---

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# SECURITIES AND
EXCHANGE COMMISSIONWASHINGTON, D.C. 20549

# FORM 20-F

# ANNUAL REPORT PURSUANT
TO SECTION 13 OR 15(d) OF 
THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year
ended December 31, 2004

SILICOM LTD. (Exact
name of Registrant as specified in its charter and translation of Registrants name
into English)

Israel 
(Jurisdiction of incorporation or organization)

|8 Hanagar Street, Kfar Sava 44000, Israel 
(Address of principal executive offices)
|-----------------------------------------------------------------------------------

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

# None

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

Ordinary Shares,
nominal value 0.01 New Israeli Shekels 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:

4,213,550

Indicate by check mark whether the
registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the
Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period
that the registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days:

# Yes x No o

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

# Item 17 o Item 18 x



---

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This annual report on Form 20-F
includes certain forward-looking statements within the meaning of Section 21E
of the Securities Exchange Act of 1934. The use of the words projects,
expects, may, plans or intends, or words
of similar import, identifies a statement as forward-looking. There can be no
assurance, however, that actual results will not differ materially from our expectations
or projections. Factors that could cause actual results to differ from our expectations or
projections include the risks and uncertainties relating to our business described in this
report at Item 3 titled Risk Factors.

As used herein or any in any document
incorporated by reference hereto, the Company, Silicom Ltd.,
Silicom, Registrant, we, us, or
our refers to Silicom Ltd. and its subsidiary.

We have prepared our consolidated
financial statements in United States dollars and in accordance with accounting principles
generally accepted in the United States. All references herein to dollars or
$ are to United States dollars, and all references to Shekels or
NIS are to New Israeli Shekels.

|Item 1. |  | IDENTITY
OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS
|------- |  | -----------------------------------------------------

Not Applicable.

|Item 2. |  | OFFER
STATISTICS AND EXPECTED TIMETABLE
|------- |  | ---------------------------------------

Not Applicable

|Item 3. |  | KEY
INFORMATION
|------- |  | ---------------

# Selected Financial Data

The selected data presented below
under the captions Consolidated Statements of Operations Data and Consolidated
Balance Sheets Data for and as of the end of each of the years in the five-year
period ended December 31, 2004, are derived from our consolidated financial statements,
which have been audited by Somekh Chaikin, Certified Public Accountants (Isr.), a member
of KPMG International independent registered public accounting firm. The consolidated
financial statements as of December 31, 2004, and for each of the years in the three-year
period ended December 31, 2004, and the report thereon, are included elsewhere in this
annual report. The financial data set forth below should be read in conjunction with our
consolidated financial statements and the notes thereto, which are set forth in Item 18
 Financial Statements and the other financial information appearing
elsewhere in this annual report.

2

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CONSOLIDATED
STATEMENTS OF OPERATIONS DATA:

Year Ended December 31
In US$ Thousands

|                                                       | 2004 | 2003 | 2002 | 2001   | 2000
|------------------------------------------------------ | ---- | ---- | ---- | ------ | ----
|
|
|
|
|Sales                                                  |      |      | $    | 4,559  |     
|                                                       |      |     
|Cost of sales                                          |      |      |      | 2,999  |     
|                                                       |      |      |      |        |     
|
|Gross profit                                           |      |      |      | 1,560  |     
|                                                       |      |      |      |        |     
|
|R&D costs, gross                                       |      |      |      | 1,596  |     
|                                                       |      |     
|(Less) government                                      |      |     
|royalty-bearing participations                         |      |      |      | (145   | )   
|                                                       |      |      |      |        |     
|                                                       |      |     
|R&D costs, net                                         |      |      |      | 1,451  |     
|                                                       |      |     
|Selling, marketing, general                            |      |     
|and administrative expenses                            |      |      |      | 1,332  |     
|                                                       |      |      |      |        |     
|Total operating expenses                               |      |      |      | 2,783  |     
|                                                       |      |      |      |        |     
|Operating income (loss)                                |      |      |      | (1,223 | )   
|                                                       |      |     
|Other expenses                                         |      |      |      | -      |     
|                                                       |      |     
|Financial income                                       |      |     
|(expenses), net                                        |      |      |      | (17    | )   
|                                                       |      |      |      |        |     
|Income (loss) before                                   |      |     
|taxes on income                                        |      |      |      | (1,240 | )   
|Taxes on income                                        |      |      |      | -      |     
|                                                       |      |      |      |        |     
|Net income (loss) (1)                                  |      |      |      | (1,240 | )   
|                                                       |      |      |      |        |     
|Earnings (loss) per share                              |      |     
|Basic earnings (loss) per                              |      |     
|ordinary share                                         |      |      | $    | (0.30  | )   
|                                                       |      |      |      |        |     
|Weighted average number of                             |      |     
|ordinary shares used to                                |      |     
|compute basic earnings (loss) per share (in thousands) |      |      |      | 4,190  |     
|                                                       |      |      |      |        |     
|Diluted earnings (loss) per                            |      |     
|ordinary share                                         |      |      | $    | (0.30  | )   
|                                                       |      |      |      |        |     
|Weighted average number of                             |      |     
|ordinary shares used to                                |      |     
|compute diluted earnings                               |      |     
|(loss) per share (in                                   |      |     
|thousands)                                             |      |      |      | 4,190  |     
|                                                       |      |      |      |        |     

(1) Net income is after  deduction of taxes on income,  which have been reduced by virtue of tax benefits to which the
Company is entitled in its  capacity as an  "Approved  Enterprise"  under  Israeli  law. As such,  the Company was not
required  to pay full  income tax for a period of up to seven  years  ending in 1997 and also for ten years  ending in
2006. See Note 10B to the Financial Statements and "Item 10" - Additional Information - Taxation."

3

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|                     | 2004 | 2003 | 2002 | 2001      | 2000
|-------------------- | ---- | ---- | ---- | --------- | ----
|
|
|
|
|Consolidated Balance |      |      |      |           |     
|Sheets Data:         |      |     
|Working capital      |      |      | $    | 3,147     |     
|Total assets         |      |      | $    | 5,525     |     
|Short-term debt      |      |      | $    | 1,530     |     
|Long-term debt       |      |      | $    | 957       |     
|Shareholders' equity |      |      | $    | 3,038     |     
|Number of shares     |      |     
|outstanding          |      |      |      | 4,213,550 |     
|                     |      |      |      |           |     

# Risk Factors

This annual report and statements
that we may make from time to time may contain forward-looking information. There can be
no assurance that actual results will not differ materially from our expectations,
statements or projections. Factors that could cause actual results to differ from our
expectations, statements or projections include the risks and uncertainties relating to
our business described below.

Our Multi Port Gigabit
Ethernet Server Networking products, including our TOE/iSCSI products are characterized by long sales cycles

The Multi Port Gigabit-Ethernet
Server Networking Adapters we manufacture and sell, became our principal sales growth
engine in 2004 and we expect them to continue being so in the coming years. Our sales of
these products and the sales of our TOE/iSCSI products, typically involve significant
capital investment decisions by prospective end customers, as well as a significant amount
of time to educate such end customers as to the benefits of systems and appliances that
include our products. As a result, before purchasing systems and appliances which include
our products (and consequently facilitating sales of our products), companies spend a
substantial amount of time performing internal reviews and obtaining capital expenditure
approvals. The decision making process of our customers includes several time consuming
processes: they need to define the required configuration of their server
system/appliance, derive the need for adapters, evaluate adapters, qualify adapters and
then (or in parallel) negotiate the terms for a purchase. It may therefore take 12 months
or more from the time we first contact a prospective customer before receiving an initial
order. These long sales cycles make it difficult to predict when and to what extent
discussions with potential customers will materialize into sales and could cause our
revenue and operating results to fluctuate widely from period to period. In addition, our
allocation of significant resources to potential sales opportunities that do not
materialize into sales could have a material adverse affect on our business, results of
operations and financial condition.

4

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The loss or
ineffectiveness of our original equipment manufacturers may have a material adverse
effect on ouroperations and financial results.

Our sales and marketing strategy is
to develop and maintain strategic relationships with leading original equipment
manufacturers (OEMs), installers and integrators in the computer industry, which sell our
connectivity products under their own private labels or integrate our products into their
systems. These OEMs are not within our control, are not obligated to purchase our
products, and may represent other lines of products. A reduction in their sales efforts or
discontinuance of sales of our products by our OEMs could lead to reduced sales and could
materially adversely affect our operating results. Use of OEMs also entails the risk that
they will build up inventories in anticipation of a growth in sales. If such growth does
not occur as anticipated, such OEMs may substantially decrease the amount of products
ordered in subsequent quarters, discontinue product orders or even attempt to return
unsold products (although our standard agreements do not allow return of products). In
2004, one OEM, which was our major customer, was responsible for the vast majority of our
sales of Ethernet/Fast Ethernet products (see footnote 12 to the consolidated financial
statements). Although sales to this customer during the first half of 2005 were slightly
higher than in the first half of 2004, information received from this OEM customer
indicates that sales to this customer will diminish in the second half of 2005. The
termination or loss of this OEM, or of several OEMs at approximately the same time,
without being able to compensate this loss with sales to other new OEM customers might
have a material adverse effect.

The markets for our
products change rapidly and demand for new products is difficult to predict.

The markets for our products are
characterized by rapidly changing technology, short product-life cycles and evolving
industry standards. For example, innovations in the modem and Ethernet industries have
enabled PC manufacturers to incorporate modems and Ethernet cards in their original
products. Such innovations have eliminated much of the need for our legacy products and
have caused the market for these products to decline significantly. As such, our Modem PC
Cards have been completely phased out and we believe that our Ethernet/Fast Ethernet PC
Cards will also be phased out completely over time. We intend to continue making
substantial investments in product and technology development. Although we have recorded
growing sales of our new lines of products, Multi Port Gigabit-Ethernet Server Networking
Adapters and TOE/iSCSI Network Adapters, there can be no assurance that we will continue
to be successful in selecting, developing, manufacturing and marketing enhanced and new
products in a timely manner.

5

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We may experience
difficulty in developing new, commercially successful products at acceptable release
times.

Since we commenced operations, we
have conducted extensive research, development and engineering activities. Our efforts
emphasize the development of new products, cost reduction of current products, and the
enhancement of existing products, generally in response to rapidly changing customer
preferences, technologies and industry standards. Although throughout 2004 and the first
months of 2005 we recorded growing sales of our latest lines of products, Multi Port
Gigabit-Ethernet Server Networking Adapters and TOE/iSCSI Network Adapters, we cannot
guarantee that these products will be widely accepted by the marketplace or that any of
our development efforts will result in commercially successful products, that such
products will be released in a timely manner or that we will be able to respond
effectively to technological changes or new product announcements by others.

# Loss of our sources
for certain key components could harm our operations.

Although we generally use standard
parts and components for our products, certain key components used in our products are
currently available from only one source, and others are available from a limited number
of sources. We believe that we maintain a sufficient inventory of these components to
protect against delays in deliveries. However, we cannot guarantee that we will not
experience delays in the supply of critical components in the future or that we will have
a sufficient inventory of critical components at such time to produce products at full
capacity. In the event that we are not able to purchase key components of our products
from our limited sources, we may need to redesign certain products. We cannot guarantee
that we will have adequate resources for such a redesign or that such a redesign will be
successful. Such inability to obtain alternative resources or to successfully redesign our
products could have a material adverse effect on our business, results of operations and
financial condition.

# The market for our
products is highly competitive and some of our competitors may be better positioned than
we are.

The data communications industry is
highly competitive. We face competition from numerous companies, some of which are more
established, benefit from greater market recognition and have greater financial,
production and marketing resources than we do. For example, in the evolving server
networking industry for which we have developed our multi-port Gigabit-Ethernet Server
Networking cards, our main competitor is Intel, in the TOE industry our main competitors
are Alacritec, Inc. and Adaptec, Inc. and in the iSCSI industry our main competitors are
Emulex, Inc., Qlogic, Inc., and JNI, Inc. We cannot guarantee that our present or
contemplated products will continue to be distinguishable from those of our competitors or
that the marketplace will find our products preferable to those of our competitors.
Furthermore, there can be no assurance that competitive pressures will not result in price
reductions that could materially adversely affect our business and financial condition and
the results of our operations.

6

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# Our success depends
on the protection of our intellectual property rights.

Our success and ability to compete
depend to a significant degree on our proprietary technology. The measures we have taken
to protect our proprietary technology afford only limited protection, and, accordingly,
there can be no assurance that such steps will be adequate to prevent misappropriation of
our technology or the independent development of similar technologies by others. Despite
our efforts, unauthorized parties may attempt to copy aspects of our products and develop
similar hardware or software or to obtain and use information that we regard as
proprietary.

# We may not be able to
prevent others from claiming that we have infringed their proprietary rights.

We cannot guarantee that one or more
parties will not assert infringement claims against us. The cost of responding to claims
could be significant, regardless of whether the claims have merit.Significant and
protracted litigation may be necessary to determine the scope of the proprietary rights of
others or to defend against claims of infringement, regardless of whether the claims have
merit. Although we believe that all our products use only our intellectual property, or
intellectual property which is properly licensed to us, in the event that any infringement
claim is brought against us and infringement is proven, we could be required to
discontinue the use of the relevant technology, to cease the manufacture, use and sale of
infringing products, to incur significant litigation damages, costs and expenses, to
develop non-infringing technology or to obtain licenses to the alleged infringing
technology and to pay royalties to use such licenses. There can be no assurance that we
would be able to develop any such alternative technologies or obtain any such licenses on
terms commercially acceptable to us. Although in the past we have resolved a claim of
infringement through a license agreement, the terms of which did not have a material
effect on our business, any infringement claim or other litigation against us could
seriously harm our business, operating results and financial condition. While there are no
lawsuits or other claims currently pending against us regarding the infringement of
patents or intellectual property rights of others, we have been a party to such claims in
the past and may be party to such claims in the future.

# We are dependent on
key personnel.

Our success has been, and will be,
dependent to a large degree on our ability to retain the services of key personnel and to
attract additional qualified personnel in the future. Competition for such personnel is
intense. There can be no assurance that we will be able to attract, assimilate or retain
key personnel in the future and our failure to do so would have a material adverse affect
on our business, financial condition and results of operations.

# Exchange rate
fluctuations and international risks could increase the cost of our operations.

Substantially all of our
international sales are denominated in U.S. dollars and may be subject to government
controls and other risks, including, in some cases, export licenses, federal restrictions
on export, currency fluctuations, political instability, trade restrictions, and changes
in tariffs and freight rates. We believe that the rate of inflation in Israel and exchange
rate fluctuations between the New Israeli Shekel (NIS) and the U.S. dollar have had a
minor effect on our business to date. However, our dollar costs in Israel will increase if
inflation in Israel exceeds the devaluation of the NIS against the dollar, if the timing
of such devaluation lags behind inflation in Israel or if the dollar devaluates against
the NIS. See Item 5. Operating and Financial Review and Prospects  Impact of
Inflation and Devaluation on Results of Operations, Liabilities and Assets.

7

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# If we are
characterized as a passive foreign investment company for U.S. federal income tax
purposes, our U.S. shareholders may suffer adverse tax consequences.

We will be a passive foreign
investment company, or PFIC, if 75% or more of our gross income in a taxable year,
including our pro rata share of the gross income of any company, U.S. or foreign, in which
we are considered to own, directly or indirectly, 25% or more of the shares by value, is
passive income. Alternatively, we will be considered to be a PFIC if at least 50% of our
assets in a taxable year, averaged over the year and ordinarily determined based on fair
market value and including our pro rata share of the assets of any company in which we are
considered to own, directly or indirectly, 25% or more of the shares by value, are held
for the production of, or produce, passive income. If we were to be a PFIC, and a U.S.
Holder does not make an election to treat us as a qualified electing fund, or
QEF, or a mark to market election, excess distributions to a U.S.
Holder, and any gain recognized by a U.S. Holder on a disposition or our ordinary shares,
would be taxed in an unfavorable way. Among other consequences, our dividends, to the
extent that they constituted excess distributions, would be taxed at the regular rates
applicable to ordinary income, rather than the 15% maximum rate applicable to certain
dividends received by an individual from a qualified foreign corporation, and certain
interest charges may apply. In addition, gains on the sale of our shares would
be treated in the same way as excess distributions. 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 the determination of PFIC status. In
addition, under the applicable statutory and regulatory provisions, it is unclear whether
we would be permitted to use a gross loss from sales (sales less cost of goods sold) to
offset our passive income in the calculation of gross income. In light of the
uncertainties described above, no assurance can be given that we will not be a PFIC in any
year. If we determine that we have become a PFIC, we will then notify our U.S. Holders and
provide them with the information necessary to comply with the QEF rules. A U.S. Holder
who makes a QEF election is taxed currently on such holders proportionate share of
our earnings. If the IRS determines that we are a PFIC for a year with respect to which we
have determined that we were not a PFIC, however, it might be too late for a U.S. Holder
to make a timely QEF election, unless the U.S. Holder qualifies under the applicable
Treasury regulations to make a retroactive (late) election. U.S. Holders who hold ordinary
shares during a period when we are a PFIC will be subject to the foregoing rules, even if
we cease to be a PFIC, subject to exceptions for U.S. Holders who made a timely QEF or
mark-to-market election, or certain other elections.

8

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# The trading volume of
our shares has been low in the past and may be low in the future, resulting in lower
than expected market prices for our shares.

Our shares have been traded at low
volumes in the past and may be traded at low volumes in the future for reasons related or
unrelated to our performance. This low trading volume may result in lower than expected
market prices for our ordinary shares and our shareholders may not be able to resell their
shares for more than they paid for them.

# Israeli courts might
not enforce judgments rendered outside of Israel.

We are incorporated in Israel. Most
of our executive officers and all of our directors are non-residents of the United States,
and a substantial portion of our assets and the assets of these 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 such persons. It may also be difficult to enforce
civil liabilities under U.S. federal securities laws in original actions instituted in
Israel. However, subject to certain time limitations, Israeli courts may enforce United
States final executory judgments for liquidated amounts in civil matters obtained after
due trial before a court of competent jurisdiction (according to the rules of private
international law currently prevailing in Israel) which enforces similar Israeli
judgments, provided that the requisite procedural and legal requirements are adhered to.
If a foreign judgment is enforced by an Israeli court, it generally will be payable in New
Israeli Shekels, which can then be converted into foreign currency at the rate of exchange
of such foreign currency on the date of payment. Pending collection, the amount of the
judgment of an Israeli court stated in New Israeli Shekels (without any linkage to a
foreign currency) ordinarily will be linked to the Israeli consumer price index plus
interest at the annual statutory rate prevailing at such time. Judgment creditors bear the
risk of unfavorable exchange rates.

# The political
environment and hostilities in Israel could harm our business.

Since the establishment of the State
of Israel in 1948, a state of hostility has existed between Israel and the Arab countries
in the region. This state of hostility has varied in degree and intensity over time. A
significant increase in violence began in September 2000 and has continued with varying
levels of severity into 2005 and negotiations between Israel and Palestinian
representatives ceased for some time. Beginning in late September 2000 and until the first
months of 2005, there was a significant increase in hostilities and unrest as between
Israel, the Palestinian Authority and certain terrorist groups operating within the
Palestinian Authority. Since the beginning of 2005, negotiations between Israel and the
Palestinian Authority have been renewed and hostilities have diminished. While such
development has calmed the region and while previous hostilities did not have a material
adverse impact on our business, we cannot guarantee that hostilities will not be renewed
and have such an effect in the future. The political and security situation in Israel may
result in parties with whom we have contracts claiming that they are not obligated to
perform their commitments under those agreements pursuant to force majeure provisions. Any
hostilities involving Israel or the interruption or curtailment of trade between Israel
and its present trading partners could adversely affect our operations and could make it
more difficult for us to raise capital. Furthermore, many of our facilities are located in
Israel. Since we do not have a detailed disaster recovery plan that would allow us to
quickly resume business activity, we could experience serious disruptions if acts
associated with this conflict result in any serious damage to our facilities. 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. Any
future armed conflicts or political instability in the region would likely negatively
affect business conditions and harm our results of operations.

9

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# Many of our employees
in Israel are required to perform military reserve duty.

All non-exempt male adult permanent
residents of Israel under the age of 40 are obligated to perform military reserve duty and
may be called to active duty under emergency circumstances. In recent years, there have
been significant call-ups of military reservists, and it is possible that there will be
additional call-ups in the future. While we have operated effectively despite these
conditions in the past, we cannot assess what impact these conditions may have in the
future, particularly if emergency circumstances arise. Our operations could be disrupted
by the absence for a significant period of one or more of our executive officers or key
employees or a significant number of our other employees due to military service. Any
disruption in our operations would harm our business.

# We are affected by
volatility in the securities markets.

Due to the recent downturn in the
world economy, the securities markets in general have recently experienced volatility
which has particularly affected the securities of many high-technology companies and
particularly those in the fields of communications, software and Internet, including
companies that have a significant presence in Israel. This volatility has often been
unrelated to the operating performance of these companies and may cause difficulties in
raising additional financing required to effectively operate and grow their businesses.
Such difficulties and the volatility of the securities markets in general may affect our
financial results.

# We are affected by
worldwide downturns in industries based on technology.

The volatility in the securities
markets discussed above and its effect on high-technology companies may have a ripple
effect on our performance. Cable companies and internet providers were severely affected
by the recent downturn in internet related technologies, and some were forced to cease
operations. We felt the effects of this downturn in 2001 through 2003. We can give no
assurance that our results will not be affected on a going forward basis by any future
downturns.

10

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|Item 4. |  | INFORMATION
ON THE COMPANY.
|------- |  | ---------------------------

# History and Development
of the Company

Our legal and commercial name is
Silicom Ltd. We were incorporated under the laws of Israel in 1987, and we operate under
Israeli law and legislation. Our registered and principal executive offices are located in
Israel at 8 Hanagar Street, Kfar Sava, Israel 44000, and our telephone number is
011-972-9-764-4555. Our website is http://www.silicom.co.il. We do not intend for any
information contained on our internet website to be considered part of this annual report.

We are engaged in the design,
manufacture, marketing and support of connectivity solutions for a broad range of computer
users. Our first products were integrated circuits for information technology, or IT,
manufacturers. In the early 1990s, we began focusing our strategy on designing,
manufacturing, marketing and supporting a range of connectivity solutions for mobile and
remote personal computer, or PC, users. Our traditional line of products serves as a
communication gateway to enable portable computers to access information and resources
found on Local Area Networks (LANs) and Wide Area Networks (WANs).

Responding to changes in the market
for connectivity products, we leveraged our expertise in developing connectivity solutions
for portable and desktop computer users and introduced a range of connectivity solutions
which facilitate connection between PCs and broadband internet modems in the years 2000
and 2001. In 2002 we leveraged our expertise and know-how in networking and operating
systems to develop a line of high-end multi-port server networking cards, which we expect
to be the principal engine of our sales growth in the coming years. In November and
December of 2003 we secured our first design wins for these new products. Since that time
we have identified the server-based network appliances market and specifically, the
server-based security appliances within such market as demonstrating a strong demand for
our products. We have added to our product lines networking products which include special
functionalities for the server based appliances and have started to receive orders for
both our server networking products and our appliance focused networking products. We
secured additional design wins throughout 2004. In April 2004, we announced our new
TOE/iSCSI Server Network Adapters, in July 2004 we announced our SSL/IPSEC encryption
cards and in November 2004 we announced our new TAP-NIC products.

# Business Overview

We are currently active in the
following markets, each of which is described in greater detail below:

| |  | High-end Server networking cards: these are the products for which we are
leveraging our expertise in networking and operating systems.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------

11

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| |  | High-end Networking Bypass cards: in this area we produce server networking cards
with special functionalities for security appliances and we leverage the achievements of
our Server Networking Cards for the growing security market.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Connectivity solutions for portable PCs: this is our traditional area of expertise,
in which demand for our products has significantly declined and in which we expect to
fully phase out over time.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Broadband Internet access: this is the area in which we leveraged our core
technology and connectivity solutions know-how in 2000 and 2001. Our operations in this
industry are declining as well.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

# High end Server
Networking Cards

In an effort to leverage our
strengths, in late 2001 we began exploring a new direction which we feel has become and
will continue to be our primary growth driver in the future: high-end server networking
cards. Our core expertise has always been our broad range of Ethernet and connectivity
products, which provided personal computer users with solutions to their connectivity
problems. In late 2002 we decided to employ our core know-how in the realm of server-based
systems. Doing so takes advantage of our competitive edge by using the expertise we have
developed in connectivity solutions for personal computers in industries which require
broader connectivity solutions with very high-performance environments. These industries
include data storage, video on demand, internet content delivery, high-performance
computing, web servers, security appliances, etc. Our decision to move into the
server-based systems area also capitalizes on our previous experience with the storage
market.

We believe that the high-end server
networking cards will continue to be a key driver of our growth in the coming years. A
distinct advantage of these products is that the demand in the server industry has been
almost continuously growing. The server-based systems industry is an industry that
continues to require innovative solutions which must become faster each time they are
implemented. However, the process of achieving design wins and obtaining new customers is
time consuming as a result of the fact that the sales cycles for products in this industry
are long. Nevertheless, each design win we achieve, may represent an opportunity for
sustained, long-term revenues.

We have developed a line of products
for the evolving server networking industry which facilitates interaction between servers,
allowing them to communicate with each other. It would be difficult to design such
high-end products without a high level of cross-disciplinary knowledge. The products we
have developed use our Ethernet and operating systems expertise. The first products in
this line are eight multi-port Gigabit-Ethernet Server Networking cards. These are
powerful products that allow server-based systems to fully exploit the high-speed
potential of Gigabit Ethernet. The products have either two, four or six ports, which plug
into the servers between which interaction is facilitated. Our main competitor in this
area, Intel, has developed cards which do not cover the full scope of features that our
products do. For instance, Intels products do not offer six ports, nor do they offer
Multi Port Fiber LX interfaces. We believe that our expanded feature set coupled with the
fact that our products are based on two different industry leader chip sets, which makes
them more compatible with our potential customers needs, gives us a competitive
edge. To the best of our knowledge we are currently the only company offering such a
comprehensive range of server networking products.

12

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Our business model for our server
networking lines of products is called the Design Win Model. It is based on the
exploitation of our core intellectual property relating to connectivity solutions and
networking. The following are the main aspects of this model:

| |  | We
approach a potential customer or are approached by such customer.
| | - | --------------------------------------------------------------------

| |  | If
the customer shows interest in the products and we believe that achievement of a business
relationship with the customer is possible, we ship products for such customers
evaluation.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | During
the evaluation process the customer receives a few of our Server Networking Cards for
initial basic testing. If the evaluation process is successful, we ship products for
qualification.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | During
the qualification process the customer receives a larger amount of our Server Networking
Cards for more specific testing and customization of our products to its specific needs.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | If
the qualification process is successful, we enter into negotiations regarding the terms
of a business relationship and only consider the achievement of a design win, upon
receipt of the first purchase orders from the customer.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | In
some cases, typically with the larger customers, the evaluation and qualification process
may take 12 months or more.
| | - | ------------------------------------------------------------------------------------------------------------------------

| |  | Once
we have achieved a design win, the customer will purchase products from us, in order to
incorporate them within its server based systems. This is generally true for as long as
there is a demand for the customers products and we are a single source for such
customer, however, in some cases we may be a second source for such products.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

# High-end Networking
Bypass Cards for Security and other Network Appliances

Following achievement of the design
wins with respect to our Server Networking Cards, we subsequently developed some of these
same products with a bypass feature. Intended for mission-critical environments, the
Silicom Gigabit Ethernet Bypass Networking Cards feature innovative bypass circuitry to
maintain continuity of network connectivity in the event of a gateway failure. Upon the
occurrence of a gateway failure, the cards bypass mechanism automatically reroutes
traffic to bypass faulty components, enabling customers to have reliable and always
available network accessibility. As with all of Silicoms Multiport Gigabit Ethernet
Networking Cards, the Bypass cards also improve server throughput and performance during
normal operations by reducing network congestion, simplifying network management, and
minimizing CPU utilization. The addition of the innovative bypass capability makes Silicom
Gigabit Ethernet Bypass Networking Cards an appropriate connectivity solution for security
appliances, as well as for appliances targeted at other high-potential, growing
markets such as network monitoring, load balancing, network event management, network
optimization, LAN policy enforcement, intrusion detection, virus protection, e-mail
content filtering, and more. To the best of our knowledge we are currently the only
company offering such a comprehensive line of bypass products, which offers dual port and
quad port cards, copper and fiber interfaces and dual chip set. Although the situation may
change in the future, we believe that our competition in the bypass card market is less
significant than in the non-bypass card market.

13

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The following is a brief description
of our networking products related to the above two sub categories:

The products are divided into two
groups: One group of products is based on Broadcoms chipset and the other group is
based on Intels chipset.

Products based on Broadcoms
chipset are: PXG6, PXG4, PXG2, PXG2F, PEG1, PEG1F, PXG2BP, PXG4BP. The number in each
product name represents the number of Gigabit-Ethernet ports that the product has. The F
(in the fourth product) represents a Fiber-optic Ethernet interface, rather than a copper
Ethernet interface as in the other products. The X represents PCI-X based products, while
E represents PCI-Express based products, indicating products which are based on the newest
PCI-Express bus. The BP represents a card that carries the bypass functionality. Products
based on the Intel chipset carry the same name with an addition of I at the
end to indicate the Intel chipset. We have: PXG6i, PXG4i, PXG2i, PXG2Fi, PXG4Fi, PXG2BPi,
PXG4BPi, PXG2BPFi and PXG4BPFi. Except for the difference in the type of chipset, type of
bus, bypass functionality, number of ports and type of Ethernet interface, all of the
following other principal applications and key features of these products are similar:

Principal Applications, all of which
demand high performance multi port connectivity:

| |  | Security
and other network appliances
| | - | -------------------------------------

| |  | Network-attached
storage (NAS)
| | - | ------------------------------

| |  | Video
on Demand servers
| | - | -----------------------

| |  | Content
Delivery servers
| | - | ------------------------

| |  | Internet
Service Providers / Web Hosting
| | - | ----------------------------------------

| |  | High
end computing
| | - | ------------------

Key Features which enable high
performance Gigabit speed multi port cards:

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| |  | Six,
four or two independent copper, or, four or two independent fiber, Gigabit Ethernet
channels with support for Gigabit Ethernet (1000Base-T), Fast Ethernet (100Base-Tx), and
Ethernet (10Base-T).
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Auto-negotiation
automatic sensing and switching between 1000Mbps full duplex or 100 / 10 Mbps operations
Simplex or Full Duplex.
| | - | ---------------------------------------------------------------------------------------------------------------------------------

| |  | Host
Interface standard support:
| | - | --------------------------------

| |  | PCI
v2.2 32/64 bit, 33/66Mhz
| | - | ----------------------------

| |  | PCI-X
v1.0 32/64-bit, 66/100/133MHz
| | - | -----------------------------------

| |  | Individual
MAC address for each port (support multiple domain/IP networks).
| | - | ---------------------------------------------------------------------------

| |  | Ultra
deep, 64 KB packet buffer per channel, which lowers CPU utilization and avoids PCI-X
congestion.
| | - | ------------------------------------------------------------------------------------------------------

| |  | Dual
high speed RISC processor per channel for advanced packet classification.
| | - | ------------------------------------------------------------------------------

| |  | TCP/UDP/IP
checksum offloadsto shift checksum processing from the host CPU to the NIC for
improved system response and longer CPU life.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------

| |  | TCP
segmentation offloads to reduce host CPU load for improved system performance.
| | - | ----------------------------------------------------------------------------------

| |  | Server
class reliability, availability and performance features.
| | - | ----------------------------------------------------------------

| |  | Link
Aggregation and Load Balancing:
| | - | ------------------------------------

| |  | Switch
dependent: 802.3ad (LACP), Generic Trunking (GEC / FEC)
| | - | --------------------------------------------------------------

| |  | Switch
and NIC Independent
| | - | --------------------------

| |  | Failover
| | - | --------

| |  | Priority
queuing  802.1p layer 2 priority encoding.
| | - | ----------------------------------------------------

| |  | Virtual
LANs -802.1q VLAN tagging.
| | - | ----------------------------------

| |  | Jumbo
Frame (9KB) to speed data transfer rates and further improve the throughput.
| | - | ----------------------------------------------------------------------------------

| |  | PCI
Hot-Plug for replacement and removal of server NIC to a PCI Hot Plug compatible
server without powering down the system.
| | - | ----------------------------------------------------------------------------------------------------------------------------

| |  | 802.x
flow control.
| | - | -------------------

| |  | Boot
ROM, embedded or optional, which can be used for Boot ROM applications.
| | - | ----------------------------------------------------------------------------

In April, 2004, we announced the
release of our next generation of products, which is based on a TOE (TCP/IP Offload
Engine) solution. Multi port Gigabit-Ethernet cards can work at very high speeds, but in
some cases, they bring the CPU utilization of the host-server to almost 100%. Our
high-performance TOE (TCP/IP Offload Engine)/iSCSI server adapters are designed to
accelerate server performance through the elimination of server-CPU bottlenecks by
independently handling many computation-intensive tasks, which releases the CPU of the
host-server and allows it to deal with its original missions. In addition, by providing
iSCSI functionality, our products facilitate implementation of the low-cost iSCSI storage
protocol without loading the server. We have already received purchase orders for our Dual
Port PCI-X TOE/iSCSI Server Adapter, the first product of the new line. We believe that
sales in this market will grow in the coming years, however, the current growth rate in
sales in this market is moderate as market education is required for the adaptation of
this type of product.

15

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# Traditional
Connectivity Solutions for Portable PCs.

Since the early 1990s, there has been
a steady growth in sales of portable computers. This growth has been driven by
technological advances, which have resulted in the continued introduction to the market
place of more compact, more powerful, lighter and easier to use portable computers. These
advances have made portable computers a solution for an increasingly mobile workforce,
such as traveling executives, consultants, salespeople, telecommuters and people who take
their work home with them. In addition, as portable computers have become more powerful,
an increasing number of portable computers are now utilized as primary PCs in and out of
the office, and are used instead of (and not in addition to) traditional desktop PCs. The
growth in the use of portable computers has corresponded with an increased dependence on
network-based communication systems, resulting from the need to effectively and
efficiently use resources and communicate information in todays competitive business
environment. In the field of portable computers, our core strength has been our broad
range of single and multi-function connectivity products that incorporate various Silicom
and third party technologies to provide portable computer users with a comprehensive
solution to their connectivity problems.

While all the above is still true,
the trend in the data communications industry has been to incorporate modems as built-in
elements of portable PCs, and to incorporate Ethernet and Fast Ethernet as built-in
elements of portable PCs. Both these trends have obviated much of the need for our Modem
and Ethernet/Fast Ethernet PC Card products. Our Modem PC Cards have therefore been
completely phased out and we believe that Ethernet/Fast Ethernet PC Cards will also be
phased out completely over time. See Item 5  Operating and Financial Review
and Prospects  Trend Information.

# Broadband Internet
Access

One of the former technological
challenges in delivering high-speed internet services to subscribers was to easily connect
a broadband modem to a subscribers PC. Most Broadband modems are external and must
be physically connected to the PC. While initially most broadband modems used Ethernet
technology, most home computers did not have an Ethernet card installed. This created a
bottleneck in installation, limiting the speed with which broadband internet service
providers could penetrate the market. This bottleneck was further complicated by the fact
that telephone and cable companies supplying broadband internet service may not have had
enough qualified technicians who had the know-how to connect the internet platform to the
PC.

Our solutions to this challenge,
which we dubbed the Last 10 Feet, were our Universal Serial Bus-based external
Ethernet product (the U2E), as well as our USB Ethernet self-install adapter
(the U2ES), a product which incorporated our self-install technology. The U2ES
was intended to connect broadband modems to PCs through the PCs USB port, while
performing automatic installation and configuration steps.

16

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While initially most broadband modems
used Ethernet technology for connection to PCs, broadband manufacturers moved towards
adding USB ports to their modems, hence enabling USB to USB connection between the modem
and the PC. Although this solution eliminates the need for Ethernet connectivity, the USB
modem must still be installed into the PC with an installation CD or diskette. The goal of
our self-install technology was to enable broadband manufacturers to offer self-install
solutions, either inside the modem or externally, that would perform all installation and
configuration steps automatically, with no user intervention. Our self-install technology,
called IPlug, removed the need for human intervention in the installation process,
whether by users or by technical support staff of broadband Internet service providers.
IPlug completely automated the installation process. Due to the general downturn
worldwide in late 2000 and 2001 in industries based on technology, the business
transactions we proposed to enter into in the broadband area moved very slowly, and the
uncertainty in the market made doing business more complicated. In addition, the
technology and products we developed in the broadband field, including the IPlug
technology, lost their competitive edge because of similar products which became
commodities in 2002. For instance, regular peripherals, which did not require self-install
technology became a commodity, to the disadvantage of peripherals which included our
self-install technology. As such, we have decided not to invest more of our resources in
the further development of this area.

# Principal Markets

The principal markets in which we
compete are set forth more particularly in, and are incorporated by reference to footnote
12(A) to Item 18 of this annual report (the financial statements). In 2002, 2003 and 2004,
approximately 21% 9%, and 6%, respectively, of our sales were in Europe, 65% 86%, and 84%,
respectively, were in the United States and Canada, and 14% 5%, and 10%, respectively,
were in other countries.Our main business is not seasonal, and we believe that
there are sufficient sources and raw materials available to sustain it.

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# Sales and Marketing

Over the last few years, our sales
and marketing has been carried out through a network of strategic relationships with
leading original equipment manufacturers, installers and integrators in the computer
industry which sell our connectivity products under their own private labels or
incorporate our integrated circuits or modules into their products. They are referred to
in this report as OEMs, or OEM customers. Our strategy of carrying out strategic
relationships with OEM customers has not changed. We believe that these relationships
enable us to take advantage of the superior financial resources and market presence of
these companies to increase our sales and establish, maintain and strengthen our position
and reputation in the market for connectivity products. We will continue to market
complete product solutions, but believe that these complete product solutions will become
less important as we move towards the server networking markets. In addition, we believe
that relationships with OEMs improve access to new technologies developed by such OEMs,
thereby shortening the time-to-market of our products and technology and ensuring smooth
integration of our products and technology with those of the OEMs. In furtherance of this
strategy, we have entered into additional strategic arrangements with additional OEMs.
These companies incorporate our connectivity products and/or technology under their own
private labels or integrate our products/technology into their systems or as part of their
systems. In 2004 we entered into an OEM agreement with a world-leading provider of
internet security solutions, and recorded design wins from other OEMs who purchase our
products. Revenues from sales of our connectivity products (including integrated circuits)
to OEM customers in 2004 constituted approximately 87% of our revenues. We expect the
percentage of our revenues that is derived from sales of connectivity products to OEM
customers to increase as we continue to focus our efforts on our server products, which
are sold to OEMs as well.As such, the loss of some of our OEM customers may have a
material adverse effect on our operations and financial results and we cannot assure you
that we will be able to enter into strategic relationships with OEMs in the future. Our
other non-OEM products are marketed directly, through our U.S.-based subsidiary and
through a worldwide network of independent distributors. Normal payment terms of our
distributors are up to 60 days net.Substantially all of our international sales
are denominated in U.S. dollars and may be subject to government controls and other risks,
including, in some cases, export licenses, federal restrictions on export, currency
fluctuations, political instability, trade restrictions, and changes in tariffs and
freight rates. We have experienced no material difficulties to date as a result of these
factors.

Our arrangements with OEMs,
distributors and resellers are generally non-exclusive. We have generally experienced good
relations with our OEM customers and distributors and are not aware of any pending
terminations other than with respect to products that newer technologies have eliminated
the need for.

Our OEMs, distributors and resellers
are not within our control. They are not obligated to purchase products from us and may
represent other lines of products. A reduction in sales effort or discontinuance of sales
of our products by our OEMs could lead to reduced sales and could materially adversely
affect our operating results. Use of OEMs also entails the risk that OEMs will build up
inventories in anticipation of a growth in sales. If such growth does not occur as
anticipated, these OEMs may substantially decrease the amount of products ordered in
subsequent quarters, discontinue product orders or even attempt to return unsold products.
The loss or ineffectiveness of our major OEMs could have a material adverse effect on our
operating results. We believe that no loss of a single OEM is likely to have a material
adverse effect on us. However, the loss of several OEMs at approximately the same time
might have a temporary material adverse effect on us.

# Research and Product
Development

Since we commenced operations, we
have conducted extensive research, development and engineering activities. Our efforts
emphasized the development of new products, cost reduction of current products, and the
enhancement of existing products, generally in response to rapidly changing customer
preferences, technologies and industry standards. We currently are capitalizing on our
technology base and our experience in order to develop server networking cards to be used
by manufacturers of server-based systems. During 2003 and 2004 we fully matured our multi
port line of products and further invested in the development of our TOE/iSCSI cards
(announced in April 2004) and our bypass and TAP solutions.

18

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We cannot assure you that any of our
development efforts will result in commercially successful products, that such products
will be released in a timely manner or that we will be able to respond effectively to
technological changes or new product announcements by others.

The markets for our products are
characterized by rapidly changing technology, short product-life cycles and evolving
industry standards. We believe that success will depend upon our ability to successfully
market new networking and connectivity concepts, and to a lesser extent, upon our ability
to enhance our existing products, and to continue to introduce new products on a timely
basis. Accordingly, we intend to make substantial investments in technology development.
Notwithstanding these efforts, we cannot assure you that we will be successful in
selecting, developing, manufacturing and marketing our technology or our enhanced and new
products in a timely manner.

# Manufacturing and
Suppliers

Our manufacturing operations for
hardware components consist primarily of producing finished goods from components and
sub-assemblies purchased from third parties. In addition, we perform testing and quality
assurance procedures with respect to the components and sub-assemblies which are
incorporated into our final products and the final products themselves.

We seek to monitor quality with
respect to each stage of the production process including, but not limited to, the
selection of component suppliers, warehouse procedures and final testing, packaging and
shipping. We have been certified as complying with ISO 9001:2000", which is a
quality control standard used in our industry. We believe that our quality assurance
procedures have been instrumental in achieving a high degree of reliability for our
products. We intend to continue to maintain and improve the efficiency of such procedures.
Although we generally use standard parts and components for our products, certain key
components used in our products are currently available from only one source, and others
are available from a limited number of sources. Components currently available from one
source include proprietary Gigabit Ethernet chipsets and other components, including other
semiconductor devices and transformers, as well as plastic and metal product housings. We
believe that we maintain a sufficient inventory of these components to protect against
delays in deliveries. There can be no assurance that we will not experience delays in the
supply of critical components in the future or that we will have a sufficient inventory of
critical components at such time to produce products at full capacity. If we do experience
such delays and there is an insufficient inventory of critical components at that time,
our operations and financial results would be adversely affected.

19

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We are generally required to fill
orders for our products within a few weeks after receipt of a firm purchase order.
Consequently, backlog is maintained at low levels.

# Competition

The data communications industry is
highly competitive. We face competition from numerous companies, some of which are more
established, benefit from greater market recognition and have greater financial,
production and marketing resources than we do. We cannot guarantee that our present or
contemplated products will continue to be distinguishable from those of our competitors or
that the marketplace will find our products preferable to those of our competitors.
Furthermore, there can be no assurance that competitive pressures will not result in price
reductions that could materially adversely affect our business and financial condition and
the results of our operations.

With respect to our legacy products
for portable computers, while the demand for such products is declining, we still face
competition from a variety of companies which may expedite the rate of decline in demand
for such legacy products. In the broadband internet access industry, we face major
competition from numerous Far Eastern companies, causing the demand for our products in
this industry to be less than previously expected. In the evolving server networking
industry for which we have developed our multi-port Gigabit-Ethernet Server Networking
cards, our main competitor is Intel. In the TOE industry our main competitors are
Alacritec, Inc. and Adaptec Inc., and in the iSCSI industry our major competitors are
Emulex Inc., Qlogic Inc., and JNI Inc. In the bypass cards industry, our competition is
not as significant. To the best of our knowledge, our only significant competitor there is
Interface Masters. There also may exist other local solutions which may compete with our
products, proposing solutions which are not an embedded card but rather an external box.

# Intellectual Property
Rights and Software Protection

Our success and ability to compete
are dependent to a significant degree on our proprietary technology. We currently rely on
a combination of trade secret, copyright and trademark laws, together with non-disclosure
agreements and technical measures, to establish and protect proprietary rights in our
products. These measures afford only limited protection, and accordingly, there can be no
assurance that the steps we take to protect these proprietary rights will be adequate to
prevent misappropriation of our technology or the independent development of similar
technologies by others. Despite our efforts to protect our proprietary rights,
unauthorized parties may attempt to copy aspects of our products and develop similar
hardware or software or to obtain and use information that we regard as proprietary. In
addition, there can be no assurance that one or more parties will not assert infringement
claims against us. The cost of responding to claims could be significant, regardless of
whether the claims are valid.

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In April 2002 we reached an agreement
with a company that claimed that certain of our connectivity products infringe its
patents. We agreed to pay the amount of $150,000 to this company in exchange for the right
to a license for our past and future products which use this alleged infringing
technology. In reaching agreement we avoided incurring additional costs and expenses. See
Note 7 to the consolidated financial statements.

# Governmental Regulation
Affecting the Company

We are affected by the terms of
research and development grants we have received from the Office of the Chief Scientist of
Israel (OCS). Under the terms of Israeli Government participation, a royalty
of 3% or up to 5% of the net sales of products developed from a project funded by the OCS
must be paid, beginning with the commencement of sales of products developed with grant
funds and ending when 100% or 150% of the grant is repaid. For projects approved after
January 1, 1999, the amount of royalties payable is up to a dollar-linked amount equal to
100% of such grants plus interest at LIBOR. The terms of Israeli Government participation
also impose significant restrictions on manufacturing outside Israel of products developed
with government grants and the transfer to third parties of technologies developed through
such projects is subject to approval of the OCS. There can be no assurance that such
approval, if requested, will be granted on reasonable commercial terms.

In addition, we receive certain tax
benefits and reduced tax rates from the Israeli government due to our being granted
Approved Enterprise status under the Law for the Encouragement of Capital
Investments-1959, as amended. See Item 10. Additional Information 
Taxation. The entitlement to these benefits is conditional upon our fulfillment of
the conditions stipulated by the law, regulations promulgated thereunder and the
instruments of approval for the specific investments. In the event of failure to comply
with these conditions, the benefits could be canceled and we would be required to refund
the amount of the benefits, in whole or in part, with the addition of linkage differences
and interest.

# Organizational Structure

We are a member of the Rad
Group of companies, which is an affiliated group of high-technology companies in
Israel. We have one wholly owned subsidiary which is incorporated in the United States
under the name Silicom Connectivity Solutions, Inc. Two of our founders, Messrs. Yehuda
and Zohar Zisapel, are also founders, directors and principal shareholders of several
other corporations within the Rad Group. See Item 7. Major Shareholders and Related
Party Transactions.

# Property, Plants and
Equipment

We do not own any real property, but
we lease property at three locations. Our executive offices and research and development
facilities are located in Kfar Sava, Israel. The original term of our lease with respect
to such space expired on October 31, 1998, and was renewable for additional one-year
periods through October 31, 2002. Since that time we have nonetheless continued to renew
our lease for additional one year periods, most recently through October 31, 2005. The
lease was originally for approximately 945 square meters and was reduced to 600 square
meters in January 2003. We currently pay a monthly rent of $5,000.

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We conduct our manufacturing from a
facility of approximately 610 square meters in Yokneam, Israel. The monthly rent payments
for this facility are $5,010. The lease was originally for a 4 year period, ending on
August 15, 2004 and included an option to renew the lease for an additional period of one
year. We exercised the renewal option for our manufacturing facility, and further extended
the lease agreement until August 15, 2006.

From March 1997 through January 2004
we leased space in Mahwah, New Jersey from an affiliate. Commencing in February 2004, we
began to sub-lease space in Paramus, New Jersey, from an affiliate. Currently, the base
monthly rent payments for this space are $405, plus an additional $50 per month for
maintenance and utilities. See Item 7  Major Shareholders and Related Party
Transactions.

We believe that our facilities in
Israel and in the United States are suitable and adequate for our operations as currently
conducted. In the event that additional facilities are required or we need to seek
alternative rental properties, we believe that we could obtain such additional or
alternative facilities at commercially reasonable prices.

|Item 5. |  | OPERATING
AND FINANCIAL REVIEW AND PROSPECTS
|------- |  | --------------------------------------------

# General

Silicom was incorporated in Israel
and commenced operations in 1987. We have traditionally been engaged in the design,
manufacture, marketing and support of connectivity solutions for mobile and remote
personal computer users. In the years 2000 and 2001, we leveraged the IP developed in this
area for use in the broadband internet access market. In late 2002 we leveraged our
expertise and know-how in networking and operating systems to develop a line of high-end
server networking cards. We made initial sales of these products to a number of customers
during 2003 and recorded growing sales of these products throughout 2004. We primarily
sell our products through Original Equipment Manufacturers and, to a lesser extent,
through independent distributors (on a non exclusive basis). In the United States, we
market our products through our wholly owned United States subsidiary, Silicom
Connectivity Solutions, Inc.

# Critical Accounting
Policies

The discussion and analysis of our
financial condition and results of operations are based upon our consolidated financial
statements, which have been prepared in accordance with accounting principles generally
accepted in the United States. The preparation of these financial statements requires us
to make estimates and judgments that affect the reported amount of assets and liabilities,
revenues and expenses, and related disclosure of contingent assets and liabilities at the
date of our financial statements. Actual results may differ from these estimates under
different assumptions or conditions.

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Critical accounting policies are
defined as those that are reflective of significant judgments and uncertainties, and
potentially result in materially different results under different assumptions and
conditions. We believe that our critical accounting policies are limited to those
described below.

 Inventories 
Inventories are stated at the lower of cost or market. Cost is determined using the
average-cost method for raw materials. The cost of the work in process and
finished goods of the Companys Traditional Products is determined based on the
allocation of labor and overhead, which are allocated on the basis of raw materials
consumption. The cost of the work in process and finished goods of the Companys
Server Networking Products is determined based on a specific allocation of overhead to
each product. We carefully examine our obsolete or slow inventory situation and establish
all allowances for obsolete or slow moving inventory to record at the lower of cost or
market. The examination of obsolete or slow moving inventory includes our estimates of the
likelihood of using or selling each of the material inventory parts.

 Allowance for doubtful
accounts  Trade receivables are recorded less the related allowance for doubtful
accounts receivable. We consider accounts receivable to be doubtful when it is probable
that we will be unable to collect all amounts, taking into account current information and
events regarding our customers ability to repay their obligations. The balance sheet
allowance for doubtful debts is determined as a specific amount for those accounts the
collection of which is uncertain. We perform our estimates regarding potential doubtful
debts based on payment history and correspondence with our customers, and based on new
information we receive about customers financial situation. As of December 31, 2004,
the allowance for doubtful debts was $20,000.

 Deferred Taxes  We
account for income taxes under SFAS 109 Accounting for Income taxes. Under
SFAS 109, deferred tax assets or liabilities are recognized in respect of temporary
differences between the tax bases of assets and liabilities and their financial reporting
amounts as well as in respect of tax losses and other deductions which may be deductible
for tax purposes in future years, based on tax rates applicable to the periods in which
such deferred taxes will be realized. Deferred tax assets for future tax benefits from
realization are included when their realization is more likely than not. Valuation
allowances are established when necessary to reduce deferred taxes assets to the amount
expected to be realized. Deferred taxes were not recorded in respect of the following
matters:

| | n Carry
forward tax losses  As of December 31, 2004, we had carry forward tax losses in
Israel of approximately $5,796,000 and our subsidiary had federal carry forward tax
losses of approximately $579,000 to be realized until 2018 to 2024 and New Jersey state
carry forward tax losses of approximately $451,000 to be realized until 2010 to 2011.
There is no assurance that these carry forwards will be realized.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | n Taxes,
which may apply upon the realization of investments in consolidated subsidiaries and
affiliated companies  currently there is no intention to realize such investments.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

23

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# Recently Enacted
Accounting Pronouncements

In November 2004, the FASB issued
FASB Statement No. 151, Inventory Costs, an amendment to ARB 43, Chapter 4 (SFAS 151). The
amendments made by SFAS 151 clarify that abnormal amounts of idle facility expense,
freight, handling costs, and wasted material (spoilage) should be recognized as
current-period charges, and also require the allocation of fixed production overhead to
inventory based on the normal capacity of the production facilities. The guidance is
effective for inventory costs incurred during fiscal years beginning after June 15, 2005.
Earlier application is permitted for inventory costs incurred during fiscal years
beginning after November 23, 2004. The provision of SFAS 151 should be applied
prospectively. Adoption of this statement is not expected to have a material impact on the
Companys financial statements.

In March 2004, the Emerging Issues
Task Force (EITF) reached a consensus on Issue No. 03-01, The Meaning of
Other-Than-Temporary Impairment and its Application to Certain Investments
(EITF 03-1). EITF 03-1 provides guidance on other-than-temporary impairment
models for marketable debt and equity securities accounted for under SFAS No. 115,
Accounting for Certain Investments in Debt and Equity Securities (SFAS
115), and non-marketable equity securities accounted for under the cost method. The
EITF developed a basic three-step model to evaluate whether an investment is
other-than-temporarily impaired. On September 30, 2004, the FASB issued FSP 03-1-1,
Effective Date of Paragraphs 10-20 of EITF Issue 03-1, The Meaning of
Other-Than-Temporary Impairment and its Application to Certain Investments,
delaying the effective date for the recognition and measurement guidance of EITF 03-1, as
contained in paragraphs 10-20, until certain implementation issues are addressed and a
final FSP providing implementation guidance is issued. The disclosure requirements of the
consensus remain in effect. The Company has adopted the quantitative and qualitative
disclosures for investments accounts for under FASB 115 in fiscal year ended December 31,
2004.

24

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In December 2004, the FASB issued
SFAS No. 123 (Revision 2004), Share-Based Payment, (SFAS 123R), that addresses
the accounting for share-based payment transactions in which employee services are
received in exchange for either equity instruments of the Company, liabilities that are
based on the fair value of the Companys equity instruments or that may be settled by
the issuance of such equity instruments. SFAS 123R eliminates the ability to account for
share-based compensation transactions using the intrinsic value method as prescribed in
APB Opinion No. 25, Accounting for Stock Issued to Employees. Instead, SFAS
123R requires that such transactions be accounted for using a fair-value-based method and
that compensation expense be recognized in the statement of operations rather than
disclosing the pro forma impact of the stock based compensation as the Company currently
discloses in Note 9. SFAS 123R provides two alternative adoption methods. The first method
is a modified prospective transition method whereby a company would recognize share-based
employee costs from the beginning of the fiscal period in which the recognition provisions
are first applied as if the fair-value-based accounting method had been used to account
for all employee awards granted, modified, or settled after the effective date and to any
awards that were not fully vested as of the effective date. Measurement and attribution of
compensation cost for awards that are unvested as of the effective date of SFAS 123R would
be based on the same estimate of the grant-date fair value and the same attribution method
used previously under SFAS No. 123, Accounting for Stock-Based Compensation
(SFAS 123). The second adoption method is a modified retrospective transition
method whereby a company would recognize employee compensation cost for periods presented
prior to the adoption of SFAS 123R in accordance with the original provisions of SFAS 123;
that is, an entity would recognize employee compensation costs in the amounts reported in
the pro forma disclosures provided in accordance with SFAS 123. A company would not be
permitted to make any changes to those amounts upon adoption of SFAS 123R unless those
changes represent a correction of an error. The provisions of SFAS 123R are effective for
annual periods beginning after June 15, 2005. This Standard will be effective for the
Company as of January 1, 2006. The Company expects the adoption of this Standard will
reduce 2006 net income by approximately US$ 144 thousand. This estimate is based on the
number of options currently outstanding and exercisable and could change based on the
number of options granted or forfeited in fiscal 2005 and 2006.

In December 2004, the FASB issued
SFAS No. 153, Exchanges of Nonmonetary Assets  an amendment to APB No.
29. This Statement amends Opinion No. 29 to eliminate the exception for nonmonetary
exchanges of similar productive assets and replaces it with a general exception for
exchanges of nonmonetary assets that do not have commercial substance. A nonmonetary
exchange has commercial substance if the future cash flows of the entity expected to
change significantly as a result of the exchange. Adoption of this statement is not
expected to have a material impact on the consolidated financial statements of the
Company.

In March 2005, the FASB issued
Interpretation No. 47, Accounting for Conditional Asset Retirement
Obligations, that requires an entity to recognize a liability for the fair value of
a conditional asset retirement obligation when incurred if the liabilitys fair value
can be reasonably estimated. This Interpretation is effective for fiscal years ending
after December 15, 2005. Accordingly, the Company is required to adopt FIN 47 in its
fiscal year ended December 31, 2005. We do not expect adoption of FIN 47 to have a
material effect on our Consolidated Financial Statements.

25

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# Operating Results

The following table sets forth, for
the periods indicated, the relationship (in percentages) of items from our Consolidated
Statement of Operations Data to our total sales:

# Year Ended December 31,

|                                 | 2004 | 2003 | 2002
|-------------------------------- | ---- | ---- | ----
|
|
|
|
|Sales                            |      |      |     
|                                 |      |     
|Cost of sales                    |      |      |     
|                                 |      |     
|Gross profit                     |      |      |     
|                                 |      |     
|R&D costs, gross                 |      |      |     
|                                 |      |     
|(Less) government royalty        |      |     
|bearing participation            |      |      |     
|                                 |      |     
|R&D costs, net                   |      |      |     
|                                 |      |     
|Selling, marketing, general and  |      |     
|administrative expenses          |      |      |     
|                                 |      |     
|Operating Loss                   |      |      |     
|                                 |      |     
|Financial income (expenses), net |      |      |     
|                                 |      |     
|Net Loss for the year            |      |      |     

Sales in 2004 increased to $4,559,000
compared to $3,725,000 in 2003, mainly due to the growing sales of our server networking
cards. Approximately 48% of our sales in 2004 were attributable to our line of multi-port
Gigabit Ethernet networking cards, 44% were attributed to our traditional connectivity
solutions for portable computer products, and 8% were attributable to broadband internet
access products and to other sales.

Sales in 2003 increased to $3,725,000
compared to $2,726,000 in 2002, mainly due to higher sales to our major OEM customer.
About 57% of our sales in 2003 were to this OEM customer. About 62% of our sales in 2003
were attributed to our traditional connectivity solutions for portable computers products,
while 14% were attributable to broadband internet access products, 6% were attributable to
our new line of multi-port Gigabit Ethernet networking cards and 18% were attributable to
other sales.

Gross profit in 2004 was $1,560,000
compared to $1,565,000 in 2003. Gross profit as percentage of sales in 2004 was 34.2%,
compared to 42.0% in 2003. The Gross profit percentage was lower in 2004 than in 2003
mainly due to 2004 being a transitional period between sales of legacy products and new
products. In such transitional period, the manufacturing quantities, which represented
only initial quantities for the new design wins, were translated into high manufacturing
costs, significantly impacting our profitability. We believe that gross profit will rise
as sales continue to build following design wins already recorded and new design wins
which we may achieve.

26

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Gross profit in 2003 was $1,565,000
compared to $635,000 in 2002. Gross profit as percentage of sales in 2003 was 42.0%,
compared to 23.3% in 2002. The Gross profit percentage was higher in 2003 than in 2002
mainly due to sales of products with higher profit margins in 2003, and also due to the
fact that as sales increase, the impact of fixed cost of sales on the gross profit is
lower. There was no significant change in labor and materials costs in 2003.

Gross research and development
expenses for 2004 decreased insignificantly by 3.1% to $1,596,000 compared to $1,647,000
during 2003. Because the markets for our products are characterized by rapidly changing
technology, short product-life cycles and evolving industry standards, our success will
depend upon our ability to select, develop, manufacture and market new and enhanced
connectivity and networking products in a timely manner to meet changing market needs. We
expect to continue to invest significant resources in new product development,
enhancements to existing products, and the development of new networking and connectivity
technologies.

Gross research and development
expenses for 2003 increased by 8.1% to $1,647,000 compared to $1,523,000 during 2002,
mainly due to the level of our investment in our server networking product lines, in which
we invested all of our research and development efforts.

Selling and marketing expenses for
2004 decreased by 28.6% to $718,000, compared to $1,006,000 during 2003, mainly due to the
fact that we ceased most of our sales and marketing activities for our traditional
products and focused mainly in promoting the sales and marketing of our server networking
products.

Selling and marketing expenses for
2003 decreased immaterially by 1.6% to $1,006,000, compared to $1,022,000 during 2002.
While in 2003 we invested significant resources in selling and marketing our new line of
multi port Gigabit Ethernet server adapters, we invested significantly less in our
traditional product lines, hence there was no material change between 2003 and 2002.

Net loss for 2004 was $1,240,000
compared to a net loss of $1,509,000 in 2003, mainly due to the decrease in selling and
marketing expenses.

Net loss for 2003 was $1,509,000
compared to a net loss of $2,485,000 in 2002, mainly due to our higher sales and higher
gross profit in 2003.

# Impact of Inflation and
Devaluation on Results of Operations, Liabilities and Assets

Since the institution by the Israeli
government of an economic recovery program for the halting of high inflation rates in
1985, inflation, while continuing, has been significantly reduced and the rate of
devaluation has been substantially diminished. Since the majority of our revenues are
denominated and paid in U.S. dollars, we believe that inflation and fluctuations in the
U.S. dollar exchange rate have no material effect on our revenue. Inflation in Israel and
the Israeli currency as well as U.S. dollar exchange rate fluctuations, do however, have
some effect on our expenses and, as a result, on our net income/loss. The cost of our
Israeli operations, as expressed in U.S. dollars, is influenced by the extent to which any
increase in the rate of inflation in Israel is not offset (or is offset on a lagging
basis) by a devaluation of the NIS in relation to the U.S. dollar.

27

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We do not presently engage in any
hedging or other transactions intended to manage the risks relating to foreign currency
exchange rate or interest rate fluctuations. However, we may in the future undertake such
transactions, if management determines that it is necessary to offset such risks.

# Liquidity and Capital
Resources

At December 31, 2004, we had working
capital of $3,147,000 and our current ratio (current assets to current liabilities) was
3.05. Since inception, our operations have been funded through capital contributions,
research and development grants and cash flow from operations.Cash and cash
equivalents as of December 31, 2004 decreased by $725,000 to $1,086,000 compared with
$1,811,000 as at December 31, 2003. Short-term investments fell by $248,000 and long-term
investments fell by $549,000. The net decrease of $1,522,000 in these three balance sheet
items in 2004 was caused mainly due to the net annual loss.

Short term trade receivables
increased to $741,000 at December 31, 2004 from $628,000 on December 31, 2003, mainly due
to the increase in sales in the fourth quarter of 2004, as compared to sales in the fourth
quarter of 2003. Other receivables increased immaterially from $290,000 to $337,000.

Cash used in operating activities in
2004 amounted to $1,536,000 compared to cash used in operating activities in the amount of
$1,414,000 in 2003. In both years the cash used in operating activities was the result of
the operating losses in such years. The figure is higher in 2004 due to the fact that as
sales grow, we are required to devote more resources to inventories and manufacturing
activities, before we receive payments from customers.

Inventories increased from $1,225,000
at the end of 2003 to $1,994,000 at the end of 2004, mainly due to the fact that as our
sales grow and customers demand receipt of products within a number of weeks following the
issuance of purchase orders, we are required to be ready to deliver our products in
accordance with our customers expectations.

Capital expenditures on property and
equipment in 2004 decreased by $71,000 compared with 2003, mainly due to the fact that in
2003 we made a significant investment in development and testing tools for our new product
lines of server networking cards.

We have cash and cash equivalents
that we believe will enable us to continue operating for at least the next 12 months.

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Other Assets: Our subsidiary, Silicom
Connectivity Solutions, Inc., entered into a Non-Exclusive Limited Patent License
Agreement in April 2002 as part of an agreement with a company that suggested that
certain of our connectivity products infringe its patents. The agreement included a
payment of a one-time license fee of $150,000 from our Subsidiary to the other company
which represented a licensing fee for both past and future Silicom sales of certain
connectors and PC cards under patents of the licensor. Our subsidiary classified this
$150,000 payment as an intangible asset, and has established a sixteen-year amortization
period which is based on the expected life of this license. In April 2002, the subsidiary
estimated that the past sales period under the licensing agreement was six years and that
the future sales period under the licensing agreement will be ten years; therefore, in
2002 the subsidiary recognized amortization expenses on the past six years of
approximately $56,200, and $7,100 related to the amortization for 2002. The total
amortization expense for 2002 was approximately $63,300. The total amortization expense
for both 2003 and 2004 was approximately $10,000. The remainder of the license fee to be
amortized as of December 31, 2004 was approximately $67,000. The amount of approximately
$10,000 is presented in Current Assets in the financial statements, while the amount of
$57,000 is presented as Other Assets in the financial statements.

Trade payables increased from
$558,000 at the end of 2003 to $1,008,000 at the end of 2004, mainly due to the growing
sales resulting in growing operating expenses. Other payables and accrued liabilities
increased immaterially from $488,000 at the end of 2003 to $522,000 at the end of 2004.

# Research and
development, patents and licenses, etc.

Because the market for our products
is characterized by rapidly changing technology, short product-life cycles and evolving
industry standards, our success depends upon our ability to select, develop, manufacture
and market new and enhanced products in a timely manner to meet changing market needs. As
such, we invest significant resources in research and new product development,
enhancements to existing products, and the development of new networking and connectivity
technologies, and we expect to continue to do so.

The Government of Israel encourages
research and development projects oriented towards products for export or projects which
will otherwise create surplus yield for the Israeli economy. As indicated below, in each
of the three fiscal years from 1999 to 2001, we received grants from the Office of the
Chief Scientist (OCS) for the development of systems and products. We have
received from the OCS approximately 30% of certain research and development expenditures
for particular projects. Under the terms of Israeli Government participation, a royalty of
3% or up to 5% of the net sales of products developed from a project funded by the OCS
must be paid, beginning with the commencement of sales of products developed with grant
funds and ending when 100% or 150% of the grant is repaid. For projects approved after
January 1, 1999, the amount of royalties payable is up to a dollar-linked amount equal to
100% of such grants plus interest at LIBOR. The terms of Israeli Government participation
also place restrictions on the location of the manufacturing of products developed with
government grants, which, in general, must be performed in Israel, and on the transfer to
third parties of technologies developed through projects in which the government
participates. See Item 10. Additional Information  Taxation. Due to the
decreasing budget of the OCS, we did not receive any grants for our projects in 2002, and
we received approximately 20% of certain research and development expenditures for a
particular project in 2003 and approximately 30% of a particular project in 2004. We
cannot guarantee that such encouragement programs will be continued, or that we will
continue to participate in them to the extent they are continued.

29

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The following table shows, for the
periods indicated, our gross research and development expenditures, the portion of such
expenditures which was funded by OCS and the net cost to us of our research and
development activities:

|                     | 1999 | 2000 | 2001 | 2002  | 2003 | 2004
|-------------------- | ---- | ---- | ---- | ----- | ---- | ----
|
|
|
|
|Gross research and   |      |      |      |       |      |     
|development expenses |      |      | $    | 1,078 |      | $   
|Portion funded by    |      |     
|Chief Scientist      |      |      | $    | 417   |      | $   
|Net research and     |      |     
|development expenses |      |      | $    | 661   |      | $   

* This amount reflects final
adjustments for projects supported in previous years.

We expect that we will continue to
commit substantial resources to research and development in the future. As of April 30,
2005, the Company employed 18 persons in research and development. Our gross research and
development expenses constituted approximately 35%, 44% and 56% of our sales, and our net
research and development expenses constituted approximately 32%, 40% and 56% of such
sales, in the respective years ended December 31, 2004, 2003 and 2002. For additional
information concerning commitments to pay royalties on sales of products developed from
projects funded by the Office of the Chief Scientist, see Note 8A to our financial
statements included elsewhere in this annual report and see Item 10. Additional
Information  Taxation.

# Trend Information

The trend in the data communications
industry has been to incorporate modems and Ethernet/Fast Ethernet as built-in elements of
portable PCs. This trend has obviated much of the need for our Ethernet/Fast Ethernet PC
Card products. We believe that this trend will continue, and that gradually, Ethernet/Fast
Ethernet PC Cards will be phased out completely.

Having anticipated the above trend,
we began a number of years ago to position ourselves to compete in the broadband internet
access industry. In 1999, 2000 and 2001, we invested most of our research and development
efforts in this industry. In 2002, 2003 and 2004 sales to the broadband internet access
and multi tenant unit, or MTU, industries constituted 35%, 14% and 7% of our total sales,
respectively. An additional trend which affected our sales of these products was the
worldwide slowdown in technology-based companies, which worsened throughout 2002 and part
of 2003, and had a ripple effect on our performance. Especially in the broadband internet
access and MTU industries, our products are used by cable companies and internet
providers. These companies were adversely affected by the global downturn in the
technology sector, which caused some of them to go out of business. Those companies which
have not gone out of business have found themselves in a more precarious situation. In the
meantime, products for this industry have become commodities, mostly manufactured by
companies from the Far East. We have therefore ceased our investments in this industry.

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In late 2002, we leveraged our
expertise and know-how in networking and operating systems to develop a line of high-end
server networking cards. In todays data communication environment, there is a
growing demand for server-based systems. The markets for such systems were less affected
by the worldwide slowdown described above and are almost continuously growing. We began
investing in marketing and sales of this line to potential markets and customers during
2003 and received initial purchase orders from a number of sources. We continued to invest
in the marketing of these products during the course of 2004 and the number of purchase
orders for these products increased significantly. The sales cycles in these markets are
long, but once we establish a customer base, each such customer will represent an
opportunity for sustained, long-term revenues. We expect this product line to be our
principal growth driver in the coming years, specifically with respect to the higher port
density cards, bypass cards and PCI-Express cards, however, there is no assurance that we
will succeed in having significant sales in this area.

The worldwide slowdown in
technology-related fields has contributed to an atmosphere of great uncertainty, in which
doing business has become more complicated. In this current environment, business
transactions which are already in progress take much longer to conclude, and new business
transactions are more difficult to come by. One positive aspect of this trend is the
growth in demand for security appliances which are a target market for the bypass cards
that we developed as part of our new line of products.

# Off-Balance Sheet
Arrangements

On July 22, 2002, our Audit Committee
and the Board of Directors approved an Indemnification Agreement with our directors and
officers. Our shareholders approved the terms of this agreement in a General and
Extraordinary Meeting held on January 7, 2004. The Agreement provides that the directors
and officers will be exempt from liability in certain circumstances. The Agreement also
provides that the expenses of these directors and officers for obligations that are
connected to an act performed in their capacity as an officer of the Company will be paid
by us. This right to indemnification is limited, and does not cover breaches of an
officers duty of loyalty or care, or reckless disregard for the consequences of such
breach. The right to indemnification also does not cover acts that are taken intentionally
to realize personal gain. The maximum amount of our liability under the Indemnification
Agreement is currently $3,000,000.

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# Tabular disclosure of
contractual obligations

The following table shows our
outstanding contractual obligations by category and by payments due as of December 31,
2004:

|                     | Payments due by period
|-------------------- | ----------------------
|
|
|
|
|Operating Leases     |                       
|Purchase Obligations |                       
|Total                |                       

The Companys total outstanding
contingencies in respect of royalty-bearing participations received or accrued from the
OCS, net of royalties paid or accrued to the OCS, amounted to approximately $3,142
thousand as of December 31, 2004 ($3,048 thousand as of December 31, 2003).

|Item 6. |  | DIRECTORS,
SENIOR MANAGEMENT AND EMPLOYEES
|------- |  | ------------------------------------------

# Directors and Senior
Management

The following table and notes thereto
set forth information regarding our officers, directors and senior managers as of April
30, 2005.

|Name             | Age | Position with Company                    
|---------------- | --- | -----------------------------------------
|
|
|
|
|Avi Eizenman     | 48  | Chairman of the Board                    
|Shaike Orbach    | 54  | Chief Executive Officer, Director        
|Yehuda Zisapel   | 62  | Director                                 
|Einat Domb-Har   | 38  | Outside Director                         
|Ilan Kalmanovich | 39  | Outside Director                         
|David Hendel     | 44  | Vice President Research and Development  
|Ilan Erez        | 38  | Chief Financial Officer and VP Operations

Avi Eizenman
co-founded the Company in 1987 and has served as its President and as a Director, since
its inception. Mr. Eizenman also served as Chief Executive Officer from our inception
until April 1, 2001, and on such date, he resigned from his position as Chief Executive
Officer and was appointed Chairman of the Board. Mr. Eizenman served as head of the ASIC
department at Scitex Ltd. in 1986. From 1979 until 1985, Mr. Eizenman held various
positions, including project manager, ASIC specialist and engineer, with the Electronic
Research & Development Department of the Israeli Ministry of Defense. Mr. Eizenman
holds a B.Sc. degree, with honors, in Electrical Engineering from the Technion, and an
M.B.A. from Tel Aviv University.

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Shaike Orbachhas been President and Chief Executive Officer of the Company since April
2001. In December, 2001, Mr. Orbach was named a Director, replacing Zohar Zisapel, who
resigned from the Board of Directors. Prior to that, for a period of four and a half
years, Mr. Orbach was President and CEO of Opgal Ltd., a high-tech subsidiary of
Israels Rafael and El-Op corporations. Previously, he was General Manager of
Edusoft, an Israeli company the shares of which were traded on the NASDAQ National Market,
and Managing Director of Tecsys Ltd. He holds a B.Sc degree in Mechanical Engineering from
the Technion.

Yehuda Zisapel
is a co-founder of the Company. He has served as a Director since its inception and served
as Chairman of the Board from 1999 until March 2001. Mr. Zisapel is also a founder and a
director of Rad Data Communications Ltd. (Rad), Bynet Data Communications Ltd.
(Bynet) and its subsidiaries and other companies in the Rad Group. We have
certain dealings with members of the Rad Group. See Item 7. Major Shareholders and
Related Party Transactions. In 1966 and 1968, Mr. Zisapel received a B.Sc. and an
M.Sc. degree, respectively, in Electrical Engineering from the Technion. In 1975, Mr.
Zisapel received an M.B.A. from Tel Aviv University.

Einat Domb-Har
has served as the CFO of Stage One Venture Capital, which focuses on seed investment in
the telecom industry, since April 2004. From 2000 to 2004 Ms. Domb-Har served as a
controller of Pitango Venture Capital, Israels largest pool of four Venture Capital
Funds. From 1994 to 1999 Ms. Domb-Har served as a senior manager at Kost, Forer and
Gabbay, CPA, a member of Ernst & Young International. Ms. Domb-Har is an Israeli
Certified Public Accountant and holds a BA in Economics and Accounting from Tel Aviv
University. She also holds an MBA from the Israeli extension of Bradford University.

Ilan Kalmanovich
has acted as an independent consultant since 2003 and as Vice President of Fahn Kaneh
Consulting since 2004. From 2001 to 2002, Mr. Kalmanovich served as the vice president of
Igud Hashkaot Veyizum (A.S.I.) Ltd. of the Igud Bank Group. From 1996 to 2000 he
served as a senior consultant at BDO Ziv Haft Consulting and Management Ltd. From 2003 to
May 2004 Mr. Kalmanovich served as a director on the board of Satcom Systems Ltd. and
previously served as a director on the board of Cukierman & Co. Investment House Ltd.,
and as an alternate director at Catalyst Investments L.P., the general partner of the
Catalyst Fund L.P. venture capital fund. Mr. Kalmanovich holds a B.Sc degree (with honors)
in Industrial Engineering from Ben-Gurion University and an MBA from Tel Aviv University.
He also serves as a court-certified mediator and holds a license for investment consulting
from the Israeli Securities Authority.

David Hendelhas
been Vice President, Research and Development of the Company since 1995. From 1991 to
1995, he served as a Senior Hardware Engineer of the Company. Mr. Hendel previously served
as an engineer in the Intelligence Corps of the Israeli Defense Forces. He holds a B.Sc.
degree in Electrical Engineering from Ben-Gurion University.

33

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Ilan Erez has
been the Chief Financial Officer of the Company since June 1998. He has also been VP
Operations of the Company since May 2001. From 1996 to 1998 Mr. Erez served as a
Controller and assistant to the Chief Executive Officer at Bio-Dar Ltd. From 1994 until
1996 Mr. Erez served as an Auditor at Kesselman & Kesselman accounting firm, a member
of PriceWaterhouseCoopers. Mr. Erez is a Certified Public Accountant in Israel and holds a
B.A in Accounting and Economics from the Hebrew University in Jerusalem and an LL.M. in
Business Law from Bar-Ilan University.

# Compensation

The aggregate direct remuneration
paid to all persons as a group who served in the capacity of director or executive officer
during the year ended December 31, 2004 was $530,000. We do not pay cash compensation to
Yehuda Zisapel for serving on our board of directors. We do pay cash compensation to Avi
Eizenman who is an active Chairman of the Board, to Shaike Orbach, who is the President
and Chief Executive Officer, and to Ms. Einat Domb-Har and Mr. Ilan Kalmanovich who are
outside directors and receive compensation in accordance with the regulations promulgated
under the Israeli Companies Law-1999. All our officers work full time for us. Certain of
the compensation previously paid to our directors was paid in the form of options under
the Silicom Directors Share Incentive Plan (1994) and certain of such compensation is paid
in the form of options under the Share Option Plan (2004) described below. The Directors
Share Incentive Plan (1994) was adopted by the board of directors in August, 1994 in order
to grant options to members of the board of directors who served on the board of directors
for at least three fiscal quarters. The Director Share Incentive Plan was administered by
the board of directors, which designated the optionees, dates of grant and the exercise
price of options. Under the Director Share Incentive Plan, 500,000 of our ordinary shares
were reserved for issuance. The options granted under the Director Share Incentive Plan
expire at the end of ten years from their date of grant and are non-assignable except by
the laws of descent. The grantee is responsible for all personal tax consequences of the
grant and the exercise thereof. We believe that we will bear no tax consequences in
connection with such grant or exercise. The Director Share Incentive Plan was cancelled in
July 2004 with respect to any share capital previously reserved and not yet allocated as
well as any share capital that becomes unallocated from time to time as outstanding
options expire or are forfeited. As of April 30, 2005, 185,000 options are outstanding
under the Director Share Incentive Plan (1994), of which, 110,000 options (at an average
exercise price of $5.61 and at termination dates that range from April 2010 to August
2010) were granted to Mr. Avi Eizenman and 75,000 options (at an average exercise price of
$3.13 and a termination date that ranges from September 2005 to April 2010) were granted
to Mr. Yehuda Zisapel. See Note 9 to the Financial Statements.

34

---

---



On October 24, 2000, the board of
directors adopted the Silicom Ltd. US Share Option Plan (2000). This Plan is intended to
constitute a means of providing additional incentive to officers, consultants and certain
other present and future employees and directors of the Company and its subsidiaries.
Pursuant to the Plan, the Company may grant both Incentive Stock Options (as such term is
defined in Section 422 of the Internal Revenue Code of 1986, as amended; ISOs)
and Nonqualified Stock Options (NSOs), provided, however, that only our
employees or employees of our subsidiaries can receive ISOs. The Plan is administered by
the board of directors, which has full authority to grant options under the Plan. Under
the terms of the Plan, up to a maximum of 200,000 of our ordinary shares are reserved for
issuance, subject to certain adjustments. The exercise price of the options granted under
the Plan shall be not less than the higher of 100 percent (or, in the case of a grant of
ISOs to a holder of more than 10% of the Companys outstanding shares, 110
percent) of the Fair Market Value (as defined in the Plan) of the ordinary shares subject
to the option on the date the option is granted. The vesting period of the options is
subject to the discretion of the Board. The term of ISOs shall not exceed 10 years from
the date on which they are granted (or 5 years, in the case of optionees who hold more
than 10% of our outstanding shares). In total, as of April 30 2005, we have granted 17,600
options pursuant to the US Share Option Plan (2000) to employees of our US subsidiary
 Silicom Connectivity Solutions, Inc., 11,300 of which were returned to the Company
due to certain employees who left their positions not exercising their options.

On December 30, 2004, our
shareholders adopted our Share Option Plan (2004). Under the terms of the Share Option
Plan (2004) up to a maximum of 282,750 of our ordinary shares are reserved for issuance,
subject to certain adjustments, upon the exercise of options granted to employees,
directors, officers, consultants and service providers. The Share Option Plan (2004) is
administered by the board of directors, which designates the optionees, dates of grant,
vesting periods and the exercise price of options. The options are non-assignable except
by the laws of descent. Certain tax advantages apply to certain of our directors, officers
and employees with respect to options granted to them under the Share Option Plan (2004).
As of April 30, 2005, we have granted a total of 238,500 options under the Share Option
Plan (2004), of which 30,000 options (at an exercise price of $2.53 and at a termination
date of December 30, 2014) were granted to Mr. Avi Eizenman, 30,000 options (at an
exercise price of $2.53 and at a termination date of December 30, 2014) were granted to
Mr. Yehuda Zisapel, 30,000 options (at an exercise price of $2.53 and at a termination
date of December 30, 2014) were granted to Mr. Shaike Orbach, 30,000 options (at an
exercise price of $2.53 and at a termination date of December 30, 2014) were granted to
Ms. Einat Domb-Har and 30,000 options (at an exercise price of $2.53 and at a termination
date of December 30, 2014) were granted to Mr. Ilan Kalmanovich.

35

---

---



In addition to the Plans described
above, the oldest of the Companys share option plans was adopted in December 1993,
and amended in 1997. Pursuant to this plan, 300,000 ordinary shares were reserved for
issuance upon the exercise of options granted to employees and consultants of the Company.
This reserve was increased by the board of directors to 500,000. The Share Option Plan was
administered by the board of directors, which designated the optionees, dates of grant,
vesting periods and the exercise price of options. The options granted under this plan
expire after 10 years from their date of grant and are non-assignable except by the laws
of descent. The grantee is responsible for all personal tax consequences of the grant and
the exercise thereof. The 1993 share option plan was cancelled in July 2004 with respect
to any share capital previously reserved and not yet allocated as well as any share
capital that becomes unallocated from time to time as outstanding options expire or are
forfeited. In total, as of April 30, 2005, 301,000 options which were granted to our
various executive officers and employees pursuant to the Share Option Plan remain
outstanding. Included in the 301,000 options described above are 180,000 options granted
to Mr. Shaike Orbach, 120,000 of which have an exercise price of $4.25 and a termination
date in January 2011 and 60,000 of which have an exercise price of $2.38 and a termination
date in December 2012.

# Board Practices

Each of Yehuda Zisapel, Avi Eizenman,
Shaike Orbach and our outside directors Ms. Einat Domb-Har and Mr. Ilan Kalmanovich, was
elected to the board of directors most recently on June 30, 2004 to serve until the next
Annual Shareholders Meeting. Messrs. Yehuda Zisapel and Avi Eizenman are both
Founders of the Company, and have served as Directors since our inception in 1987. None of
the members of the board of directors is entitled to receive any severance or similar
benefits upon termination of his or her service with the board of directors, except for
Avi Eizenman, who also functions as the active Chairman of the board.

# Board of Directors

Our Articles of Association provide
for a board of directors of not less than two nor more than eight members. Each director
is elected to serve until the next annual general meeting of shareholders and until his or
her successor has been elected. Officers serve at the discretion of the board of
directors. The Israeli Companies Law-1999 which entered into effect on February 1, 2000
and was amended most recently in March 2005, requires the board of directors of a public
company to determine the number of directors who shall possess accounting and financial
expertise. This requirement is subject to and will only enter into effect upon
promulgation of regulations by the Israeli Minister of Justice. Such regulations have not
yet been published. The board of directors must make such determination by no later than
90 days following publication of such regulations. The Articles of Association of the
Company provide that any director may, by written notice to the Company, appoint another
person to serve as a substitute director and may cancel such appointment. Under the
Israeli Companies Law-1999, a person who is already serving as a director will not be
permitted to act as a substitute director. Additionally, the Israeli Companies Law-1999
prohibits a person from serving as a substitute director for more than one director.
Appointment of a substitute director for a member of a board committee is only permitted
if the substitute is a member of the board of directors and does not regularly serve as a
member of such committee. If the committee member being substituted is an outside
director, the substitute may only be another outside director who possesses the same
expertise as the outside director being substituted and may not be a regular member of
such committee. The term of appointment of a substitute director may be for one meeting of
the board of directors or for a specified period or until notice is given of the
cancellation of the appointment. To our knowledge, no director currently intends to
appoint any other person as a substitute director, except if the director is unable to
attend a meeting of the board of directors.

36

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---



# Outside Directors; Audit
Committee

Under the Israeli Companies Law-1999,
companies registered under the laws of Israel the shares of which have been offered to the
public in or outside of Israel are required to appoint no less than two outside directors.
No person may be appointed as an outside director if such person or the persons
relative, partner, employer or any entity under the persons control, has or had, on
or within the two years preceding the date of the persons appointment to serve as
outside director, any affiliation with the company or any entity controlling, controlled
by or under common control with the company. The term affiliation includes:

| |  | an
employment relationship;
| | - | ---------------------------

| |  | a
business or professional relationship maintained on a regular basis;
| | - | ----------------------------------------------------------------------

| |  | control;
and
| | - | ------------

| |  | service
as an office holder.
| | - | ----------------------------

A person shall be qualified to serve
as an outside director only if he or she possesses accounting and financial expertise or
professional qualifications. At least one outside director must posses accounting and
financial expertise. The conditions and criteria for possessing accounting and financial
expertise or professional qualifications are subject to promulgation of regulations by the
Israeli Minister of Justice in consultation with the Israeli Securities Authority, which
have not yet been published; moreover, these criteria do not apply to external directors
appointed before the recent amendment to the Companies Law  1999, but will apply to
their reappointment for an additional term. No person may serve as an outside director if
the persons position or other business activities create, or may create, a conflict
of interest with the persons responsibilities as an outside director or may
otherwise interfere with the persons ability to serve as an outside director. If, at
the time outside directors are to be appointed, all current members of the board of
directors are of the same gender, then at least one outside director must be of the other
gender.

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

| |  | the
majority of shares voted at the meeting, including at least one-third of the shares held
by non-controlling shareholders voted at the meeting, vote in favor of election of the
director; or
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | the
total number of shares held by non-controlling shareholders voted against the election of
the director does not exceed one percent of the aggregate voting rights in the company.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

37

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The initial term of an outside
director is three years and may be extended for one additional term of three years.
Outside directors may be removed only by the same percentage of shareholders as is
required for their election, or by a court, and then only if the outside directors cease
to meet the statutory qualifications for their appointment, violate their duty of loyalty
to the company or are found by a court to be unable to perform their duties on a full time
basis. Outside directors may also be removed by an Israeli court if they are found guilty
of bribery, fraud, administrative offenses in a company or use of inside information. Each
committee of a companys board of directors must include at least one outside
director.

An outside director is entitled to
compensation as provided in regulations adopted under the Israeli Companies Law-1999 and
is otherwise prohibited from receiving any other compensation, directly or indirectly, in
connection with service provided as an outside director. Ms. Einat Domb-Har and Mr. Ilan
Kalmanovich were elected to the board of directors as outside directors on June 30, 2004.
Pursuant to the listing requirements of the Nasdaq National Market, we are required to
have at least two independent directors on our board of directors and to establish an
audit committee, at least a majority of whose members are independent of management.

# Audit Committee

The Israeli Companies Law-1999
requires public companies to appoint an audit committee. The responsibilities of the audit
committee include identifying irregularities in the management of our business and
approving related party transactions as required by law. An audit committee must consist
of at least three directors, including all the outside directors of the company. The
chairman of the board of directors, any director employed by or otherwise providing
services to the company, and a controlling shareholder or any relative of a controlling
shareholder, may not be a member of the audit committee. Currently, Ms. Einat Domb-Har,
Mr. Ilan Kalmanovich and Mr. Yehuda Zisapel serve as members of our audit committee.

# Internal Auditor

Under the Israeli Companies Law-1999,
the board of directors must appoint an internal auditor, nominated by the audit committee.
The role of the internal auditor is to examine, among other matters, whether our actions
comply with the law and orderly business procedure. Under the Israeli Companies Law-1999,
the internal auditor may be an employee of the company but not an office holder (as
defined in Item 10 below), or an affiliate, or a relative of an office holder or
affiliate, and he or she may not be our independent accountant or its representative. Our
board of directors appointed Fahn Kaneh Control Management to be our internal auditor on
April 26, 2005, according to the recommendation of the audit committee.

38

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# Employees

The number of employees over the last
three financial years is set forth in the table below.

|As at December 31                       | 2002 | 2003 | 2004
|--------------------------------------- | ---- | ---- | ----
|
|
|
|
|Total Employees                         | 41   | 42   | 38  
|Marketing, Sales, Customer Services     | 5    | 6    | 3   
|Research & Development                  | 19   | 19   | 17  
|Manufacturing                           | 11   | 12   | 13  
|Corporate Operations and Administration | 6    | 5    | 5   

At April 30, 2005, we had 41
employees, including 4 in marketing, sales and customer services, 18 in research and
development, 14 in manufacturing, and 5 in corporate operations and administration. All
such employees, except for 2 employees in the United States, are based in Israel. We
consider our relations with our employees excellent and have never experienced a labor
dispute, strike or work stoppage. None of our employees is represented by a labor union.
We do not employ a significant number of temporary employees, but we do use temporary
employees from time to time, as necessary.

Certain provisions of the collective
bargaining agreements between the Histadrut (General Federation of Labor in Israel) and
the Coordination Bureau of Economic Organizations including the Industrialists
Associations are applicable to our Israeli employees by order of the Israeli Ministry of
Labor. The laws principally concern the length of the work day, minimum daily wages for
professional workers, contributions to a pension fund, insurance for work-related
accidents, procedures for dismissing employees, determination of severance pay and other
conditions of employment. We generally provide our employees with benefits and working
conditions beyond the required minimums. See Note 6 of Notes to our Consolidated Financial
Statements.

Israeli law generally requires
severance pay, which may be funded by Managers Insurance described below, upon the
retirement or death of an employee or termination of employment without cause (as defined
in the law). The payments thereto amount to approximately 8.33% of wages. Furthermore,
Israeli employees and employers are required to pay predetermined sums to the National
Insurance Institute, which is similar to the United States Social Security Administration.
Such amounts also include payments for national health insurance. The payments to the
National Insurance Institute are equal to approximately 16% of the wages, of which the
employee contributes approximately 62.5% and the employer contributes approximately 37.5%.
In the past, National Insurance payments were made on salaries up to a specified ceiling,
but this ceiling was cancelled for the period between June 2002 and July 2003.

39

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---



A general practice followed by the
Company, although not legally required, is the contribution of funds on behalf of most of
its employees to a fund known as Managers Insurance. This fund provides
a combination of savings plan, insurance and severance pay benefits to the employee,
giving the employee a lump sum payment upon retirement and securing the severance pay, if
legally entitled, upon termination of employment. The Company decides whether each
employee is entitled to participate in the plan; each employee who agrees to participate
contributes an amount equal to 5% of his salary, and the employer contributes between
13.3% and 15.8% of the employees salary.

# Share Ownership

The following table sets forth, as of
April 30, 2005, the number of Shares owned by officers, directors and senior management of
the Company:

|Name and Address                      | Number of Shares
and Options Owned1 | Percent of
Outstanding Shares
|------------------------------------- | ----------------------------------- | -----------------------------
|
|
|
|
|Yehuda Zisapel                        | 923,723                             | 21.48%                       
|Avi Eizenmann                         | 328,315                             | 7.57%                        
|Shaike Orbach                         | 190,000                             | 4.31%                        
|Einat Domb Har                        | *                                   | *                            
|Ilan Kalmanovich                      | *                                   | *                            
|David Hendel                          | *                                   | *                            
|Ilan Erez                             | *                                   | *                            
|All directors and officers as a group | 1,502,838                           | 32.17%                       

* Denotes ownership of less than 1%
of the outstanding shares.

The terms of the options granted to each
of the shareholders in the above table who hold more than 1% of the Companys shares
are described above. See Item 6. Directors and Senior Management 
Compensation.

---

1 The table above includes
the number of shares and underlying options that are exercisable within 60 days of April
30, 2005. Ordinary shares subject to these options are deemed beneficially owned for the
purpose of computing the ownership percentage of the person or group holding these
options, but are not deemed outstanding for purposes of computing the ownership
percentage of any other person. To our knowledge, the persons and entities named in the
table have sole voting and dispositive power with respect to all shares shown as
beneficially owned by them.

40

---

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|Item 7. |  | MAJOR
SHAREHOLDERS AND RELATED PARTY TRANSACTIONS
|------- |  | -------------------------------------------------

# Major Shareholders

The shareholders of the Company who
own over 5% or more of each class of shares, as well as the number of shares owned and the
percentage of outstanding shares owned by each, and additional information, is set forth
below. The voting rights of our major shareholders do not differ from the voting rights of
other holders of our ordinary shares.

|Name of Shareholder | Number ofShares andOptions Owned2 | Percentage ofOutstanding Shares | Any Significant
Change in Past 3
Years
|------------------- | --------------------------------- | ------------------------------- | --------------------------------------
|
|
|
|
|Yehuda Zisapel      | 923,723                           | 21.48%                          | No                                    
|Zohar Zisapel       | 860,906                           | 20.42%                          | +79,020                               
|Avi Eizenman        | 328,315                           | 7.57%                           | No                                    

As of May 9, 2005, there were
approximately 15 record holders of ordinary shares, including approximately 9 record
holders in the United States. Collectively, these record holders held approximately 45% of
the outstanding ordinary shares.

# Related Party
Transactions

Messrs.
          Yehuda and Zohar Zisapel are brothers and are our founders. Mr. Yehuda Zisapel
          currently serves as a Director on our board of directors. Messrs. Yehuda and
          Zohar Zisapel are also founders, directors and principal shareholders of several
          other corporations within the Rad Group, as described above. The
          other members of the Rad Group are actively engaged in designing, manufacturing,
          marketing and supporting data communications products, none of which are
          currently the same as our products. Certain products of members of the Rad Group
          are complementary to, and may be used in connection with, our products. We and
          other members of the Rad Group also market certain of our products through the
          same distribution channels. Such products may, to a limited extent, compete with
          one another for the distributors time and efforts. Rad Data Communications
          provided us until January 31, 2004 with certain services pursuant to a sublease
          agreement for space in Mahwah, New Jersey, for which we paid $924 per month in
          rent, and $410 for maintenance and utilities. Commencing in February 2004, we
          began to sub-lease space in Paramus, New Jersey, from Radcom Equipmet, Inc., an
          affiliated company. Currently, the base monthly rent payments for this space are
          $405, plus an additional $50 per month for maintenance and utilities.

---

2 The table above includes
the number of shares and underlying options that are exercisable within 60 days of April
30, 2005. Ordinary shares subject to these options are deemed beneficially owned for the
purpose of computing the ownership percentage of the person or group holding these
options, but are not deemed outstanding for purposes of computing the ownership
percentage of any other person. To our knowledge, the persons and entities named in the
table have sole voting and dispositive power with respect to all shares shown as
beneficially owned by them.

41

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Commencing in February  2004,  we began to sub-lease  space in Paramus,  New Jersey,  from Radcom  Equipmet,  Inc., an
affiliated  company.  Currently,  the base monthly rent payments for this space are $405,  plus an additional  $50 per
month for maintenance and utilities.

Finally, the Rad Group provides us
with certain personnel and other services, and is reimbursed by us for the costs of
providing such services. We believe that the terms of the transactions in which we have
engaged and are currently engaged with other members of the Rad Group are generally no
less favorable to us than terms which might be available to us from unaffiliated third
parties. All future related party transactions and arrangements (or modifications of
existing ones) with members of the Rad Group, transactions in which office holders of the
Company have a personal interest, or transactions which raise issues of such office
holders fiduciary duties, may require audit committee, board of directors and
shareholder approval under the Israeli Companies Law-1999.

In addition to being a founder,
director and principal shareholder of each member of the Rad Group, Yehuda Zisapel is the
founder and principal shareholder of Bynet and its subsidiaries. Bynet acts as a
distributor in Israel for us and for other members of the Rad Group and also acts as a
distributor in Israel for numerous unaffiliated manufacturers of data communications and
other equipment. We believe that the terms of our relationship with Bynet are generally no
less favorable to us than terms which might be available to us from unaffiliated third
parties.

Except as indicated above, we do not
currently compete with other members of the Rad Group and do not currently contemplate
engaging in competition with any other member of the Rad Group in the future. However,
opportunities to develop, manufacture or sell new products (or otherwise enter new fields)
may arise in the future, which opportunities might be pursued by us or by one or more
other members of the Rad Group to the exclusion of (or in competition with) other members
of the Rad Group (including us). In the event that any such opportunity arises, the
directors then in office will determine whether or not we should seek to pursue it. Any
such determination will be based upon such factors as the directors then deem relevant.
However, in making any such determination, the directors will be bound by their fiduciary
duties to the Company (and to any other corporation or other person to whom they then owe
a fiduciary duty).

42

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On July 22, 2002, our audit committee
and the Board of Directors approved an Indemnification Agreement with our directors and
officers. Our shareholders approved the terms of this agreement in a General and
Extraordinary Meeting held on January 7, 2004. The Agreement provides that our directors
and officers will be exempt from liability in certain circumstances. The Agreement also
provides that the expenses of these directors and officers for obligations that are
connected to an act performed in their capacity as an officer of the Company will be paid
by us. This right to indemnification is limited, and does not cover breaches of an
officers duty of loyalty or care, or reckless disregard for the consequences of such
breach. The right to indemnification also does not cover acts that are taken intentionally
to realize personal gain. The maximum amount of our liability under the Indemnification
Agreement is currently $3,000,000. On January 7, 2004 our shareholders also approved the
procurement of a 12 month discovery period relating to our directors and officers
insurance policy, which expired on April 30, 2003. We procured such discovery period, which
was in effect until April 30, 2004. The discovery period provided coverage for incidents
or actions that were originally covered by the insurance policy that expired on April 30,
2003, in the event that claims arising from such incidents or actions were initiated
between April 30, 2003 and April 30, 2004. On December 30, 2004 our shareholders approved
the procurement of a new insurance policy for our directors and officers to provide for
coverage of up to $4,000,000, effective from February 1 2004 until January 31, 2005. This
policy has been renewed for the period of February 1, 2005 until January 31, 2006,
following approval by our audit committee and board of directors. Under Israeli law, we
are also required to obtain the approval of our shareholders for such renewal and we
intend to seek such approval at the next annual general meeting of our shareholders. All
of our directors are parties to our Indemnification Agreement and are covered by our
directors and officers insurance policy.

|Item 8. |  | FINANCIAL
INFORMATION
|------- |  | ---------------------

Our consolidated financial statements
and other financial information are incorporated herein by reference to pages F-1 through
F-30.

# Legal Proceedings

We are not a party to any material
litigation and we are not aware of any pending or threatened litigation that would have a
material adverse effect on us or our business.

|Item 9. |  | THE
OFFER AND LISTING
|------- |  | ---------------------

# Markets and Share Price
History

The primary trading market for our
ordinary shares is the NASDAQ Small-Cap Market, where our shares are listed and traded
under the symbol SILCF. Our ordinary shares are not listed on any other stock exchange and
have not been publicly traded outside the United States.

43

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---



The table below sets forth the high
and low bid prices in dollars of our ordinary shares, as reported by NASDAQ during the
indicated periods:

|PERIOD                                       | HIGH   | LOW   
|-------------------------------------------- | ------ | ------
|
|
|
|
|LAST 6 CALENDAR MONTHS                       |        |       
|April, 2005                                  | 4.02   | 3.60  
|March, 2005                                  | 3.46   | 2.34  
|February, 2005                               | 2.90   | 2.36  
|January, 2005                                | 2.84   | 2.34  
|December, 2004                               | 2.72   | 2.32  
|November, 2004                               | 2.84   | 1.83  
|FINANCIAL QUARTERS DURING THE PAST TWO YEARS
|Fourth Quarter, 2004                         | 2.84   | 1.72  
|Third Quarter 2004                           | 2.44   | 1.76  
|Second Quarter 2004                          | 3.00   | 1.70  
|First Quarter 2004                           | 3.21   | 1.67  
|Fourth Quarter, 2003                         | 1.97   | 0.81  
|Third Quarter 2003                           | 1.04   | 0.78  
|Second Quarter 2003                          | 1.07   | 0.30  
|First Quarter 2003                           | 0.44   | 0.28  
|FIVE MOST RECENT FULL FINANCIAL YEARS       
|2004                                         | 3.21   | 1.67  
|2003                                         | 1.97   | 0.28  
|2002                                         | 1.01   | 0.30  
|2001                                         | 5.44   | 0.56  
|2000                                         | 23.375 | 3.4375

|Item 10. |  | ADDITIONAL
INFORMATION
|-------- |  | ----------------------

# Memorandum and Articles
of Association

Articles of Association

Our shareholders last approved the
amendment of our Articles of Association (Articles) on January 7, 2004. The
objective stated in the Articles is to engage in any business permitted under the law.

We have currently outstanding only
one class of securities, our Ordinary Shares, having a nominal value of NIS 0.01 per
share. Holders of Ordinary Shares have one vote per share, and are entitled to participate
equally in the payment of dividends and share distributions and, in the event of a
liquidation of the Company, in the distribution of assets after satisfaction of
liabilities to creditors. No preferred shares are currently authorized.

Our Articles require that we hold our
annual general meeting of shareholders each year no later than 15 months from the last
annual meeting, at a time and place determined by the board of directors, upon at least 7
days prior notice to our shareholders or, if a special resolution is to be proposed
at an extraordinary general meeting, upon at least 21 days prior notice to our
shareholders. No business may be commenced at a general meeting until a quorum of two or
more shareholders is present in person or by proxy. No business may be commenced at an
extraordinary general meeting, which is anything other than an annual general meeting,
until a quorum of two or more shareholders holding at least 51% of the voting rights is
present in person or by proxy. Shareholders may vote in person or by proxy.

44

---

---



The Israeli Companies Law-1999,
provides that a simple majority is required to amend the articles of association of a
company unless such articles provide otherwise. According to our Articles ,
as amended, any amendment of the Articles, any modification of the shareholders rights,
and any increase or reduction of our authorized share capital and alterations of our share
capital, must be decided upon in a special resolution, by a majority of 75% of the
shareholders who vote at the general meeting, without taking abstaining votes into
account.

Pursuant to the Israeli Companies
Law-1999, resolutions regarding the following matters must be passed at a general meeting
of shareholders:

| |  | appointment
or termination of our auditors;
| | - | -------------------------------------------

| |  | appointment
and dismissal of directors;
| | - | ---------------------------------------

| |  | approval
of interested party acts and transactions requiring general meeting approval as provided
in sections 255 and 268 to 275 of the Israeli Companies Law-1999;
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | a
merger as provided in section 320(a) of the Israeli Companies Law-1999;
| | - | -------------------------------------------------------------------------

| |  | the
exercise of the powers of the board of directors, if the board of directors is unable to
exercise its powers and the exercise of any of its powers is vital for our proper
management, as provided in section 52(a) of the Israeli Companies Law-1999.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

An extraordinary general meeting may
be convened by demand of two directors or by written request of one or more shareholders
holding at least 5% of our issued share capital and 1% of the voting rights or one or more
shareholders holding at least 5% of the voting rights. Shareholders requesting a special
meeting must submit their proposed resolution with their request. Within 21 days of
receipt of the request, the board of directors must convene a special meeting and send out
notices setting forth the date, time and place of such meeting.

The Israeli Companies
Law-1999

We are subject to the provisions of
the Israeli Companies Law-1999, which became effective on February 1, 2000 and was amended
most recently in March 2005. The Israeli Companies Law-1999 codifies the fiduciary duties
that office holders, including directors and executive officers, owe to a
company. An office holder, as defined in the Israeli Companies Law-1999, is a director,
general manager, chief business manager, deputy general manager, vice general manager,
executive vice president, vice president, another manager directly subordinate to the
managing director or any other person assuming the responsibilities of any of the
foregoing positions without regard to such persons title. Each person listed in the
table in Item 6. Directors, Senior Management and Employees above is an office
holder.

45

---

---



The Israeli Companies Law-1999
requires that an office holder of a company promptly disclose, no later than the first
board meeting in which such transaction is 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. In addition, if the transaction is an
extraordinary transaction, the office holder must also disclose any personal interest held
by the office holders relative, or by any corporation in which the office holder is
a 5% or greater shareholder, holder of 5% or more of the voting power, director or general
manager or in which he or she has the right to appoint at least one director or the
general manager. An extraordinary transaction is defined as a transaction not in the
ordinary course of business, not on market terms, or that is likely to have a material
impact on the companys profitability, assets or liabilities.

In the case of a transaction that is
not an extraordinary transaction, after the office holder complies with the above
disclosure requirement, only board approval is required unless the articles of association
of the company provide otherwise. The transaction must not be adverse to the
companys interests. If the transaction is an extraordinary transaction, then, in
addition to any approval required by the articles of association, it must also be approved
by the audit committee and by the board of directors, and, under specified circumstances,
by a meeting of the shareholders, as well.

Subject to certain exceptions
provided for in the regulations to the Israeli Companies Law-1999, agreements regarding
directors terms of compensation require the approval of the audit committee, board
of directors and the shareholders of the company. In all matters in which a director has a
personal interest, including matters of his or her terms of compensation, he or she shall
not be permitted to vote on the matter or be present in the meeting in which the matter is
considered. However, if a majority of the audit committee or of the board of directors has
a personal interest in the matter then:

| | a) | all
of the directors are permitted to vote on the matter and attend the meeting           in
which the matter is considered; and
| | -- | --------------------------------------------------------------------------------------------------------------------------------

| | b) | the
matter requires approval of the shareholders at a general meeting.
| | -- | ----------------------------------------------------------------------

According to the Israeli Companies
Law-1999, the disclosure requirements discussed above also apply to a controlling
shareholder of a public company. Such requirements also apply to certain shareholders of a
public company, with respect to private placements that will increase their relative
holdings in the company. The term controlling shareholder is defined as a
shareholder who has the ability to direct the activities of a company, other than if this
power derives solely from the shareholders position on the board of directors or any
other position with the company, and the definition for these purposes also includes
shareholders that hold 25% or more of the voting rights if no other shareholder owns more
than 50% of the voting rights in the company. In general, extraordinary transactions with
a controlling shareholder or in which a controlling shareholder has a personal interest,
and agreements relating to employment and compensation terms of a controlling shareholder,
require the approval of the audit committee, the board of directors and the shareholders
of the company. The shareholder approval must either include at least one-third of the
shares held by disinterested shareholders who actively participate in the voting process
(without taking abstaining votes into account), or, alternatively, the total shareholdings
of the disinterested shareholders who vote against the transaction must not represent more
than one percent of the voting rights in the company.

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Private placements in a public
company require approval by a companys board of directors and shareholders in the
following cases:

| |  | A
private placement that meets all of the following conditions:
| | - | ---------------------------------------------------------------

| |  | The
private placement will increase the relative holdings of a shareholder that
               holds five percent or more of the companys outstanding share
capital,                assuming the exercise of all of the securities convertible into
shares held by                that person, or that will cause any person to become, as a
result of the                issuance, a holder of more than five percent of the companys
outstanding                share capital.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | 20
percent or more of the voting rights in the company prior to such issuance
               are being offered.
| | - | ---------------------------------------------------------------------------------------------------------------

| |  | All
or part of the consideration for the offering is not cash or registered
               securities, or the private placement is not being offered at market terms.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | A
private placement which results in anyone becoming a controlling shareholder of the
public company.
| | - | -----------------------------------------------------------------------------------------------------

In addition, under the Companies Law
 1999, certain transactions or a series of transactions are considered to be one
private placement.

Any placement of securities that does
not fit the above description may be issued at the discretion of the board of directors.

Under the Israeli Companies Law-1999,
a shareholder has a duty to act in good faith towards the company and other shareholders
when exercising his or her rights and refrain from abusing his power in the company,
including, among other things, voting in the general meeting of shareholders on the
following matters:

| |  | any
amendment to the articles of association;
| | - | ---------------------------------------------

| |  | an
increase of the company's authorized share capital;
| | - | ------------------------------------------------------

| |  | a
merger; or
| | - | ------------

| |  | approval
of interested party acts and transactions that require general meeting approval as
provided in sections 255 and 268 to 275 of the Israeli Companies Law-1999.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------

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In addition, any controlling
shareholder, any shareholder who knows that it possesses power to determine the outcome of
a shareholder vote and any shareholder who has the power to appoint or prevent the
appointment of an office holder in the company is under a duty to act with fairness
towards the company. The breach of such duty is governed by Israeli contract laws. The
Israeli Companies Law-1999 does not describe the substance of this duty. The Israeli
Companies Law-1999 requires that specified types of transactions, actions and arrangements
be approved as provided for in a companys articles of association and in some
circumstances by the audit committee, by the board of directors and by the general meeting
of the shareholders. In general, the vote required by the audit committee and the board of
directors for approval of these matters, in each case, is a majority of the disinterested
directors participating in a duly convened meeting.

# NASD Marketplace Rules
and Home Country Practices

In accordance with Israeli law and
practice and subject to the exemption set forth in Rule 4350(a)(1) of the NASD Marketplace
Rules, we follow the provisions of the Israeli Companies Law  1999, rather than the
requirements of Rule 4350 of the Market Place Rules with respect to the following
requirements:

| |  | Distribution
of annual and quarterly reports to shareholders Under Israeli law we
are not required to distribute annual and quarterly reports directly to shareholders and
the generally accepted business practice in Israel is not to distribute such reports to
shareholders. We do however make our audited financial statements available to our
shareholders prior to our annual general meeting and file our quarterly and annual
financial results with the Securities Exchange Commission on Form 6-K.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Quorum  Under
Israeli law a company is entitled to determine in its articles of association the number
of shareholders and percentage of holdings required for a quorum at a shareholders
meeting. Our Articles of Association provide that a quorum of two or more shareholders is
required for commencement of business at a general meeting. However, the quorum set forth
in our Articles of Association with respect to an extraordinary general meeting, which is
anything other than an annual general meeting, consists of two or more shareholders
holding at least 51% of the voting rights in person or by proxy.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Approval
of Related Party Transactions  All related party transactions are
approved in accordance with the requirements and procedures for approval of interested
party acts and transactions, set forth in sections 268 to 275 of the Israeli Companies
Law-1999.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Shareholder
Approval  We seek shareholder approval for all corporate action
requiring such approval, in accordance with the requirements of the Israeli Companies Law
 1999.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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# Material Contracts

All of our contracts over the past
two years have been entered into in the ordinary course of business, except for our real
property leases, described in Item 4. Information on the Company  Property,
Plants and Equipment.

# Exchange Controls

Under current Israeli regulations,
any dividends or other distributions paid in respect of our ordinary shares purchased by
nonresidents of Israel with certain non-Israeli currencies (including dollars) and any
amounts payable upon the dissolution, liquidation or winding up of our affairs, as well as
the proceeds of any sale in Israel of our securities to an Israeli resident, will be
freely repatriable in such non-Israeli currencies at the rate of exchange prevailing at
the time of conversion pursuant to the general permit issued under the Israeli Currency
Law, 1978, provided that Israeli income tax has been paid on (or withheld from) such
payments. Because exchange rates between the NIS and the U.S. dollar fluctuate
continuously, U.S. shareholders will be subject to any such currency fluctuation during
the period from when such dividend is declared through the date payment is made in U.S.
dollars.

Investments outside Israel by the
Company no longer require specific approval from the Controller of Foreign Currency at the
Bank of Israel.

# Taxation

The following is a summary of some of
the current tax law applicable to companies in Israel, with special reference to its
effect on us. The following also contains a discussion of specified Israeli tax
consequences to our shareholders and government programs from which we benefit. To the
extent that the discussion is based on tax legislation (including the legislation passed
as part of the recent tax reform in Israel) that has not been subject to judicial or
administrative interpretation, there can be no assurance that the views expressed in the
discussion will be accepted by the tax authorities in question.

The discussion is not intended, and
should not be construed, as legal or professional tax advice and is not exhaustive of all
possible tax considerations.

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

General Corporate Tax
Structure

Israeli companies are subject to
corporate tax at the rate of 35% of taxable income in the 2004 tax year, 34% in the 2005
tax year, 32% in the 2006 tax year and 30% in the 2007 tax year. However, the effective
tax rate payable by a company which derives income from an Approved Enterprise (as further
discussed below) may be considerably less.

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Law for the Encouragement
of Capital Investments, 1959

Certain of our facilities have been
granted Approved Enterprise status under the Law for the Encouragement of
Capital Investments, 1959, as amended (the Investment Law). The Investment Law
provides that a capital investment in eligible facilities may, upon application to the
Israel Investment Center of the Ministry of Industry and Trade of the State of Israel
(referred to as the Investment Center), be designated as an Approved Enterprise. Each
certificate of approval for an Approved Enterprise relates to a specific investment
program delineated both by its financial scope, including its capital sources and its
physical characteristics, for example, the equipment to be purchased and utilized pursuant
to the program. The tax benefits derived from any such certificate of approval relate only
to taxable income attributable to the specific Approved Enterprise.

A recent amendment to the Investment
Law which came into effect as of April 1, 2005 (the Amendment) has
significantly changed the provisions of the Investment Law. The Amendment limits the scope
of enterprises which may be approved by the Investment Center by determining criteria for
the approval of a facility as an Approved Enterprise, such as provisions generally
requiring that at least 25% of the income of an Approved Enterprise will be derived from
export. Additionally, as explained below, the Amendment sets forth major changes in the
manner in which tax benefits are awarded under the Investment Law whereby companies no
longer require Investment Center approval (and Approved Enterprise status) in order to
qualify for tax benefits. However, the Investment Law provides that terms and benefits
included in any certificate of approval already granted will remain subject to the
provisions of the Investment Law as in effect on the date of such approval. Therefore the
tax benefits granted to our Approved Enterprises under the Investment Law will generally
not be subject to the provisions of the Amendment.

# Tax Benefits Prior to
the Amendment

In general, taxable income of a
company derived from an Approved Enterprise was subject to corporate tax at the maximum
rate of 25% rather than the rates stated above (this will also apply to Approved
Enterprises approved after the Amendment, as explained below). The 25% corporate tax rate
applies for a period of time termed the benefit period. The benefit period is
a period of seven years commencing with the year in which the Approved Enterprise first
generated taxable income. In any event, the benefit period is limited to 12 years from the
commencement of production or 14 years from the year of receipt of approval, whichever is
earlier. Under certain circumstances (as further detailed below), the benefit period may
extend to a maximum of ten years from the commencement of the benefit period. In the event
that a company is operating under more than one approval or that only part of its capital
investments are approved (a Mixed Enterprise), its effective Company Tax rate
is the result of a weighted combination of the various applicable rates.

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A company which qualifies as a
Foreign Investors Company is entitled to an extended benefit period and
further reductions in the tax rate normally applicable to Approved Enterprises. Subject to
certain conditions, a Foreign Investors Company is a company which has
more than 25% of its combined shareholders investment in share capital (in terms of
rights to profits, voting and the appointment of directors) and in long term
shareholders loans, as defined in the Investment Law, made by persons who are not
residents of Israel. The percentage owned by nonresidents of Israel for any tax year will
be determined by the lowest percentage of any of the above rights held by nonresidents
during that year. Such a company will pay Company Tax at reduced rates for an extended
ten-year (rather than the otherwise applicable seven-year) period as detailed below:

|Level of Foreign Investment   | Company Tax Rate | Benefit period (years)
|----------------------------- | ---------------- | ----------------------
|
|
|
|
|Over 0% but less than 25%     | 25%              | 7                     
|Over 25% but less than 49%    | 25%              | 10                    
|49% or more but less than 74% | 20%              | 10                    
|74% or more but less than 90% | 15%              | 10                    
|90% or more                   | 10%              | 10                    

There can be no assurance that the
above-mentioned shareholding proportion will be reached for each subsequent year.

Prior to the Amendment, a company
owning an Approved Enterprise approved after April 1, 1986 (or prior thereto provided no
government grants or loans had previously been granted regarding such enterprise) was
entitled to elect (as we have) to forego certain Government grants extended to Approved
Enterprises in return for an alternative route of tax benefits (the
Alternative Route). Under the Alternative Route, a companys
undistributed income derived from an Approved Enterprise is exempt from corporate 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 is
eligible for the reduced tax rates under the Investment Law for the remainder of the
benefit period as mentioned above.

Our production facilities have been
granted Approved Enterprise status under the Alternative Route according to
the Investment Law. The initial Approved Enterprise status was granted in 1988
(Initial Approved Enterprise). An extension program was granted Approved
Enterprise status in 1995 (the Extended Approved Enterprise). Income derived
from our Approved Enterprises is tax exempt during six years of the seven year tax benefit
period and is subject to a reduced tax rate of 25% in the seventh year. The seven year
period of benefits commences in the year the Approved Enterprise first earns taxable
income but is limited to twelve years from commencement of production or fourteen years
from date of approval, whichever is earlier. The period of tax benefits, relating to our
Initial Approved Enterprise, commenced in 1991 and expired in 1997. The period of tax
benefits relating to our Extended Approved Enterprise commenced in 1997 and will expire in
2006, as explained below.

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In June 1995, we reached an agreement
with the tax authorities regarding our entitlement to benefits under the Investment Law.
The agreement, effective from tax year 1994 and thereafter, relates to the method of
determination of taxable income from our research and development activities. Pursuant to
the agreement, for the purpose of determining our tax liability, our income will be
allocated to our manufacturing plant and to our research and development center, according
to a formula based on the net costs plus royalties of the research and development center
and our profitability. Income allocated to the expansion of the manufacturing plant will
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 25% rate.

Our income to be attributed to our
Extended Approved Enterprise in any year will be computed as a ratio of the increase in
our sales turnover, if any, in that year to our turnover in the year before the Extended
Approved Enterprise commenced its tax benefits entitlement. The tax authorities have
reserved their right to reconsider our claim to such tax benefits in future years.

The entitlement to the above benefits
is conditional upon our fulfillment of the conditions stipulated by the law, regulations
published thereunder and the instruments of approval for the specific investments in the
Approved Enterprise. In the event of failure to comply with these conditions, the benefits
may be canceled and we may be required to refund the amount of the benefits, in whole or
in part, with the addition of linkage differences, interest and penalties. Should we derive income from sources
other than the Approved Enterprise during the relevant periods of benefits, such income
will be taxable at regular corporate tax rates (36%).

A company that elected the
Alternative Route prior to the Amendment and that subsequently pays a dividend out of
income derived from the Approved Enterprise(s) during the tax exemption period will be
subject to Company Tax in the year the dividend is distributed in respect of the amount
distributed (including the corporate tax thereon), at the rate that would have been
applicable had the company not elected the Alternative Route (10%-25%, depending on the
level of foreign investment in the company, as explained above). In addition, the dividend
recipient is taxed at the reduced rate applicable to dividends from Approved Enterprises
(15%), if the dividend is distributed during the tax exemption period or within a
specified period thereafter. (In the event, however, that the company qualifies as a
Foreign Investors Company, there is no such time limitation). This tax must be
withheld by the company at source, regardless of whether the dividend is converted into
foreign currency.

Subject to certain provisions
concerning income subject to the Alternative Route, all dividends are considered to be
attributable to the entire enterprise and the effective tax rate is the result of a
weighted combination of the various applicable tax rates.

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The Investment Law also provides that
an Approved Enterprise is entitled to accelerated depreciation on its property and
equipment that are included in an approved investment program. We have not utilized this
benefit.

Grants and certain other incentives
received by a company in accordance with the Investment Law remain subject to final
ratification by the Israel Investment Center and final determination by the Israel Tax
Authority. Such ratification and determination are conditional upon fulfillment of all of
the terms of the approved program.

# Tax Benefits under the
Amendment

As a result of the Amendment, a
company is no longer required to acquire Approved Enterprise status in order to receive
the tax benefits previously available under the Alternative Route and therefore such
companies need not apply to the Investment Center for this purpose. However, the
Investment Center will continue to grant Approved Enterprise status to companies seeking
Governmental grants. A company may claim the tax benefits offered by the Investment Law
directly in its tax returns, provided that its facilities meet the criteria for tax
benefits set forth in the Amendment (a Benefited Enterprise). Companies are
also entitled to approach the Israeli Tax Authority for a pre-ruling regarding their
eligibility for benefits under the Amendment. The Amendment includes provisions intended
to ensure that a company will not enjoy both government grants and tax benefits for the
same investment program. Tax benefits are available under the
Amendment to production facilities and other eligible facilities, which are generally
required to derive more than 25% of their business income from export. In order to receive
the tax benefits, the Amendment states that the company must make an investment in the
Benefited Enterprise exceeding a minimum amount specified in the Investment Law. Such
investment may be made over a period of no more than three years, such period concluding
at the end of the year in which the company requests to have the tax benefits apply to its
Benefited Enterprise (the Year of Election). Where the company requests to
have the tax benefits apply to an expansion of existing facilities, only the expansion
will be considered a Benefited Enterprise and the companys effective tax rate will
be the result of a weighted combination of the applicable rates. In the case of an
expansion of existing facilities, the minimum investment required in order to qualify as a
Benefited Enterprise is determined as a certain percentage of the companys
production assets before the expansion. The tax benefits available under the Amendment to
qualifying income of a Benefited Enterprise are determined by the geographic location of
the Benefited Enterprise in Israel. The Investment Law divides the country into three
zones  A, B and C, so that a Benefited Enterprise operating in Zone A (which
generally includes areas remote from the center of Israel) will receive the greatest
benefits and Benefited Enterprises in Zone C will receive the least benefits.

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The Amendment provides that a company
producing income from a Benefited Enterprise in Zone A may elect either that (i) the
undistributed income derived from the Benefited Enterprise will be fully tax exempt for
the entire benefit period described below (tax exemption), in which case the
ordinary provisions described below concerning the taxation of the company and shareholder
for distribution of dividends will apply; or (ii) that the income from its Benefited
Enterprise will be subject to corporate tax at a rate of a 11.5%, in which case dividends
paid out of such income to a foreign resident will be taxed at a rate of 4% and the
company will not be subject to additional tax upon dividend distribution. Further benefits
are available in the event of certain large investments by multinational companies.
Benefited Enterprises located in Zones B and C will be exempt from tax for six and two
years, respectively, and subject to tax at a rate of 10%-25% for the remainder of the
benefit period, depending on the extent of foreign investment in the Company, as described
above.

Dividends paid out of income derived
by a Benefited Enterprise, or out of dividends received from a company whose income is
derived from a Benefited Enterprise, are generally subject to withholding tax at the rate
of 15%, such tax being deductible at source. The reduced withholding tax rate of 15% is
limited to dividends and distributions out of income derived during the benefit period and
actually paid at any time up to 12 years thereafter. A company qualifying for tax benefits
under the Amendment which pays a dividend out of income derived by its Benefited
Enterprise during the tax exemption period will be subject to corporate tax in respect of
the gross amount of the dividend. The rate of such corporate tax will be 25%, which is the
rate to which a Benefited Enterprise is generally subject. Such tax rate is lower in the
case of a qualified Foreign Investors Company which is a company at
least 49% of which is owned by non-Israeli residents. The dividend recipient is subject to
tax at the rate of 15% on the amount received which tax is deductible at source.

The period for which tax benefits are
available under the Amendment is also determined by the geographical location of the
Benefited Enterprise in Israel. The benefit period for Benefited Enterprises in Zone A
will end on the earlier of (i) a period of ten years from the tax year in which the
company first derived taxable income from the Benefited Enterprise (the Commencement
Year); or (ii) twelve years (or in certain cases fourteen years) from the first day
of the Year of Election. The benefit period for Benefited Enterprises in Zones B and C
will extend until the earlier of (i) seven years from the Commencement Year or (ii) 12
years from the first day of the Year of Election. This period may be extended for
Benefited Enterprises owned by a Foreign Investors Company during all or
part of the benefit period.

Additionally, the Amendment sets
forth a minimal amount of foreign investment required for a company to be regarded a
Foreign Investors Company.

There can be no assurance that we
will attain approval for additional tax benefits under the Amendment, or receive approval
for Approved Enterprises in the future.

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Law for the Encouragement
of Industrial Research and Development, 1984

Under the Law for the Encouragement
of Industrial Research and Development (the Research Law), research and
development programs approved by the Research Committee (the Research
Committee) of the Office of the Chief Scientist (OCS) are eligible for
grants or loans if they meet certain criteria, in return for the payment of royalties from
the sale of the product developed in accordance with the program and subject to other
restrictions. Once a project is approved, the OCS will award grants of up to 50% of the
projects expenditures in return for royalties, usually at the rate of 3% to 5% of
sales of products developed with such grants, up to a dollar-linked amount equal to 100%
or 150% of such grants. For projects approved after January 1, 1999, the amount of
royalties payable is up to a dollar-linked amount equal to 100% of such grants plus
interest at LIBOR. There is no further liability for payment.

The terms of these grants prohibit
the manufacture outside of Israel without the prior consent of the Research Committee of
the OCS. Such approval, if granted, is generally subject to an increase in the total
amount to be repaid to the OCS to between 120% and 300% of the amount granted, depending
on the extent of the manufacturing to be conducted outside of Israel.

The Research Law also provides that
know-how from the research and development, which is used to produce the product, may not
be transferred to Israeli third parties without the approval of the Research Committee.
Until recently, the Research Law stated that such know-how may not be transferred to
non-Israeli third parties at all. A recent amendment to the Research Law has set forth
certain exceptions to this rule, however, the practical implications of such exceptions
are quite limited. The Research Law has stressed, that it is not just transfer of know-how
that is prohibited, but also transfer of any rights in such know-how. Such restriction
does not apply to exports from Israel of final products developed with such technologies.
Approval of the transfer may be granted only if the transferee undertakes to abide by all
of the provisions of the Research Law and regulations promulgated thereunder, including
the restrictions on the transfer of know-how and the obligation to pay royalties. There
can be no assurance that such consent, if requested, will be granted or, if granted, that
such consent will be on reasonable commercial terms.

Tax Benefits and Grants
for Research and Development

Israeli tax law allows, under certain
conditions, a tax deduction in the year incurred for expenditures (including capital
expenditures) in scientific research and development projects, if the expenditures are
approved by the relevant Israeli Government Ministry (determined by the field of research)
and the research and development is for the promotion of the enterprise and is carried out
by or on behalf of the company seeking such deduction. Such expenditures not so approved
are deductible over a three-year period.

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:

(a)       
          Amortization of purchases of know-how and patents over eight years for tax
          purposes.

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(b)       
          The right to elect, under specified conditions, to file a consolidated tax
          return with other related Israeli Industrial Companies.

(c)       
          Amortization of expenses incurred in connection with certain public securities
          issuances over a three-year period.

(d)       
          Tax exemption for shareholders who held shares before a public offering on
          capital gains derived from the sale (as defined by law) of securities, if
          realized after more than five years from the public issuance of additional
          securities of the company. (As of November 1994, this exemption was repealed,
          however, it applies to some of our shareholders pursuant to a grand-fathering
          clause; the recent tax reform repealed the grandfathered exemption for any gains
          accrued from January 1, 2003.)

(e)       
          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.

Taxation under
Inflationary Conditions

The Income Tax Law (Inflationary
Adjustments), 1985 (the Inflationary Adjustments Law) represents an attempt to
overcome the problems presented to a traditional tax system by an economy undergoing rapid
inflation. The Inflationary Adjustments Law is characterized by a high degree of
complexity and its salient features can be described generally as follows:

(a)       
          A special tax adjustment for the preservation of equity whereby certain
          corporate assets are classified broadly into Fixed (inflation resistant) Assets
          and Non-Fixed (non-inflation resistant) Assets. Where a corporations
          equity, as defined in such law, exceeds the depreciated cost of Fixed Assets, a
          tax deduction which takes into account the effect of the annual inflationary
          change on such excess is allowed (up to a ceiling of 70% of taxable income in
          any single tax year, with the unused portion permitted to be carried forward on
          a linked basis). If the depreciated cost of Fixed Assets exceeds a
          corporations equity, then such excess multiplied by the annual inflation
          rate is added to taxable income.

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(b)       
          Depreciation deductions on Fixed Assets and losses carried forward are adjusted
          for inflation based on the increase in the Israeli Consumer Price Index.

(c)       
          Gains from the sale of certain traded securities are fully taxable
          notwithstanding the exemptions or reduced tax rates which might otherwise apply
          to those securities.

Capital Gains Tax on
Sales of Our Ordinary Shares

Until the end of the year 2002 and
provided we maintained our status as an industrial corporation, capital gains from the
sale of our securities were generally exempt from Israeli Capital Gains Tax. This
exemption did not apply to a shareholder whose taxable income is determined pursuant to
the Israeli Income Tax Law (Inflationary Adjustments) 1985, or to a person whose gains
from selling or otherwise disposing of our securities were deemed to be business income.

As a result of the recent tax reform
legislation in Israel, gains from the sale of our ordinary shares derived from January 1,
2003 and on will in general be liable to capital gains tax of up to 15%. This will be the
case so long as our securities remain listed for trading on the NASDAQ or are listed on
another designated foreign stock exchange or on the Tel Aviv Stock Exchange. However,
according to the tax reform legislation, non-residents of Israel will be exempt from any
capital gains tax from the sale of our securities so long as the gains are not derived
through a permanent establishment that the non-resident maintains in Israel, and so long
as our securities remain listed for trading as described above. These provisions dealing
with capital gains are not applicable to a person whose gains from selling or otherwise
disposing of our securities are deemed to be business income or whose taxable income is
determined pursuant to the Israeli Income Tax Law (Inflation Adjustments) 1985; the latter
law would not normally be applicable to non-resident shareholders who have no business
activity in Israel.

In any event, under the US-Israel Tax
Treaty, a US treaty resident may in general only be liable to Israeli capital gains tax on
the sale of our ordinary shares (subject to the provisions of Israeli domestic law as
described above) if that US treaty resident holds 10% or more of the voting power in our
company.

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%, (or lower in case of
distributions out of certain income subject to tax benefits under the Investment Law) 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%;
however, dividends generated by an Approved Enterprise as defined in the Investment Law
are taxed at the rate of 15%. Furthermore, dividends not generated by an Approved
Enterprise paid to a U.S. company holding 10% or more of our ordinary shares for a certain
period of time are taxed at a rate of 12.5%.

57

---

---



Passive Foreign
Investment Company Status under U.S. Federal Income Tax Law

In general, a foreign corporation
will be classified for U.S. tax purposes as a passive foreign investment company
(hereafter also referred to as a PFIC) in any taxable year in which either (i)
75% or more of its gross income (including the pro rata gross income of any company (U.S.
or foreign) in which it is considered to own 25% or more of the ordinary shares by value)
for the taxable year is passive income, or (ii) at least 50% of the average value of all
of its gross assets (including the pro rata fair market value of the assets of any company
in which it is considered to own 25% or more of the ordinary shares by value) during the
taxable year, calculated quarterly by value, produce, or are held for the production of,
passive income. Passive income for these purposes includes items such as dividends,
interest, royalties, rents and gains from commodities and securities transactions.

If we are classified as a passive
foreign investment company, highly complex rules will apply to our U.S. shareholders.
Accordingly, U.S. shareholders are urged to consult their tax advisors regarding the
application of such rules.

If a corporation is a passive foreign
investment company, a U.S. shareholder will be subject to one of three alternative taxing
regimes:

The simplest is the QEF
regime. If the shareholder elects to treat the PFIC as a qualified electing
fund (QEF), then each year the shareholder includes in its gross income
a proportionate share of the PFICs ordinary income and net capital gain. A second
regime may be elected if the PFIC stock is marketable. The U.S. shareholder
may elect to mark the stock to market each year. At the end of each taxable
year, the shareholder recognizes gain equal to the excess of the fair market value of the
PFIC stock over the shareholders tax basis in the stock.(Losses may also be recognized to the
extent of previously recognized gains.)

A U.S. shareholder making neither of
these elections is subject to the excess distribution regime. The tax is
triggered when the shareholder receives an excess distribution from the PFIC.
An excess distribution is either (1) a distribution with respect to stock that is greater
than 125% of the average of such distributions over the preceding three years, or (2) 100%
of the gain from the disposition of shares in the PFIC.

An excess distribution is subject to
special tax rules. In most cases, only a portion of it is included in the gross income of
the U.S. shareholder and taxed at normal rates. The remainder is never so included, but
is used as the basis for calculating a deferred tax amount, which is simply
added to the shareholders tax bill.

58

---

---



The deferred tax amount is computed
as follows. The excess distribution is first ratably allocated, share by share, to each
day of the shareholders holding period. Portions allocated to the current year, and
to any pre-PFIC years (that is, years before 1987, when there were no PFICs, or years
before the first year in which the company was a PFIC with respect to that shareholder),
are included in ordinary income for the current year. Portions allocated to prior PFIC
years are hypothetically taxed at the highest marginal rate in effect for those years
(without regard to the shareholders actual rate or to any deductions or credits for
those years). To this hypothetical tax is added the interest that the shareholder would
have paid if it were simply paying that tax late for that year. The sum of the tax and the
interest charge is the deferred tax amount, which cannot be offset or otherwise affected
by current net operating losses or other deductions.

A U.S. person who inherits shares in
a foreign corporation that was a PFIC in the hands of the decedent (who did not make
either of the elections described above), is denied the otherwise available step-up in the
tax basis of such shares to fair market value at the date of death. The U.S. person steps
into the shoes of the decedent and will be subject to the rules described above.

Although a determination as to a
corporations PFIC status is made annually, an initial determination that a
corporation is a PFIC for any taxable year generally will cause the above-described
consequences to apply for all future years as to U.S. shareholders who held shares in the
corporation at any time during the PFIC taxable year and who made neither a valid QEF
election with respect to such shares nor a valid election to mark such shares to market.
This will be true even if the corporation loses its PFIC status in later years. However,
with respect to a PFIC that does not make any distributions or deemed distributions, the
above tax treatment would apply only to gains realized on the disposition of such shares
by a U.S. shareholder.

If we are classified as a PFIC,
complicated rules will apply to our U.S. shareholders. Our status in future years will
depend on our assets and activities in those years, although shareholders will be treated
as continuing to own an interest in a passive foreign investment company if we are a
passive foreign investment company in any year in which a shareholder owns our shares,
unless certain elections are made.

This discussion does not address all
aspects of U.S. federal income taxation that may be relevant to a U.S. shareholder in
light of his or her particular circumstances or to a U.S. shareholder subject to special
treatment under U.S. federal income tax law. U.S. shareholders are urged to consult their
tax advisors about the U.S. federal income taxation rules to which they will be subject,
as well as the PFIC rules, including the advisability, procedure and timing of making a
mark-to-market election, in connection with their holding of our shares, including
warrants or rights to acquire our shares.

59

---

---



Tax Assessment

Silicom Ltd. received final tax
assessments for all years up to and including the tax year ended December 31st, 2000. Our
U.S. subsidiary, Silicom Connectivity Solutions, Inc., has not yet been assessed for tax
purposes since incorporation in 1993.

# Documents on Display

We are required to file reports and
other information with the Securities and Exchange Commission (the SEC) under
the Securities Exchange Act of 1934 (the Exchange Act) and the regulations
thereunder applicable to foreign private issuers. Although as a foreign private issuer we
are not required to file periodic information as frequently or as promptly as United
States companies, we generally do publicly announce our quarterly and year-end results
promptly and file periodic information with the SEC under cover of Form 6-K. We are also
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 other provisions in Section 16 of the Exchange Act.

You may review a copy of our filings
with the SEC, including any exhibits and schedules, at the SECs public reference
facilities in Room 1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549
and at the regional offices of the SEC located at the Northwestern Atrium Center, 500 West
Madison Street, Suite 1400, Chicago, Illinois 60661. You may also obtain copies of such
materials from the Public Reference Section of the SEC, Room 1024, Judiciary Plaza, 450
Fifth Street, N.W., Washington, D.C. 20549, at prescribed rates. You may call the SEC at
1-800-SEC-0330 for further information on the public reference rooms. In addition, such
information concerning our company can be inspected and copied at the offices of the
National Association of Securities Dealers, Inc., 9513 Key West Avenue, Rockville,
Maryland 20850 and at the offices of the Israel Securities Authority at 22 Kanfei Nesharim
St., Jerusalem, Israel. As a foreign private issuer, all documents which were filed after
November 4, 2002 on the SECs EDGAR system will be available for retrieval on the
SECs website at www.sec.gov. You may read and copy any reports, statements or other
information that we file with the SEC at the SEC facilities listed above. These SEC
filings are also available to the public from commercial document retrieval services. The
documents referred to in this document may be inspected at the Companys offices,
located at 8 Hanagar Street, Kfar Sava, Israel 44000.

Any statement in this annual report
about any of our contracts or other documents is not necessarily complete. If the contract
or document is filed as an exhibit to the annual report the contract or document is deemed
to modify the description contained in this annual report. We urge you to review the
exhibits themselves for a complete description of the contract or document.

60

---

---



|Item 11. |  | QUANTITATIVE
AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
|-------- |  | ----------------------------------------------------------

Market risk represents the risk of
changes in the value of a financial instrument caused by fluctuations in interest rates,
equity prices and foreign exchange rates.

# Interest Rate Risk

At December 31, 2004 we did not have
any short or long term interest bearing loans or debts, hence there was no exposure to
interest rate risk.

# Equity Price Risk

At December 31, 2004 we did not have
any marketable securities which were recorded at a fair value, hence there was no exposure
to equity price risk.

# Foreign Currency
Exchange Risk

At December 31, 2004 we had accounts
receivable in New Israeli Shekels (NIS) or in funds linked thereto in the amount of
$480,000. Market risk was estimated as the potential decrease in fair value resulting from
a hypothetical 10% increase in the year-end Dollar exchange rate. Assuming such increase
in the Dollar exchange rate, the fair value of our accounts receivable would decrease by
$44,000. At December 31, 2004 we had accounts payable in New Israeli Shekels (NIS) or in
funds linked thereto in the amount of $1,669,000. Market risk was estimated as the
potential increase in fair value resulting from a hypothetical 10% decrease in the
year-end Dollar exchange rate. Assuming such decrease in the Dollar exchange rate, the
fair value of our accounts payable would increase by $185,000.

In 2004 there was a decrease of 1.62%
in the Dollar exchange rate which resulted in an aggregate increase in the fair value of
our assets of $14,000 and an aggregate increase in the fair value of our liabilities of
$31,000.

As at December 31, 2004 we were not
engaged in any hedging transactions.

|Item 12. |  | DESCRIPTION
OF SECURITIES OTHER THAN EQUITY SECURITIES
|-------- |  | ------------------------------------------------------

Not applicable.

# PART II.

|Item 13. |  | DEFAULTS,
DIVIDEND ARREARAGES AND DELINQUENCIES
|-------- |  | -----------------------------------------------

None.

61

---

---



|Item 14. |  | MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS
|-------- |  | ----------------------------------------------------------------------------

None.

|Item 15. |  | CONTROLS
AND PROCEDURES
|-------- |  | -----------------------

We have performed an evaluation of
the effectiveness of our disclosure controls and procedures that are designed to ensure
that the material financial and non-financial information required to be disclosed on Form
20-F and filed with the Securities and Exchange Commission is recorded, processed,
summarized and reported timely. Based on our evaluation, which was completed within 90
days of the filing date of this annual report, our management, including our chief
executive officer and chief financial officer, has concluded that our disclosure controls
and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act
of 1934, as amended) as of the end of the period covered by this report are effective.

There have been no significant
changes in our internal controls or in other factors that could significantly affect these
controls subsequent to the date of the evaluation thereof. Therefore, no corrective
actions with regard to significant deficiencies and material weaknesses were taken.

|Item 16. |  | Reserved
|-------- |  | --------

|Item 16A. |  | AUDIT
COMMITTEE FINANCIAL EXPERT
|--------- |  | --------------------------------

Our board of directors has determined
that Ms. Einat Domb-Har is our audit committee financial expert.

|Item 16B. |  | CODE
OF ETHICS
|--------- |  | --------------

Our company has adopted a code of
ethics, which applies to all of our employees, officers and directors, including our chief
executive officer, our chief financial officer and our principal accountant. A copy of the
code of ethics will provided to any person upon request.

|Item 16C. |  | PRINCIPAL
ACCOUNTANT FEES AND SERVICES
|--------- |  | --------------------------------------

The following table presents fees for
professional audit services rendered by Somekh Chaikin for the audit of the Companys
consolidated annual financial statements for the years ended December 31, 2004 and
2003, and fees billed for other services rendered by Somekh Chaikin and KPMG
International.

|              | 2004 | 2003
|------------- | ---- | ----
|
|
|
|
|Audit Fees(1) |      |     
|              |      |     
|Tax Fees(2)   |      |     

|(1) | Audit
fees consist of fees for professional services rendered for the audit of the Companys
consolidated financial statements and services normally provided by the independent
auditor in connection with statutory and regulatory filings or engagements.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | Tax
services fees consist of compliance fees for the preparation of original and amended tax
returns and claims for refunds.
|--- | ----------------------------------------------------------------------------------------------------------------------------

62

---

---



|Item 16D. |  | EXEMPTIONS
FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES
|--------- |  | ----------------------------------------------------------

As a foreign private issuer we remain exempt,
until July 31, 2005, from NASDAQ audit committee related listing standards that have come
into effect following December 13, 1999.

|Item 16E. |  | PURCHASES
OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS
|--------- |  | ----------------------------------------------------------------------

Not applicable.

# PART III.

|Item 17. |  | FINANCIAL
STATEMENTS
|-------- |  | --------------------

Not applicable

|Item 18. |  | FINANCIAL
STATEMENTS
|-------- |  | --------------------

See pages F-1 to F-30.

63

---

---



|Item 19. |  | EXHIBITS
|-------- |  | --------

|1.1 |  | Articles
of Association, adopted on February 1, 1994, filed by us as an Exhibit to our annual
report on              Form 20-F for the fiscal year ended December 31, 2000, as filed
with the Securities and Exchange              Commission on June 30, 2001, and
incorporated herein by reference (other than Article 122).
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|1.2 |  | Article
122 of our Articles of Association as amended on January 7, 2004, filed by us as an
Exhibit to              our annual report on Form 20-F for the fiscal year ended December
31, 2003, as filed with the Securities              and Exchange Commission on June 30,
2004, and incorporated herein by reference.
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.1. |  | Lease
between the Company and Yaakov Metzkin and Dov Segev, for premises in Kfar Sava, Israel,
dated              November 1, 1994, and amendment dated March 17, 2002, filed by us as
an Exhibit to our annual report on              Form 20-F for the fiscal year ended
December 31, 2001, as filed with the Securities and Exchange              Commission on
June 27, 2002, and incorporated herein by reference. As this lease and the amendment are
             written in Hebrew, a summary of each was included in the Exhibit.
|---- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.2 |  | Lease
between the Company and Ground A.S. Ltd., for manufacturing facility in Yokneam, Israel,
dated              June 27, 2000. As this lease is written in Hebrew, a summary was filed
by us as an Exhibit to our annual              report on Form 20-F for the fiscal year
ended December 31, 2000, as filed with the Securities and              Exchange
Commission on June 30, 2001. It is incorporated herein by reference.
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.3 |  | Lease
between Silicom Connectivity Solutions, Inc. and RAD Data Communications Inc., for space
in              Mahwah, New Jersey, dated as of September 1, 1997, filed by us as an
Exhibit to our annual report on              Form 20-F for the fiscal year ended December
31, 2000, as filed with the Securities and Exchange              Commission on June 30,
2001, and incorporated herein by reference.
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.4 |  | Sublease
Agreement between Silicom Connectivity Solutions, Inc. and Radcom Equipmet, Inc., for
space in              Paramus, New Jersey, dated as of February 1, 2004, filed by us as
an Exhibit to our annual report on              Form 20-F for the fiscal year ended
December 31, 2003, as filed with the Securities and Exchange              Commission on
June 30, 2004, and incorporated herein by reference.
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.5 |  | Addendum
to Lease dated June 27, 2000, dated as of May 5, 2005, between the Company, Ground A.S.
Ltd.,              Shaarei Haeer Investment Company Ltd. and Kanyon HaDrachim No. 1
Yokneam Ltd. As this addendum is              written in Hebrew, a translation is
attached hereto.
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|8. |  | List
of subsidiaries, filed by us as an Exhibit to our annual report on Form 20-F for the
fiscal year ended              December 31, 2000, as filed with the Securities and
Exchange Commission on June 30, 2001, and              incorporated herein by reference.
|-- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

64

---

---



|12.1 |  | Certification
by Chief Executive Officer pursuant to section 302 of the Sarbanes-Oxley Act of 2002.
|---- |  | ---------------------------------------------------------------------------------------------------

|12.2 |  | Certification
by Chief Financial Officer pursuant to section 302 of the Sarbanes-Oxley Act of 2002.
|---- |  | ---------------------------------------------------------------------------------------------------

|13.1 |  | Certification
by Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
|---- |  | ---------------------------------------------------------------------------------------------------

|13.2 |  | Certification
by Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
|---- |  | ---------------------------------------------------------------------------------------------------

|14.1 |  | Opinion
of McGladrey & Pullen, LLP, dated January 6, 2003, on the financial statements of Silicom
             Connectivity Solutions, Inc., for the two years ended December 31, 2001 and
2002, filed by us as an              Exhibit to our annual report on Form 20-F for the
fiscal year ended December 31, 2003, as filed with the              Securities and
Exchange Commission on June 30, 2004, and incorporated herein by reference.
|---- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|14.2 |  | Opinion
of McGladrey & Pullen, LLP, dated January 6, 2003, on the financial statements of Silicom
             Connectivity Solutions, Inc., for the year ended December 31, 2002.
|---- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

65

---

---



# SIGNATURES

Pursuant
to the requirements of Section 12 of the Securities Exchange Act of 1934, the Registrant
certifies that it meets all of the requirements for filing on Form 20-F and has duly
caused this Annual Report to be signed on its behalf by the undersigned, thereunto duly
authorized, in the City of Kfar Sava, State of Israel, on the 31st day of May,
2005.

| |  | SILICOM LIMITEDBY: /S/ Shaike Orbach
Shaike OrbachChief Executive Officer
| |  | ---------------------------------------------------------------------------------------

66

---

---



# Silicom Ltd.

# (An Israeli
Corporation)

# and its Consolidated
Subsidiary

# Financial Statements

# December 31, 2004



---

---



|Silicom Ltd. (An Israeli Corporation) and its Consolidated Subsidiary
|---------------------------------------------------------------------
|                                                                     
|Consolidated Financial Statements as of December 31, 2004            
|                                                                     
|                                                                     

Contents

|                                                           | Page         
|---------------------------------------------------------- | -------------
|
|
|
|
|Report of Independent Registered Public Accounting Firm    | F - 1        
|Consolidated Financial Statements:                        
|Consolidated Balance Sheets                                | F - 2 - F - 3
|Consolidated Statements of Income                          | F - 4        
|Consolidated Statements of Changes in Shareholders' Equity | F - 5        
|Consolidated Statements of Cash Flows                      | F - 6        
|Notes to Consolidated Financial Statements                 | F - 7        



---

---



# Report of Independent
Registered Public Accounting Firm

Board of Directors and Shareholders
of Silicom Ltd. and its Subsidiary

We have audited the accompanying
consolidated balance sheets of Silicom Ltd. (Silicom) and its subsidiary as of
December 31, 2004 and 2003 and the related consolidated statements of income, changes in
shareholders equity and cash flows for each of the years in the three-year period
ended December 31, 2004. These consolidated financial statements are the responsibility of
Silicom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 the consolidated subsidiary whose revenues constitute approximately 63.9% of
total consolidated revenues for the years ended December 31, 2002. Those financial
statements were audited by other auditors whose reports thereon have been furnished to us
and our opinion expressed herein, insofar as it relates to the amounts included for the
abovementioned subsidiary, is based solely upon the reports of the other auditors.

We conducted our audits in accordance
with the standards of the Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audit to obtain reasonable assurance that
the financial statements are free of material misstatement. An audit includes examining,
on a test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by the board of directors and management, as well as evaluating
the overall financial statements presentation. We believe that our audits and the report
of the other auditors provide a reasonable basis for our opinion.

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

Somekh Chaikin
Certified Public Accountants (Isr.)
Member Firm of KPMG International

Tel Aviv, Israel, May 31,
2005

F - 1

---

---



|Silicom Ltd. (An Israeli Corporation) and its Consolidated Subsidiary
|---------------------------------------------------------------------
|                                                                     
|Consolidated Balance Sheets at December 31                           
|                                                                     
|                                                                     

|                                   |  | 2004 | 2003
|---------------------------------- |  | ---- | ----
|
|
|
|
|Assets                             |  |      |     
|                                   |  |     
|Current assets                     |  |     
|Cash and cash equivalents          |  |      |     
|Investment securities              |  |      |     
|Receivables:                       |  |     
|Trade                              |  |      |     
|Other                              |  |      |     
|Inventories                        |  |      |     
|                                   |  |      |     
|                                   |  |     
|Total current assets               |  |      |     
|                                   |  |      |     
|                                   |  |     
|Investment securities              |  |      |     
|                                   |  |      |     
|                                   |  |     
|Assets held for severance benefits |  |      |     
|                                   |  |      |     
|                                   |  |     
|Property, plant and equipment      |  |      |     
|                                   |  |     
|Cost                               |  |      |     
|Less - accumulated depreciation    |  |      |     
|                                   |  |      |     
|                                   |  |     
|Net, property and equipment        |  |      |     
|                                   |  |      |     
|                                   |  |     
|Other assets                       |  |      |     
|                                   |  |      |     
|                                   |  |     
|                                   |  |     
|                                   |  |     
|Total assets                       |  |      |     
|                                   |  |      |     

|/S/ Avi Eizenman
Avi EizenmanChairman of the Board of Directors | /S/ Shaike Orbach
Shaike OrbachChief Executive Officer | /S/ Ilan Erez
Ilan ErezChief Financial Officer
|----------------------------------------------------------------------------- | -------------------------------------------------------------------- | ------------------------------------------------------------

Kfar-Saba, Israel: May 31, 2005

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

F - 2

---

---



|Silicom Ltd. (An Israeli Corporation) and its Consolidated Subsidiary
|---------------------------------------------------------------------
|                                                                     
|Consolidated Balance Sheets at December 31                           
|                                                                     
|                                                                     

|                                                         |  | 2004 | 2003
|-------------------------------------------------------- |  | ---- | ----
|
|
|
|
|Liabilities and shareholders' equity                     |  |      |     
|                                                         |  |     
|Current liabilities                                      |  |     
|Trade accounts payable                                   |  |      |     
|Other accounts payable and accrued expenses              |  |      |     
|                                                         |  |      |     
|                                                         |  |     
|Total current liabilities                                |  |      |     
|                                                         |  |      |     
|                                                         |  |     
|Long-term liability                                      |  |     
|                                                         |  |     
|Liability for employees severance benefits               |  |      |     
|                                                         |  |      |     
|                                                         |  |     
|Total liabilities                                        |  |      |     
|                                                         |  |      |     
|                                                         |  |     
|Commitments and contingencies                            |  |      |     
|                                                         |  |     
|                                                         |  |     
|Shareholders' equity                                     |  |      |     
|Ordinary shares, NIS 0.001 par value;                    |  |     
|authorized 10,000,000 shares;                            |  |     
|issued and outstanding 4,213,550 shares as of            |  |     
|December 31, 2004 and 4,126,800  as of December 31, 2003 |  |      |     
|Additional paid in capital                               |  |      |     
|Treasury shares (at cost) - 14,971 ordinary shares as at |  |     
|December 31, 2004 and 2003                               |  |      |     
|Retained deficit                                         |  |      |     
|                                                         |  |      |     
|                                                         |  |     
|Total shareholders' equity                               |  |      |     
|                                                         |  |      |     
|                                                         |  |     
|Total liabilities and shareholders' equity               |  |      |     
|                                                         |  |      |     

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

F - 3

---

---



|Silicom Ltd. (An Israeli Corporation) and its Consolidated Subsidiary
|---------------------------------------------------------------------
|                                                                     
|Consolidated Statements of Income for the Year Ended December 31,    
|                                                                     
|                                                                     

|                                            |  | 2004 | 2003 | 2002
|------------------------------------------- |  | ---- | ---- | ----
|
|
|
|
|Sales                                       |  |      |      | 12A 
|                                            |  |     
|Cost of sales                               |  |      |      | 12B 
|                                            |  |      |      |     
|                                            |  |     
|Gross profit                                |  |      |      |     
|                                            |  |      |      |     
|                                            |  |     
|Research and development costs              |  |      |      | 12C 
|Total costs                                 |  |      |      |     
|Less: royalty-bearing participations, net   |  |      |      | 8A  
|                                            |  |      |      |     
|                                            |  |     
|Research and development costs, net         |  |      |      |     
|                                            |  |      |      |     
|                                            |  |     
|                                            |  |     
|                                            |  |     
|Selling, marketing, general and             |  |     
|administrative expenses                     |  |     
|Selling and marketing expenses              |  |      |      | 12D 
|General and administrative expenses         |  |      |      |     
|                                            |  |      |      |     
|                                            |  |     
|                                            |  |      |      |     
|                                            |  |      |      |     
|                                            |  |     
|Operating loss                              |  |      |      |     
|                                            |  |     
|Financial (expenses) income, net            |  |      |      | 12E 
|                                            |  |      |      |     
|                                            |  |     
|Net loss for the year                       |  |      |      |     
|                                            |  |      |      |     
|                                            |  |     
|                                            |  |     
|Loss per share                              |  |     
|Basic and diluted losses per ordinary share |  |      |      |     
|                                            |  |      |      |     
|                                            |  |     
|                                            |  |     
|Weighted average number of ordinary         |  |     
|shares used to compute basic and diluted    |  |     
|losses per share (in thousands)             |  |      |      |     
|                                            |  |      |      |     

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

F - 4

---

---



|Silicom Ltd. (An Israeli Corporation) and its Consolidated Subsidiary
|---------------------------------------------------------------------
|                                                                     
|Statements of Changes in Shareholders' Equity                        
|                                                                     
|                                                                     

|                       | Ordinary
shares | Share
capital | Additional
paid-in
capital | Cost of
Silicom
shares held
by its
subsidiary | Retained
earnings
(deficit)* | Total
|---------------------- | --------------- | ------------- | -------------------------- | --------------------------------------------- | ---------------------------- | -----
|
|
|
|
|Balance at             |                 |               |                            |                                               |                              |      
|January 1, 2002        |                 |               |                            | 4,110,329                                     |                              |      
|                       |                 |              
|Changes during 2002    |                 |              
|Net loss for the year  |                 |               |                            | -                                             |                              |      
|                       |                 |               |                            |                                               |                              |      
|                       |                 |              
|Balance at             |                 |              
|December 31, 2002      |                 |               |                            | 4,110,329                                     |                              |      
|                       |                 |              
|Changes during 2003    |                 |              
|Ordinary shares issued |                 |              
|in connection with the |                 |              
|exercise of stock      |                 |              
|options                |                 |               |                            | 1,500                                         |                              |      
|                       |                 |              
|Net loss for the year  |                 |               |                            | -                                             |                              |      
|                       |                 |               |                            |                                               |                              |      
|                       |                 |              
|Balance at             |                 |              
|December 31, 2003      |                 |               |                            | 4,111,829                                     |                              |      
|                       |                 |              
|Changes during 2004    |                 |              
|Ordinary shares issued |                 |              
|in connection with the |                 |              
|exercise of stock      |                 |              
|options                |                 |               |                            | 86,750                                        |                              |      
|                       |                 |              
|Net loss for the year  |                 |               |                            | -                                             |                              |      
|                       |                 |               |                            |                                               |                              |      
|                       |                 |              
|Balance at             |                 |              
|December 31, 2004      |                 |               |                            | 4,198,579                                     |                              |      
|                       |                 |               |                            |                                               |                              |      

|* | See
Note 9C.
|- | ------------

|** | Net
of 14,971 shares held by subsidiary.
|-- | ----------------------------------------

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

F - 5

---

---



|Silicom Ltd. (An Israeli Corporation) and its Consolidated Subsidiary
|---------------------------------------------------------------------
|                                                                     
|Statements of Cash Flows for the Year Ended December 31,             
|                                                                     
|                                                                     

|                                                             | 2004 | 2003 | 2002
|------------------------------------------------------------ | ---- | ---- | ----
|
|
|
|
|Cash flows from operating activities                         |      |      |     
|Net loss                                                     |      |      |     
|Adjustments to reconcile net income to net cash              |      |     
|provided by operating activities:                            |      |     
|Depreciation and amortization of property, plant and         |      |     
|Equipment                                                    |      |      |     
|Severance, net                                               |      |      |     
|Amortization of discounts or premium of                      |      |     
|investment security and interest                             |      |      |     
|                                                             |      |     
|Changes in operating assets and liabilities                  |      |     
|Decrease (increase) in trade receivables                     |      |      |     
|Decrease (increase) in other receivables                     |      |      |     
|Decrease (increase) in inventories                           |      |      |     
|Increase (decrease) in trade payables and accruals           |      |      |     
|Increase (decrease) in other payables and accruals           |      |      |     
|                                                             |      |      |     
|Net cash used in operating activities                        |      |      |     
|                                                             |      |      |     
|                                                             |      |     
|Cash flows from investing activities                         |      |     
|Acquisition of property and equipment                        |      |      |     
|Acquisition of other assets                                  |      |      |     
|Proceeds from maturity of investment securities and deposits |      |      |     
|Purchase of investment securities and deposits               |      |      |     
|                                                             |      |      |     
|Net cash provided by (used in) investing activities          |      |      |     
|                                                             |      |      |     
|                                                             |      |     
|Cash flows from financing activities                         |      |     
|Issuance of ordinary shares in connection with the           |      |     
|exercise of stock options                                    |      |      |     
|                                                             |      |      |     
|Net cash provided by financing activities                    |      |      |     
|                                                             |      |      |     
|                                                             |      |     
|Net increase (decrease) in cash and cash equivalents         |      |      |     
|                                                             |      |     
|Cash and cash equivalents at beginning of year               |      |      |     
|                                                             |      |      |     
|Cash and cash equivalents at end of year                     |      |      |     
|                                                             |      |      |     
|                                                             |      |     
|                                                             |      |     
|Supplementary disclosure of cash flow information:           |      |     
|Cash paid during the year for:                               |      |     
|Financing expenses                                           |      |      |     
|                                                             |      |      |     
|Taxes on income                                              |      |      |     
|                                                             |      |      |     

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

F - 6

---

---



|Silicom Ltd. (An Israeli Corporation) and its Consolidated Subsidiary
|---------------------------------------------------------------------
|                                                                     
|Notes to the Consolidated Financial Statements                       
|                                                                     
|                                                                     

|Note 1 |  | General
|------ | - | -------

| | Silicom
Ltd. (Silicom) is an Israeli corporation engaged in designing, manufacturing,
marketing and supporting server networking solutions for manufacturers of storage systems,
internet traffic management systems, security appliances and other manufacturers providing
a variety of server-based systems (Server Networking Products). It also offers
an extensive range of connectivity solutions for portable computers, broadband Internet
access, Multi Tenant Unit (MTU), home networking, and other hardware manufacturers
(Traditional Products). Silicoms products and technologies combine
hardware and software.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Silicom
markets its products directly, through (i) its US-based subsidiary, (ii) a worldwide
network of independent distributors and (iii) OEMs which sell the Companys
connectivity products under their own private labels or incorporate the Companys
products into their products.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Most
of the Companys raw materials are readily available, but certain key components are
currently available from only one source, and others are available from a limited number
of sources.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
these financial statements the term Company refers to the Silicom Ltd. and its
wholly owned subsidiary, Silicom Connectivity Solutions, Inc. whereas the term
subsidiary refers to Silicom Connectivity Solutions, Inc., a wholly owned
subsidiary of Silicom Ltd., that is engaged in marketing the products of Silicom Ltd. in
North America.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Note 2 |  | Significant
Accounting Policies
|------ | - | -------------------------------

| | The
significant accounting policies, applied on a consistent basis, are as follows:
| | -----------------------------------------------------------------------------------

| | A. | Financial
statements in U.S. dollars
| | -- | ------------------------------------

| | Substantially
all sales of the Company are made outside of Israel (see note 12A regarding geographical
destination), in U.S. dollars (dollars). Most purchases of materials and
supplies and marketing costs are made or incurred outside Israel, primarily in dollars.
Thus, the functional currency of the Company is the dollar.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Transactions
and balances in other currencies are remeasured into dollars in accordance with the
principles set forth in Statement No. 52 of the Financial Accounting Standards Board of
the United States (FASB).
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | All
exchange gains and losses from remeasurement of monetary balance sheet items denominated
in non-dollar currencies are reflected in the statement of income (loss) when they arise.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | B. | Principles
of consolidation
| | -- | ---------------------------

| | The
consolidated financial statements include the accounts of Silicom Ltd. and its wholly
owned subsidiary.
| | -----------------------------------------------------------------------------------------------------------

| | All
significant intercompany balances and transactions have been eliminated in consolidation.
| | ---------------------------------------------------------------------------------------------

F - 7

---

---



|Silicom Ltd. (An Israeli Corporation) and its Consolidated Subsidiary
|---------------------------------------------------------------------
|                                                                     
|Notes to the Consolidated Financial Statements                       
|                                                                     
|                                                                     

|Note 2 |  | Significant
Accounting Policies (contd)
|------ | - | ----------------------------------------

| | C. | Use
of estimates in the preparation of financial statements
| | -- | -----------------------------------------------------------

| | Management
of the Company has made a number of estimates and assumptions relating to the reporting of
assets and liabilities and the disclosure of contingent assets and liabilities and
prepared these financial statements in conformity with generally accepted accounting
principles. Actual results could differ from those estimates.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | D. | Cash
and cash equivalents
| | -- | -------------------------

| | The
Company considers all highly liquid debt instruments with original maturities of three
months or less at date of purchase, to be cash equivalents.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------

| | E. | Investment
securities
| | -- | ---------------------

| | Investments
which the Company has the intent and ability to hold to maturity are classified as
held-to-maturity investments as defined in Statement of Financial Accounting Standard No.
115 Accounting for Certain Investments in Debt and Equity Securities and are
recorded at amortized cost adjusted for the amortization or accretion of premiums or
discounts.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | A
decline in the market value of any held-to-maturity security below cost, that is deemed to
be other than temporary, results in a reduction in carrying amount to fair value. The
impairment is charged to the statement of income and a new carrying basis is established.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Interest
income is accrued as earned. Premiums and discounts are amortized over the life of the
related held-to-maturity security as an adjustment to yield using the effective interest
method.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | F. | Trade
receivables
| | -- | -----------------

| | Accounts
receivable are recorded at cost, less the related allowance for doubtful accounts
receivable. Management considers current information and events regarding the
customers ability to repay their obligation and judges accounts receivable to be
impaired when it is probably that the Company will be unable to collect all amounts due.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | G. | Inventories
| | -- | -----------

| | Inventories
are stated at the lower of cost or market. Cost is determined using the
average-cost method for raw materials.
| | ----------------------------------------------------------------------------------------------------------------------------

| | The
Company writes down obsolete or slow moving inventory to its lower of cost or market.
| | -----------------------------------------------------------------------------------------

F - 8

---

---



|Silicom Ltd. (An Israeli Corporation) and its Consolidated Subsidiary
|---------------------------------------------------------------------
|                                                                     
|Notes to the Consolidated Financial Statements                       
|                                                                     
|                                                                     

|Note 2 |  | Significant
Accounting Policies (contd)
|------ | - | ----------------------------------------

| | H. | Assets
held for severance benefits
| | -- | ----------------------------------

| | Assets
held for employee severance benefits represent contributions to severance pay funds and
cash surrender value of life insurance policies that are recorded at their current
redemption value, which also represents their fair value.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | I. | Property
plant and equipment
| | -- | ----------------------------

| | Property
plant and equipment are stated at cost.
| | ------------------------------------------------

| | Depreciation
is calculated on the straight-line method over the estimated useful life of the assets.
| | ----------------------------------------------------------------------------------------------------

| | Annual
rates of depreciation are as follows:
| | --------------------------------------------

| |                                                                   | %    
| | ----------------------------------------------------------------- | -----
|
|
|
|
| | Research and development equipment, having alternative future use | 20-33
| | Manufacturing equipment                                           | 20-33
| | Motor vehicles                                                    | 15   
| | Office furniture and equipment                                    | 6-20 
| | Leasehold improvements                                            | (*)  

| | (*) | Leasehold improvements are amortized by the straight-line method over the term
                    of the lease or the estimated useful life of the improvements, whichever is
                    shorter.
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | J. | Other
assets
| | -- | ------------

| | Other
assets consist of patents. The cost of patents is amortized by the straight-line method
over the estimated useful lives of the respective assets. The remaining weighted average
life of patents at December 31, 2004 is seven years.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company reviews its other assets for impairment whenever events or circumstances indicate
that the carrying amount of an asset may not be recoverable. If the sum of expected cash
flows, undiscounted and without interest is less than the carrying amount of asset, an
impairment loss is recognized as the amount by which the carrying amount of the asset
exceeds its fair value.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | K. | Revenue
recognition
| | -- | -------------------

| | The
Company recognizes revenue on sales when products are shipped, the collectibility of debts
is probable and the customer takes ownership and assumes risk of loss.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 9

---

---



|Silicom Ltd. (An Israeli Corporation) and its Consolidated Subsidiary
|---------------------------------------------------------------------
|                                                                     
|Notes to the Consolidated Financial Statements                       
|                                                                     
|                                                                     

|Note 2 |  | Significant
Accounting Policies (contd)
|------ | - | ----------------------------------------

| | L. | Research
and development costs
| | -- | ------------------------------

| | Research
and development costs are expensed as incurred.
| | --------------------------------------------------------

| | M. | Royalty
bearing participations
| | -- | ------------------------------

| | Royalty
bearing participations from the Government of Israel for funding research and development
activities are recognized at the time the Company is entitled to such grants based on the
related cost incurred. See Note 8A.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | N. | Service
warranty
| | -- | ----------------

| | The
Company grants service warranties related to certain products to end-users. The Company
estimates its obligation for such warranties to be immaterial on the basis of historical
experience. Accordingly, these financial statements do not include an accrual for the
subject warranty obligations.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | O. | Treasury
shares
| | -- | ---------------

| | Treasury
shares are recorded at cost and presented as a reduction of shareholders equity.
| | ------------------------------------------------------------------------------------------

| | P. | Taxes
on income
| | -- | ---------------

| | The
Company accounts for income taxes in accordance with Statement of Financial Accounting
Standards No. 109 Accounting for Income Taxes. The statement prescribes the
use of the liability method whereby deferred tax assets and liability account balances are
determined based on differences between financial reporting and tax bases of assets and
liabilities and are measured using the enacted tax rates and laws that will be in effect
when the differences are expected to reverse. See also Note 10G.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Q. | 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 an interpretation
of APB Opinion No. 25 issued in March 2000, to account for its fixed plan stock
options. Under this method, compensation expense is recorded on the date of grant only if
the current market price of the underlying stock exceeded the exercise price. The Company
applies SFAS No. 123 with respect to options issued to persons other than employees. 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 compensation plans. As allowed by SFAS No. 123, the Company has elected to
continue to apply the intrinsic value-based method of accounting for grants to employees
as described above, and has adopted the disclosure requirements of SFAS No. 123.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 10

---

---



|Silicom Ltd. (An Israeli Corporation) and its Consolidated Subsidiary
|---------------------------------------------------------------------
|                                                                     
|Notes to the Consolidated Financial Statements                       
|                                                                     
|                                                                     

|Note 2 |  | Significant
Accounting Policies (contd)
|------ | - | ----------------------------------------

| | Q. | Stock
option plans (contd)
| | -- | ---------------------------

| | Pro
forma information regarding net income and earnings per share is required by SFAS 123, and
has been determined as if the Company had accounted for its employee stock options under
the fair value method of this statement.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | See also Note 16D.
| | ------------------

| | Had
compensation expense for stock option grants issued been determined under the fair value
method of SFAS No. 123, the Companys net loss and loss per share for the fiscal
years ended December 31, 2004, 2003 and 2002 would have been:
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |                                    | 2004 | 2003 | 2002
| | ---------------------------------- | ---- | ---- | ----
|
|
|
|
| | Net loss as reported               |      |      |     
| | Add: compensation expenses         |      |     
| | according to APB 25                |      |      |     
| | Deduct: compensation expenses      |      |     
| | according to SFAS 123              |      |      |     
| |                                    |      |      |     
| | Net loss pro forma                 |      |      |     
| |                                    |      |      |     
| | Basic and diluted losses per share |      |     
| | as reported (US$)                  |      |      |     
| |                                    |      |      |     
| | Pro forma basic and diluted losses |      |     
| | per share (US$)                    |      |      |     
| |                                    |      |      |     

| | R. | Impairment
or disposal of long-lived assets
| | -- | -------------------------------------------

| | The
Company accounts for 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 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 future net cash flows expected to be generated by the asset. If the
carrying amount of an asset exceeds its estimated future cash flows, an impairment charge
is recognized by the amount by which the carrying amount of the asset exceeds the fair
value of the asset. Assets to be disposed of are reported at the lower of the carrying
amount or fair value less costs to sell.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | S. | Earnings
per share (EPS)
| | -- | ------------------------

| | Basic
earnings (loss) per ordinary shares (EPS) are calculated by dividing net
income (loss) available to ordinary shareholders by the weighted average number of
ordinary shares outstanding during the period according to SFAS 128 Earnings per
Share. The computation of diluted EPS assumes the issuance of ordinary shares for
all dilutive-potential ordinary shares outstanding during the reporting period. The
dilutive effect of stock options is considered in earnings per ordinary share
calculations, if dilutive, using the treasury stock method.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 11

---

---



|Silicom Ltd. (An Israeli Corporation) and its Consolidated Subsidiary
|---------------------------------------------------------------------
|                                                                     
|Notes to the Consolidated Financial Statements                       
|                                                                     
|                                                                     

|Note 3 |  | Cash and Cash Equivalent
|------ | - | ------------------------

|                 | December 31
2004 | December 31
2003
|---------------- | ---------------- | ----------------
|
|
|
|
|Cash             |                  |                 
|Cash equivalent* |                  |                 
|                 |                  |                 
|                 |                  |                 
|                 |                  |                 

| | * | Cash
deposits in bank as at December 31, 2004 carrying interest of 0.449%.
| | - | --------------------------------------------------------------------------

|Note 4 |  | Investment Securities
|------ | - | ---------------------

| | The
amortized cost, gross unrealized holding losses and fair value of held-to-maturity
securities at December 31, 2004 and 2003, were as follows:
| | -------------------------------------------------------------------------------------------------------------------------------------------------

|                                                       | Amortized cost | Gross unrealized
holding losses | Fair value
|------------------------------------------------------ | -------------- | ------------------------------- | ----------
|
|
|
|
|At December 31, 2004*                                  |                |                                 |           
|Corporate debt securities                              |                |                                 |           
|At December 31, 2003                                   |                |                                
|Corporate debt securities and certificates of deposits |                |                                 |           

| | * | Investment
securities are due within one year
| | - | ---------------------------------------------

| | Proceeds
from redemption of investment securities held-to-maturity are $ 2,342, $ 4,676 thousand
and $ 1,345 thousand in fiscal years 2004, 2003 and 2002, respectively.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
following table shows the gross unrealized losses and fair value of Companys
investments with unrealized losses that are not deemed to be other-than-temporarily
impaired, aggregated by investment category and length of time that individual securities
have been in a continuous unrealized loss position at December 31, 2004:
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|               | Less than 12 months | 12 months or more
|-------------- | ------------------- | -----------------
|
|
|
|
|Corporate debt |                     |                  
|securities     |                     |                  
|               |                     |                  

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

F - 12

---

---



|Silicom Ltd. (An Israeli Corporation) and its Consolidated Subsidiary
|---------------------------------------------------------------------
|                                                                     
|Notes to the Consolidated Financial Statements                       
|                                                                     
|                                                                     

|Note 5 |  | Property Plant and Equipment
|------ | - | ----------------------------

|                               | Cost | Accumulated depreciationand amortization
|------------------------------ | ---- | ----------------------------------------
|
|
|
|
|Research and development       |      |                                         
|equipment                      |      |                                         
|Manufacturing equipment        |      |                                         
|Motor vehicles                 |      |                                         
|Office furniture and equipment |      |                                         
|Leasehold improvements         |      |                                         
|                               |      |                                         
|                               |      |                                         
|                               |      |                                         
|                               |      |                                         

| | Depreciation
expense amounted to $ 150, $ 145 and $ 137 thousand for the years ended December 31, 2004,
2003 and 2002 respectively.
| | -----------------------------------------------------------------------------------------------------------------------------------

|Note 6 |  | Assets Held for Severance Benefits
|------ | - | ----------------------------------

| | A. | Under
Israeli law and labor agreements, Silicom is required to make severance
          payments to dismissed employees and employees leaving employment in certain
          other circumstances. Silicoms severance pay liability to its employees,
          based upon length of service and latest monthly salary (one months salary
          for each year worked), is reflected by the balance sheet accrual and is partly
          covered by pension funds and insurance policies in the name of Silicom.
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
balances accrued and funded at balance sheet dates are as follows:
| | ----------------------------------------------------------------------

|                                      | December 31
|------------------------------------- | -----------
|
|
|
|
|Liability for employees severance pay |            
|                                      |            
|                                      |            
|Severance pay fund                    |            
|                                      |            

| | B. | The
net severance pay expense was $ 100 thousand, $ 168 thousand and $ 98           thousand
in the years ended December 31, 2004, 2003 and 2002 respectively.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 13

---

---



|Silicom Ltd. (An Israeli Corporation) and its Consolidated Subsidiary
|---------------------------------------------------------------------
|                                                                     
|Notes to the Consolidated Financial Statements                       
|                                                                     
|                                                                     

|Note 7 |  | Other Assets
|------ | - | ------------

| | The
Subsidiary entered into a Non-Exclusive Limited Patent License Agreement in
April 2002. The agreement included a one-time license fee of $150 thousand which
represented a licensing fee for both past (six years) and future (ten years) sales of
certain connectors and PC cards under patents of the licensor. The total amortization
expense for 2004 was approximately $ 9,375.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
maturities of other assets were as follows at December 31, 2004:
| | --------------------------------------------------------------------

|                                         | U.S. dollars
In thousands
|---------------------------------------- | -------------------------
|
|
|
|
|Due within one year                      |                          
|Due within two years                     |                          
|Due within three years and more          |                          
|                                         |                          
|                                         |                          
|                                         |                          
|Less: Amount including in current assets |                          
|                                         |                          
|                                         |                          
|                                         |                          
|                                         |                          

|Note 8 |  | Commitments and Contingencies
|------ | - | -----------------------------

| | A. | Royalty
commitments
| | -- | -------------------

| | The
Company is obligated to pay royalties to the Government of Israel on revenues from product
sales related to research and development, which was undertaken with Government grants.
Since January 1, 1997, royalty rates are 2% to 5% (prior to January 1, 1997, royalty rates
were 2% to 3%). The royalty rates applicable for the Companys Research and
Development projects are 2%  3.5%, except for one project that took place in the
period July 1, 1997  January 31, 2000, where the royalty rate is 4%.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Royalties
are payable from the commencement of sales of each 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 approved prior to December 31, 2000 and with LIBOR
interest for amounts received after that date.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Companys total outstanding contingencies in respect of royalty-bearing
participations received or accrued, net of royalties paid or accrued, amounted to
approximately $ 3,142 thousand as of December 31, 2004 ($ 3,048 thousand as of December
31, 2003).
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | B. | Lease
commitments
| | -- | -----------------

| | The
premises and facilities occupied by the Company and its subsidiary are leased under
various lease agreements. Furthermore, the Company has entered into several operating
lease agreements for motor vehicles in Israel.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
agreements are in local currencies or linked to the dollar or to the Israeli Consumer
Price Index.
| | ------------------------------------------------------------------------------------------------------

F - 14

---

---



|Silicom Ltd. (An Israeli Corporation) and its Consolidated Subsidiary
|---------------------------------------------------------------------
|                                                                     
|Notes to the Consolidated Financial Statements                       
|                                                                     
|                                                                     

|Note 8 |  | Commitments and Contingencies (contd)
|------ | - | --------------------------------------

| | B. | Lease
commitments (contd)
| | -- | --------------------------

| | The
minimum projected rental payments under the above leases in effect as of December 31, 2004
are as follows:
| | --------------------------------------------------------------------------------------------------------------

|                         | U.S. dollarsin thousands
|------------------------ | ------------------------
|
|
|
|
|Year ending December 31, |                         
|2005                     |                         
|2006                     |                         
|2007                     |                         

| | C. | Guarantees
| | -- | ----------

| | The
Company has provided bank guarantee in respect of certain future rental payments in the
amount of $ 29,985.
| | ---------------------------------------------------------------------------------------------------------------

|Note 9 |  | Shareholders Equity
|------ | - | --------------------

| | A. | Share
capital
| | -- | -------------

| | Silicoms
Ordinary Shares are traded in the United States on the National Association of Securities
Dealers Automated Quotation System (NASDAQ) small cap market, since February
1994.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | B. | Stock
compensation plans
| | -- | ------------------------

| | At
December 31, 2004, Silicom had four stock-based compensation plans, which are described
below. Silicom applies APB Opinion 25 and related interpretations in accounting for its
plans. Accordingly, no compensation cost has been recognized for its fixed stock option
plans.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
fair value for option grant is estimated on the date of grant using the Black-Scholes
option pricing model with the following weighted average assumptions for 2004, 2003* and
2002:
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                               | 2004 | 2003* | 2002
|------------------------------ | ---- | ----- | ----
|
|
|
|
|Risk-free interest rate        |      |       |     
|Dividend yield                 |      |       |     
|Volatility factor              |      |       |     
|Weighted average expected life |      |       |     

| | * | No
options were granted in 2003.
| | - | --------------------------------

F - 15

---

---



|Silicom Ltd. (An Israeli Corporation) and its Consolidated Subsidiary
|---------------------------------------------------------------------
|                                                                     
|Notes to the Consolidated Financial Statements                       
|                                                                     
|                                                                     

|Note 9 |  | Shareholders Equity (contd)
|------ | - | -----------------------------

| | B. | Stock
compensation plans (contd)
| | -- | ---------------------------------

| | Had
compensation cost for Silicoms four stock-based compensation plans been determined
based on the fair value at the grant dates for awards under those plans consistent with
the method of Statement 123, Silicoms net income and earnings per share would have
been reduced to the pro forma amounts indicated below:
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                                     | 2004 | 2003 | 2002
|---------------------------------------------------- | ---- | ---- | ----
|
|
|
|
|Net loss as reported                                 |      |      |     
|Add: compensation expenses according to APB25        |      |      |     
|Deduct: compensation expenses                        |      |     
|according to SFAS 123                                |      |      |     
|                                                     |      |      |     
|Net loss pro forma                                   |      |      |     
|                                                     |      |      |     
|Basic and diluted losses per share as reported (US$) |      |      |     
|                                                     |      |      |     
|Pro forma basic and diluted losses per share (US$)   |      |      |     
|                                                     |      |      |     

| | Fixed
Stock Option Plans
| | ------------------------

| | 1. | In
1993 the Board of Directors of Silicom adopted a share option plan (the           Share
Option Plan) covering up to 88,676 options at a conversion           rate of 1:1,
to be granted to certain employees and consultants of Silicom. In           June 1997,
the Board of Directors of Silicom expanded the number of options           covered by
this plan by 211,324 options to 300,000 options. In April 2002, the           Board of
Directors expanded the number of options covered by this plan by           200,000
options to 500,000 options. The Share Option Plan is administered by the           Board
of Directors, which designates the options and dates of grant. The price           of
shares to be issued under this plan is equal to the market price of Silicom
          shares on the date upon which the options were granted. The options are for a
          10-year term and are non-assignable except by the laws of succession.
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2. | In
1994 the Board of Directors of Silicom approved a Directors Share Incentive
          Option Plan (1994) (the Directors Plan) covering up to 200,000
          options at a conversion rate of 1:1.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
June 1999, the Board of Directors of Silicom expanded the number of options covered by
this plan by 120,000 options to 320,000 options.
| | ------------------------------------------------------------------------------------------------------------------------------------------

| | In
January 2001, the Board of Directors of Silicom expanded again the number of options
covered by this plan by 180,000 options to 500,000 options.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------

| | The
price of shares to be issued to the directors under the Directors Plan is equal to the
market price of Silicom shares on the dates upon which the options were granted.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 16

---

---



|Silicom Ltd. (An Israeli Corporation) and its Consolidated Subsidiary
|---------------------------------------------------------------------
|                                                                     
|Notes to the Consolidated Financial Statements                       
|                                                                     
|                                                                     

|Note 9 |  | Shareholders Equity (contd)
|------ | - | -----------------------------

| | B. | Stock
compensation plans (contd)
| | -- | ---------------------------------

| | Fixed
Stock Option Plans (contd)
| | ---------------------------------

| | 3. | In
October 2000, the Board of Directors of Silicom adopted the Silicom Ltd. US
          Share Option Plan (2000) (US Plan). The US Plan provides that options may be
          granted to any officer, consultants and certain other present and future
          employees and directors of Silicom and its subsidiary. Under the terms of the
US           Plan, up to a maximum of 200,000 ordinary shares of Silicom are reserved for
          issuance, subject to certain adjustments. The exercise price of the options
          granted under the US Plan shall be not less than 100 percent (or, in the case
of           a grant to a holder of more than 10% of Silicoms outstanding shares,
110           percent) of the fair market value of the ordinary shares subject to the
option           on the date the option is granted. The vesting period of the options is
subject           to the discretion of the Board. The term of the option shall not exceed
10 years           from the date that the option was granted (or five years, in the case
of           optionees who hold more than 10% of Silicoms outstanding shares).
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 4. | On
July 21, 2004, the Board resolved, subject to shareholder approval that was
          given on December 30, 2004, to adopt the Share Option Plan (2004) (the
          2004 Plan) and to cancel any authorized share capital of the
Company           that had been previously reserved under the 1993 and 1994 plans, which
was not           then allocated under such plans or which would become unallocated from
time to           time as outstanding options expire or are forfeited (the Cancelled
          Reserve). At such time, the Cancelled Reserve consisted of 282,750
          authorized Ordinary Shares of the Company.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
2004 Plan covering up to 282,750 options at a conversion rate of 1:1 to be granted to
Israeli employees and directors. The vesting period of the options and the price of
shares to be issued to the directors under the 2004 Plan is subject to the shareholders
approval. The vesting period of the options and the price of shares to be issued to the
employees under the 2004 Plan is subject to the Board approval. The term of the options
shall not exceed 10 years from the date that the option was granted.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 5. | No
options have been granted other than to employees and directors.
| | -- | -------------------------------------------------------------------

F - 17

---

---



|Silicom Ltd. (An Israeli Corporation) and its Consolidated Subsidiary
|---------------------------------------------------------------------
|                                                                     
|Notes to the Consolidated Financial Statements                       
|                                                                     
|                                                                     

|Note 9 |  | Shareholders Equity (contd)
|------ | - | -----------------------------

| | B. | Stock
compensation plans (contd)
| | -- | ---------------------------------

| | Fixed
Stock Option Plans (contd)
| | ---------------------------------

| | 5. | (contd)
| | -- | --------

| | A
summary of the status of Silicoms four fixed stock option plans as of December 31,
2004, 2003 and 2002 and changes during the years ending on those dates, is presented
below:
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                  | Shares
(in thousands) | Weighted
Average
Exercise Price | Shares
(in thousands) | Weighted
Average
Exercise Price | Shares
(in thousands) | Weighted
Average
Exercise Price
|----------------- | --------------------- | ------------------------------- | --------------------- | ------------------------------- | --------------------- | -------------------------------
|
|
|
|
|Outstanding at    |                       |                                 |                       |                                 |                       |                                
|beginning of year |                       |                                 |                       | 767,750                         |                       |                                
|Granted           |                       |                                 |                       | 240,500                         |                       | $                              
|Exercised         |                       |                                 |                       | (86,750                         | )                     | $                              
|Forfeited         |                       |                                 |                       | (193,000                        | )                     | $                              
|                  |                       |                                 |                       |                                 |                       |                                
|Outstanding at    |                       |                                
|end of year       |                       |                                 |                       | 728,500                         |                       |                                
|                  |                       |                                 |                       |                                 |                       |                                
|Options           |                       |                                
|exercisable at    |                       |                                
|year-end          |                       |                                 |                       | 503,300                         |                       |                                
|                  |                       |                                 |                       |                                 |                       |                                
|Weighted average  |                       |                                
|fair value of     |                       |                                
|options granted   |                       |                                
|during the year   |                       |                                 |                       |                                 |                       | $                              
|                  |                       |                                 |                       |                                 |                       |                                

| | C. | Stock
options granted under the Employee Share Option Plan are as follows:
| | -- | --------------------------------------------------------------------------

| | The
following table summarizes information about stock options outstanding at December 31,
2004:
| | ------------------------------------------------------------------------------------------------

|            | Options outstanding | Option exercisable
|----------- | ------------------- | ------------------
|
|
|
|
|0.6 - 0.9   |                     |                   
|1.69        |                     |                   
|2.25 - 2.53 |                     |                   
|4.25 - 5.75 |                     |                   
|            |                     |                   
|            |                     |                   
|            |                     |                   
|            |                     |                   

F - 18

---

---



|Silicom Ltd. (An Israeli Corporation) and its Consolidated Subsidiary
|---------------------------------------------------------------------
|                                                                     
|Notes to the Consolidated Financial Statements                       
|                                                                     
|                                                                     

|Note 9 |  | Shareholders Equity (contd)
|------ | - | -----------------------------

| | C. | Retained
earnings:
| | -- | ------------------

| | 1. | In
the event of distribution by the Company of cash dividends out of retained
          earnings which were tax exempt due to the Approved Enterprises          status,
the Company would be subject to a 25% corporate tax on the amount           distributed,
and further 15% withholding tax would be deducted from the amounts           distributed
to the recipients. The Company has decided not to distribute the           said
tax-exempt income as dividends. In the event of dividend distribution as           above,
the said tax amount would be charged as an expense in the statement of           income.
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2. | In
the event that cash dividends are declared by the Company, such dividends           will
be declared and paid in Israeli currency. Under current Israeli           regulations,
any cash dividend in Israeli currency paid in respect of Ordinary           Shares
purchased by non-residents of Israel with non-Israeli currency may be           freely
repatriated in such non-Israeli currency, at the rate of exchange           prevailing at
the time of conversion.
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Note 10 |  | 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 parties
| | -- | -------------------------------------------------------------------

| | The
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 that the transfer pricing policy adopted with foreign affiliates is
economically fair, an adjustment may be required following the issue of the said
Regulations.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2. | Employee
stock incentive plans
| | -- | ------------------------------

| | The
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 a deduction for tax purposes while the employee will be fully taxed up to
the maximum marginal tax rate of 50% or the Company can waive the tax deduction and the
employee will pay a reduced tax rate of 25%. Where there is no trustee arrangement, the
employee is fully taxable and no deduction 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 under the 2004 Plan are in accordance with the capital
gains track.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 19

---

---



|Silicom Ltd. (An Israeli Corporation) and its Consolidated Subsidiary
|---------------------------------------------------------------------
|                                                                     
|Notes to the Consolidated Financial Statements                       
|                                                                     
|                                                                     

|Note 10 |  | Taxes on Income (contd)
|------- | - | ------------------------

| | A. | Israel
Tax Reform (contd)
| | -- | --------------------------

| | 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 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. | The
seven year limit for carrying forward of capital losses has been removed           with
respect to capital losses arising from 1996 and thereafter.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------

| | B. | Tax
benefits under the Law for the Encouragement of Capital Investments, 1959
          (hereinafterthe 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 the first investment program was
tax-exempt until 1997.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | b. | The
Companys program for expansion of its approved enterprise in Yokneam
               was approved in September 1995. As the Company has elected to apply the
               alternative benefits method for this program, the company is entitled to a
tax                exemption with respect to the additional income derived from that
expansion for                ten years. In June 1995 the Israeli tax authorities and the
Company have agreed                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 expansion of the manufacturing plant will                benefit from a ten-year
tax exemption, commenced in 1997 to be expired in 2006,                while income
allocated to the research and development center will benefit from                a
two-year exemption and for a five-year period immediately following to be
               expired in 2004 will be taxed at a 25% rate.
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
final report as to the completion of investments under this program has been submitted to
the Investment Center. The final approval was received in October 2001.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 20

---

---



|Silicom Ltd. (An Israeli Corporation) and its Consolidated Subsidiary
|---------------------------------------------------------------------
|                                                                     
|Notes to the Consolidated Financial Statements                       
|                                                                     
|                                                                     

|Note 10 |  | Taxes on Income (contd)
|------- | - | ------------------------

| | B. | Tax
benefits under the Law for the Encouragement of Capital Investments, 1959
          (hereinafterthe Law) (contd)
| | -- | -----------------------------------------------------------------------------------------------------------------------

| | 1. | Rates
(contd)
| | -- | --------------

| | c. | In
the event of distribution by the Company of cash dividends out of retained
               earnings which were tax exempt due to the Approved Enterprise               status,
the Company would be subject to a 25% corporate tax on the amount
               distributed, and a further 15% withholding tax would be deducted from the
               amounts distributed to the recipients.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | d. | Should
the Company derive income from sources other than the Approved
               Enterprise during the relevant period of benefits, such income will
be                taxable at regular corporate tax rates  35% (in 2004).
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2. | Accelerated
depreciation
| | -- | ------------------------

| | The
Company is entitled to claim accelerated depreciation for a period of five years in
respect of property and equipment of an Approved Enterprise. The Company has
not utilized this benefit to date.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 3. | Conditions
for entitlement to the benefits
| | -- | ------------------------------------------

| | Entitlement
to the benefits of the Companys Approved Enterprise is 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 investment
in the Companys Approved Enterprise.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
the event of failure to comply with these conditions, the tax benefits may be canceled,
and the Company may be required to refund the amount of the cancelled benefits, with the
addition of linkage differences and interest. As of the date of these financial
statements, the Company believes it complies with these conditions.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | C. | Measurement
of results for tax purposes under the Income Tax Regulations           (Rules forMaintaining
Accounting Records of Foreign Invested Companies           and Certain Partnerships and Determining Their
Taxable Income)  1986
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
a foreign invested company (as defined in the Law for the Encouragement of
Capital Investments  1959), the Companys management has elected to apply
Income Tax Regulations (Rules for Maintaining Accounting Records of Foreign Invested
Companies and Certain Partnerships and Determining Their Taxable Income)  1986 from
January 1, 2002. Accordingly, its taxable income or loss is calculated in U.S. Dollars.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | D. | Tax
benefits under the Law for Encouragement of Industry (Taxes), 1969
| | -- | ----------------------------------------------------------------------

| | The
Company currently qualifies as an Industrial Company under the above Law. As
such it is entitled to certain tax benefits, mainly the right to deduct share issuance
costs for tax purposes in the event of a public offering, and to amortize know-how
acquired from third parties.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 21

---

---



|Silicom Ltd. (An Israeli Corporation) and its Consolidated Subsidiary
|---------------------------------------------------------------------
|                                                                     
|Notes to the Consolidated Financial Statements                       
|                                                                     
|                                                                     

|Note 10 |  | Taxes on Income
|------- | - | ---------------

| | E. | On
June 29, 2004, the Israeli Knesset passed Income Tax Ordinance (No. 140 and
Temporary Order), 2004 (hereinafter  the Amendment) The
amendment provides for gradual reduction of the tax rates for companies, from
the rate of 36% to the rate of 30%, in the following manner: in the 2004 tax
year the tax rate will be 35%, in the 2005 tax year the tax rate will be 34%,
in the 2006 tax year the tax rate will be 32%, and in the 2007 tax year and
thereafter the tax rate will be 30%.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
current taxes and the balances of the deferred taxes as at December 31, 2004 are
calculated in accordance with the new tax rates, as provided in the Amendment.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | F. | Tax
assessments of Silicom Ltd.
| | -- | -------------------------------

| | Silicom
received final tax assessments for all years up to and including the tax year ended
December 31, 2001.
| | --------------------------------------------------------------------------------------------------------------

| | Silicoms
carryforward tax losses are approximately $ 5,796 and $ 4,231 thousand as of December 31,
2004 and 2003, respectively.
| | --------------------------------------------------------------------------------------------------------------------------------

| | G. | Taxation
of the subsidiary
| | -- | --------------------------

| | At
December 31, 2004, the subsidiary had approximately $ 579 thousand net operating loss
carryforwards for U.S. federal income tax reporting purposes expiring $ 75 thousand in
2018, $ 265 thousand in 2021, $ 188 thousand in 2022 and $ 17 thousand in 2023 and $
34 thousand in 2024. At December 31, 2004, the subsidiary had approximately $ 451
thousand net operating loss carryforwards for New Jersey state income tax reporting
purposes expiring $ 263 thousand in 2010 and $ 188 thousand in 2011.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
subsidiary has not yet been assessed for tax purposes since incorporation (1993).
| | -------------------------------------------------------------------------------------

| | H. | Deferred
income taxes:
| | -- | ----------------------

| | 1. | Most
of Silicoms income is tax exempt due to the Approved           Enterprise status
granted to its production facilities. Silicom has           decided to permanently
reinvest the amount of the said tax-exempt income, and           not to distribute such
income as dividends.
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
amount of tax that would be           payable had such tax-exempt income been distributed
as dividends is           approximately $ 0 thousand at December 31, 2004 (December 31,
2003  $ 0           thousand).
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 22

---

---



|Silicom Ltd. (An Israeli Corporation) and its Consolidated Subsidiary
|---------------------------------------------------------------------
|                                                                     
|Notes to the Consolidated Financial Statements                       
|                                                                     
|                                                                     

|Note 10 |  | Taxes on Income (contd)
|------- | - | ------------------------

| | H. | Deferred
income taxes: (contd)
| | -- | -------------------------------

| | 2. | The
components of deferred tax assets and liabilities, assuming taxation at           maximum
rates, are as follows:
| | -- | --------------------------------------------------------------------------------------------------------------------

|                                        | December 31 | December 31
|--------------------------------------- | ----------- | -----------
|
|
|
|
|Employees' rights liabilities           |             |            
|Allowance for doubtful debts            |             |            
|Deferred research and development costs |             |            
|Loss for tax purposes                   |             |            
|                                        |             |            
|                                        |             |            
|Valuation allowance                     |             |            
|                                        |             |            
|                                        |             |            
|                                        |             |            
|Statutory tax rate                      |             |            
|                                        |             |            

| | The
Company has recognized a valuation allowance for its deferred tax assets for which it is
not more likely than not that they will be realized.
| | -------------------------------------------------------------------------------------------------------------------------------------------------

| | I. | Reconciliation
of the statutory tax expense to actual tax expense
| | -- | -----------------------------------------------------------------

| | A
reconciliation of the statutory tax expense, assuming all income is taxed at the statutory
rate of 35% for the year ended December 31, 2004 and 36% for the years ended December 31,
2003 and 2002 applicable to income of companies in Israel, and the actual tax expense, are
as follows:
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                                     | Year ended December 31
|---------------------------------------------------- | ----------------------
|
|
|
|
|Income (Loss) before taxes on income, as reported    |                       
|in the statements of income                          |                       
|                                                     |                       
|Tax rate                                             |                       
|Theoretical tax on the above amount                  |                       
|                                                     |                       
|Increase (decrease) in taxes resulting from          |                       
|permanent differences:                               |                       
|                                                     |                       
|Non-deductible operating expenses                    |                       
|Tax exempt income                                    |                       
|Valuation allowance                                  |                       
|Adjustments arising from changes in tax rates        |                       
|Adjustments arising from differences in the basis of |                       
|measurement for tax purposes and for financial       |                       
|reporting purposes and other                         |                       
|                                                     |                       
|Tax on income                                        |                       
|                                                     |                       

F - 23

---

---



|Silicom Ltd. (An Israeli Corporation) and its Consolidated Subsidiary
|---------------------------------------------------------------------
|                                                                     
|Notes to the Consolidated Financial Statements                       
|                                                                     
|                                                                     

|Note 11 |  | Supplementary Balance Sheet Information
|------- | - | ---------------------------------------

|   |  | December 31
|-- |  | -----------
|
|
|
|
|A. |  |            
|   |  |            
|   |  |            
|   |  |            
|   |  |            
|   |  |            
|   |  |            
|   |  |            
|   |  |            
|   |  |            
|   |  |            
|B. |  |            
|   |  |            
|   |  |            
|   |  |            
|   |  |            
|   |  |            
|   |  |            
|   |  |            
|   |  |            
|C. |  |            
|   |  |            
|   |  |            
|   |  |            
|   |  |            
|   |  |            
|   |  |            
|D. |  |            
|   |  |            
|   |  |            
|   |  |            
|   |  |            
|   |  |            
|   |  |            
|   |  |            

F - 24

---

---



|Silicom Ltd. (An Israeli Corporation) and its Consolidated Subsidiary
|---------------------------------------------------------------------
|                                                                     
|Notes to the Consolidated Financial Statements                       
|                                                                     
|                                                                     

|Note 12 |  | Supplementary Income Statement Data
|------- | - | -----------------------------------

|   |  | Year ended December 31
|-- |  | ----------------------
|
|
|
|
|A. |  |                       
|   |  |                       
|   |  |                       
|   |  |                       
|   |  |                       
|   |  |                       
|   |  |                       
|   |  |                       
|   |  |                       
|   |  |                       
|   |  |                       
|*  |  |                       
|   |  |                       
|   |  |                       
|   |  |                       
|   |  |                       
|** |  |                       

|   |  | Year ended December 31
|-- |  | ----------------------
|
|
|
|
|B. |  |                       
|   |  |                       
|   |  |                       
|   |  |                       
|   |  |                       
|   |  |                       
|   |  |                       
|   |  |                       
|   |  |                       
|   |  |                       
|   |  |                       
|   |  |                       
|   |  |                       
|   |  |                       
|   |  |                       

F - 25

---

---



|Silicom Ltd. (An Israeli Corporation) and its Consolidated Subsidiary
|---------------------------------------------------------------------
|                                                                     
|Notes to the Consolidated Financial Statements                       
|                                                                     
|                                                                     

|Note 12 |  | Supplementary Income Statement Data (contd)
|------- | - | --------------------------------------------

|   |  | Year ended December 31
|-- |  | ----------------------
|
|
|
|
|C. |  |                       
|   |  |                       
|   |  |                       
|   |  |                       
|   |  |                       
|   |  |                       
|   |  |                       
|   |  |                       
|   |  |                       
|   |  |                       
|   |  |                       
|   |  |                       
|   |  |                       
|   |  |                       
|   |  |                       
|
|
|
|
|D. |  |                       
|   |  |                       
|   |  |                       
|   |  |                       
|   |  |                       
|   |  |                       
|   |  |                       
|   |  |                       
|   |  |                       
|   |  |                       
|   |  |                       
|   |  |                       
|
|
|
|
|E. |  |                       
|   |  |                       
|   |  |                       
|   |  |                       
|   |  |                       
|   |  |                       
|   |  |                       
|   |  |                       
|   |  |                       

F - 26

---

---



|Silicom Ltd. (An Israeli Corporation) and its Consolidated Subsidiary
|---------------------------------------------------------------------
|                                                                     
|Notes to the Consolidated Financial Statements                       
|                                                                     
|                                                                     

|Note 13 |  |  Related Party Balances and Transactions
|------- | - | -----------------------------------------

| | A. | Balances
with related parties:
| | -- | ------------------------------

|                   | December 31
|------------------ | -----------
|
|
|
|
|Trade receivables* |            
|                   |            

| | B. | Expenses
to (income from) related parties:
| | -- | ------------------------------------------

|                     | Year ended December 31
|-------------------- | ----------------------
|
|
|
|
|Sales*               |                       
|                     |                       
|Costs and expenses** |                       
|                     |                       

| | * | Most
of the transactions are sales to a related party, which is a distributor of the Companys
products in Israel. The terms of the transactions are not different from regular market
terms.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | ** | Mainly
participation in insurance, recruiting expenses and public relations expenses.
| | -- | -------------------------------------------------------------------------------------

|Note 14 |  | Financial Instruments and Risk Management
|------- | - | -----------------------------------------

| | A. | Concentrations
of credit risk
| | -- | -----------------------------

| | Financial
instruments, which potentially subject Silicom to significant concentrations of credit
risk, consist principally of cash and cash equivalents, short term and long-term
investments and trade receivables. Cash and cash equivalents balances of Silicom, which
are subject to credit risk, consist of cash accounts held with major financial
institutions. Short-term investments, which consist of debentures and commercial paper,
are invested at December 31, 2004 in several highly rated corporations. Concentrations of
credit risk with respect to trade receivables are limited due to the Companys
diverse customer base and their wide geographical dispersion. The Company closely monitors
extensions of credit and has never experienced significant credit losses.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 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. Components currently available from one
source include a proprietary LAN (Fast Ethernet and Ethernet) chipset, modem chipsets and
other components, including other semiconductor devices, transformers and plastic and
metal product housings. The Company believes that it maintains a sufficient inventory of
these components to protect against delays in deliveries. There can be no assurance that
it will not experience delays in the supply of critical components in the future or that
it will have a sufficient inventory of critical components at such time to produce
products at full capacity. 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.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 27

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|Silicom Ltd. (An Israeli Corporation) and its Consolidated Subsidiary
|---------------------------------------------------------------------
|                                                                     
|Notes to the Consolidated Financial Statements                       
|                                                                     
|                                                                     

|Note 14 |  | Financial Instruments and Risk Management (contd)
|------- | - | --------------------------------------------------

| | B. | Concentrations
of business risk (contd)
| | -- | ----------------------------------------

| | The
Companys OEMs, distributors and resellers are not within the Companys control.
They are not obligated to purchase products from the Company and may represent other lines
of products. A reduction in sales effort or discontinuance of sales of products by OEMs,
distributors and resellers could lead to reduced sales and could materially adversely
affect our operating results. Use of distributors and OEMs also entails the risk that
distributors or OEMs will build up inventories in anticipation of a growth. If such growth
does not occur as anticipated, these distributors or OEMs may substantially decrease the
amount of products ordered in subsequent quarters, discontinue product orders or even
attempt to return unsold products (although the Companys standard agreements do not
allow return of products). The distribution industry has been characterized by rapid
change, including consolidations and financial difficulties of distributors and the
emergence of alternative distribution channels. In addition, an increasing number of
companies are competing for access to these channels. The loss or ineffectiveness of any
of the major distributors or OEMs (see Note 12A) could have a material adverse effect on
the operating results. The Company believes that no termination of a single distributor is
likely to have a material adverse effect. However, the termination or loss of several
distributors at approximately the same time might have a temporary material adverse
effect.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Note 15 |  | Fair Value of Financial Instruments
|------- | - | -----------------------------------

| | The
Companys financial instruments consist of cash and cash equivalents, investment
securities, trade and other receivables, assets held for severance benefits and trade
accounts payable. The carrying amounts of these financial instruments, except for
investment securities, approximate fair value because of the short maturity of these
investments.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
fair value of investment securities is presented in Note 4 to these consolidated financial
statements.
| | ----------------------------------------------------------------------------------------------------------

|Note 16 |  | Recently Enacted Accounting Pronouncements
|------- | - | ------------------------------------------

| | a. | In
November 2004, the FASB issued FASB Statement No. 151, Inventory Costs, an
          amendment to ARB 43, Chapter 4 (SFAS 151). The amendment made by SFAS 151
          clarify that abnormal amounts of idle facility expense, freight, handling
costs,           and wasted material (spoilage) should be recognized as current-period
charges,           and also require the allocation of fixed production overhead to
inventory based           on the normal capacity of the production facilities. The
guidance is effective           for inventory costs incurred during fiscal years
beginning after June 15, 2005.           Earlier application is permitted for inventory
costs incurred during fiscal           years beginning after November 23, 2004. The
provision of SFAS 151 should be           applied prospectively.
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Adoption
of this statement is not expected to have a material impact on the Companys
financial statements.
| | -----------------------------------------------------------------------------------------------------------

F - 28

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|Silicom Ltd. (An Israeli Corporation) and its Consolidated Subsidiary
|---------------------------------------------------------------------
|                                                                     
|Notes to the Consolidated Financial Statements                       
|                                                                     
|                                                                     

|Note 16 |  | Recently Enacted Accounting Pronouncements (contd)
|------- | - | ---------------------------------------------------

| | b. | In
March 2004, the Emerging Issues Task Force (EITF) reached a
          consensus on Issue No. 03-01, The Meaning of Other-Than-Temporary
          Impairment and its Application to Certain Investments (EITF
          03-1). EITF 03-1 provides guidance on other-than-temporary impairment
          models for marketable debt and equity securities accounted for under SFAS No.
          115, Accounting for Certain Investments in Debt and Equity
          Securities (SFAS 115), and non-marketable equity securities
          accounted for under the cost method. The EITF developed a basic three-step
model           to evaluate whether an investment is other-than-temporarily impaired. On
          September 30, 2004, the FASB issued FSP 03-1-1, Effective Date of
          Paragraphs 10-20 of EITF Issue 03-1, The Meaning of Other-Than-Temporary
          Impairment and its Application to Certain Investments, delaying the
          effective date for the recognition and measurement guidance of EITF 03-1, as
          contained in paragraphs 10-20, until certain implementation issues are
addressed           and a final FSP providing implementation guidance is issued. The
disclosure           requirements of the consensus remain in effect.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company has adopted the disclosures requirements of EITF Issue 03-1 for investments
accounts accounted for under SFAS 115 in fiscal year ended December 31, 2004.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | c. | In
December 2004, the FASB issued SFAS No. 123 (Revision 2004),           Share-Based
Payment, (SFAS 123R), that addresses the accounting for           share-based
payment transactions in which employee services are received in           exchange for
either equity instruments of the Company, liabilities that are           based on the
fair value of the Companys equity instruments or that may be           settled by
the issuance of such equity instruments. SFAS 123R eliminates the           ability to
account for share-based compensation transactions using the intrinsic           value
method as prescribed in APB Opinion No. 25, Accounting for Stock           Issued
to Employees. Instead, SFAS 123R requires that such transactions be
          accounted for using a fair-value-based method and that compensation expense be
          recognized in the statement of operations rather than disclosing the pro forma
          impact of the stock based compensation as the Company currently discloses in
          Note 9. SFAS 123R provides two alternative adoption methods. The first
          method is a modified prospective transition method whereby a company would
          recognize share-based employee costs from the beginning of the fiscal period in
          which the recognition provisions are first applied as if the fair-value-based
          accounting method had been used to account for all employee awards granted,
          modified, or settled after the effective date and to any awards that were not
          fully vested as of the effective date. Measurement and attribution of
          compensation cost for awards that are unvested as of the effective date of SFAS
          123R would be based on the same estimate of the grant-date fair value and the
          same attribution method used previously under SFAS No. 123, Accounting
for           Stock-Based Compensation (SFAS 123). The second adoption
          method is a modified retrospective transition method whereby a company would
          recognize employee compensation cost for periods presented prior to the
adoption           of SFAS 123R in accordance with the original provisions of SFAS 123;
that is, an           entity would recognize employee compensation costs in the amounts
reported in           the pro forma disclosures provided in accordance with SFAS 123. A
company would           not be permitted to make any changes to those amounts upon
adoption of SFAS 123R           unless those changes represent a correction of an error.
The provisions of SFAS           123R are effective for annual periods beginning after
June 15, 2005. This           Standard will be effective for the Company as of January 1,
2006. The Company           expects the adoption of this Standard will reduce 2006 net
income by           approximately US$ 144 thousand. This estimate is based on the number
of options           currently outstanding and exercisable and could change based on the
number of           options granted or forfeited in fiscal 2005 and 2006.
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 29

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|Silicom Ltd. (An Israeli Corporation) and its Consolidated Subsidiary
|---------------------------------------------------------------------
|                                                                     
|Notes to the Consolidated Financial Statements                       
|                                                                     
|                                                                     

|Note 16 |  | Recently Enacted Accounting Pronouncements (contd)
|------- | - | ---------------------------------------------------

| | d. | In
December 2004, the FASB issued SFAS No. 153, Exchanges of Nonmonetary
          Assets  an amendment to APB No. 29. This Statement amends Opinion
          No. 29 to eliminate the exception for nonmonetary exchanges of similar
          productive assets and replaces it with a general exception for exchanges of
          nonmonetary assets that do not have commercial substance. A nonmonetary
exchange           has commercial substance if the future cash flows of the entity
expected to           change significantly as a result of the exchange. Adoption of this
statement is           not expected to have a material impact on the consolidated
financial statements           of the Company.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | e. | In
March 2005, the FASB issued Interpretation No. 47, Accounting for
          Conditional AssetRetirement Obligations, that requires an
          entity to recognize a liability for the fair value of a conditional asset
          retirement obligation when incurred if the liabilitys fair value can be
          reasonably estimated. This Interpretation is effective for fiscal years ending
          after December 15, 2005. Accordingly, the Company is required to adopt FIN 47
in           its fiscal year ended December 31, 2005. We do not expect adoption of FIN 47
to           have a material effect on our consolidated financial statements.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 30

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