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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
 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 registeredNone
    
    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: 10,506,876 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




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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. PrismLite, Omni-Q, MediaPro and Wirespeed are our trademarks. All
other trademarks and trade names appearing in this annual report are owned by
their respective holders.




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TABLE OF CONTENTS PagePART 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
    
    
    13A. HISTORY AND DEVELOPMENT OF THE COMPANY
    
    
    13B. BUSINESS OVERVIEW
    
    
    13C. ORGANIZATIONAL STRUCTURE
    
    
    24D. PROPERTY, PLANTS AND EQUIPMENT
    
    
    24ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS
    
    
    24A. RESULTS OF OPERATIONS
    
    
    26B. LIQUIDITY AND CAPITAL RESOURCES
    
    
    29C. RESEARCH AND DEVELOPMENT, PATENTS AND LICENSES
    
    
    33D. TREND INFORMATION
    
    
    33E. OFF BALANCE SHEET ARRANGEMENTS
    
    
    34F. TABULAR DISCLOSURE OF CONTRACTUAL OBLIGATIONS
    
    
    34ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES
    
    
    35A. DIRECTORS AND SENIOR MANAGEMENT
    
    
    35B. COMPENSATION
    
    
    37C. BOARD PRACTICES
    
    
    38D. EMPLOYEES
    
    
    41
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TABLE OF CONTENTS(continued) PageE. SHARE OWNERSHIP
    
    
    41ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS
    
    
    42A. MAJOR SHAREHOLDERS
    
    
    42B. RELATED PARTY TRANSACTIONS
    
    
    43C. INTERESTS OF EXPERTS AND COUNSEL
    
    
    44ITEM 8. FINANCIAL INFORMATION
    
    
    45A. CONSOLIDATED STATEMENTS AND OTHER FINANCIAL INFORMATION
    
    
    45B. SIGNIFICANT CHANGES
    
    
    45ITEM 9. THE OFFER AND LISTING
    
    
    48A. OFFER AND LISTING DETAILS
    
    
    48B. PLAN OF DISTRIBUTION
    
    
    48C. MARKETS
    
    
    48D. SELLING SHAREHOLDERS
    
    
    49E. DILUTION
    
    
    49F. EXPENSES OF THE ISSUE
    
    
    49ITEM 10. ADDITIONAL INFORMATION
    
    
    49A. SHARE CAPITAL
    
    
    49B. MEMORANDUM AND ARTICLES OF ASSOCIATION
    
    
    49C. MATERIAL CONTRACTS
    
    
    55D. EXCHANGE CONTROLS
    
    
    55E. TAXATION
    
    
    55F. DIVIDENDS AND PAYING AGENTS
    
    
    66G. STATEMENTS BY EXPERTS
    
    
    66H. DOCUMENTS ON DISPLAY
    
    
    67I. SUBSIDIARY INFORMATION
    
    
    67ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
    
    
    67
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TABLE OF CONTENTS (continued) PageITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES
    
    
    67PART II
    
    
    68ITEM 13. DEFAULTS, DIVIDEND AVERAGES AND DELINQUENCIES
    
    
    68ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS.
    
    
    68ITEM 15. CONTROLS AND PROCEDURES
    
    
    68ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT
    
    
    68ITEM 16B. CODE OF ETHICS
    
    
    69ITEM 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES
    
    
    69ITEM 16D. EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES
    
    
    70ITEM 16E. PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS
    
    
    70PART III
    
    
    71ITEM 17. FINANCIAL STATEMENTS
    
    
    71ITEM 18. FINANCIAL STATEMENTS
    
    
    71ITEM 19. EXHIBITS
    
    
    71SHARE AND WARRANT PURCHASE AGREEMENTFORM OF WARRANTLIST OF SUBSIDIARIESCODE OF ETHICSCERTIFICATION OF CEOCERTIFICATION OF CFOCERTIFICATION OF CEOCERTIFICATION OF CFOCONSENT OF KPMG SOMEKH CHAIKINCONSENT OF BLICK ROTHENBERG
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##### Table of Contents



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, 2002 and 2003 and for each of the years ended December 31, 2001,
2002, and 2003 from our consolidated financial statements and notes included in
this annual report. The selected consolidated financial data as of December
31, 1999, 2000, and 2001 and for the years ended as of December 31, 1999 and
2000 have been derived from audited consolidated financial statements not
included in this annual report. Beginning with the fourth quarter of 2000, our
financial results were reported according to U.S. Generally Accepted Accounting
Principles (GAAP). For comparison purposes, all previous-period information
has been restated according to U.S. GAAP. Based on the International Financial
Reporting and Discloser 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. - 1 -




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Year Ended December 31,In Thousands of U.S. dollars (except weighted average number of ordinary shares,basic and diluted earnings (loss) per ordinary share)1999
    
    2000
    
    2001
    
    2002
    
    2003Statement of Operations Data:Sales
    
    
    24,723
    
    
    
    30,583
    
    
    
    18,676
    
    
    
    14,591
    
    
    
    11,203Cost of sales
    
    
    7,418
    
    
    
    10,095
    
    
    
    8,811
    
    
    
    5,047
    
    
    
    4,894Gross profit
    
    
    17,305
    
    
    
    20,488
    
    
    
    9,865
    
    
    
    9,544
    
    
    
    6,309Operating expenses:Research and development, gross
    
    
    6,521
    
    
    
    9,693
    
    
    
    9,380
    
    
    
    6,481
    
    
    
    5,593Less royalty bearing participation
    
    
    2,496
    
    
    
    2,622
    
    
    
    1,976
    
    
    
    2,328
    
    
    
    1,997Research and development, net
    
    
    4,025
    
    
    
    7,071
    
    
    
    7,404
    
    
    
    4,153
    
    
    
    3,596Sales and marketing, net
    
    
    11,956
    
    
    
    15,393
    
    
    
    11,513
    
    
    
    8,306
    
    
    
    7,411General and administrative
    
    
    1,806
    
    
    
    2,102
    
    
    
    2,437
    
    
    
    2,018
    
    
    
    1,620Total operating expenses
    
    
    17,787
    
    
    
    24,566
    
    
    
    21,354
    
    
    
    14,477
    
    
    
    12,627Operating loss
    
    
    (482
    )
    
    
    (4,078
    )
    
    
    (11,489
    )
    
    
    (4,933
    )
    
    
    (6,318
    )Financing income, net
    
    
    848
    
    
    
    1,051
    
    
    
    41
    
    
    
    217
    
    
    
    93Net (loss) income for the year
    
    
    366
    
    
    
    (3,027
    )
    
    
    (11,448
    )
    
    
    (4,716
    )
    
    
    (6,225
    )Basic earnings (loss) per ordinary share
    
    $
    0.04
    
    
    $
    (0.29
    )
    
    $
    (1.09
    )
    
    $
    (0.45
    )
    
    $
    (0.59
    )Weighted average number of ordinary
shares used to compute basic earnings
(loss) per ordinary share
    
    
    10,005,550
    
    
    
    10,337,275
    
    
    
    10,511,789
    
    
    
    10,492,050
    
    
    
    10,493,184Diluted earnings (loss) per ordinary share
    
    $
    0.04
    
    
    $
    (0.29
    )
    
    $
    (1.09
    )
    
    $
    (0.45
    )
    
    $
    (0.59
    )Weighted average number of ordinary
shares used to compute diluted earnings
(loss) per ordinary share
    
    
    10,379,274
    
    
    
    10,337,275
    
    
    
    10,511,789
    
    
    
    10,492,050
    
    
    
    10,493,184Balance Sheet Data:Working capital
    
    $
    26,595
    
    
    $
    24,608
    
    
    $
    14,444
    
    
    $
    10,707
    
    
    $
    5,467Total assets
    
    
    37,280
    
    
    
    38,078
    
    
    
    24,306
    
    
    
    19,429
    
    
    
    14,403Short-term credits, including current
maturities of long-term debt
    
    
    629
    
    
    
    20
    
    
    
    
    
    
    
    
    
    
    
    Shareholders equity
    
    $
    29,807
    
    
    $
    28,050
    
    
    $
    16,926
    
    
    $
    12,344
    
    
    $
    6,246
 
 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. - 2 -




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Risks Related to our Business and our Industry We incurred losses for the years ended December 31, 2001, 2002 and 2003,
and we may incur losses again in the future. In each of the fiscal years ended December 31, 2001, 2002 and 2003, we
incurred losses of approximately $11.4 million, $4.7 million, and $6.2 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, 2003, we
used approximately $4.6 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 and during the
winter months in South America;
    
    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 - 3 -




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
    
    the size and timing of approval of grants from the Government
of Israel. 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. Any quarterly fluctuations in our results of operations may have a
material adverse effect on the market price of our ordinary shares. 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 in the
past year, 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 October 2003, we received a notice from Nasdaq that our shares would be
delisted from the Nasdaq National Market if we did not demonstrate a plan to
achieve and sustain compliance with all of the continued listing requirements.
As further described below, we submitted a plan of compliance to Nasdaq and
subsequently appeared before a Nasdaq Listing Qualifications Panel to present
an updated plan to achieve and maintain compliance with all of the Nasdaq
National Market continued listing requirements. Our plan included, among other
things, a recently completed $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 such market) or the
Over-The-Counter Bulletin Board. For additional information on the Nasdaq
continued listing requirements and the private placement, please see the
section entitled Item 5Liquidity and Capital ResourcesPrivate Placement. A continuation of the 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. 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. 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 - 4 -




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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. We continue to be
affected by the pre-2003 slowdown in the general telecommunications market and
by changing market demands for different technologies. 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. 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 internetworking test and
analysis solutions and voice quality management. 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, - 5 -




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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. 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 31.3% of our sales in 2001, 22.4% of our sales in 2002, and 30.1%
of our sales in 2003. Our six largest manufacturers representatives in North
America accounted for a total of approximately 31% of our sales in 2001, 30.5%
of our sales in 2002, and 34.7% of our sales in 2003. 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. - 6 -




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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. 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. 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. No precise amount of damages has been asserted to date. We
filed an answer to the complaint denying the allegations in the complaint and
served a counterclaim - 7 -




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for a declaratory judgment, attacking the patent being asserted on the
basis of non-infringement, invalidity due to prior existing technology, and
unenforceability due to certain alleged improper actions taken by Acterna in
obtaining the patent. We believe that our defenses are meritorious and we
intend to vigorously defend our right to sell the products. Should it ever
become necessary to do so, we believe that we can continue to sell the accused
products using alternative technologies. At this stage, it is not possible to
estimate the amount of the potential damages or the chances of success. Yehuda Zisapel and Zohar Zisapel, beneficially own approximately 34.9% of our
ordinary shares and therefore have significant influence over the outcome of
matters requiring shareholder approval, including the election of directors. As of March 31, 2004, Yehuda Zisapel and Zohar Zisapel (our Chairman of
the Board of Directors), who are brothers, beneficially owned an aggregate of
5,146,562 ordinary shares, representing approximately 34.9% of the ordinary
shares outstanding following the private placement. 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. We may encounter difficulties with our international operations and sales which
could affect our results of operations. While we are headquartered in Israel, approximately 98.4% of our sales in
2002 and 99.2% of our sales in 2003 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; - 8 -




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
    
    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. We are required to
register the ordinary shares, and the shares issuable upon the exercise of the
warrants, for resale by filing a resale registration statement within 45 days
after the closing of the transaction, and to keep the registration statement
effective for a period of two (2) years. In addition, as of March 31, 2004,
options to purchase a total of 2,859,827 ordinary shares were outstanding, and
an additional 801,197 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. 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. 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; - 9 -




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
    
    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. 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
issued an advisory - 10 -




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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. 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. 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. If the dollar costs of our operations in Israel increase, our
dollar-measured results of operations will be adversely affected. 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, - 11 -




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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. See Item 4  Business Overview  Research and
Development for discussion regarding the R&D Law (as hereinafter defined),
which may affect our eligibility for certain government programs. 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 a majority of the ordinary shares held by shareholders
other than 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) 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 not be completed unless at least 70
days have passed since the filing of the merger proposal with the Israeli
Registrar of Companies by each of the merging companies. 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. - 12 -




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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. 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. 
 B. BUSINESS OVERVIEW Overview We develop, manufacture, market and support innovative, network test and
quality management solutions for data communications and telecommunications
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 real-time identification, diagnosis,
isolation and resolution of network problems. We introduced our first test
equipment solution in 1993 and currently offer the following product lines:  
    
    The Performer family consists of solutions for both
Voice-over-Data, or VoD, and cellular networks.For VoD, we provide
a comprehensive solution for pre/post-deployment stages, research
and development verification, stress testing and recurring VoD
system performance testing. 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 setup and operation.
    
    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 VoD (e.g. ATM, IP), testing.
    
    Omni-Q. A voice quality management system which service
providers use to perform quality testing on their live networks,
which better enables them to deliver reliable, high-quality packet
telephony services and to optimize network resources. Our objective is to become a leader in the market for performance analysis
and quality management. 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, and data over cellular networks; - 13 -




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
    
    capitalizing upon our customer base and distribution channels
to gain understanding into the emerging needs of the marketplace;
    
    broadening market penetration by expanding our traditional
customer base to include convergence market segments; and
    
    continuing to enhance our distribution channels. Our sales network includes 10 manufacturers representatives in North
America, a sales office in China and, in the rest of the world, a network of
more than 55 distributors selling in over 45 countries. Our test and analysis
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 Broadband and 3G technologies enhance the value proposition of convergence
networks. Services enabled by these technologies, such as web-based call
centers, IP Centrex and messaging solutions, represent cost-effective
opportunities for enterprises to increase efficiency and productivity. In
developing 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 measurably high quality of service to their customers.
Vendors need solutions to help them develop the convergence devices which their
customers need to support mission-critical applications. As such, a variety of
new measurement and testing needs are growing in the marketplace. Products We categorize our products into three primary lines: (i) the Performer
series of performance analyzers (ii) the Prism series of multitechnology
analyzers, and (iii) the Omni-Q voice quality management solution. The Performer Series of Performance Analyzers Since 1999, we have been developing the Performer series of analyzers,
which is focused on performance measurement. 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 in its combination of strong
performance through hardware with ease of use of flexible software. 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 550 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. - 14 -




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With simplified control from a central console, the Performer hardware and
software suite generates the stress levels of a real-world network environment
and tests the quality and grade of service. 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.  
    
    The Cellular Performer 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 must set up and
operate these networks. It utilizes our proprietary Performer technology to
comprehensively test and analyze network performance at all cellular network
layers, independent of protocols and technologies. The Cellular Performer is differentiated mainly by two features: 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. 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). The Voice-over-Data Performer Designed to 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-Data Performer:  
    
    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-data 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;  
    
    Cellular QPro-tool for analyzing voice quality over 2.5 and third generation cellular networks; - 15 -




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
    
    NetSim simulates real life network impairments, such as latency, jitter and packet loss caused by dynamic routing effects
by emulating the behavior of complex, multi-node IP networks;  
    
    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;  
    
    MegaSIPhigh volume SIP call generator for packet based media testing; 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. 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 Prism series of protocol analyzers can simultaneously analyze the ATM
protocols as well as the LAN and WAN encoded data contained within the ATM
payload. They can be upgraded with various hardware components, such as memory
and CPU. By virtue of their ability to monitor data from either the ATM, WAN
or LAN side of a network, managers may isolate more rapidly the source of a
network fault. We offer our customers a variety of software packages to meet
their specific needs as to protocols and technologies to be analyzed. The
optional software packages for the Prism series offer a high degree of
versatility in analyzing over 550 protocols. The Prism series of analyzers currently supports most of our software
packages, including the ATM Signaling Simulation package. The Prism series of
analyzers also supports our software applications designed for testing
voice-over-data networks and new generation cellular networks. The Prism
series of analyzers is suited for these testing applications due to its
capability to simultaneously monitor data traffic over two different data
segments with different technologies. 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 Cellular Performer
product line. Omni-Q Voice Quality Management Solution Omni-Q, our voice quality management solution, is used by IP telephony
service providers to help them deliver consistently high quality packet
telephony services. Omni-Q 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. - 16 -




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The Omni-Q 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. 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 2001, 2002 and 2003 by product: Year ended December 312001
    
    2002
    
    2003(in thousands)Performer
    
    $
    2,249
    
    
    $
    3,860
    
    
    $
    7,075Prism
    
    $
    15,376
    
    
    $
    9,924
    
    
    $
    3,300Omni-Q
    
    $
    247
    
    
    $
    536
    
    
    $
    518Others
    
    $
    804
    
    
    $
    271
    
    
    $
    310Total
    
    $
    18,676
    
    
    $
    14,591
    
    
    $
    11,203
 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
primarily 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 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. 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 55 independent distributors, some of
which have exclusive rights to sell our products in their respective
geographical areas. We continue to search for new distributors to penetrate
new geographical 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 opened regional sales support offices in China and Spain. These
offices support our distributors in these regions. - 17 -




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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. We also provide our distributors with reduced prices on
demonstration systems (which consist of hardware and software, including the
basic system and all optional software packages), and allow distributors to
receive all new software packages as they are released. Since 2001, we have
been adjusting our sales and marketing expenses in line with our reduced
revenues. For example, we now focus our efforts on specific conferences rather
than general shows for marketing initiatives. In 2001, 2002 and 2003, our sales in North America were 38.1%, 38.0% and
41.0%, respectively; our sales in Europe were 35.9%, 34.9% and 36.4%,
respectively; our sales in Asia Pacific were 18.3%, 21.3% and 20.0%,
respectively; and our sales in Israel were 1.7%, 1.6% and 0.8%, respectively.
Our sales in other countries in 2001, 2002 and 2003, were 6.0%, 4.2% and 1.8%,
respectively. 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
also 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, new
protocols included in the software packages since 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. In order to encourage customers to participate in
such programs, we also offer a discount for certain software upgrades during
the warranty period. We also provide a customer hot line. Manufacturing and Suppliers Since 2003, we have increasingly shifted to a subcontracting model for the
manufacture of our products. Our manufacturing facilities, which are located
in Tel Aviv and Jerusalem, Israel, consist primarily of final assembly, testing
and quality control of materials, wiring, subassemblies and systems. - 18 -




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Electronic components and subassemblies are prepared by subcontractors
according to our designs and specifications. 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. 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, and Internet 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. Network Integrators and Value-Added Resellers.This group of customers
includes companies that provide installation and maintenance services for other
organizations networks, and employ installers and field service engineers who
use our products to monitor and analyze traffic on those networks. These users
find our products, which on the one hand fit the need for sophisticated
laboratory protocol analyzers and providers of performance measurement and on
the other hand demonstrate portability, multitechnology support and ease of use
in the field. They require reliable analyzers with simulation and monitoring
capabilities and the ability to test networks that integrate new and existing
technologies. They also require the ability to test different technologies
simultaneously, export data to other applications and save statistical data for
subsequent analysis. In addition, the Omni-Q benefits global IP carriers, by providing
end-to-end voice quality monitoring and management. Omni-Q 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. 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 We believe that our future success will depend upon our ability to enhance
our existing product lines and introduce new products addressing the changing
demands of the data communications and telecommunications industry on a timely
basis. As part of the product development process, we work - 19 -




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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. Our gross research and development costs were approximately $9.4 million
in 2001, $6.5 million in 2002, and $5.6 million in 2003, representing 50.2%,
44.4%, and 49.9% of sales, respectively. Aggregate research and development
expenses funded by the Office of the Chief Scientist were approximately $2.0
million in 2001, $2.3 million in 2002, and $2.0 million in 2003. 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, 2003, our research and development staff consisted of
56 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 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 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 program 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 Office of the Chief
Scientist of the Israeli Ministry of Industry and Trade, and Labor 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 Office of

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. The royalty
rates applicable to our programs range from 3% to 3.5% and as of 2004, the
royalty rate is 3.5%. 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. - 20 -




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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 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 Office of
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 Office of the Chief Scientist to
comply with the R&D Law. In addition, the rules of the Office of the Chief
Scientist may require prior approval of the Office 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. The funds available for Office of the 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 Office of 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 Office of the
Chief Scientist. At December 31, 2003, our contingent liability to the Office
of the Chief Scientist in respect of grants received was approximately $16.1
million. Binational Industrial Research and Development Fund We received from the BIRD Foundation funding for the research and
development of products. At December 31, 2003, our contingent liability to
the Bird Foundation in respect of funding received was approximately $281,000.
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. - 21 -




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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. No precise amount of damages has been asserted to date. We
filed an answer to the complaint denying the allegations in the complaint and
served a counterclaim for a declaratory judgment, attacking the patent being
asserted on the basis of non-infringement, invalidity due to prior existing
technology, and unenforceability due to certain alleged improper actions taken
by Acterna in obtaining the patent. We believe that our defenses are
meritorious and we intend to vigorously defend our right to sell the products.
Should it ever become necessary to do so, we believe that we can continue to
sell the accused products using alternative technologies. At this stage, it is
not possible to estimate the amount of the potential damages or the chances of
success. 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 - 22 -




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
    
    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.,
J3Nova and Empirix. On the quality management front our competitors include
Agilent, Brix Networks, Ectel, 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, 2003, we had 96 permanent employees and 17 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, 56 were employed
in research and development, 18 in operations (including manufacturing and
production), 27 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. 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 - 23 -




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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,
2003, 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 IncorporationRADCOM Equipment, 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. 
 D. PROPERTY, PLANTS AND EQUIPMENT We do not own any real property. We currently lease an aggregate of
approximately 2,407 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 2003,
aggregate annual lease payments for the Tel Aviv premises were approximately
$524,000, of which approximately $475,000 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 2003, aggregate annual lease payments for
the premises were approximately $154,000. We sub-lease 2,815 square feet of
the New Jersey premises to a third party, and in 2003 received aggregate rental
payments of approximately $41,000. We also lease approximately 144 square
meters in Beijing. In 2003, aggregate annual lease payments for the premise
were approximately $35,000. 
 ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS - 24 -




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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 that involve risks and
uncertainties. Our actual results may differ materially from those anticipated
in these forward-looking statements as a result of certain factors, including,
but not limited to, those set forth in Item 3Key InformationRisk Factors. Overview We develop, manufacture, market and support network test and quality
management solutions for data communications and telecommunications 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 real-time identification, diagnosis,
isolation and resolution of network problems. Our legacy product line is the
Prism family of WAN/LAN/ATM protocol analyzers, consisting of the PrismLite and
Prism UltraLite suite of integrated multi-technology test equipment. In 1999,
we began to develop the Performer family of products, consisting of solutions
for both Voice-over-Data , or VoD, and cellular networks. 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 protocol
independent testing of high speed links on-line in full line rate. The
Performer is designed for substantially enhanced performance relative to the
Prism product line. During the first quarter of 2003, we launched the Cellular
Performer, designed to provide testing performance at all cellular network
layers, independent of protocols and technologies. The Cellular Performer
offers a range of applications for analyzing and troubleshooting 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). In 2001, 2002 and 2003, we recorded net losses in the respective amounts
of approximately $11.4 million, $4.7 million and $6.2 million, primarily as 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 particular, since 2002, we have faced
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. In the first quarter of 2003, we commenced sales of our Cellular
Performer, after which we began to see a reverse in our revenue decline. The
Cellular Performer line has been received well in the marketplace and resulted
in growing sales in each quarter since its introduction. In 2003, our sales
increased from $1.6 million in the first quarter to $2.4 million in the second
quarter, representing a 50% increase, and then increased further to $3.1
million in the third quarter, representing an additional 29% increase, and then
increased to $4.0 million in the fourth quarter, representing an additional 29%
increase The Cellular Performer has been chosen by leading worldwide
operators and equipment vendors in the cellular industry. Nevertheless, there
can be no assurance that our sales will continue to increase. As a result of the rapid decline in revenues that began in 2001, our cost
structure became disproportionate to our revenue level. Beginning in the first
quarter of 2001 and continuing through 2003, we took a number of cost-cutting
measures. Beginning in 2001 through 2003, we increasingly shifted to a
subcontracting model for the manufacture of our products. By reducing fixed
manufacturing costs, we will seek to ensure that our cost of goods sold
fluctuates more directly in line with revenues. Second, in each of 2001, 2002
and 2003, we reduced our research and development workforce. Since our - 25 -




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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, in each of 2001, 2002 and 2003, we reduced our sales
and marketing workforce and related expenses in line with our reduced revenues.
For example, we are now focusing on specific conferences rather than on
general shows for marketing initiatives. In addition, potential customers for
the new Cellular Performer product line are larger and more well-known and, as
a result, our marketing efforts can be more focused. 
 A. RESULTS OF OPERATIONS The following table sets forth, for the periods indicated, certain
financial data expressed as a percentage of sales: Year Ended December 31,2001
    
    2002
    
    2003Sales
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %Cost of sales
    
    
    47.2
    
    
    
    34.6
    
    
    
    43.7Gross profit
    
    
    52.8
    
    
    
    65.4
    
    
    
    56.3Operating expenses:Research and development, gross
    
    
    50.2
    
    
    
    44.4
    
    
    
    49.9Less royaltybearing participation
    
    
    10.6
    
    
    
    15.9
    
    
    
    17.8Research and development, net
    
    
    39.6
    
    
    
    28.5
    
    
    
    32.1Sales and marketing
    
    
    61.6
    
    
    
    56.9
    
    
    
    66.1General and administrative
    
    
    13.1
    
    
    
    13.8
    
    
    
    14.5Total operating expenses
    
    
    114.3
    
    
    
    99.2
    
    
    
    112.7Operating loss
    
    
    (61.5
    )
    
    
    (33.8
    )
    
    
    (56.4
    )Financial income, net
    
    
    0.2
    
    
    
    1.5
    
    
    
    0.8Tax on Income
    
    
    
    
    
    
    
    
    
    
    Net loss
    
    
    (61.3
    )
    
    
    (32.3
    )
    
    
    (55.6
    )
 Year Ended December 31, 2003 Compared with Year Ended December 31, 2002 and
Year Ended December 31, 2001 Revenues Year ended December 31,% Change
    
    % Change(approximate $ in millions)
    
    2002 vs.
    
    2003 vs.2001
    
    2002
    
    2003
    
    2001
    
    2002Performer
    
    
    2.2
    
    
    
    3.9
    
    
    
    7.1
    
    
    
    77.3
    
    
    
    82.1Prism
    
    
    15.4
    
    
    
    9.9
    
    
    
    3.3
    
    
    
    (35.7
    )
    
    
    (66.7
    )Others
    
    
    1.1
    
    
    
    0.8
    
    
    
    0.8
    
    
    
    (27.3
    )
    
    
    0.0Total revenues
    
    
    18.7
    
    
    
    14.6
    
    
    
    11.2
    
    
    
    (21.9
    )
    
    
    (23.3
    )
 Revenues. Revenues consist of gross sales of products, less discounts,
refunds and returns. The reduction in sales since 2001 reflects the global
communications industry slowdown, which continued to restrain the overall level
of our customers capital expenditures since 2001, and it also reflects a sharp - 26 -




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reduction in demand for our Prism product line. This reduction was
mitigated somewhat during the third and fourth quarters of 2003 by the increase
in sales of our new Cellular Performer. Our sales network includes RADCOM Equipment, Inc., our wholly-owned
subsidiary in the United States, as well as nine manufacturers
representatives, and more than 60 independent distributors in over 50 other
countries. The table below shows the sales breakdown by territory: Year ended December 31,
    
    Year ended December 31,(approximate $ in millions)
    
    (in percentage)2001
    
    2002
    
    2003
    
    2001
    
    2002
    
    2003North America
    
    
    7.1
    
    
    
    5.6
    
    
    
    4.6
    
    
    
    38.1
    %
    
    
    38.0
    %
    
    
    41.0
    %Europe
    
    
    6.7
    
    
    
    5.1
    
    
    
    4.1
    
    
    
    35.9
    
    
    
    34.9
    
    
    
    36.4Asia Pacific
    
    
    3.4
    
    
    
    3.1
    
    
    
    2.2
    
    
    
    18.3
    
    
    
    21.3
    
    
    
    20.0Israel
    
    
    0.3
    
    
    
    0.2
    
    
    
    0.1
    
    
    
    1.7
    
    
    
    1.6
    
    
    
    0.8Others
    
    
    1.2
    
    
    
    0.6
    
    
    
    0.2
    
    
    
    6.0
    
    
    
    4.2
    
    
    
    1.8Total revenues
    
    
    18.7
    
    
    
    14.6
    
    
    
    11.2
    
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
 The relative reduction in sales in other territories reflects mainly the
economic slowdown in South America. Cost of sales and Gross profit Year ended December 31,(approximate $ in millions)2001
    
    2002
    
    2003Cost of sales
    
    
    8.8
    
    
    
    5.0
    
    
    
    4.9Gross profit
    
    
    9.9
    
    
    
    9.6
    
    
    
    6.3
 Cost of sales. Cost of sales consists primarily of our manufacturing
costs, warranty expenses, allocation of overhead expenses and royalties to the
Office of 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 $2.3 million, $1.5 million and
$1.4 million, in 2001, 2002 and 2003, respectively. We believe that reducing
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. The increase in gross profit from 2001 to 2002 was
primarily attributable to the success of our ongoing cost-cutting program and
reducing the cost of components. Cost of sales for 2001 included an inventory
write-off of approximately $1.0 million, and a provision for the layoff of
employees of approximately $275,000, both taken in the first and second
quarters of 2001. The write-off in 2001 was made to reflect the reduced value
of components used in products that were discontinued due to 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. Generally, our gross profit is lower during the initial launch
and manufacturing ramp-up of a new product 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 increases, our
gross profit generally improves. We have higher gross profit on sales of
optional software packages than on sales of our other products. We also have
higher gross profit - 27 -




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on sales in North America, where we sell primarily through manufacturers
representatives, than on sales outside North America where we sell through
distributors. Operating Costs and Expenses Year ended December 31,(approximate $ in millions)2001
    
    2002
    
    2003Research and Development, gross
    
    
    9.4
    
    
    
    6.5
    
    
    
    5.6Less Royalty-bearing participation
    
    
    2.0
    
    
    
    2.3
    
    
    
    2.0Research and Development, net
    
    
    7.4
    
    
    
    4.2
    
    
    
    3.6Sales and Marketing
    
    
    11.5
    
    
    
    8.3
    
    
    
    7.4General and Administrative
    
    
    2.4
    
    
    
    2.0
    
    
    
    1.6Total Operating Expenses
    
    
    21.3
    
    
    
    14.5
    
    
    
    12.6
 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. These expenses
were partially offset by royalty-bearing grants from the Office of the Chief
Scientist. The decrease in gross research and development expenses from 2001
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. In 2001, research and development gross expenses included a
charge of approximately $645,000 related to a one-time provision for layoffs,
and write-off of assets of approximately $60,000. 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 2001 to 2003 also
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. Sales and
marketing expenses for 2001 includes two charges: a write-off of demonstration
equipment valued at approximately $115,000, and a provision for layoffs of
employees of approximately $260,000. General and Administrative. General and administrative expenses consist
primarily of salaries, professional fees and staffing recruitment. General and
administrative expenses included a provision for bad debts and other totaling
approximately $8,000 for 2003, $338,000 for 2002 and $401,000 for 2001. In
2001, we also recorded a provision of approximately $20,000 for the layoff of
employees. 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 $41,000 in 2001, $217,000 in 2002 and $93,000 in
2003. 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. In 2001, financial income net included a charge of
approximately $710,000 reflecting impairment of investment in marketable
securities as a result of a decline in the market value of the securities. - 28 -




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B. LIQUIDITY AND CAPITAL RESOURCES We have financed our operations through cash generated from operations and
from the proceeds of our 1997 initial public offering. Cash and cash
equivalents, marketable securities and short-term investments in 2001, 2002 and
2003 were approximately $12.3 million, $10.2 million and $5.6 million,
respectively. Investments in (or redemptions of) short term deposits and
redemption of marketable securities in 2001, 2002 and 2003 were approximately
$4.0 million, ($5.4 million) and ($3.0 million), respectively. Capital Expenditures.Capital expenditures in 2001, 2002, and 2003 were
approximately $1.2 million, $434,000 and $222,000, respectively. These
expenditures were principally for computers and equipment purchases. Net Cash Provided by/Used in Operating Activities.Net cash used in
operating activities was approximately $3.9 million, $1.7 million, and $4.4
million in 2001, 2002, and 2003, respectively. In 2003, this was primarily due
to a net loss of approximately $6.2 million and an increase of approximately
$786,000 in trade receivables in line with increasing our revenue in the fourth
quarter of 2003 and a decrease of approximately $147,000 in trade payables.
This was partially offset by a decrease of approximately $279,000 in
inventories, an increase of approximately $853,000 in other payables and
accruals, a decrease of approximately $255,000 in other current assets and
approximately $1.1 million of depreciation and amortization. The increase in
trade receivables is due primarily to the increase in revenues in the fourth
quarter of 2003 and an increase in the average number of sales days that are
outstanding before we receive payment for the sale. The decrease in
inventories is primarily a result of the write-off of approximately $960,000
which was taken during the first quarter of 2003. The decrease was partially
offset by an increase in inventory of generic analyzer processors, known as
GEAR that form a part of our new product, the Performer Analyzer. The
decrease in trade payables is primarily a result of shifting to a
subcontracting model for the manufacture of our products. The decrease in
other current assets is primarily a result of a decrease in receivables from
the Office of the Chief Scientist and prepaid expenses. The increase in
payables and accruals is primarily a result of an increase in the deferred
revenues and an increase in commissions payable due to an increase in revenue
in North America in the fourth quarter of 2003. Net Cash Provided by/Used in Investing Activities.Our investment
activities consist primarily of investments and redemptions of short-term bank
deposits. Net cash provided by investing activities in 2002 and 2003 was
approximately $5.0 million and $2.8 million, respectively. Net cash used in
investing activities in 2001 was approximately $4.9 million. Net Cash Provided by/Used in Financing Activities.As explained above,
our financial income and expenses consist 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. Net cash provided by financing activities in
2003 was approximately $4,000, and net cash used in financing activities in
2001 was approximately $92,000. We had no net change from financing activities
in 2002. 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. In October 2003, we received a notice from Nasdaq
that our shares would be delisted from the Nasdaq National Market if we did not
demonstrate a plan to achieve and sustain compliance with all of the continued
listing requirements. We submitted a plan of compliance to Nasdaq and
subsequently appeared before a Nasdaq Listing Qualifications Panel to present
an updated plan to achieve and maintain compliance with all of the Nasdaq
National Market continued listing requirements. Our plan included, among other
things, the - 29 -




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recently completed $5.5 million private placement of ordinary shares and
warrants. The Panel determined that we presented a definitive plan that should
enable the company to achieve compliance with the minimum shareholders equity
requirement and stayed the delisting, provided that we publicly evidence
achievement of the minimum shareholders equity requirement on or before March
30, 2004, and meet certain other requirements, as described below. On March 29, 2004, we announced the closing of the private placement
transaction and that as a result of the closing, our management believes we
regained compliance with Nasdaqs $10 million shareholders equity requirement.
Under the PIPE investment, 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 have agreed to file a resale
registration statement covering the shares purchased in the private placement
(including the shares underlying the warrants) within 45 days following the
closing. Since completion of the private placement, we are in compliance with the
$10 million shareholders equity requirement. We will continue to be monitored
by a Nasdaq Listing Qualifications Panel until we meet certain requirements of
the Panels Determination regarding our continued listing. These requirements
include publicly filing a balance sheet on or before June 30, 2004, including
pro forma adjustments for any significant events or transactions occurring on
or before the date of the filing, to demonstrate achievement of the
shareholders equity requirement. In addition, we must demonstrate an ability
to sustain compliance with the minimum shareholders equity requirement 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,
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Since we pay the salaries of our Israeli employees in NIS, the dollar cost
of our operations is influenced by the extent to which inflation in Israel is
(or is not) offset (or is offset on a lagging basis) by a devaluation of the
NIS in relation to the dollar. Inflation in Israel will have a negative effect
on our profits for contracts under which we are to receive payment in dollars
or dollar-linked NIS while incurring expenses in NIS, unless such inflation is
offset on a timely basis by a devaluation of the NIS in relation to the dollar. For some time, until 1997, inflation in Israel exceeded the devaluation of
the NIS against the dollar and we experienced increases in the dollar cost of
our operations in Israel. This trend was reversed in 1997 and has continued in
reverse for every year thereafter until the present. In 2003, the rate of
increase in value of the NIS against the dollar was 7.6% and the rate of
deflation was 1.9%. 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. We do not believe that, historically, inflation in Israel, as well as
exchange rate fluctuations between the NIS and the dollar, have had a material
effect on our results of operations. Effective Corporate Tax Rate Israeli companies are generally subject to tax at the rate of 36% of
taxable income. 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, 2003, we had net operating loss carry forwards (unlimited in time)
of approximately $18.9 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 $10.3 million available at December 31, 2003 for federal and
state income tax purposes. These carry-forwards will offset future taxable
income and expire in 2008 through 2023 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 $359,000
for U.K. tax purposes. 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 - 31 -




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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 $2.0 million in 2001, $2.3 million in 2002, and $2.0
million in 2003. 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, 2003, our contingent liability to the
Office of the Chief Scientist in respect of grants received was approximately
$16.1 million. For additional information, see Item 4B  Information on the
Company  Israeli Office of Chief Scientist. 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, 2003, we had a contingent obligation
to pay the BIRD Foundation aggregate royalties in the amount of approximately
$281,000. 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 97-2, Software Revenue Recognition, upon shipment to
customers and 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  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 to be provided during the PCS
period is unbundled utilizing our price lists 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 - 32 -




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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. Allowance for product warranty. We grant a warranty for our products for
an initial period of up to two years. We determine the balance sheet provision
for warranties for all periods through December 31, 2003, as a percentage of
sales during the period plus certain expenses we expect to incur based upon
past experience. We estimate that those expenses will be insignificant, but
there could be unexpected defects in the products which will cause us to incur
higher expenses than expected. 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, 2003, is determined as a specific
amount for those accounts the collection of which is uncertain. If our
customers ability to repay their obligations changes 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. Property and equipment, net. Property and equipment, net are reviewed for
impairment whenever events or changes in circumstances indicate that the
carrying amount for 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. Events or
changes in circumstances could require us to recognize an impairment in the
value of our assets. 
 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 and have incurred significant
operating - 33 -




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losses. Many carriers and service providers have stopped either deploying
new data communications or telecommunications systems or purchasing new data
communications or telecommunications products or have ceased operations
completely and are no longer potential customers for us and for the developers
and manufacturers to which we sell our products. 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. We experienced strong initial sales and demand for our new Cellular
Performer product, which was launched in February 2003. The Cellular Performer
addresses the needs of equipment manufacturers and service providers in the
Data Over Cellular markets. 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. 
 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, 2003, summarizes the aggregate effect that these obligations are expected
to have on our cash flows in the periods indicated: Payments due by periodLess than
    
    2-3
    
    4-5
    
    More thanContractual Obligations
    
    Total
    
    1 year
    
    years
    
    years
    
    5 years(in thousands US$)Property Leases
    
    $
    1,303
    
    
    $
    674
    
    
    $
    629
    
    
    $
    
    
    
    $
    Open purchase orders
    
    
    830
    
    
    
    830Operating Leases
    
    
    179
    
    
    
    151
    
    
    
    27
    
    
    
    1
    
    
    
    Total
    
    $
    2,312
    
    
    $
    1655
    
    
    $
    656
    
    
    $
    1
    
    
    $
    
 In addition, at December 31, 2003, our contingent liability to the Office
of the Chief Scientist in respect of grants received was approximately $16.1
million and our contingent liability to the Bird Foundation in respect of
funding received was approximately $281,000. These liabilities will be paid as
percentages based on revenues derived from sales of products funded with these
grants. - 34 -




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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.
    
    
    55
    
    
    Chairman of the Board of DirectorsArnon Toussia-Cohen
    
    
    49
    
    
    President, Chief Executive Officer and DirectorDavid Zigdon.
    
    
    47
    
    
    Vice President Finance and Chief Financial OfficerHanan Klainer.
    
    
    43
    
    
    Vice President Sales and MarketingDavid Ripstein.
    
    
    37
    
    
    General Manager, Products and TechnologiesIlan Bar.
    
    
    43
    
    
    Chief Technology OfficerRuth Koren.
    
    
    47
    
    
    Vice President Human ResourcesMichael Shilinger.
    
    
    49
    
    
    Vice President OperationsRony Ross.
    
    
    54
    
    
    DirectorZohar Gilon.
    
    
    56
    
    
    DirectorDan Barnea.
    
    
    59
    
    
    Director
 Mr. Zohar Zisapel, one of the co-founders of our company, has served as
our Chairman of the Board since our inception. Mr. Zisapel also serves as a
director of RADCOM Equipment, Inc. 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., Ceragon
Ltd. and RIT Technologies 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 has served as a director since September 1999. Mr.
Toussia-Cohen also serves as a director 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. 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. 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 - 35 -




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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 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 solution and one of the co-founders of Speedbit,
a company that focuses on increasing the speed of downloading from the
internet, and he 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. 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 degree in practical engineering. 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 several private companies. Mr. Gilon is also a - 36 -




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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. 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., a developer of medical imaging equipment,
most recently as Vice President and Manager of the engineering division. 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 (11 persons) for the year ended December 31, 2003 was
approximately $1.1 million. This amount includes approximately $203,000, 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, 2003, our directors and officers as a group held
options to purchase an aggregate of 1,654,300 ordinary shares. Other than the
options granted to our directors under the Directors Share Incentive Plan
(1997), the 2001 Share 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. We expect
the financial effect of the repricing to be an increase in our non-cash
compensation expense of approximately $27,000, in 2004. - 37 -




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As of December 31, 2003, we have granted options to purchase 3,715,001
ordinary shares, of which options to purchase 709,635 ordinary shares have been
exercised and options to purchase 3,005,366 ordinary shares remain outstanding.
An additional 706,448 ordinary shares are reserved for issuance under our
stock option plans. On October 19, 2003, our Board of Directors and the Audit
Committee resolved to grant options to purchase 30,000 ordinary shares at an
exercise price of $1.27 to Arnon Toussia-Cohen, our Chief Executive Officer,
under the 2003 Share Option Plan, all of which will expire on October 19, 2013.
This resolution was approved by our shareholders at the Special Shareholders
Meeting on March 15, 2004. 
 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,
Arnon Toussia-Cohen 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 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. 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. - 38 -




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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 as required by the Nasdaq rules. 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
    
    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, - 39 -




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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 two
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. Jonathan Glazer 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. Committees The Board of Directors appoints committees to help carry out its duties.
Each committee reviews the results of its meetings with the full Board of
Directors. In addition to the audit committee, the Board of Directors has
formed an investments committee and a share incentive committee. The
investments committee, of which Ms. Ross and Messrs. Zohar Zisapel and Gilon
are the current members, exercises the power of the Board of Directors with
respect to our investment policy. The share incentive committee, of which Ms.
Ross and Messrs. Toussia-Cohen and Zohar Zisapel are the current members,
administers: (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. Under Section 112 of the Companies Law, the share
incentive committee may only advise our Board of Directors with regard to the
grant of options, and the actual grant of options must be approved by our Board
of Directors. 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. - 40 -




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D. EMPLOYEES As of December 31, 2003, we had 130 permanent and temporary employees
worldwide, of which 56 were employed in research and development, 42 in sales
and marketing, 14 in management and administration and 18 in operations. As of
December 31, 2003, 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 stoppage. 
 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
March 31, 2004. The percentage of outstanding ordinary shares is based on
14,392,931(3) ordinary shares outstanding as of March 31, 2004. Percentage ofNumber of Ordinary
    
    Outstanding OrdinaryShares Beneficially
    
    Shares BeneficiallyName
    
    Owned(1)
    
    Owned(2) (3)Zohar Zisapel(4)(5)
    
    
    3,297,242
    
    
    
    22.5
    %Arnon Toussia-Cohen(6)
    
    
    310,000
    
    
    
    2.1
    %David Zigdon
    
    
    *
    
    
    
    *Hanan Klainer
    
    
    *
    
    
    
    *Ilan Bar
    
    
    *
    
    
    
    *Ruth Koren
    
    
    *
    
    
    
    *Michael Shilinger
    
    
    *
    
    
    
    *David Ripstein
    
    
    *
    
    
    
    *Rony Ross
    
    
    *
    
    
    
    *Zohar Gilon
    
    
    *
    
    
    
    *Dan Barnea
    
    
    *
    
    
    
    *All directors and executive officers as a group
(11 persons) (1) (2)
    
    
    4,386,542
    
    
    
    27.9
    %
   *
    
    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 March 31, 2004. 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 by March 31, 2004. See Item 5LIQUIDITY AND
CAPITAL RESOURCES  Private placement.
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(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 160,000 ordinary shares, as follows: options to purchase
30,000 ordinary shares at an exercise price of $4.531 per share, expiring on September 16, 2004; 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 105,000 ordinary shares are
exercisable as of March 31, 2004 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.(6)
    
    Mr. Toussia Cohen has been granted options to purchase 425,000 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 30,000 ordinary shares at an exercise price of $4.531 per share, expiring on September
16, 2004; 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 30,000 ordinary shares at an exercise price of $1.03 per
share, expiring on September 10, 2013; and options to purchase 30,000 ordinary shares at an exercise price
of $1.27 per share, expiring on October 19, 2013. Of the aggregate options granted, options to purchase
310,000 ordinary shares are exercisable as of March 31, 2004 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 March 31, 2004, 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. Number of Ordinary
    
    Percentage ofShares Beneficially
    
    Outstanding OrdinaryName
    
    Owned(1)
    
    Shares(2)Zohar Zisapel(3) (4)
    
    
    3,297,242
    
    
    
    22.5
    %Yehuda Zisapel(3) (5)
    
    
    2,027,161
    
    
    
    14.0
    %RAD Data Communications Ltd (6)
    
    
    177,841
    
    
    
    1.2
    %Star Growth Enterprise, a
German Civil Law Partnership
(with limitation of liability)
(7)
    
    
    1,225,490
    
    
    
    8.4
    %J. Carrlo Cannell, D/B/A
Cannell Capital Management (8)
    
    
    1,935,540
    
    
    
    13.4
    %
 - 42 -




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(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 March 31, 2004, 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 14,392,931 ordinary shares
outstanding as of March 31, 2004. 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 March 31, 2004. 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.(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, 105,000 ordinary shares issuable upon exercise of options
exercisable within 60 days of March 31, 2004, 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.(7)
    
    Includes 70,028 ordinary shares owned of record by SVM Star Ventures Managementgesellschaft
mbH Nr. 3 and 245,098 warrants to purchase ordinary shares.(8)
    
    J. Carrlo Cannell, D/B/A Cannell Capital Management, acquired beneficial ownership of the
ordinary shares during the past years. This information is based on Mr. Cannells Form 13-G
filings as of January 5, 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. - 43 -




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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. 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 $61,000, $33,000 and $28,000 in 2001, 2002 and
2003, respectively. We purchase certain products and services of members of the RAD-BYNET
Group, in circumstances in which the terms are beneficial to us and no less
favorable to us than terms that might be available to us from unaffiliated
third parties. The aggregate amount of such purchases were approximately
$74,000, $28,000 and $45,000 in 2001, 2002 and 2003, 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 $45,000, $41,000 and $35,000 in 2001, 2002 and 2003,
respectively. We currently lease office premises in Tel Aviv, Paramus, New-Jersey and
manufacturing premises in Jerusalem from an affiliate. The aggregate amount of
lease payments were approximately $804,000, $708,000, and $628,000 in 2001,
2002, and 2003, 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. 
 C. INTERESTS OF EXPERTS AND COUNSEL Not applicable. - 44 -




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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 2003, the amount of our export sales was approximately $11.1 million,
which represented 99.2% 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. No precise amount of damages has been asserted to date. We
filed an answer to the complaint denying the allegations in the complaint and
served a counterclaim for a declaratory judgment, attacking the patent being
asserted on the basis of non-infringement, invalidity due to prior existing
technology, and unenforceability due to certain alleged improper actions taken
by Acterna in obtaining the patent. We believe that our defenses are
meritorious and we intend to vigorously defend our right to sell the products.
Should it ever become necessary to do so, we believe that we can continue to
sell the accused products using alternative technologies. At this stage, it is
not possible to estimate the amount of the potential damages or the chances of
success. 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, 2003. 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. In October 2003, we received a notice from Nasdaq that our shares would
be delisted from the Nasdaq National Market if we did not demonstrate a plan to
achieve and sustain compliance with all of the continued listing requirements.
We submitted a plan of compliance to Nasdaq and subsequently appeared before a
Nasdaq Listing Qualifications Panel to present an updated plan to achieve and
maintain compliance with all of the Nasdaq National Market continued listing
requirements. Our plan included, among other things, the recently completed
$5.5 million private placement of ordinary shares and warrants. The Panel
determined that we presented a definitive plan that should enable the company
to achieve compliance with the minimum shareholders equity requirement and
stayed the delisting, provided that we publicly evidence achievement of the
minimum shareholders equity requirement on or before March 30, 2004. On March
29, 2004, we announced that we completed the PIPE investment and that as a
result of the closing, management believes we regained compliance with Nasdaqs
$10 million shareholders equity requirement. We will continue to be monitored
by a Nasdaq Listing Qualifications Panel until we meet
certain requirements of the Panels Determination regarding our continued
listing. These requirements - 45 -




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include publicly filing a balance sheet on or
before June 30, 2004, including pro forma adjustments for any significant
events or transactions occurring on or before the date of the filing, to
demonstrate achievement of the shareholders equity requirement. In addition,
we must demonstrate an ability to sustain compliance with the minimum
shareholders equity requirement over the long term. Our unaudited statement of operations for the three months ended March 31,
2004 and unaudited balance sheets as of March 31, 2004 after giving effect to
the PIPE investment are provided below. Consolidated Statements of Operations
(1000s of U.S. dollars, except per share data) Three months ended March 31,2004
    
    2003(unaudited)
    
    (unaudited)Sales
    
    $
    3,504
    
    
    $
    1,600Cost of sales*
    
    
    1,144
    
    
    
    1,621Gross profit (loss)
    
    
    2,360
    
    
    
    (21
    )Research and development, gross
    
    
    1,246
    
    
    
    1,417Less - royalty-bearing participation
    
    
    500
    
    
    
    451Research and development, net
    
    
    746
    
    
    
    966Sales and marketing
    
    
    1,744
    
    
    
    1,822General and administrative
    
    
    452
    
    
    
    393Total operating expenses
    
    
    2,942
    
    
    
    3,181Operating loss
    
    
    (582
    )
    
    
    (3,202
    )Financing income, net
    
    
    6
    
    
    
    22Net loss
    
    
    (576
    )
    
    
    (3,180
    )Basic loss per ordinary share
    
    $
    (0.05
    )
    
    $
    (0.30
    )Weighted average number of
ordinary shares (basic)
    
    
    10,610,274
    
    
    
    10,492,050
 * Cost of Sales for the first quarter of 2003 included an inventory
write-off in the amount of $960,000 - 46 -




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Consolidated Balance Sheets
(1000s of U.S. dollars) As of
    
    As ofMarch 31, 2004
    
    December 31, 2003(unaudited)
    
    (audited)Current AssetsCash and cash equivalents
    
    
    10,460
    
    
    
    5,614Trade receivables, net
    
    
    3,228
    
    
    
    3,769Inventories and inventory prepayments
    
    
    1,826
    
    
    
    1,739Other current assets
    
    
    678
    
    
    
    346Total Current Assets
    
    
    16,192
    
    
    
    11,468Assets held for severance benefits
    
    
    1,470
    
    
    
    1,449Property and equipment, net
    
    
    1,387
    
    
    
    1,486Total Assets
    
    
    19,049
    
    
    
    14,403Liabilities and Shareholders EquityCurrent LiabilitiesTrade payables
    
    
    1,536
    
    
    
    1,152Other payables and accrued expenses
    
    
    4,283
    
    
    
    4,849Total Current Liabilities
    
    
    5,819
    
    
    
    6,001Liability for employees severance pay
benefits
    
    
    2,159
    
    
    
    2,156Total Liabilities
    
    
    7,978
    
    
    
    8,157Shareholders EquityShare capital
    
    
    100
    
    
    
    57Additional paid-in capital
    
    
    43,631
    
    
    
    38,273Accumulated deficit
    
    
    (32,660
    )
    
    
    (32,084
    )Total Shareholders Equity
    
    
    11,071
    
    
    
    6,246Total Liabilities and
Shareholders Equity
    
    
    19,049
    
    
    
    14,403
 - 47 -




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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: High
    
    Low1999
    
    $
    7.88
    
    
    $
    2.192000
    
    $
    20.50
    
    
    $
    2.442001
    
    $
    4.75
    
    
    $
    0.742002
    
    $
    2.67
    
    
    $
    0.352003
    
    $
    2.19
    
    
    $
    0.642002First Quarter
    
    $
    2.67
    
    
    $
    1.13Second Quarter
    
    $
    1.46
    
    
    $
    0.50Third Quarter
    
    $
    1.07
    
    
    $
    0.35Fourth Quarter
    
    $
    1.18
    
    
    $
    0.492003First Quarter
    
    $
    1.20
    
    
    $
    0.70Second Quarter
    
    $
    1.10
    
    
    $
    0.64Third Quarter
    
    $
    1.77
    
    
    $
    0.95Fourth Quarter
    
    $
    2.19
    
    
    $
    1.042004First Quarter
    
    $
    2.78
    
    
    $
    1.20Most recent six monthsNovember 2003
    
    $
    2.15
    
    
    $
    1.20December 2003
    
    $
    2.19
    
    
    $
    1.21January 2004
    
    $
    2.78
    
    
    $
    1.25February 2004
    
    $
    2.37
    
    
    $
    1.69March 2004
    
    $
    2.05
    
    
    $
    1.48April 2004
    
    $
    1.99
    
    
    $
    1.30
 
 B. PLAN OF 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. - 48 -




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D. SELLING SHAREHOLDERS Not applicable. 
 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. - 49 -




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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. - 50 -




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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 - 51 -




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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. 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. 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. - 52 -




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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. 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, 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 Our articles of association provide that we may indemnify an office holder
in respect of an obligation or expense imposed on the office holder in respect
of an act performed in his or her capacity as an office holder, as follows:  
    
    a monetary liability imposed on an office holder in favor of
another person in accordance with a judgment, including a settlement
or an arbitration award approved by a court; and
    
    reasonable litigation expenses, including attorneys fees,
incurred by the office holder or which the office holder was ordered
to pay by a court, in a proceeding we instituted against him or her
or which was instituted on our behalf or by another person, or in a
criminal charge from which he or she was acquitted, or a criminal
charge in which he or she was convicted for a criminal offense that
does not require proof of criminal intent. - 53 -




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Our articles of association also include provisions:  
    
    authorizing us to undertake in advance to indemnify an office
holder, provided that the undertaking is restricted to types of
events which our Board of Directors deems to be anticipated at the
time of the undertaking and limited to an amount determined by our
Board of Directors to be reasonable under the circumstances; and
    
    authorizing us to retroactively indemnify an office holder. 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, 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 a majority of the
shares of one party to the merger 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 70 days have passed from the time
that the requisite proposals for approval of the merger were filed with the
Israeli Registrar of Companies. 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 holding at least 75% of the shares voted on the
matter. In - 54 -




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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. 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% share-holder of the company,
unless there is already a majority shareholder of the company. The Israeli
Minister of Justice has the authority to adopt regulations exempting from these
tender offer requirements companies that are publicly traded outside of Israel,
such as ourselves. In any event, if as a result of an acquisition of shares a
purchaser would hold more than 90% of a companys shares, the acquisition must
be made by means of a tender offer for all of the companys shares. If more
than 95% of the outstanding shares are tendered in the tender offer, all shares
that the purchaser offered to acquire are transferred to such purchaser. 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. 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. - 55 -




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Tax Reform On January 1, 2003, the Law for Amendment of the Income Tax Ordinance
(Amendment No. 132), 5762-2002, as amended, known as the tax reform, came into
effect. The tax reform, aimed at broadening the categories of taxable income and
reducing the tax rates imposed on employment income, introduced the following,
among other things:  
    
    Reduction of the tax rate levied on capital gains (other than
gains deriving from the sale of listed securities) derived after
January 1, 2003, to a general rate of 25% for both individuals and
corporations. Regarding assets acquired prior to January 1, 2003,
the reduced tax rate will apply to a proportionate part of the gain,
in accordance with the holding periods of the asset, before or after
January 1, 2003, on a linear basis;
    
    Imposition of Israeli tax on all income of Israeli residents,
individuals and corporations, regardless of the territorial source
of income, including income derived from passive sources such as
interest, dividends and royalties;
    
    Introduction of controlled foreign corporation (CFC) rules
into the Israeli tax structure. Generally, under such rules, an
Israeli resident who holds , directly of indirectly, 10% or more of
the rights in a foreign corporation whose shares are not publicly
traded (or which has offered less than 30% of its shares or any
rights to its shares to the public), in which more than 50% of the
rights are held directly or indirectly by Israeli residents, and a
majority of whose income in a tax year is considered passive income,
will be liable for tax on the portion of such income attributed to
his holdings in such corporation, as if such income were distributed
to him as a dividend;
    
    Imposition of capital gains tax on capital gains realized by
individuals as of January 1, 2003, from the sale of shares of
publicly traded companies (such gain was previously exempt from
capital gains tax in Israel). For information with respect to the
applicability of Israeli capital gains taxes on the sale of ordinary
shares, see Capital Gains Tax on Sales of Our Ordinary Shares
below;
    
    Introduction of a new regime for the taxation of shares and
options issued to employees and officers (including directors); and
    
    Introduction of tax at a rate of 25% on dividends paid by one
Israeli company to another (which are generally not subject to tax),
if the source of such dividends is income that was derived outside
of Israel. General Corporate Tax Structure Generally, Israeli companies are subject to Company Tax at the rate of
36% of taxable income (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. - 56 -




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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. Expenditures not so approved are deductible over a
three-year period. 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. 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
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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. The Government of Israel has indicated that it may amend or eliminate these
provisions of the Inflationary Adjustments Law in the future, due to the low
rate of inflation in Israel in recent years.  
    
    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 following the tax reform)
are taxable at the Company Tax rate in certain circumstances. Capital Gains Tax on Sales of Our Ordinary Shares Israeli law generally imposes a capital gains tax on the sale of capital
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. Pursuant to the tax reform, generally, capital gains tax is imposed at a
rate of 15% on real gains derived on or after January 1, 2003, from the sale of
shares in companies (i) publicly traded on the Tel Aviv Stock Exchange (TASE)
or; (ii) 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), or (iii) companies dual-
traded on both the TASE and Nasdaq or a recognized stock exchange or a
regulated market outside of Israel. This tax rate is contingent upon the
shareholder not claiming a deduction for financing expenses in connection with
such shares, and does not apply to: (i) the sale of shares to a relative (as
defined in the tax reform); (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; or (iii) shareholders who acquired their shares
prior to an initial public offering (that are 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. In December 2003 regulations promulgated pursuant to the tax reform were
amended so that, in certain circumstances, capital gains derived from the sale
and subsequent (same day) repurchase of shares traded on the TASE or from
shares of Israeli companies publicly traded on a recognized stock exchange or
regulated market in a country that has a treaty for the prevention of double
taxation with Israel, may be taxed at a rate equal to the withholding tax rate
applicable to revenues derived from such sale. In accordance with an
announcement published by the Israeli Income Tax Commission, the withholding
tax rate applicable to the sale of such shares until the end of the 2003 tax
year, which was equal at such time to 1% of the revenues generated in their
sale, was determined as the final tax rate applicable to such sale. The
amended regulations also determined that the day of such sale and repurchase
shall be considered the - 58 -




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new date of purchase of such shares. The foregoing was not applicable to:
(i) dealers in securities; (ii) shareholders that report in accordance with the
Inflationary Adjustment Law; (iii) shareholders who acquired their shares
prior to an initial public offering; (iv) in some cases, shareholders that
received their shares within the framework of an employer-employee
relationship; or (iii) shareholders claiming a deduction for financing
expenses in connection with such shares. Such regulations further provided
that with respect to shares of Israeli companies traded in a stock exchange
outside of Israel, the market price determined at the close of the trading day
preceding the day of sale and repurchase of such shares, shall constitute the
new tax basis for any future sale of such shares. Non-Israeli residents are exempt from Israeli capital gains tax on any
gains derived from the sale of shares publicly traded on the TASE, provided
such gains did not derive from a permanent establishment of such shareholders
in Israel, and 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, 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. 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 - 59 -




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U.S. company holding 10% or more of our ordinary shares in the 12 month
period preceding the distribution of such dividends, are 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 June 30, 2004, unless its terms
are extended. Accordingly, requests for new programs or expansions that are
not approved by June 30, 2004 will not confer any tax benefits, unless the term
of the law is extended. 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 36% as stated
above) 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. 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 - 60 -




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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. In 1993, 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 authority 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. - 61 -




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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 and received approval for a third expansion of our Approved
Enterprise in Jerusalem for the period from April 16, 1998 to December 31,
1999. 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 CPI 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. 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 States;
    
    a corporation (or other entity taxable as a corporation for
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
their 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 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 - 62 -




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discussion does not address the potential application of the alternative
minimum tax or United States federal income tax consequences to Holders that
are subject to special treatment, including Holders that :  
    
    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 ordinary shares as part of a straddle, hedge or
conversion transaction with other investments;
    
    acquired their shares upon the exercise of employee stock
options or otherwise as 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 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 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. 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 - 63 -




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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, a foreign personal holding company or a foreign investment
company (as such terms are 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. 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 - 64 -




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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. Passive Foreign Investment Company Status. We would be a passive foreign
investment company (a PFIC) for 2003 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 2003. 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 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. Based upon our market capitalization during each year prior to 2001, we
believe that we were not a PFIC for any 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
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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. 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, 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 ordinary shares. U.S.
Holders are also generally subject to back-up withholding on dividends paid in
the United States on 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, 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. - 66 -




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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 1-800-SEC-0330 for further information on the public reference
room. 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. - 67 -




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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,
2003, approximately $0.3 million of the net proceeds has been used for the
construction of facilities; $7.4 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
$8.5 million has been used for operational expenditures. 
 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, 2003. 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, 2003 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. - 68 -




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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 filed as
an exhibit to this annual report. 
 ITEM 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES In the annual meeting held in September 2003, our shareholders
re-appointed KPMG to serve as our independent auditors. KPMG billed the following fees to us for professional services in each of
the last two fiscal years: Year Ended December 31,2003
    
    2002Audit Fees
    
    $
    11,000
    
    
    $
    35,000Audit-Related Fees
    
    
    
    
    
    
    Tax Fees
    
    $
    26,000
    
    
    $
    34,000All Other Fees
    
    
    
    
    
    
    Total
    
    $
    37,000
    
    
    $
    69,000
 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. During the last two years we were not billed for such services by
KPMG. 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. - 69 -




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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. - 70 -




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PART III 
 ITEM 17. FINANCIAL STATEMENTS We have responded to Item 18 in lieu of this item. 
 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. Exhibit No.
    
    Description1.1
    
    Memorandum of Association*1.2
    
    Articles of Association, as amended**2.1
    
    Form of ordinary share certificate*4.1
    
    2000 Share Option Plan**4.2
    
    1998 Employee Bonus Plan***4.3
    
    1998 Share Option Plan****4.4
    
    International Employee Stock Option Plan*****4.5
    
    Directors Share Incentive Plan (1997)******4.6
    
    Key Employee Share Incentive Plan (1996)*******4.7
    
    2001 Share Option Plan********4.8
    
    2003 Share Option Plan*********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)**********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)**********4.11
    
    Lease Agreement, dated August 12, 1998, between RAD Communications
Ltd. and Radcom Ltd. (English summary accompanied by Hebrew
original)**********
 - 71 -




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Exhibit No.
    
    Description4.12
    
    Lease Agreement, dated December 1, 2000, among Zohar Zisapel
Properties, Inc., Yehuda Zisapel Properties, Inc. and Radcom
Equipment, Inc.**********4.13
    
    Lease Agreement, dated January 22, 2002, between Regus Business
Centre and Radcom Ltd. ***********4.14
    
    Registration Rights Agreement by and among (i) RADCOM Ltd. and (ii)
Yehuda Zisapel, Zohar Zisapel, Moty Ben-Arie and Zohar Gilon*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.*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**********4.17
    
    Share and Warrant Purchase Agreement, dated as of March 17, 2004,
by and between RADCOM Ltd. and the purchasers listed therein4.18
    
    Form of Warrant8
    
    List of Subsidiaries11
    
    Code of Ethics12.1
    
    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 Certified Public Accountants (Israel)14.2
    
    Consent of Blick Rothenberg Certified Public Accountants (UK)
   *
    
    Incorporated herein by reference to the Registration Statement on Form
F-1 of RADCOM Ltd. (File No. 333-05022).**
    
    Incorporated herein by reference to the Registration Statement on Form
S-8 of RADCOM Ltd. (File No. 333-07964). - 72 -




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##### Table of Contents



***
    
    Incorporated herein by reference to the Registration Statement on Form
S-8 of RADCOM Ltd. (File No. 333-13244).****
    
    Incorporated herein by reference to the Registration Statement on Form
S-8 of RADCOM Ltd. (File No. 333-13246).*****
    
    Incorporated herein by reference to the Registration Statement on Form
S-8 of RADCOM Ltd. (File No. 333-13248).******
    
    Incorporated herein by reference to the Registration Statement on Form
S-8 of RADCOM Ltd. (File No. 333-13250).*******
    
    Incorporated herein by reference to the Registration Statement on Form
S-8 of RADCOM Ltd. (File No. 333-13254).********
    
    Incorporated herein by reference to the Registration Statement on Form
S-8 of RADCOM Ltd. (File No. 333-14236).*********
    
    Incorporated herein by reference to the Registration Statement on
Form S-8 of RADCOM Ltd. (File No. 333-111931).**********
    
    Incorporated herein by reference to the Form 20-F of RADCOM Ltd. for
the fiscal year ended December 31, 2000***********
    
    Incorporated herein by reference to the Form 20-F of RADCOM Ltd.
for the fiscal year ended December 31, 2001 - 73 -




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##### Table of Contents



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-CohenName:  Arnon Toussia-CohenTitle:   Chief Executive
Officer
Date: May 5, 2004 - 74 -




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Radcom Ltd. Consolidated Financial Statements
As of December 31, 2003




---



##### Table of Contents



Radcom Ltd. (An Israeli Corporation)
and its consolidated subsidiaries Consolidated Financial Statements as of December 31, 2003 Contents PageReport of Independent Auditors
    
    
    F-2Consolidated Financial Statements:Consolidated Balance Sheets as of December 31, 2003 and 2002
    
    
    F-3 - F-4Consolidated Statements of Operations for the years ended
December 31, 2003, 2002 and 2001
    
    
    F-5Consolidated Statements of Changes in Shareholders Equity for
the years ended December 31, 2003, 2002 and 2001
    
    
    F-6Consolidated Statements of Cash Flows for the years ended
December 31, 2003, 2002 and 2001
    
    
    F-7 - F-8Notes to the Consolidated Financial Statements as of December 31, 2003
    
    
    F-9 - F-50




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##### Table of Contents



Report of Independent Auditors to the Board of Directors and Shareholders of Radcom Ltd. We have audited the accompanying consolidated balance sheets of Radcom Ltd.
(the Company) and its subsidiaries as of December 31, 2003 and 2002, and the
related consolidated statements of operations, changes in shareholders equity
and cash flows for each of the years in the three-year period ended December
31, 2003. These consolidated financial statements are the responsibility of the
Companys Board of Directors and 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
assets as a percentage of total consolidated assets constitute 0.2% as of
December 31, 2002, and 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 have been furnished to us. Our opinion expressed herein, insofar as it
relates to the amounts emanating from financial statements of this subsidiary,
is based solely upon the report of the other auditors. We conducted our audits 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 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 its subsidiaries as of December 31, 2003 and 2002 and the
consolidated results of their operations, their changes in shareholders equity
and their cash flows for each of the years in the three-year period ended
December 31, 2003, 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, February 1, 2004, except for Note 7A(2) and Note 12, as to
which the date is April 20, 2004




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##### Table of Contents



Consolidated Balance Sheets December 312003
    
    2002US$ (in thousands)
    
    US$ (in thousands)AssetsCurrent Assets (Note 9A7)Cash and cash equivalents (Notes 2E and 9A1)
    
    
    5,614
    
    
    
    7,207Short-term bank deposits (Note 9A2)
    
    
    
    
    
    
    3,006Trade receivables, net (Notes 2G and 9A3)
    
    
    3,769
    
    
    
    2,983Inventories and inventory prepayments (Notes 2H and 9A4)
    
    
    1,739
    
    
    
    2,182Other current assets (Note 9A5)
    
    
    346
    
    
    
    601Total current assets
    
    
    11,468
    
    
    
    15,979Assets held for severance benefits (Notes 2I and 5)
    
    
    1,449
    
    
    
    1,187Property and equipment, net (Notes 2J and 4)
    
    
    1,486
    
    
    
    2,263Total Assets
    
    
    14,403
    
    
    
    19,429




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##### Table of Contents



Radcom Ltd. (An Israeli Corporation)
and its consolidated subsidiaries December 312003
    
    2002US$ (in thousands)
    
    US$ (in thousands)Liabilities and Shareholders EquityCurrent Liabilities (Note 9A7)Trade payables
    
    
    1,152
    
    
    
    1,276Other payables and accrued expenses (Note 9A6)
    
    
    4,849
    
    
    
    3,996Total current liabilities
    
    
    6,001
    
    
    
    5,272Long-Term LiabilitiesLiability for employees severance pay benefits (Note 5)
    
    
    2,156
    
    
    
    1,813Total liabilities
    
    
    8,157
    
    
    
    7,085Commitments and contingencies (Note 6)Shareholders Equity (Notes 2P, 2Q, 2T and 7)Share capital *
    
    
    57
    
    
    
    57Additional paid-in capital
    
    
    38,273
    
    
    
    38,146Accumulated deficit
    
    
    (32,084
    )
    
    
    (25,859
    )Total shareholders equity
    
    
    6,246
    
    
    
    12,344Total Liabilities and Shareholders Equity
    
    
    14,403
    
    
    
    19,429
 /s/ Arnon Toussia-Cohen
    
    /s/David ZigdonArnon Toussia-Cohen
    
    David ZigdonChief Executive Officer and Director
    
    Chief Financial Officer
 Date: February 1, 2004, except for Note 7A(2) and Note 12, as to which the
date is April 20, 2004  *
    39,990,680 Ordinary Shares of NIS 0.05 par value and 9,320 Deferred
Shares of NIS 0.05 par value authorized as of December 31, 2003 and 2002;
10,506,876 and 10,492,050 Ordinary Shares issued and outstanding as of
December 31, 2003 and 2002, respectively, and 9,320 Deferred Shares issued
and outstanding as of December 31, 2003 and 2002. The accompanying notes are an integral part of the consolidated financial statements. F-4




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Radcom Ltd. (An Israeli Corporation)
and its consolidated subsidiaries 
 Consolidated Statements of Operations Year ended December 312003
    
    2002
    
    2001US$ (in thousands)
    
    US$ (in thousands)
    
    US$ (in thousands)Sales (Notes 2L and 9B1)
    
    
    11,203
    
    
    
    14,591
    
    
    
    18,676Cost of sales (Note 2N and 9B2)
    
    
    (2)4,894
    
    
    
    5,047
    
    
    
    (1)8,811Gross profit
    
    
    6,309
    
    
    
    9,544
    
    
    
    9,865Operating expenses:Research and development, gross (Notes 2M and 9B3)
    
    
    5,593
    
    
    
    6,481
    
    
    
    (1)9,380Less - royalty-bearing participation (Notes 2N and 6A1)
    
    
    1,997
    
    
    
    2,328
    
    
    
    1,976Research and development, net
    
    
    3,596
    
    
    
    4,153
    
    
    
    7,404Sales and marketing (Note 9B4)
    
    
    7,411
    
    
    
    8,306
    
    
    
    (1)11,513General and administrative (Note 9B5)
    
    
    1,620
    
    
    
    2,018
    
    
    
    (1)2,437Total operating expenses
    
    
    12,627
    
    
    
    14,477
    
    
    
    21,354Operating loss
    
    
    (6,318
    )
    
    
    (4,933
    )
    
    
    (11,489
    )Financing income, net (Note 9B6):Financing income
    
    
    111
    
    
    
    254
    
    
    
    777Financing expenses
    
    
    (18
    )
    
    
    (37
    )
    
    
    (736
    )Financing income, net
    
    
    93
    
    
    
    217
    
    
    
    41Taxes on income (Notes 2R and 8)
    
    
    
    
    
    
    
    
    
    
    Net loss for the year
    
    
    (6,225
    )
    
    
    (4,716
    )
    
    
    (11,448
    )Loss per share (Note 2S):Basic and diluted loss per ordinary share (US$)
    
    
    (0.593
    )
    
    
    (0.449
    )
    
    
    (1.089
    )Weighted average number of ordinary shares used to
compute basic and diluted loss per ordinary share
    
    
    10,493,184
    
    
    
    10,492,050
    
    
    
    10,511,789
  (1)
    See Note 3A.(2)
    See Note 3B. The accompanying notes are an integral part of the consolidated financial statements. F-5




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Radcom Ltd. (An Israeli Corporation)
and its consolidated subsidiaries 
 Consolidated Statements of Changes in Shareholders Equity Share capital
    
    
    
    
    
    AccumulatedAdditional
    
    other
    
    
    
    
    
    TotalNumber of
    
    
    
    
    
    paid-in
    
    comprehensive
    
    Accumulated
    
    Shareholdersshares
    
    Amount
    
    capital
    
    loss
    
    deficit
    
    equityUS$ (thousands)
    
    US$ (thousands)
    
    US$ (thousands)
    
    US$ (thousands)
    
    US$ (thousands)Balance as of
January 1, 2001
    
    
    10,550,770
    
    
    
    58
    
    
    
    38,054
    
    
    
    (367
    )
    
    
    (9,695
    )
    
    
    28,050Changes during 2001:Net loss for the year
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (11,448
    )
    
    
    (11,448
    )Net unrealized loss on
available for sale
securities
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (343
    )
    
    
    
    
    
    
    (343
    )Impairment of available
for sale securities
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    710
    
    
    
    
    
    
    
    710Comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (11,081
    )Exercise of options
    
    
    64,652
    
    
    
    1
    
    
    
    153
    
    
    
    
    
    
    
    
    
    
    
    154Redemption of loans
to employees
    
    
    
    
    
    
    
    
    
    
    59
    
    
    
    
    
    
    
    
    
    
    
    59Acquisition of ordinary
shares by the Company
    
    
    (123,372
    )
    
    
    (2
    )
    
    
    (282
    )
    
    
    
    
    
    
    
    
    
    
    (284
    )Employees stock
option compensation
    
    
    
    
    
    
    
    
    
    
    28
    
    
    
    
    
    
    
    
    
    
    
    28Balance as of
December 31, 2001
    
    
    10,492,050
    
    
    
    57
    
    
    
    38,012
    
    
    
    
    
    
    
    (21,143
    )
    
    
    16,926Changes during 2002:Net loss for the year
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (4,716
    )
    
    
    (4,716
    )Employees stock
option compensation
    
    
    
    
    
    
    
    
    
    
    134
    
    
    
    
    
    
    
    
    
    
    
    134Balance as of
December 31, 2002
    
    
    10,492,050
    
    
    
    57
    
    
    
    38,146
    
    
    
    
    
    
    
    (25,859
    )
    
    
    12,344Changes during 2003:Net loss for the year
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (6,225
    )
    
    
    (6,225
    )Employees stock option
compensation
    
    
    
    
    
    
    
    
    
    
    123
    
    
    
    
    
    
    
    
    
    
    
    123Exercise of options
    
    
    14,826
    
    
    
    *
    
    
    
    4
    
    
    
    
    
    
    
    
    
    
    
    4Balance as of
December 31, 2003
    
    
    10,506,876
    
    
    
    57
    
    
    
    38,273
    
    
    
    
    
    
    
    (32,084
    )
    
    
    6,246
 * Less than 1 thousand. The accompanying notes are an integral part of the consolidated financial statements. F-6




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Radcom Ltd. (An Israeli Corporation)
and its consolidated subsidiaries 
 Consolidated Statements of Cash Flows Year ended December 312003
    
    2002
    
    2001US$ (in thousands)
    
    US$ (in thousands)
    
    US$ (in thousands)Cash flows from operating activities:Net loss for the year
    
    
    (6,225
    )
    
    
    (4,716
    )
    
    
    (11,448
    )Adjustments to reconcile net loss to net cash
used in operating activities:Depreciation and amortization
    
    
    1,145
    
    
    
    1,400
    
    
    
    1,705Decrease in value and accrued interest from
marketable securities
    
    
    
    
    
    
    17
    
    
    
    879Decrease (increase) in value and accrued interest, net,
from short-term bank deposits
    
    
    6
    
    
    
    49
    
    
    
    (55
    )Loss from sale of property and equipment
    
    
    7
    
    
    
    11
    
    
    
    122Employees stock option compensation
    
    
    123
    
    
    
    134
    
    
    
    28Increase (decrease) in severance pay
    
    
    81
    
    
    
    (135
    )
    
    
    313Decrease (increase) in trade receivables, net
    
    
    (786
    )
    
    
    613
    
    
    
    4,268Decrease in other current assets
    
    
    255
    
    
    
    888
    
    
    
    678Decrease in inventories
    
    
    279
    
    
    
    356
    
    
    
    2,218Increase (decrease) in trade payables
    
    
    (147
    )
    
    
    84
    
    
    
    (1,555
    )Increase (decrease) in other payables and
accrued expenses
    
    
    853
    
    
    
    (374
    )
    
    
    (1,070
    )Net cash used in operating activities
    
    
    (4,409
    )
    
    
    (1,673
    )
    
    
    (3,917
    )Cash flows from investing activities:Redemption of short-term bank deposits
    
    
    3,000
    
    
    
    6,600
    
    
    
    Investment in short-term bank deposits
    
    
    
    
    
    
    (3,000
    )
    
    
    (6,600
    )Proceeds from sale of marketable securities
    
    
    
    
    
    
    1,808
    
    
    
    2,595Proceeds from sale of property and equipment
    
    
    34
    
    
    
    46
    
    
    
    312Purchase of property and equipment
    
    
    (222
    )
    
    
    (434
    )
    
    
    (1,196
    )Net cash provided by (used in) investing activities
    
    
    2,812
    
    
    
    5,020
    
    
    
    (4,889
    )
 The accompanying notes are an integral part of the consolidated financial statements. F-7




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Radcom Ltd. (An Israeli Corporation)
and its consolidated subsidiaries Consolidated Statements of Cash Flows (contd) Year ended December 312003
    
    2002
    
    2001US$ (in thousands)
    
    US$ (in thousands)
    
    US$ (in thousands)Cash flows from financing activities:Decrease in short-term bank credit
    
    
    
    
    
    
    
    
    
    
    (21
    )Issue of share capital
    
    
    4
    
    
    
    
    
    
    
    154Redemption of loans to employees
    
    
    
    
    
    
    
    
    
    
    59Acquisition of Companys ordinary shares by
the Company
    
    
    
    
    
    
    
    
    
    
    (284
    )Net cash provided by (used in) financing activities
    
    
    4
    
    
    
    
    
    
    
    (92
    )Increase (decrease) in cash and cash equivalents
    
    
    (1,593
    )
    
    
    3,347
    
    
    
    (8,898
    )Cash and cash equivalents at beginning of year
    
    
    7,207
    
    
    
    3,860
    
    
    
    12,758Cash and cash equivalents at end of year
    
    
    5,614
    
    
    
    7,207
    
    
    
    3,860
 Schedule A - Non-Cash Investing Activities Purchase of property and equipment on credit in the amount of US$ 55 thousand,
US$ 32 thousand and US$ 103 thousand as at December 31, 2003, 2002 and 2001,
respectively. Supplemental disclosures Cash paid for taxes during the years ended December 31, 2003, 2002 and 2001
amounted to US$ 70 thousand, US$ 112 thousand and US$ 63 thousand,
respectively. The accompanying notes are an integral part of the consolidated financial statements. F-8




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Radcom Ltd. (An Israeli Corporation)
and its consolidated subsidiaries 
 Notes to the Consolidated Financial Statements as of December 31, 2003 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 internetworking test solutions and
quality management for a variety of voice and converged data. 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 internetworking
test equipment manufactured by and imported from the Company. In July 1996, the Company incorporated a wholly-owned subsidiary in
Israel, Radcom Investments (1996) Ltd. (the Israeli Subsidiary),
intended to make various investments, including in securities. As at the
balance sheet date, the Israeli subsidiary holds part of the Companys
outstanding shares. 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 U.K subsidiary was 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 Index NIS - 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. F-9




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Radcom Ltd. (An Israeli Corporation)
and its consolidated subsidiaries Notes to the Consolidated Financial Statements as of December 31, 2003 Note 2 - Significant Accounting Policies (contd) B. Financial statements in US dollars (dollars) (contd) 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. Amounts in the financial statements representing the dollar equivalents
of balances denominated in other currencies do not necessarily represent
their real or economic value in dollars and they may not necessarily be
exchangeable for dollars. The consolidated financial statements have been prepared in accordance
with the historical cost convention. C. Estimates and assumptions in the consolidated financial statements 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. 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-10




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Radcom Ltd. (An Israeli Corporation)
and its consolidated subsidiaries Notes to the Consolidated Financial Statements as of December 31, 2003 Note 2 - Significant Accounting Policies (contd)  F.
    
    Marketable securities  In accordance with SFAS No. 115, Accounting for Certain Investments in
Debt and Equity Securities, the Company has classified its marketable
securities as available for sale. Such marketable securities were stated
at market value.Unrealized gains and losses are reported as a separate component of
shareholders equity and comprehensive income (loss).
Other-than-temporary impairment is included in financial income
(expenses).Realized gains and losses are included in financing income (expenses),

net.  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, 2003 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 life insurance policies that are
recorded at their current redemption value, which also represent their
fair value. F-11




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Radcom Ltd. (An Israeli Corporation)
and its consolidated subsidiaries Notes to the Consolidated Financial Statements as of December 31, 2003 Note 2 - Significant Accounting Policies (contd)  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 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 alternative
future 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.Upon the sale or retirement of equipment and leasehold improvements, the
cost and related accumulated depreciation are eliminated from the
respective accounts and the resulting gain or loss is reflected in the
consolidated statement of operations.  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. SFAS 144 has no impact on the
Companys results of operations. F-12




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Radcom Ltd. (An Israeli Corporation)
and its consolidated subsidiaries Notes to the Consolidated Financial Statements as of December 31, 2003 Note 2 - Significant Accounting Policies (contd)  L.
    
    Revenue recognition1.
    
    Revenue from product sales is recognized in accordance with
Statement of Position (SOP)
97-2, Software Revenue Recognition, upon shipment to customers
and 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 one-year free
software update, which includes bugs fixing and hardware warranty
(post customer support  PCS). In these cases, revenue from PCS
during the first year is recognized upon delivery in accordance
with the provisions of SOP 97-2. For other products, the Company
provides PCS for a period greater than one year up to two years.
In these cases, revenue attributable to the PCS to be provided
during the PCS period is unbundled utilizing the Companys price
lists 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.
With respect to the hardware warranty, the Company applied the
provisions of SFAS 5, Accounting for Contingencies, and recorded
an appropriate provision.The Company generally does not grant rights of return except for
defective products for which a warranty allowance is recorded at
the time of the shipment. 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 sells 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.M.
    
    Research and development costs1.
    
    Research and development costs are charged to the statement
of operations as incurred.2.
    
    Software development costs are capitalized in accordance with
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 have been expensed.   F-13




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Radcom Ltd. (An Israeli Corporation)
and its consolidated subsidiaries Notes to the Consolidated Financial Statements as of December 31, 2003   Note 2 - Significant Accounting Policies (contd)  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 hardware products. The balance sheet provision for
warranties for all periods through December 31, 2003, is determined as a
percentage of sales during the year, based upon the Companys past
experience regarding the relationship between sales and warranty expenses
(see Note 2L(1)).The followings are the changes in liability for product warranty: US$ thousandsBalance at December 31, 2001
    
    
    93Warranties for products sold
    
    
    73Warranty expenses
    
    
    (21
    )Lapsed warranties
    
    
    (72
    )Balance at December 31, 2002
    
    
    73Warranties for product sold
    
    
    86Warranty expenses
    
    
    (21
    )Lapsed warranties
    
    
    (47
    )Balance at December 31, 2003
    
    
    91
  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. F-14




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##### Table of Contents



Radcom Ltd. (An Israeli Corporation)
and its consolidated subsidiaries Notes to the Consolidated Financial Statements as of December 31, 2003 Note 2 - Significant Accounting Policies (contd)  P.
    
    Stock option plans (contd)  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 7D): Year ended
    
    Year ended
    
    Year endedDecember 31
    
    December 31
    
    December 312003
    
    2002
    
    2001US$ (in thousands)
    
    US$ (in thousands)
    
    US$ (in thousands)Net loss as reported
    
    
    (6,225
    )
    
    
    (4,716
    )
    
    
    (11,448
    )Add: compensation expenses according to APB 25
included in the reported net loss
    
    
    123
    
    
    
    134
    
    
    
    28Deduct: compensation expenses according
to SFAS 123
    
    
    (840
    )
    
    
    (1,294
    )
    
    
    (2,293
    )Net loss - pro forma
    
    
    (6,942
    )
    
    
    (5,876
    )
    
    
    (13,713
    )Basic and diluted loss per share as reported (US$)
    
    
    (0.593
    )
    
    
    (0.449
    )
    
    
    (1.089
    )Pro forma basic and diluted loss per share (US$)
    
    
    (0.662
    )
    
    
    (0.560
    )
    
    
    (1.305
    )
  Q.
    
    Comprehensive income  The Company applies SFAS No. 130, Reporting Comprehensive Income. SFAS
No. 130 established standards for reporting and presentation of
comprehensive income and its components in a full set of financial
statements. Comprehensive income consists of net income and net
unrealized gains (losses) on securities and is presented in the statement
of shareholders equity. SFAS No. 130 requires only additional
disclosures in the consolidated financial statements; it does not affect
the Companys financial position or results of operations. F-15




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##### Table of Contents



Radcom Ltd. (An Israeli Corporation)
and its consolidated subsidiaries Notes to the Consolidated Financial Statements as of December 31, 2003  Note 2
    - Significant Accounting Policies (contd)  R.
    
    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.  S.
    
    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. Diluted loss per share reflects the effect
of ordinary shares issued upon exercise of stock options and warrants.
The common stock equivalent of anti-dilutive securities is not included
in the computation of diluted loss per share.  T.
    
    Treasury stock  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.  U.
    
    Reclassification  Certain prior year amounts have been reclassified to conform with current
year presentation. F-16




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Radcom Ltd. (An Israeli Corporation)
and its consolidated subsidiaries Notes to the Consolidated Financial Statements as of December 31, 2003 Note 3 - Employee Layoffs, Inventories Write-Off, Provision for Doubtful Debts,
and Assets Write-Off  A.
    
    During the year 2001, the Companys management adjusted their
forecast for the 2001 fiscal year and year 2002 turnover, due to the
sharp and unexpected decline in demand for telecommunication
equipment, including the Companys products. Based on its updated
estimate, Management decided to dismiss approximately 50 employees
(about 23% of its workforce), and adjust the value of certain assets
of the Company.  1.
    
    Employee LayoffsManagement recorded a provision for employee layoffs in 2001
which amounted to US$ 1,200 thousand. This charge was
recorded in cost of sales (US$ 275 thousand), gross research
and development (US$ 645 thousand), sales and marketing (US$
260 thousand) and general and administrative expenses (US$ 20
thousand).2.
    
    Inventories Write-OffManagement wrote-off inventories in 2001 which amounted to
US$ 1,061 thousand which in their estimate, reflects
reduction of inventories to their realizable value. This
charge was recorded in cost of sales.3.
    
    Provision for Doubtful Debts and OthersManagement recorded a provision for doubtful debts and others
in 2001 which amounted to US$ 401 thousand. This charge was
recorded in general and administrative expenses.4.
    
    Assets Write-OffManagement recorded in 2001 a charge in respect of write-off
of demonstration equipment and other assets which amounted to
US$ 115 thousand and US$ 60 thousand, respectively, which
were recorded in sales and marketing expenses and gross
research and development, respectively.  B.
    1.
    
    In January 2002, the Company reduced salaries for both
management and non-management employees.2.
    
    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.3.
    
    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-17




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##### Table of Contents



Radcom Ltd. (An Israeli Corporation)
and its consolidated subsidiaries Notes to the Consolidated Financial Statements as of December 31, 2003 Note 4 - Property and Equipment, Net  A.
    
    Composition of assets, grouped by major classification, is as follows: December 312003
    
    2002US$ (in thousands)
    
    US$ (in thousands)CostDemonstration and rental equipment
    
    
    3,859
    
    
    
    3,709Research and development equipment
    
    
    4,275
    
    
    
    4,110Motor vehicles
    
    
    116
    
    
    
    198Manufacturing equipment
    
    
    1,123
    
    
    
    1,062Office furniture and equipment
    
    
    1,212
    
    
    
    1,237Leasehold improvements
    
    
    392
    
    
    
    54310,977
    
    
    
    10,859Accumulated depreciationDemonstration and rental equipment
    
    
    3,613
    
    
    
    3,352Research and development equipment
    
    
    3,678
    
    
    
    3,185Motor vehicles
    
    
    83
    
    
    
    104Manufacturing equipment
    
    
    861
    
    
    
    740Office furniture and equipment
    
    
    1,022
    
    
    
    880Leasehold improvements
    
    
    234
    
    
    
    3359,491
    
    
    
    8,5961,486
    
    
    
    2,263
  B.
    
    Depreciation expenses amounted to US$ 1,145 thousand, US$
1,400 thousand and US$ 1,685 thousand for the years ended December
31, 2003, 2002 and 2001, 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. F-18




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Radcom Ltd. (An Israeli Corporation)
and its consolidated subsidiaries Notes to the Consolidated Financial Statements as of December 31, 2003 Note 5 - Liability for Employees Severance Pay Benefits (contd)  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, 2003, 2002 and 2001 amounted to
US$ 567 thousand, US$ 358 thousand (see also Note 3A(1)) and US$ 1,327
thousand, respectively. Note 6 - Commitments and Contingencies  A.
    
    Royalty commitments1.
    
    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 2002, and will be 3.5% in
subsequent years.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 Companys total outstanding contingencies in respect of
royalty-bearing participation received or accrued, net of royalties
paid or accrued, amounted to approximately US$ 16.1 million as of
December 31, 2003.2.
    
    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.As of December 31, 2003, total grants received, net of royalties
paid or accrued, amounted to approximately US$ 281 thousand.3.
    
    The Company is committed to pay royalties to certain
companies (including related parties) for the integration of certain
of these companies technologies into certain of the Companys
products. Royalties are payable based on the volume of sales of
such products, as long as the Company uses such technologies,
without limit as to the amount.Such royalties are based on a fixed amount per product sold by the
Company, or a percentage of the list price of such products. F-19




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##### Table of Contents



Radcom Ltd. (An Israeli Corporation)
and its consolidated subsidiaries Notes to the Consolidated Financial Statements as of December 31, 2003 Note 6 - Commitments and Contingencies (contd)  B.
    
    Rental commitments  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 expire
on December 31, 2005 and on January 31, 2006, respectively. Since
January 2002, a part of the premises in New Jersey are leased to a
sublessee according to a sublease agreement which expires in January 2006
at a yearly rate of US$ 41 thousand. In addition, the Company rented
additional office premises in Tel Aviv. This rental agreement expires on
October 20, 2004. Some of these agreements are renewable at the
Companys option. Minimum future gross rental payments due under the
above agreements, at exchange rates in effect on December 31, 2003 are as
follows: Year ended December 31
    
    US$ (in thousands)2004
    
    
    6742005
    
    
    6222006
    
    
    7
  Rental expenses (net of premises under sublease agreement) amounted to
US$ 676 thousand, US$ 744 thousand and US$ 875 thousand, for the years
ended December 31, 2003, 2002 and 2001, respectively.  C.
    
    Operating leases  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, 2003, non-cancelable operating rentals are payable as
follows: Year ended December 31
    
    US$ (in thousands)2004
    
    
    1512005
    
    
    212006
    
    
    62007
    
    
    1
  During 2003, 2002 and 2001, an amount of US$ 347 thousand, US$ 473
thousand and US$ 431 thousand, respectively, was recognized as an expense
in the statement of operation in respect of operating leases. F-20




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##### Table of Contents



Radcom Ltd. (An Israeli Corporation)
and its consolidated subsidiaries Notes to the Consolidated Financial Statements as of December 31, 2003 Note 6 - Commitments and Contingencies (contd)  D.
    
    Indemnification agreements  On September 10, 2003, the annual general meeting of the shareholders of
the Company resolved to approve a maximum liability under all
indemnification agreements entered into with the Companys directors and
officers in the amount of US$ 15 million with regard to any financial
obligation imposed by a court judgment or related settlements and all
reasonable litigation expenses in respect of acts performed in their
capacity as directors and officers. At the same meeting, the
shareholders of the Company also approved the Companys purchase of a
directors and officers liability insurance policy, with maximum coverage
of US$ 15 million for the benefit of all directors of the Company.In September 2003, the Company entered into a directors and officers
liability insurance policy regarding acts and omissions of officers and
directors. The policy covers a maximum liability of US$ 5 million full
coverage and US$ 3 million Side A Only for each of the prospectus and
non-prospectus policies, with a year premium of approximately US$ 112
thousand.  E.
    
    Purchase of inventory  On November 6, 2002, an amendment of an agreement dated June 1, 1999 was
signed between the Company and a supplier. In accordance with the
amendment, the Company undertook to purchase chips for the total amount
of US$ 530 thousand, of which US$ 265 thousand will be paid upon the
signing of the agreement and the balance will be paid upon delivery of
the chips and/or on March 1, 2003, whichever earlier. As at December 31,
2003, the Company had purchased chips in the total amount of US$ 58
thousand. Furthermore, as at December 31, 2003, the Company had made an
advance payment in the amount of US$ 472 thousand which is included in
inventories and inventory prepayments.  F.
    
    Legal proceedings  On December 31, 2003, a company from New Jersey
(hereinafter - CNJ) filed
a complaint against the Company and its US subsidiary in the District
Court of New Jersey in which it alleges that both companies have
infringed its patent in two products that the Company has sold. The
amount of the damages has not been determined in the complaint. On
January 13, 2004, the complaint was served on the US subsidiary. The
complaint against the Company has not been served on it. As of signing
the financial statements, the Company has not yet submitted its defense
statements.At this early stage, it is not possible to estimate the amount of the
lawsuit or the chances of this lawsuit. F-21




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##### Table of Contents



Radcom Ltd. (An Israeli Corporation)
and its consolidated subsidiaries Notes to the Consolidated Financial Statements as of December 31, 2003 Note 7 - Shareholders Equity  A.
    
    Share capital1.
    
    Comprised of: December 31, 2003Authorized
    
    Issued
    
    OutstandingNumber of sharesOrdinary 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
 December 31, 2002Authorized
    
    Issued
    
    OutstandingNumber of sharesOrdinary Shares of NIS 0.05 par value (i)
    
    
    39,990,680
    
    
    
    *10,492,050
    
    
    
    *10,492,050Deferred 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 are non-voting and non-participatory.  2.
    
    Nasdaq ListingThe 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. F-22




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##### Table of Contents



Radcom Ltd. (An Israeli Corporation)
and its consolidated subsidiaries Notes to the Consolidated Financial Statements as of December 31, 2003 Note 7 - Shareholders Equity (contd)  A.
    
    Share capital (contd)  On January 15, 2004, the Company had a hearing before Nasdaq Listing
Qualifications Panel (Panel) to review the Staff Determination.
As a result of a private placement transaction (see Note 12), the Panel
determined that the Company presented a definitive plan that should
enable the Company to achieve compliance with the minimum shareholders
equity requirement and stayed the delisting, provided that the Company
publicly evidence achievement of the minimum shareholders equity
requirement on or before March 30, 2004. The Company will continue to be
monitored by a Panel until the Company meets certain requirements of the
Panels Determination regarding its continued listing.  B.
    
    Dividends  Dividends may be paid by the Company only out of unconsolidated earnings
and other surplus in Israeli currency as defined in the Companies Law as
of the end of the most recent fiscal year or as accrued over a period of
two years, whichever is higher. Such dividends will be declared and paid
in New Israeli Shekels. There are no restrictions on the ability of the
US Subsidiary and the UK Subsidiary to transfer funds to their parent,
and there are no restrictions on the transfer of funds to foreign
shareholders for the payment of dividends (see also Note 8B1(f)).  C.
    
    Share option plans1.
    
    The Company has granted options under option plans as follows:  a.
    
    Directors Share Option PlanIn September 1999, the annual general meeting of the
shareholders of the Company resolved (following approval by
the Audit Committee and the Board of Directors of the
Company) to reserve 475,000 Ordinary shares for the purposes
of the Director plan, of which 225,000 options were granted
to the Directors, at an exercise price of US$ 4.5312 per
share. 40,000 of these options were cancelled, and 20,000 of
these options were forfeited.In December 2000, the Annual General Meeting of the Company
granted additional options to purchase 100,000 Ordinary
Shares at an exercise price of US$ 4.50 per share. 45,000 of
these options were cancelled.On January 1, 2002, the Board of Directors of the Company
resolved to grant options to purchase 165,000 Ordinary Shares
to directors of the Company. Of these options, the Chairman
of the Board was granted 45,000 options. In September 2002,
these grants were approved by the Companys shareholders at
the annual general meeting.On July 10, 2003, the Board of Directors of the Company
resolved that reserved shares in respect of which options had
not been granted to date under the Directors Share Option
Plan shall be transferred for issuance under the 2003 Share
Option Plan. Following the Board of Directors resolution,
on September 10, 2003, the annual general meeting of the
shareholders resolved to approve the transfer of 212,500 such
reserved shares. F-23




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##### Table of Contents



Radcom Ltd. (An Israeli Corporation)
and its consolidated subsidiaries Notes to the Consolidated Financial Statements as of December 31, 2003 Note 7 - Shareholders Equity (contd)  C.
    
    Share option plans (contd)  b.
    
    Employee option plans  (1)
    
    On November 16, 1998, the Board of
Directors of the Company resolved:  (a)
    
    to replace the then
existing Employee Incentive Option Plan (1996)
with the following three other plans:  A.
    
    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 0.05 New Israeli Shekel.The plan is made pursuant to the provisions
of section 3(9) of the Israeli Income Tax
Ordinance.Exercise price shall be determined by the
Committee.The options and the right to acquire shares
shall terminate within 10 years after the
date of the grantB.
    
    The Radcom
Ltd. 1998 Employees Bonus Plan (the Radcom
Bonus Plan)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.In 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. F-24




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##### Table of Contents



Radcom Ltd. (An Israeli Corporation)
and its consolidated subsidiaries Notes to the Consolidated Financial Statements as of December 31, 2003 Note 7 - Shareholders Equity (contd)  C.
    
    Share option plans (contd)  b.
    
    Employee option plans (contd)  B.
    
    The Radcom Ltd. 1998 Employees Bonus Plan (the Radcom
Bonus Plan) (contd)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.The plan was accounted for as a noncompensatory plan in accordance with
paragraphs 7 and 8 of APB No. 25.C.
    
    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). F-25




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##### Table of Contents



Radcom Ltd. (An Israeli Corporation)
and its consolidated subsidiaries Notes to the Consolidated Financial Statements as of December 31, 2003 Note 7 - Shareholders Equity (contd)  C.
    
    Share option plans (contd)  b.
    
    Employee option plans (contd)  (b)
    
    to reserve 720,000 Authorized, but unissued Ordinary shares, of a par
value of NIS 0.05 each, of the Company for
purposes of the three Option Plans; and -(c)
    
    to equalize the exercise price of the options in the 3(9) plan, the Radcom
Plan and the International Plan, to the share
market price at that day, which was US$2.375. The
Board of Directors also resolved to extend the
vesting period of the unvested options (at the
date of the resolution) granted to officers (the
3(9) plan) and to the companys subsidiarys
employees (the International Plan) by one year.
Since the exercise price reflects the fair value
of the ordinary shares at date of a repricing, no
compensation has been recorded in accordance with
EITF 87-33.  (2)
    
    2000 share option planDuring 2000, the annual general meeting of the shareholders of the Company adopted the Companys 2000
share option plan (the 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 (3(9) Options).On July 17, 2000 the Board of Directors of the Company
resolved to reserve 650,000 Ordinary Shares for issuance pursuant to the 2000 Share Option Plan. F-26




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##### Table of Contents



Radcom Ltd. (An Israeli Corporation)
and its consolidated subsidiaries Notes to the Consolidated Financial Statements as of December 31, 2003 Note 7 - Shareholders Equity (contd)  C.
    
    Share option plans (contd)1.
    
    The Company has granted options under option plans as follows: (contd)  b.
    
    Employee option plans (contd)  (3)
    
    2001 share option planDuring 2000, the annual general meeting of the shareholders of the Company adopted the Companys 2001
share option plan (the 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.On December 11, 2000 the annual general meeting of the
shareholders of the Company resolved (following
approval by the Audit Committee and the Board of
Directors of the Company) to reserve 4% from the
Outstanding Ordinary Shares of the Company, every year
for three years starting January 1, 2001 and ending
December 31, 2003, for the purposes of the 2001 Share
Option Plan.On January 1, 2002, the Board of Directors of the
Company resolved to grant options to purchase 480,000
Ordinary Shares to officers of the Company under the
2001 Share Option Plan. Of these options, the Chief
Executive Officer was granted 120,000 options.On December 22, 2002, the Board of Directors of the
Company resolved that reserved shares in respect of
which options have not been granted to date under the
2001 Share Option Plan shall be transferred for
issuance under the 2003 Share Option Plan. Following
the Board of Directors resolution, on September 10,
2003, the annual general meeting of the shareholders
resolved to approve the transfer of 734,248 of such
reserved shares. F-27




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##### Table of Contents



Radcom Ltd. (An Israeli Corporation)
and its consolidated subsidiaries Notes to the Consolidated Financial Statements as of December 31, 2003 Note 7 - Shareholders Equity (contd)  C.
    
    Share option plans (contd)1.
    
    The Company has granted options under option plans as follows: (contd)  b.
    
    Employee option plans (contd)  (4)
    
    2003 Share Option PlanIn December 2002, the Board of Directors of the Company
approved the Companys 2003 share option plan (the
2003 Share Option Plan).On September 10, 2003, the annual general meeting of
the shareholders approved the adoption of this 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.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)) for
the first year.
The Board of Directors of the Company resolved to
reserve 3% from the Outstanding Ordinary Shares of the
Company for the purposes of the 2003 Share Option Plan.On January 26, 2003, the Board of Directors of the
Company and the Audit Committee resolved to grant
options to purchase 210,000 Ordinary Shares to
directors of the Company under the 2003 Share Option
Plan. Of these options, the Chairman of the Board was
granted 60,000 options and the Chief Executive Officer
was granted 30,000 options. On September 10, 2003, the
annual general meeting of the shareholders approved the
grant of 180,000 options out of the 210,000.On September 10, 2003, the annual general meeting of
the shareholders resolved to approve the transfer of
734,248 and 212,500 reserved shares from the 2001 Share
Option Plan and the Directors Share Option Plan for
issuance under the 2003 Share Option Plan.On October 19, 2003, the Board of Directors of the
Company and the Audit Committee resolved to grant
options to purchase 30,000 Ordinary shares at an
exercise price of US$ 1.27 to the Chief Executive
Officer of the Company under the 2003 Share Option
Plan. This grant is subject to the approval of the
Companys shareholders at the next annual general
meeting. F-28




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##### Table of Contents



Radcom Ltd. (An Israeli Corporation)
and its consolidated subsidiaries Notes to the Consolidated Financial Statements as of December 31, 2003 Note 7 - Shareholders Equity (contd)  C.
    
    Share option plans (contd)1.
    
    The Company has granted options under option plans as follows: (contd)  b.
    
    Employee option plans (contd)  (5)
    
    During 2003, the Board of Directors
granted options to employees under the 2003 Share Option
Plan.During 2002, the Board of Directors granted options to
employees under the 2001 Share Option Plan, the 2000
Share Option Plan, the 3(9) Plan and the International
Plan. During 2001, the Board of Directors granted
options to employees under the 2000 Share Option Plan
and the International Plan. All grants in 2002 and
2001 were at exercise prices which reflect the market
value of the Ordinary Shares at grant date.(6)
    
    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. F-29




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##### Table of Contents



Radcom Ltd. (An Israeli Corporation)
and its consolidated subsidiaries Notes to the Consolidated Financial Statements as of December 31, 2003 Note 7 - Shareholders Equity (contd)  C.
    
    Share option plans (contd)2.
    
    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, 2003Expiration (fromVested
    
    Unvested
    
    Exercise price
    
    Vesting period
    
    resolution date)No. of options
    
    US$
    
    Years
    
    YearsThe Directors
Share Option Plan
    
    
    347,200
    
    
    
    90,000
    
    
    
    1.84-6.25
    
    
    
    3
    
    
    
    5The Radcom
Bonus Plan
    
    
    237,532
    
    
    
    
    
    
    
    2.3125-13.375
    
    
    
    3
    
    
    
    6The Radcom
3(9) Plan
    
    
    507,800
    
    
    
    25,000
    
    
    
    2.3125-5.75
    
    
    
    3-6
    
    
    
    10The International
Plan
    
    
    128,691
    
    
    
    64,597
    
    
    
    0.00-3.875
    
    
    
    1-4
    
    
    
    10The 2000
Share Option
Plan
    
    
    371,378
    
    
    
    218,018
    
    
    
    0.00-6.125
    
    
    
    3-4
    
    
    
    10The 2001
Share Option
Plan
    
    
    148,998
    
    
    
    388,002
    
    
    
    0.51-1.84
    
    
    
    3-4
    
    
    
    10The 2003
Share Option
Plan
    
    
    
    
    
    
    478,150
    
    
    
    1.03-1.27
    
    
    
    2-4
    
    
    
    101,741,599
    
    
    
    1,263,767
 F-30




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##### Table of Contents



Radcom Ltd. (An Israeli Corporation)
and its consolidated subsidiaries Notes to the Consolidated Financial Statements as of December 31, 2003 Note 7 - Shareholders Equity (contd)  C.
    
    Share option plans (contd)2.
    
    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, 2002Expiration (fromVested
    
    Unvested
    
    Exercise price
    
    Vesting period
    
    resolution date)No. of options
    
    US$
    
    Years
    
    YearsThe Directors
Share Option Plan
    
    
    273,866
    
    
    
    183,334
    
    
    
    1.84-6.25
    
    
    
    3
    
    
    
    5The Radcom
Bonus Plan
    
    
    235,532
    
    
    
    2,000
    
    
    
    2.3125-13.375
    
    
    
    3
    
    
    
    6The Radcom
3(9) Plan
    
    
    474,050
    
    
    
    71,750
    
    
    
    0.51-5.75
    
    
    
    3-6
    
    
    
    10The International
Plan
    
    
    86,120
    
    
    
    132,670
    
    
    
    0.00-3.875
    
    
    
    1-4
    
    
    
    10The 2000
Share Option
Plan
    
    
    194,426
    
    
    
    490,268
    
    
    
    0.00-6.125
    
    
    
    3-4
    
    
    
    10The 2001
Share Option
Plan
    
    
    
    
    
    
    543,000
    
    
    
    0.51-1.84
    
    
    
    3-4
    
    
    
    101,263,994
    
    
    
    1,423,022
 F-31




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##### Table of Contents



Radcom Ltd. (An Israeli Corporation)
and its consolidated subsidiaries Notes to the Consolidated Financial Statements as of December 31, 2003 Note 7 - Shareholsders Equity (contd)  C.
    
    Share option plans (contd)3.
    
    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, the 2003 Share Option Plan
and the warrants: Weighted
    
    Weightedaverage
    
    average valueNumber of
    
    exercise
    
    of optionsoptions
    
    price
    
    granted (1)US$
    
    US$Options unexercised as at January 1, 2001
    
    
    2,483,160
    
    
    
    5.092
    
    
    
    5.318Granted during 2001
    
    
    148,600
    
    
    
    1.523
    
    
    
    1.338Exercised during 2001
    
    
    (64,652
    )
    
    
    2.375
    
    
    
    2.080Expired during 2001
    
    
    (115,004
    )
    
    
    6.857
    
    
    
    3.493Forfeited during 2001
    
    
    (432,217
    )
    
    
    5.320
    
    
    
    5.113Options unexercised as at December 31,
2001
    
    
    2,019,887
    
    
    
    3.492
    
    
    
    2.934Granted during 2002
    
    
    1,045,570
    
    
    
    1.677
    
    
    
    0.837Expired during 2002
    
    
    (217,852
    )
    
    
    6.669
    
    
    
    4.404Forfeited during 2002
    
    
    (160,589
    )
    
    
    2.472
    
    
    
    2.520Options unexercised as at December 31,
2002
    
    
    2,687,016
    
    
    
    2.593
    
    
    
    2.024Granted during 2003
    
    
    478,150
    
    
    
    1.180
    
    
    
    0.457Exercised during 2003
    
    
    (14,826
    )
    
    
    0.297
    
    
    
    0.955Expired during 2003
    
    
    (37,147
    )
    
    
    1.960
    
    
    
    2.099Forfeited during 2003
    
    
    (107,827
    )
    
    
    1.031
    
    
    
    0.877Options unexercised as at December 31,
2003
    
    
    3,005,366
    
    
    
    2.443
    
    
    
    1.820
  (1)
    
    The fair value of each option grant is estimated
on the date of grant using the Black  Scholes option-pricing
model.(2)
    
    As at December 31, 2003, 2002 and 2001, the
number of options exercisable was 1,741,599, 1,263,994 and
1,008,981, respectively, and the total number of authorized
options was 3,874,901, 3,465,103 and 3,040,479, respectively. F-32




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##### Table of Contents



Radcom Ltd. (An Israeli Corporation)
and its consolidated subsidiaries Notes to the Consolidated Financial Statements as of December 31, 2003 Note 7 - Shareholders Equity (contd)  C.
    
    Share option plans (contd)3.
    
    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, the 2003 Share Option Plan
and the warrants: (contd) December 31,2003
    
    2002
    
    2001Exercise price (US$ per share)
    
    Number of options0.00
    
    
    339,926
    
    
    
    395,890
    
    
    
    439,8150.51-1.84
    
    
    1,465,618
    
    
    
    1,081,054
    
    
    
    108,6502.3125 - 2.375
    
    
    363,768
    
    
    
    365,768
    
    
    
    427,4502.50 - 4.5312
    
    
    402,520
    
    
    
    402,770
    
    
    
    415,6025.1875 - 5.75
    
    
    265,000
    
    
    
    273,000
    
    
    
    273,6676.125 -6.50
    
    
    157,200
    
    
    
    157,200
    
    
    
    226,0357.3125- 8.125
    
    
    
    
    
    
    
    
    
    
    3349.50
    
    
    
    
    
    
    
    
    
    
    86,0009.9375- 13.375
    
    
    11,334
    
    
    
    11,334
    
    
    
    42,3343,005,366
    
    
    
    2,687,016
    
    
    
    2,019,887
  D.
    
    Effect of SFAS 123  The Company applies APB 25 and related interpretations in accounting for
stock options to employees and directors.The unamortized balance of the compensation expenses according to SFAS
123 in respect of these stock option grants amounted to US$ 610 thousand
as of December 31, 2003, which will be amortized in accordance with the
vesting period of the options by the end of fiscal 2007. F-33




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##### Table of Contents



Radcom Ltd. (An Israeli Corporation)
and its consolidated subsidiaries Notes to the Consolidated Financial Statements as of December 31, 2003 Note 7 - Shareholders Equity (contd)  D.
    
    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, 2003, 2002 and 2001 would have been as follows: Year ended
    
    Year ended
    
    Year endedDecember 31
    
    December 31
    
    December 312003
    
    2002
    
    2001US$ (in thousands)
    
    US$ (in thousands)
    
    US$ (in thousands)Net loss as reported
    
    
    (6,225
    )
    
    
    (4,716
    )
    
    
    (11,448
    )Add: compensation expenses according to APB 25
included in the reported net loss
    
    
    123
    
    
    
    134
    
    
    
    28Deduct: compensation expenses according
to SFAS 123
    
    
    (840
    )
    
    
    (1,294
    )
    
    
    (2,293
    )Net loss - pro forma
    
    
    (6,942
    )
    
    
    (5,876
    )
    
    
    (13,713
    )Basic and diluted loss per share as reported (US$)
    
    
    (0.593
    )
    
    
    (0.449
    )
    
    
    (1.089
    )Pro forma basic and diluted loss per share (US$)
    
    
    (0.662
    )
    
    
    (0.560
    )
    
    
    (1.305
    )
  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 for dollar linked financial
investments as published by the Tel Aviv Stock Exchange are as
follows: %Year ended December 31, 2001
    
    
    2.5-5Year ended December 31, 2002
    
    
    1.5-2Year ended December 31, 2003
    
    
    1-1.5
  4.
    
    Expected lives of 3-10 years (as of the date of the grant) for each
option granted.5.
    
    Expected annual volatility of 25.3%, 45.1% and 90.4% for the
years ended December 31, 2003, 2002 and 2001, respectively. F-34




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##### Table of Contents



Radcom Ltd. (An Israeli Corporation)
and its consolidated subsidiaries Notes to the Consolidated Financial Statements as of December 31, 2003 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. The main provisions of the tax
reform that may affect the Company are as follows:  1.
    
    Transfer pricing of international transactions with related
partiesThe Income Tax Ordinance was amended to include provisions
concerning transfer pricing between related parties, where one of
the parties is situated abroad. Detailed provisions are to be
included in Income Tax Regulations that have yet to be issued.
Although the Company considers the transfer pricing policy adopted
with foreign affiliates is to be economically fair, an adjustment
may be required following the issue of the Regulations.2.
    
    Employee stock incentive plansThe tax reform codified past practice and determined three
alternative tracks for taxing employee stock option plans. 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 50% (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 under plans adopted before December 31, 2002. The options
granted by the Company during 2003 were granted pursuant the
Capital Gains Route.3.
    
    Controlled foreign company (CFC)The amendment to the law introduced Controlled Foreign Company
(CFC) provisions, which, in certain circumstances, will lead to the
Israeli company being charged tax on passive income of foreign
affiliates as if it had received a dividend from such companies.4.
    
    Capital gains taxCapital gains tax is reduced to 25% from 36%, except with respect
to capital gains from marketable securities, with transitional
provisions for assets acquired prior to January 1, 2003.5.
    
    Carryforward capital lossesThe seven year limit for carrying forward of capital losses has
been removed with respect to capital losses arising from 1996 and
thereafter. F-35




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##### Table of Contents



Radcom Ltd. (An Israeli Corporation)
and its consolidated subsidiaries Notes to the Consolidated Financial Statements as of December 31, 2003 Note 8 - Taxes on Income (contd)  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.(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. F-36




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##### Table of Contents



Radcom Ltd. (An Israeli Corporation)
and its consolidated subsidiaries Notes to the Consolidated Financial Statements as of December 31, 2003 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)(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.(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, which was
36% in 1996 and thereafter.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. F-37




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##### Table of Contents



Radcom Ltd. (An Israeli Corporation)
and its consolidated subsidiaries Notes to the Consolidated Financial Statements as of December 31, 2003 Note 8 - Taxes on Income (contd)  B.
    
    Tax benefits under the Law for the Encouragement of Capital
Investments, 1959
(the Law) (contd)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.  E.
    
    Carryforward tax loss  The Companys carryforward tax losses were approximately US$ 18,906
thousand and US$ 15,930 thousand as of December 31, 2003 and 2002,
respectively (see also Note 8D). F-38




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##### Table of Contents



Radcom Ltd. (An Israeli Corporation)
and its consolidated subsidiaries Notes to the Consolidated Financial Statements as of December 31, 2003 Note 8 - Taxes on Income (contd)  F.
    
    US Subsidiary1.
    
    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$ 10,257 thousand as of December 31, 2003 (2002 -
US$ 8,650 thousand). Such losses are available to offset any future
US taxable income of the US subsidiary and will expire in the years
2008 - 2023.3.
    
    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$ 359
thousand as of December 31, 2003 (2002 - US$ 302 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 312003
    
    2002US$ (in thousands)
    
    US$ (in thousands)Tax asset in respect of:Allowance for doubtful accounts
    
    
    40
    
    
    
    203Severance pay
    
    
    254
    
    
    
    226Vacation pay
    
    
    248
    
    
    
    225Research and development
    
    
    442
    
    
    
    442Employees stock option compensation
    
    
    93
    
    
    
    53Losses and deductions for tax purposes
    
    
    11,138
    
    
    
    9,641Other
    
    
    24
    
    
    
    7012,239
    
    
    
    10,860Less: valuation allowance
    
    
    (12,239
    )
    
    
    (10,860
    )
    
    
    
    
  The Company has recorded a valuation allowance for all of its deferred
tax assets because based on the weight of available evidence it is more
likely than not that all of the deferred tax asset will not be realized. F-39




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##### Table of Contents



Radcom Ltd. (An Israeli Corporation)
and its consolidated subsidiaries Notes to the Consolidated Financial Statements as of December 31, 2003 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 36% for the years ended December 31,
2003, 2002 and 2001, respectively, applicable to income of companies in
Israel, and the actual tax expense, is as follows: Year ended December 312003
    
    2002
    
    2001US$ (in thousands)
    
    US$ (in thousands)
    
    US$ (in thousands)Loss before taxes, as reported in the
statements of operations
    
    
    (6,225
    )
    
    
    (4,716
    )
    
    
    (11,448
    )Statutory tax on the above amount (according to
tax rate of 36%)
    
    
    (2,241
    )
    
    
    (1,698
    )
    
    
    (4,121
    )Tax effect on non-Israeli subsidiaries
    
    
    165
    
    
    
    (13
    )
    
    
    (79
    )Increase (decrease) in taxes resulting from
permanent differences:Non-deductible operating expenses
    
    
    98
    
    
    
    134
    
    
    
    468Non-taxable income
    
    
    
    
    
    
    (64
    )
    
    
    (232
    )Timing differences in respect of which no deferred
taxes were recorded:Income (expenses), deductions and losses for
tax purposes
    
    
    2,484
    
    
    
    1,630
    
    
    
    3,443Other timing difference, net
    
    
    142
    
    
    
    (44
    )
    
    
    (176
    )Differences in taxes arising from differences
between Israeli currency income and dollar
income, net *
    
    
    (648
    )
    
    
    55
    
    
    
    697Taxes 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-40




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##### Table of Contents



Radcom Ltd. (An Israeli Corporation)
and its consolidated subsidiaries Notes to the Consolidated Financial Statements as of December 31, 2003 Note 9 - Supplementary Financial Statement Information  A.
    
    Balance Sheet1.
    
    Cash and cash equivalents  Cash and cash equivalents include short-term deposits denominated in US
dollars of approximately US$ 4,437 thousand as of December 31, 2003,
bearing an average annual interest of 1.22 % (December 31, 2002 - US$
5,063 thousand, bearing an average annual interest of 1.5%).  2.
    
    Short-term bank deposits  Short-term deposits as of December 31, 2002, include bank deposits
denominated in US dollars with original maturities of more than three
months and less than one year bearing an average annual interest of
1.38%. As of December 31, 2003, the Company does not hold short-term
deposits.  3.
    
    Trade receivables, net  As of December 31, 2003 and 2002 trade receivables are presented net of
an allowance for doubtful accounts of US$ 109 thousand and US$ 518
thousand, respectively.The following are the changes in allowance for doubtful accounts: US$ thousandsBalance at December 31, 2001
    
    
    231Additions during 2002
    
    
    419Deductions during 2002
    
    
    (132
    )Balance at December 31, 2002
    
    
    518Additions during 2003
    
    
    16Deductions during 2003
    
    
    (425
    )Balance at December 31, 2003
    
    
    109
  4.
    
    Inventories and inventory prepayments December 312003
    
    2002US$ (in thousands)
    
    US$ (in thousands)Raw materials
    
    
    260
    
    
    
    1,090Work in process
    
    
    532
    
    
    
    705Finished products
    
    
    451
    
    
    
    387Inventory prepayments
    
    
    496
    
    
    
    1,739
    
    
    
    2,182
 F-41




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##### Table of Contents



Radcom Ltd. (An Israeli Corporation)
and its consolidated subsidiaries Notes to the Consolidated Financial Statements as of December 31, 2003 Note 9 - Supplementary Financial Statement Information (contd)  A.
    
    Balance Sheet (contd)5.
    
    Other current assets December 312003
    
    2002US$ (in thousands)
    
    US$ (in thousands)Value Added Tax authorities
    
    
    79
    
    
    
    191Prepaid expenses
    
    
    240
    
    
    
    368Others
    
    
    27
    
    
    
    42346
    
    
    
    601
  6.
    
    Other payables and accrued expenses December 312003
    
    2002US$ (in thousands)
    
    US$ (in thousands)Employees and employee institutions
    
    
    1,313
    
    
    
    1,284Government
of Israel - OCS
    
    
    473
    
    
    
    328Commissions payable
    
    
    428
    
    
    
    334Deferred revenue (See Note 2L(2))
    
    
    1,058
    
    
    
    591Royalties
    
    
    235
    
    
    
    343Allowance for product warranty
    
    
    91
    
    
    
    73Others
    
    
    1,251
    
    
    
    1,0434,849
    
    
    
    3,996
 F-42




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##### Table of Contents



Radcom Ltd. (An Israeli Corporation)
and its consolidated subsidiaries Notes to the Consolidated Financial Statements as of December 31, 2003 Note 9 - Supplementary Financial Statement Information (contd)  A.
    
    Balance Sheet (contd)7.
    
    Monetary balances in non-dollar currencies December 31, 2003Israeli currencyOtherNot
    
    Linked to the
    
    non-dollarlinked
    
    dollar
    
    currencyUS$ (in thousands)
    
    US$ (in thousands)
    
    US$ (in thousands)Current assets
    
    
    144
    
    
    
    
    
    
    
    11Current liabilities
    
    
    1,541
    
    
    
    2
    
    
    
    7
 December 31, 2002Israeli currencyOtherNot
    
    Linked to the
    
    non-dollarlinked
    
    dollar
    
    currencyUS$ (in thousands)
    
    US$ (in thousands)
    
    US$ (in thousands)Current assets
    
    
    265
    
    
    
    
    
    
    
    22Current liabilities
    
    
    1,852
    
    
    
    
    
    
    
    17
  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.  8.
    
    Fair value of financial instruments  The financial instruments of the Company consist mainly of cash and cash
equivalents, trade receivables, and accounts payables and accruals. Due
to the nature of such financial instruments, their fair value is usually
approximate to their carrying value. F-43




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##### Table of Contents



Radcom Ltd. (An Israeli Corporation)
and its consolidated subsidiaries Notes to the Consolidated Financial Statements as of December 31, 2003 Note 9 - Supplementary Financial Statement Information  B.
    
    Statement of Operations1.
    
    Sales(a)
    
    Sales - classified by geographical destination: Year ended December 312003
    
    2002
    
    2001US$ (in thousands)
    
    US$ (in thousands)
    
    US$ (in thousands)North America
    
    
    4,593
    
    
    
    5,547
    
    
    
    7,117Europe
    
    
    4,082
    
    
    
    5,085
    
    
    
    6,696Far East
    
    
    2,234
    
    
    
    3,114
    
    
    
    3,400Other
    
    
    294
    
    
    
    845
    
    
    
    1,46311,203
    
    
    
    14,591
    
    
    
    18,676
  (b)
    
    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.During years 2003, 2002 and 2001, no single customer exceeded 10%
of the total sales.2.
    
    Cost of Sales  Comprised of: Year ended December 312003
    
    2002
    
    2001US$ (in thousands)
    
    US$ (in thousands)
    
    US$ (in thousands)Payroll and related benefits
    
    
    906
    
    
    
    918
    
    
    
    1,635Stock compensation expenses
    
    
    5
    
    
    
    10
    
    
    
    2Materials purchased
    
    
    2,527
    
    
    
    2,534
    
    
    
    3,109Royalties to the OCS
    
    
    424
    
    
    
    455
    
    
    
    696Subcontracted work
    
    
    35
    
    
    
    63
    
    
    
    32Inventories write-off
    
    
    (2)960
    
    
    
    
    
    
    
    (1)1,061Depreciation
    
    
    158
    
    
    
    165
    
    
    
    167Other production costs
    
    
    396
    
    
    
    432
    
    
    
    5275,411
    
    
    
    4,577
    
    
    
    7,229Decrease (increase) in inventories
    
    
    (517
    )
    
    
    470
    
    
    
    1,5824,894
    
    
    
    5,047
    
    
    
    8,811
  (1)
    
    See Note 3A(2).(2)
    
    See Note 3B(3). F-44




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##### Table of Contents



Radcom Ltd. (An Israeli Corporation)
and its consolidated subsidiaries Notes to the Consolidated Financial Statements as of December 31, 2003 Note 9 - Supplementary Financial Statement Information (contd)  B.
    
    Statement of Operations (contd)3.
    
    Research and development, gross  Comprised of: Year ended December 312003
    
    2002
    
    2001US$ (in thousands)
    
    US$ (in thousands)
    
    US$ (in thousands)Payroll and related benefits
    
    
    3,928
    
    
    
    4,130
    
    
    
    6,502Stock compensation expenses
    
    
    63
    
    
    
    66
    
    
    
    13Materials consumed
    
    
    43
    
    
    
    156
    
    
    
    112Subcontracted work
    
    
    83
    
    
    
    361
    
    
    
    639Maintenance and office services
    
    
    958
    
    
    
    1,102
    
    
    
    1,365Depreciation
    
    
    501
    
    
    
    641
    
    
    
    665Others
    
    
    17
    
    
    
    25
    
    
    
    845,593
    
    
    
    6,481
    
    
    
    9,380
  4.
    
    Sales and marketing  Comprised of: Year ended December 312003
    
    2002
    
    2001US$ (in thousands)
    
    US$ (in thousands)
    
    US$ (in thousands)Payroll and related benefits
    
    
    3,664
    
    
    
    4,017
    
    
    
    5,693Stock compensation expenses
    
    
    43
    
    
    
    56
    
    
    
    12Depreciation
    
    
    381
    
    
    
    450
    
    
    
    704Commissions
    
    
    916
    
    
    
    1,108
    
    
    
    1,515Travel abroad
    
    
    661
    
    
    
    656
    
    
    
    947Advertising
    
    
    98
    
    
    
    289
    
    
    
    172Maintenance and office services
    
    
    913
    
    
    
    1,132
    
    
    
    937Conventions and exhibitions
    
    
    362
    
    
    
    309
    
    
    
    284Marketing and sales tools
    
    
    15
    
    
    
    45
    
    
    
    13Others
    
    
    358
    
    
    
    244
    
    
    
    1,2367,411
    
    
    
    8,306
    
    
    
    11,513
 F-45




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##### Table of Contents



Radcom Ltd. (An Israeli Corporation)
and its consolidated subsidiaries Notes to the Consolidated Financial Statements as of December 31, 2003 Note 9 - Supplementary Financial Statement Information (contd)  B.
    
    Statement of Operations (contd)5.
    
    General and administrative  Comprised of: Year ended December 312003
    
    2002
    
    2001US$ (in thousands)
    
    US$ (in thousands)
    
    US$ (in thousands)Payroll and related benefits
    
    
    764
    
    
    
    758
    
    
    
    925Stock compensation expenses
    
    
    12
    
    
    
    2
    
    
    
    1Depreciation
    
    
    105
    
    
    
    144
    
    
    
    149Recruitment of manpower
    
    
    5
    
    
    
    24
    
    
    
    41Maintenance of building and tax
    
    
    67
    
    
    
    73
    
    
    
    112Professional costs
    

    
    266
    
    
    
    205
    
    
    
    204Provision for doubtful debts
    
    
    8
    
    
    
    338
    
    
    
    288Others
    
    
    393
    
    
    
    474
    
    
    
    7171,620
    
    
    
    2,018
    
    
    
    2,437
  6.
    
    Financing income, net  Comprised of: Year ended December 312003
    
    2002
    
    2001US$ (in thousands)
    
    US$ (in thousands)
    
    US$ (in thousands)Financing income:Interest from banks
    
    
    96
    
    
    
    206
    
    
    
    705Interest from employees
    
    
    1
    
    
    
    4
    
    
    
    1Exchange translation gain, net
    
    
    14
    
    
    
    44
    
    
    
    71111
    
    
    
    254
    
    
    
    777Financing expenses:Interest and bank charges on short- term
bank credit
    
    
    18
    
    
    
    20
    
    
    
    26Impairment
of marketable securities(1)
    
    
    
    
    
    
    17
    
    
    
    71018
    
    
    
    37
    
    
    
    736Financing income, net
    
    
    93
    
    
    
    217
    
    
    
    41
  (1)
    
    In 2001, Management recorded an impairment charge in respect
of its investment in marketable securities as a result of
other-than-temporary declines in the value of the securities. F-46




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##### Table of Contents



Radcom Ltd. (An Israeli Corporation)
and its consolidated subsidiaries Notes to the Consolidated Financial Statements as of December 31, 2003 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.  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.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. F-47




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##### Table of Contents



Radcom Ltd. (An Israeli Corporation)
and its consolidated subsidiaries Notes to the Consolidated Financial Statements as of December 31, 2003 Note 10 - Related Party Balances and Transactions (contd)  A.
    
    Balances with related parties December 312003
    
    2002US$ (in thousands)
    
    US$ (in thousands)Receivables:Trade
    
    
    16
    
    
    
    124Accounts payable:Trade
    
    
    43
    
    
    
    106
  B.
    
    Expenses to or income from related parties Year ended December 312003
    
    2002
    
    2001US$ (in thousands)
    
    US$ (in thousands)
    
    US$ (in thousands)Income:Sales
    
    
    134
    
    
    
    264
    
    
    
    320Expenses:Cost of sales *
    
    
    158
    
    
    
    157
    
    
    
    208Operating expenses:Research and development, gross
    
    
    243
    
    
    
    283
    
    
    
    327Sales and marketing, gross
    
    
    238
    
    
    
    272
    
    
    
    311General and administrative
    
    
    74
    
    
    
    82
    
    
    
    111
  *
    
    Cost of sales includes the components purchased from related
parties that are included in production costs.C.
    
    Acquisition of fixed assets from related parties amounted to
US$ 23 thousand, US$ 16 thousand and US$ 27 thousand in the years
ended December 31, 2003, 2002 and 2001, respectively. F-48




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##### Table of Contents



Radcom Ltd. (An Israeli Corporation)
and its consolidated subsidiaries Notes to the Consolidated Financial Statements as of December 31, 2003 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 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 - Subsequent Events  On January 13, 2004, the Company executed term sheets to raise US$ 4,413
thousand from current and new investors (the Investors) in a private
placement (the PIPE), out of an aggregate of US$ 5,500 thousand to be
offered. In addition, the Company executed a letter of intent with one
of its principal shareholders to purchase the remaining US$ 1,087
thousand of the offering in the event that such amount remains
unsubscribed. Pursuant to the PIPE, the Company will issue ordinary
shares, par value $0.05 per share (the Ordinary Shares), at a price per
Ordinary Share based on the average closing market price of the Ordinary
Shares over the 10 trading days prior to the special shareholders
meeting to be held in connection with the PIPE (the Market Price). If
the Market Price for Ordinary Shares is US$ 1.30 or lower, the purchase
price per Ordinary Share in the PIPE will be at a discount of 10% to such
Market Price. If the Market Price per Ordinary Share is between US$ 1.30
and US$ 2.00 per share, the purchase price per Ordinary Share will be at
a discount of between 10% and 25% to such Market Price. The Ordinary
Shares will be sold at a discount of 25% to the Market Price if the
Market Price is over US$ 2.00. The Company will issue warrants (the
Warrants) to the Investors to purchase one Ordinary Share for every
four Ordinary Shares purchased by each of them in the PIPE. The Warrants

will be exercisable for a period of two years from the anniversary of the
closing of the PIPE (the Closing) at an exercise price per Ordinary
Share that is 25% above the Market Price. F-49




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Radcom Ltd. (An Israeli Corporation)
and its consolidated subsidiaries Notes to the Consolidated Financial Statements as of December 31, 2003 Note 12 - Subsequent Events (contd)  On March 29, 2004, the Company closed the private placement transaction.
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.As part of the PIPE, the Company has agreed to file a resale registration
statement covering the Ordinary Shares purchased in the PIPE (including
the Ordinary Shares underlying the Warrants) within 45 days following the
Closing. Note 13 - Recently Enacted Accounting Pronouncements  The Company examined the recently issued accounting standards SFAS No.
149, SFAS No. 150, and FIN 46 and believes that the adoption of these
standards will not have a significant impact on the Companys financial
position or results of operations. F-50