIT Technologies Ltd., and of
several private companies. Mr. Gilon is also a private investor in numerous
high-technology companies, including affiliates of ours in Israel. He holds a
B.Sc. degree in electrical engineering from the Technion and an M.B.A. degree
from Tel Aviv University.




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Mr. Dan
Barnea has served as a Director since September 1999. Mr. Barnea is
Senior Vice President for Research and Development of BMC Software Inc., one of
the world’s largest software publishers. Prior to that he served as President
and Chief Executive Officer of New Dimension Software, an Israeli-based mission
critical software developer, from 1995 until its acquisition by BMC. From 1991
to 1995, Mr. Barnea was the General Manager and, later, President and Chief
Executive Officer of Laser Industries Ltd., a world leader in the development of
laser systems for medical applications. From 1987 to 1991, Mr. Barnea was
the General Manager of Indigo Ltd., an innovator and leader in digital offset
color printing. From 1981 to 1987, Mr. Barnea held senior positions at
Elscint Ltd., then a developer of medical imaging equipment. Mr. Barnea
holds a B.Sc. degree in Electronics and a M.Sc. in computer science from the
Technion.




**B.**  **COMPENSATION**




The
aggregate direct remuneration paid to all of our directors and officers as a
group (12 persons) for the year ended December 31, 2004 was approximately
$1.3 million. This amount includes approximately $208,000, which was set aside
or accrued to provide pension, retirement or similar benefits, but does not
include any amounts we paid to reimburse our affiliates for costs incurred in
providing services to us during such period.




As of
December 31, 2004, our directors and officers as a group held options to
purchase an aggregate of 1,829,300 ordinary shares. Other than the options
granted to our directors under the Directors Share Incentive Plan (1997), the
2001 Share Option Plan, the International Employee Stock Option Plan and the
2003 Share Option Plan and reimbursement for expenses, we do not compensate our
directors for serving on our Board of Directors.




**Stock
Option Plans**




We have
the following eight stock option plans for the granting of options to our
employees, officers, directors and consultants: (i) the Key Employee Share
Incentive Plan (1996); (ii) the Directors Share Incentive Plan (1997);
(iii) the 1998 Employee Bonus Plan; (iv) the 1998 Share Option Plan;
(v) the International Employee Stock Option Plan; (vi) the 2000 Share
Option Plan; (vii) the 2001 Share Option Plan; and (viii) the 2003 Share
Option Plan. Options granted under our option plans generally vest over a period
of between two and four years, and generally expire ten years from the date of
grant. The stock options plans are administered either by the Board of Directors
or, subject to applicable law, by the Share Incentive Committee, which has the
discretion to make all decisions relating to the interpretation and operation of
the options plans, including determining who will receive an option award and
the terms and conditions of the option awards.




On
October 22, 2001, our Board of Directors resolved to reprice options to
purchase 439,815 ordinary shares, which had been granted to our and our
subsidiaries’ non-management employees under the 2000 Share Option Plan and the
International Employee Stock Option Plan. According to the resolution, the
exercise price of these options was reduced to $0.0, subject to the following
conditions: (i) the aggregate amount of options issued to each employee was
reduced by 25%; (ii) the vesting period of all options was reduced to a period
of three years commencing on the date of the resolution; and (iii) for a period
of two years commencing on the date of the resolution each employee is not
permitted to exercise his or her options if the market price of our ordinary
shares on the date of exercise is under $3.00 per ordinary share.




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In July
2004 our Board of Directors resolved to increase by 659,000 the number of
ordinary shares reserved for issuance under the RADCOM Ltd. 2003 Share Option
Plan, and to increase by 150,000 Ordinary Shares the number of shares reserved
for issuance under the RADCOM Ltd. International Employee Stock Option Plan. The
RADCOM Ltd. 2003 Share Option Plan was increased by a transfer of 209,000 shares
from the Company’s older share incentive plans and a corresponding reduction in
ordinary shares available under those plans, in respect of which shares had been
reserved, but not issued, and by an increase of 450,000 Ordinary shares.




As of
December 31, 2004, we have granted options to purchase 4,040,364 ordinary
shares, of which options to purchase 789,567 ordinary shares have been exercised
and options to purchase 3,250,797 ordinary shares remain outstanding. An
additional 957,003 ordinary shares are reserved for issuance under our stock
option plans.




**C.**  **BOARD
PRACTICES** ****




**Terms
of Office**




Directors
are elected by the shareholders at the annual general meeting of the
shareholders, except in certain cases where directors are appointed by the Board
of Directors and their appointment is later ratified at the first meeting of the
shareholders thereafter. Except for external directors (as discussed below),
directors serve until the next Annual General Meeting. The current Board of
Directors is comprised of Zohar Zisapel, Zohar Gilon, Dan Barnea and Rony Ross.
None of our directors have service contracts with the company relating to their
serving as a director, and none of the directors will receive benefits upon
termination of their position as a director.




**External
Directors**




We are
subject to the provisions of the new Israeli Companies Law, 5759-1999, which
became effective on February 1, 2000, superseding most of the provisions of
the Israeli Companies Ordinance (New Version), 5743-1983.




Under the
Companies Law, companies incorporated under the laws of Israel whose shares have
been offered to the public in or outside of Israel are required to appoint at
least two external directors. The Companies Law provides that a person may not
be appointed as an external director if the person or the person’s relative,
partner, employer or any entity under the person’s control, has, as of the date
of the person’s appointment to serve as external director, or had during the two
years preceding that date, any affiliation with the company, any entity
controlling the company or any entity controlled by the company or by such
controlling entity. The term affiliation includes:





·
    an employment
relationship;
 
 ·
    a
      business or professional relationship maintained on a regular
    basis;
 
 ·
    control; and
 
 ·
    service
      as an office holder, excluding service as an office holder during the
      three-month period in which the company first offers its shares to the
      public.




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No person
can serve as an external director if the person’s position or other business
creates, or may create, a conflict of interest with the person’s
responsibilities as an external director or if his or her position or business
might interfere with his or her ability to serve as a director. Until the lapse
of two years from termination of service as an external director, a company may
not engage an external director to serve as an office holder and cannot employ
or receive services from that person, either directly or indirectly, including
through a corporation controlled by that person.




External
directors are to be elected by a majority vote at a shareholders meeting,
provided that either:




·
    a majority of the shares voted at the meeting,
      including at least one third of the shares of non-controlling
      shareholders, vote in favor of the election; or
 
 ·
    the total number of shares voted against the
      election of the external director does not exceed one percent of the
      aggregate number of voting shares of the
company.





The
initial term of an external director is three years and may be extended for an
additional three years. Each committee of a company’s Board of Directors is
required to include at least one external director. Both Rony Ross and Dan
Barnea qualify as external directors under the Companies Law. At least one of
the external directors has been appointed to each of the
committees.




**Audit
Committee**




*Nasdaq
Requirements*




Our
ordinary shares are listed for quotation on the Nasdaq National Market and we
are subject to the rules of the Nasdaq National Market applicable to listed
companies. Under the current Nasdaq rules, a listed company is required to have
an audit committee consisting of at least three independent directors, all of
whom are financially literate and one of whom has accounting or related
financial management expertise. Rony Ross, Dan Barnea and Zohar Gilon qualify as
independent directors under the current Nasdaq requirements, and are all members
of the Audit Committee. In addition, we have adopted an audit committee
charter.




The Audit
Committee of the Board of Directors assists the board in fulfilling its
responsibility for oversight of the quality and integrity of our accounting,
auditing and financial reporting practices and financial statements and the
independence qualifications and performance of our independent auditors. The
Audit Committee also has the authority and responsibility to oversee our
independent auditors, to recommend for shareholder approval the appointment and,
where appropriate, replacement of our independent auditors and to pre-approve
audit engagement fees and all permitted non-audit services and fees.




*Companies
Law Requirements*




Under the
Companies Law, the Board of Directors of a public company is required to appoint
an audit committee, which must be comprised of at least three directors and
include all of the external directors, but may not include:




·
    the chairman of the Board of
    Directors;
 
 ·
    any controlling shareholder or any relative of
      a controlling shareholder; and





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·
    any director employed by the company or
      providing services to the company on a regular
basis.




The duty
of the audit committee is to identify irregularities in the management of the
company’s business, including in consultation with the internal auditor and the
company’s independent accountants, and to recommend remedial action relating to
such irregularities. In addition, the approval of the audit committee is
required under the Companies Law to effect certain related-party
transactions.




An audit
committee of a public company may not approve a related-party transaction under
the Companies Law unless at the time of such approval the external directors are
serving as members of the audit committee and at least one of them is present at
the meeting at which such approval is granted.




Under the
Companies Law, the Board of Directors of a public company must also appoint an
internal auditor proposed by the audit committee. The duty of the internal
auditor is to examine, among other things, whether the company’s conduct
complies with applicable law and orderly business procedure. Under the Companies
Law, the internal auditor may not be an interested party, an office holder, or
an affiliate, or a relative of an interested party, an office holder or
affiliate, nor may the internal auditor be the company’s independent accountant
or its representative. An interested party is defined in the Companies Law as a
5% or greater shareholder, any person or entity who has the right to designate
at least one director or the general manager of the company and any person who
serves as a director or as a general manager.




Mr. Yossi
Ginosar a partner of Fahn Kane, a member of Grant Thornton, serves as our
internal auditor.




**Exculpation,
Indemnification and Insurance of Directors and Officers**




We have
agreed to exculpate and indemnify our office holders to the fullest extent
permitted under the Companies Law. We have also purchased a directors and
officers liability insurance policy. For information regarding exculpation,
indemnification and insurance of directors and officers under applicable law and
our articles of association, see “Item 10B - Additional Information - Memorandum
and Articles of Association”.




**Management
Employment Agreements**




We
maintain written employment agreements with substantially all of our key
employees. These agreements provide, among other matters, for monthly salaries,
our contributions to Managers’ Insurance and an Education Fund and severance
benefits. Most of our agreements with our key employees are subject to
termination by either party upon the delivery of notice of termination as
provided therein.




**D.** **EMPLOYEES**




As of
December 31, 2004, we had 130 permanent and temporary employees worldwide,
of which 58 were employed in research and development, 40 in sales and
marketing, 14 in management and administration and 18 in operations. As of
December 31, 2004, 113 of our employees were based in Israel, 12 were based
in the United States and 5 were based in Spain and China. All of our employees
have executed employment agreements, including confidentiality and non-compete
provisions, with us. We are subject to labor laws and regulations in Israel and
the United States. We and our Israeli employees are also subject to certain
provisions of the general collective agreements between the Histadrut (General
Federation of Labor in Israel) and the Coordination Bureau of Economic
Organizations (including the Industrialists Association) by order of the Israeli
Ministry of Labor and Welfare. None of our employees are represented by a labor
union and we have not experienced any work stoppages.




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****


**E.**  **SHARE
OWNERSHIP**




The
following table sets forth certain information regarding the beneficial
ownership of our ordinary shares by our directors and officers as of February
28, 2005. The percentage of outstanding ordinary shares is based on
14,768,516 (3) ordinary
shares outstanding as of February 28, 2005.




Name
    
    Number
      of Ordinary Shares Beneficially Owned(1)
    
    Percentage
      of Outstanding Ordinary Shares Beneficially Owned(2)
      (3)Zohar
      Zisapel(4)(5)
    
    
    3,302,242
    
    
    22.0
    %Arnon
      Toussia-Cohen(6)
    
    
    362,500
    
    
    2.4
    %David
      Zigdon
    
    
    *
    
    
    *Hanan
      Klainer
    
    
    *
    
    
    *Avi
      Zamir
    
    
    *
    
    
    *Ilan
      Bar
    
    
    *
    
    
    *Ruth
      Koren
    
    
    *
    
    
    *Michael
      Shilinger
    
    
    *
    
    
    *David
      Ripstein
    
    
    *
    
    
    *Rony
      Ross
    
    
    *
    
    
    *Zohar
      Gilon
    
    
    *
    
    
    *Dan
      Barnea
    
    
    *
    
    
    *All
      directors and executive officers as a group (12 persons)(1) (2)
    
    
    4,550,042
    
    
    28.0
    %


________________________


*
    Less
      than 1%.(1)
    Except
      as otherwise noted and pursuant to applicable community property laws,
      each person named in the table has sole voting and investment power with
      respect to all ordinary shares listed as owned by such person. Shares
      beneficially owned include shares that may be acquired pursuant to options
      and warrants to purchase ordinary shares that are exercisable within 60
      days of February 28, 2005. See “Item 5--Liquidity and Capital Resources -
      Private placement.”(2)
    For
      determining the percentage owned by each person or group, ordinary shares
      for each person or group includes ordinary shares that may be acquired by
      such person or group pursuant to options and warrants to purchase ordinary
      shares that are exercisable within 60 days of February 28, 2005. See “Item
      5--Liquidity and Capital Resources - Private placement.”(3)
    The
      number of outstanding ordinary shares does not include shares that were
      repurchased by us.(4)
    Includes
      beneficial ownership of ordinary shares held by RAD Data Communications
      Ltd and Klil and Michael Ltd, Israeli companies.(5)
    Mr. Zisapel
      has been granted options to purchase 130,000 ordinary shares, as follows:
      options to purchase 25,000 ordinary shares at an exercise price of $4.50
      per share, expiring on December 11, 2005; options to purchase 45,000
      ordinary shares at an exercise price of $1.84 per share, expiring on
      December 31, 2006; and options to purchase 60,000 ordinary shares, at an
      exercise price of $1.03 per share expiring on September 10, 2013. Of the
      aggregate options granted, options to purchase 110,000 ordinary shares are
      exercisable as of February 28, 2005 or within 60 days thereof. In
      addition**,**as
      part of the PIPE transaction Mr. Zisapel has been granted warrants to
      purchase up to 129,377 ordinary shares and Rad Data Communications Ltd.
      has been granted warrants to purchase up to 9,979 ordinary shares, at an
      exercise price of $2.253 per share. See “Item 5--Liquidity and Capital
      Resources - Private placement.”
  Pg
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 (6)
    Mr. Toussia
      Cohen has been granted options to purchase 485,000 ordinary shares, as
      follows: options to purchase 140,000 ordinary shares at an exercise price
      of $2.375 per share, expiring on November 16, 2008; options to purchase
      75,000 ordinary shares at an exercise price of $5.75 per share, expiring
      on December 27, 2009; options to purchase 120,000 ordinary shares at an
      exercise price of $1.84 per share, expiring on December 31, 2011; options
      to purchase 20,000 ordinary shares at an exercise price of $1.03 per
      share, expiring on July 18, 2005; options to purchase 30,000 ordinary
      shares at an exercise price of $1.27 per share, expiring on October 19,
      2013 ; and options to purchase 100,000 ordinary shares at an exercise
      price of $2.45 per share, expiring on January 24, 2015. Of the aggregate
      options granted, options to purchase 362,500 ordinary shares are
      exercisable as of February 28, 2005 or within 60 days thereof.





**ITEM
7.** **MAJOR
SHAREHOLDERS AND RELATED PARTY TRANSACTIONS**




**A.** **MAJOR
SHAREHOLDERS**




The
following table sets forth certain information regarding the beneficial
ownership of our ordinary shares as of February 28, 2005, by each person or
entity known to own beneficially more than 5% of our outstanding ordinary shares
based on information provided to us by the holders or disclosed in public
filings with the Securities and Exchange Commission.




Name
    
    Number
      of Ordinary
      Shares
      Beneficially Owned(1)
    
    Percentage
      of
      Outstanding
      Ordinary
      Shares(2)Zohar
      Zisapel(3) (4)
    
    
    3,302,242
    
    
    22.0
    %Yehuda
      Zisapel(3) (5)
    
    
    2,027,161
    
    
    13.6
    %RAD
      Data Communications Ltd (6).
    
    
    177,841
    
    
    1.2
    %Dr.
      Barel Meir (7)
    
    
    1,225,490
    
    
    8.3
    %J.
      Carrlo Cannell, D/B/A
      Cannell
      Capital Management (8)
    
    
    1,770,441
    
    
    12.0
    %


______________


(1)
    Except
      as otherwise noted and pursuant to applicable community property laws,
      each person named in the table has sole voting and investment power with
      respect to all ordinary shares listed as owned by such person. Shares
      beneficially owned include shares that may be acquired pursuant to options
      that are exercisable within 60 days of February 28, 2005, and shares that
      may be acquired upon exercise of the Warrants. See “Item 5--Liquidity and
      Capital Resources - Private placement”(2)
    The
      percentage of outstanding ordinary shares is based on 14,768,516 ordinary
      shares outstanding as of February 28, 2005. For determining the percentage
      owned by each person, ordinary shares for each person includes ordinary
      shares that may be acquired by such person pursuant to options and
      warrants to purchase ordinary shares that are exercisable within 60 days
      of February 28, 2005. See “Item 5--Liquidity and Capital Resources -
      Private placement.”
      
      The
      number of outstanding ordinary shares does not include shares that were
      repurchased by us.(3)
    Includes
      beneficial ownership of Messrs. Zohar Zisapel and Yehuda Zisapel of
      ordinary shares held by RAD Data Communications Ltd., an Israeli company.
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 (4)
    Includes
      167,862 ordinary shares and 9,979 warrants to purchase ordinary shares
      owned of record by RAD Data Communications, 54,500 ordinary shares owned
      of record by Klil and Michael Ltd., an Israeli company, 110,000 ordinary
      shares issuable upon exercise of options exercisable within 60 days of
      February 28, 2005, and 129,377 warrants to purchase ordinary shares. Zohar
      Zisapel is a principal shareholder and director of each of RAD Data
      Communications Ltd. and Klil and Michael Ltd. and, as such,
      Mr. Zisapel may be deemed to have voting and dispositive power over
      the ordinary shares held by RAD Data Communications and Klil and Michael
      Ltd. Mr. Zisapel disclaims beneficial ownership of these ordinary
      shares except to the extent of his pecuniary interest
therein.(5)
    Includes
      167,862 ordinary shares and 9,979 warrants to purchase ordinary shares
      owned of record by RAD Data Communications and 910,360 ordinary shares
      owned of record by Retem Local Networks Ltd., an Israeli company and
      116,246 warrants to purchase ordinary shares. Yehuda Zisapel is a
      principal shareholder and director of each of RAD Data Communications and
      Retem Local Networks and, as such, Mr. Zisapel may be deemed to have
      voting and dispositive power over the ordinary shares held by RAD Data
      Communications and Retem Local Networks. Mr. Zisapel disclaims
      beneficial ownership of these ordinary shares.(6)
    Includes
      9,979 warrants to purchase ordinary shares. Messrs. Zohar and Yehudah
      Zisapel have shared voting anddispositivepower with respect to the shares held by Rad Data Communications Ltd. The
      shares held by Rad Data Communications Ltd. are reflected under Zohar
      Zisapel’s and Yehuda Zisapel’s names in the table.(7)
    Includes
      1,137,955 ordinary shares owned of record by Star Growth Enterprise
      (“Growth”), a German Civil Law Partnership (without limitation of
      liability), and 85,535 ordinary shares owned of record by SVM Star
      Ventures Managementgesellschaft mbH Nr. 3 (“SVM 3”). Growth is managed by
      SVM 3. Dr. Meir Barel is the sole director and primary owner of SVM 3. Dr.
      Barel has the sole power to vote or direct the vote, and the sole power to
      dispose of or direct the disposition of, the shares beneficially owned by
      SVM 3 and by Growth. SVM 3 has the sole power to vote or direct the vote,
      and the sole power to dispose of or direct the disposition of, the shares
      beneficially owned by Growth. Dr. Barel disclaims beneficial ownership of
      the shares held by Growth (including the shares issuable upon exercise of
      the warrants) except to the extent of any pecuniary interest
      therein.(8)
    This
      information is based on Mr. Cannell’s Schedule 13-G/A filing as of
      December 31, 2004.


**B.**  **RELATED
PARTY TRANSACTIONS**




The
RAD-BYNET Group




Messrs. Yehuda
and Zohar Zisapel are founders and principal shareholders of our company. Zohar
Zisapel is a director. One or both of Messrs. Yehuda Zisapel and Zohar
Zisapel are also founders, directors and principal shareholders of several other
companies which, together with us and their respective subsidiaries and
affiliates, are known as the RAD-BYNET Group. Such other corporations include:
RAD Data Communications Ltd. ; RADVision Ltd.; BYNET Data Communications Ltd.;
BYNET SAMECH LTD.; BYNET SYSTEMS APPLICATIONS LTD.; BYNET ELECTRONICS LTD. (a
non-exclusive distributor in Israel for us); AB-NET Communication Ltd.




Members
of the RAD-BYNET Group, each of which is a separate legal entity, are actively
engaged in designing, manufacturing, marketing and supporting data
communications and telecommunications products, none of which is currently the
same as any product of ours. One or both of Messrs. Yehuda Zisapel and
Zohar Zisapel are also founders, directors and principal shareholders of several
other real estate, services, holdings and pharmaceutical companies. The above
list does not constitute a complete list of the investments of Messrs. Yehuda
and Zohar Zisapel.




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We and
other members of the RAD-BYNET Group also market certain of our products through
the same distribution channels. Certain products of members of the RAD-BYNET
Group are complementary to, and may be used in connection with, products of ours
and others of such products may be used in place of (and thus might be deemed to
be competitive with) our products. We incorporate into our product line
(i) a software package for SNA decoding and a microcode for the programming
of a certain chip that is included in our LAN hardware and (ii) a software
package for voice-over-IP simulation (H.323, SIP), both of which we purchased
from members of the RAD-BYNET Group. The aggregate amount of such purchases were
approximately $33,000, $28,000 and $30,000 in 2002, 2003 and 2004, respectively.




We
purchase certain products and services of members of the RAD-BYNET group, on
terms that are either beneficial to the Company or are no less favorable than
terms that might be available to the Company from unrelated third parties based
on quotes the Company received from unrelated third parties. In some cases, the
RAD-BYNET group obtains volume discounts for services from unrelated parties,
and the Company pays its pro rata cost of such services. Based on the Company’s
experience, the volume discounts provide better terms than the Company would be
able to obtain on its own. The aggregate amount of such purchases were
approximately $28,000, $45,000 and $60,000 in 2002, 2003 and 2004,
respectively.




Each of
RAD and BYNET provides legal, tax, personnel and administrative services to us
and leases space to us, and each is reimbursed by us for its costs in providing
such services. The aggregate amount of such reimbursements were approximately
$41,000, $35,000 and $83,000 in 2002, 2003 and 2004, respectively.




We
currently lease office premises in Tel Aviv, Paramus, New-Jersey and
manufacturing premises in Jerusalem from an affiliate. When these agreements
were signed, the lease payments were at fair market prices based on quotes the
Company received from third parties for similar space. Historically, the Company
has had some additional flexibility to change the leased space, which it might
not have with unrelated third parties. The aggregate amount of lease payments
were approximately $708,000, $628,000 and $621,000 in 2002, 2003 and 2004,
respectively. We also sub-lease 276 square feet of the New Jersey premises to a
related party, and in 2004 received aggregate rental payments of approximately
$5,000.




We are
party to a non-exclusive distribution agreement with BYNET ELECTRONICS LTD. a
related party. We sell our products and services to BYNET on the same terms and
conditions as it sells to unrelated Israeli distributors with which it has
distribution agreements. The aggregate amount of such sales were approximately
$264,000, $134,000 and $345,000 in 2002, 2003 and 2004,
respectively.




We
believe that the terms of the transactions in which we have entered and are
currently engaged with other members of the RAD-BYNET Group are beneficial to us
and no less favorable to us than terms that might be available to us from
unaffiliated third parties. All future transactions and arrangements (or
modifications of existing ones) with members of the RAD-BYNET Group in which our
office holders have a personal interest or which raise issues of such office
holders’ fiduciary duties will require approval by our audit committee and, in
certain circumstances, a meeting of our shareholders under the Companies
Law.




**Registration
Rights**




We have
entered into agreements with certain of our directors and principal shareholders
entitling them to certain registration rights. Pursuant to such agreements,
certain directors will each have the right to demand one registration of their
shares and the principal shareholders (as a group) will have the right to demand
one registration of their shares. In addition, each of such parties has the
right to have its shares included in certain registration statements of ours.




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**C.** **INTERESTS
OF EXPERTS AND COUNSEL**




Not
applicable.




**ITEM 8.**  **FINANCIAL
INFORMATION**




**A.** **CONSOLIDATED
STATEMENTS AND OTHER FINANCIAL INFORMATION**




The
Financial Statements required by this item are found at the end of this Annual
Report, beginning on page F-1.




**Other
Financial Information**




In 2004,
the amount of our export sales was approximately $15.6 million, which
represented 96.9% of our total sales.




**Legal
Proceedings**




On
January 13, 2004, we were served with a complaint, in the United States District
Court for the District of New Jersey, by Acterna, LLC, alleging that certain of
our products infringed one or more claims of a patent allegedly owned by
Acterna. In December 2004, although we have not and do not acknowledge
infringing this patent, we decided to reach a settlement with Acterna in order
to save management time and litigation costs. In connection with the settlement
agreement, we paid an undisclosed sum, as well as legal expenses, and Acterna
granted us a worldwide license to the patent and we
acknowledged the patent’s validity .




**Dividend
Policy**




We have
never declared or paid any cash dividends on our ordinary shares. We currently
intend to retain any future earnings to finance operations and to expand our
business and, therefore, do not expect to pay any cash dividends in the
foreseeable future.




**B.** **SIGNIFICANT
CHANGES**




Except as
otherwise disclosed in this annual report on Form 20-F, there has been no
material change in our financial position since December 31,
2004.




**ITEM 9.**  **THE OFFER AND LISTING**




**A.** **OFFER
AND LISTING DETAILS**




The
following table sets forth the high and low bid prices of our ordinary shares as
reported by the Nasdaq National Market for the calendar periods
indicated:




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High
    
    Low2000
    
    $
    20.50
    
    $
    2.442001
    
    $
    4.75
    
    $
    0.742002
    
    $
    2.67
    
    $
    0.352003
    
    $
    2.19
    
    $
    0.642004
    
    $
    2.78
    
    $
    1.002003First
      Quarter
    
    $
    1.20
    
    $
    0.70Second
      Quarter
    
    $
    1.10
    
    $
    0.64Third
      Quarter
    
    $
    1.77
    
    $
    0.95Fourth
      Quarter
    
    $
    2.19
    
    $
    1.042004First
      Quarter
    
    $
    2.78
    
    $
    1.25Second
      Quarter
    
    $
    1.99
    
    $
    1.29Third
      Quarter
    
    $
    1.77
    
    $
    1.00Fourth
      Quarter
    
    $
    2.66
    
    $
    1.162005First
      Quarter (through March 24, 2005)
    
    $
    3.40
    
    $
    2.22Most
      recent six monthsOctober
      2004
    
    $
    1.85
    
    $
    1.16November
      2004
    
    $
    2.66
    
    $
    1.73December
      2004
    
    $
    2.47
    
    $
    2.01January
      2005
    
    $
    2.80
    
    $
    2.22February
      2005
    
    $
    3.40
    
    $
    2.31March
      2005 (through March 24, 2005)
    
    $
    3.14
    
    $
    2.44





**B.** **PLANOF DISTRIBUTION** ****




Not
applicable.




**C.**  **MARKETS**




Since our
initial public offering on September 24, 1997, our ordinary shares have
been traded on the Nasdaq National Market under the symbol RDCM. Prior to such
date, there was no market for our ordinary shares.




**D.**  **SELLING
SHAREHOLDERS**




Not
applicable.




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**E.** **DILUTION**




Not
applicable.




**F.** **EXPENSES
OF THE ISSUE**




Not
applicable.




**ITEM
10.** **ADDITIONAL
INFORMATION**




**A.**  **SHARE
CAPITAL**




Not
applicable.




**B.** **MEMORANDUM
AND ARTICLES OF ASSOCIATION**




The
following is a summary description of certain provisions of our memorandum of
association and articles of association.




**Objects
and Purposes**




We were
first registered by the Israeli Registrar of Companies on July 5, 1985, as
a private company. We later became a public company, registered by the Israeli
Registrar of Companies on October 1, 1997 with the company number
52-004345-6.




The full
details of all our objects and purposes can be found in Section 2 of our
memorandum of association, as filed with the Israeli Registrar of Companies and
amended from time to time by resolution of our shareholders. One of the objects
listed is to manufacture, market and deal with in all ways computer equipment,
including communications equipment and all other equipment related in any way to
such equipment. Some additional objects of our listing include: having business
relationships with representatives and agents; engaging in research and
development; gaining intellectual property; engaging in business actions with
other business owners; lending money when we deem it proper; dealing in any form
of business (import, export, marketing, etc.); and many other general business
activities, whether in Israel or in any other country.




**Directors**




According
to our articles of association, our Board of Directors is to consist of not less
than three and not more than nine directors (which may be changed by resolution
of the shareholders).




**Election
of Directors**




Directors,
other than external directors, are elected by the shareholders at the annual
general meeting of the shareholders or appointed by the Board of Directors. In
the event that any directors are appointed by the Board of Directors, their
appointment is required to be ratified by the shareholders at the next
shareholders’ meeting following such appointment. Our shareholders may remove a
director from office in certain circumstances. There is no requirement that a
director own any of our capital shares. Directors may appoint alternative
directors in their place, with the exception of external directors, who may
appoint an alternate director only in very limited circumstances.




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**Remuneration
of Directors**




Directors’
remuneration is subject to shareholder approval, except for reimbursement of
reasonable expenses incurred in connection with carrying out Directors’
duties.




**Powers
of the Board**




The Board
of Directors may resolve to take action at a meeting when a quorum is present,
and each resolution must be passed by a vote of at least a majority of the
directors present at the meeting. A quorum of directors requires at least a
majority of the directors then in office. The Board of Directors may elect one
director to serve as the chairman of the Board of Directors to preside at the
meetings of the Board of Directors, and may also remove such
director.




The Board
of Directors retains all power in running the company that is not specifically
granted to the shareholders. The Board of Directors may, at its discretion,
cause us to borrow or secure the payment of any sum or sums of money for our
purposes at such times and upon such terms and conditions in all respects as it
deems fit, and, in particular, through the issuance of bonds, perpetual or
redeemable debentures, debenture stock, or any mortgages, charges, or other
securities on the undertaking or the whole or any part of our property, both
present and future, including our uncalled or called but unpaid capital for the
time being.




**Dividends**




The Board
of Directors may declare dividends as it deems justified, but the final dividend
for any fiscal quarter must be proposed by the Board of Directors and approved
by the shareholders. Dividends may be paid in assets or shares of capital stock,
debentures or debenture stock of us or of other companies. The Board of
Directors may decide to distribute our profits among the shareholders. Dividends
that remain unclaimed after seven years will be forfeited and returned to us.
Unless there are shareholders with special dividend rights, any dividend
declared will be distributed among the shareholders in proportion to their
respective holdings of our shares for which the dividend is being
declared.




Neither
our memorandum of association or our articles of association nor the laws of the
State of Israel restrict in any way the ownership or voting of ordinary shares
by non-residents of Israel, except with regard to subjects of countries which
are in a state of war with Israel who may not be recognized as owners of
ordinary shares. If we are wound up, then aside from any special rights of
shareholders, our assets will be distributed among the shareholders in
proportion to their respective holdings.




Our
articles of association allows us to create redeemable shares, although at the
present time we do not have any such redeemable shares.




**External
Directors**




See “Item
6—Board Practices, External Directors.”




**Fiduciary
Duties of Office Holders**




The
Companies Law imposes a duty of care and a duty of loyalty on all office holders
of a company.




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The duty
of care requires an office holder to act with the level of care with which a
reasonable office holder in the same position would have acted under the same
circumstances. The duty of care of an office holder includes a duty to utilize
reasonable means to obtain:





·
    information regarding the advisability of a
      given action submitted for his or her approval or performed by him or her
      by virtue of his position; and
 
 ·
    all other important information pertaining to
      such actions.
 
  The duty of loyalty of an office holder includes a duty to:
 
 ·
    refrain from any conflict of interest between
      the performance of his or her duties for the company and the performance
      of his or her other duties or personal affairs;
 
 ·
    refrain from any activity that is competitive
      with the company;
 
 ·
    refrain from exploiting any business
      opportunity of the company to receive a personal gain for himself or
      herself, or for others; and
 
 ·
    disclose to the company any information or
      documents relating to the company’s affairs which the office holder has
      received due to his or her position as an office
holder.


Each
person listed in the table above under “-Directors and Senior Management” above
is an office holder. Under the Companies Law, the approval of the Board of
Directors is required for all compensation arrangements of office holders who
are not directors. Under the Companies Law, directors’ compensation arrangements
require the approval of the audit committee and the Board of Directors, in such
order, and in a public company, the approval of the audit committee, the Board
of Directors and the shareholders, in that order.




**Conflict
of Interest**




The
Companies Law requires that an office holder of a company disclose to the
company, promptly and in any event no later than the Board of Directors meeting
in which the transaction is first discussed, any personal interest that he or
she may have and all related material information known to him or her in
connection with any existing or proposed transaction by the company. A personal
interest of an office holder includes an interest of a company in which the
office holder is a 5% or greater shareholder, director or general manager or in
which the office holder has the right to appoint at least one director or the
general manager. In the case of an extraordinary transaction, the office
holder’s duty to disclose applies also to the personal interest of the office
holder’s relative, which term is defined in the Companies Law as the person’s
spouse, siblings, parents, grandparents, descendants, spouse’s descendants and
the spouses of any of the foregoing. Under Israeli law, an extraordinary
transaction is a transaction which is:




·
    not in the ordinary course of
    business;
 
 ·
    not on market terms;
or
 
 ·
    is likely to have a material impact of the
      company’s profitability, assets or
liabilities.





Under the
Companies Law, the Board of Directors may approve a transaction between the
company and an office holder or a third party in which an office holder has a
personal interest. A transaction that is adverse to the company’s interest may
not be approved. If the transaction is an extraordinary transaction, the
transaction requires the approval of the audit committee and the Board of
Directors, in that order. In certain circumstances, shareholder approval may
also be required. An office holder who has a personal interest in an
extraordinary transaction that is considered at a meeting of the Board of
Directors or the audit committee generally may not be present at such meeting or
vote on such transaction, unless a majority of the members of the Board of
Directors or the audit committee, as the case may be, also have a personal
interest. If a majority of the members of the Board of Directors or the audit
committee, as the case may be, also have a personal interest, shareholder
approval is also required.




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****


**Changing
Rights of the Shareholders**




The
company may change the rights of owners of shares of capital stock only with the
approval of a majority of the holders of such class of stock present and voting
at a separate general meeting called for such class of stock. An enlargement of
a class of stock is not considered changing the rights of such class of
stock.




**Shareholder
Meetings**




The
company has two types of general shareholder meetings: the annual general
meeting and the extraordinary general meeting. An annual general meeting must be
held once in every calendar year, but not more than 15 months after the last
annual general meeting. We are required to give notice of general meetings no
less than seven days before the general meetings. A quorum in a general meeting
consists of two or more holders of ordinary shares (present in person or by
proxy), who together hold at least one-third (1/3) of the voting power of the
company. If there is no quorum within an hour of the time set, the meeting is
postponed until the following week (or any other time upon which the chairman of
the board and the majority of the voting power represented at the meeting
agree). Every ordinary share has one vote. A shareholder may only vote the
shares for which all calls have been paid, except in separate general meetings
of a particular class. A shareholder may vote in person or by proxy, or, if the
shareholder is a corporate body, by its representative. We have an exemption
from the Nasdaq Stock Market, Inc. from the requirement to distribute our annual
report to our shareholders, but we have undertaken to post a copy of it on our
website, www.radcom.com, after filing it with the SEC.




**Duties
of Shareholders**




Under the
Companies Law, the disclosure requirements which apply to an office holder also
apply to a controlling shareholder of a public company. A controlling
shareholder is a shareholder who has the ability to direct the activities of a
company, including a shareholder that holds 25% or more of the voting power of a
company if no other shareholder owns more than 50% of the voting power of the
company, but excluding a shareholder whose power derives solely from his or her
position as a director of the company or any other position with the company.
Extraordinary transactions of a public company with a controlling shareholder or
with a third party in which a controlling shareholder has a personal interest,
and the terms of engagement of a controlling shareholder as an office holder or
employee, require the approval of the audit committee, the Board of Directors
and the shareholders of the company, in such order. The shareholder approval
must be by a majority vote, provided that either:




·
    at least one-third of the shares of
      shareholders who have no personal interest in the transaction and are
      present and voting, in person, by proxy or by written ballot, at the
      meeting, vote in favor of the transaction; or
 
 ·
    the shareholders who have no personal interest
      in the transaction who vote against the transaction do not represent more
      than one percent of the voting power of the
company.





For
information concerning the direct and indirect personal interests of certain of
our office holders and principal shareholders in certain transactions with us,
see “Item 7-Related Party Transactions.”




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In
addition, under the Companies Law each shareholder has a duty to act in good
faith in exercising his or her rights and fulfilling his or her obligations
toward the company and other shareholders and to refrain from abusing any power
he or she has in the company, such as in shareholder votes. In addition, certain
shareholders have a duty of fairness toward the company, although such duty is
not defined in the Companies Law. These shareholders include any controlling
shareholder, any shareholder who knows that it possesses the power to determine
the outcome of a shareholder vote and any shareholder who, pursuant to the
provisions of the articles of association, has the power to appoint or to
prevent the appointment of an office holder or any other power in regard to the
company.




**Exculpation
of Office Holders**




Under the
Companies Law, an Israeli company may not exempt an office holder from liability
with respect to a breach of his duty of loyalty, but may exempt in advance an
office holder from his liability to the company, in whole or in part, with
respect to a breach of his duty of care (except in connection with
distributions), provided that the articles of association of the company permit
it to do so. Our articles of association allow us to exempt our office holders
to the fullest extent permitted by law.




**Insurance
of Office Holders**




Our
articles of association provide that, subject to the provisions of the Companies
Law, we may enter into a contract for the insurance of the liability of any of
our office holders with respect to an act performed by such individual in his or
her capacity as an office holder, for:




·
    a breach of an office holder’s duty of care to
      us or to another person;
 
 ·
    a breach of an office holder’s duty of loyalty
      to us, provided that the office holder acted in good faith and had
      reasonable cause to assume that his or her act would not prejudice our
      interests; or
 
 ·
    a financial liability imposed upon an office
      holder in favor of another person concerning an act performed by an office
      holder in his or her capacity as an office
holder.




**Indemnification
of Office Holders**




Under the
Companies Law, we may indemnify an office holder with respect to an act
performed in his capacity as an office holder against:




·
    a financial liability imposed on him in favor
      of another person by any judgment, including a settlement or an
      arbitration award approved by a court; such indemnification may be
      approved (i) after the liability has been incurred or (ii) in advance,
      provided that our undertaking to indemnify is limited to events that our
      board of directors believes are foreseeable in light of our actual
      operations at the time of providing the undertaking and to a sum or
      criterion that our board of directors determines to be reasonable under
      the circumstances.
 
 ·
    reasonable litigation expenses, including
      attorney’s fees, expended by the office holder as a result of an
      investigation or proceeding instituted against him by a competent
      authority, provided that such investigation or proceeding concluded
      without the filing of an indictment against him or the imposition of any
      financial liability in lieu of criminal proceedings other than with
      respect to a criminal offense that does not require proof of criminal
      intent; and




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·
    reasonable litigation expenses, including
      attorney’s fees, expended by the office holder or charged to him by a
      court, in proceedings we institute against him or instituted on our behalf
      or by another person, a criminal indictment from which he was acquitted,
      or a criminal indictment in which he was convicted for a criminal offense
      that does not require proof of criminal
intent.




**Limitations
on Exculpation, Indemnification and Insurance**




The
Companies Law provides that a company may not enter into a contract for the
insurance of its office holders nor indemnify an office holder nor exempt an
officer from responsibility toward the company, for any of the
following:




·
    a breach by the office holder of his or her
      duty of loyalty, unless, with respect to insurance coverage or
      indemnification, the office holder acted in good faith and had a
      reasonable basis to believe that such act would not prejudice the
      company;
 
 ·
    a breach by the office holder of his or her
      duty of care if the breach was committed intentionally or
      recklessly;
 
 ·
    any act or omission committed with the intent
      to unlawfully yield a personal profit; or
 
 ·
    any fine imposed on the office
    holder.




In
addition, under the Companies Law, indemnification of, and procurement of
insurance coverage for, our office holders must be approved by our audit
committee and Board of Directors and, if the beneficiary is a director, by our
shareholders. Our audit committee, Board of Directors and shareholders resolved
to indemnify and exculpate our office holders by providing them with
indemnification agreements and approving the purchase of a directors and
officers liability insurance policy.




**Anti-Takeover
Provisions; Mergers and Acquisitions**




The
Companies Law allows for mergers, provided that each party to the transaction
obtains the approval of its Board of Directors and shareholders. For the purpose
of the shareholder vote of each party, unless a court rules otherwise, a
statutory merger will not be deemed approved if shares representing a majority
of the voting power present at the shareholders meeting and which are not held
by the other party to the potential merger (or by any person who holds 25% or
more of the shares of the other party to the potential merger, or the right to
appoint 25% or more of the directors of the other party to the potential merger)
have voted against the merger. Upon the request of a creditor of either party to
the proposed merger, the court may delay or prevent the merger if the court
concludes that there exists a reasonable concern that as a result of the merger
the surviving company will be unable to satisfy the obligations of such party.
Finally, a merger may not be completed unless at least (i) 50 days have passed
from the time that the requisite proposals for approval of the merger were filed
with the Israeli Registrar of Companies and (ii) 30 days have passed since the
merger was approved by the shareholders of each merging company.




In
addition, provisions of the Companies Law that address “arrangements” between a
company and its shareholders allow for “squeeze-out” transactions in which a
target company becomes a wholly-owned subsidiary of an acquiror. These
provisions generally require that the merger be approved by a majority of the
participating shareholders (excluding those abstaining) holding at least 75% of
the shares voted on the matter. In addition to shareholder approval, court
approval of the transaction is required, which entails further delay. The
Companies Law also provides for a merger between Israeli companies after
completion of the above procedure for an “arrangement” transaction and court
approval of the merger.




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The
Companies Law also provides that an acquisition of shares in a public company
must be made by means of a tender offer if, as a result of such acquisition, the
purchaser would become a 25% shareholder of the company. This rule does not
apply if there is already another 25% shareholder of the company. Similarly, the
Companies Law provides that an acquisition of shares in a public company must be
made by means of a tender offer if, as a result of the acquisition, the
purchaser would become a 45% or greater shareholder of the company, unless there
is already a 45% or greater shareholder of the company. These requirements do
not apply if, in general, the acquisition (1) was made in a private placement
that received shareholder approval, (2) was from a 25% or greater shareholder of
the company which resulted in the acquiror becoming a 25% or greater shareholder
of the company, or (3) was from a 45% or greater shareholder of the company
which resulted in the acquiror becoming a 45% or greater shareholder of the
company. The tender offer must be extended to all shareholders, but the offeror
is not required to purchase more than 5% of the company's outstanding shares,
regardless of how many shares are tendered by shareholders. The tender offer may
be consummated only if (i) at least 5% of the company’s outstanding shares will
be acquired by the offeror and (ii) the number of shares tendered in the offer
exceeds the number of shares whose holders objected to the offer.




If, as a
result of an acquisition of shares, the acquirer will hold more than 90% of a
company’s outstanding shares, the acquisition must be made by means of a tender
offer for all of the outstanding shares. If less than 5% of the outstanding
shares are not tendered in the tender offer, all the shares that the acquirer
offered to purchase will be transferred to it. The Companies Law provides for
appraisal rights if any shareholder files a request in court within three months
following the consummation of a full tender offer. If more than 5% of the
outstanding shares are not tendered in the tender offer, then the acquiror may
not acquire shares in the tender offer that will cause his shareholding to
exceed 90% of the outstanding shares. Israeli
tax law treats stock-for-stock acquisitions between an Israeli company and
another company less favorably than does U.S. tax law. For example, Israeli tax
law may, under certain circumstances, subject a shareholder who exchanges his
ordinary shares for shares of another corporation to taxation prior to the sale
of the shares received in such stock-for-stock swap.




**C.**  **MATERIAL
CONTRACTS**




For a
summary of our material contracts, see “Item 7-Related Party Transactions” and
“Item 4-Information on the Company-Property, Plants and Equipment.”




**D.** **EXCHANGE
CONTROLS** ****




There are
currently no Israeli currency control restrictions on payments of dividends or
other distributions with respect to our ordinary shares or the proceeds from the
sale of our ordinary shares, except for the obligation of Israeli residents to
file reports with the Bank of Israel regarding certain transactions. However,
legislation remains in effect pursuant to which currency controls can be imposed
by administrative action at any time and from time to time.




**E.** **TAXATION**




**Israeli
Tax Considerations**




The
following is a summary of the current tax structure applicable to companies
incorporated in Israel, with special reference to its effect on us. The
following also contains a discussion of the material Israeli consequences to
purchasers of our ordinary shares and Israeli government programs benefiting us.
To the extent that the discussion is based on new tax legislation which has not
been subject to judicial or administrative interpretation, we cannot assure you
that the views expressed in the discussion will be accepted by the appropriate
tax authorities or the courts. The discussion is not intended, and should not be
construed, as legal or professional tax advice and is not exhaustive of all
possible tax considerations.




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Holders
of our ordinary shares should consult their own tax advisors as to the United
States, Israeli or other tax consequences of the purchase, ownership and
disposition of ordinary shares, including, in particular, the effect of any
foreign, state or local taxes.




General
Corporate Tax Structure




Generally,
Israeli companies are subject to Corporate Tax on their taxable income at the
rate of 35% for the 2004 tax year, 34% for the 2005 tax year, 32% for the 2006
tax year and 30% for the 2007 tax year and thereafter, and are subject to
Capital Gains Tax at a rate of 25% for capital gains (other than gains deriving
from the sale of listed securities) derived after January 1, 2003. However, the
effective tax rate payable by a company which derives income from an approved
enterprise (as further discussed below) may be considerably less.




Tax
Benefits and Grants for Research and Development




Israeli
tax law allows, under specified conditions, a tax deduction for expenditures,
including capital expenditures, for the year in which they are incurred. These
expenses must relate to scientific research and development projects and must be
approved by the relevant Israeli government ministry, determined by the field of
research, and the research and development must be for the promotion of the
company and carried out by or on behalf of the company seeking such deduction.
However, the amount of such deductible expenses shall be reduced by the sum of
any funds received through government grants for the finance of such scientific
research and development projects. Expenditures not so approved are deductible
over a three-year period.




Tax
Benefits Under the Law for the Encouragement of Industry (Taxes),
1969




Under the
Law for the Encouragement of Industry (Taxes), 1969 (the “Industry Encouragement
Law”), Industrial Companies (as defined below) are entitled to the following tax
benefits, among others:




·
    deductions over an eight-year period for
      purchases of know-how and patents;
 
 ·
    deductions over a three-year period of
      expenses involved with the issuance and listing of shares on the Tel Aviv
      Stock Exchange or, on or after January 1, 2003, on a recognized stock
      exchange outside of Israel;
 
 ·
    the right to elect, under specified
      conditions, to file a consolidated tax return with other related Israeli
      Industrial Companies; and
 
 ·
    accelerated depreciation rates on equipment
      and buildings.




Eligibility
for benefits under the Industry Encouragement Law is not subject to receipt of
prior approval from any governmental authority. Under the Industry Encouragement
Law, an “Industrial Company” is defined as a company resident in Israel, at
least 90% of the income of which, in any tax year, determined in Israeli
currency, exclusive of income from government loans, capital gains, interest and
dividends, is derived from an “Industrial Enterprise” owned by it. An
“Industrial Enterprise” is defined as an enterprise whose major activity in a
given tax year is industrial production activity.




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We
believe that we currently qualify as an Industrial Company within the definition
of the Industry Encouragement Law. No assurance can be given that we will
continue to qualify as an Industrial Company or that the benefits described
above will be available in the future.




Special
Provisions Relating to Taxation Under Inflationary Conditions




The
Income Tax Law (Inflationary Adjustments), 1985, represents an attempt to
overcome the problems presented to a traditional tax system by an economy
undergoing rapid inflation. The Inflationary Adjustments Law is highly complex.
Its features which are material to us can be described as follows:




·
    When the value of a company’s equity, as
      calculated under the Inflationary Adjustments Law, exceeds the depreciated
      cost of Fixed Assets (as defined in the Inflationary Adjustments Law), a
      deduction from taxable income is permitted equal to the product of the
      excess multiplied by the applicable annual rate of inflation. The maximum
      deduction permitted in any single tax year is 70% of taxable income, with
      the unused portion permitted to be carried forward, linked to the increase
      in the consumer price index.
 
 ·
    If the depreciated cost of Fixed Assets
      exceeds a company’s equity, then the product of such excess multiplied by
      the applicable annual rate of inflation is added to taxable
    income.
 
 ·
    Subject to certain limitations, depreciation
      deductions on Fixed Assets and losses carried forward are adjusted for
      inflation based on the increase in the consumer price
    index.
 
 ·
    Taxable gains on certain listed securities (
      which are taxed at a reduced tax rate with respect to individuals) are
      taxable at the Company Tax rate in certain
  circumstances.




However,
the Minister of Finance may, with the approval of the Knesset Finance Committee,
determine by order, during each fiscal
year (or until February 28th of the following year ) in which the rate of
increase of the price index would not exceed or shall not have exceeded, as
applicable, 3%, that all or some of the provisions of this Law shall not apply
to such fiscal year, or, that the rate of increase of the price index relating
to such fiscal year shall be deemed to be 0%, and to make the adjustments
required to be made as a result of such determination.




The
Israeli Income Tax Ordinance and regulations promulgated thereunder allow
“Foreign-Invested Companies,” which maintain their accounts in U.S. dollars in
compliance with the regulations published by the Israeli Minister of Finance, to
base their tax returns on their operating results as reflected in the dollar
financials statements or to adjust their tax returns based on exchange rate
changes rather than changes in the Israeli consumer price index, in lieu of the
principles set forth by the Inflationary Adjustments Law. For these
purposes, a Foreign-Invested Company is a company, more than 25% of whose share
capital, in terms of rights to profits, voting and appointment of directors, and
of whose combined share and loan capital, is held by persons who are not
residents of Israel. A company
that elects to measure its results for tax purposes based on the dollar exchange
rate cannot change that election for a period of three years following the
election. We
believe that we qualify as a Foreign Investment Company within the meaning of
the Inflationary Adjustments Law. We have not yet elected to measure our results
for tax purposes based on the U.S. dollar exchange rate, but may do so in the
future.




Capital
Gains Tax on Sales of Our Ordinary Shares




Israeli
law generally imposes a capital gains tax on the sale of any capital assets by
residents of Israel, as defined for Israeli tax purposes, and on the sale of
assets located in Israel, including shares in Israeli companies, by both
residents and non-residents of Israel, unless a specific exemption is available
or unless a tax treaty between Israel and the shareholder’s country of residence
provides otherwise. The law distinguishes between real gain and inflationary
surplus. The inflationary surplus is equal to the increase in the purchase price
of the relevant asset attributable to the increase in the Israeli consumer price
index or, in certain circumstances, a foreign currency exchange rate, between
the date of purchase and the date of sale. The real gain is the excess of the
total capital gain over the inflationary surplus.




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Capital
gains tax is generally imposed on Israeli residents at a rate of 15% on real
gains derived on or after January 1, 2003, from the sale of shares in Israeli
companies publicly traded on Nasdaq or on a recognized stock exchange or
regulated market in a country that has a treaty for the prevention of double
taxation with Israel (such as RADCOM ). This tax rate is contingent upon the
shareholder not claiming a deduction for financing expenses in connection with
such shares (in which case the gain will be taxed at a rate of 25%), and does
not apply to: (i) the sale of shares to a relative (as defined in Israeli Income
Tax Ordinance); (ii) the sale of shares by dealers in securities; (iii) the
sale of shares by shareholders that report in accordance with the Inflationary
Adjustment Law (that will be taxed at Corporate Tax rates for corporations and
at marginal tax rates for individuals); or (iv) the sale of shares by
shareholders who acquired their shares prior to an initial public offering (that
may be subject to a different tax arrangement). The tax basis of shares acquired
prior to January 1, 2003 will be determined in accordance with the average
closing share price in the three trading days preceding January 1, 2003.
However, a request may be made to the tax authorities to consider the actual
adjusted cost of the shares as the tax basis if it is higher than such average
price.




Non-Israeli
residents are exempt from Israeli capital gains tax on any gains derived from
the sale of shares of Israeli companies publicly traded on a recognized stock
exchange or regulated market outside of Israel (such as RADCOM ), provided such
shareholders did not acquire their shares prior to the issuer’s initial public
offering and that the gains did not derive from a permanent establishment of
such shareholders in Israel. However, non-Israeli corporations will not be
entitled to such exemption if an Israeli resident (i) has a controlling interest
of 25% or more in such non-Israeli corporation, or (ii) is the beneficiary of or
is entitled to 25% or more of the revenues or profits of such non-Israeli
corporation, whether directly or indirectly.




In some
instances where our shareholders may be liable to Israeli tax on the sale of
their ordinary shares, the payment of the consideration may be subject to the
withholding of Israeli tax at source.




U.S.-Israel
Tax Treaty




Pursuant
to the Convention between the Government of the United States of America and the
Government of Israel with Respect to Taxes on Income, as amended (the “the U.S.-
Israel Tax Treaty”), the sale, exchange or disposition of ordinary shares by a
person who (i) holds the ordinary shares as a capital asset,
(ii) qualifies as a resident of the United States within the meaning of the
U.S.-Israel Tax Treaty and (iii) is entitled to claim the benefits afforded
to such resident by the U.S.-Israel Tax Treaty generally will not be subject to
Israeli capital gains tax unless either such resident holds, directly or
indirectly, shares representing 10% or more of the voting power of a company
during any part of the 12-month period preceding such sale, exchange or
disposition, subject to certain conditions, or the capital gains from such sale,
exchange or disposition can be allocated to a permanent establishment in Israel.
In the event that the exemption shall not be available, the sale, exchange or
disposition of ordinary shares would be subject to such Israeli capital gains
tax to the extent applicable; however, under the U.S.-Israel Tax Treaty, such
residents would be permitted to claim a credit for such taxes against U.S.
federal income tax imposed with respect to such sale, exchange or disposition,
subject to the limitations in U.S. laws applicable to foreign tax credits. The
U.S.-Israel Tax Treaty does not relate to state or local taxes.




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Taxation
of Non-Residents




Non-residents
of Israel are subject to income tax on income accrued or derived from sources in
Israel. Such sources of income include passive income such as dividends,
royalties and interest, as well as non-passive income from services rendered in
Israel. On distributions of dividends other than bonus shares or stock
dividends, income tax at the rate of 25% is withheld at source, unless a
different rate is provided in a treaty between Israel and the shareholder’s
country of residence. Under the U.S.-Israel Tax Treaty, the maximum tax on
dividends paid to a holder of ordinary shares who is a U.S. resident will be
25%; provided, however, that under the Investment Law, dividends generated by an
Approved Enterprise are taxed at the rate of 15%. Furthermore, dividends not
generated by an Approved Enterprise paid to a U.S. company holding at least 10%
of our issued voting power during the part of the tax year which precedes the
date of payment of the dividend and during the whole of its prior tax year , are
generally taxed at a rate of 12.5%.




For
information with respect to the applicability of Israeli capital gains taxes on
the sale of ordinary shares by United States residents, see “Capital Gains Tax
on Sales of Our Ordinary Shares” above.




Law for
the Encouragement of Capital Investments, 1959




The Law
for the Encouragement of Capital Investments, 1959, as amended, or the
“Investments Law”, provides that a capital investment in eligible facilities
may, upon application to the Investment Center of the Ministry of Industry and
Commerce of the State of Israel, be designated as an Approved Enterprise. The
Investments Law will expire on March 31, 2005, unless its terms are extended.
Accordingly, requests for new programs or expansions that are not approved by
March 31, 2005, will not confer any tax benefits, unless the term of the law is
extended. On January 12, 2005, a bill was submitted to the Israeli parliament
providing for certain changes to the Investments Law. Among others, the bill
proposes certain changes to both the criteria and procedure for obtaining
Approved Enterprise status for an investment program, and changes to the grants
and tax benefits afforded in certain circumstances to Approved Enterprises under
the Investments Law. The proposed amendment is expected to apply to new
investment programs following the enactment of the bill into law. In order to
enact the bill as legislation, the bill must be approved by the Israeli
parliament and published. Such bill was approved by Israeli Parlament on March
29, 2005. However the final law as yet to be published therefore we and our
shareholders face uncertainties as to the potential consequences of the
law.




Each
certificate of approval for an Approved Enterprise relates to a specific
investment program delineated both by its financial scope, including its capital
sources, and by its physical characteristics, e.g., the equipment to be
purchased and utilized pursuant to the program. Taxable income of a company
derived from an Approved Enterprise is subject to company tax at the maximum
rate of 25% (rather than the regular Corporate Tax rates) for the “Benefit
Period”, a period of seven years commencing with the year in which the Approved
Enterprise first generated taxable income (limited to 12 years from commencement
of production or 14 years from the year of receipt of approval, whichever is
earlier) and, under certain circumstances (as further detailed below), extending
to a maximum of ten years from the commencement of the Benefit Period. Under an
amendment to the Investments Law that was made within the framework of the tax
reform, it was clarified that tax benefits under the Investments Law shall also
apply to income generated by a company from the grant of a usage right with
respect to know-how developed by the Approved Enterprise, income generated from
royalties, and income derived from a service which is auxiliary to such usage
right or royalties, provided that such income is generated within the Approved
Enterprise’s ordinary course of business.




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A company
that has an Approved Enterprise program is eligible for further tax benefits if
it qualifies as a “foreign investors’ company”. A “foreign investors’ company”
is a company more than 25% of whose shares of capital stock and combined share
and loan capital is owned by non-Israeli residents. A company that qualifies as
a foreign investors’ company and has an approved enterprise program is eligible
for tax benefits for a ten year benefit period. As specified below, depending on
the geographic location of the Approved Enterprise within Israel, income derived
from the Approved Enterprise program may be exempt from tax on its undistributed
income for a period of between two and ten years and will be subject to a
reduced tax rate for the remainder of the benefits period. The tax rate for the
remainder of the benefits period is between 10% and 25%, depending on the level
of foreign investment in each year.




A company
with an Approved Enterprise designation may elect (as we have done) to forego
certain Government grants extended to Approved Enterprises in return for an
“alternative package of benefits.” Under such alternative package of benefits, a
company’s undistributed income derived from an Approved Enterprise will be
exempt from Company Tax for a period of between two and ten years from the first
year of taxable income, depending on the geographic location of the Approved
Enterprise within Israel, and such company will be eligible for the tax benefits
under the Investments Law for the remainder of such Benefits
Period.




A company
that has elected such alternative package of benefits and that subsequently pays
a dividend out of income derived from the Approved Enterprise(s) during the tax
exemption period will be subject to Corporate Tax in respect of the amount
distributed (including the tax thereon) at the rate which would have been
applicable had the company not elected the alternative package of benefits
(10%-25%, depending on the extent of foreign shareholders holding the company’s
ordinary shares). The dividend recipient is taxed at the reduced rate applicable
to dividends from Approved Enterprises (15%), if the dividend is distributed out
of the income derived in the tax exemption period. This tax must be withheld by
the company at source, regardless of whether the dividend is converted into
foreign currency. See Note 8 to the Consolidated Financial Statements.




In
distributing dividends (if any), we may decide from which profits to declare
such dividends for tax purposes in any given year. However, we are not obliged
to distribute exempt retained profits under the alternative package of benefits,
and we may generally decide from which year’s profits to declare dividends. We
intend to permanently reinvest the amount of our tax-exempt income and not to
distribute such income as a dividend. In the event that we pay a cash dividend
from income that is derived from our Approved Enterprise and, thus, is tax
exempt, we would be required to pay tax at the rate which would have been
applicable had we not elected the alternative package of benefits (generally
10%-25%, as described above), and to withhold 15% at source for the dividend
recipient, on the amount distributed and the corporate tax thereon.




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In 1994,
our investment program in our Tel Aviv facility was approved as an Approved
Enterprise under the Investments Law. We elected the alternative package of
benefits in respect thereof. Our program for expansion of our Approved
Enterprise to Jerusalem was submitted to the Investment Center for approval in
October 1994 and the approval thereof was received in February 1995.
As we selected the alternative package of benefits for our program, once we
begin generating taxable net income we will be entitled to a tax exemption with
respect to the additional income derived from that program for six years and
will be taxed at a rate of 10%-25%, depending on the level of foreign
investment, for one additional year. The approval provides that the tax rates on
income allocated to our research and development and marketing and management
activities (which are located in Tel Aviv) are to be determined by the Israeli
tax authorities. The approval also provides that the six-year period may be
extended to ten years if our application to the Investment Center for
recognition as a “high technology” facility is approved. In this case we would
not be entitled to an additional year at the 10%- 25% tax rate. In letters dated
May 30, 1996 and June 16, 1996, the Israeli tax authorities provided
that, for the purpose of determining our tax liability, our income will be
allocated to our manufacturing plant (which is located in Jerusalem) and to our
research and development center (in Tel Aviv), according to the formula
described below. Income allocated to the manufacturing plant will benefit from a
six-year tax exemption, and for the year immediately following, will be taxed at
a rate of 10%-25%, depending on the level of foreign investment, or benefit from
a ten year tax exemption, while income allocated to the research and development
center will benefit from a two-year exemption and for a five-year period
immediately following will be taxed at a 10%-25% rate. The tax authorities
further provided that the income allocated to our research and development
center will be in an amount equal to the expenses of such center (after
deducting the grants from the office of the Chief Scientist and adding royalties
paid to the office of the Chief Scientist as well as a pro rata portion of our
general and administrative expenses) plus a certain portion of our profit
derived from our industrial activities, calculated as follows. If we are not
profitable, no profits before tax will be allocated to the research and
development center. If profits do not exceed 35% of sales, the profits allocated
to the research and development center will be at a rate equal to our rate of
profits on our sales, plus 5%, up to a maximum of 35%. In the event that profits
exceed 35% of sales, the research and development center will be allocated
profits at a 35% rate. The letter also states that the Israeli tax authorities
may reexamine the above arrangement in 1998 or when we are granted an approval
for an additional expansion, whichever is earlier, based on development in the
manufacturing plant, the number of employees employed therein and its location.
Any such new arrangement would be applied only with respect to tax years
following the year in which we were notified of an intention to reexamine the
arrangement.




In
December 1996, our request for a second expansion of our Approved
Enterprise in Jerusalem was approved by the Investment Center. The investments
relating to this expansion were completed as of April 15, 1998. In April
1998, we requested a third expansion of our Approved Enterprise in Jerusalem for
the period from April 16, 1998 to December 31, 1999. The Investment
Center has not yet approved such request.




Each
application to the Investment Center is reviewed separately and a decision as to
whether or not to approve such application is based, among other things, on the
then prevailing criteria set forth in the law, on the specific objectives of the
applicant company set forth in such application and on certain financial
criteria of the applicant company. Accordingly, there can be no assurance that
any such application will be approved. In addition, the benefits available to an
Approved Enterprise are conditional upon the fulfillment of certain conditions
stipulated in the law and its regulations and the criteria set forth in the
specific certificate of approval, as described above. In the event that these
conditions are violated, in whole or in part, we would be required to refund the
amount of tax benefits, with the addition of the consumer price index linkage
adjustment and interest.




We
believe our Approved Enterprise operates in substantial compliance with all such
conditions and criteria although none of the tax benefits have been utilized by
RADCOM to date (subject to the tax assessments for the years 1998-1999). The
Israeli government may reduce or eliminate tax benefits available to approved
enterprise programs in the future. We cannot assure you that our program will
continue to be approved and/or that we will continue to receive benefits for it
at the current level, if at all. See “Item 3-Key Information - Risk Factors -
Risks Relating to Our Location in Israel”.




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****


**The
Israeli Stamp Duty on Documents Law, 1961**




The
Israeli Stamp Duty on Documents Law, 1961 (the “Stamp Duty Law”), provides that
any document (or part thereof) that is signed in Israel or that is signed
outside of Israel and refers to an asset or other thing in Israel or to an
action that is executed or will be executed in Israel, is subject to a stamp
duty, generally at a rate of between 0.4% and 1% of the value of the subject
matter of such document. De facto, it has been common practice in Israel not to
pay such stamp duty unless a document is filed with a governmental authority. An
amendment to the Stamp Duty Law that came into effect on June 1, 2003, generally
provides that stamp duty on most agreements shall be paid by the parties that
signed such agreement, jointly or severally, or by the party that undertook
under such agreement to pay the stamp duty.




Following
such amendment, in July 2004, a large number of Israeli companies received a
request from the Customs and VAT Department of the Israel Ministry of Finance to
disclose agreements (including memoranda) that were signed after June 1, 2003
with the aim of collecting stamp duty with respect to such agreements. The
legitimacy of the aforementioned amendment to the Stamp Duty Law and of said
actions by the Israeli tax authorities are currently under review by the Israeli
High Court of Justice.




In
January 2005, an order was signed in accordance with which the said requirement
to pay stamp duty is cancelled with effect from January 1, 2008. Furthermore,
pursuant to such order, as of January 1, 2005, stamp duty is no longer
chargeable on, among others, loan agreements.




**United
States Federal Income Tax Considerations**




Subject
to the limitations described herein, the following discussion summarizes the
material United States federal income tax consequences to a U.S. Holder of our
ordinary shares. A “U.S. Holder” means a holder of our ordinary shares who
is:




·
    a citizen or resident of the United
      Statesfor U.S. federal income tax purposes;
 
 ·
    a corporation or
      partnership(or
      other entity taxable as a corporationor
      partnershipfor U.S. federal income tax purposes) created or organized in the United
      States or under the laws of the United States or any political subdivision
      thereof;
 
 ·
    an estate, the income of which is subject to
      United States federal income tax regardless of its source;
    or
 
 ·
    a trust,(i) if, in general, a court within the United States is able to exercise
      primary supervision over its administration and one or more U.S. persons
      have the authority to control all of its substantial decisions, or (ii)
      that has in effect a valid election under applicable U.S. Treasury
      regulations to be treated as a U.S.
person.




Material
aspects of U.S. federal income tax relevant to a holder of our ordinary shares
that is not a U.S. Holder (a “Non-U.S. Holder”) are also discussed below. This
discussion considers only U.S. Holders that will own our ordinary
shares as capital assets and does not purport to be a comprehensive description
of all of the tax considerations that may be relevant to each person’s decision
to purchase our ordinary
shares.




This
discussion is based on current provisions of the Internal Revenue Code of 1986,
as amended (the “Code”), current and proposed Treasury regulations promulgated
thereunder, and administrative and judicial decisions as of the date hereof, all
of which are subject to change, possibly on a retroactive basis. This discussion
does not address all aspects of United States federal income taxation that may
be relevant to any particular U.S. Holder in light of such holder ’s
individual circumstances. In particular, this discussion does not address the
potential application of the alternative minimum tax or United States federal
income tax consequences to U.S. Holders
that are subject to special treatment, including U.S. Holders
that :




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·
    are
      broker-dealers or insurance companies;
 
 ·
    have elected mark-to-market
    accounting;
 
 ·
    are tax-exempt organizations or retirement
      plans;
 
 ·
    are financial institutions or “financial
      services entities”
 
 ·
    hold ourordinary
      shares as part of a straddle, “hedge” or “conversion transaction” with
      other investments;
 
 ·
    acquiredour ordinaryshares upon the exercise of employee stock options or otherwiseas
      compensation;
 
 ·
    are, or hold their shares through**,**partnerships or other pass-through
entities;
 
 ·
    own directly, indirectly or by attribution at
      least 10% of our voting power; or
 
 ·
    have a functional currency that is not the
      U.S. dollar.





In
addition, this discussion does not address any aspect of state, local or
non-United States tax laws or the possible application of United States federal
gift or estate tax.




**Each
holder of** **our** **ordinary shares is advised to consult such person’s own tax advisor with respect
to the specific tax consequences to such person of purchasing, holding or
disposing of our ordinary shares, including the applicability and effect of
federal, state, local and foreign income tax and other tax laws in such person’s
particular circumstances.**




***Taxation
of Ordinary Shares***




*Taxation
of Dividends Paid On Ordinary Shares.* Subject
to the discussion below under “Passive Foreign Investment Company Status,” a
U.S. Holder will be required to include in gross income as ordinary dividend
income the amount of any distribution paid on or ordinary
shares, including any Israeli taxes withheld from the amount paid, on the date
the distribution is received to the extent the distribution is paid out of our
current or accumulated earnings and profits as determined for United States
federal income tax purposes. Distributions in excess of such earnings and
profits will be applied against and will reduce the U.S. Holder’s basis in our
ordinary shares and, to the extent in excess of such basis, will be treated as
gain from the sale or exchange of our ordinary shares. The dividend portion of
such distributions generally will not qualify for the dividends received
deduction available to corporations.




Subject
to the discussion below under “Passive Foreign Investment Company Status,”
dividends that are
received by U.S. Holders that are individuals, estates or trusts will be taxed
at the rate applicable to long-term capital gains (a maximum rate of 15%),
provided that such dividends meet the requirements of “qualified dividend
income.” Dividends that fail to meet such requirements, and dividends received
by corporate U.S. Holders, are taxed at ordinary income rates. No dividend
received by a U.S. Holder will be a qualified dividend (1) if the U.S.
Holder held the ordinary share with respect to which the dividend was paid for
less than 61 days during the 121-day period beginning on the date that is 60
days before the ex-dividend date with respect to such dividend, excluding for
this purpose, under the rules of Code section 246(c), any period during which
the U.S. Holder has an option to sell, is under a contractual obligation to
sell, has made and not closed a short sale of, is the grantor of a
deep-in-the-money or otherwise nonqualified option to buy, or has otherwise
diminished its risk of loss by holding other positions with respect to, such
ordinary share (or substantially identical securities); or (2) to the
extent that the U.S. Holder is under an obligation (pursuant to a short sale or
otherwise) to make related payments with respect to positions in property
substantially similar or related to the ordinary share with respect to which the
dividend is paid. If we were to be a “passive foreign investment
company ” (as
such term is
defined in the Code) for any year, dividends paid on our ordinary shares in such
year or in the following year would not be qualified dividends. In addition, a
non-corporate U.S. Holder will be able to take a qualified dividend into account
in determining its deductible investment interest (which is generally limited to
its net investment income) only if it elects to do so; in such case the dividend
will be taxed at ordinary income rates.




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Distributions
of current or accumulated earnings and profits paid in foreign currency to a
U.S. Holder (including any Israeli taxes withheld therefrom) will be includible
in the income of a U.S. Holder in a U.S. dollar amount calculated by reference
to the exchange rate on the day the distribution is received. A U.S. Holder that
receives a foreign currency distribution and converts the foreign currency into
U.S. dollars subsequent to receipt will have foreign exchange gain or loss based
on any appreciation or depreciation in the value of the foreign currency against
the U.S. dollar, which will generally be U.S. source ordinary income or
loss.




U.S.
Holders will have the option of claiming the amount of any Israeli income taxes
withheld at source either as a deduction from gross income or as a
dollar-for-dollar credit against their United States federal income tax
liability. Individuals who do not claim itemized deductions, but instead utilize
the standard deduction, may not claim a deduction for the amount of the Israeli
income taxes withheld, but such amount may be claimed as a credit against the
individual’s United States federal income tax liability. The amount of foreign
income taxes which may be claimed as a credit in any year is subject to complex
limitations and restrictions, which must be determined on an individual basis by
each shareholder. These limitations include, among others, rules which limit
foreign tax credits allowable with respect to specific classes of income to the
United States federal income taxes otherwise payable with respect to each such
class of income. The total amount of allowable foreign tax credits in any year
cannot exceed regular U.S. tax liability for the year attributable to foreign
source taxable income. A U.S. Holder will be denied a foreign tax credit with
respect to Israeli income tax withheld from a dividend received on the ordinary
shares if such U.S. Holder has not held the ordinary shares for at least 16 days
of the 30-day period beginning on the date which is 15 days before the
ex-dividend date with respect to such dividend, or to the extent such U.S.
Holder is under an obligation to make related payments with respect to
substantially similar or related property. Any days during which a U.S. Holder
has substantially diminished its risk of loss on the ordinary shares are not
counted toward meeting the required 16 **-** day
holding period. Distributions of current or accumulated earnings and profits
will be foreign source passive income for United States foreign tax credit
purposes.




*Taxation
of the Disposition of Ordinary Shares.* Subject
to the discussion below under “Passive Foreign Investment Company Status,” upon
the sale, exchange or other disposition of our ordinary shares, a U.S. Holder
will recognize capital gain or loss in an amount equal to the difference between
such U.S. Holder’s basis in such ordinary shares, which is usually the cost of
such shares, and the amount realized on the disposition. A U.S. Holder that uses
the cash method of accounting calculates the U.S. dollar value of the proceeds
received on the sale as of the date that the sale settles, while a U.S. Holder
that uses the accrual method of accounting is required to calculate the value of
the proceeds of the sale as of the “trade date,” unless such U.S. Holder has
elected to use the settlement date to determine its proceeds of sale. Capital
gain from the sale, exchange or other disposition of ordinary shares held more
than one year is long-term capital gain, and is eligible for a reduced rate of
taxation for individuals. Gains recognized by a U.S. Holder on a sale, exchange
or other disposition of ordinary shares will be treated as United States source
income for United States foreign tax credit purposes. A loss recognized by a
U.S. Holder on the sale, exchange or other disposition of ordinary shares is
allocated to U.S. source income. The deductibility of a capital loss recognized
on the sale, exchange or other disposition of ordinary shares is subject to
limitations. A U.S. Holder that receives foreign currency upon disposition of
ordinary shares and converts the foreign currency into U.S. dollars subsequent
to the settlement date or trade date (whichever date the taxpayer was required
to use to calculate the value of the proceeds of sale) will have foreign
exchange gain or loss based on any appreciation or depreciation in the value of
the foreign currency against the U.S. dollar, which will generally be U.S.
source ordinary income or loss.




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**


*Passive
Foreign Investment Company Status* . We
would be a passive foreign investment company (a “PFIC”) for 2004 if (taking
into account certain “look-through” rules with respect to the income and assets
of our subsidiaries) either 75 percent or more of our gross income for the
taxable year was passive income or the average percentage (by value) of our
passive assets during the taxable year was at least 50 percent. As discussed
below, we believe that we were not a PFIC for 2004.




If we
were a PFIC, each U.S. Holder would (unless it made one of the elections
discussed below on a timely basis) be taxable on gain recognized from the
disposition of ordinary shares (including gain deemed recognized if the ordinary
shares are used as security for a loan) and upon receipt of certain
distributions with respect to our ordinary
shares as if such income had been recognized ratably over the U.S. Holder’s
holding period for the ordinary shares. The U.S. Holder’s income for the current
taxable year would include (as ordinary income) amounts allocated to the current
year and to any period prior to the first day of the first taxable year for
which we were a PFIC. Tax would also be computed at the highest ordinary income
tax rate in effect for each other period to which income is allocated, and an
interest charge on the tax as so computed would also apply. Additionally, if we
were a PFIC, U.S. Holders who acquire our ordinary shares from decedents (other
than nonresident aliens) dying before 2010 would be denied the
normally-available step-up in basis for such shares to fair market value at the
date of death and, instead, would have a tax basis in such shares equal to the
decedent’s basis, if lower.




As an
alternative to the tax treatment described above, a U.S. Holder could elect to
treat us as a “qualified electing fund” (a “QEF”), in which case the U.S. Holder
would be taxed currently on its pro rata share of our ordinary earnings and net
capital gain (subject to a separate election to defer payment of taxes, which
deferral is subject to an interest charge). Special rules apply if a U.S. Holder
makes a QEF election after the first year in its holding period in which we are
a PFIC. We have agreed to supply U.S. Holders with the information needed to
report income and gain under a QEF election if we were a PFIC. As another
alternative to the tax treatment described above, if our shares are then
“marketable,” within the meaning of the Code, a U.S. Holder could elect to mark
our shares 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 our shares and the shareholder’s adjusted basis in the
shares. Losses would be allowed only to the extent of net mark-to-market gain
previously included in income by the U.S. Holder.




We
believe that we were not a PFIC for 2004 or any year prior to 2001,
based upon our
market capitalization during each such
year. Based upon independent valuations of our assets as of the end of each
quarter of 2001, 2002 and 2003, we believe that we were not a PFIC for 2001,
2002 or 2003 despite the relatively low market price of our ordinary shares
during much of those years. The tests for determining PFIC status are applied
annually and it is difficult to make accurate predictions of future income and
assets, which are relevant to this determination. Accordingly, there can be no
assurance that we will not become a PFIC. If we determine that we have become a
PFIC, we will notify our U.S. Holders and provide them with the information
necessary to comply with the QEF rules. U.S. Holders who hold ordinary shares
during a period when we are a PFIC will be subject to the foregoing rules, even
if we cease to be a PFIC, subject to certain exceptions for U.S. Holders who
made a QEF election. U.S. Holders are urged to consult their tax advisors about
the PFIC rules, including the consequences to them of making a mark-to-market or
QEF election with respect to our ordinary shares in the event that we qualify as
a PFIC.




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Tax
Consequences for Non-U.S. Holders of Ordinary Shares




Except as
described in “Information Reporting and Back-up Withholding” below, a Non-U.S.
Holder of ordinary shares will not be subject to U.S. federal income or
withholding tax on the payment of dividends on, and the proceeds from the
disposition of, our ordinary
shares, unless:




·
    such
      item is effectively connected with the conduct by the Non-U.S. Holder of a
      trade or business in the United States and, in the case of a resident of a
      country which has a treaty with the United States, such item is
      attributable to a permanent establishment or, in the case of an
      individual, a fixed place of business, in the United
    States,
 
 ·
    the Non-U.S. Holder is an individual who holds
      the ordinary shares as a capital asset and is present in the United States
      for 183 days or more in the taxable year of the disposition and does not
      qualify for an exemption, or
 
 ·
    the Non-U.S. Holder is subject to tax pursuant
      to the provisions of United States tax law applicable to U.S.
      expatriates.




Information
Reporting and Back-up Withholding




U.S.
Holders generally are subject to information reporting requirements with respect
to dividends paid in the United States on our ordinary
shares. U.S. Holders are also generally subject to back-up withholding on
dividends paid in the United States on our ordinary
shares unless the U.S. Holder provides IRS Form W-9 or otherwise establishes an
exemption. U.S. Holders are subject to information reporting and back-up
withholding (currently at a rate of up to 28%) on proceeds paid from the
disposition of ordinary shares unless the U.S. Holder provides IRS Form W-9 or
otherwise establishes an exemption.




Non-U.S.
Holders generally are not subject to information reporting or back-up
withholding with respect to dividends paid on, or upon the disposition
of, our ordinary
shares, provided that such non-U.S. Holder provides a taxpayer identification
number, certifies to its foreign status, or otherwise establishes an
exemption.




The
amount of any back-up withholding will be allowed as a credit against a U.S. or
Non-U.S. Holder’s United States federal income tax liability and may entitle
such holder to a refund, provided that certain required information is furnished
to the IRS.




**F.** **DIVIDENDS
AND PAYING AGENTS**




Not
Applicable.




**G.** **STATEMENTS
BY EXPERTS**




Not
applicable.




**H.** **DOCUMENTS
ON DISPLAY**




We are
subject to the informational requirements of the Securities Exchange Act of
1934, as amended, applicable to foreign private issuers and fulfill the
obligation with respect to such requirements by filing reports with the
Securities and Exchange Commission. You may read and copy any document we file
with the Securities and Exchange Commission without charge at the Securities and
Exchange Commission’s public reference room at 450 Fifth Street, N.W.,
Washington, D.C. 20549. Copies of such material may be obtained by mail from the
Public Reference Branch of the Securities and Exchange Commission at such
address, at prescribed rates. Please call the Securities and Exchange Commission
at l-800-SEC-0330 for further information on the public reference
room.




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As a
foreign private issuer, we are exempt from the rules under the Exchange Act
prescribing the furnishing and content of proxy statements, and our officers,
directors and principal shareholders are exempt from the reporting and
“short-swing” profit recovery provisions contained in Section 16 of the Exchange
Act. In addition, we are not required under the Exchange Act to file periodic
reports and financial statements with the Securities and Exchange Commission as
frequently or as promptly as United States companies whose securities are
registered under the Exchange Act. A copy of each report submitted in accordance
with applicable United States law is available for public review at our
principal executive offices.




**I.** **SUBSIDIARY
INFORMATION**




Not
applicable.




**ITEM 11.**  **QUANTITATIVE
AND QUALITATIVE DISCLOSURES ABOUT MARKET** **RISK**




Not
applicable.




**ITEM 12.**  **DESCRIPTION
OF SECURITIES OTHER THAN EQUITY SECURITIES**




Not
applicable.




**PART II**




**ITEM 13.**  **DEFAULTS,
DIVIDEND AVERAGES AND DELINQUENCIES**




Not
applicable.




**ITEM 14.**  **MATERIAL
MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF
PROCEEDS**




**Use
of Proceeds**




The
initial public offering of our ordinary shares, NIS 0.05 per share, commenced on
September 24, 1997, and terminated after the sale of all the securities
registered. The managing underwriters of the offering were Unterberg Harris,
Pennsylvania Merchant Group Ltd. and Fahnestock & Co., Inc. We registered
2,645,000 ordinary shares in the offering, including shares issued pursuant to
the exercise of the underwriter’s over-allotment option. Of such shares, we sold
2,645,000 ordinary shares at an aggregate offering price of approximately $25.1
million ($9.50 per share). Under the terms of the offering, we incurred
underwriting discounts and commissions of approximately $1.7 million. We also
incurred estimated expenses of $1.3 million in connection with the offering.
None of the expenses consisted of amounts paid directly or indirectly to any of
our directors, officers, general partners or their associates, any persons
owning 10% or more of any class of our equity securities or any of our
affiliates. The net proceeds that we received as a result of the offering were
approximately $22.1 million. As of
December 31, 2004, approximately $0.3 million of the net proceeds has been
used for the construction of facilities; $7.6 million has been used for the
purchase and installation of machinery and equipment; approximately $0.3 million
has been used for the repurchase of 123,372 of our ordinary shares; and
approximately $8.9 million has been used for operational expenditures.




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****


**ITEM 15.**  **CONTROLS
AND PROCEDURES** ****




( a)  Disclosure
Controls and Procedures.




Our Chief
Executive Officer, or CEO, and Chief Financial Officer, or CFO, are responsible
for establishing and maintaining our disclosure controls and procedures. These
controls and procedures were designed to ensure that information required to be
disclosed in the reports that we file under the Securities Exchange Act of 1934,
as amended, is recorded, processed, summarized and reported within the time
periods specified in the rules and forms of the SEC. We evaluated these
disclosure controls and procedures under the supervision of our CEO and CFO as
of December 31, 2004. Based on this evaluation, our CEO and CFO concluded that
our disclosure controls and procedures are effective in timely alerting them to
information required to be disclosed in our periodic reports to the SEC.




(b)  Internal
Control Over Financial Reporting.




There
were no changes in the Company’s internal control over financial reporting that
occurred during the year ended December 31, 2004 that have materially affected,
or are reasonably likely to materially affect, our internal control over
financial reporting.




**ITEM 16A.AUDIT COMMITTEE FINANCIAL
EXPERT**




Our Board
of Directors has determined that Zohar Gilon is our “audit committee financial
expert” as defined in Item 16A of Form 20-F.




**ITEM 16B.CODE OF ETHICS** ****




On
February 1, 2004, our Board of Directors adopted our Code of Ethics, a code that
applies to all directors, officers and other employees of the Company, including
our Chief Executive Officer and President, and Chief Financial Officer and Vice
President Finance.




Our code
of ethics is publicly available on our website at www.radcom.com.




**ITEM 16C.PRINCIPAL ACCOUNTANT FEES AND
SERVICES**




In the
annual meeting held in September 2004, our shareholders re-appointed Somekh
Chaikin, an independent registered public accounting firm, a member of KPMG
International, or KPMG Somekh Chaikin, to serve as our independent auditors.




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KPMG
Somekh Chaikin billed the following fees to us for professional services in each
of the last two fiscal years:




Year
      Ended December 31,2004
    
    2003Audit
      Fees
    
    $
    54,000
    
    $
    70,000Audit-Related
      Fees
    
    $
    3,000
    
    
    -Tax
      Fees
    
    $
    5,000
    
    $
    26,000All
      Other Fees
    
    
    -
    
    
    -Total
    
    $
    62,000
    
    $
    96,000




“Audit
Fees” are the aggregate fees billed (for the year) for the audit of our annual
financial statements, reviews of interim financial statements and attestation
services that are normally provided in connection with statutory and regulatory
filings or engagements.




“Audit-Related
Fees” are the aggregate fees billed (for the year) for assurance and related
services that are reasonably related to the performance of the audit or review
of our financial statements and are not reported under Audit Fees. “Tax
Fees” are the aggregate fees billed (in the year) for professional services
rendered for tax compliance, tax advice on actual or contemplated transactions
and tax planning. KPMG provided us with tax services such as PFIC evaluation and
tax planning.




Our Audit
Committee oversees our independent auditors. See also the description under the
heading “Board Practices” in “Item 6. Directors, Senior Management and
Employees.” Our Audit Committee’s policy is to approve any audit or permitted
non-audit services proposed to be provided by our independent auditors before
engaging our independent auditors to provide such services. Pursuant to this
policy, which is designed to assure that such engagements do not impair the
independence of our auditors, the Chairperson of our Audit Committee is
authorized to approve any such services between meetings of our Audit Committee,
subject to ratification by the Audit Committee, and to report any such approvals
to the Audit Committee at its next meeting.




ITEM 16D.EXEMPTIONS
FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES.




Not
applicable.




ITEM 16E.PURCHASES
OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED
PURCHASERS.




Not
applicable.




**ITEM 17. FINANCIAL STATEMENTS**




We have
responded to Item 18 in lieu of this item.




**PART III**




**ITEM 18.FINANCIAL STATEMENTS**




The
Financial Statements required by this item are found at the end of this Annual
Report, beginning on page F-1.




**ITEM 19.EXHIBITS** ****




The
exhibits filed with or incorporated into this annual report are listed on the
index of exhibits below.




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Exhibit
      No.
    Description1.1
    Memorandum
      of Association(1)1.2
    Articles
      of Association, as amended(2)2.1
    Form
      of ordinary share certificate(1)4.1
    2000
      Share Option Plan(2)4.2
    1998
      Employee Bonus Plan(3)4.3
    1998
      Share Option Plan(4)4.4
    International
      Employee Stock Option Plan(5)4.5
    Directors
      Share Incentive Plan (1997)(6)4.6
    Key
      Employee Share Incentive Plan (1996)(7)4.7
    2001
      Share Option Plan(8)4.8
    2003
      Share Option Plan(9)4.9
    Lease
      Agreement, dated November 15, 2000, among Vitalgo Textile Industries
      Ltd., Zisapel Properties (1992) Ltd., Klil and Michael Properties (1992)
      Ltd. and RADCOM Ltd. (English summary accompanied by Hebrew
      original)(10)4.10
    Lease
      Agreement, dated March 1, 2001, among Zisapel Properties (1992) Ltd.,
      Klil and Michael Properties (1992) Ltd. and RADCOM Ltd. (English summary
      accompanied by Hebrew original)(10)4.11
    Lease
      Agreement, dated August 12, 1998, between RAD Communications Ltd. and
      RADCOM Ltd. (English summary accompanied by Hebrew original)(10)4.12
    Lease
      Agreement, dated December 1, 2000, among Zohar Zisapel Properties,
      Inc., Yehuda Zisapel Properties, Inc. and RADCOM Equipment,
      Inc.(10)4.13
    Lease
      Agreement, dated January 22, 2002, between Regus Business Centre and
      RADCOM Ltd.(11)4.14
    Registration
      Rights Agreement by and among (i) RADCOM Ltd. and (ii) Yehuda
      Zisapel, Zohar Zisapel, Moty Ben-Arie and Zohar Gilon(1)4.15
    Registration
      Rights Agreement by and among (i) RADCOM Ltd. and (ii) Walden
      Israel Fund L.P., Gadish Provident Fund Ltd., Tagmulim Central Provident
      Fund, Keren Or Provident Fund, Katzir Provident Compensation Fund Ltd.,
      Keren Hishtalmut Le’akademaim Ltd., Dovrat Shrem Yozma Polaris Fund L.P.,
      Dovrat Shrem Skies ‘92 Fund Ltd., Dovrat Shrem Rainbow Fund Ltd., Dovrat
      Shrem & Co. S.A. and Yaad Consulting & Management Services (1995)
      Ltd.(1)4.16
    Software
      License Agreement, dated as of January 13, 1999, between RADVision,
      Ltd. and RADCOM Ltd., and Supplement No. 1 thereto, dated as of
      January 24, 2001(10)
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  Exhibit
      No.
    Description
 4.17
    Share
      and Warrant Purchase Agreement, dated as of March 17, 2004, by and between
      RADCOM Ltd. and the purchasers listed therein.(12)4.18
    Form
      of Warrant.(12)8
    List
      of Subsidiaries11
    Code
      of Ethics.(12)12.1
    Certification
      of CEO of the Registrant pursuant to Rule 13a-14(a) as adopted pursuant to
      Section 302 of the Sarbanes-Oxley Act of 200212.2
    Certification
      of CFO of the Registrant pursuant to Rule 13a-14(a) as adopted pursuant to
      Section 302 of the Sarbanes-Oxley Act of 200213.1
    Certification
      of CEO of the Registrant pursuant to Rule 13a-14(b), as adopted pursuant
      to Section 906 of the Sarbanes-Oxley Act of 200213.2
    Certification
      of CFO of the Registrant pursuant to Rule 13a-14(b), as adopted pursuant
      to Section 906 of the Sarbanes-Oxley Act of 200214.1
    Consent
      of KPMG Somekh Chaikin an independent registered public accounting
      firm.14.2
    Consent
      of Blick Rothenberg an independent registered public accounting
      firm.


_________________




(1)
    Incorporated
      herein by reference to the Registration Statement on Form F-1 of RADCOM
      Ltd. (File No. 333-05022).




(2)
    Incorporated
      herein by reference to the Registration Statement on Form S-8 of RADCOM
      Ltd. (File No. 333-13244).




(3)
    Incorporated
      herein by reference to the Registration Statement on Form S-8 of RADCOM
      Ltd. (File No. 333-13246).




(4)
    Incorporated
      herein by reference to the Registration Statement on Form S-8 of RADCOM
      Ltd. (File No. 333-13248).




(5)
    Incorporated
      herein by reference to the Registration Statement on Form S-8 of RADCOM
      Ltd. (File No. 333-13250).




(6)
    Incorporated
      herein by reference to the Registration Statement on Form S-8 of RADCOM
      Ltd. (File No. 333-13254).




(7)
    Incorporated
      herein by reference to the Registration Statement on Form S-8 of RADCOM
      Ltd. (File No. 333-13252).




(8)
    Incorporated
      herein by reference to the Registration Statement on Form S-8 of RADCOM
      Ltd. (File No. 333-14236).




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(9)
    Incorporated
      herein by reference to the Registration Statement on Form S-8 of RADCOM
      Ltd. (File No. 333-111931).




(10)
    Incorporated
      herein by reference to the Form 20-F of RADCOM Ltd. for the fiscal year
      ended December 31, 2000.




(11)
    Incorporated
      herein
      by reference to the Form 20-F of RADCOM Ltd. for the fiscal year ended
      December 31, 2001.




(12)
    Incorporated
      herein by reference to the Form 20-F of RADCOM Ltd. for the fiscal year
      ended December 31, 2003.







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SIGNATURE




The
registrant hereby certifies that it meets all of the requirements for filing on
Form 20-F and that it has duly caused and authorized the undersigned to sign
this annual report on its behalf.




RADCOM
LTD.








By:  */s/
Arnon Toussia-Cohen*


Name:
Arnon Toussia-Cohen


Title:
Chief Executive Officer


Date:
March 30, 2005







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****


**Radcom
Ltd.**


**(an
Israeli Corporation)**
 **and
its Consolidated Subsidiaries**
 
 **Consolidated
Financial Statements**
 **As
of December 31, 2004**





Table of Contents









Radcom
Ltd. (An Israeli Corporation)


and its
consolidated subsidiaries





****Consolidated Financial Statements as of December 31,
2004****








**Contents****Page**Report of Independent Registered Public Accounting
      Firm
    F-2**Consolidated
      Financial Statements:**Consolidated Balance Sheets as of December 31, 2004 and
      2003
    F-3 - F-4Consolidated Statements of Operations for the years
      ended December 31, 2004, 2003 and 2002
    F-5Consolidated Statements of Shareholders' Equity and
      Comprehensive Loss forthe years ended December 31, 2004, 2003 and
      2002
    F-6Consolidated Statements of Cash Flows for the years
      endedDecember 31, 2004, 2003 and 2002
    F-7 - F-8Notes to the Consolidated Financial Statements as of
      December 31, 2004
    F-9 - F-37





Index to Consolidated Financial
Statements













**Report of IndependentRegistered Public Accounting Firm**





To the
Board of Directors and Shareholders of Radcom Ltd.







We have
audited the accompanying consolidated balance sheets of Radcom Ltd. (the
"Company") and subsidiaries as of December 31, 2004 and 2003, and the related
consolidated statements of operations, shareholders' equity and comprehensive
loss and cash flows for each of the years in the three-year period ended
December 31, 2004. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our
audits.





We did
not audit the financial statements of a consolidated subsidiary, whose revenues
constitute approximately 0.5% of consolidated revenues for the year ended
December 31, 2002. The financial statements of this subsidiary were audited by
other auditors whose report thereon has been furnished to us and our opinion,
insofar as it relates to the amounts included for this subsidiary, is based
solely on the report of the other auditors.





We
conducted our audits in accordance with the Standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the 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 statements presentation. We believe that our audits and the report of
other auditors provide a reasonable basis for our opinion.





In our
opinion, based on our audits and the report of the above-mentioned other
auditors, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of the
Company and subsidiaries as of December 31, 2004 and 2003 and the results of
their operations and their cash flows for each of the years in the three-year
period ended December 31, 2004, in conformity with generally accepted accounting
principles in the United States of America.





*/s/Somekh
Chaikin*


Somekh
Chaikin


Certified
Public Accountants (Isr.)


A member
of KPMG International





Tel Aviv,
Israel, March 30, 2005







Index to Consolidated Financial Statements





Radcom
Ltd. (An Israeli Corporation)


and its
consolidated subsidiaries





**Consolidated BalanceSheets**










**December
      31****2004**
    
    
    **2003******
    
    
    **US$
      (in thousands)**
    
    ****
    **US$
      (in thousands)**
    ****


**Assets****Current
      Assets (Note 9A7)**Cash
      and cash equivalents (Note 9A1)
    
    
    **6,558**
    
    
    5,614Marketable
      securities (Note 9A2)
    
    
    **1,992**
    
    
    -Trade
      receivables, net (Note 9A3)
    
    
    **5,341**
    
    
    3,769Inventories
      and inventory prepayments (Note 9A4)
    
    
    **2,400**
    
    
    1,739Other
      current assets (Note 9A5)
    
    
    **880**
    
    
    346Total
      current assets
    
    
    **17,171**
    
    
    11,468**Assets
      held for severance benefits (Note 5)**
    
    
    **1,784**
    
    
    1,449**Property
      and equipment, net (Note 4)**
    
    
    **1,174**
    
    
    1,486

















**Total
      Assets**
    
    
    **20,129**
    
    
    14,403









F-3
 Index to Consolidated Financial Statements





Radcom
Ltd. (An Israeli Corporation)


and its
consolidated subsidiaries





**Consolidated
Balance Sheets**







**December
      31**
    ********
    ****
    ****
    **2004**
    ****
    ****
    ****
      **2003**
    ********
    ****
    ****
    **US$ (in thousands)**
    ****
    ****
    **US$
      (in thousands)**
    ****


**Liabilities
      and Shareholders' Equity****Current
      Liabilities (Note 9A7)**Trade
      payables
    
    
    **2,027**
    
    
    1,152Current
      deferred revenue
    
    
    **889**
    
    
    823Other
      payables and accrued expenses (Note 9A6)
    
    
    **4,204**
    
    
    3,791Total
      current liabilities
    
    
    **7,120**
    
    
    5,766**Long-Term
      Liabilities**Long-term
      deferred revenue
    
    
    **583**
    
    
    235Liability
      for employees severance pay benefits (Note 5)
    
    
    **2,402**
    
    
    2,156Total
      long-term liabilities
    
    
    **2,985**
    
    
    2,391Total
      liabilities
    
    
    **10,105**
    
    
    8,157**Commitments
      and contingencies (Note 6)****Shareholders'
      Equity (Note 7)**Share
      capital *
    
    
    **101**
    
    
    57Additional
      paid-in capital
    
    
    **43,698**
    
    
    38,273Accumulated
      other comprehensive loss
    
    
    **(13**
    **)**
    
    -Accumulated
      deficit
    
    
    **(33,762**
    **)**
    
    (32,084
    )Total
      shareholders' equity
    
    
    **10,024**
    
    
    6,246**Total
      Liabilities and Shareholders' Equity**
    
    
    **20,129**
    
    
    14,403








/s/
      Arnon Toussia-Cohen
    
    /s/
      David ZigdonArnon
      Toussia-Cohen
    
    David
      ZigdonChief
      Executive Officer and Director
    
    Chief
      Financial Officer





Date:
March 30, 2005








*
    39,990,680
      Ordinary Shares of NIS 0.05 par value ("Ordinary Shares") and 9,320
      Deferred Shares of NIS 0.05 par value authorized as of December 31, 2004
      and 2003; 14,438,348 and 10,506,876 Ordinary Shares issued and outstanding
      as of December 31, 2004 and 2003, respectively, and 9,320 Deferred Shares
      issued and outstanding as of December 31, 2004 and 2003.






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





F-4
 Index to Consolidated Financial
Statements





Radcom
Ltd. (An Israeli Corporation)


and its
consolidated subsidiaries





**Consolidated Statementsof Operations**









**Year
      ended December 31****2004**
    
    **2003**
    
    **2002****US$
      (in thousands)**
    
    
    **US**$**
      (in thousands)**
    ****
    ****
    **US$
      (in thousands)**
    ****





Sales
      (Note 9B1)
    
    
    **16,055**
    
    
    11,203
    
    
    14,591Cost
      of sales
    
    
    **5,127**
    
    
    (1)
      4,894
    
    
    5,047**Gross
      profit**
    
    
    **10,928**
    
    
    6,309
    
    
    9,544**Operating
      expenses:**Research
      and development, gross
    
    
    **5,232**
    
    
    5,593
    
    
    6,481Less
      - royalty-bearing participation (Note 6A1)
    
    
    **1,722**
    
    
    1,997
    
    
    2,328Research
      and development, net
    
    
    **3,510**
    
    
    3,596
    
    
    4,153Sales
      and marketing
    
    
    **6,983**
    
    
    7,411
    
    
    8,306General
      and administrative
    
    
    **2,191**
    
    
    1,620
    
    
    2,018**Total
      operating expenses**
    
    
    **12,684**
    
    
    12,627
    
    
    14,477**Operating
      loss**
    
    
    **(1,756**
    **)**
    
    (6,318
    )
    
    (4,933
    )**Financing
      income, net (Note 9B2):**Financing
      income
    
    
    **118**
    
    
    111
    
    
    254Financing
      expenses
    
    
    **(40**
    **)**
    
    (18
    )
    
    (37
    )Financing
      income, net
    
    
    **78**
    
    
    93
    
    
    217**Loss
      before taxes on income**
    
    
    **(1,678**
    **)**
    
    (6,225
    )
    
    (4,716
    )Taxes
      on income (Note 8)
    
    
    **-**
    
    
    -
    
    
    -**Net
      loss for the year**
    
    
    **(1,678**
    **)**
    
    (6,225
    )
    
    (4,716
    )





**Loss
      per share:**Basic
      and diluted loss per ordinary share (US$)
    
    
    **(0.125**
    **)**
    
    (0.593
    )
    
    (0.449
    )





Weighted
      average number of Ordinary Shares used tocompute basic and
      diluted loss per Ordinary Share
    
    
    **13,453,509**
    
    
    10,493,184
    
    
    10,492,050








(1) See Note
3C.
















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





F-5
 Index to Consolidated Financial
Statements





Radcom
Ltd. (An Israeli Corporation)


and its
consolidated subsidiaries





**Consolidated Statements of Shareholders'Equity and Comprehensive
Loss**










**Share
      capital**
    
    
    
    
    
    ******Additional**
    
    
    ****Accumulated**other**
    
    
    
    
    
    **Total******
    ****
    ****Number
      of****
    ****
    ****
    ****
    ****
    ****
    ****paid-in****
    ****
    ****
    **comprehensive**
    ****
    ****
    ****Accumulated****
    ****
    ****
    **Shareholders'**
    ********
    ****
    ****
    ******shares******
    ****
    ****
    ****Amount****
    ****
    ****
    ****capital****
    ****
    ****
    ****loss****
    ****
    ****
    ****deficit****
    ****
    ****
    ****equity****
    ********
    ****
    ****
    ****
    ****
    ****
    **US$ (thousands)**
    ****
    ****
    **US$ (thousands)**
    ****
    ****
    **US$ (thousands)**
    ****
    ****
    ****US$
      (thousands)****
    ****
    ****
    **US$ (thousands)**
  **Balance
      as ofJanuary 1, 2002**
    
    
    10,492,050
    
    
    57
    
    
    38,012
    
    
    -
    
    
    (21,143
    )
    
    16,926**Changes
      during 2002:**Net
      loss for the year
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    (4,716
    )
    
    (4,716
    )Employees'
      stockoption compensation
    
    
    -
    
    
    -
    
    
    134
    
    
    -
    
    
    -
    
    
    134**Balance
      as ofDecember 31, 2002**
    
    
    10,492,050
    
    
    57
    
    
    38,146
    
    
    -
    
    
    (25,859
    )
    
    12,344**Changes
      during 2003:**Net
      loss for the year
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    (6,225
    )
    
    (6,225
    )Employees'
      stockoption compensation
    
    
    -
    
    
    -
    
    
    123
    
    
    -
    
    
    -
    
    
    123Exercise
      of options
    
    
    14,826
    
    
    *-
    
    
    4
    
    
    -
    
    
    -
    
    
    4****Balance
      as of**December 31, 2003**
    
    
    10,506,876
    
    
    57
    
    
    38,273
    
    
    -
    
    
    (32,084
    )
    
    6,246**Changes
      during 2004:**Net
      loss for the year
    
    
    **-**
    
    
    **-**
    
    
    **-**
    
    
    **-**
    
    
    **(1,678**
    **)**
    
    **(1,678**
    **)**Net
      unrealized loss on available for salesecurities
    
    
    **-**
    
    
    **-**
    
    
    **-**
    
    
    **(13**
    **)**
    
    **-**
    
    
    **(13**
    **)**Comprehensive
      loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    **(1,691**
    **)**Issuance
      of OrdinaryShares
      and detachable warrants, net of issuance expenses of US$ 189 thousand
      **
    
    
    **3,851,540**
    
    
    **42**
    
    
    **5,269**
    
    
    **-**
    
    
    **-**
    
    
    **5,311**Employees'
      stockoption compensation
    
    
    **-**
    
    
    **-**
    
    
    **94**
    
    
    **-**
    
    
    **-**
    
    
    **94**Exercise
      of options
    
    
    **79,932**
    
    
    **2**
    
    
    **62**
    
    
    **-**
    
    
    **-**
    
    
    **64****Balance
      as ofDecember 31, 2004**
    
    
    **14,438,348**
    
    
    **101**
    
    
    **43,698**
    
    
    **(13**
    **)**
    
    **(33,762**
    **)**
    
    **10,024**








*
    Less
      than 1 thousand.**
    See
      Note 7A2.









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





F-6
 Index to Consolidated Financial
Statements





Radcom
Ltd. (An Israeli Corporation)


and its
consolidated subsidiaries





**Consolidated Statementsof Cash Flows**





**Year
      ended December 31****2004**
    
    
    **2003**
    
    
    **2002******
    
    
    **US$
      (in thousands)**
    
    ****
    **US$
      (in thousands)**
    ****
    ****
    **US$
      (in thousands)**
    ****





**Cash
      flows from operating activities:**Net
      loss for the year
    
    
    **(1,678**
    **)**
    
    (6,225
    )
    
    (4,716
    )Adjustments
      to reconcile net loss to net cashused in operating
      activities:Depreciation
    
    
    **797**
    
    
    1,145
    
    
    1,400Decrease
      (increase) in value and accrued interest frommarketable
      securities
    
    
    **(5**
    **)**
    
    -
    
    
    17Decrease
      in value and accrued interest, net,from short-term bank
      deposits
    
    
    **-**
    
    
    6
    
    
    49Loss
      from sale of property and equipment
    
    
    **9**
    
    
    7
    
    
    11Employees'
      stock option compensation
    
    
    **94**
    
    
    123
    
    
    134Increase
      (decrease) in severance pay, net
    
    
    **(89**
    **)**
    
    81
    
    
    (135
    )Decrease
      (increase) in trade receivables, net
    
    
    **(1,572**
    **)**
    
    (786
    )
    
    613Increase
      (decrease) in deferred revenue
    
    
    **414**
    
    
    467
    
    
    (1
    )Decrease
      (increase) in other current assets
    
    
    **(534**
    **)**
    
    255
    
    
    888Decrease
      (increase) in inventories and inventory prepayments
    
    
    **(892**
    **)**
    
    279
    
    
    356Increase
      (decrease) in trade payables
    
    
    **864**
    
    
    (147
    )
    
    84Increase
      (decrease) in other payables andaccrued
    expenses
    
    
    **413**
    
    
    386
    
    
    (373
    )Net
      cash used in operating activities
    
    
    **(2,179**
    **)**
    
    (4,409
    )
    
    (1,673
    )**Cash
      flows from investing activities:**Redemption
      of short-term bank deposits
    
    
    **-**
    
    
    3,000
    
    
    6,600Investment
      in short-term bank deposits
    
    
    **-**
    
    
    -
    
    
    (3,000
    )Proceeds
      from sale of marketable securities
    
    
    **1,000**
    
    
    -
    
    
    1,808Investment
      in marketable securities
    
    
    **(3,000**
    **)**
    
    -
    
    
    -Proceeds
      from sale of property and equipment
    
    
    **40**
    
    
    34
    
    
    46Purchase
      of property and equipment
    
    
    **(292**
    **)**
    
    (222
    )
    
    (434
    )Net
      cash provided by (used in) investing activities
    
    
    **(2,252**
    **)**
    
    2,812
    
    
    5,020











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





F-7
 Index to Consolidated Financial
Statements





Radcom
Ltd. (An Israeli Corporation)


and its
consolidated subsidiaries





**Consolidated
Statements of Cash Flows (cont'd)**










**Year
      ended December 31****2004**
    
    **2003**
    
    **2002******
    
    
    **US$
      (in thousands)**
    
    ****
    **US$
      (in thousands)**
    ****
    ****
    **US$
      (in thousands)**
    ****





**Cash
      flows from financing activities:**Issuance
      of shares and detachable warrants,net of issuance
      expenses
    
    
    **5,311**
    
    
    -
    
    
    -Exercise
      of options
    
    
    **64**
    
    
    4
    
    
    -Net
      cash provided by financing activities
    
    
    **5,375**
    
    
    4
    
    
    -**Increase
      (decrease) in cash and cash equivalents**
    
    
    **944**
    
    
    (1,593
    )
    
    3,347**Cash
      and cash equivalents at beginning of year**
    
    
    **5,614**
    
    
    7,207
    
    
    3,860**Cash
      and cash equivalents at end of year**
    
    
    **6,558**
    
    
    5,614
    
    
    7,207





**Schedule
A - Non-Cash Investing Activities**





Purchase
of property and equipment on credit in the amount of US$ 66 thousand, US$ 55
thousand and US$ 32 thousand as at December 31, 2004, 2003 and 2002,
respectively.








**Supplemental
disclosures**





Cash paid
for taxes during the years ended December 31, 2004, 2003 and 2002 amounted to
US$ 47 thousand, US$ 70 thousand and US$ 112 thousand,
respectively.












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










F-8
 Index to Consolidated Financial
Statements





Radcom
Ltd. (An Israeli Corporation)


and its
consolidated subsidiaries





**Notes to theConsolidated Financial Statements as of December 31,
2004**









**Note
      1 - General**Radcom
      Ltd. (the "Company") is an Israeli corporation which operates in one
      business segment of communication networks. The Company develops,
      manufactures, markets and supports innovative, network test, and service
      monitoring solutions for data communications and telecommunications
      networks mainly for cellular 2.5, third generation and Voice-over
      IP.The
      Company has a wholly-owned subsidiary in the United States, Radcom
      Equipment, Inc. (the "US Subsidiary"), which was incorporated in 1993
      under the laws of the state of New Jersey. The US Subsidiary is primarily
      engaged in the selling and marketing in North America of equipment
      manufactured by and imported from the Company.In
      August 2001, the Company incorporated a wholly-owned subsidiary in the
      United Kingdom, Radcom (UK) Limited (the "UK Subsidiary"). The UK
      subsidiary was primarily engaged in business development activities in the
      United Kingdom. The business activities of the UK subsidiary were frozen
      in the first quarter of 2003.**Note
      2 - Significant Accounting Policies**The
      significant accounting policies followed in the preparation of the
      financial statements, applied on a consistent basis, are as
      follows:**A.****Certain
      definitions**CPI
      - Israeli Consumer Price IndexNIS
      - New Israeli Shekel**B.****Financial
      statements in US dollars ("dollars")**Substantially
      all of the Company's sales are made outside Israel (see Note 9B1 regarding
      geographical distribution). All sales outside Israel are denominated in
      dollars. Most purchases of materials and components, and most marketing
      costs, are incurred outside Israel, primarily in transactions denominated
      in dollars. In addition, the sales in Israel as well as the majority of
      expenses in Israel are denominated in dollars or linked thereto.
      Therefore, the currency of the primary economic environment in which the
      operations of the Company are conducted is the US dollar, which is used as
      the functional currency of the Company.Transactions
      and balances originally denominated in dollars are presented at their
      original amounts. Transactions and balances in other currencies are
      remeasured into dollars in accordance with the principles set forth in
      Statement of Financial Accounting Standards ("SFAS")
  No.52.All
      exchange gains and losses from remeasurement of monetary balance sheet
      items denominated in non-dollar currencies are reflected in the
      consolidated statement of operations when they arise.




F-9
 Index to Consolidated Financial Statements


Radcom
Ltd. (An Israeli Corporation)
 and its
consolidated subsidiaries
  **Notes
to the Consolidated Financial Statements as of December 31,
2004**


**Note
      2 - Significant Accounting Policies (cont'd)****C.****Estimates
      and assumptions**The
      preparation of the consolidated financial statements in conformity with
      generally accepted accounting principles in the United States of America
      ("US GAAP") requires management to make estimates and assumptions that
      affect the reported amounts of assets and liabilities and the disclosure
      of contingent assets and liabilities at the date of the consolidated
      financial statements and the reported amounts of revenue and expenses
      during the reporting years. Actual results may vary from these estimates.
      Estimates and assumptions are periodically reviewed and the effects of any
      material revisions are reflected in the period that they are determined to
      be necessary.**D.****Principles
      of consolidation**The
      consolidated financial statements include the financial statements of the
      Company and its subsidiaries. All intercompany transactions and balances
      have been eliminated in consolidation.**E.****Cash
      and cash equivalents**The
      Company considers all highly liquid deposit instruments purchased with an
      original maturity of three months or less at the date of purchase to be
      cash equivalents.**F.****Marketable
      securities**In
      accordance with SFAS No. 115, "Accounting for Certain Investments in Debt
      and Equity Securities", the Company has classified all its marketable
      securities as available-for-sale. Such marketable securities are stated at
      market value.Unrealized
      gains and losses are reported as a separate component of shareholders'
      equity and comprehensive income (loss). Interest income is included in
      financing income.Realized
      gains and losses are included in financing income, net.The
      following table shows the gross unrealized losses and fair value of the
      Company's investments with unrealized losses that are not deemed to be
      other-than-temporarily impaired, aggregated by investment category and
      length of time that individual securities have been in a continuous
      unrealized loss position, at December 31,
2004:




**Less
      than 12 months**
    
    **12
      months or Greater**
    
    
    
    ******Fair
      value**
    
    ****Unrealized**losses**
    
    **Fair
      value**
    
    ****Unrealized**losses**
    
    ****Total**fair
      value**
    
    ******Total**unrealized**losses****US$
      (thousands)**
    ****
    **US$ (thousands)**
    ****
    **US$ (thousands)**
    ****
    **US$ (thousands)**
    ****
    **US$ (thousands)**
    ****
    **US$ (thousands)**Fixed
      rate bonds
    
    
    1,992
    
    
    (13
    )
    
    -
    
    
    -
    
    
    1,992
    
    
    (13
    )Total
    
    
    1,992
    
    
    (13
    )
    
    -
    
    
    -
    
    
    1,992
    
    
    (13
    )





The
      unrealized losses on the Company's investments in fixed rate bonds were
      caused by interest rate increases. Because the Company has the ability to
      hold these investments until a recovery of fair value, which may be
      maturity, the Company does not consider these investments to be
      other-than-temporarily impaired at December 31,
2004.








F-10
 Index to Consolidated Financial
Statements


Radcom
Ltd. (An Israeli Corporation) and its
consolidated subsidiaries
  Notes to
the Consolidated Financial Statements as of December 31, 2004





**Note
      2 - Significant Accounting Policies (cont'd)****G.****Trade
      receivables, net**Trade
      receivables are recorded less the related allowance for doubtful accounts
      receivable. Management, considering current information and events
      regarding the customers' ability to repay their obligations, consider
      accounts receivable to be doubtful when it is probable that the Company
      will be unable to collect all amounts.The
      balance sheet allowance for doubtful debts for all periods through
      December 31, 2004 is determined as a specific amount for those accounts
      the collection of which is uncertain.**H.****Inventories
      and inventory prepayments**Inventories
      are stated at the lower of cost or net realizable
value.Cost
      is determined by calculating raw materials, work in process and finished
      products on a "moving average" basis. In addition, inventory write-off and
      write-down provisions are provided according to management's estimation to
      cover risks arising from slow-moving items or technological
      obsolescence.Inventory
      prepayments represent non-refundable advance payments on account of
      purchase of inventory.**I.****Assets
      held for severance benefits**Assets
      held for employee severance benefits represent contributions to severance
      pay funds and cash surrender value of life insurance policies that are
      recorded at their current redemption value, which also represent their
      fair value.**J.****Property
      and equipment**Property
      and equipment are stated at cost less accumulated depreciation.
      Maintenance and repairs are charged to operations as
    incurred.Products
      used for research and development (unless no alternative future use
      exists) and demonstration equipment are capitalized at amounts equal to
      their production costs.Depreciation
      is calculated on the straight-line method over the estimated useful lives
      of the assets, as estimated by the Company.Annual
      rates of depreciation are as follows:





**%**





Demonstration
      and rental equipment
    33Research
      and development equipment having alternativefuture
      use
    20
      - 50Motor
      vehicles
    15Manufacturing
      equipment
    15
      - 33Office
      furniture and equipment
    7 -
      33Leasehold
      improvements
    *





*At the shorter of
      the lease period or useful life of the leasehold
    improvement.








F-11
 Index to Consolidated Financial
Statements


Radcom
Ltd. (An Israeli Corporation) and its
consolidated subsidiaries
  Notes to
the Consolidated Financial Statements as of December 31, 2004





**Note
      2 - Significant Accounting Policies (cont'd)****K.**
    **Impairment
      of long-lived assets**The
      Company accounts for the impairment of long-lived assets in accordance
      with the provisions of SFAS No. 144 "Accounting for the Impairment or
      Disposal of Long-Lived Assets". This statement requires that long-lived
      assets and certain identifiable intangibles be reviewed for impairment
      whenever events or changes in circumstances indicate that the carrying
      amount of an asset may not be recoverable. Recoverability of assets to be
      held and used is measured by a comparison of the carrying amount of an
      asset to undiscounted future net cash flows expected to be generated by
      the asset. If such assets are considered to be impaired, the impairment to
      be recognized is measured by the amount by which the carrying amount of
      the assets exceeds the fair value of the assets. Assets to be disposed of
      are reported at the lower of the carrying amount or fair value less costs
      to sell.**L.**
    **Revenue
      recognition**1.
    Revenue
      from product sales is recognized in accordance with Statement of Position
      ("SOP") 97-2, "Software Revenue Recognition", when the following criteria
      are met: (1) persuasive evidence of an arrangement exists, (2) delivery
      has occurred, (3) the vendor's fee is fixed or determinable and (4)
      collectibility is probable.Amounts
      received from customers prior to product shipments are classified as
      advances from customers. With certain of its products, the Company
      provides a one-year free software update, which includes bugs fixing and a
      hardware warranty ("post customer support" or "PCS"). In these cases, the
      revenue from PCS is recognized upon delivery in accordance with the
      provisions of Par. 59 of SOP 97-2. With respect to PCS recognized upon
      delivery, the Company records an appropriate provision for warranty in
      accordance with SFAS 5, "Accounting for Contingencies". For other
      products, the Company provides PCS for a period up to two years. In these
      cases, the revenue attributable to the PCS component is determined using
      vendor specific objective evidence for such service and deferred at the
      time of the initial sale and recognized ratably over the PCS period in
      accordance with the provisions of SOP 97-2.The
      Company generally does not grant rights of return except for defective
      products for which a warranty allowance is recorded. However, in certain
      circumstances, the Company has granted limited rights of return. In these
      situations, the Company had deferred revenue until the right of return has
      expired.2.
    After
      the PCS period, initially provided with the Company's products, the
      Company may sell extended PCS contracts, which includes full software
      updates, new protocols included in the packages at time of purchase, and
      full hardware repair of all faulty units. In such cases, revenues
      attributable to the extended PCS are deferred at the time of the initial
      sale and recognized ratably over the extended contract PCS
      period.3.
    Most
      of the Company's revenues are generated from sales to independent
      distributors. The Company has a standard contract with its distributors.
      Based on this agreement, sales to distributors are final and distributors
      have no rights of return or price protection. The Company is not a party
      to the agreements between distributors and their customers.4.
    The
      Company also generates sales through independent manufacturer's
      representatives. These representatives do not hold any of the Company's
      inventories, and they do not buy products from the Company. The Company
      invoices the end-user customers directly, collects payment directly and
      then pays commissions to the manufacturer's representative for the sales
      in its territory. The Company reports sales through independent
      manufacturer's representatives on a gross basis, based on the indicators
      of EITF 99-19,*Reporting
      Revenue Gross as a Principal versus Net as an Agent.*





F-12
 Index to Consolidated Financial
Statements


Radcom
Ltd. (An Israeli Corporation) and its
consolidated subsidiaries
  Notes to
the Consolidated Financial Statements as of December 31, 2004


**Note
      2 - Significant Accounting Policies (cont'd)****M.**
    **Research
      and development costs**1.
    Research
      and development costs are expensed as incurred.2.
    The
      Company applies the provisions of SFAS No. 86, "Accounting for Costs of
      Computer Software to be Sold, Leased or Otherwise Marketed". Expenditures
      incurred during the period between attaining technological feasibility and
      general release of the associated product have been immaterial and
      accordingly, software development costs have been
  expensed.**N.**
    **Government
      grants**The
      Company receives royalty-bearing participation, which represents
      participation of the Government of Israel (Office of the Chief Scientist -
      "OCS") in approved programs for research and development. These amounts
      are recognized on the accrual basis as a reduction of research and
      development costs as such costs are incurred. Royalties to the OCS are
      recorded in cost of sales.**O.**
    **Allowance
      for product warranty**It
      is the Company's policy to grant a product warranty for a period of up to
      24 months on its products. In respect to contracts where the PCS were
      recognized upon delivery, the Company recorded an appropriate provision.
      The provision for warranties for all periods through December 31, 2004, is
      determined based upon the Company's past experience (see Note 2L(1)).The
      followings are the changes in liability for product
    warranty:








**US$
      thousands**Balance
      at December 31, 2002
    
    
    73Warranties
      for products sold
    
    
    86Warranty
      expenses
    
    
    (21
    )Lapsed
      warranties
    
    
    (47
    )Balance
      at December 31, 2003
    
    
    91Warranties
      for products sold
    
    
    **198**Warranty
      expenses
    
    
    **(110**
    **)**Lapsed
      warranties
    
    
    **(7**
    **)**Balance
      at December 31, 2004
    
    
    **172**








F-13
 Index to Consolidated Financial
Statements


Radcom
Ltd. (An Israeli Corporation) and its
consolidated subsidiaries
  Notes to
the Consolidated Financial Statements as of December 31, 2004


**Note
      2 - Significant Accounting Policies (cont'd)****P.**
    **Stock
      option plans**The
      Company applies the intrinsic value-based method of accounting prescribed
      by Accounting Principles Board ("APB") Opinion No. 25, "Accounting for
      Stock Issued to Employees", and related interpretations including FASB
      Interpretation No. 44, "Accounting for Certain Transactions Involving
      Stock Compensation" of APB Opinion No. 25 ("FIN 44"), in accounting for
      its stock option plans for employees and directors. Under this method,
      compensation is recorded on the date of grant only if the current market
      price of the underlying stock exceeded the exercise price. SFAS No. 123,
      "Accounting for Stock-Based Compensation", established accounting and
      disclosure requirements using a fair value-based method of accounting for
      stock-based employee stock compensation plans and as a measurement basis
      for transactions involving the acquisition of goods or services from
      non-employees. As allowed by SFAS No. 123, the Company has elected to
      continue to apply the intrinsic value-based method of accounting for
      employee stock options and has adopted the disclosure requirements of SFAS
      No. 123.See
      also Note 12(3) in respect to the issuance of SFAS No.
    123R.The
      following table illustrates the effect on net loss and loss per ordinary
      share if the Company had applied the fair value recognition provisions of
      SFAS 123 (see also Note 7C) :




**Year
      ended**
    
    **Year
      ended**
    
    **Year
      ended****December
      31**
    
    **December
      31**
    
    **December
      31****2004**
    
    
    **2003**
    
    
    **2002******
    
    
    **US$
      (in thousands)**
    
    ****
    **US$
      (in thousands)**
    ****
    ****
    **US$
      (in thousands)**
    ****
 
 Net
      loss as reported
    
    
    **(1,678**
    **)**
    
    (6,225
    )
    
    (4,716
    )Add:
      compensation expenses according to APB 25included in the
      reported net loss
    
    
    **94**
    
    
    123
    
    
    134Deduct:
      compensation expenses according to SFAS 123
    
    
    **(561**
    **)**
    
    (840
    )
    
    (1,294
    )Net
      loss - pro forma
    
    
    **(2,145**
    **)**
    
    (6,942
    )
    
    (5,876
    )
 
 Basic
      and diluted loss per share as reported (US$)
    
    
    **(0.125**
    **)**
    
    (0.593
    )
    
    (0.449
    )Pro
      forma basic and diluted loss per share (US$)
    
    
    **(0.159**
    **)**
    
    (0.662
    )
    
    (0.560
    )




**Q.**
    **Deferred
      income taxes**The
      Company accounts for income taxes in accordance with SFAS No. 109,
      "Accounting for Income Taxes". Deferred tax asset and liability account
      balances are recognized for the future tax consequences attributable to
      differences between the financial statements carrying amounts of existing
      assets and liabilities and their respective tax bases and operating loss
      and tax credit carryforwards. Deferred tax assets and liabilities are
      measured using enacted tax rates expected to apply to taxable income in
      the years in which those temporary differences are expected to be
      recovered or settled. The effect on deferred tax assets and liabilities of
      a change in tax rates is recognized in the consolidated statement of
      operations in the period that includes the enactment date. The Company
      provides a valuation allowance to reduce deferred tax assets to their
      estimated realizable value.





F-14
 Index to Consolidated Financial
Statements


Radcom
Ltd. (An Israeli Corporation) and its
consolidated subsidiaries
  Notes to
the Consolidated Financial Statements as of December 31, 2004


**Note
      2 - Significant Accounting Policies (cont'd)****R.**
    **Loss
      per share**Basic
      and diluted loss per ordinary share is presented in conformity with SFAS
      No. 128 "Earnings Per Share", for all years presented. Basic loss per
      share is computed by dividing net loss available to common shareholders by
      the weighted average number of Ordinary Shares outstanding for the period.
      The common stock equivalent of anti-dilutive securities is not included in
      the computation of diluted loss per share.**S.**
    **Treasury
      shares**Acquisitions
      of the Company's shares by the Company and the Company's subsidiaries are
      deducted from the share capital and additional paid-in capital,
      respectively.**T.**
    **Reclassification**Certain
      prior year amounts have been reclassified to conform with current year
      presentation.**Note
      3 - Salary Reductions, Inventories Write-Off and Provision for Doubtful
      Debts****A.**
    In
      January 2002, the Company reduced salaries for both management and
      non-management employees.**B.**
    In
      2002, management recorded a provision for doubtful debts, which amounted
      to US$ 338 thousand, related to the bankruptcy of the Company's
      distributor in Canada. This charge was recorded in general and
      administrative expenses.**C.**
    During
      the first quarter of 2003, the Company recorded an inventory write-off in
      the amount of US$ 960 thousand to reflect the reduced value of some of the
      Company's products and components caused by changing market conditions,
      especially weakness in revenues of ATM/Frame Relay products. This charge
      was recorded in cost of sales.











F-15
 Index to Consolidated Financial
Statements


Radcom
Ltd. (An Israeli Corporation) and its
consolidated subsidiaries
  Notes to
the Consolidated Financial Statements as of December 31, 2004


**Note
      4 - Property and Equipment, Net****A.**
    Composition
      of assets, grouped by major classification, is as
  follows:





**December
      31****2004**
    
    
    **2003******
    
    
    **US$
      (in thousands)**
    
    ****
    **US$
      (in thousands)**
    ****





**Cost**Demonstration
      and rental equipment
    
    
    **3,298**
    
    
    3,859Research
      and development equipment
    
    
    **4,497**
    
    
    4,275Motor
      vehicles
    
    
    **3**
    
    
    116Manufacturing
      equipment
    
    
    **1,226**
    
    
    1,123Office
      furniture and equipment
    
    
    **1,247**
    
    
    1,212Leasehold
      improvements
    
    
    **385**
    
    
    392**10,656**
    
    
    10,977**Accumulated
      depreciation**Demonstration
      and rental equipment
    
    
    **3,090**
    
    
    3,613Research
      and development equipment
    
    
    **4,058**
    
    
    3,678Motor
      vehicles
    
    
    **2**
    
    
    83Manufacturing
      equipment
    
    
    **962**
    
    
    861Office
      furniture and equipment
    
    
    **1,103**
    
    
    1,022Leasehold
      improvements
    
    
    **267**
    
    
    234**9,482**
    
    
    9,491**1,174**
    
    
    1,486








**B.**
    Depreciation
      expenses amounted to US$ 797 thousand, US$ 1,145 thousand and US$ 1,400
      thousand for the years ended December 31, 2004, 2003 and 2002,
      respectively.








**Note
      5 - Liability for Employees Severance Pay
  Benefits**Under
      Israeli law and labor agreements, the Company is required to make
      severance payments to its dismissed employees and to employees who leave
      its employment under certain other circumstances.The
      Company's liability for severance pay benefits is covered mainly by
      deposits with recognized funds in the name of the employee and/or by
      purchase of insurance policies. The liability is calculated on the basis
      of the latest salary of the employees multiplied by the number of years of
      employment as of the balance sheet date. The provision for employee
      severance pay benefits included in the balance sheet represents the total
      liability for such severance benefits, while the assets held for severance
      benefits included in the balance sheet represent the Company's
      contributions to severance pay funds and to insurance
      policies.The
      Company may make withdrawals from the funds only upon complying with the
      Israeli severance pay law or labor agreements. Severance pay expenses for
      the years ended December 31, 2004, 2003 and 2002 amounted to US$ 283
      thousand, US$ 567 thousand and US$ 358 thousand,
    respectively.





F-16
 Index to Consolidated Financial
Statements


Radcom
Ltd. (An Israeli Corporation) and its
consolidated subsidiaries
  Notes to
the Consolidated Financial Statements as of December 31, 2004


**Note
      6 - Commitments and Contingencies****A.**
    **Royalty
      commitments**1.
    The
      Company received research and development grants from the Office of the
      Chief Scientist (the "OCS"). In consideration for the research and
      development grants received from the OCS, the Company has undertaken to
      pay royalties as a percentage on revenues from products developed from
      research and development projects financed. Royalty rates were 3%-3.5% in
      2003 and 3.5% in 2004 and subsequent years. In case the Company will not
      generate sales of products developed with funds provided by the OCS, the
      Company will not be obligated to pay royalties for such
      products.Royalties
      are payable from the time of commencement of sales of all of these
      products until the cumulative amount of the royalties paid equals 100% of
      the dollar-linked amounts of the grants received, without interest for
      projects authorized until December 31, 1998. For projects authorized since
      January 1, 1999, the repayment bears interest at the Libor
      rate.The
      total research and development grants that the Company has received from
      the OCS as of December 31, 2004 was US$ 21.3 million. For projects
      authorized since January 1, 1999, the repayment interest rate is Libor.
      The accumulated interest as of December 31, 2004 was US$ 1.6 million. As
      of December 31, 2004, the accumulated royalties paid to the OCS were US$
      5.0 million. Accordingly, the Company's total outstanding contingencies in
      respect of royalty-bearing participation received or accrued, net of
      royalties paid or accrued, amounted to approximately US$ 17.9 million as
      of December 31, 2004.2.
    According
      to the Company's agreements with the Israel - US Bi-National Industrial
      Research and Development Foundation ("BIRD-F"), the Company is required to
      pay royalties at a rate of 5% of sales of products developed with funds
      provided by the BIRD-F, up to an amount equal to 150% of BIRD-F's grant
      (linked to the United States Consumer Price Index) relating to such
      products. In case the Company will not generate sales of products
      developed with funds provided by BIRD-F, the Company will not be obligated
      to pay royalties for such products.The
      total research and development funds that the Company has received from
      the BIRD-F as of December 31, 2004, was US$ 340 thousand. Accordingly, as
      of December 31, 2004, the Company is required to pay royalties up to an
      amount of US$ 510 thousand, plus linkage to the United States Consumer
      Price Index in the amount of US$ 76 thousand, that is a total of US$ 586
      thousand. As of December 31, 2004, the accumulated royalties paid to the
      BIRD-F were US$ 296 thousand. Accordingly, as of December 31, 2004, total
      grants received, net of royalties paid or accrued, amounted to
      approximately US$ 290 thousand.








F-17
 Index to Consolidated Financial
Statements


Radcom
Ltd. (An Israeli Corporation) and its
consolidated subsidiaries
 
 Notes to
the Consolidated Financial Statements as of December 31, 2004


**Note
      6 - Commitments and Contingencies (cont'd)****B.**
    **Operating
      leases**1.
    Premises
      occupied by the Company and the US Subsidiary are rented under various
      rental agreements with related parties (see Note 10).The
      rental agreements for the premises in Tel Aviv and New Jersey, United
      States, expire on December 31, 2005 and on January 31, 2006, respectively.
      Since January 2002, a part of the premises in New Jersey is leased to a
      sub lessee according to a sublease agreement which expires in January 2006
      at a yearly rate of US$ 41 thousand. Further, since February 2004,
      another part of the premises in New Jersey is leased to a sub lessee,
      which is an affiliate of the Company's principal shareholders, at a yearly
      rate of US$ 5 thousand. In addition, the Company rented additional office
      premises in Tel Aviv. These rental agreements expire on December 31, 2005
      and October 20, 2007. Some of these agreements are renewable at the
      Company's option. Minimum future gross rental and maintenance payments due
      under the above agreements, at exchange rates in effect on December 31,
      2004 are as follows:





**Year
      ended December 31**
    
    
    **US$
      (in thousands)**





2005
    
    
    7762006
    
    
    292007
    
    
    1





Rental
      and maintenance expenses (net of sublease income from premises under
      sublease agreement) amounted to US$ 748 thousand, US$ 828 thousand and US$
      873 thousand, for the years ended December 31, 2004, 2003 and 2002,
      respectively.2.
    The
      Company leases a number of motor vehicles under operating leases. The
      leases typically run for an initial period of three years with an option
      to renew the leases after that date.As
      of December 31, 2004, non-cancelable operating rentals are payable as
      follows:





**Year
      ended December 31**
    
    
    **US$
      (in thousands)**





2005
    
    
    3032006
    
    
    2922007
    
    
    167





During
      2004, 2003 and 2002, an amount of US$ 285 thousand, US$ 347 thousand and
      US$ 473 thousand, respectively, was recognized as an expense in the
      statement of operation in respect of operating
leases.








F-18
 Index to Consolidated Financial
Statements


Radcom
Ltd. (An Israeli Corporation) and its
consolidated subsidiaries
  Notes to
the Consolidated Financial Statements as of December 31, 2004


**Note
      6 - Commitments and Contingencies (cont'd)****C.**
    **Legal
      proceedings**On
      January 13, 2004, the Company was served with a complaint in the United
      States District Court of New Jersey, by Acterna LLC ("Acterna"), alleging
      that certain of the Company's products infringed one or more claims of a
      patent allegedly owned by Acterna. In December 2004, although the Company
      has not and do not acknowledge infringing such patent, the Company decided
      to reach a settlement with Acterna in order to save management’s time and
      litigation costs. In connection with the settlement agreement, the Company
      paid an undisclosed sum, as well as legal expenses, and Acterna granted
      the Company a worldwide license to the patent and the Company acknowledged
      the patent's validity. This financial amount has been immediately recorded
      as an expense since the Company did not purchase any intangible assets and
      the aforesaid amount represents legal expenses. The total expensesfor
      this legal proceeding were US$ 697 thousand and were recorded in the year
      ended December 31, 2004.**D.**
    **Bank
      guarantee**The
      Company has granted a bank performance guarantee in favor of one of its
      customers in the amount of US$ 204 thousand. The guarantee shall expire in
      December 2007.**Note
      7 - Shareholders' Equity****A.**
    **Share
      capital****1.**
    **Comprised
      of:**




**December
      31, 2004****Authorized**
    
    
    **Issued**
    
    
    **Outstanding****Number of
      shares******Ordinary
      Shares of NIS 0.05 par value (i)
    
    
    **39,990,680**
    
    
    ***14,438,348**
    
    
    ***14,438,348**Deferred
      Shares of NIS 0.05 par value (ii)
    
    
    **9,320**
    
    
    **9,320**
    
    
    **9,320**




**December
      31, 2003****Authorized**
    
    
    **Issued**
    
    
    **Outstanding****Number
      of shares**Ordinary
      Shares of NIS 0.05 par value (i)
    
    
    39,990,680
    
    
    *10,506,876
    
    
    *10,506,876Deferred
      Shares of NIS 0.05 par value (ii)
    
    
    9,320
    
    
    9,320
    
    
    9,320





*
    Does
      not include 20,757 Ordinary Shares, which are held by a subsidiary, and
      123,372 Ordinary Shares which are held by the Company (see i (b)
      below).(i)
    (a)
    Ordinary
      Shares confer all rights to their holders, e.g. voting, equity and receipt
      of dividend.(b)
    In
      March and April 2001, the Company purchased 123,372 shares of the
      Company's Ordinary Shares in the over-the-counter market. This purchase
      was approved by the Tel Aviv-Jaffa District Court.(ii)
    Deferred
      Shares confer only the right to their par value upon liquidation of the
      Company. The Deferred Shares were Ordinary Shares which were deferred in
      1996 and 1997 after being bought from employees by a wholly-owned
      subsidiary of the Company. The Deferred Shares are treated as treasury
      stock. The Deferred Shares are non-voting and
      non-participatory.





F-19
 Index to Consolidated Financial
Statements


Radcom
Ltd. (An Israeli Corporation) and its
consolidated subsidiaries
  Notes to
the Consolidated Financial Statements as of December 31, 2004


**Note
      7 - Shareholders' Equity (cont'd)****A.**
    **Share
      capital (cont'd)****2.**
    On
      March 29, 2004, the Company closed a private placement transaction (the
      "PIPE"). Under the PIPE investment, the Company issued 3,851,540 of the
      Company's Ordinary Shares at an aggregate purchase price of US$ 5,500
      thousand or US$ 1.428 per Ordinary Share. The Company also issued to the
      investors warrants to purchase up to 962,887 Ordinary Shares at an
      exercise price of US$ 2.253 per share. The warrants are exercisable for
      two years from the closing of the PIPE.**3.**
    **Nasdaq
      Listing**The
      Company's Ordinary Shares are traded in the United States on the
      over-the-counter market and are listed on the Nasdaq National
      Market.On
      December 1, 2003, the Company received from the staff ("the Staff") of the
      Nasdaq Stock Market, Inc. ("Nasdaq") a determination (the "Staff
      Determination") indicating that the Company failed to comply with the
      shareholders' equity requirement under Maintenance Standard 1 for
      continued listing on the Nasdaq National Market, as set forth in
      Marketplace Rule 4450(a)(3). In addition, the Staff Determination stated
      that the Staff intended to delist the Company's securities from the Nasdaq
      National Market.On
      January 15, 2004, the Company had a hearing before Nasdaq Listing
      Qualifications Panel ("Panel") to review the Staff
      Determination.On
      May 18, 2004, as a result of a private placement transaction (see Note
      7(A2) above), the Company received a determination from the Panel
      indicating that the Company has evidenced compliance with all requirements
      for continued listing on the Nasdaq National Market and accordingly, the
      Company's securities will continue to be listed on the Nasdaq National
      Market.**B.**
    **Share
      option plans**1.
    The
      Company has granted options under option plans as
  follows:a.
    Directors
      Share Option PlanUnder
      this plan the Company grants options to purchase Ordinary Shares of a par
      value of NIS 0.05. The plan is made pursuant to the provisions of Section
      3(9) of the Israeli Income Tax Ordinance. The options and the right to
      acquire shares shall terminate within 5 years after the date of the
      grant.b.
    The
      Radcom Ltd. 1998 Share Option Plan (the "3(9)
Plan")Under
      this plan the Company grants options to purchase Ordinary Shares of a par
      value of NIS 0.05. The plan is made pursuant to the provisions of section
      3(9) of the Israeli Income Tax Ordinance. The options and the right to
      acquire shares shall terminate within 10 years after the date of the
      grantc.
    The
      Radcom Ltd. 1998 Employees Bonus Plan (the "Radcom Bonus
      Plan")Under
      this plan the Company grants option to purchase Ordinary Shares of a par
      value of NIS 0.05. The options allotted under the plan were deposited with
      a trustee. Exercise of the options and sale of the shares issued as a
      result of the exercise can be implemented only through the
      trustee.





F-20
 Index to Consolidated Financial
Statements


Radcom
Ltd. (An Israeli Corporation) and its
consolidated subsidiaries
  Notes to
the Consolidated Financial Statements as of December 31, 2004


**Note
      7 - Shareholders' Equity (cont'd)****B.**
    **Share
      option plans (cont'd)**c.
    The
      Radcom Ltd. 1998 Employees Bonus Plan (the "Radcom Bonus Plan")
      (cont'dIn
      accordance with the plan, the trustee received irrevocable instructions
      from the Company to sell two years after the date of the grant (the
      "exercise date") all the shares issued as a result of exercising all the
      options in respect of which their vesting period has ended, on the
      condition that the price of the Company's shares is equal to or higher
      than 125% of the exercise price on the date of sale.The
      trustee will attempt to sell the shares during the 20 trading days after
      the exercise date if the condition regarding the price is fulfilled. If
      the condition is not fulfilled, the right to exercise the options will be
      deferred to the beginning of the first quarter subsequent to the exercise
      date. If the price of the Company's shares is lower than 125% of the
      exercise price, the right to exercise the options will be deferred to the
      beginning of the second quarter and so on over the six years from the date
      of their allotment. If on the last quarterly exercise date the condition
      is not fulfilled then the right to exercise the options will be deferred
      to the final exercise date, six years after the date of the
      grant.If
      on the final exercise date the market price of the shares is lower than
      115% of the exercise price the options will lapse, will not be exercisable
      and will be cancelled.Gains
      from the sale of the shares are taxed in accordance with Section 102 of
      the Income Tax Ordinance (New Version) - 1961, its related regulations and
      arrangements with Tax Authorities.d.
    The
      Radcom Ltd. International Employee Stock Option Plan (the "International
      Plan")The
      plan grants options to purchase Ordinary Shares of a par value of NIS
      0.05, for the purpose of providing incentives to officers, directors,
      employees and consultants of its non-Israeli subsidiaries. The options
      will be for a term of 10 years (5 years in the case of an Incentive Stock
      Option granted to a Ten-Percent Stockholder).e.
    2000
      share option planThe
      2000 Share Option Plan (the "2000 Share Option Plan") grants options to
      purchase Ordinary Shares of a par value of NIS 0.05. These options are
      granted pursuant to the 2000 Share Option Plan for the purpose of
      providing incentives to employees, directors, consultants and contractors
      of the Company. These options will be granted pursuant to 3(9) of the
      Income Tax Ordinance (New Version) - 1961.f.
    2001
      share option planThe
      2001 Share Option Plan (the "2001 Share Option Plan") grants options to
      purchase Ordinary Shares of a par value of NIS 0.05. These options are
      granted pursuant to the 2001 Share Option Plan for the purpose of
      providing incentives to employees, directors, consultants and contractors
      of the Company. These options will be granted pursuant to Section 3(9) of
      the Income Tax Ordinance (New Version) - 1961.g.
    2003
      Share Option PlanThe
      2003 Share Option Plan (the "2003 Share Option Plan") grants options to
      purchase Ordinary Shares of a par value of NIS 0.05. These options are
      granted pursuant to the 2003 Share Option Plan for the purpose of
      providing incentives to employees, directors, consultants and contractors
      of the Company.





F-21
 Index to Consolidated Financial
Statements


Radcom
Ltd. (An Israeli Corporation) and its
consolidated subsidiaries
  Notes to
the Consolidated Financial Statements as of December 31, 2004





**Note
      7 - Shareholders' Equity (cont'd)****B.**
    **Share
      option plans (cont'd)**g.
    2003
      Share Option Plan (cont'd)The
      Company's share incentive committee will determine whether the options
      will be granted pursuant to Section 102 of the Income Tax Ordinance (New
      Version) - 1961 ("102 Options") or Section 3(9) of the Income Tax
      Ordinance (New Version) - 1961 ("3(9) Options").With
      respect to 102 Options, the Board of Directors elected the "Capital Gains
      Route" (see Note 8A).2.
    Generally,
      grants in 2004 and 2003 were at exercise prices which reflect the market
      value of the Ordinary Shares at grant date.3.
    Repricing
      of optionsOn
      October 22, 2001, the Board of Directors of the Company resolved to
      reprice 439,815 options which had been granted to employees of the Company
      and its subsidiary under the 2000 Share Option Plan and the International
      Plan. According to the resolution of the Board, the exercise price of
      these options was reduced to zero, subject to the following conditions:
      the aggregate amount of options issued to the employee was reduced by 25%;
      the vesting period of all options was amended to a period of three years
      commencing on the date of resolution; and for a period of two years
      commencing on the date of resolution the employee shall not be permitted
      to exercise the options if the market price on the date of exercise shall
      be under US$ 3.00 per share.The
      repricing of the options was accounted for as new measurement date in
      accordance with FIN 44.4.
    Stock
      options under the Directors'Share Option Plan, the 3(9) Plan, the Radcom Bonus Plan, the International
      Plan, the 2000 Share Option Plan, the 2001 Share Option Plan and the 2003
      Share Option Plan:




**December
      31, 2004****Expiration
      (from****Vested**
    
    
    **Unvested**
    
    
    **Exercise
      price**
    
    
    **Vesting
      period**
    
    
    **resolution
      date)****No.
      of options**
    
    
    **US$**
    
    
    **Years**
    
    
    **Years**The
      Directors' Share Option Plan
    
    
    **145,000**
    
    
    **45,000**
    
    
    **1.84-4.5**
    
    
    **3**
    
    
    **5**The
      RadcomBonus Plan
    
    
    **237,532**
    
    
    **-**
    
    
    **2.3125-13.375**
    
    
    **3**
    
    
    **6**The
      Radcom3(9) Plan
    
    
    **532,800**
    
    
    **-**
    
    
    **2.3125-5.75**
    
    
    **3-6**
    
    
    **10**The
      InternationalPlan
    
    
    **139,619**
    
    
    **177,339**
    
    
    **0.00-3.875**
    
    
    **1-4**
    
    
    **10**The
      2000Share Option Plan
    
    
    **449,691**
    
    
    **58,690**
    
    
    **0.00-6.125**
    
    
    **3-4**
    
    
    **10**The
      2001Share Option Plan
    
    
    **289,662**
    
    
    **232,504**
    
    
    **0.51
      - 1.84**
    
    
    **3-4**
    
    
    **10**The
      2003Share Option Plan
    
    
    **137,435**
    
    
    **805,525**
    
    
    **1.03-2.22**
    
    
    **2-4**
    
    
    **10****1,931,739**
    
    
    **1,319,058**





F-22
 Index to Consolidated Financial
Statements


Radcom
Ltd. (An Israeli Corporation) and its
consolidated subsidiaries
  Notes to
the Consolidated Financial Statements as of December 31, 2004


**Note
      7 - Shareholders' Equity (cont'd)****B.**
    **Share
      option plans (cont****'****d)**4.
    Stock
      options under the Directors'Share Option Plan, the 3(9) Plan, the Radcom Bonus Plan, the International
      Plan, the 2000 Share Option Plan, the 2001 Share Option Plan and the 2003
      Share Option Plan: (cont'd)




**December
      31, 2003****Expiration
      (from****Vested**
    
    
    **Unvested**
    
    
    **Exercise
      price**
    
    
    **Vesting
      period**
    
    
    **resolution
      date)****No.
      of options**
    
    
    **US$**
    
    
    **Years**
    
    
    **Years**The
      Directors'Share Option Plan
    
    
    347,200
    
    
    90,000
    
    
    1.84-6.25
    
    
    3
    
    
    5The
      RadcomBonus Plan
    
    
    237,532
    
    
    -
    
    
    2.3125-13.375
    
    
    3
    
    
    6The
      Radcom3(9) Plan
    
    
    507,800
    
    
    25,000
    
    
    2.3125-5.75
    
    
    3-6
    
    
    10The
      InternationalPlan
    
    
    128,691
    
    
    64,597
    
    
    0.00-3.875
    
    
    1-4
    
    
    10The
      2000Share Option Plan
    
    
    371,378
    
    
    218,018
    
    
    0.00-6.125
    
    
    3-4
    
    
    10The
      2001Share Option Plan
    
    
    148,998
    
    
    388,002
    
    
    0.51-1.84
    
    
    3-4
    
    
    10The
      2003Share Option Plan
    
    
    -
    
    
    478,150
    
    
    1.03-1.27
    
    
    2-4
    
    
    101,741,599
    
    
    1,263,767






5.
    Stock
      options under the Directors Share Option Plan, the 3(9) Plan, the Radcom
      Bonus Plan, the International Plan, the 2000 Share Option Plan, the 2001
      Share Option Plan and the 2003 Share Option
Plan:





****Numberof**options**
    
    
    ****Weighted**average**exercise**price********US$**Options
      outstanding as at January 1, 2002
    
    
    2,019,887
    
    
    3.497Granted
      during 2002
    
    
    1,045,570
    
    
    1.677Expired
      during 2002
    
    
    (217,852
    )
    
    6.669Forfeited
      during 2002
    
    
    (160,589
    )
    
    2.472Options
      outstanding as at December 31, 2002
    
    
    2,687,016
    
    
    2.593Granted
      during 2003
    
    
    478,150
    
    
    1.180Exercised
      during 2003
    
    
    (14,826
    )
    
    0.297Expired
      during 2003
    
    
    (37,147
    )
    
    1.960Forfeited
      during 2003
    
    
    (107,827
    )
    
    1.031Options
      outstanding as at December 31, 2003
    
    
    3,005,366
    
    
    2.443Granted
      during 2004
    
    
    **645,860**
    
    
    **2.044**Exercised
      during 2004
    
    
    **(79,932**
    **)**
    
    **0.783**Expired
      during 2004
    
    
    **(278,972**
    **)**
    
    **4.647**Forfeited
      during 2004
    
    
    **(41,525**
    **)**
    
    **1.060**Options
      outstanding as at December 31, 2004
    
    
    **3,250,797**
    
    
    **2.233**





(1)
    As
      at December 31, 2004, 2003 and 2002, the number of options exercisable
      was, 1,931,739, 1,741,599 and 1,263,994, respectively, and the total
      number of authorized options was 4,207,800, 3,711,814 and 3,465,103,
      respectively.(2)
    Weighted
      average value of options granted during 2004, 2003 and 2002 were US$
      1.480, US$ 0.457 and US$ 0.837,
respectively.





F-23
 Index to Consolidated Financial
Statements


Radcom
Ltd. (An Israeli Corporation) and its
consolidated subsidiaries
  Notes to
the Consolidated Financial Statements as of December 31, 2004





**Note
      7 - Shareholders' Equity (cont'd)****B.**
    **Share
      option plans (cont****'****d)**5.
    Stock
      options under the Directors Share Option Plan, the 3(9) Plan, the Radcom
      Bonus Plan, the International Plan, the 2000 Share Option Plan, the 2001
      Share Option Plan and the 2003 Share Option Plan: (cont'd)




**Options
      outstanding at December 31, 2004**
    
    
    **Options
      exercisable at December 31, 2004******Exercise
      price**(US$ per share)**
    
    
    ****Number**outstanding**
    
    
    **Weighted
      average
      **Exercise
      price
      **(in
      US$)******
    
    
    **Weighted
      average
      **Remaining

      **Contractual
      life
      **(in
      years)********
    
    
    **Numberexercisable**
    
    
    ******Weighted
      average**exercise price**(in
      US$)**0.00
    
    
    291,895
    
    
    0.00
    
    
    6.81
    
    
    291,895
    
    
    0.000.51
      - 1.90
    
    
    1,541,920
    
    
    1.542
    
    
    7.44
    
    
    697,722
    
    
    1.5862.18
      - 3.00
    
    
    882,379
    
    
    2.301
    
    
    6.49
    
    
    407,519
    
    
    2.4413.063
      -4.50
    
    
    178,269
    
    
    3.869
    
    
    2.61
    
    
    178,269
    
    
    3.8695.75
      - 13.375
    
    
    356,334
    
    
    6.054
    
    
    5.01
    
    
    356,334
    
    
    6.0543,250,797
    
    
    
    
    
    
    
    
    1,931,739








6.
    The following summarizes the
      departmental allocation of the stock-based compensation
  charge:








**Year
      ended December 31,****2004**
    
    
    **2003**
    
    
    **2002****US$
      ( (in thousands)**





Cost
      of sales
    
    
    **2**
    
    
    5
    
    
    10Research
      and development
    
    
    **43**
    
    
    63
    
    
    66Selling
      and marketing
    
    
    **34**
    
    
    43
    
    
    56General
      and administrative
    
    
    **15**
    
    
    12
    
    
    2**94**
    
    
    123
    
    
    134








**C.**
    **Effect
      of SFAS 123**The
      unamortized balance of the compensation expenses according to SFAS 123 in
      respect of these stock option grants amounted to US$ 1,103 thousand as of
      December 31, 2004, of which US$ 303 thousand will be amortized in the
      first six months period ended June 30, 2005 and US$ 800 thousand will be
      amortized in accordance with the vesting period of the options by the end
      of fiscal 2008.





F-24
 Index to Consolidated Financial
Statements


Radcom
Ltd. (An Israeli Corporation) and its
consolidated subsidiaries
  Notes to
the Consolidated Financial Statements as of December 31, 2004


**Note
      7 - Shareholders' Equity (cont'd)****C.**
    **Effect
      of SFAS 123 (cont****'****d)**Had
      compensation expenses for stock options granted been determined based on
      the fair value at the grant dates, consistent with the method of SFAS 123,
      the effect on the results of operation for the years ended December 31,
      2004, 2003 and 2002 would have been as follows:





**Year
      ended**
    
    **Year
      ended**
    
    **Year
      ended****December
      31**
    
    **December
      31**
    
    **December
      31****2004**
    
    
    **2003**
    
    
    **2002****US$
      (in thousands)**
    
    ****
    **US$
      (in thousands)**
    ****
    ****
    **US$
      (in thousands)**
    ****





Net
      loss as reported
    
    
    **(1,678**
    **)**
    
    (6,225
    )
    
    (4,716
    )Add:  
      compensation expenses according to APB 25included in the
      reported net loss
    
    
    **94**
    
    
    123
    
    
    134Deduct:
      compensation expenses accordingto SFAS
123
    
    
    **(561**
    **)**
    
    (840
    )
    
    (1,294
    )Net
      loss - pro forma
    
    
    **(2,145**
    **)**
    
    (6,942
    )
    
    (5,876
    )Basic
      and diluted loss per share as reported (US$)
    
    
    **(0.125**
    **)**
    
    (0.593
    )
    
    (0.449
    )Pro
      forma basic and diluted loss per share (US$)
    
    
    **(0.159**
    **)**
    
    (0.662
    )
    
    (0.560
    )








The
      fair value of stock-based compensation awards granted were estimated using
      the Black-Scholes options pricing model with the following
      assumptions:1.
    The
      current price of the stock is the fair market value of such shares on the
      grant date.2.
    Dividend
      yield of zero percent for all relevant years.3.
    Risk
      free interest rates are as follows:





**%**





Year
      ended December 31, 2002
    
    3.07
      - 5.19Year
      ended December 31, 2003
    
    1.50
      - 3.53Year
      ended December 31, 2004
    
    1.97
      - 3.83





4.
    Expected
      lives of 2 - 10 years (as of the date of the grant) for each option
      granted.5.
    Expected
      annual volatility of 87.3% - 104.4%, 104.7% - 110.0% and 107.4% - 108.7%
      for the years ended December 31, 2004, 2003 and 2002,
      respectively.





F-25
 Index to Consolidated Financial
Statements


Radcom
Ltd. (An Israeli Corporation) and its
consolidated subsidiaries
  Notes to
the Consolidated Financial Statements as of December 31, 2004






**Note
      8 - Taxes on Income****A.**
    **Israel
      Tax Reform**During
      2003, tax reform legislation was enacted with effect from January 1, 2003,
      which significantly changed the taxation basis of corporate and individual
      taxpayers from a territorial basis to a worldwide basis. From such date,
      an Israeli resident taxpayer will be taxed on income produced and derived
      both in and out of Israel. In respect of employee stock incentive plans,
      the tax reform codified past practice and determined three alternative
      tracks for taxing employee stock options. Where a trustee arrangement is
      in place, the employer can either claim an expense for tax purposes while
      the employee will be fully taxed up to the maximum marginal tax rate of
      49% (the "Ordinary Income Route") or the Company can waive the tax expense
      and the employee will pay a reduced tax rate of 25% (the "Capital Gains
      Route"). Where there is no trustee arrangement, the employee is fully
      taxed and no expense is allowed to the Company. There are detailed
      provisions for implementing these tracks. The tax reform's new practice is
      not in effect for options granted before December 31, 2002. The options
      granted by the Company during 2003 and 2004 were granted pursuant the
      Capital Gains Route.**B.**
    **Tax
      benefits under the Law for the Encouragement of Capital Investments, 1959
      (the "Law")****1.**
    **Rates**(a)
    The
      Company's first investment program has been granted "Approved Enterprise"
      status under the Law. For this program, the Company has elected to be
      taxed under the alternative benefits method, whereby the Company waives
      grants in return for tax exemptions. Pursuant thereto, the income of the
      Company derived from its Approved Enterprise program is tax-exempt for the
      periods stated below and will enjoy reduced tax rates thereafter as
      follows:Income
      derived from the Company's Approved Enterprise program will be tax exempt
      during the first two of the seven-year period in the tax benefits period,
      and is subject to a reduced tax rate of 25% during the remaining five
      years. The seven-year period of benefits will commence in the year in
      which the enterprise first generates taxable income, provided that 14
      years have not passed since the year in which the approval was granted,
      and 12 years have not passed since the year in which the Approved
      Enterprise became operational (1994).The
      final report as to the completion of investments under this program was
      approved by the Investment Center of the Ministry of Industry and Commerce
      (hereafter "Investment Center") on December 1, 1994. The Company has not
      utilized benefits of this program to date.





F-26
 Index to Consolidated Financial
Statements


Radcom
Ltd. (An Israeli Corporation) and its
consolidated subsidiaries
  Notes to
the Consolidated Financial Statements as of December 31, 2004


**Note
      8 - Taxes on Income (cont'd)****B.**
    **Tax
      benefits under the Law for the Encouragement of Capital Investments, 1959
      (the "Law") (cont'd)****1.**
    **Rates
      (cont****'****d)**(b)
    The
      Company's program for expansion of its Approved Enterprise to Jerusalem
      was submitted to the Investment Center for approval in October 1994, and
      the approval was received in February 1995. As the Company has elected to
      apply the alternative benefits method for this program, the Company will
      be entitled to a tax exemption with respect to the additional income
      derived from that program for six years and will be taxed at a 25% rate
      for one additional year. The six-year period may be extended to ten years
      if the Company's application to the Investment Center for recognition as a
      "High Technology" facility is recognized. In this case, the Company will
      not be entitled to an additional year of being taxed at a 25% rate. In
      letters dated May 30, 1996 and June 16, 1996, the Israeli tax authorities
      provided that, for the purpose of determining the Company's tax liability,
      the Company's income will be allocated to its manufacturing plant and to
      its research and development center, according to a formula based on the
      net costs plus royalties of the research and development center and the
      Company's profitability. Income allocated to the manufacturing plant will
      benefit from either (i) a six-year tax exemption, and for the year
      immediately following will be taxed at a 25% rate or (ii) a ten year tax
      exemption as described above, while income allocated to the research and
      development center will benefit from a two-year exemption and will be
      taxed at a 25% rate for a five-year period immediately
      following.The
      final report as to the completion of investments under this program was
      approved by the Investment Center on April 1, 1997. The Company has not
      utilized benefits of this program to date.(c)
    The
      Company's
      request for a second expansion of its approved enterprise was submitted to
      the Investment Center for an approval in March 1996, and was approved in
      December 1996. The investments relating to this expansion were completed
      by April 15, 1998.The
      final report as to the completion of investments under this program was
      approved by the Investment Center on November 14, 1999.(d)
    In
      April 1998, the Company requested a third expansion of its Approved
      Enterprise in Jerusalem for the period April 16, 1998 to December 31,
      1999.The
      Investment Center has not yet approved the request because it has not
      decided whether to approve the program as an expansion or as an additional
      investment relating to a previous expansion.(e)
    In
      the letters mentioned in (b) above the tax authorities notified the
      Company that the tax calculation formula may be reexamined regarding
      expansion programs that will be submitted as of 1998 relating to
      production plans in areas outside Tel Aviv with a research and development
      center in Tel Aviv.(f)
    In
      the event of distribution by the Company of a cash dividend out of
      retained earnings which were tax exempt due to its Approved Enterprise
      status, the Company would have to pay 25% corporate tax on the amount
      distributed, and a further 15% withholding tax would be deducted from the
      amounts distributed to the recipients.





F-27
 Index to Consolidated Financial
Statements


Radcom
Ltd. (An Israeli Corporation) and its
consolidated subsidiaries
  Notes to
the Consolidated Financial Statements as of December 31, 2004


**Note
      8 - Taxes on Income (cont'd)****B.**
    **Tax
      benefits under the Law for the Encouragement of Capital Investments, 1959
      (the "Law") (cont'd)****1.**
    **Rates
      (cont****'****d)**(g)
    Should
      the Company derive income from sources other than the "Approved
      Enterprise" during the relevant period of benefits, such income will be
      taxable at the regular corporate tax rate, (see (h) below).(h)
    On
      June 29, 2004, the Israeli Knesset passed Income Tax Ordinance (No.140 and
      Temporary Order), 2004 (hereinafter - "the Amendment"). The Amendment
      provides for gradual reduction of the tax rates for companies, from the
      rate of 36% to the rate of 30%, in the following manner: in the 2004 tax
      year the tax rate will be 35%, in the 2005 tax year the tax rate will be
      34%, in the 2006 tax year the tax rate will be 32%, and in the 2007 tax
      year and thereafter the tax rate will be 30%.This
      change had no effect on the financial statements of the
      Company.**2.**
    **Accelerated
      depreciation**The
      Company is entitled to claim accelerated depreciation for a period of five
      years in respect of property and equipment of its Approved Enterprise. The
      Company has not utilized this benefit to date.**3.**
    **Conditions
      for entitlement to the benefits**The
      benefits from the Company's
      Approved Enterprise status are dependent upon the Company fulfilling the
      conditions stipulated by the Law and the regulations published thereunder,
      as well as the criteria set forth in the approval for the specific
      investments in the Company's
      Approved Enterprise.If
      the Company does not comply with these conditions, the tax benefits may be
      canceled, and the Company may be required to refund the amount of the
      canceled benefits, with the addition of linkage differences and
      interest.As
      of the date of these financial statements, the Company believes it is in
      compliance with these conditions, although none of these benefits have
      been utilized by the Company to date.**C.**
    **Measurement
      of results for tax purposes under the Inflationary Adjustments Law, 1985
      (the "Inflationary Adjustments Law")**Under
      the Inflationary Adjustments Law, the Company's results for tax purposes
      are measured in real terms, in accordance with the changes in the Israeli
      CPI.**D.**
    **Tax
      assessments**The
      Company received final tax assessments for all years up to and including
      the tax year ended December 31, 2000.On
      January 8, 2003, the Israeli tax authorities issued to the Company tax
      assessments for the years 1997 to 2000 according to their best estimate of
      the tax liability.On
      January 29, 2004, the Company signed a final tax assessment agreement with
      the Israeli tax authorities for the years 1997 to 2000. According to the
      final tax assessment for those years, the Company's carryforward tax
      losses as at December 31, 2003, was reduced in an amount of approximately
      US$ 3,464 thousand.





F-28
 Index to Consolidated Financial
Statements


Radcom
Ltd. (An Israeli Corporation) and its
consolidated subsidiaries
 
 Notes to
the Consolidated Financial Statements as of December 31, 2004





**Note
      8 - Taxes on Income (cont'd)****E.**
    **Carryforward
      tax loss**The
      Company's carryforward tax losses were approximately US$ 20,096 thousand
      and US$ 18,906 thousand as of December 31, 2004 and 2003, respectively
      (see also Note 8D).**F.**
    **US
      Subsidiary**1.
    The
      US Subsidiary is taxed under United States federal and state tax
      rules.2.
    The
      US Subsidiary's carryforward tax losses amounted to approximately US$
      10,866 thousand as of December 31, 2004 (2003 - US$ 10,257 thousand). Such
      losses are available to offset any future US taxable income of the US
      subsidiary and will expire in the years 2008 - 2024.3.
    The
      US subsidiary has received final tax assessments for all years until
      1998.**G.**
    **UK
      Subsidiary**The
      UK Subsidiary is taxed under United Kingdom tax rules. The UK Subsidiary's
      carryforward tax losses amounted to approximately US$ 366 thousand as of
      December 31, 2004 (2003 - US$ 349 thousand).**H.**
    **Deferred
      taxes**Deferred
      taxes reflect the net tax effects of temporary differences between the
      carrying amounts of assets and liabilities for financial reporting
      purposes and such amounts for tax purposes.Significant
      components of the Company's deferred tax assets and liabilities are as
      follows:





**December
      31****2004**
    
    
    **2003****US$
      (in thousands)**
    
    ****
    **US$
      (in thousands)**
    ****





Tax
      asset in respect of:Carryforward
      losses
    
    
    **10,773**
    
    
    11,303Allowance
      for doubtful accounts
    
    
    **38**
    
    
    40Severance
      pay
    
    
    **185**
    
    
    254Vacation
      pay
    
    
    **263**
    
    
    248Research
      and development
    
    
    **556**
    
    
    442Employee's
      stock option compensation
    
    
    **69**
    
    
    67Other
    
    
    **170**
    
    
    24**12,054**
    
    
    12,378Less:
      valuation allowance
    
    
    (12,054
    )
    
    (12,378
    )****
    
    
    -
    
    
    -





The
      Company has recorded a valuation allowance for all of its deferred tax
      assets because based on the weight of available evidence it is not more
      likely than not that all of the deferred tax assets will be
      realized.





F-29
 Index to Consolidated Financial
Statements


Radcom
Ltd. (An Israeli Corporation) and its
consolidated subsidiaries
  **Notes
to the Consolidated Financial Statements as of December 31,
2004**






**Note
      8 - Taxes on Income (cont'd)****I.**
    **Reconciliation
      of the theoretical tax expense and the actual tax
      expense**A
      reconciliation of the theoretical tax expense, assuming all income is
      taxed at the statutory rates of 35% for the year ended December 31, 2004
      and 36% for the years ended December 31, 2003 and 2002, applicable to
      income of companies in Israel, and the actual tax expense, is as
      follows:





**Year
      ended December 31****2004**
    
    
    **2003**
    
    
    **2002******
    
    
    **US$
      (in thousands)**
    
    ****
    **US$
      (in thousands)**
    ****
    ****
    **US$
      (in thousands)**
    ****





Loss
      before taxes, as reported in thestatements of
    operations
    
    
    **(1,678**
    **)**
    
    (6,225
    )
    
    (4,716
    )Statutory
      tax on the above amount (according totax rate of 35% in 2004
      and 36% in 2003 and 2002)
    
    
    **(587**
    **)**
    
    (2,241
    )
    
    (1,698
    )Tax
      effect on non-Israeli subsidiaries
    
    
    **(48**
    **)**
    
    165
    
    
    (13
    )Increase
      (decrease) in taxes resulting frompermanent
      differences:Non-deductible
      operating expenses
    
    
    **55**
    
    
    98
    
    
    134Non-taxable
      income
    
    
    -
    
    
    -
    
    
    (64
    )Timing
      differences in respect of which no deferredtaxes were
      recorded:Income
      (expenses), deductions and losses fortax
      purposes
    
    
    **511**
    
    
    2,485
    
    
    1,673Other
      timing difference, net
    
    
    **627**
    
    
    142
    
    
    (65
    )Adjustments
      arising from changes in tax rates
    
    
    **(1,463**
    **)**
    
    -
    
    
    -Differences
      in taxes arising from differencesbetween
      Israeli currency income and dollarincome, net
      *
    
    
    **905**
    
    
    (649
    )
    
    33Taxes
      on income
    
    
    **-**
    
    
    -
    
    
    -







*
    Resulting
      from the differences between the changes in the Israeli CPI (the basis for
      computation of taxable income of the Company and its Israeli Subsidiary)
      and the exchange rate of Israeli currency relative to the
      dollar.








F-30
 Index to Consolidated Financial
Statements


Radcom
Ltd. (An Israeli Corporation) and its
consolidated subsidiaries
  **Notes
to the Consolidated Financial Statements as of December 31,
2004**





**Note
      9 - Supplementary Financial Statement
  Information****A.**
    **Balance
      Sheet****1.**
    **Cash
      and cash equivalents**Cash
      and cash equivalents include short-term deposits denominated in US dollars
      of approximately US$ 5,520 thousand as of December 31, 2004, bearing
      an average annual interest of 2.23% (December 31, 2003 - US$ 4,437
      thousand, bearing an average annual interest of 1.22%).**2.**
    **Marketable
      securities**As
      of December 31, 2004, the Company holds fixed rates bonds, which are
      tradable securities. The bonds were issued at par value and bear interest
      of 2.3-2.5% per annum.**3.**
    **Trade
      receivables, net**As
      of December 31, 2004 and 2003 trade receivables are presented net of an
      allowance for doubtful accounts of US$ 121 thousand and US$ 109 thousand,
      respectively.The
      following are the changes in allowance for doubtful
    accounts:




**US$
      thousands**Balance
      at December 31, 2002
    
    
    518Additions
      during 2003
    
    
    16Deductions
      during 2003
    
    
    (425
    )Balance
      at December 31, 2003
    
    
    109Additions
      during 2004
    
    
    **15**Deductions
      during 2004
    
    
    **(3**
    **)**Balance
      at December 31, 2004
    
    
    **121**








**4.**
    **Inventories
      and inventory prepayments**





**December
      31****2004**
    
    
    **2003******
    
    
    **US$
      (in thousands)**
    
    ****
    **US$
      (in thousands**
    **)**





Raw
      materials
    
    
    **907**
    
    
    260Work
      in process
    
    
    **729**
    
    
    532Finished
      products:Sale
      or return inventory and deferred costs of sales
    
    
    **557**
    
    
    248Others
    
    
    **207**
    
    
    203Inventory
      prepayments
    
    
    **-**
    
    
    496**2,400**
    
    
    1,739





F-31
 Index to Consolidated Financial
Statements


Radcom
Ltd. (An Israeli Corporation) and its
consolidated subsidiaries
  **Notes
to the Consolidated Financial Statements as of December 31,
2004**





**Note
      9 - Supplementary Financial Statement Information
      (cont'd)****A.**
    **Balance
      Sheet (cont****'****d)****5.**
    **Other
      current assets**





**December
      31****2004**
    
    
    **2003******
    
    
    **US$
      (in thousands)**
    
    ****
    **US$
      (in thousands)**
    ****





Value
      Added Tax authorities
    
    
    **226**
    
    
    79Government
      of Israel - OCS
    
    
    **370**
    
    
    -Prepaid
      expenses
    
    
    **200**
    
    
    240Others
    
    
    **84**
    
    
    27**880**
    
    
    346





**6.**
    **Other
      payables and accrued expenses**





**December
      31****2004**
    
    
    **2003******
    
    
    **US$
      (in thousands)**
    
    ****
    **US$
      (in thousands)**
    ****





Employees
      and employee institutions
    
    
    **1,807**
    
    
    1,313Government
      of Israel - OCS
    
    
    **326**
    
    
    473Commissions
      payable
    
    
    **480**
    
    
    428Other
      royalties
    
    
    **171**
    
    
    235Allowance
      for product warranty
    
    
    **172**
    
    
    91Advances
      from customers
    
    
    **511**
    
    
    19Others
    
    
    **737**
    
    
    1,232**4,204**
    
    
    3,791








**7.**
    **Monetary
      balances in non-dollar currencies**




**December
      31, 2004****Israeli
      currency**
    
    
    **Other****Not**
    
    
    **Linked to
      the**
    
    
    **non-dollar****Linked**
    
    
    **dollar**
    
    
    **currency****US$
      (in thousands)**
    
    
    **US$
      (in thousands)**
    
    
    **US$
      (in thousands)**Current
      assets
    
    
    **872**
    
    
    **-**
    
    
    **7**Current
      liabilities
    
    
    **1,939**
    
    
    **22**
    
    
    **8**




**December
      31, 2003****Israeli
      currency**
    
    
    **Other****Not**
    
    
    **Linked
      to the**
    
    
    **non-dollar****Linked**
    
    
    **dollar**
    
    
    **currency****US$
      (in thousands)**
    
    
    **US$
      (in thousands)**
    
    
    **US$
      (in thousands)**Current
      assets
    
    
    144
    
    
    -
    
    
    11Current
      liabilities
    
    
    1,541
    
    
    2
    
    
    7





The
      preceding tables reflect the exposure of the Company's
      monetary balances in non-dollar currencies to the effect of changes in the
      rate of exchange of the NIS or other non-dollar currencies, to the dollar
      at the indicated balance sheet dates.





F-32
 Index to Consolidated Financial
Statements


Radcom
Ltd. (An Israeli Corporation) and its
consolidated subsidiaries
 **Notes
to the Consolidated Financial Statements as of December 31,
2004**





**Note
      9 - Supplementary Financial Statement Information
      (cont'd)****8.**
    **Fair
      value of financial instruments**The
      financial instruments of the Company consist mainly of cash and cash
      equivalents, marketable securities, trade receivables, assets held for
      severance benefits and accounts payables and accruals. Due to the nature
      of such financial instruments, their fair value usually approximates to
      their carrying value.**B.**
    **Statement
      of Operations****1.**
    **Sales**(a)
    Sales
      - classified by geographical destination:





**Year
      ended December 31****2004**
    
    
    **2003**
    
    
    **2002******
    
    
    **US$
      (in thousands)**
    
    ****
    **US$
      (in thousands)**
    ****
    ****
    **US$
      (in thousands)**
    ****





North
      America
    
    
    **4,452**
    
    
    4,593
    
    
    5,547Europe
    
    
    **8,536**
    
    
    4,082
    
    
    5,085Far
      East
    
    
    **2,295**
    
    
    2,234
    
    
    3,114Other
    
    
    **772**
    
    
    294
    
    
    845**16,055**
    
    
    11,203
    
    
    14,591








(b)
    Sales
      - classified by products





**Year
      ended December 31****2004**
    
    
    **2003**
    
    
    **2002******
    
    
    **US$
      (in thousands)**
    
    ****
    **US$
      (in thousands)**
    ****
    ****
    **US$
      (in thousands)**
    ****





Performer
    
    
    **11,180**
    
    
    7,075
    
    
    3,860Omni
      - Q
    
    
    **2,394**
    
    
    518
    
    
    536Prism
    
    
    **2,311**
    
    
    3,300
    
    
    9,924Others
    
    
    **170**
    
    
    310
    
    
    271**16,055**
    
    
    11,203
    
    
    14,591





(c)
    Principal
      customersIn
      North America, the Company sells its products directly to end users,
      primarily through manufacturer's
      representatives. Outside North America the Company sells its products
      primarily to independent distributors for resale to
    end-users.In
      2004, the Company had two customers whose purchases separately contributed
      more than 10% of the total consolidated sales. The sales generated from
      these two principle customers for the year ended December 31, 2004 were
      US$ 4,191 thousand.During
      years 2003 and 2002, no single customer exceeded 10% of the total
      sales.





F-33
 Index to Consolidated Financial
Statements




Radcom
Ltd. (An Israeli Corporation) and its
consolidated subsidiaries
 **Notes
to the Consolidated Financial Statements as of December 31,
2004**





**Note
      9 - Supplementary Financial Statement Information
      (cont'd)****B.**
    **Statement
      of Operations (cont****'****d)****2.**
    **Financing
      income, net****Comprised
      of:**





**Year
      ended December 31****2004**
    
    
    **2003**
    
    
    **2002******
    
    
    **US$
      (in thousands)**
    
    ****
    **US$
      (in thousands)**
    ****
    ****
    **US$
      (in thousands)**
    ****





Financing
      income:Interest
      from banks
    
    
    **118**
    
    
    96
    
    
    206Interest
      from employees
    
    
    **-**
    
    
    1
    
    
    4Exchange
      translation gain, net
    
    
    **-**
    
    
    14
    
    
    44**118**
    
    
    111
    
    
    254Financing
      expenses:Interest
      and bank charges on short- termbank
credit
    
    
    **22**
    
    
    18
    
    
    20Exchange
      translation loss, net
    
    
    **18**
    
    
    -
    
    
    -Impairment
      of marketable securities
    
    
    **-**
    
    
    -
    
    
    17**40**
    
    
    18
    
    
    37Financing
      income, net
    
    
    **78**
    
    
    93
    
    
    217







**Note
      10 - Related Party Balances and Transactions**The
      Company carries out transactions with related parties as detailed below.
      Certain principal shareholders of the Company are also principal
      shareholders of subsidiaries and affiliates known as the RAD-BYNET Group.
      The Company's transactions with related parties are carried out on an
      arm's-length basis.1.
    Certain
      premises occupied by the Company and the US Subsidiary are rented from
      related parties (see Note 6B).2.
    Certain
      entities within the RAD-BYNET Group provided the Company with
      administrative services. Such amounts expensed by the Company are
      disclosed in Note 10(B) below as "Cost of sales, sales and marketing,
      general and administrative expenses". Additionally, certain entities
      within the RAD-BYNET Group perform research and development on behalf of
      the Company. Such amounts expensed by the Company are disclosed in Note
      10(B) below as "Research and development, gross".3.
    The
      Company purchased from certain entities within the RAD-BYNET Group
      software packages and microcodes for programming a certain chip included
      in the Company's hardware from related parties. The software package is
      included in the Company's hardware and is thus incorporated into its
      product line.Such
      purchases by the Company are disclosed in Note 10(B) as "Cost of Sales"
      and as "Research and development, gross".





F-34
 Index to Consolidated Financial
Statements


Radcom
Ltd. (An Israeli Corporation) and its
consolidated subsidiaries
 **Notes
to the Consolidated Financial Statements as of December 31,
2004**





**Note
      10 - Related Party Balances and Transactions
    (cont'd)**4.
    The
      Company is party to a distribution agreement with Bynet Electronics Ltd.
      ("BYNET"), a related party, giving Bynet the exclusive right to distribute
      the Company's products in Israel and in certain parts of the West Bank and
      Gaza Strip.Revenues
      related to this distribution agreement are included in Note 10(B) below as"Sales".
      The remainder of the amount of"Sales"included in Note 10(B) below comprised of sales of the Company's products
      to entities within RAD-BYNET Group.**A.**
    **Balances
      with related parties**





**December
      31****2004**
    
    
    **2003****US$
      (in thousands)**
    
    ****
    **US$
      (in thousands)**
    ****





Receivables:Trade
    
    
    **110**
    
    
    16Accounts
      payable:Trade
    
    
    **77**
    
    
    43Other
      payables and accrued expenses
    
    
    **9**
    
    
    -








**B.**
    **Expenses
      to or income from related parties**




**Year
      ended December 31****2004**
    
    
    **2003**
    
    
    **2002******
    
    
    **US$
      (in thousands)**
    
    ****
    **US$
      (in thousands)**
    ****
    ****
    **US$
      (in thousands)**
    ****





Income:Sales
    
    
    **345**
    
    
    134
    
    
    264Expenses:Cost
      of sales *
    
    
    **162**
    
    
    158
    
    
    157Operating
      expenses:Research
      and development, gross
    
    
    **260**
    
    
    243
    
    
    283Sales
      and marketing, gross**
    
    
    **236**
    
    
    238
    
    
    272General
      and administrative
    
    
    **127**
    
    
    74
    
    
    82





*
    Cost
      of sales includes the components purchased from related parties that are
      included in production costs.**
    Sales
      and marketing, gross includes US$ 5 thousand rental revenue from sublease
      agreement with an affiliate of the Company's principal
      shareholders.**C.**
    Acquisition
      of fixed assets from related parties amounted to US$ 9 thousand, US$ 23
      thousand and US$ 16 thousand in the years ended December 31, 2004, 2003
      and 2002, respectively.








F-35
 Index to Consolidated Financial
Statements


Radcom
Ltd. (An Israeli Corporation) and its
consolidated subsidiaries


**Notes
to the Consolidated Financial Statements as of December 31,
2004**











**Note
      11 - Financial Instruments and Risk Management****A.**
    **Concentration
      of credit risk**Financial
      instruments that may subject the Company to significant concentrations of
      credit risk consist mainly of cash, investments and trade
      receivables.Cash
      and cash equivalents, marketable securities and short-term deposits are
      maintained by major financial institutions in Israel and in the United
      States.The
      Company grants credit to customers without generally requiring collateral
      or security. The Company performs ongoing credit evaluations of the
      financial condition of its customers. The risk of collection associated
      with trade receivables is reduced by the large number and geographical
      dispersion of the Company's customer base.**B.**
    **Concentrations
      of business risk**Although
      the Company generally uses standard parts and components for products,
      certain key components used in the products are currently available from
      only one source, and others are available from a limited number of
      sources. The Company believes that it will not experience delays in the
      supply of critical components in the future. If the Company experiences
      such delays and there is an insufficient inventory of critical components
      at that time, the Company's operations and financial results would be
      adversely affected.**Note
      12 - Recently Enacted Accounting
Pronouncements**1.
    In
      November 2004, the FASB issued FASB Statement No. 151, Inventory Costs, an
      amendment to ARB 43, Chapter 4 (SFAS 151). The amendment made by SFAS 151
      clarify that abnormal amounts of idle facility expense, freight, handling
      costs, and wasted material (spoilage) should be recognized as
      current-period charges, and also require the allocation of fixed
      production overhead to inventory based on the normal capacity of the
      production facilities. The guidance is effective for inventory costs
      incurred during fiscal years beginning after June 15, 2005. Earlier
      application is permitted for inventory costs incurred during fiscal years
      beginning after November 23, 2004. The provision of SFAS 151 should be
      applied prospectively.Adoption
      of this statement is not expected to have a material impact on the
      Company's financial statements.2.
    In
      March 2004, the Emerging Issues Task Force ("EITF") reached a consensus on
      EITF Issue No. 03-1, “The Meaning of Other-Than-Temporary Impairment and
      Its Application to Certain Investments” (“EITF 03-1”) regarding
      disclosures for certain SFAS 115 investment securities and investments
      accounted for under SFAS 124. The objective of EITF 03-1 is to provide
      guidance on determining when an investment is considered impaired, whether
      that impairment is other-than-temporary, and the measurement of an
      impairment loss. The guidance also includes accounting considerations
      subsequent to the recognition of an other-than-temporary impairment and
      requires certain disclosures about unrealized losses that have not been
      recognized as other-than-temporary impairments. In September 2004, the
      FASB issued FASB Staff Position (“FSP”) EITF Issue 03-1-1 that delays the
      effective date for the measurement and recognition guidance included in
      EITF 03-1.





F-36
 Index to Consolidated Financial
Statements


Radcom
Ltd. (An Israeli Corporation) and its
consolidated subsidiaries


**Notes
to the Consolidated Financial Statements as of December 31,
2004**











**Note
      12 - Recently Enacted Accounting Pronouncements
      (cont'd)**2.
    (cont'd)The
      FASB recently announced that it intends on reconsidering in its entirety
      EITF 03-1 and all other guidance on disclosing, measuring, and recognizing
      other-than-temporary impairments of debt and equity securities. Until new
      guidance is issued, companies must continue to comply with the disclosure
      requirements of EITF 03-1 and all relevant measurement and recognition
      requirements in other accounting literature. The Company's does not expect
      the adoption of EITF 03-1's new guidance to have a material effect on its
      results of operations and financial condition. Quantitative and
      qualitative disclosures for investments accounted for under SFAS 115 are
      effective for the Company's fiscal year ended December 31, 2004 and are
      included in Note 2F.3.
    In
      December 2004, the FASB issued SFAS No. 123 (Revision 2004), "Share-Based
      Payment", (SFAS 123R), that addresses the accounting for share-based
      payment transactions in which employee services are received in exchange
      for either equity instruments of the Company, liabilities that are based
      on the fair value of the Company's equity instruments or that may be
      settled by the issuance of such equity instruments. SFAS 123R eliminates
      the ability to account for share-based compensation transactions using the
      intrinsic value method as prescribed in APB Opinion No. 25, "Accounting
      for Stock Issued to Employees". Instead, SFAS 123R requires that such
      transactions be accounted for using a fair-value-based method and that
      compensation expense be recognized in the statement of operations rather
      than disclosing thepro
      forma impact of the stock based compensation as the Company currently
      discloses in Note 7.SFAS 123R provides two alternative adoption methods. The first method is a
      modified prospective transition method whereby a company would recognize
      share-based employee costs from the beginning of the fiscal period in
      which the recognition provisions are first applied as if the
      fair-value-based accounting method had been used to account for all
      employee awards granted, modified, or settled after the effective date and
      to any awards that were not fully vested as of the effective date.
      Measurement and attribution of compensation cost for awards that are
      unvested as of the effective date of SFAS 123R would be based on the same
      estimate of the grant-date fair value and the same attribution method used
      previously under SFAS No. 123, “Accounting for Stock-Based Compensation”
      (“SFAS 123”). The second adoption method is a modified retrospective
      transition method whereby a company would recognize employee compensation
      cost for periods presented prior to the adoption of SFAS 123R in
      accordance with the original provisions of SFAS 123; that is, an entity
      would recognize employee compensation costs in the amounts reported in the
      pro forma disclosures provided in accordance with SFAS 123. A company
      would not be permitted to make any changes to those amounts upon adoption
      of SFAS 123R unless those changes represent a correction of an error. The
      provisions of SFAS 123R are effective for periods beginning after June 15,
      2005, which will be the Company’s third quarter beginning July 1, 2005.
      The Company expects the adoption of this standard will reduce the second
      half of 2005 net income by approximately US$ 307 thousand. This estimate
      is based on the number of options currently outstanding and exercisable
      and could change based on the number of options granted or forfeited in
      fiscal 2005.4.
    In
      December 2004, the FASB issued SFAS No. 153, “Exchanges of Nonmonetary
      Assets - an amendment to APB No. 29.” This Statement amends Opinion No. 29
      to eliminate the exception for nonmonetary exchanges of similar productive
      assets and replaces it with a general exception for exchanges of
      nonmonetary assets that do not have commercial substance. A nonmonetary
      exchange has commercial substance if the future cash flows of the entity
      expected to change significantly as a result of the exchange. Adoption of
      this statement is not expected to have a material impact on the
      consolidated financial statements of the
Company.







F-37


Radcom
(UK) Ltd




**Financial
Statements as at December 31, 2002**




**Report
of Independent Accountants**


**To
the Shareholders of Radcom (UK) Ltd.**




We have
audited the balance sheets of Radcom (UK) Ltd. (“the Company”) at December 31,
2002, statements of income, shareholders’ equity and cash flows for the year
ended December 31, 2002. These financial statements are the responsibility of
the Company’s Board of Directors and management. Our responsibility is to
express an opinion on these financial statements based on our audit.





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





In our
opinion, based upon our audit the aforementioned financial statements present
fairly, in all material respects, the financial position of the Company at
December 31, 2002 and the results of its operations, changes in shareholder’s
equity and its cash flows for the year ended December 31, 2002 in conformity
with generally accepted accounting principles in the United States of America.





/s/ Blick
Rothenberg





Blick
Rothenberg


**Chartered
Accountants**


London,
England


**21
January 2003**




F-38