**UNITED
      STATES**




**SECURITIES
      AND EXCHANGE COMMISSION**




**Washington,
      D.C. 20549**




**FORM
      20-F**




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




**OR**





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




**For
      the fiscal year ended**  December
      31, 200 5




**OR**




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


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






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


**Date
      of event requiring this shell company report _________**




**Commission
      file number 0-30324**




**RADWARE
      LTD.**


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




**Israel**


**(Jurisdiction
      of incorporation or organization)**




**22
      Raoul Wallenberg Street, Tel Aviv 69710, Israel**


**(Address
      of principal executive offices)**




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


**Title
      of each class**  **** **** **Name
      of each exchange on which registered**


**None**     **None**




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


**Ordinary
      Shares, NIS 0.1 par value per share**


**(Title
      of Class)**




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


**None**


**(Title
      of Class)**




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


**19,061,760
      Ordinary Shares, NIS 0.1 par value per share**




Indicate
      by check mark if the registrant is a well-known seasoned issuer, as defined
      in
      Rule 405 of the Securities act.


o Yes x No






If
      this
      report is an annual or transition report, indicate by check mark if the
      registrant is not required to file reports pursuant to Section 13 or 15(d)
      of the Securities Exchange Act of 1934. o Yes x No




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


x Yes o No







Indicate
      by check mark whether the registrant is a large accelerated filer, an
      accelerated filer, or a non-accelarated filer. See definition of “accelerated
      filer and large accelerated filer” in Rule 12b-2 of the Exchange
      Act.




Large
      Accelerated Filer o Accelerated Filer x Non-Accelerated Filer o





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


o Item 17 x Item
      18





If
      this
      is an annual report, indicate by check mark whether the registrant is a shell
      company (as defined in Rule 12b-2 of the Exchange Act). o Yes x No


2


**INTRODUCTION**




As
      used
      in this annual report, the terms “we,” “us,” “our,” the “Company,” and “Radware”
mean Radware Ltd. and its subsidiaries, unless otherwise indicated. The
      references to "Companies Law" or the “Israeli Companies Law” are to the Israeli
      Companies Law, 5759-1999 (as amended).




**CAUTIONARY
      STATEMENT REGARDING**


**FORWARD-LOOKING
      STATEMENTS**




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




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




We
      have
      registered trademarks for “Web Server Director®,” “Cache Server Director®”,
“FireProof®”, “LinkProof®”, “Triangulation®”, “Smart Nat®”, “Get Certain®”,
“CertainT®”, “Peer Director®”,, “Synapps Architecture®”, “DefensePro®”,
“StringMatch Engine®” and “CID - Content Inspection Director®” and we have
      trademark applications pending for “UpLinkTM”, “RadwareTM”, “APSolute TM ”,
      “AppDirector”TM, “AppXCel”TM and “SecureFlow”TM.. All other trademarks and
      tradenames appearing in this annual report are owned by their respective
      holders.




1


**PART
                I**
            
            
            **4****ITEM
                1.**
            **Identity
              of Directors, Senior Management and Advisors**
            **4****ITEM
                2.**
            **Offer
              Statistics and Expected Timetable**
            **4****ITEM
                3.**
            **Key
              Information**
            **5****Selected
              Financial Data**
            **5****Risk
              Factors**
            **6****ITEM
                4.**
            **Information
              on the Company**
            **17****A.**
            **History
                and Development of the Company**
            **17****B.**
            **Business
                Overview**
            **17****C.**
            **Organizational
                Structure**
            **26****D.**
            **Property,
                Plants and Equipment**
            **27****ITEM
                4A.**
            **Unresolved Staff
              Comments**
            **27****ITEM
                5.**
            **Operating
              and Financial Review and Prospects**
            **28****ITEM
                6.**
            **Directors,
              Senior Management and Employees**
            **39****A.**
            **Directors
                and Senior Management**
            **39****B.**
            **Compensation**
            **41****C.**
            **Board
                Practices**
            **42****D.**
            **Employees**
            **47****E.**
            **Share
                Ownership**
            **48****ITEM
                7.**
            
            **Major
                Shareholders and Related Party Transactions**
            **50****A.**
            **Major
              Shareholders**
            **50****B.**
            **Related
                Party Transactions**
            **50****C.**
            **Interests
                of Experts and Counsel**
            **51****ITEM
                8.**
            **Financial
              Information**
            **52****A.**
            **Consolidated
                Statements and other Financial Information**
            **52****B.**
            **Significant
                Changes**
            **53****ITEM
                9.**
            **The
              Listing**
            **54****A.**
            **Listing
                Details**
            **54****B.**
            **Plan
                of Distribution**
            **56****C.**
            **Markets**
            **56**




2


**D.**
            **Selling
                Shareholders**
            **56****E.**
            **Dilution**
            **56****F.**
            **Expenses
                of the Issue**
            **56****ITEM
                10.**
            **Additional
              information**
            **57****A.**
            **Share
                Capital**
            **57****B.**
            **Memorandum
                and Articles of Association**
            **57****C.**
            **Material
                Contracts**
            **61****D.**
            **Exchange
                Controls**
            **62****E.**
            **Taxation**
            **62****F.**
            **Dividends
                and Paying Agents**
            **72****G.**
            **Statement
                by Experts**
            **72****H.**
            **Documents
                on Display**
            **72****I.**
            **Subsidiary
                Information**
            **73****ITEM
                11.**
            **Quantitative
              and Qualitative Disclosures about Market Risk**
            **74****ITEM
                12.**
            **Description
              of Securities other than Equity Securities**
            **74****PART
                II**
            
            
            **75****ITEM
                13.**
            **Defaults,
              Dividend Averages and Delinquencies**
            **75****ITEM
                14.**
            **Material
              Modifications to the Rights of Security Holders and Use of
              Proceeds**
            **75****ITEM
                15.**
            **Controls
              and Procedures**
            **75****ITEM
                16.**
            **Reserved**
            **75****PART
                III**
            
            
            **78****ITEM
                17.**
            **Financial
              Statements**
            **78****ITEM
                18.**
            **Financial
              Statements**
            **78****ITEM
                19.**
            **Exhibits**
            **78**







3


**PART
      I**






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




Not
      applicable.






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




Not
      applicable.




4




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




**Selected
      Financial Data**




The **** following **** tables present our
      consolidated statement of operations and balance sheet data for the periods
      and
      as of the dates indicated. We derived the statement of operations for the years
      ended December 31, 2003, 2004 and 2005 and the balance sheet data as at December
      31, 2004 and 2005 from our audited consolidated financial statements included
      elsewhere in this annual report, which
      have been prepared in accordance with generally accepted accounting principles
      in the United States (“U.S. GAAP”) .
      The selected
      consolidated **** statement
      of operations financial
      data for the
      years ended December 31, 2001 and 2002 and the balance sheet data for the years
      ended December 31, 2001, 2002 and 2003 are derived **** from **** our **** audited **** consolidated **** financial
      statements not **** included
      in this annual report, which have been prepared in accordance with U.S. GAAP. *You
      should read the following selected financial data together with the section
      of
      this annual report entitled “Operating and Financial Review and Prospects” and
      our consolidated financial statements together with the notes thereto included
      elsewhere in this annual report.* Please
      see notes 2R and 12B of the notes to our consolidated financial statements
      for
      an explanation regarding the computation of basic and diluted net earnings
      (loss) per ordinary share.




**Year
                ended**
            
            
            **Year
                ended**
            
            
            **Year
                ended**
            
            
            **Year
                ended**
            
            
            **Year
                ended****December
                31,**
            
            
            **December
                31,**
            
            
            **December
                31,**
            
            
            **December
                31,**
            
            
            **December
                31,****2001**
            
            
            **2002**
            
            
            **2003**
            
            
            **2004**
            
            
            **2005****(US
                $ in thousands, except per share data)****Statement
                of Operations Data:**Revenues
            
            $
            43,327
            
            $
            43,663
            
            $
            54,780
            
            $
            68,439
            
            $
            77,584Cost
                of revenues
            
            
            7,709
            
            
            7,946
            
            
            9,854
            
            
            12,184
            
            
            14,896Gross
                profit
            
            
            35,618
            
            
            35,717
            
            
            44,926
            
            
            56,255
            
            
            62,688Operating
                expenses:Research
                and development, net
            
            
            8,293
            
            
            7,809
            
            
            8,398
            
            
            10,342
            
            
            13,017Sales
                and Marketing
            
            
            29,986
            
            
            30,019
            
            
            29,753
            
            
            31,898
            
            
            40,002General
                and administrative
            
            
            4,543
            
            
            4,219
            
            
            4,120
            
            
            4,493
            
            
            5,244Total
                operating expenses
            
            
            42,822
            
            
            42,047
            
            
            42,271
            
            
            46,733
            
            
            58,263Operating
                profit (loss)
            
            
            (7,204
            )
            
            (6,330
            )
            
            2,655
            
            
            9,522
            
            
            4,425Financial
                income, net
            
            
            6,312
            
            
            4,240
            
            
            3,740
            
            
            4,565
            
            
            5,159Income
                (loss) before income taxes
            
            
            (892
            )
            
            (2,090
            )
            
            6,395
            
            
            14,087
            
            
            9,584Income
                taxes
            
            
            (389
            )
            
            -
            
            
            -
            
            
            (341
            )
            
            (240
            )Loss
                in respect of an investment in an affiliate
            
            
            (6,333
            )
            
            -
            
            
            -
            
            
            -
            
            
            -Minority
                interest in losses ( earnings) of a subsidiary
            
            
            37
            
            
            (23
            )
            
            (40
            )
            
            34
            
            
            -Net
                income (loss)
            
            $
            (7,577
            )
            $
            (2,113
            )
            $
            6,355
            
            $
            13,780
            
            $
            9,344Basic
                net earnings (losses) per share
            
            $
            (0.46
            )
            $
            (0.13
            )
            $
            0.37
            
            $
            0.77
            
            $
            0.50Diluted
                net earnings (losses) per share
            
            $
            (0.46
            )
            $
            (0.13
            )
            $
            0.34
            
            $
            0.70
            
            $
            0.47


5





**Year
                ended**
            
            
            **Year
                ended**
            
            
            **Year
                ended**
            
            
            **Year
                ended**
            
            
            **Year
                ended****December
                31,**
            
            
            **December
                31,**
            
            
            **December
                31,**
            
            
            **December
                31,**
            
            
            **December
                31,****2001**
            
            
            **2002**
            
            
            **2003**
            
            
            **2004**
            
            
            **2005****(in
                thousands)**Weighted
                average number of ordinary shares used in computing basic net earnings
                (loss) per share
            
            
            16,423
            
            
            16,655
            
            
            17,184
            
            
            17,995
            
            
            18,800Weighted
                average number of ordinary shares used in computing diluted net earnings
                (loss) per share
            
            
            16,423
            
            
            16,655
            
            
            18,666
            
            
            19,805
            
            
            20,072











**December
                31,****2001**
            
            **2002**
            
            **2003**
            
            **2004**
            
            **2005****(US
                $ in thousands)****Balance
                Sheet Data:**Cash
                and cash equivalents, short-term
              bank
                deposits and marketable
              securities
                and current maturities of
              long-term
                bank deposits
            
            $
            125,680
            
            $
            52,274
            
            $
            62,882
            
            $
            109,020
            
            $
            126,901Long-term
                bank deposits, structured note and marketable securities
            
            
            -
            
            
            73,027
            
            
            76,139
            
            
            48,021
            
            
            37,592Working
                capital
            
            
            124,911
            
            
            50,690
            
            
            60,477
            
            
            107,687
            
            
            124,005Total
                assets
            
            
            144,461
            
            
            142,998
            
            
            158,114
            
            
            183,241
            
            
            204,347Shareholders’
                equity
            
            
            128,938
            
            
            127,357
            
            
            140,246
            
            
            160,917
            
            
            177,426




**Risk
      Factors**




*Our
      business, operating results and financial condition could be seriously harmed
      due to any of the following risks. The trading price of our ordinary shares
      could decline due to any of these risks* .




**Risks
      Related to Our Business and Our Industry**




**We
      have incurred losses in the past, and may incur losses in the
      future**




While
      we
      were profitable in 2005, 2004 and 2003, we incurred losses in 2002 and 2001.
      We
      had net income of approximately $9.3 million in 2005, $13.8 million in 2004
      and
      $6.4 million in 2003. We incurred net losses of approximately $2.1 million
      in
      2002 and $7.6 million in 2001. We will need to generate increased revenues
      as
      well as manage our costs to maintain and increase profitability. We cannot
      assure you that we will be able to maintain and/or increase profitability.
      Our
      gross margin is currently approximately 81%. As a result, any decrease in sales
      may have a significant effect on our profitability.




Our
      revenues may not grow or continue at their current level. For example, the
      growth rate in 2004 compared to 2003 was approximately 25%, whereas the growth
      rate in 2005 compared to 2004 was approximately 13%. In addition, our operating
      expenses may increase. Our decision to increase operating expenses and the
      scope
      of such increase will depend upon several factors, including the market
      situation and the results that our past expenditures produce. We may make
      additional expenditures in anticipation of generating higher revenues, which
      we
      may not realize, if at all, until some time in the future. If our revenues
      do
      not increase as anticipated, or if our expenses increase at a greater pace
      than
      revenues, we may not be profitable or, if we are profitable, we may not be
      able
      to sustain or increase profitability on a quarterly or annual
      basis.




6


Our
      net
      profit for 2005 derives also from financial income in an amount of approximately
      $5.2 million. We cannot assure you that we will be able to generate financial
      income in the future or that such financial income will remain at the same
      level. For
      example, in December 2005 we acquired the business of V-Secure Technologies
      Inc., or V-Secure, for a total amount of $15 million, of which $9 million was
      paid in December 2005 and $6 million may be paid during the first half of 2006,
      subject to meeting a certain milestone. The amount spent on the acquisition,
      as
      well as any additional investments we make in the future, will reduce our level
      of cash and consequently reduce the amount of financial income derived in the
      future.




**Volatility
      of the market for our products, including deterioration of the economy
      worldwide, slow-down in expenditures by service providers,
      e-commerce** **** **businesses
      and other trends** **in** **our
      industry could** **have** **a
      material adverse effect on our results of operations.**




Our
      business is dependent on current and anticipated market demand for our products.
      Beginning in late 2000, market demand was
      negatively impacted by the general deterioration of the global economy and
      the
      economic uncertainties in the telecommunications market. These conditions,
      and
      the uncertainties surrounding the growth rates of economies worldwide, resulted
      in a curtailment of capital investment by companies in our target markets and
      caused our revenue growth to increase at a significantly slower pace during
      2001
      and 2002 relative to prior years. According to our estimates, in 2003, the
      market remained substantially flat and in 2004 and 2005 there was slight
      improvement in the market. Due to the past volatility of the market it is
      difficult to predict the conditions of our market going forward. In addition,
      we
      believe that market conditions could cause our customers and potential customers
      to be more conservative in planning their spending. If the global conditions
      deteriorate, and companies in our target markets continue to reduce capital
      expenditures, we may experience a reduction in sales, as well as downward
      pressure on the price of our products. In addition, if the market will be flat
      and customers experience low visibility we may not be able to increase our
      sales. Each of the above scenarios would have a material adverse effect on
      our
      business, operating results and financial condition.




**We
      may experience significant fluctuations in our quarterly financial performance
      because of the factors discussed below and seasonal fluctuations in our sales.**




Our
      quarterly operating results have varied significantly in the past and may vary
      significantly in the future as a result of various factors, many of which are
      outside of our control. These factors include:




·
            Our
                limited order backlog;




·
            Our
                dependence upon our suppliers;




·
            Our
                need to develop and introduce new and enhanced products; and




·
            The
                long sales cycles of our products.




As
      a
      result of the foregoing our results in any quarter may also fall below projected
      results.




In
      addition, our quarterly operating results have been, and are likely to continue
      to be, influenced by seasonal fluctuations in our sales. Because our sales
      have
      grown significantly since inception, these fluctuations may not be apparent
      from
      our historical financial statements. However, we believe that our sales and
      sales growth have been, and will continue to be, affected by the seasonal
      purchasing patterns of some of our customers. For example, we believe that
      our
      sales may be reduced from the levels which we might otherwise have been able
      to
      attain during the third quarter of 2006 because of the slowdown in business
      activities during the summer months in Europe, and that our sales during the
      fourth quarter of 2006 may be increased because some of our customers tend
      to
      make greater capital expenditures towards the end of their own fiscal years.
      Because of these anticipated fluctuations, our sales and operating results
      in
      any quarter may not be indicative of future performance and it **** may
      be
      difficult for investors to properly evaluate our prospects.




7


**If
      the market for Application Delivery solutions does not continue to develop,
      we
      will not be able to sell enough of our products to maintain profitability.**




The
      Application Delivery market in which we operate is rapidly evolving and we
      cannot assure you that it will continue to develop and grow or that our products
      and technology will keep
      pace
      with these changes .
      Market
      acceptance of Application Delivery solutions is not proven and may be inhibited
      by, among other factors, a lack of anticipated congestion and strain on existing
      network infrastructures and the availability of alternative solutions. If demand
      for Application Delivery solutions does not continue to grow, we may not be
      able
      to sell enough of our products to maintain and increase profitability.




**Competition
      in the market for Application Delivery solutions is intense. As a result, we
      may
      lose market share and we may be unable to maintain
      profitability.**




The
      Application Delivery market is highly competitive and we expect competition
      to
      intensify in the future. We may lose market share if we are unable to compete
      effectively with our competitors. Our principal competitors in the Application
      Delivery solutions market include: Cisco Systems, Inc., Nortel Networks Corp.,
      F5 Networks, Inc., Citrix Systems, Inc. and Juniper Networks Inc. In addition,
      we face competitors in the Application Security space, with respect to our
      Intrusion Prevention Systems (IPS). Such competitors include Internet Security
      Systems, Inc., Juniper Networks, Inc., 3Com Systems, Inc. and McAfee, Inc.
      We
      expect to continue to face additional competition as new participants enter
      the
      market. Larger companies with substantial resources, brand recognition and
      sales
      channels may form alliances with or acquire competing Application Delivery
      solutions and emerge as significant competitors. For example, Juniper Networks
      Inc. became a competitor in the application delivery market by acquiring Peribit
      Networks Inc. and Redline Networks Inc., and Citrix Systems Inc, became a
      competitor in the Application Delivery market by acquiring Netscaler Inc.
      Competition may result in lower prices or reduced demand for our products and
      a
      corresponding reduction in our ability to recover our costs, which may impair
      our ability to maintain and increase profitability. Furthermore, the dynamic
      market environment, which is demonstrated by the above acquisitions, poses
      a
      challenge in predicting market trends and expected growth.




**Some
      of our competitors have greater resources than us, which may limit our ability
      to effectively compete with them.**




Some
      of
      our competitors have greater financial, personnel and other resources than
      us,
      which may limit our ability to effectively compete with them. These competitors
      may be able to:




·
            respond
                more quickly to new or emerging technologies or changes in customer
                requirements;




·
            benefit
                from greater economies of scale;




·
            offer
                more aggressive pricing;




·
            devote
                greater resources to the promotion of their products;
                and/or




·
            bundle
                their products or incorporate an Application Delivery component into
                existing products in a manner that renders our products partially
                or fully
                obsolete.




**We
      must develop new products and enhancements to existing products to remain
      competitive. If we fail to develop new products and product enhancements on
      a
      timely basis, we may lose market share.**




The
      market for Application Delivery solutions is characterized by rapid
      technological change, frequent new product introductions, changes in customer
      requirements and evolving industry standards. Accordingly, our future success
      will depend to a substantial extent on our ability to:




·
            invest
                significantly in research and
                development;




·
            develop,
                introduce and support new products and enhancements on a timely basis;
                and




·
            gain
                and consecutively increase market acceptance of our
                products.




8


We
      are
      currently developing new products and enhancements to our existing products.
      We
      may not be able to successfully complete the development and market introduction
      of new products or product enhancements. If we fail to develop and deploy new
      products and product enhancements on a timely basis, or if we fail to gain
      market acceptance of our new products, our revenues will decline and we may
      lose
      market share to our competitors. For example, at the end of 2005 we introduced
      our next generation APSolute application delivery product family. This product
      launch includes a high end application switch with enhanced system software
      called APSolute OS, and introducing three new products, AppDirector, AppXcel
      and
      SecureFlow. During
      2005 we invested, and plan to continue to invest in 2006, in creating and
      increasing market acceptance of our APSolute product family. There is no
      assurance that we will be successful in marketing and selling our next
      generation application delivery solution and growing revenues to justify our
      investments.




**We
      have a very limited order backlog. If revenue levels for any quarter fall below
      our expectations, our earnings will decrease.**




We
      have a
      very limited order backlog, which makes revenues in any quarter dependent on
      orders received and delivered in that quarter. A delay in the recognition of
      revenue, even from one customer, may have a significant negative impact on
      our
      results of operations for a given period. We base our decisions regarding our
      operating expenses on anticipated revenue trends, and our expense levels are
      relatively fixed, or require some time for adjustment. Because only a small
      portion of our expenses varies with our revenues, if revenue levels fall below
      our expectations, our earnings will decrease.




**We
      depend upon independent distributors to sell our products to customers. If
      our
      distributors do not succeed in selling our products, our revenues will
      suffer.**




We
      sell
      our products primarily to independent distributors, including value added
      resellers, original equipment manufacturers and systems integrators. These
      distributors resell our products to the ultimate customers. We currently have
      over 200 active independent distributors and resellers that sell our products.
      We are highly dependent upon our distributors’ active marketing and sales
      efforts. Our distribution agreements generally are non-exclusive, one-year
      agreements with no obligation on the part of our distributors to renew the
      agreements. Typically, our distribution agreements do not prevent our
      distributors from selling products of other companies, including products that
      may compete with our products, and do not contain minimum sales or marketing
      performance requirements. As a result, our distributors may give higher priority
      to products of other companies or to their own products, thus reducing or
      discontinuing their efforts to sell our products. We may not be able to maintain
      our existing distribution relationships. If our distributors terminate their
      relationships with us, we may not be successful in replacing them. In addition,
      we may need to develop new distribution channels for new products and we may
      not
      succeed in doing so. Any changes in our distribution channels, or our inability
      to establish distribution channels for new products, will impair our ability
      to
      sell our products and result in the loss of revenues.




**Our
      products generally have long sales cycles, which increases our costs in
      obtaining orders and reduces the predictability of our
      earnings.**




Our
      products are technologically complex and are typically intended for use in
      applications that may be critical to the business of our customers. As a result,
      our sales process is often subject to delays associated with lengthy approval
      processes that typically accompany the design and testing of new equipment.
      The
      sales cycles of our products to new customers can last as long as twelve months
      from initial presentation to sale. This delays the time in which we recognize
      revenue, and results in our having to invest significant resources in marketing
      and sales.




Long
      sales cycles also subject us to risks not usually encountered in a short sales
      cycle, including our customers’ budgetary constraints, internal acceptance
      reviews and cancellation. In addition, orders expected in one quarter could
      shift to another because of the timing of our customers’ procurement decisions.
      Furthermore, customers may defer orders in anticipation of new products or
      product enhancements introduced by us or by our competitors. These factors
      complicate our planning processes and reduce the predictability of our
      earnings.




**We
      must manage our anticipated growth effectively in order to maintain
      profitability.**




We
      have
      actively expanded our operations in the past and may continue to expand them
      in
      the future in order to gain market share in the evolving market for Application
      Delivery solutions. This expansion has required, and may continue to require,
      managerial, operational and financial resources.




9


We
      cannot
      assure you that we will continue to expand, or that we will be able to offer
      and
      expand our operations successfully. If we are unable to manage our expanding
      operations effectively, our revenues may not increase, our cost of operations
      may rise and we may not be profitable.




As
      we
      grow we may need new or enhanced systems, procedures or controls. For example,
      we are in the process of purchasing and migrating to a new ERP system. The
      purchase, migration and implementation of such a system can take up to 24
      months. The transition to such systems, procedures or controls, as well as
      any
      delay in transitioning to new or enhanced systems, procedures or controls,
      may
      seriously harm our ability to accurately forecast sales demand, manage our
      product inventory and record and report financial and management information
      on
      a timely and accurate basis.




**Our
      efforts to increase our presence in additional markets may not be
      profitable.**




We
      currently offer our products in over 40 countries in addition to North America.
      In fiscal years 2004 and 2005, our sales outside the Americas represented
      approximately 58% and 59%, respectively, of our total sales. Our ability to
      penetrate new markets is subject to risks inherent to these markets. The risks
      may impair our ability to generate profits from our increased sales efforts
      outside North America. In addition, any future political or economic instability
      in these or other foreign countries could significantly reduce demand for our
      products.




**Our
      success depends on our ability to attract, train and retain highly qualified
      sales, technical and customer support personnel.**




As
      we
      grow, we may need to increase our research and development, sales and marketing,
      and support staff. Our products require a sophisticated marketing and sales
      effort targeted at several levels within a prospective customer’s organization.
      The integration of these solutions into existing networks and ongoing support
      can be complex. Accordingly, we need highly-trained sales, marketing and
      customer support personnel. Competition for qualified sales personnel, as well
      as technical and customer support personnel is intense, and we may not be able
      to hire sufficient personnel to support our research and development and sales
      and marketing efforts. Our success depends upon our ability to attract, train
      and retain highly qualified personnel.




**We
      are dependent on Roy Zisapel, our Chief Executive Officer and President, the
      loss of whom would negatively affect our business.**




Our
      future success depends in large part on the continued services of our senior
      management and key personnel. In particular, we are highly dependent on the
      services of Roy Zisapel, our Chief Executive Officer and President. Although
      we
      have employment contracts with our senior management and key personnel, we
      do
      not carry life insurance on our senior management or key personnel. Any loss
      of
      the services of Roy Zisapel, other members of senior management or other key
      personnel could negatively affect our business.




**Undetected
      hardware and software errors may increase our costs and impair the market
      acceptance of our products.**




Our
      products have occasionally contained, and may in the future contain, undetected
      errors, especially when first introduced or when new versions are released,
      either due to errors we fail to detect or errors in components supplied by
      third
      parties. These errors tend to be found from time to time in new or enhanced
      products after the commencement of commercial shipments. Our customers integrate
      our products into their networks with products from other vendors. As a result,
      when problems occur in a network, it may be difficult to identify the product
      that has caused the problem. Regardless of the source of these errors, we will
      need to divert the attention of our engineering personnel from our product
      development efforts to address the detection and correction of these errors.
      In
      the past, we have not incurred significant warranty or repair costs, nor have
      we
      been subject to liability claims for damages related to product errors or
      experienced any material lags or delays as a result of these errors. However,
      we
      cannot assure you that we will not incur these costs or liabilities or
      experience these lags or delays in the future. Any insurance policies that
      we
      may have may not provide sufficient protection should a claim be asserted.
      Moreover, the occurrence of errors, whether caused by our products or the
      products of another vendor, may result in significant customer relations
      problems and injure our reputation, thus impairing the market acceptance of
      our
      products.




10


**We
      rely on third party manufacturing vendors to provide key components of our
      products. If USR Technologies and Electronics (2003) Ltd., or USR, is not able
      to provide us with adequate supplies of the principal component used in our
      products, we may not be able to deliver sufficient quantities of our products
      to
      satisfy demand, or may have a delay in fulfilling orders.**




We
      rely
      on USR to supply us with circuit boards. These circuit boards are a principal
      component, which we use in the manufacture of our products. If we are unable
      to
      acquire circuit boards from USR on acceptable terms, or should USR cease to
      supply us with circuit boards for any reason, we may not be able to identify
      and
      integrate an alternative source of supply in a timely fashion or at the same
      costs. Any transition to one or more alternate suppliers would likely result
      in
      delays, operational problems and increased costs, and may limit our ability
      to
      deliver our products to our customers on time for such transition period. There
      is no assurance, that we will be able to obtain an additional supplier or that
      we will be able to get components from an additional supplier in prices that
      are
      competitive to USR prices. We
      are
      currently negotiating an agreement with an additional supplier, however, for
      supply of a limited number of product platforms.




**A
      shortage of components or manufacturing capacity could cause a delay in our
      ability to fulfill orders or increase our manufacturing
      costs**




Our
      growth and ability to meet customer demands depend in part on our ability to
      obtain timely deliveries of parts from our suppliers and contract manufacturers.
      We may experience a shortage of certain component parts as a result of our
      own
      manufacturing issues, manufacturing issues at our suppliers or contract
      manufacturers, capacity problems experienced by our suppliers or contract
      manufacturers, or strong demand in the industry for those parts, especially
      if
      the economy grows. Growth in the economy is likely to create greater pressures
      on us and our suppliers to accurately project overall component demand and
      component demands within specific product categories and to establish optimal
      component levels. If shortages or delays persist, the price of these components
      may increase, or the components may not be available at all, and we may also
      encounter shortages if we do not accurately anticipate our needs. We may not
      be
      able to secure enough components at reasonable prices or of acceptable quality
      to build new products in a timely manner in the quantities or configurations
      needed. Accordingly, our revenues and gross margins could suffer until other
      sources can be developed. Our operating results would also be adversely affected
      if, anticipating greater demand than actually develops, we commit to the
      purchase of more components than we need. There can be no assurance that we
      will
      not encounter these problems in the future. Although in many cases we use
      standard parts and components for our products, certain components are presently
      available only from a single source or limited sources. We may not be able
      to
      diversify sources in a timely manner, which could harm our ability to deliver
      products to customers and seriously impact present and future
      sales..




**Our
      products may not meet the** **new
      European governmental regulations, including environmental**  **standards** , **required for their sale, which may negatively affect our sales.**




Our
      activities in Europe require that we comply with European Union Directives
      with
      respect to product
      quality assurance standards and environmental standards. Directive
      2002/95/EC on Restriction Of the Use of Certain Hazardous Substances in
      Electrical and Electronic Equipment (known as the “RoHs” Directive), requires
      products sold in Europe to meet certain design specifications, which exclude
      the
      use of hazardous substances, will
      take effect on July 1, 2006 and **** requires
      that certain of our products be modified to meet this regulation. Directive
      2002/96/EC on Waste Electrical and Electronic Equipment (known as the “WEEE”
Directive) requires produces of electrical and electronic equipment to register
      in different European countries and provide collection and recycling facilities
      for used products. If
      we
      fail to achieve compliance, we may be
      restricted from selling our products in the European Union and this could
      adversely affect our
      results of operations.





**Following
      the Implementation of SFAS No. 123R, we are required to record a compensation
      expense in connection with share based compensation, and, as a result, our
      profitability will be reduced significantly.**




On
      December 16, 2004, the Financial Accounting Standards Board (FASB) issued
      Statement No. 123 (revised 2004), Share-Based Payment ("SFAS No. 123(R) "),
      which is a revision of SFAS No. 123.




11


Generally,
      the approach in SFAS 123(R) is similar to the approach described in Statement
      123. However, SFAS No. 123 permitted, but did not require, share-based payments
      to employees to be recognized based on their fair values while SFAS No. 123(R)
      requires, as of the first quarter of 2006, all share-based payments to employees
      to be recognized as a compensation expense based on their fair values. SFAS
      No.
      123(R) also revises, clarifies and expands guidance in several areas, including
      measuring fair value, classifying an award as equity or as a liability and
      attributing compensation cost to reporting periods. The impact of the adoption
      of SFAS No. 123(R) cannot be predicted at this time because it will depend
      also
      on levels of share-based compensation granted in the future. Had we adopted
      this
      standard in prior period, however, we would have recorded a material amount
      as
      compensation expense, which would have a material adverse effect on our
      profitability. The adoption of this standard could materially adversely affect
      our profitability in the future. In addition, if as a result of SFAS No. 123(R)
      we would stop or limit the use of stock options as an incentive and retention
      tool, it could have a negative effect on our ability to recruit and retain
      employees.




**Our
      profitability could suffer if third parties infringe upon our proprietary
      technology.**




Our
      profitability could suffer if third parties infringe upon our intellectual
      property rights or misappropriate our technologies and trademarks for their
      own
      businesses. Our success depends upon the protection of our proprietary software
      installed in our products, our trade secrets and our trademarks. To protect
      our
      rights to our intellectual property, we rely on a combination of trademark
      and
      patent law, trade secret protection, confidentiality agreements and other
      contractual arrangements with our employees, affiliates, distributors and
      others. In the United States, we have registered trademarks for “Web Server
      Director®,” “Cache Server Director®”, “FireProof®”, “LinkProof®”,
“Triangulation®”, “Smart Nat®”, “Get Certain®”, “CertainT®”, “Peer Director®”,
“Synapps Architecture®”, “DefencePro®”, StringMatch Engine®” and “CID - Content
      Inspection Director®”. We also have trademark applications pending for
“UpLinkTM”, “RadwareTM”, “APSolute TM ”,
      “AppDirector”TM, “AppXCell”TM and “SecureFlow”TM. In addition, we have registered
      patents in the United States for our triangle redirection method used for the
      global load balancing, for our mechanism for efficient management and
      optimization of multiple links used in our LinkProof product, for our method
      for
      load balancing by global proximity used in our WSD product and for our method
      for controlling traffic on links between autonomous BGP systems. We also have
      pending patent applications and provisional patents in connection with several
      features used in our products. The protective steps we have taken may be
      inadequate to deter misappropriation of our proprietary information. We may
      be
      unable to detect the unauthorized use of our proprietary technology or take
      appropriate steps to enforce our intellectual property rights. Effective
      trademark, patent and trade secret protection may not be available in every
      country in which we offer, or intend to offer, our products. Failure to
      adequately protect our intellectual property could devalue our proprietary
      content and impair our ability to compete effectively. Furthermore, defending
      our intellectual property rights could result in the expenditure of significant
      financial and managerial resources. For example, on July 16, 2004 we filed
      a
      lawsuit in the District Court of New Jersey against F5 Networks, Inc. for
      infringement of our patent directed at a method for load balancing by global
      proximity. The lawsuit was settled on March 10, 2005. Although the lawsuit
      did
      not result in a significant expenditure we spent time and resources litigating
      and settling the claim.




**Our
      products may infringe on the intellectual property rights of
      others.**




Third
      parties may assert against us infringement claims or claims that we have
      violated a patent or infringed a copyright, trademark or other proprietary
      right
      belonging to them. As a result we may incur costs defending ourselves or
      settling lawsuits even if we believe we do not infringe third parties
      rights. For
      example, on March 19, 2003, F5
      Networks, Inc. filed a lawsuit against us for patent infringement in U.S.
      District Court for the Western District of Washington. We settled the claim
      in
      September 2004 and licensed the F5 patent in suit. Although the settlement
      and
      license did not have a material affect on our financial results, we spent time
      and resources on defending and settling the claim.




12


**Our
      non-competition agreements with our employees may not be enforceable in certain
      jurisdictions. If any of these employees leaves our company and joins a
      competitor, our competitor could benefit from the expertise our former employee
      gained while working for us.**




We
      currently have non-competition agreements with all of our employees. These
      agreements prohibit our employees, in the event they cease to work for us,
      from
      directly competing with us or working for our competitors for a limited period
      after termination of employment. The laws of the U.S., Israel and other
      countries in which we have employees, may limit or prohibit our ability to
      enforce these non-competition agreements, or may allow us to enforce them only
      to a limited extent. In the event that we are unable to enforce any of these
      agreements, competitors that employ our former employees could benefit from
      the
      expertise our former employees gained while working for us.




**Some
      of our deposits and other investments may be in excess of insured limits and
      are
      not insured in other jurisdictions.**




The
      majority of our cash and cash equivalents, and short-term and long-term bank
      deposits are invested in banks in the United States and in the U.K. Some of
      these deposits may be in excess of insured limits and are not otherwise insured.
      If one or more of these financial institutions were to become insolvent, the
      loss of these investments would have a material adverse effect on our financial
      condition.




**Risks
      Related to the Market for Our Ordinary Shares**




**Two
      shareholders may exert significant influence in the election of our directors
      and over the outcome of matters requiring shareholder
      approval.**




As
      of
      April 24, 2006, Mr. Yehuda Zisapel, Chairman of our board of directors,
      beneficially owns an aggregate of 2,577,477 ordinary shares, representing
      approximately 13.27% of the ordinary shares outstanding as of April 24, 2006
      and
      options to purchase 60,000 ordinary shares, of which 20,000 are vested. Roy
      Zisapel, Mr. Yehuda Zisapel’s son, is our Chief Executive Officer, President and
      a director. Roy Zisapel owns 457,584 ordinary shares and options to purchase
      800,000 ordinary shares, of which 700,000 are fully vested as of April 24,
      2006. **** In
      addition, Mr. Yehuda Zisapel has the right to vote the ordinary shares issuable
      upon exercise of options while held by the trustee under our share option plan.
      As a result, these shareholders may exert significant influence in the outcome
      of various actions that require shareholder approval, such as the election
      of
      our directors, approve or reject a merger and similar corporate transactions.




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




Generally,
      if for any taxable year 75% or more of our gross income is passive income,
      or at
      least 50% of our assets are held for the production of, or produce, passive
      income, we would be characterized as a passive foreign investment company,
      or
      PFIC, for U.S. federal income tax purposes. This characterization could result
      in adverse U.S. tax consequences to our U.S. shareholders, including having
      gain
      realized on the sale of our ordinary shares treated as ordinary income, as
      opposed to capital gain income, and having potentially punitive interest charges
      apply to such sales proceeds. U.S. shareholders should consult with their own
      U.S. tax advisors with respect to the U.S. tax consequences of investing in
      our
      ordinary shares.




We
      believe we were not a PFIC for our 2005 tax year.  It
      is
      possible that the Internal Revenue Service will attempt to treat us as a PFIC
      for 2005 or prior years. The tests for determining PFIC status are applied
      annually and it is difficult to make accurate predictions of future income
      and
      assets, which are relevant to this determination. Accordingly, there can be
      no
      assurance that we will not become a PFIC in 2006 or in subsequent years. For
      a
      discussion of the rules relating to passive foreign investment companies and
      related tax consequences, please see the section of this annual report entitled
      “Taxation — United States Federal Income Tax Considerations.”




13







**Risks
      Related to Operations in Israel**




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




We
      are
      incorporated under Israeli law and our principal offices and manufacturing
      and
      research and development facilities are located in Israel. Accordingly, our
      operations and financial results could be adversely affected if political,
      economic and military events curtailed or interrupted trade between Israel
      and
      its present trading partners or if major hostilities involving Israel should
      occur in the Middle East.




Since
      the
      establishment of the State of Israel in 1948, a number of armed conflicts have
      taken place between Israel and its Arab neighbors. A state of hostility, varying
      in degree and intensity, has led to security and economic problems for Israel.
      Since October 2000, there has been a high level of violence between the
      Palestinians and Israel, which has strained Israel’s relationship with its Arab
      citizens, Arab countries and, to some extent, with other countries around the
      world. We do not believe that the political and security situation has had
      a
      material impact on our business to date, however, there is no assurance that
      this will always be the case in the future. We could be adversely affected
      by
      any major hostilities, including acts of terrorism or any other hostilities
      involving or threatening Israel, the interruption or curtailment of trade
      between Israel and its trading partners or a significant downturn in the
      economic or financial condition of Israel. Furthermore, several countries
      restrict business with Israel and Israeli companies, and additional countries
      or
      companies may restrict doing business with Israel and Israeli companies as
      the
      result of the aforementioned hostilities. No predictions can be made as to
      whether or when a final resolution of the area’s problems will be achieved or
      the nature thereof and to what extent the situation will impact Israel’s
      economic development or our operations.




**Some
      of our directors and officers as well as many of our Israeli employees are
      obligated to perform annual military reserve duty in Israel. We cannot assess
      the potential impact of these obligations on our business.**




Some
      of
      our directors, officers and employees are, unless exempt, obligated to perform
      annual military reserve duty, depending upon their age and prior position in
      the
      army. They may also be further subject to being called to active duty at any
      time under emergency circumstances. Directors, officers, and key employees
      falling within these requirements include Roy Zisapel, our Chief Executive
      Officer and President, Amir Peles, our Chief Technical Officer, and Assaf Ronen,
      our Vice President, Research and Development. Our operations could be disrupted
      by the absence, for a significant period, of one of more of these officers
      or
      other key employees due to military service, and any disruption in our
      operations would harm our business. The full impact on our workforce or business
      if some of our officers and employees will be called upon to perform military
      service, especially in times of national emergency, is difficult to predict.




**The
      rate of inflation in Israel and the change in the exchange rate between the
      New
      Israeli Shekel against the U.S. dollar and/or the U.S. dollar against the Euro
      is volatile, and may negatively impact our costs.**




Most
      of
      our revenues are denominated in U.S. dollars or are dollar-linked, but we incur
      a portion of our expenses, principally salaries and related personnel expenses,
      in other currencies mainly in Israel, in New Israeli Shekels (“NIS”) and in
      Europe, in Euros. In 2005, we sold in Euros in most European countries. In
      this
      respect, we are exposed to the following risks: the rate of inflation in Israel
      may exceed the rate of devaluation of the NIS in relation to the dollar, the
      timing of this devaluation may lag behind inflation in Israel, or the NIS may
      increase in value relative to the dollar. In such events, the dollar cost of
      our
      operations in Israel will increase and our dollar-measured results of operations
      will be adversely affected. In addition, if the Euro increases in value relative
      to the dollar and sales in Euros do not exceed expenses incurred in Euros,
      the
      dollar cost of our operations in Europe will increase and our operating profit
      will be adversely affected. If the Euro decreases in value relative to the
      dollar and sales in Euros exceed expenses incurred in Euros, our operating
      profit will be negatively affected as a result of a decrease in the dollar
      value
      of our sales. In 2005, the value of the dollar increased in relation to the
      NIS
      by 6.8%, the inflation rate in Israel was 2.4%, and the value of the dollar
      increased in relation to the Euro by 15.3%. As a result, during 2005, we had
      a
      decrease in expenses (as a result of the decrease in the Euro exchange rate),
      which was offset by the decrease we had in our sales due to the fact that our
      sales to the EU countries are also denominated in Euro. We cannot provide
      assurances that we will not be materially adversely affected by the rate of
      inflation in Israel or exchange rate fluctuations in the future.







14




**The
      tax benefits we may receive in connection with our approved enterprise program
      require us to satisfy prescribed conditions and may be terminated or reduced
      in
      the future. This would increase taxes and decrease our net
      profit**




The
      Investment Center has granted us an approval to establish an “Approved
      Enterprise” program at our Tel Aviv and Jerusalem facilities. An Approved
      Enterprise is eligible for tax benefits on taxable income derived from its
      Approved Enterprise programs. The benefits available to an Approved Enterprise
      are dependent upon the fulfillment of conditions stipulated in applicable law
      and in the certificate of approval. If we fail to comply with these conditions,
      in whole or in part, with respect to any Approved Enterprise program we
      establish, or if we voluntarily decide to cease the Approved Enterprise program,
      we may be required to pay additional taxes for the period in which we benefited
      from the tax exemption or reduced tax rates and we would likely be denied these
      benefits in the future. One criterion for establishing the level of tax benefits
      is the percentage of holdings by foreign (i.e. non-Israeli) investors in our
      shares. A decrease in the level of foreign investors’ holdings may increase our
      tax rate.





A
      recent
      amendment to the Investment Law, which was published on April 1, 2005 (the
      “Amendment") has changed certain provisions of the Investment Law. As a result
      of the Amendment, the Company is no longer obliged to obtain an Approved
      Enterprise status in order to receive the tax benefits previously available
      under the Alternative Benefits provisions, and therefore there is no need to
      apply to the Investment Center for this purpose (Approved Enterprise status
      remains mandatory for companies seeking grants). Rather, the 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 out by
      the
      Amendment. The Company is also granted a right to approach the Israeli Tax
      Authority for a pre-ruling regarding their eligibility for benefits under the
      Amendment. Tax benefits are available under the Amendment to production
      facilities (or other eligible facilities), which are generally required to
      derive more than 25% of their business income from export (referred to as a
      “Benefited Enterprise” under the Amendment). 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 Law. Such
      investment may be made over a period of no more than three years ending at
      the
      end of the year in which the Company requested to have the tax benefits apply
      to
      the Benefited Enterprise (the "Year of Election"). Where the Company requests
      to
      have the tax benefits apply to an expansion of existing facilities, then 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 this case, the minimum investment required in order to
      qualify as a Benefited Enterprise is required to exceed a certain percentage
      of
      the Company’s production assets before the expansion.




Our
      approved program and tax benefits thereunder may not continue in the future
      at
      their current levels or at any level. The termination or reduction of these
      tax
      benefits would likely increase our taxes. The amount, if any, by which our
      taxes
      would increase will depend upon the rate of any tax increase, the amount of
      any
      tax benefit reduction, and the amount of any taxable income that we may earn
      in
      the future.




**We
      may be required to pay stamp duty on agreements executed by us after June 1,
      2003 and prior to January 1, 2006. This would increase our
      taxes.**




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




15


Under
      an
      order published in December 2005, the requirement to pay stamp duty was
      terminated with respect to documents signed on or after January 1,
      2006.





**Provisions
      of Israeli law could delay, prevent, or make difficult, a change of control,
      thereby depressing the price of our ordinary shares.**




The
      Israeli Companies Law generally provides that a merger be approved by both
      the
      board of directors of a company and a majority of the shares present and voting
      on the proposed merger. For purposes of the shareholder vote, unless a court
      rules otherwise, the merger will not be deemed approved if shares representing
      a
      majority of the voting power present at the shareholders meeting and which
      are
      not held by the other party to the merger (or by any person who holds 25% or
      more of the voting power or the right to appoint 25% or more of the directors
      of
      the other party or its general manager) voted against the merger. Upon the
      request of any creditor of a party to the proposed merger, a court may delay
      or
      prevent the merger if it concludes that there is a reasonable concern that,
      as a
      result of the merger, the surviving company will be unable to satisfy the
      obligations of the surviving company. In addition, a merger generally may not
      be
      completed unless at least (i) 50 days have passed since the filing of the merger
      proposal signed by each of the merging companies with the Israeli Registrar
      of
      Companies and (ii) 30 days have passed since the merger was approved by the
      shareholders of each of the parties to the merger. Also, in certain
      circumstances an acquisition of shares in a public company must be made by
      means
      of a tender offer. Lastly, Israeli tax law treats some acquisitions, such as
      stock-for-stock exchanges between an Israeli company and a foreign company,
      less
      favorable than U.S. tax laws. These provisions of Israeli corporate and tax
      law
      may have the effect of delaying, preventing or make more difficult an
      acquisition of or merger with us, which could depress our share price.




**It
      may be difficult to enforce a U.S. judgment against us and/or our officers
      and
      directors, or to assert U.S. securities laws claims in Israel.**




Service
      of process upon us, our Israeli subsidiaries and affiliates, and our directors
      and officers named herein substantially all of whom reside outside the United
      States, may be difficult to obtain within the United States. Furthermore,
      because the majority of our assets and investments, and substantially all of
      our
      directors and officers are located outside the United States, any judgment
      obtained in the United States against us or any of them may not be collectible
      within the United States.




There
      is
      doubt as to the enforceability of civil liabilities under the Securities Act
      and
      the Securities Exchange Act in original actions instituted in Israel. However,
      subject to specified time limitations, Israeli courts may enforce a U.S. final
      executory judgment in a civil matter, provided that:




·
            Adequate
                service of process has been effected and the defendant has had a
                reasonable opportunity to be heard;




·
            The
                judgment and its enforcement are not contrary to the law, public
                policy,
                security or sovereignty of the State of
                Israel;




·
            The
                judgment was obtained after due process before a court of competent
                jurisdiction according to the rules of private international law
                prevailing in Israel;




·
            The
                judgment was not obtained by fraudulent means and does not conflict
                with
                any other valid judgment in the same matter between the same
                parties;




·
            An
                action between the same parties in the same matter is not pending
                in any
                Israeli court at the time the lawsuit is instituted in the U.S. court;
                and




·
            The
                U.S. court is not prohibited from enforcing the judgments of Israeli
                courts.







16




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




**History
      and Development of the Company**




Radware
      Ltd. was organized in May 1996 as a corporation under the laws of the State
      of
      Israel, and commenced operations in April 1997. Our principal executive offices
      are located at 22 Raoul Wallenberg Street, Tel-Aviv 69710, Israel and our
      telephone number is 972-3-766-8666. Our website address is www.radware.com. *Information
      contained on our website does not constitute a part of this annual
      report.*




As
      of
      January 1, 1999, we established a wholly-owned subsidiary in the United States,
      Radware Inc., which conducts the sales and marketing of our products in the
      Americas and is our authorized representative and agent in the United States.
      The principal offices of Radware Inc. are located at 575 Corporate Dr., Lobby
      2,
      Mahwah, NJ 07430 and its telephone number is 201-512-9771.




We
      also
      have several wholly owned subsidiaries world-wide handling local support and
      promotion activities.




For
      a
      discussion of our capital expenditures and divestitures, see “Item 5—Operating
      and Financial Review and Prospects - Liquidity and Capital
      Resources.”




**Business
      Overview**




**General**




We
      develop, manufacture and market Application-smart networking solutions that
      provide end-to-end availability, performance and security of mission critical
      networked applications. Radware’s integrated Application Front-End, Application
      Security and Application Access solutions enable enterprises and carriers to
      deliver their mission critical applications successfully between data centers
      and remote locations, over all critical points in the network.




Our
      Application Delivery solutions enable customers to manage their network
      infrastructure, bypass systems failures, scale their application performance,
      and secure their Internet protocol (“IP”) traffic. Our products align network
      behavior with business process to improve productivity and extract the greatest
      value from investments in network infrastructures by intelligently distributing
      traffic within the network, optimizing the use of available network resources
      and protecting applications, networks and users at high speeds. Since our
      establishment, our products have won a number of awards for performance,
      including Network Computing Editor’s Choice, SC Magazine Recommended Buy Award,
      Network Computing Well-Connected, Internet World Best of Show, PC Magazine
      Editor’s Choice and Network Magazine Product of the Year. In addition, we have
      been recognized as industry leaders by independent, third party analysts such
      as
      Gartner, IDC and Yankee Group.




**Solution
      Architecture, Management and Products**




All
      Radware APSolute products are built around our family of intelligent ASIC and
      Network Processor based application switches, and incorporate our innovative
      new
      APSolute OS software platform. APSolute products ship with the full set of
      integrated APSolute OS availability, performance and security capabilities
      and
      users have the flexibility to choose the integrated functionality they want
      activated across the product family for custom-fit application delivery
      solutions. APSolute OS aligns network operations and resources with application
      needs for end-to-end fault tolerance and maximum availability, performance
      and
      security. Deployed enterprise wide, from the data center to branch offices,
      APSolute OS meets application demands across application infrastructure server
      farms, and connectivity and security layers of the network.





APSolute
      OS is a modular operating system built around Radware’s core software engines,
      the Application Classifier and Flow Manager, that are used to classify traffic
      based on an extensive and granular set of application intelligence. Users can
      define classes of traffic and policies for how network resources should handle
      that traffic based on any combination of network, application, content and
      user
      information. APSolute OS service modules (each as described below), which are
      available on our hardware products, include: Advanced Health Monitoring, Traffic
      Redirection and Load Balancing, Bandwidth Management, Content Acceleration,
      Compression, SSL Offloading, Intrusion Prevention and DoS Protection. With
      APSolute OS, enterprises and carriers can address existing and emergent
      application service requirements across server farms, security and connectivity
      layers.




17


**Advanced
      Health Monitoring**  provides
      accurate detection of application failures, controls operational components,
      immediately bypasses failures for non-stop operation, provides failure alerts,
      and takes automatic corrective action to deliver redundancy at all levels.
      By
      tracking traffic flows across the datacenter and distributed sites, and
      implementing multi-step decisions at every critical point across the transaction
      path, health monitoring ensures reliable application delivery. Advanced
      Health Monitoring enables the comprehensive monitoring of resources such as
      servers, firewalls, VPN gateways, IDS, anti- virus
      gateways, ISP links, cache and routers. The Health Monitoring module extends
      predefined health checks including: HTTP (Hypertext Transfer Protocol), HTTPS
      (Hypertext Transfer Protocol over Secure Socket Layer), FTP (File Transfer
      Protocol), RADIUS, RTSP (Real-Time Streaming Protocol), while enabling the
      configuration of customized checks by device, transaction path and
      content.





**Traffic
      Redirection and Load Balancing** intelligently distributes traffic across network devices, optimizing the
      utilization of site-wide resources to accelerate application performance. By
      providing maximum utilization and flexible traffic distribution across server
      farms and distributed sites, enterprises gain virtually unlimited scaling of
      applications, server operations and handling of increased user traffic for
      economical growth. Traffic
      redirection optimizes existing resources (locally and remotely), by dynamically
      distributing traffic across the various servers and sites using an extensive
      array of traffic redirection algorithms to dispatch traffic - including cyclic
      distribution, least users, least packets and least bytes. Using patented load
      balancing technology, Radware distributed traffic according to client/site
      network proximity and site availability, thus providing a global load balancing
      solution based on real end user performance. Applications are delivered to
      the
      users quickly, no matter where they are located. APSolute
      traffic redirection extracts granular application intelligence, classifies
      different types of traffic based on any one, or combination of, application,
      content, user, and network parameters, and aligns network behavior with business
      processes, by adapting network behavior to accommodate different types of
      traffic.





**Bandwidth
      Management**  provides
      control over bandwidth resource allocation, to prioritize all network traffic,
      and guarantee service levels for mission critical applications. This ensures
      that bandwidth required for mission critical applications is not being
      over-utilized by bandwidth intensive non-critical applications. Bandwidth
      management policies leverage the classification of traffic by users,
      applications, and content, for the configuration and prioritization of traffic
      to ensure that each class receives the level of service according to the defined
      policy. Based
      on
      business requirements, APSolute solutions utilize granular traffic shaping
      to
      ensure that critical business applications get higher priority than non-critical
      applications. With automatic application discovery for over 70 enterprise
      applications, administrators can limit/guarantee bandwidth on a per-user and
      per-session basis, and provide granular control to ensure quality of service.





**Content
      Acceleration** provides
      economical and transparent scaling of network and server resources with
      multi-layer acceleration methods, including content caching, TCP optimization,
      HTTP offloading, SSL offloading, and open-ended content and image compression.
      These acceleration capabilities reduce bandwidth overhead, congestion and
      network bottlenecks, and dramatically accelerate content delivery to
      end-users.





**End-to-end**  **Compression** reduces
      network latency, and lowers bandwidth costs. Providing open-ended compression
      eliminates the need for client-side devices or proprietary software for
      compression over the LAN, and across the WAN. Compression optimizes
      under-utilized bandwidth and controls bandwidth utilization by compressing
      web
      content (reducing the average page size by 50%), and optimizing images (reducing
      a file size by a factor of 10).





**SSL
      (Secure Socket Layer) Offloading** of
      server
      intensive SSL operations and persistent functions frees server CPU’s to handle a
      greater number of requests, thus reduces the need to buy additional hardware
      to
      support application processing requirements. Radware uses a dedicated high
      throughput, and specialized acceleration platform that enables 16,000 SSL
      transactions per second, and supports up to 150,000 concurrent connections.
      A
      FIPS (Federal Information Processing Standard) compliance card is used for
      storing security keys and certificates, greatly simplifying key and certificate
      management. Providing centralized management for all security keys and
      certificates eliminates the need to maintain keys and certificates on individual
      servers - saving costs and reducing complexity.





18


**Intrusion
      Prevention** automatically secures network resources from over 1,700 malicious attack
      signatures for Viruses,
      Worms, Trojans, Scanning software, Spyware, and Protocol anomalies.


By
      continuously monitoring all network traffic at Gigabit speeds, Intrusion
      Prevention detects and prevents attacks in real time, immediately blocks
      malicious traffic to safeguard enterprise operations from hacking. Suspect
      traffic is monitored and reported, enabling network administrators to take
      proactive measures against potential intruders. Radware's Security Update
      Service (SUS) provides the additional security of having immediate protection
      from any emerging application threat by
      issuing new attack signatures as they emerge. Unknown attacks are detected
      using
      protocol anomaly inspection. Looking for protocol anomalies enables the
      detection of abnormal packet fragmentation which, in most cases, indicates
      malicious activity.





**DoS
      Protection** identifies and blocks debilitating Denial of Service attacks, protecting the
      network from service failures and downtime. Coupling multi-gigabit throughput
      speeds with an advanced sampling algorithm, the DoS protection module detects
      abnormal service requests and stops DoS attacks before they undermine network
      operations for
      complete security and business continuity. Additionally, SYN Flood protection
      protects the network from both known and unknown SYN Flood attacks. This means
      that while attack mitigation is taking place, legitimate traffic flows normally
      and users are unaffected by the attack. APSolute also provides DHCP Flood
      protection to maintain uninterrupted network access.





At
      the
      end of 2005 we acquired the business of V-Secure, which included the acquisition
      of the technology, customers relationship, and goodwill. As a result of the
      acquisition, V-Secure’s key research and development employees were hired by us.
      Following this acquisition we integrated the V-Secure self-learning expert
      system algorithms for proactive zero-day protection into our integrated IPS
      and
      DoS security solutions. The first version of the integrated product was launched
      in February 2006. V-Secure adaptive technology is designed to provide customers
      with immediate protection from new and unknown security threats using advanced
      behavioral based IPS technology that protects against worms propagation and
      DoS
      attacks by identifying anomalous traffic patterns without human
      intervention.




***APSolute
      Insite***




The
      common application management tool which runs across all Radware products is
      APSolute Insite. APSolute
      Insite is a unified management tool with an intuitive GUI that provides
      end-to-end network visibility, control and policy management of all application
      switching devices .
      APSolute Insite’s unified administration allows users to control and monitor IP
      application performance across the enterprise. APSolute Insite is a service
      driven management tool that optimizes business performance and availability
      by
      providing a unified environment for the seamless management of all Radware
      devices. Features such as trend analysis and full views of statistics allow
      network administrators to proactively monitor, manage and tune network resources
      to optimize their mission critical enterprise services.







Based
      on
      an easy-to-use site map interface, APSolute Insite lets users draw their
      network, configure Radware Application-smart switching devices and set-up the
      APSolute OS Services (as described above) to address end-to-end IP application
      service requirements. APSolute Insite’s statistics module provides real-time and
      historical views of actual application performance levels for monitoring
      site-wide operations and simple pinpointing of vulnerabilities and failures,
      affording complete visibility and control over the performance of Web and
      Application Servers, security tools, cache servers, anti-virus tools and
      Internet links.




APSolute
      Insite provides real-time and historical views of all Radware Application
      Switching devices and APSolute OS services for complete visibility of site-wide
      IP application performance, facilitating trend analysis while extending
      comprehensive control of enterprise operations. The collected statistics enable
      administrators to identify network vulnerabilities and take proactive steps
      to
      mitigate service failures before they affect the site. APSolute Insite offers
      a
      comprehensive set of user defined statistics that provide performance and
      bandwidth consumption data per device, including bi-directional traffic,
      failures, bottlenecks, resource management and client information. Based on
      this
      information, network administrators can decide to add resource capacities,
      tune
      bandwidth policies or relocate devices to better manage actual traffic loads
      and
      IP application performance requirements.







19




**Application
      Switch Platforms**




All
      Radware products are powered by our Application Switch platforms. Radware
      purpose-built Application Switching hardware offers scalable and flexible
      throughput performance to meet the broad range of enterprise and carrier
      end-to-end application delivery requirements.




Radware's
      Application Switch 1 combines ASIC-based switching, CPU processing power and
      APSolute OS Services to deliver the performance and service breadth to address
      all IP application requirements across network layers 4-7. Designed to guarantee
      application availability, security and performance, Application Switch 1 bridges
      the gap between IT infrastructure and IP Applications for comprehensive control
      of all critical operations across the enterprise.





Application
      Switch 2 is powered by a multi-layered switching architecture designed to
      address the widest set of protocols and service requirements across network
      layers 4-7 while boosting IP application performance to Gigabit Speeds.
      Delivering accelerated processing speeds with the ability to optimize routing
      decisions based on specific applications, web requests and content, Application
      Switch 2 provides reliability, performance and security across IP applications,
      for complete control over enterprise operations.







Application
      Switch 3 is a 3-tier processing architecture designed to meet the high capacity
      processing requirements for the most intensive layer 4-7 switching operations.
      Dual network processors in the second tier of the Application Switch 3
      architecture, accelerate traffic redirection, load-balancing, quality of service
      control, real-time intrusion prevention and DoS mitigation for application
      security to multi-Gigabit speeds. The third-tier in the Application Switch
      3
      architecture is the powerful RISC processor that is responsible for managing
      and
      prioritizing all active application sessions.




In
      2005,
      we introduced our new high-end Application Switch 4 which provides superior
      performance and port density with 20 ports of Gigabit Ethernet.




The
      APSoluteTM product
      family consists of the following products, all of which are built around Radware
      application switch platforms and a common APSolute OS and APSolute Insite
      software architecture:




·
            *AppDirectorTM
                and Web Server Director®*provides
                full availability, redundancy, security and optimized operation of
                servers
                - in order to achieve high performing IP applications.




·
            The*LinkProof®
                Family: LinkProof®*manages
                Internet traffic for networks, commonly referred to as multi-homed
                networks, which access the Internet through multiple connections
                via
                several ISPs, to provide fault tolerant and cost effective Internet
                connectivity.*LinkProof®
                Branch*manages the operation of multiple links across all remote office
                links,
                allowing large, multi-branched enterprises to control and reduce
                the costs
                of their connectivity and VPN between headquarters and branch offices.
                The
                LinkProof Family delivers an end-to-end multi-homing solution from
                central
                headquarters to remote branch offices.




·
            *DefensePro*®
                Intrusion Prevention and Denial of Service Switch protects against
                worms,
                viruses, malicious intrusions and Denial of Service attacks at up
                to 3
                Gigabit speeds, preventing attacks in real-time for intrusion prevention
                and multi-layer application defense.




·
            *AppXcelTM
                and CertainT 100 ® Application Accelerator*performs
                web compression and HTTP multiplexing, and accelerates web applications
                for high performance content serving and Secure Sockets Layer (“SSL”)
                encryption and decryption, providing secure and effective SSL
                processing.




20


·
            *SecureFlowTM
                simplifies the management and optimizes performance of best of breed
                enterprise security tools to*enable
                transparent, selective integration of content inspection, anti-virus,
                VPN,
                IDS and firewalls into a unified switched architecture to eliminate
                the
                security/performance tradeoff




·
            *CID
                - Content Inspection Director*®
                managed service delivery platform for carriers that enables centralized
                and optimized IP value added service deployment. With Content Inspection
                Director carriers can extend high-performance security and media
                services
                to customers, customizing delivery, guaranteeing SLAs and generating
                a new
                source of revenues.




Our
      products are compatible with any system that uses the Internet protocol and
      can
      operate with various network structures, configurations and operating systems.
      Our products support a wide variety of IP-based applications, including web
      services, e-mail, voice, P2P, ERP, Customer Relationship Management tools,
      database and file transfers.




**Security
      Update Service**




Radware’s
      Security Update Service is an optional subscription service that delivers
      immediate and ongoing security updates, to protect customers against the latest
      security threats. The Security Update Service, available as a subscription
      service, is comprised of the following services: A Security Operations Center,
      Emergency Filters, Weekly Security Updates and Custom Filters, which are sent
      to
      the service subscribers.




**Customers
      and End Users**




With
      the
      exception of our limited direct sales efforts to select customers, we sell
      our
      products through distributors or resellers who then sell our products to end
      users.




We
      have a
      globally diversified end-user base, consisting of corporate enterprises
      including banks, insurance companies, manufacturing and retail, government
      agencies, media companies and service providers, such as telecommunication
      carriers, Internet service providers and application service providers.
      Customers in these different vertical markets deploy Radware for availability,
      performance and security of their applications from headquarters to branch
      offices.




In
      2005,
      approximately 41% of our sales were in the Americas (principally in the United
      States), 31% were in EMEA (Europe, Middle East and Africa) and 28% in
      Asia-Pacific. Other than the United States, no single country accounted for
      more
      than 10% of our sales for 2005. ****




For
      the
      years ended December 31, 2005, 2004 and 2003, one single customer (a
      distributor) accounted for 16%, 11% and 11% of our sales, respectively. As
      of
      December 31, 2005 one single customer (a distributor) represented 16% of the
      trade receivables balance. As of December 31, 2004, no single customer
      represented more than 10% of the trade receivables balance.




**Sales
      and Marketing**




*Sales.* We
      market
      and sell our products primarily through an indirect sales channel that consists
      primarily of distributors located in North America, Europe and Asia. In
      addition, we generate direct sales to select customers. Our sales channels
      are
      supported by our sales managers who are also responsible for recruiting
      potential distributors and resellers and for initiating and managing marketing
      projects in their assigned regions. The sales managers are supported by our
      internal sales support staff who help generate and qualify leads for the sales
      managers. As of December 31, 2005, we employed a total of 51 sales managers
      and
      sales staff in the Americas with locations in various states. We also employed
      62 sales managers and sales staff based in the rest of the world, who are
      responsible for developing and maintaining distribution channels outside the
      Americas. We have subsidiaries and representative offices and branches in
      several countries, which promote and market our products and provide customer
      support in their respective regions.




*Marketing
      Strategy.* Our
      marketing strategy is to enhance brand recognition and maintain our reputation
      as a provider of technologically advanced, quality Application-smart solutions.
      We seek to build upon our marketing and branding efforts globally to achieve
      greater worldwide sales. Our sales force and




21


marketing
      efforts are principally directed at developing brand awareness and providing
      sales support to our distributors. We participate in major trade shows and
      offer
      support to our distributors who participate in regional trade shows and events.
      We also invest in web based and print advertising campaigns as well as a global
      media and public relations campaign. In addition to our independent marketing
      efforts, we invest in joint marketing efforts with our distributors, value
      added
      resellers and other companies that have formed strategic alliances with us.
      We
      have entered into co-marketing arrangements with companies in other
      complementary Internet segments, including:




-
            Aventail
                Corporation;


-
            Finjan
                Software;


-
            Oracle
                Corporation;


-
            BEA
                Systems, Inc.;


-
            BMC
                Software Inc.;


-
            Aladdin
                Knowledge Systems Ltd.;


-
            Secure
                Computing Corporation;


-
            Microsoft
                Corporation;


-
            WatchGuard
                Technologies Inc.; and


-
            Hewlett
                Packard Company.







*Strategic
      Alliances and Original Equipment Manufacturer Agreements.* We
      have
      entered into strategic alliances and original equipment manufacturer agreements
      with other software and hardware vendors, including Comverse Technology, Inc.
      and NEC Corporation, as well as mutual channel information sharing arrangements.
      We believe that these companies have significant customer relationships and
      offer products which complement our products. Our agreements allow these
      companies to distribute our products on a world-wide non-exclusive basis with
      discounts based upon the volume of orders received. There usually is no
      requirement for a minimum sales quota. The products are branded with the names
      of these companies or co-branded with our name. These agreements are standard
      distributor agreements, purchase agreements, OEM (original equipment
      manufacturer) agreements or other specific agreements and are terminable by
      either party at will. We plan to further invest in the development of strategic
      alliances in order to provide greater access to our target markets and enhance
      our brand name.




**Technical
      Management**




Our
      technical team, which consists of 106 employees worldwide as of December 31,
      2005, supports our sales force during the sales process, assists our customers
      and distributors with the initial installation, set-up and ongoing support
      of
      our products, trains distributors and customers to use our products and provides
      software updates and product upgrades for our products. In addition, our
      technical team trains and certifies our distributors to provide limited
      technical support in each of the geographical areas in which our products are
      sold, and is directly responsible for remote support. Our Certainty Support
      Program provides offerings which allow customers to automatically get new
      software versions of their products and obtain optimized performance by
      purchasing any of the following five optional offerings: extended warranty,
      software updates,
      24x7 help-desk (directly to our customers and through our distributors), on-site
      support and unit replacement.




**Research
      and Development**




In
      order
      to maintain our share of the Application Switching market, we place considerable
      emphasis on research and development to expand the capabilities of our existing
      products, develop new products and improve our existing technologies and
      capabilities. We believe that our future success will depend upon our ability
      to
      maintain our technological expertise, enhance our existing products and
      introduce, on a timely basis, new commercially viable products that will
      continue to address the needs of our customers. Accordingly, we intend to
      continue devoting a significant portion of our personnel and financial resources
      to research and development. In order to identify market needs and to define
      appropriate product specifications, as part of the product development process
      we seek to maintain close relationships with current and potential distributors,
      customers and vendors in related industry segments.




22


As
      of
      December 31, 2005, our research and development staff consisted of 122
      employees. Research and development activities take place at our facilities
      in
      Israel. We employ established procedures for the requirement management,
      development and quality assurance of our new product developments. Our research
      and development organization is divided according to our existing products.
      Each
      product group is headed by a group leader and includes team leaders and
      engineers. In addition, we have a hardware and infrastructure group responsible
      for the development of the Radware hardware platforms and infrastructure which
      is the basis for all products, serving all product groups, which consists of
      a
      group leader, team leaders, and engineers and a generic software group
      responsible for the software which is common to all our products (such as the
      management tools), which consists of a group leader, team leaders and engineers.
      We furthermore have a quality assurance department, which assists all product
      groups, and includes a group leader and quality control engineers and
      technicians. We occasionally use third party subcontractors for the development
      of portions of research and development projects.




**Manufacturing
      and Suppliers**




USR
      Technologies and Electronics (2003) Ltd. (“USR”) manufactures the circuit boards
      which are the principal hardware component used in our products. It supplies
      us
      with finished circuit boards for final assembly. The other components and
      subassemblies included in our products are supplied to USR from a limited group
      of suppliers and subcontractors. USR monitors each stage of the circuit board
      production process, including the selection of components and subassembly
      suppliers. USR is ISO 9002 certified, indicating that its manufacturing
      processes adhere to established quality standards.




We
      install our proprietary software onto the circuit boards we receive from USR.
      Quality assurance testing, final assembly and packaging and shipping operations
      are primarily performed at our facility in Jerusalem, Israel.




These
      circuit boards are the principal component which we use in the manufacture
      of
      our products. If we are unable to acquire circuit boards from USR on acceptable
      terms, or should USR cease to supply us with circuit boards for any reason,
      we
      may not be able to identify and integrate an alternative source of supply in
      a
      timely fashion or at the same costs. Any transition to one or more alternate
      suppliers would likely result in delays, operational problems and increased
      costs, and may limit our ability to deliver our products to our customers on
      time for such transition period. We
      are
      currently negotiating an agreement with an additional supplier for a limited
      number of product platforms.




Our
      activities in Europe require that we comply with European Union Directives
      with
      respect to


product
      quality assurance standards and environmental standards. The “RoHS” Directive,
      will take effect on July 1, 2006 and **** requires
      that certain of our products be modified to meet this regulation. The
      “WEEE” Directive requires produces of electrical and electronic equipment to
      register in different European countries and provide collection and recycling
      facilities for used products. If
      we
      fail to achieve compliance, we may be restricted from selling our products
      in
      the European Union and this could adversely affect


our
      results of operations.




**Proprietary
      Rights**




We
      rely
      on patent, trademark and trade secret laws, as well as confidentiality
      agreements and other contractual arrangements with our employees, distributors
      and others to protect our technology. We have a policy that requires our
      employees to execute employment agreements, including confidentiality and
      non-compete provisions.




We
      have
      registered trademarks for “Web Server Director®,” “Cache Server Director®”,
“FireProof®”, “LinkProof®”, “Triangulation®”, “Smart Nat®”, “Get Certain®”,
“CertainT®”, “Peer Director®”,“Synapps Architecture®”, “DefensePro®”,
“StringMatch Engine®” and “CID - Content Inspection Director®” and we have
      trademark applications pending for “UpLinkTM”, “RadwareTM”, “APSolute TM ”,
      “AppDirector”TM, “AppXCel”TM and “SecureFlow”TM. We do not currently own any
      registered copyrights. We have registered patents in the United States for
      our
      triangle redirection method used for the global load balancing, for our
      mechanism for efficient management and optimization of multiple links used
      in
      our LinkProof product, for our method for load balancing by global proximity
      used in our WSD product and for our method for controlling traffic on links
      between autonomous BGP systems, and pending patent applications and provisional
      patents in connection with several methods and features used in our products.
      These applications may not result in any patent being issued, and, if issued,
      the patents may not provide adequate protection against competitive technology
      and may not be held valid and enforceable if challenged. In addition, other
      parties may assert rights as inventors of the underlying technologies, which
      could limit our ability to fully exploit the rights conferred by any patent
      that
      we receive. Our competitors may be able to design around any patent we receive
      and other parties may obtain patents that we would need to license or circumvent
      in order to exploit our patents.




23


The
      protective steps we have taken may be inadequate to deter misappropriation
      of
      our technology and information. We may be unable to detect the unauthorized
      use
      of, or take appropriate steps to enforce, our intellectual property rights.
      Some
      of the countries in which we sell our products do not protect intellectual
      property to the same extent as the United States and Israel. In addition, our
      competitors may independently develop technologies that are substantially
      equivalent or superior to our technology. Any licenses for intellectual property
      that might be required for our services or products may not be available on
      reasonable terms.




For
      example, in March 2003, F5
      Networks, Inc. filed a lawsuit against us for patent infringement in U.S.
      District Court for the Western District of Washington. We settled the claim
      in
      September 2004.




In
      July
      2004, we filed a lawsuit in the District Court of New Jersey against F5
      Networks, Inc. for infringement of our patent directed at a method for load
      balancing by global proximity. We settled the lawsuit in March 2005.




**Competition**




Our
      industry is characterized by intense competition. Our principal competitors
      in
      the sale of Application Delivery solutions include Cisco Systems, Inc., Nortel
      Networks Corporation, Juniper Networks Inc, Citrix Networks Inc., and F5
      Networks, Inc. We expect to face increasing competition as new competitors
      enter
      our market and multinational corporations purchase players in the market. In
      addition, we face competition in the Intrusion Prevension space. Such
      competitors include 3Com Systems, Inc., Internet Security Systems, Inc. Juniper
      Networks, Inc. and McAfee, Inc.




Some
      of
      our competitors have substantially greater financial, personnel and other
      resources, and may offer a broader range of products than we do. These
      competitors may be able to respond more quickly to new or emerging technologies
      or changes in customer requirements. They may also benefit from greater
      economies of scale, offer more aggressive pricing, devote greater resources
      to
      the promotion of their products, bundle their products or incorporate an
      existing Application Delivery solution into existing products. Furthermore,
      in
      the past year there have been several acquisitions of companies in our market
      creating larger competitors. For example, Juniper Networks Inc. became a
      competitor in the application delivery market by acquiring Peribit Networks
      Inc.
      and Redline Networks Inc., and Citrix Systems Inc, became a competitor in the
      application delivery market by acquiring Netscaler Inc. Examples of two
      additional acquisitions by competitors in the application delivery space were
      Cisco Systems Inc.’s purchase of FindGround Networks Inc. and F5 Networks Inc.’s
      acquisition of Swan Labs Corp. The dynamic market environment, which is
      demonstrated by the above acquisitions, poses a challenge in predicting market
      trends and expected growth.




We
      believe that our success will depend primarily on our ability to provide more
      technologically advanced and cost-effective Application Delivery solutions,
      and
      more responsive customer service and support, than our competitors. However,
      we
      cannot assure you that the products we offer will compete successfully with
      those of our competitors. Furthermore, should competition intensify, we may
      have
      to reduce the prices of our products which will negatively impact our business
      and financial condition.




**I** **sraeli
      Office of Chief Scientist**




From
      time
      to time, eligible participants may receive grants under programs of the Office
      of the Chief Scientist of the Israeli Ministry of Industry, Trade and Labor,
      or
      the Chief Scientist. Grants received are generally repaid through a mandatory
      royalty based on revenues from products (and ancillary services) incorporating
      know-how developed, in whole or in part, with the grants. This governmental
      support is conditioned upon the participant’s ability to comply with certain
      applicable requirements and conditions specified in the Chief Scientist’s
      program and with the provisions of the Law for the Encouragement of Research
      and
      Development in the Industry, 1984, and the regulations promulgated thereunder,
      or the Research and Development Law. In June 2005, an amendment to the Research
      and Development Law came into effect, among other things, relaxes restrictions
      on the transfer of manufacturing rights outside Israel and on the transfer
      of
      Chief Scientist-funded know-how outside of Israel, as described
      below.




24


Under
      the
      Research and Development Law, research and development programs that meet
      specified criteria and are approved by the research committee of the Chief
      Scientist are eligible for grants usually of up to 50% of certain approved
      expenditures of such programs, as determined by said committee. In exchange,
      the
      recipient of such grants is required to pay the Chief Scientist royalties from
      the revenues derived from products incorporating know-how developed within
      the
      framework of each such program or derived therefrom (including ancillary
      services in connection therewith), up to an aggregate of 100 - 150% of the
      dollar-linked value of the total grants received in respect of such program,
      plus interest.




The
      Israeli government is currently in the process of formulating a proposed
      amendment to the royalty regulations promulgated under the Research and
      Development Law. The amendment is expected to include changes to
      the royalty rates, which would vary from company to company based on the
      amount of its revenues and approval date of its program, up to a rate
      of 6%, and, as of 2006, to increase the rate of interest
      accruing on grants by 1% per year. The amendment is expected
      to have retroactive effect from January 1, 2006, although there is no
      assurance as to whether and when it will be adopted. The Research
      and Development Law generally requires that the product developed under a
      program be manufactured in Israel. However, upon the approval of the Chief
      Scientist, some of the manufacturing volume may be performed outside of Israel,
      provided that the grant recipient pays royalties at an increased rate, which
      may
      be substantial, and the aggregate repayment amount is increased up to 300%
      of
      the grant, depending on the portion of the total manufacturing volume that
      is
      performed outside of Israel. The June 2005 amendment to the Research and
      Development Law further permits the Chief Scientist, among other things, to
      approve the transfer of manufacturing rights outside Israel in exchange for
      an
      import of different manufacturing into Israel as a substitute, in lieu of the
      increased royalties. Effective April 1, 2003, the Research and Development
      Law
      also allows for the approval of grants in cases in which the applicant declares
      that part of the manufacturing will be performed outside of Israel or by
      non-Israeli residents and the research committee is convinced that doing so
      is
      essential for the execution of the program. This declaration will be a
      significant factor in the determination of the Chief Scientist whether to
      approve a program and the amount and other terms of benefits to be granted.
      For
      example, the increased royalty rate and repayment amount will be required in
      such cases.




By
      December 31, 2001, we repaid by way of royalties the full amount we owed to
      the Chief
      Scientist.  In
      2004,
      we applied, together with another company, to obtain a grant from the Chief
      Scientist under the “joint R&D project” track. The Chief Scientist approved
      the maximum grant to the project of approximately $0.2 million. In 2005, we
      applied to obtain an additional grant from the Chief Scientist, under the same
      project. The Chief Scientist approved an additional grant to the project in
      an
      additional maximum amount of approximately $0.2 million. During 2005 we have
      received an aggregate amount of $0.3 million for this project from the Chief
      Scientist. In the beginning of 2006 we applied to obtain an additional grant,
      under the same project, in an amount of approximately $0.3 million. Under the
      “joint R&D project” track there is no royalty commitment but other
      limitations of the Research and Development Law are applicable.




The
      Research and Development Law also provides that know-how developed under an
      approved research and development program may not be transferred to third
      parties in Israel without the approval of the research committee. Such approval
      is not required for the export of any products resulting from such research
      or
      development. The Research and Development Law further provides that the know-how
      developed under an approved research and development program may not be
      transferred to any third parties outside Israel, except in certain circumstances
      and subject to the Chief Scientist’s prior approval. The Chief Scientist may
      approve the transfer of Chief Scientist-funded know-how outside Israel,
      generally in the following cases: (a) the grant recipient pays to the Chief
      Scientist a portion of the sale price paid in consideration for such Chief
      Scientist-funded know-how (according to certain formulas), or (b) the grant
      recipient receives know-how from a third party in exchange for its Chief
      Scientist-funded know-how, or (c) such transfer of Chief Scientist-funded
      know-how arises in connection with certain types of cooperation in research
      and
      development activities.




25


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




The
      Israeli authorities have indicated in the past that the government may further
      reduce or abolish the Chief Scientist grants in the future. Even if these grants
      are maintained, we cannot presently predict what would be the amounts of future
      grants, if any, that we might receive.




**Organizational
      Structure**




As
      of
      January 1, 1999, we established a wholly-owned subsidiary in the United States,
      Radware Inc., which conducts the sales and marketing of our products in America.
      We also have subsidiaries in Australia, France, Germany, the United Kingdom,
      Italy, Japan, Singapore, Korea, Canada and Switzerland. We have also established
      representative offices in China, Taiwan and Russia, and a liaison office in
      India. All the above subsidiaries are wholly-owned. Our subsidiaries
      include:




**Name
                of Subsidiary**
            **Country
                of Incorporation**Radware
                Inc.
            New
                Jersey, United States of AmericaRadware
                UK Limited
            United
                KingdomRadware
                France
            FranceRadware
                Srl
            ItalyRadware
                GmbH
            GermanyNihon
                Radware KK
            JapanRadware
                Australia Pty. Ltd.
            AustraliaRadwareSingapore Pte. Ltd.
            SingaporeRadware
                Korea Ltd.
            KoreaRadware
                Canada Inc.
            CanadaRadware
                GmbH
            Switzerland





Yehuda
      Zisapel is a co-founder and shareholder of Radware. Yehuda Zisapel is also
      the
      Chairman of the Board of Directors of Radware. Individually or together with
      his
      brother, Zohar Zisapel, he is also a founder, director and/or principal
      shareholder of several other companies which, together with Radware and our
      subsidiaries listed above are known as the RAD-Bynet Group. These corporations
      include:




26


AB-NET
                Communications Ltd.
              BYNET
                Data
              Communications
                Ltd.
              BYNET
                Electronics Ltd.
              BYNET
                SEMECH (outsourcing) Ltd.
              Bynet
                Software Systems Ltd.
              Bynet
                System Applications Ltd.
            Ceragon
                Networks Ltd.
              Commex
                Technologies Inc.
              Infogate
                On Line Ltd.
              Modules
                Inc.
              Packetlight
                Networks Ltd.
              RAD-Bynet
                Properties and Services (1981) Ltd.
              RADCOM
                Ltd.
              RAD
                Data
              Communications
                Ltd.
            WISAIR
                Inc.
              Sanrad
                Inc.
              RADLive
                Inc.
              RAD-OP,
                Inc.
              RADView
                Software Ltd.
              RADVision
                Ltd.
              RADWIN
                Ltd.
              RiT
                Technologies Ltd.
              Silicom
                Ltd.




The
      group
      also includes several other holdings, real estate companies and pharmaceutical
      companies . The
      above
      list does not constitute a complete list of the investments of Messrs. Yehuda
      and Zohar Zisapel.




In
      addition to engaging in other businesses, members of the RAD-Bynet Group are
      actively engaged in designing, manufacturing, marketing and supporting data
      communications products, none of which currently compete with our products.
      Some
      of the products of members of the RAD-Bynet Group are complementary to, and
      may
      be used in connection with, our products. See also Item 7 - *Related
      Party Transactions* .




**Property,
      Plants and Equipment**




Our
      headquarters and principal administrative, finance, research and development
      and
      marketing operations are located in approximately 31,500 square feet of leased
      office space in Tel Aviv, Israel. The lease expires in October 2007. The
      facilities are leased from affiliated companies owned by Messrs. Yehuda and
      Zohar Zisapel - see Item 7 - *“Major
      Shareholders and Related Parties Transactions.”*




We
      also
      sublease approximately 5,482 square feet of space in Jerusalem for our
      manufacturing facility from USR. The sublease with respect to 2,150 square
      feet
      expires in April 2009 and the sublease with respect to the remaining 3,332
      square feet expires in December 2007. In the United States, we lease approximately
      12,382  square
      feet in Mahwah, New Jersey from a related party, which lease will expire in
      April 2007. We also lease 4,916 square feet
      from an unaffiliated party in Costa Mesa, California, which lease expires in March
      2007. We also
      lease 3,024 square feet in Dallas, Texas, which lease expires in February 2009.
      In addition, we lease facilities for the operation of our subsidiaries and
      representative offices in several locations in the United States, Europe and
      Asia Pacific. We may need additional space if we expand our business and believe
      that we will be able to obtain space as needed.









**ITEM
      4A.** **UNRESOLVED
      STAFF COMMENTS**




None.




27




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




**General**




**Our
      discussion and analysis of our financial condition and results of operation
      are
      based upon our consolidated financial statements, which have been prepared
      in
      accordance with generally accepted accounting principles in the United States.
      Our operating and financial review and prospects should be read in conjunction
      with our financial statements, accompanying notes thereto and other financial
      information appearing elsewhere in this annual report.**




We
      commenced operations in April 1997. Since then, we have focused on developing
      and enhancing our products, building our worldwide direct and indirect
      distribution network and establishing and expanding our sales, marketing and
      customer support infrastructure.




Most
      of
      our revenues are generated in U.S. dollars or are dollar-linked and the majority
      of our expenses are incurred in dollars and, as such, we use the dollar as
      our
      functional currency. Our consolidated financial statements are prepared in
      dollars and in accordance with generally accepted accounting principles in the
      United States.




*Revenues.* Our
      revenues are derived primarily from sales of our products and, to a lesser
      extent, from sales of post-contract customer support through our Certainty
      Support program and sales of a security subscription service the “Security
      Update Service” (hereunder “SUS”). We generally recognize product revenue when
      persuasive evidence of an arrangement exists, delivery has occurred, the fee
      is
      fixed or determinable, no further obligation exists and collectability is
      probable. Post-contract customer support and the SUS service, which represents
      mainly software update subscriptions, help-desk support and unit replacements,
      is recognized ratably over the contract period, which is typically one year.




*Cost
      of Sales.* Our
      cost
      of sales consists primarily of the cost of circuit boards and other components
      required for the assembly of our products, salaries and related personnel
      expenses for those engaged in the final assembly and maintenance service of
      our
      products and other overhead costs.




*Research
      and Development Expenses.* Research
      and development expenses consist primarily of salaries and related personnel
      expenses, costs of subcontractors and prototype expenses related to the design,
      development, testing and enhancement of our products. All research and
      development costs are expensed as incurred. We believe that continued investment
      in research and development is critical to attaining our strategic product
      objectives.




*Marketing
      and Selling Expenses.* Marketing and selling expenses consist primarily of salaries, commissions and
      related personnel expenses for those engaged in the sales and marketing of
      our
      products as well as related trade shows, advertising, promotional, web site
      maintenance and public relations expenses.




*General
      and Administrative Expenses.* General
      and administrative expenses consist primarily of salaries and related personnel
      expenses for executive, accounting and administrative personnel, professional
      fees (which include legal, audit and additional consulting fees), bad debt
      expenses and other general corporate expenses.




Operating
      expenses also included amortization of stock-based compensation, which is
      allocated among research and development expenses, marketing and selling
      expenses and general and administrative expenses, based on the division in
      which
      the recipient of the option grant is employed. Amortization of stock-based
      compensation results from the granting of stock options to employees with
      exercise prices per share determined to be below the deemed fair market value
      per share of our ordinary shares on the dates of grant or from modifications
      to
      specific stock option grants. The stock-based compensation is being amortized
      to
      operating expenses over the vesting period of the individual
      options.




On
      December 16, 2004, the Financial Accounting Standards Board (FASB) issued
      Statement No. 123 (revised 2004), Share-Based Payment ("SFAS No. 123 (R) "),
      which
      is a revision of SFAS No. 123. Generally, the approach in SFAS 123(R) is similar
      to the approach described in Statement 123. However, SFAS No. 123 permitted,
      but
      did not require, share-based payments to employees to be recognized based on
      their fair values while SFAS No. 123(R) requires all share-based payments to
      employees to be recognized, as of the first quarter of 2006, based on their
      fair
      values. SFAS No. 123 (R) also
      revises, clarifies and expands guidance in several areas, including measuring
      fair value, classifying an award as equity or as a liability and attributing
      compensation cost to reporting periods.




28


SFAS
      No.
      123(R) permits public companies to adopt its requirements using one of two
      methods: (i) a “modified prospective” method in which compensation cost is
      recognized beginning with the effective date (a) based on the requirements
      of
      Statement SFAS No. 123(R) for all share-based payments granted after the
      effective date and (b) based on the requirements of SFAS No. 123 for all awards
      granted to employees prior to the effective date of SFAS No. 123(R) that remain
      unvested on the effective date. (ii) a “modified retrospective” method which
      includes the requirements of the modified prospective method described above,
      but also permits entities to restate based on the amounts previously recognized
      under SFAS No. 123 for purposes of pro forma disclosures either (a) all prior
      periods presented or (b) prior interim periods of the year of adoption.




We
      plan
      to adopt the new statement effective January 1, 2006, using the “modified
      prospective” method. We expect the adoption of SFAS No. 123R may have a
      significant effect on the Company's results of operations and net earnings
      per
      share. However, our assessment of the estimated compensation charges is affected
      by our stock price as well as assumptions regarding a number of complex and
      subjective variables and the related tax impact. These variables include, but
      are not limited to, the volatility of our stock price and employee stock option
      exercise patterns. Had we adopted SFAS No. 123(R) in prior periods, the impact
      of that standard would have approximated the impact of SFAS No. 123 as described
      in the disclosure of pro forma net income and earnings per share in Note 2
      to
      our consolidated financial statements.




*Financial
      Income (Expenses), Net.* Financial
      income, net consists primarily of interest earned on short-term and long-term
      bank deposits, and of amortization of premiums, accretion of discounts and
      interest earned on investment in marketable securities of proceeds from the
      issuance of our shares to the public, from the exercise of options to purchase
      our shares, from cash generated from our operations and from income and expenses
      from the translation of monetary balance sheet items denominated in non-dollar
      currencies.




*Taxes,* Israeli
      companies are generally subject to corporate tax on their taxable income at
      the
      rate of 35% for the 2004 tax year, 34% for the 2005 tax year, 31% for the 2006
      tax year 29% for the 2007 tax year, 27% for the 2008 tax year, 26% for the
      2009
      tax year and 25% for the 2010 tax year and thereafter, and are subject to
      capital gains tax at a rate of 25% for capital gains (other than gains deriving
      from the sale of listed securities) derived after January 1, 2003. However,
      we
      have established an approved enterprise program (the "Program"), which is
      eligible for the tax benefits for operational profit, described below under
      the
      heading "Corporate Tax Rate." These benefits result in part of our income being
      tax exempt or taxed at a lower rate for some time after we begin to report
      taxable income. The tax rate depends upon the percentage of our income derived
      at that time from the Approved Enterprise program. The tax benefits depend
      on
      our meeting the requirements of the Program and there is no assurance we will
      be
      able to obtain such benefits. Our U.S. subsidiary has carry-forward tax losses
      to offset against future taxable profit. We have recorded a deferred tax asset
      in relation to these carry-forward tax losses and we anticipate that we will
      utilize part of these tax losses in 2006. Other subsidiaries of ours are taxed
      according to the laws in their countries of incorporation and tax expenses
      are
      recorded accordingly. We may incur, for accounting purposes, tax expenses in
      2006 which we anticipate to be at a rate of approximately 10%. The tax expenses
      for accounting purposes might be higher than the actual tax payments to the
      tax
      authorities, due to exercise of non qualified options by our employees which
      gains from such exercises are considered a deductible expense for tax purposes.
      The tax benefit resulting from the exercise of such stock options will be
      credited to additional paid-in-capital, when probable, rather than a deduction
      from the tax expenses for accounting purposes.




*Market
      trends.* According
      to our estimations, the market in 2005 has continued the trend which started
      in
      2004 and continued to grow slightly. This slight growth in the past two years
      has followed a few years in which there was a deterioration of the economy
      worldwide and economic uncertainty in the telecommunications market which
      resulted in a curtailment of capital investment by companies in our




29


target
      markets and caused our revenue growth to increase at a significantly slower
      pace
      during the last few years relative to prior years. Due to the past volatility
      of
      the market it is difficult to predict the conditions of our market going
      forward. In addition, we believe that market conditions cause our customers
      and
      potential customers to be more conservative in planning their spending. If
      the
      global conditions deteriorate, and companies in our target markets continue
      to
      reduce capital expenditures, we may experience a reduction in sales, as well
      as
      downward pressure on the price of our products. In addition, if the market
      continues to be flat and customers continue to experience low visibility we
      may
      not be able to increase our sales. Each of the above scenarios would have a
      material adverse effect on our business, operating results and financial
      condition. Furthermore, 2005 was marked by several acquisitions of companies
      in
      our space which resulted in continuous changes in the competitive landscape. For
      example, 3Com Systems, Inc. became a competitor in the Intrusion Prevention
      market by acquiring Tipping Point Technologies, Inc., Juniper Networks Inc.
      became a competitor in the application delivery market by acquiring Peribit
      Networks Inc. and Redline Networks Inc., and Citrix Systems Inc, became a
      competitor in the application delivery market by acquiring Netscaler Inc. The
      dynamic market environment, which is demonstrated by the above acquisitions,
      poses a challenge in predicting market trends and expected growth.




We
      intend
      to continue our investment in the marketing and branding of our APSolute
      application delivery product family which we released a few months ago, in
      order
      to broaden market acceptance of such products. Such investment includes
      recruitment of skilled personnel, participation in trade shows, testing and
      certification of our products by leading firms in the industry, investment
      in
      brand awareness and so forth. There is no assurance that we will be successful
      in such marketing and selling activities and that the increase in revenues,
      if
      any, will justify the investment.





*Business
      combination - acquisition of V-Secure..* In
      December 2005, we acquired the business of V-Secure which included the
      acquisition of intellectual property, technology, customers relationship and
      goodwill. The total consideration for the acquisition was $9,168,000, out of
      which an amount of $ 9,011,000 was paid in cash; and $148,000 was paid by
      issuance of fully vested warrants to V-Secure to purchase 45,454 ordinary shares
      of the Company. The remaining balance is related to acquisition costs payable.
      Additional cash consideration of $6,000,000 is payable contingent upon meeting
      a
      certain milestone by June 28, 2006. The purchase price was allocated to the
      identifiable intangible assets acquired (which have been valued by a third
      party
      valuation specialist) based upon their estimated fair values. The acquisition
      of
      V-Secure was accounted for under the purchase method of accounting. See also
      Note 1e to our Consolidated Financial Statements included in this annual
      report.







**Critical
      Accounting Policies** ******




Our
      consolidated financial statements are prepared in accordance with U.S. GAAP.
      These accounting principles require management to make certain estimates,
      judgments and assumptions based upon information available at the time that
      they
      are made, historical experience and various other factors that are believed
      to
      be reasonable under the circumstances. These estimates, judgments and
      assumptions can affect the reported amounts of assets and liabilities as of
      the
      date of the financial statements, as well as the reported amounts of revenues
      and expenses during the periods presented.




In
      many
      cases, the accounting treatment of a particular transaction is specifically
      dictated in the U.S. GAAP and does not require management’s judgment in its
      application. There are also areas in which management’s judgment in selecting
      among available alternatives would produce a materially different result. The
      Company’s management has reviewed these critical accounting policies and related
      disclosures with the Company’s Audit Committee. See Note 2 to our Consolidated
      Financial Statements, which contains additional information regarding our
      accounting policies and other disclosures required by U.S. GAAP. ****




Our
      management believes the significant accounting policies which affect its more
      significant judgments and estimates used in the preparation of its consolidated
      financial statements and which are the most critical to aid in fully
      understanding and evaluating our reported financial results include the
      following:




30


·
            Revenue
                recognition;




·
            Accounting
                for doubtful accounts;




·
            Inventory
                valuation;




·
            Income
                taxes; and




·
            Legal
                contingencies.




*Revenue
      recognition* .
      The
      Company and its subsidiaries generate revenues from selling their products
      and
      post-contract customer support primarily through distributors and resellers,
      all
      of which are considered as end-users.




Revenues
      from product sales are recognized when delivery has occurred, persuasive
      evidence of an agreement exists, the fee is fixed or determinable, no further
      obligation exists and collectability is probable.




Revenues
      in arrangements with multiple deliverables are recognized under the “residual
      method” when Vendor specific objective evidence ("VSOE") of fair value exists
      for all undelivered elements, no VSOE exists for the delivered elements, and
      all
      other revenue recognition criteria are satisfied. VSOE for post-contract
      customer support is determined based on the price when it is sold separately
      in
      similar arrangements. The price may vary in the territories and vertical markets
      in which the Company conducts business. Price is determined by using a
      consistent percentage of the product price.




Revenue
      derived from post-contract customer support, which represents mainly software
      subscription, SUS and unit replacement services, is recognized ratably over
      the
      contract period, which is typically one year.




Revenues
      from training and installation, which are considered as not essential to the
      functionality of the product, included in multiple elements arrangements are
      recognized at the time they are rendered.




The
      Company and its subsidiaries provide a provision for product returns and stock
      rotation based on their experience with historical sales returns, analysis
      of
      credit memo data and other known factors, in accordance with Statement of
      Financial Accounting Standard No. 48 "Revenue Recognition When Right of Return
      Exists" ("SFAS No. 48"). If the historical data used to calculate these
      estimates does not properly reflect future returns, additional provision for
      sales returns may be required, and revenues in that period could be adversely
      affected.




Deferred
      revenue includes unearned amounts received under post-contract customer support
      and SUS.




*Accounting
      for doubtful accounts* .
      Our
      accounts receivable are derived from our sales to our customers located all
      over
      the world. We perform periodic credit evaluations of our customers’ financial
      condition. We maintain an allowance for doubtful accounts for estimated losses,
      which may result from the inability of our customers to make required payments.
      Management exercises judgment as to its ability to collect outstanding
      receivables. Allowances for doubtful accounts are made based upon a specific
      review of all significant outstanding invoices. For those invoices not
      specifically reviewed, allowances for doubtful accounts are made based upon
      the
      age of the receivable. In determining the allowance, we analyze our historical
      collection experience and current economic trends. If the historical data used
      to calculate the allowances for doubtful accounts do not reflect the future
      ability to collect outstanding receivables, additional allowances for doubtful
      accounts may be needed and the future results of operations could be materially
      affected.




*Inventory
      valuation.* At each
      balance sheet date, we evaluate our inventory balance for excess quantities
      and
      obsolescence. This evaluation includes an analysis of sales levels by product
      and projections of future demand. In addition, we write off inventories that
      are
      considered obsolete. Remaining inventory balances are adjusted to the lower
      of
      cost or market value. If future demand for our old or new products, or market
      conditions are less favorable than our projections, additional inventory
      write-downs may be required and would be reflected in cost of sales for such
      period.




*Income
      taxes.* We
      account for income taxes in accordance with Statement of Financial Accounting
      Standards No. 109, "Accounting for Income Taxes" ("SFAS No. 109"). This
      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. We provide a valuation allowance, if necessary, to
      reduce deferred tax assets to their estimated realizable value.




31




In
      evaluating our ability to recover our deferred tax assets, we consider all
      available positive and negative evidence including our past operating results,
      the existence of cumulative losses in the most recent fiscal years and our
      forecast of future taxable income on a jurisdiction by jurisdiction basis.
      In
      determining future taxable income, we are responsible for assumptions utilized,
      the reversal of temporary differences and the implementation of feasible and
      prudent tax planning strategies. These assumptions require significant judgment
      about the forecasts of future taxable income and are consistent with the plans
      and estimates we use to manage the underlying business.




*Legal
      contingencies.* As
      discussed in “Item 8 - Financial Information” under the caption “Legal
      Proceedings,” in December
      2001, we were named as a defendant in a class action complaint alleging
      violations of the federal securities laws in the United States District Court,
      Southern District of New York, together with approximately 300 additional
      issuers. We
      have
      approved a settlement agreement and related agreements, which set forth the
      terms of a settlement between us, the plaintiff class and the vast majority
      of
      the other approximately 300 issuer defendants.




The
      settlement agreement provides a guaranteed recovery of $1 billion to plaintiffs
      for the cases relating to all of the approximately 300 issuers. To the extent
      that the underwriter defendants settle all of the cases for at least $1 billion,
      no payment will be required under the issuers’ settlement agreement. To the
      extent that the underwriter defendants settle for less than $1 billion, the
      issuers are required to make up the difference. On April 20, 2006, JPMorgan
      Chase and the plaintiffs reached a preliminary agreement for a settlement for
      $425 million. The JPMorgan Chase settlement has not yet been approved by the
      Court. However, if it is finally approved, then the maximum amount that the
      issuers or their insurers will be potentially liable for is $575 million, of
      which our part is less than $2 million.




It
      is
      anticipated that any potential financial obligation of ours to plaintiffs due
      pursuant to the terms of the settlement agreement and related agreements will
      be
      covered by existing insurance. Therefore, our management, based on the opinions
      of our legal advisors handling the claim, does not expect that the settlement
      will involve any payment by the Company. Accordingly, no provision for such
      contingency was provided in our financial statements.




The
      settlement agreement and related agreements are subject to a number of
      contingencies, including the approval of the settlement agreement by the Court.
      On February 15, 2005, the court granted preliminary approval of the settlement
      agreement, subject to certain modifications consistent with its opinion. Those
      modifications have been made. On March 20, 2006, the Underwriter Defendants
      submitted objections to the settlement to the Court. The Court held a hearing
      regarding these and other objections to the settlement at a fairness hearing
      on
      April 24, 2006, but has not yet issued a ruling. There is no assurance that
      the
      court will grant final approval to the settlement. If the settlement agreement
      is not approved and we are found liable, we are unable to estimate or predict
      the potential damages that might be awarded, whether such damages would be
      greater than our insurance coverage, and whether such damages would have a
      material impact on our results of operations, cash flows or financial condition
      in any future period.






32




**A.
        Operating Results**




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




Year
                ended
            
            Year
                ended
            
            Year
                ended
            
            Year
                endedDecember
                31,
            
            December
                31,
            
            December
                31,
            
            December
                31,2002
            
            2003
            
            2004
            
            2005Revenues
            
            
            100.0
            %
            
            100.0
            %
            
            100.0
            %
            
            100.0
            %Cost
                of revenues
            
            
            18.2
            
            
            18.0
            
            
            17.8
            
            
            19.2Gross
                profit
            
            
            81.8
            
            
            82.0
            
            
            82.2
            
            
            80.8Operating
                expenses:Research
                and development, net
            
            
            17.9
            
            
            15.3
            
            
            15.1
            
            
            16.8Sales
                and Marketing
            
            
            68.7
            
            
            54.3
            
            
            46.6
            
            
            51.5General
                and administrative
            
            
            9.7
            
            
            7.6
            
            
            6.6
            
            
            6.8Total
                operating expenses
            
            
            96.3
            
            
            77.2
            
            
            68.3
            
            
            75.1Operating
                profit (loss)
            
            
            (14.5
            )
            
            4.8
            
            
            13.9
            
            
            5.7Financial
                income, net
            
            
            9.7
            
            
            6.9
            
            
            6.7
            
            
            6.6Income
                (loss) before income taxes
            
            
            (4.8
            )
            
            11.7
            
            
            20.6
            
            
            12.3Income
                taxes
            
            
            -
            
            
            -
            
            
            (0.5
            )
            
            (0.3
            )Minority
                interest in earnings of a subsidiary
            
            
            -
            
            
            (0.1
            )
            
            -
            
            
            -Net
                income (loss)
            
            
            (4.8
            )%
            
            11.6
            %
            
            20.1
            %
            
            12.0
            %





**Executive
      Summary - Year Ended December 31, 2005**




Sales
      in
      2005 were approximately $77.6 million, an increase of 13% compared with sales
      of
      $68.4 million in 2004. In 2005 we have continued the trend of sequential
      increase in sales, year over year, since our first year of incorporation. The
      cost of sales as percentage of revenues slightly increased, compared to its
      level in 2003 and 2004. In order to continue to strengthen and broaden our
      product lines we have slightly increased our investments in research and
      development during 2005. In order to increase market acceptance of our new
      products and to strengthen our branding and market penetration in certain
      regions, we decided to continue and increase our sales and marketing expenses
      throughout the year. Our sales increased at a lower rate than the increase
      of
      our operating expenses. As a result, there was a decrease in our operating
      profit in 2005 to an amount of $4.4 million, compared to an amount of $9.5
      million in 2004. The financial income increased due to the increase in our
      cash
      and due to the increase in interest rates. This increase was partially offset
      by
      loss from foreign currency translation differences. Such differences resulted
      mainly from the decrease in the value of the Euro relative to the Dollar during
      2005.




In
      2006
      we intend to continue and increase investment in the development of new products
      and directions, as well as support continued growth in our sales and enhancement
      of market acceptance for our end to end product offerings. As a result our
      research and development and sales and marketing expenses are expected to
      increase compared to 2005.There is no assurance that our investment in new
      products and market penetration will increase our revenues and justify the
      additional expense.




**Year
      Ended December 31, 2005 Compared with Year Ended December 31,
      2004**




*Sales.* Sales in
      2005 were approximately $77.6 million, an increase of approximately 13% compared
      with sales of approximately $68.4 million in 2004. The growth in sales during
      2005 is primarily attributable to the expansion of our sales and marketing
      activities, and a slight improvement in the market environment and corporate
      spending.




*Cost
      of Sales.* Cost of
      sales was approximately $14.9 million in 2005, compared with cost of sales
      of
      approximately $12.2 million in 2004. Cost of sales as a percentage of sales
      was
      19.2% in 2005, a slight increase compared to the cost of sales level of 17.8%
      in
      2004. This increase is primarily attributable to the introduction of new
      products as well as a different mix of products.




33


*Research
      and Development (“R&D”) Expenses.* Research
      and development expenses were approximately $13.0 million in 2005, an increase
      of 26% compared with research and development expenses of approximately $10.3
      million in 2004. The increase is primarily due to hiring of new R&D
      personnel. Additional R&D employees were hired during 2005 in order to
      support our Application Delivery capabilities and development of new platforms
      and products, including enhancement of our quality assurance department. A
      small
      part of the increase was offset due to the decrease in the Dollar cost of our
      salaries for our research and development staff caused by the decrease in value
      of the NIS against the dollar. All these salaries were paid in NIS. We expect
      the R&D expenses to increase in 2006 due to the recruitment of additional
      personnel and salary increases of existing personnel.




*Sales
      and Marketing Expenses.* Sales
      and marketing expenses were approximately $40.0 million in 2005, an increase
      of
      25% compared with sales and marketing expenses of approximately $31.9 million
      in
      2004. Percentage-wise, the share of sales and marketing expenses of total
      revenues increased from 46.6% in 2004 to 51.5% in 2005. The increase of our
      sales and marketing expenses in 2005 is related to the increase in sales as
      well
      as the continued investment in market acceptance of new products and our next
      generation APSolute application delivery product family, and investment in
      new
      geographical markets, mainly in Europe and the Far East. We anticipate
      increasing sales and marketing expenses for 2006 primarily for the purpose
      of
      (i) increasing brand awareness and market acceptance of our new products (by
      participation in trade shows and seminars, testing and certification of our
      products by leading firms in the industry); (ii) strengthening our international
      presence (by adding sales and marketing personnel, as well as technical support
      people).




*General
      and Administrative Expenses.* General
      and administrative expenses were approximately $5.2 million in 2005, an
      increase of approximately 16.7% compared
      with general and administrative expenses of approximately $4.5 million in 2004.
      This increase is primarily attributable to the actions we have taken in order
      to
      improve our information systems and to professional services received in order
      to prepare our company to comply with the Sarbanes Oxley Act.




*Financial
      Income, Net.* Financial income, net was approximately $5.2 million in 2005, an
      increase of approximately 13% compared
      with financing income, net of approximately $4.6 million in 2004. This increase
      is attributable to the total increase in cash and cash equivalents, bank
      deposits and marketable securities and increase in interest rates which was
      partially offset by a loss from foreign currency translation differences which
      are included in financial income, caused mainly by a decrease in the value
      of
      the Euro relative to the Dollar.




*Income
      Taxes* .
      Income
      taxes were approximately $0.3 million in 2005 (in and outside Israel), the
      same
      as in 2004. This amount derives mainly from current taxes and change in deferred
      taxes.




**Year
      Ended December 31, 2004 Compared with Year Ended December 31,
      2003**




*Sales.* Sales in
      2004 were approximately $68.4 million, an increase of approximately 25% compared
      with sales of approximately $54.8 million in 2003. The growth in sales during
      2004 is primarily attributable to the expansion of our sales and marketing
      activities, the introduction of new products, and a slight improvement in the
      market environment and corporate spending.




*Cost
      of Sales.* Cost of
      sales was approximately $12.2 million in 2004, compared with cost of sales
      of
      approximately $9.9 million in 2003. This increase is primarily attributable
      to
      the increase in sales. Cost of sales as a percentage of sales were 17.8% in
      2004, similar to the cost of sales level of 18.0% in 2003.




*Research
      and Development (“R&D”) Expenses.* Research
      and development expenses were approximately $10.3 million in 2004, an increase
      of 23% compared with research and development expenses of approximately $8.4
      million in 2003. The increase is primarily due to hiring of new R&D
      personnel. Additional R&D employees were hired during 2004 in order to
      support our Application Security and IPS capabilities and development of new
      platforms and products, including enhancement of our Quality Assurance
      department. A small part of the increase can be attributed to the increase
      in
      the dollar cost of our salaries for our research and development staff caused
      by
      the increase in value of the NIS against the dollar. All these salaries were
      paid in NIS.




34


*Sales
      and Marketing Expenses.* Sales
      and marketing expenses were approximately $31.9 million in 2004, an increase
      of
      7% compared with sales and marketing expenses of approximately $29.8 million
      in
      2003. Percentage-wise, however, the share of Sales and Marketing expenses of
      total revenues decreased from 54.3% in 2003 to 46.6% in 2004. The increase
      of
      our sales and marketing expenses in 2004 is related to the increase in sales
      as
      well as the investment in market acceptance of new products, and investment
      in
      new geographical markets, mainly in Europe and the Far East.




*General
      and Administrative Expenses.* General
      and administrative expenses were approximately $4.5 million in 2004, an
      increase of approximately 9% compared
      with general and administrative expenses of approximately $4.1 million in 2003.
      This increase is primarily attributable to the legal expenses resulting from
      a
      lawsuit for patent infringement which was filed against us and was settled
      in
      2004. In addition we filed a lawsuit for patent infringement in July 2004 which
      was settled in March 2005, however, we did not incur material cost in connection
      with this lawsuit.




*Financial
      Income, Net.* Financial income, net was approximately $4.6 million in 2004, an
      increase of approximately 22% compared
      with financing income, net of approximately $3.7 million in 2003. This increase
      is attributable to the total increase in cash, bank deposits and marketable
      securities, increase in interest rates and an increase in the value of the
      Euro
      relative to the Dollar. As a result, there was an increase in foreign currency
      translation differences, which are included in the financial income.




*Income
      Taxes* .
      Income
      taxes were approximately $0.3 million in 2004. This amount derives mainly from
      taxes in respect to prior years and current taxes, offset by deferred
      taxes.




**B.**
            **Liquidity
                and Capital Resources**




Since
      our
      inception, we have financed our operations through a combination of issuing
      debt
      and/or equity securities, including two public offerings, research and
      development and/or marketing grants from the Government of Israel and cash
      generated by operations. We raised approximately $12.9 million in two private
      placements, in November 1997 and June 1999. In October 1999, we raised net
      proceeds of approximately $56.8 million in the initial public offering of our
      ordinary shares. In January 2000, we raised net proceeds to the Company of
      approximately $59.8 million in a public offering of our ordinary
      shares.




Our
      principal commitments consist of outstanding operating leases for the Company’s
      facilities. The lease agreements expire in the years 2006 to 2009 (some with
      renewal options). Our future minimum payments under non-cancelable operating
      lease agreements at December 31, 2005, are approximately as
      follows:




**Payments
                Due By Period (US$ in thousands)****Contractual
                Obligations**
            
            
            **Total**
            
            
            **Less
                than**
              **1
                year**
            
            
            **1-3**
              **years**
            
            
            **3-5**
              **years**
            
            
            **More**
              **than
                5 years**Operating
              leases
            
            
            3,154
            
            
            1,674
            
            
            1,357
            
            
            123
            
            
            -Total
                contractual cash obligations
            
            
            3,154
            
            
            1,674
            
            
            1,357
            
            
            123
            
            
            -




We
      operate from leased premises mainly in Tel Aviv and Jerusalem in Israel and
      New
      Jersey and California in the United States. We also lease premises for our
      subsidiaries’, representative offices’ and branches’ activities, in several
      locations in the United States, Europe and Asia Pacific. Our aggregate annual
      rent obligations under these leases are approximately $1,674,000 for 2006.
      Our
      aggregate rent expenses paid under our lease obligations for 2005 were
      approximately $1,768,000.




Capital
      expenditures for the years ended December 31, 2003, 2004 and 2005 were
      approximately $1.3 million, $2.4 million and $3.6 million, respectively. These
      expenditures were mainly comprised of machinery and equipment, computers, lab
      equipment and testing tools. We
      are
      currently in the process of purchasing and migrating to a new ERP system. Significant
      expenditures on such system are likely to take place in 2006 and 2007. We may
      have additional capital spending consistent with possible growth in our
      operations, infrastructure and personnel.




35


During
      2005 we generated cash (which was further invested in bank deposits and
      marketable securities) in a net amount of approximately $7.5 million. Cash
      generation derived mainly from our operating activities, from the exercise
      of
      options under our Employees Share Incentive Plan and from the purchase of shares
      under our Employee Stock Purchase Plans, offset by an amount of $9 million
      paid
      in connection with the acquisition of the
      business V-Secure in
      December 2005.




Net
      cash
      provided by operating activities was approximately $13.9 million for the year
      ended December 31, 2005, compared with $ 15.2 million for the year ended
      December 31, 2004 and $9.0 million for the year ended December 31, 2003. Net
      cash provided by operating activities for the years 2005, 2004 and 2003 changed
      primarily due to the changes in our operating profit in these years, as a result
      of our increasing sales and increase in operating expenses - which , for
      example, in 2005 exceeded in its pace the increase in sales. Net cash provided
      by operating activities for the year 2005 consisted primarily of net income
      plus
      an increase in deferred revenues and other payables and accrued expenses, offset
      by an increase in trade receivables and inventories. Net cash provided by
      operating activities for the year 2004 consisted primarily of net income plus
      an
      increase in deferred revenues, offset by an increase in trade receivables and
      inventories. Net cash provided by operating activities for the year 2003
      consisted primarily of net income plus an increase in trade payables and in
      deferred revenues, offset by a decrease in other payables and accrued
      expenses.




Net
      cash
      provided by investing activities was approximately $26.3 million for the year
      ended December 31, 2005, compared to net cash used in investing activities
      of
      approximately $45.0 million for the year ended December 31, 2004, and to net
      cash provided by investing activities of approximately $0.2 million for the
      year
      ended December 31, 2003. Cash was provided in 2005 mainly from redemption of
      long-term bank deposits which was partially offset by the purchase of marketable
      securities and by the acquisition of the business
      of V-Secure Technologies Inc. and other property
      and equipment. Cash was used in 2004 mainly to purchase long-term marketable
      securities and for capital expenditures. Cash was provided in 2003 mainly from
      the redemption of marketable securities, which was almost fully offset by
      investments in long-term bank deposits and purchase of property and equipment.




Net
      cash
      provided by financing activities was $7.3, $6.9 and $6.6 million for the years
      ended December 31, 2005, 2004 and 2003, respectively, generated from options
      exercised by our employees under the Key Employee Share Option Plans and
      Employee Stock Purchase Plans (see Item 6 - *Key
      Employee Share Incentive Plan; 1999 Employee Stock Purchase Plan; 2001 Employee
      Stock Purchase Plan and 2002 Employee Stock Purchase Plan).*




As
      of
      December 31, 2005, we had cash and cash equivalents, including short-term and
      long-term bank deposits and marketable securities of approximately $164.5
      million, as compared to approximately $157.0 million as of December 31, 2004.
      Our capital requirements depend on numerous factors, including market acceptance
      of our products and the resources we allocate to our research and development
      efforts and our marketing and sales activities. Since our inception, we have
      experienced substantial increases in our expenditures consistent with growth
      in
      our operations and personnel, and we may increase our expenditures in the
      foreseeable future in order to execute our strategy. We anticipate that
      operating activities as well as capital expenditures will demand the use of
      our
      cash resources. We believe that cash balances will provide sufficient cash
      resources to finance our operations and the projected expansion of our marketing
      and sales activities and research and development efforts for a period of no
      less than the next twelve months.




36


**Related
      Parties**




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




In
      addition, the Company purchases different services from third parties at special
      rates offered to the RAD-Bynet Group, such as car leases, maintenance, insurance
      and communication services. In the event that we cease to be a member of the
      RAD-Bynet Group, we may not be able to obtain the current rates for such
      services.




**Impact
      of Inflation and Currency Fluctuations** ****




The
      U.S.
      dollar cost of our operations is influenced by the extent to which any increase
      in the rate of inflation in Israel is offset, or is offset on a lagging basis,
      by the devaluation of the NIS in relation to the dollar, if any, and the
      appreciation or depreciation of the Euro to the dollar. Most of our sales are
      denominated in dollars or are dollar-linked and we incur a portion of our
      expenses, principally salaries and related personnel expenses, in Israel -
      in
      NIS, and in Europe - in Euros. An appreciation of the NIS, or, unless offset
      by
      a devaluation of the NIS, inflation in Israel, will have a negative effect
      on
      our profitability. Conversely, devaluations of the NIS relative to the dollar
      at
      a rate in excess of the rate of inflation in Israel could have a positive effect
      on our profitability. In 2004 we began selling to the European Union countries
      in Euros instead of dollars in order to reduce the exposure to fluctuations
      in
      the Euro exchange rate. We are still exposed to the risk of an appreciation
      of
      the Euro in the event our expenses in Euros exceed our sales in Euros. In
      addition, if the Euro devaluates relative to the dollar and sales in Euros
      exceed expenses incurred in Euros, our operating profit may be negatively
      affected as a result of a decrease in the dollar value of our
      sales.




The
      following table presents information about the rate of inflation in
      Israel:




**Year
                ended December 31,**
            
            **Israeli
                inflation rate %**2001
            
            1.42002
            
            6.52003
            
            (1.9)2004
            
            1.22005
            
            2.4






We
      cannot
      assure you that we will not be materially and adversely affected in the future
      if inflation in Israel exceeds the devaluation of the NIS against the dollar
      or
      if the timing of the devaluation lags behind inflation in Israel, or if there
      will be a revaluation of the NIS or a revaluation or devaluation of the Euro
      against the Dollar. Because exchange rates between the NIS and the dollar and
      between the Euro and the dollar fluctuate continuously, exchange rate
      fluctuations and especially larger periodic devaluations or revaluations will
      have an impact on our profitability and period-to-period comparisons of our
      results. The effects of foreign currency re-measurements are reported in our
      consolidated financial statements in the statement of operations.




37


**Market
      Risk**




We
      do not
      invest in, or otherwise hold, for trading or other purposes, any financial
      instruments subject to market risk, with the exception of the following:
      Approximately 6% of our investment portfolio is invested in a structured note
      with guaranteed principal and changing interest. An increase in short-term
      interest rates will negatively affect the income received from this note.
      Approximately 53% of our investment portfolio is invested in high-rated
      marketable securities, mainly U.S. government agency bonds, and corporate bonds.
      Since these investments carry fixed interest rates, interest income over the
      holding period is not sensitive to changes in interest rates. We have no
      debt.






38


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




**Directors
      and Senior Management**




The
      following table lists our current directors and executive officers:







**Name**
            
            **Age**
            
            **Position**Yehuda
                Zisapel(1)
            
            63
            
            Chairman
                of the Board of DirectorsRoy
                Zisapel(2)
            
            35
            
            Chief
                Executive Officer, President and DirectorMeir
                Moshe
            
            52
            
            Chief
                Financial OfficerLarry
                Marino
            
            48
            
            President,
                Radware Inc.Vered
                Raviv-Schwarz
            
            36
            
            General
                Counsel and SecretaryMichelle
                Blank
            
            51
            
            Chief
                Marketing OfficerAlexandre
                Bertuzzi
            
            35
            
            Vice
                President, Sales EMEAAmir
                Peles
            
            34
            
            Vice
                President, Chief Technology OfficerAsaf
                Ronen
            
            32
            
            Vice
                President, Research and DevelopmentYiftach
                Atir(1)(3)(4)
            
            56
            
            DirectorAvigdor
                Willenz(1)(3)(4)
            
            49
            
            DirectorChristopher
                McCleary (4)(5)
            
            53
            
            DirectorLiora
                Katzenstein (2)(4)
            
            50
            
            DirectorKenneth
                E. Sichau (4) (5)
            
            51
            
            DirectorHagen
                Hultzsch (5)
            
            65
            
            Director





(1)
      Term
      as director expires at the annual meeting of shareholders to be held in
      2006.


(2)
      Term
      as director expires at the annual meeting of shareholders to be held in
      2007.


(3)
      External Director, as defined in the Israeli Companies Law.


(4)
      Qualified as an Independent Director, as determined under the Nasdaq rules,
      and
      serves on the Audit Committee of the Board of Directors.


(5)
      Term
      as director expires at the annual meeting of shareholders to be held in
      2008.





**Yehuda
      Zisapel** ,
      co-founder of our company, has served as our Chairman of the Board of Directors
      since our inception. Mr. Zisapel also serves as a director of Radware Inc.
      Mr.
      Zisapel is also a founder and a director of RAD Data Communications Ltd., a
      worldwide data communications company headquartered in Israel, and BYNET Data
      Communications Ltd., a distributor of data communications products in Israel,
      Chairman of the Board of Directors of RIT Technologies Ltd., and a director
      of
      other companies in the RAD-Bynet Group, including SILICOM Ltd., and several
      private companies. Mr. Zisapel has a B.Sc. and an M.Sc. degree in electrical
      engineering as well as an Award of Honorary Doctorate (DHC-Doctor Honoris Causa)
      from the Technion, Israel Institute of Technology and an M.B.A. degree from
      Tel
      Aviv University. Yehuda Zisapel is the father of Roy Zisapel.




**Roy
      Zisapel** ,
      co-founder of our company, has served as our President and Chief Executive
      Officer and a director since our inception. Mr. Zisapel also serves as a
      director of Radware Inc. and other subsidiaries. From February 1996 to March
      1997, Mr. Zisapel was a team leader of research and development projects for
      RND
      Networks Ltd. From July 1994 to February 1996, Mr. Zisapel was employed as
      a
      software engineer for unaffiliated companies in Israel. Mr. Zisapel serves
      as a
      director in Infogate On Line Ltd. Mr. Zisapel has a B.Sc. degree in mathematics
      and computer science from Tel-Aviv University. Roy Zisapel is the son of Yehuda
      Zisapel.




**Meir
      Moshe** has
      served as our Chief Financial Officer since June 1999. From June 1997 to June
      1999, Mr. Moshe was Chief Financial Officer, Secretary and Treasurer of ForSoft
      Ltd. Mr. Moshe holds a B.Sc. in economics and accounting from Tel Aviv
      University and is a certified public accountant.




39


**Larry
      Marino** joined
      us
      in January 2006 as President of Radware, Inc. Previously, Mr. Marino held
      various executive positions at AT&T with over 25 years of experience in the
      telecommunications industry. Mr. Marino holds a BS in Electrical Engineering
      from Worcester Polytechnic Institute and an MBA from the University of
      Pennsylvania, Wharton School.




**Vered
      Raviv-Schwarz** has
      served as our General Counsel since July 2000. From May 1995 to June 2000,
      Mrs.
      Raviv-Schwarz was an Associate at the law firm M. Seligman & Co. Mrs.
      Raviv-Schwarz has LL.B. and LL.M degrees from Tel Aviv University.




**Michelle
      Blank** was
      appointed Chief Marketing Officer in August 2005. Dr. Blank has 25
      years
      of experience building businesses around commercializing innovative new
      technologies. From 1997 to 2001 Dr. Blank was at RADVISION where she held the
      positions of  Senior VP of Global Marketing and President of RADVISION,
      Inc. From 2002 through 2005 she was engaged in private consulting work. She
      began her career in 1981 at Bell Laboratories. She left in 1984 to pursue her
      entrepreneurial interest working with early stage companies. Dr. Blank holds
      a
      BA in Communication Arts & Sciences/Psychology from Queens College of the
      City University of New York and a Ph.D in Cognitive Science from the University
      of Texas.




**Alexandre
      Bertuzzi** has
      served as our Vice President EMEA since January 2002. From January 2000 to
      December 2002, Mr. Bertuzzi served as our Regional Director for France and
      Benelux. Prior to joining us, Mr. Bertuzzi had various sales and management
      positions within networking companies such as Cabletron Systems and Fore Systems
      (known as “Marconi” since 1999). **** Mr.
      Bertuzzi has a degree in computer science from EPITA (Ecole Pour L’Informatique
      et le Techniques Avancees)..




**Amir
      Peles** has
      served as our Vice President, Chief Technology Officer since April 2000. Prior
      to that, Mr. Peles was our Vice President of Research and Development since
      July
      1997. From July 1996 to July 1997, Mr. Peles was a senior team leader at Amdocs
      Corporation. Mr. Peles has a B.Sc. degree in computer science, statistics and
      operations research from Tel Aviv University.




**Assaf
      Ronen** has
      served as our Vice President of Research and Development since April 2000.
      From
      February 1997 to April 2000, Mr. Ronen served as a senior program manager at
      Comverse Network Systems. Prior to February 1997, Mr. Ronen served in various
      positions in the Israel Defense Forces Computers Unit. Mr. Ronen has a B.Sc.
      degree in computer science from the Israeli Open University and an M.B.A. from
      Manchester University.




**Yiftach
      Atir** has
      served as a director since November 1997. Since January 2003, Mr. Atir has
      been
      a private consultant in the field of investments and investment banking. From
      August 2000 until January 2003, Mr. Atir served as the managing director of
      Koor
      Corporation Venture Capital. Until July 2000, Mr. Atir served as a managing
      director in Evergreen Venture Capital Funds, a management company for a group
      of
      technology focused venture capital funds, where he had been employed since
      November 1994. Prior to joining Evergreen, Mr. Atir served as a Brigadier
      General in the Intelligence Corps of the Israel Defense Forces. Mr. Atir also
      serves as a director in Aran Industries Ltd *.* Mr.
      Atir
      has a B.A. in political science from Haifa University and an M.B.A. from Tel
      Aviv University.




**Avigdor
      Willenz** has
      served as a director since October 1999. From November 1992 until January 2001,
      Mr. Willenz served as Chief Executive Officer and Chairman of the Board of
      Directors of Galileo Technology Ltd. During the years 2001-2002, Mr. Willenz
      served as a director in Marvell ® Technology Group Ltd. Mr. Willenz currently serves as a director in both UCLT
      Ltd. and Wintegra Inc. Mr. Willenz holds a B.S.E.E. from the Technion, Israel
      Institute of Technology.




**Christopher
      McCleary** has
      served as a director since February 2000. Mr. McCleary is currently a Venture
      Partner at Blue Chip Venture Company. He was previously the founder, Chairman
      and CEO of Evergreen Assurance, Incorporated. Mr. McCleary was previously
      non-executive Chairman of USinternetworking Inc. and served as the Chairman
      and
      Chief Executive Officer of USi from January 1998 until June 2000. Prior to
      founding USi, he was the Chairman and Chief Executive Officer of DIGEX, Inc.
      from January 1996 to December 1997. From October 1990 to January 1996, Mr.
      McCleary served as Vice President and General Manager for Satellite Telephone
      Service at American Mobile Satellite Corporation, a satellite communications
      company. Mr. McCleary serves as a director in JackBe, Inc. and in Digital 5,
      Inc.. Mr. McCleary has a BGS from the University of Kentucky.




40


**Liora
      Katzenstein** has
      served as a director since January 2001. In 1996 Prof. Katzenstein founded
      and
      has since served as President of ISEMI - Israel School of Entrepreneurial
      Management and Innovation (Part of Swinburne University of Technology’s
      (Australia) Graduate School of Entrepreneurship). Prof. Katzenstein also
      lectured in Business Administration at the Harvard Business School, Tel Aviv
      University, Nanyang Technological University (Singapore), the Technion, Israel
      Institute of Technology and in the Israeli Management Center. From 1995 to
      1996
      Prof. Katzenstein was an associate Dean at TISOM - Tel Aviv International School
      of Business, and from 1992 to 1995 she was a Senior Lecturer at the Tel Aviv
      University Recanati Graduate School of Business Administration. Prof.
      Katzenstein also serves as a director in Radvision Ltd., RiT Technologies Ltd.
      and OTI Ltd. Prof. Katzenstein has a ‘License’ and a Ph.D. in International
      Economics from the Graduate Institute of International Studies, University
      of
      Geneva, and an MALD in Law and Diplomacy from the Fletcher School of Law and
      Diplomacy, Tufts University.




**Kenneth
      E. Sichau** has
      served as a director since October 2004. Mr. Sichau is a seventeen year veteran
      of the telecommunications industry, having held senior leadership positions in
      sales, marketing, product management and operations. Most recently he was
      President, AT&T Business Sales for AT&T where he was an EVP and a member
      of AT&T’s Executive Committee. He retired from AT&T in 2003. Prior to
      AT&T, he was a Vice President of Business Development at Marriott
      Corporation. Currently Mr. Sichau serves as a management advisor to small and
      mid- size companies. Mr. Sichau is a veteran of the U.S. Navy, where he served
      as a Naval Aviator. He holds a BS from the US Naval Academy and a MBA from
      Harvard Business School.




**Hagen
      Hultzsch** has
      served as a director since January, 2005. Dr. Hultzsch served on the Board
      of
      Management of Deutsche Telekom AG from 1993 until 2001. Since 2001, Dr.
      Hultzsch has served on the Boards or Advisory Boards of
      several companies and academic institutions. As of March 2005, he
      serves as a Board Member in the following companies: InSynCo AG,
      VoiceObjects Inc., VoiceObjects GmbH, T-Systems Solutions for Research, ICANN
      Inc., TranSwitch Corporation Inc., SCM-Microsystems Inc., RIT Ltd., Aspect
      Corporate Advisors, EUTEX AG, SUP Consultants, Convergys Inc., Communardo
      Software GmbH, TVM GmbH, XTraMind Technologies GmbH, Narus Corporation Inc.,
      Actelis Networks Inc., Axerra Networks, Ceragon Networks, International Club
      La
      Redoute Bonn. Dr. Hultzsch holds a PhD. from Mainz
      University **.**




Except
      as
      described above, there are no family relationships between any of the directors
      or members of senior management named above.




Under
      Nasdaq National Market requirements, commencing July 31, 2005, a majority of
      the
      members of our
      board
      of directors are
      required to be “independent,” as defined thereunder. We currently satisfy this
      requirement as Mr. Chris McCleary, Mr. Yiftach Atir, Mr. Avigdor Willenz, Prof.
      Liora Katzenstein, Mr. Kenneth Sichau and Dr .
      Hagen
      Hultzsch, i.e., six out of of our eight directors, qualify as independent
      directors under such Nasdaq rules.




**Compensation**




Under
      our
      articles of association, no director may be paid any remuneration by the company
      for his services as director except as may be approved pursuant to the
      provisions of the Companies Law, which generally require the approval of the
      Audit Committee, the Board of Directors and then the approval of the
      shareholders of the company, in that order. An external director is entitled
      to
      consideration and reimbursement of expenses only as provided in regulations
      promulgated under the Israeli Companies Law and is otherwise prohibited from
      receiving any other compensation, directly or indirectly, in connection with
      his
      service as an external director.




The
      following table sets forth all compensation we paid with respect to all of
      our
      directors and officers as a group for the year ended December 31, 2005. The
      table does not include any amounts we paid to reimburse any of our affiliates
      for costs incurred in providing us with services during such period.




41


**Salaries,
                fees, commissions and bonuses**
            
            **Pension,
                retirement**
              **and
                other similar benefits**All
                directors and officers as a group, consisting of 15
                persons
            
            $
            1,510,000
            
            $
            128,000




As
      of
      April 24, 2006, our directors and officers as a group, consisting of 13 persons,
      held options to purchase an aggregate of 1,610,000 ordinary shares. Other than
      reimbursement for expenses and grant of options to purchase shares of the
      Company, during fiscal year 2005, we did not compensate our directors for
      serving on our board of directors.




Each
      of
      our independent directors, including our external directors, is granted options
      to purchase 10,000 ordinary shares for each year of service. This grant was
      approved by our shareholders.




During
      2005, we granted to our directors and officers options to purchase 125,000
      ordinary shares, in the aggregate, at a weighted average exercise price of
      $17.08. The options expire sixty-two months after grant.




**Board
      Practices**




**Introduction**




According
      to the Israeli Companies Law and our articles of association, the oversight
      of
      the management of our business is vested in our board of directors. The board
      of
      directors may exercise all powers and may take all actions that are not
      specifically granted to our shareholders. As part of its powers, our board
      of
      directors may cause us to borrow or secure payment of any sum or sums of money
      for our purposes, at times and upon terms and conditions as it determines,
      including the grant of security interests in all or any part of our property.




Our
      articles of association provide for a board of directors of not less than five
      and not more than nine directors. Currently, our board consists of eight
      directors, including the external directors (as described below). In accordance
      with current
      Nasdaq National Market requirements, nominees for election as directors are
      approved and recommended to the board by a decision of a majority of our
      independent directors. Under
      an
      amendment to the Israeli Companies Law, our board of directors is required
      to
      determine, by April 19, 2006, the minimum number of directors who must have
      “accounting and financial expertise” (as such term is defined in regulations
      promulgated under the Companies Law).




Since
      our
      ordinary shares are listed for quotation on the Nasdaq National Market, we
      are
      subject to the rules of the Nasdaq National Market applicable to listed
      companies. In addition, since we are incorporated as an Israeli company, we
      are
      subject to the provisions of the Israeli Companies Law and the regulations
      adopted thereunder.




**Staggered
      Board**




In
      accordance with the terms of our articles of association, our board of directors
      (other than our external directors) is divided into three classes with each
      class serving until the third annual meeting following their election as
      follows:




**Class***
            
            **Term
                expiring at**
              **the
                annual meeting**
              **for
                the year**
            
            **Directors**Class
                I
            
            2006
            
            Yehuda
                ZisapelClass
                II
            
            2007
            
            Roy
                Zisapel and Prof. Liora KatzensteinClass
                III
            
            2008
            
            Christopher
                McCleary, Ken Sichau, Hagen
                Hultzsch




42


At
      each
      annual meeting of shareholders after the initial classification, the successors
      to directors whose terms will then expire will be elected to serve from the
      time
      of election and qualification until the third annual meeting following the
      election. Directors, other than external directors, are elected by a simple
      majority of the votes cast, whereas their removal from office requires the
      vote
      of a majority of at least seventy-five percent of the voting power represented
      at the general meeting. Any additional directorships resulting from an increase
      in the number of directors will be distributed among the three classes so that,
      as nearly as possible, each class will consist of one-third of the directors.
      This classification of our board of directors may have the effect of delaying
      or
      preventing changes in control or management of our company.




The
      above
      classification does not apply to Messrs. Avigdor Vilenz and Yiftach Atir, who
      were appointed as external directors whose term of appointment ends in
      2006.




**External
      Directors**




*Qualifications
      of External Directors*




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




·
            the
                company;




·
            any
                entity controlling the company; or




·
            any
                entity controlled by the company or by this controlling
                entity.




The
      term
      affiliation includes:




·
            an
                employment relationship;




·
            a
                business or professional relationship maintained on a regular
                basis;




·
            control;
                and




·
            service
                as an office holder, excluding service as a director that was appointed
                to
                serve as an external director of a company that is about to make
                its
                initial public offering.




The
      Companies Law defines the term “office holder” of a company to include a
      director, the chief executive officer, the chief financial officer, a vice
      president and any officer of the company that reports directly to the chief
      executive officer.




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




*Election
      of External Directors*




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




·
            At
                least one third of the shares of non-controlling shareholders voted
                at the
                meeting in favor of the election;
                or




·
            The
                total number of shares voted against the election of the external
                director
                does not exceed one percent of the aggregate voting rights in the
                company.




43




The
      initial term of an external director is three years and may be extended for
      one
      additional three year term. External directors may be removed from office only
      by the vote of the same percentage of shareholders as is required for their
      election, or by a court only if they cease to meet the statutory qualifications
      for appointment or if they violate their duty of loyalty to the company. Each
      committee of a company's board of directors is required to include at least
      one
      external director, except for the audit committee which is required to include
      all the external directors.




Currently,
      Messrs. Yiftach Atir and Avigdor Vilenz qualify as external directors under
      the
      Companies Law and were elected by the general shareholders meeting held in
      June
      2000, to serve as our external directors, and were re-elected to an additional
      three-year term in June of 2003.




Pursuant
      to an amendment to the Companies Law, effective as of January 19, 2006, (1)
      an
      external director must have
      either “accounting and financial expertise” or “professional qualifications” (as
      such terms are defined in regulations promulgated under the Companies Law)
      and
      (2) at least one of the external directors must have “accounting and financial
      expertise.” These requirements will apply to us upon the election of
      one or more  external directors.




Our
      Committees




The
      board
      of directors appoints committees to help carry out its duties. Each committee
      reviews the results of its meetings with the full board of directors. The board
      of directors established its Audit and Share Incentive Committees in 1999,
      and
      its Compensation Committee (which replaced the Share Incentive Committee) in
      2004. Only non-employee directors serve on our Audit Committee and Compensation
      Committee.




**Audit
      Committee**




*Nasdaq
      Requirements*




Our
      ordinary shares are listed for quotation on the Nasdaq National Market and
      we
      are subject to the rules of the Nasdaq National Market applicable to listed
      companies. Under the
      Nasdaq rules, we are required to have an audit committee consisting of at least
      three independent directors, all of whom are financially literate and one of
      whom has accounting or related financial management expertise. The members
      of
      the Audit Committee, Mr. Chris McCleary, Mr. Yiftach Atir, Mr. Avigdor Willenz,
      Prof. Liora Katzenstein, and Mr. Kenneth Sichau qualify as independent directors
      under the current Nasdaq National Market requirements. In accordance with Nasdaq
      rules, the Audit Committee has adopted a charter.




The
      Audit
      Committee assists the board in fulfilling its responsibility for oversight
      of
      the quality and integrity of our accounting, auditing and financial reporting
      practices and financial statements and the independence qualifications and
      performance of our independent auditors. The Audit Committee also has the sole
      authority and responsibility to select, evaluate and, where appropriate,
      recommend to replace the independent auditors (or to nominate the independent
      auditors subject to shareholder approval) and to pre-approve audit engagement
      fees and all permitted non-audit services and fees.




The
      Audit
      Committee met five times during fiscal year 2005. Mr. Yiftach Atir, Mr. Kenneth
      Sichau, Mr. Christopher McCleary and Mr. Avigdor Willenz attended all of the
      Audit Committee meetings and Prof. Liora Katzenstein attended four of the
      meetings.






*Israeli
      Companies Law Requirements*




Under
      the
      Companies Law, our board of directors is required to appoint an audit committee,
      comprised of at least three directors including all of the external directors,
      but excluding:




·
            the
                chairman of the board of directors;
                and




·
            a
                controlling shareholder or a relative of a controlling shareholder
                and any
                director employed by the company or who provides services to the
                company
                on a regular basis.




In
      accordance with the Companies Law, the duty of our audit committee is, in
      addition to the requirements imposed by Nasdaq rules (1) to identify
      irregularities in the business management of the company, including in
      consultation with the internal auditor and/or the company's independent
      accountants, and to recommend remedial measures to the board, and (2) to review,
      and, where appropriate, approve certain interested party transactions specified
      under the Companies Law, as more fully described below. Our Audit Committee
      consists of our external directors, and three additional directors, Mr.
      Christopher McCleary, Prof. Liora Katzenstein and Mr. Kenneth Sichau.




44




*Approval
      of Interested Party Transactions*




The
      approval of the audit committee is required under the Israeli Companies Law
      to
      effect specified actions and transactions with office holders, controlling
      shareholders and entities in which they have a personal interest. An audit
      committee may not approve an action or a transaction with interested parties
      or
      with an office holder unless at the time of approval the two external directors
      are serving as members of the audit committee and at least one of whom was
      present at the meeting in which an approval was granted. The Companies Law
      defines the term “interested party” to include a person who holds 5% or more of
      the company’s outstanding share capital or voting rights, a person who has the
      right to appoint one or more directors or the general manager, or any person
      who
      serves as a director or as the general manager.




**Compensation
      Committee**




Our
      compensation committee consists of our independent directors, Messrs. Kenneth
      Sichau, Chris McCleary and Avigdor Willenz. On March 8, 2005, our compensation
      committee adopted a charter, which sets forth the committee’s responsibilities.
      Pursuant to the charter, the compensation committee is authorized to make
      decisions regarding executive compensation and terms and conditions of
      employment, to follow
      market trends and provide recommendations to the board of directors in
      connection with the Company’s general compensation philosophy and policies, as
      well
      as to recommend that the board of directors issue options under our stock option
      plans .




**Internal
      Auditor**




Under
      the
      Companies Law, the board of directors of a public company must appoint an
      internal auditor proposed by the audit committee. The role of the internal
      auditor is to examine, among
      other things ,
      whether
      the company's conduct complies with applicable law and orderly business
      procedure. The internal auditor may participate in all audit committee meetings
      and has the right to demand that the chairman of the audit committee convene
      a
      meeting. Under the Companies Law, the internal auditor may be
      an
      employee of the company but may not
      be an
      interested party, an office holder or a relative of any of the foregoing, nor
      may the internal auditor be the company's independent accountant or its
      representative. Mr. Gideon Duvshani, CPA, was our internal auditor until the
      end
      of 2005, and in December 2005, we have appointed Mrs. Sharon Vitkovski-Tabib,
      CPA, of BDO Ziv Haft, CPAs, as our internal auditor.




**Approval
      of Specified Related Party Transactions Under Israeli Law**




*Fiduciary
      Duties of Office Holders*




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




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




·
            Information
                regarding the advisability of a given action submitted for his approval
                or
                performed by him by virtue of his position; and




·
            All
                other important information pertaining to these
                actions.




The
      duty
      of loyalty of an office holder includes a duty to:




·
            Refrain
                from any conflict of interest between the performance of his duties
                in the
                company and the performance of his other duties or his personal affairs;




·
            Refrain
                from any activity that is competitive with the
                company;




45




·
            Refrain
                from exploiting any business opportunity of the company to receive
                a
                personal gain for himself or others;
                and




·
            Disclose
                to the company any information or documents relating to a company's
                affairs which the office holder has received due to his position
                as an
                office holder.




*Disclosure
      of Personal Interest of an Office Holder*




The
      Companies Law requires that an office holder of a company disclose to the
      company any personal interest that he may have and all related material
      information known to him, in connection with any existing or proposed
      transaction by the company. The disclosure is required to be made promptly
      and
      in any event no later than the board of directors meeting in which the
      transaction is first discussed. If the transaction is an extraordinary
      transaction, the office holder’s duty to disclose also applies to a personal
      interest of a relative of the office holder.




Under
      the
      Companies law, an extraordinary transaction is a transaction:




·
            Other
                than 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.




Once
      an
      office holder complies with the above disclosure requirement, the board of
      directors may approve a transaction between the company and an office holder,
      or
      a third party in which an office holder has a personal interest unless the
      articles of association provide otherwise. Nevertheless, a transaction that
      is
      adverse to the company's interest may not be approved.




If
      the
      transaction is an extraordinary transaction, approval is required of both the
      audit committee and the board of directors, in that order. Under specific
      circumstances, shareholder approval may also be required. A director who has
      a
      personal interest in a matter which is considered at a meeting of the board
      of
      directors or the audit committee may not be present at this meeting or vote
      on
      this matter, unless a majority of the members of the board of directors or
      the
      audit committee, as the case may be, has a personal interest in the matter.
      If a
      majority of members of the board of directors have a personal interest therein,
      shareholder approval is also required.




Under
      the
      Companies Law, all arrangements as to compensation of directors in public
      companies such as ours generally require the approvals of the audit committee,
      the board of directors and the shareholders, in that order.




*Disclosure
      of Personal Interests of a Controlling Shareholder*




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




·
            At
                least one-third of the shares of shareholders who have no personal
                interest in the transaction, and who are present and voting (in person,
                by
                proxy or by written ballot) vote in favor thereof;
                or




·
            The
                shareholders who have no personal interest in the transaction who
                vote
                against the transaction do not represent more than one percent of
                the
                voting power in the company.




Shareholders
      generally have the right to examine any document in the company's possession
      pertaining to any matter that requires shareholder approval.




46




*General
      Duties of Shareholders*




Under
      the
      Companies Law, each shareholder has a duty to act in good faith in exercising
      his rights and fulfilling his obligations toward the company and other
      shareholders and to refrain from abusing his power in the company, such as
      shareholder votes. Furthermore, specified shareholders have a duty of fairness
      toward the company. These shareholders include any controlling shareholder,
      any
      shareholder who knows that he/it possesses the power to determine the outcome
      of
      a shareholder vote, and any shareholder who, pursuant to the provisions of
      the
      articles of association, has the power to appoint or to prevent the appointment
      of an office holder or any other power toward the company. However, the
      Companies Law does not define the substance of this duty of
      fairness.




**Founders’
      Agreement**




On
      April
      1, 1997, we entered into an agreement with our founders, Messrs. Zohar, Yehuda
      and Roy Zisapel, pursuant to which Roy Zisapel agreed to serve as our chief
      executive officer for a period of no less than five years. In consideration
      for
      his services:




·
            We
                agreed to pay Roy Zisapel an annual salary of approximately $44,000,
                plus
                benefits, including contributions to a managers’ insurance policy (his
                salary was increased in 2000 and 2001 and is now approximately $120,000,
                plus benefits); and




·
            We
                granted Roy Zisapel options under our share option plan equal to
                9.9% of
                the total amount of our issued and outstanding share capital as of
                April
                1997.




In
      addition, the agreement provides that Roy Zisapel may not compete with us or
      disclose to third parties information pertaining to our business for a period
      ranging from twelve to thirty months from the date of termination of his
      employment, depending on the length of his term of employment with
      us.




**Employees**




At
      the
      time of commencement of employment, our employees in North America generally
      sign offer letters specifying basic terms and conditions of employment, and
      our
      employees in Israel generally, including our executive officers, sign standard
      written employment agreements, which include confidentiality and non-compete
      provisions. The employees in our subsidiaries sign employment agreements which
      differ according to the country in which they are located.




As
      of
      December 31, 2005, we had 432 employees worldwide, of whom 191 ** were
      based in Israel, 118 were based in the United States and 123 were based in
      our
      other subsidiaries and offices. Of these 432 employees, 122 were employed in
      research and development, 243 were employed in sales, technical support and
      marketing, and 67 were employed in management, operations and administration.




We
      are
      subject to Israeli labor laws and regulations with respect to our Israeli
      employees. These laws principally concern matters such as paid annual vacation,
      paid sick days, length of the workday and work week, minimum wages, pay for
      overtime, insurance for work-related accidents, severance pay and other
      conditions of employment.




Furthermore,
      we and our Israeli employees are subject to provisions of the collective
      bargaining agreements between the Histadrut, the General Federation of Labor
      in
      Israel, and the Coordination Bureau of Economic Organizations, including the
      Industrialists Association, by order of the Israeli Ministry of Labor and
      Welfare. These provisions principally concern cost of living increases,
      recreation pay and other conditions of employment. We provide our employees
      with
      benefits and working conditions above the required minimums. Our employees
      are
      not represented by a labor union. To date, we have not experienced any work
      stoppages.




The
      employees of our subsidiaries are subject to local labor laws, regulations
      and/or collective bargaining agreements that vary from country to
      country.




47


**Share
      Ownership**




The
      following table sets forth certain information regarding the beneficial
      ownership of our ordinary shares by our directors and officers as of April
      24,
      2006. The percentage of outstanding ordinary shares is based on 19,429,319
      ordinary shares outstanding as of April 24, 2006.




**Name**
            
            **Number
                of ordinary**
              **shares**
            
            **Percentage
                of**
              **outstanding**
              **ordinary
                shares**Yehuda
                Zisapel
            
            2,597,477(1)
            
            13.35%Roy
                Zisapel
            
            1,157,584
                (2)
            
            5.75%Meir
                Moshe
            
            286,165(3)
            
            1.45%All
                directors and executive officers as a group (13 persons)
                (4)(5)
            
            4,337,005
            
            18.25%




(1)
            Consists
                of 2,577,477 shares and 20,000 options which are fully vested at
                the date
                of this Annual Report.(2)
            Consists of 457,584 shares and 700,000
              options which are fully vested or will be vested in the 60 days following
              the date of this Annual Report.(3)
            Consists
                of 36,165 shares and 250,000 options which are fully vested or which
                will
                be fully vested within the next 60 days.(4)
            Consists
                of 3,079,505 shares and 1,257,500 options which are fully vested
                or which
                will be fully vested within the next 60 days.(5)
            Each
                of the directors and executive officers not separately identified
                in the
                above table beneficially own less than 1% of our outstanding ordinary
                shares (including options held by each such party, and which are
                vested or
                shall become vested within 60 days of the date of this Annual Report)
                and
                have therefore not been separately disclosed.




**Key
      Employee Share Incentive Plan**




In
      June
      1997, we adopted our Key Employee Share Incentive Plan (1997). Options granted
      pursuant to our share option plan are for a term of sixty-two months from the
      date of the grant of the option. As of December 31, 2005, 7,474,484 ordinary
      shares have been reserved for option grants under the plan, of which we have
      granted options to purchase 6,964,185 ordinary shares, at a weighted average
      exercise price of $10.93 per ordinary share. The amount of reserved shares
      includes an increase of the number of shares reserved under the plan in an
      amount of 3% of our issued and outstanding stock, plus 60,000 additional shares,
      approved by the annual shareholders meeting held on December 11, 2005. We intend
      to grant further options under our share option plan to our executive officers
      and employees. In light of the new accounting standard SFAS No. 123(R), however,
      we may amend our option plan, reduce the number of options granted to the
      employees or suggest alternative compensation schemes. In 2006 we intend to
      reduce the number of options granted to each employee.




Our
      share
      option plan is administered by the compensation committee of our board of
      directors. Pursuant to the plan, the committee has the authority to determine
      (subject to applicable law), or advise the board of directors, in its
      discretion:




·
            The
                persons to whom options are granted;




·
            The
                number of shares underlying each options award;




·
            The
                time or times at which the award shall be made;




·
            The
                exercise price, vesting schedule and conditions pursuant to which
                the
                options are exercisable; and




·
            Any
                other matter necessary or desirable for the administration of the
                plan.




48


Pursuant
      to our share option plan, all options, or shares issued upon exercise of
      options, are held in trust and registered in the name of a trustee which was
      selected by the share incentive committee. The trustee will not release the
      options or ordinary shares to the option holder before the options are vested
      (unless pre-approved by us) or before the lapse of a longer period if so
      required under local tax laws and regulations. Our board of directors may
      terminate or amend our share option plan, provided that any action by our board
      of directors which will alter or impair the rights of an option holder requires
      the prior consent of that option holder.




In
      order
      to comply with the provisions of Section 102 of the Israeli Income Tax Ordinance
      [New Version], 1961 (the “Ordinance”), which was amended in January 2003, on
      March 5, 2003, our board of directors adopted an addendum to our share option
      plan with respect to options granted on or after January 1, 2003 to grantees
      who
      are residents of Israel (the “Addendum”). The Addendum does not add to nor
      modify our share option plan in respect to grantees that are not residents
      of
      Israel.




**Directors
      and Consultants Option Plan**




On
      February 18, 2000 we adopted a Directors and Consultants Option Plan. Options
      granted pursuant to our share option plan are for a term of sixty-two months
      from the date of the grant of the option. The terms of the Directors and
      Consultants Option Plan are similar to the terms of the Key Employee Share
      Incentive Plan. The shares reserved for the Key Employee Share Incentive Plan
      provide for the Directors and Consultants Option Plan as well, and the same
      Compensation Committee administers the two plans. The Compensation Committee
      may
      not grant options to members of the Committee or to a shareholder of over 10%
      of
      our issued and outstanding shares. The shares reserved for the 1997 Key Employee
      Share Incentive Plan, are also used for option grants under the Directors and
      Consultants Option Plan.




**Employee
      Stock Purchase Plans**




The
      Company's Board of Directors adopted three Employee Share Purchase Plans (the
      "ESPP"), during the years 2000, 2001 and 2002, which provided for the issuance
      of a maximum of 750,000, 200,000 and 300,000 ordinary shares, respectively.
      Pursuant to the ESPPs, eligible employees could have up to 10% of their net
      income withheld, up to certain maximums, to be used to purchase our ordinary
      shares. The ESPPs were implemented with purchases once in every six-month
      period. The price of each ordinary share purchased under the ESPP was equal
      to
      85% of the lower of the fair market value of the ordinary share at the
      commencement date of each offering period or on the semi-annual purchase date
      pursuant to the plans. During 2005, 69,639 shares were issued under the ESPPs
      for an aggregate consideration of $ 1,161,000. As of November 2005,
      a ll
      three
      ESPPs were terminated by our Board.




49




**ITEM
      7.** **Major
      Shareholders and Related Party Transactions**




**A.** **Major
      Shareholders**




The
      following table sets forth certain information regarding the beneficial
      ownership of our ordinary shares as of April 24, 2006, by each person or entity
      known to own beneficially more than 5% of our outstanding ordinary shares based
      on information provided to us by the holders or disclosed in public filings
      with
      the Securities and Exchange Commission. The voting rights of all major
      shareholders are the same as for all other shareholders.




**Name**
            
            **Number
                of ordinary**
              **shares**
            
            **Percentage
                of**
              **outstanding
                ordinary**
              **shares**Yehuda
                Zisapel (1)
            
            2,597,477
            
            13.35%Roy
                Zisapel (2)
            
            1,157,584
            
            5.75%Artizan
                Partners Limited Partnership
              Artizan
                Investment Corporation
              Andrew
                A. Ziegler
              Carlene
                Murphy Ziegler (3)
            
            1,398,900
            
            7.2%FMR
                Corp. (4)
            
            975,100
            
            5.02%




(1)
      Includes 295,000  ordinary
      shares owned of record by Carm-AD Ltd., an Israeli company, which is controlled
      by Yehuda Zisapel, and 20,000 options which are fully vested at the date of
      this
      Annual Report.




(2)
      Includes 457,584 shares and 700,000 options which are fully vested or will
      be
      vested in the 60 days following the date of this Annual Report.




(3)
      Artizan Partners Limited Partnership (“Artizan Partners”) is an investment
      adviser registered under section 203 of the Investment Advisers Act of 1940;
      Artizan Investment Corporation is the General Partner or Artizan Partners;
      Mr.
      Ziegler and Ms. Ziegler are the principle stockholders of Artisan Investment
      Corporation. This information is based on FMR’s Form 13-G filing on January 27,
      2006.




(4)
      Includes 681,300 shares beneficially owned by Fidelity Management & Research
      Company, a wholly owned subsidiary of FMR Corp., as a result of acting as an
      investment advisor to various investment companies registered under Section
      8 of
      the Investment Company Act of 1940. **** 45,100
      shares are beneficially owned by Fidelity Management Trust Company, a wholly
      owned subsidiary of FMR Corp., and a bank as defined in Section 3(a)(6) of
      the
      Securities Exchange Act of 1934, as a result of its serving as an investment
      manager of institutional accounts. The remaining 248,700 shares are held by
      Fidelity International Limited, an investment advisor to various investment
      companies, and various foreign-based subsidiaries. This
      information is based on FMR’s Form 13-G filing on February 14,
      2006.




**B.** **Related
      Party Transactions**




We
      have
      entered into a number of agreements with certain companies, of which Yehuda
      and
      Zohar Zisapel are co-founders, directors and/or principal stockholders,
      collectively known as the RAD-Bynet Group. Of these agreements, the lease for
      our headquarters in Tel Aviv is material to our operations. We believe that
      the
      terms of the transactions in which we have entered with members of the RAD-Bynet
      Group are not different in any material respect from terms we could obtain
      from
      unaffiliated third parties. The pricing of the transactions were arrived at
      based on negotiations between the parties. Members of our management reviewed
      the pricing of the lease agreement, and confirmed that they were not different
      than that which could have been obtained from unaffiliated third parties. In
      addition, the Company purchases different services from third parties at special
      rates offered to the RAD-Bynet Group, such as car leases, maintenance,
      insurance and communication services. In the event that we cease to be a member
      of the RAD-Bynet Group, we may not be able to obtain the current rates for
      such
      services. We believe, however, that due to the affiliation between us and the
      RAD-Bynet Group, we have greater flexibility in certain terms than might be
      available from unaffiliated third parties on similar issues. In the event that
      the transaction with members of the RAD-Bynet Group is terminated and we enter
      into similar transactions with unaffiliated third parties, that flexibility
      may
      not be available to us.




50




All
      transactions and arrangements with affiliated parties, including other members
      of the RAD-Bynet Group, require approval by the audit committee and our board
      of
      directors and may, in certain circumstances, require approval by our
      shareholders.




**Services
      Furnished by members of the RAD-Bynet Group**




Some
      companies which are also members of the RAD-Bynet Group provide us with
      marketing, administrative and network management services, and we reimburse
      each
      for its costs in providing such services. The aggregate amount of the
      reimbursements to such companies amounted to approximately $393,000 in 2005.




**Lease
      of Property**




We
      lease
      the office space for our headquarters and principal R&D, administrative,
      finance and marketing and sales operations from two private companies owned
      by
      Messrs. Zohar Zisapel and Yehuda Zisapel. The facilities are located in a
      five-story building in Tel Aviv, Israel, and consist of approximately 31,500
      square feet, plus storage and parking space. The monthly rent amounts to
      approximately $34,000. The lease expires in October 2007. We also lease
      additional 3,800 square feet in the building under the same lease agreement
      and
      sublease this area to an unaffiliated company, back-to-back. We entered into
      an
      agreement with RAD Data Communications, Inc., pursuant to which we will lease
      approximately 12,382 () square
      feet in Mahwah, New Jersey, consisting of 8,121 square feet of office space
      and
      4,261  square
      feet of
      warehouse space, in consideration for annual rent of approximately $18,000
      (including taxes and management fees). The lease expires on April 20,
      2007. ******




**Distribution
      Agreement**




Bynet
      Data Communications Ltd., a member of the RAD-Bynet Group distributes our
      products in Israel on a non-exclusive basis. We have a written distributor
      agreement with Bynet according to which we provide them with discounts similar
      to the discounts provided to third-party distributors in the region in the
      ordinary course of business. The total sales to Bynet Data Communications
      amounted to $3,111,000 during 2005.




**Founders’
      Agreement**




See
      discussion in Item 6 - “Directors and Senior Management.”




**C.** **Interests
      of Experts and Counsel**




Not
      applicable




51




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




A. 
      Consolidated
      Statements and other Financial Information




See
      financial statements under Item 18.




**A.7. 
      Legal Proceedings**




In
      December 2001, the Company, its Chairman Yehuda Zisapel, its President, Chief
      Executive Officer and Director Roy Zisapel and its Chief Financial Officer
      Meir
      Moshe (the “Individual Defendants”) and several underwriters in the syndicates
      for our September 30, 1999 initial public offering and January 24, 2000
      secondary offering, were named as defendants in a class action complaint
      alleging violations of the federal securities laws in the United States District
      Court, Southern District of New York. The complaint seeks unspecified damages
      as
      a result of alleged violations of Section 11 of the Securities Act of 1933
      against all the defendants and Section 15 of the Securities Act of 1933 against
      the Individual Defendants arising from activities purportedly engaged in by
      the
      underwriters in connection with our initial public offering and secondary
      offering. Plaintiffs allege that the underwriter defendants agreed to allocate
      stock in the Company's initial public offering and secondary offering to certain
      investors in exchange for excessive and undisclosed commissions and agreements
      by those investors to make additional purchases of stock in the aftermarket
      at
      pre-determined prices.




An
      amended complaint filed on April 19, 2002, which is now the operative complaint,
      added a claim under Section 10(b) of the Securities Exchange Act of 1934 against
      the Company and a claim under Section 20(a) of the Securities Exchange Act
      of
      1934 against the Individual Defendants. Plaintiffs allege that the Prospectuses
      for the Company's initial public offering and secondary offering were false
      and
      misleading because they did not disclose these arrangements.




The
      action is being coordinated with approximately three hundred other nearly
      identical actions filed against other companies before one judge in the U.S.
      District Court for the Southern District of New York. A
      motion
      to dismiss addressing issues common to the companies and individuals who have
      been sued in these actions was filed on July 15, 2002. On October 9, 2002,
      the
      court dismissed the Individual Defendants from the case without prejudice based
      upon Stipulations of Dismissal filed by the plaintiffs and the Individual
      Defendants. This dismissal disposed of the Section 15 and 20(a) control person
      claims without prejudice, since these claims were asserted only against the
      Individual Defendants.  On
      February 19, 2003, the Court denied the motion to dismiss with respect to the
      Company. On
      October 13, 2004, the Court certified a class in six of the approximately 300
      other nearly identical actions and noted that the decision is intended to
      provide strong guidance to all parties regarding class certification in the
      remaining cases. Plaintiffs have not yet moved to certify a class in the Radware
      case.




We
      approved a settlement agreement and related agreements which set forth the
      terms
      of a settlement between the Company, the Individual Defendants, the plaintiff
      class and the vast majority of the other approximately 300 issuer defendants.
      Among other provisions, the settlement provides for a release of the Company
      and
      the Individual Defendants for the conduct alleged in the action to be wrongful.
      We would agree to undertake certain responsibilities, including agreeing to
      assign away, not assert, or release certain potential claims we may have against
      our underwriters. The settlement agreement also provides a guaranteed recovery
      of $1 billion to plaintiffs for the cases relating to all of the approximately
      300 issuers. To the extent that the underwriter defendants settle all of the
      cases for at least $1 billion, no payment will be required under the issuers’
settlement agreement. To the extent that the underwriter defendants settle
      for
      less than $1 billion, the issuers are required to make up the difference. On
      April 20, 2006, JPMorgan Chase and the plaintiffs reached a preliminary
      agreement for a settlement for $425 million. The JPMorgan Chase settlement
      has
      not yet been approved by the Court. However, if it is finally approved, then
      the
      maximum amount that the issuers or their insurers will be potentially liable
      for
      is $575 million.




It
      is
      anticipated that any potential financial obligation of ours to plaintiffs
      pursuant to the terms of the settlement agreement and related agreements will
      be
      covered by existing insurance. We are currently not aware of any material
      limitations on the expected recovery of any potential financial obligation
      to
      plaintiffs from its insurance carriers. The carriers are solvent, and we are
      not
      aware of any uncertainties as to the




52


legal
      sufficiency of an insurance claim with respect to any recovery by plaintiffs.
      Therefore, we do not expect that the settlement will involve any payment by
      the
      Company. If material limitations on the expected recovery of any potential
      financial obligation to the plaintiffs from our insurance carriers should arise,
      our maximum financial obligation to plaintiffs pursuant to the settlement
      agreement would be less than $3.4 million. However, if the JPMorgan Chase
      settlement is finally approved, our maximum financial obligation to the
      plaintiffs pursuant to the settlement agreement would be less than $2
      million.




On
      February 15, 2005, the court granted preliminary approval of the settlement
      agreement, subject to certain modifications consistent with its opinion. Those
      modifications have been made. On March 20, 2006, the Underwriter Defendants
      submitted objections to the settlement to the Court. The Court held a hearing
      regarding these and other objections to the settlement at a fairness hearing
      on
      April 24, 2006, but has not yet issued a ruling. There is no assurance that
      the
      court will grant final approval to the settlement. If the settlement agreement
      is not approved and we are found liable, we are unable to estimate or predict
      the potential damages that might be awarded, whether such damages would be
      greater than our insurance coverage, and whether such damages would have a
      material impact on our results of operations, cash flows or financial condition
      in any future period.




From
      time
      to time, we are involved in routine trade litigation. We are not subject to
      any
      additional material legal proceedings.




**B.** **Significant
      Changes**




Except
      as
      otherwise disclosed in this annual report, we are not aware of any significant
      changes since the date of the audited consolidated financial statements included
      in this annual report.




53




**ITEM
      9.** **The
      Listing** ****




**A.** **Listing
      Details** ****




Our
      ordinary shares have been listed for quotation on the Nasdaq National Market
      as
      of September 30, 1999, and, since May 12, 2004 on the Tel Aviv Stock
      Exchange, or TASE, both under the symbol “RDWR”.




The
      following table sets forth the high and low closing price for our ordinary
      shares as reported by the Nasdaq National Market and TASE for the periods
      indicated:




**Annual
                High and Low**
            
            **Nasdaq
                National Market**
            
            **Tel
                Aviv Stock Exchange****High**
            
            **Low**
            
            **High**
            
            **Low****2001**
            
            $
            21.94
            
            $
            7.63
            
            
            --
            
            
            --**2002**
            
            $
            12.95
            
            $
            6.5
            
            
            --
            
            
            --**2003**
            
            $
            28.54
            
            $
            7.97
            
            
            --
            
            
            --**Quarterly
                High and Low****2004**First
                Quarter
            
            $
            32.42
            
            $
            22.83
            
            
            --
            
            
            -Second
                Quarter
            
            $
            28.22
            
            $
            14.94
            
            
            NIS
                82.62
            
            
            NIS
                69.60Third
                Quarter
            
            $
            22.00
            
            $
            16.45
            
            
            NIS
                98.76
            
            
            NIS
                74.43Fourth
                Quarter
            
            $
            27.19
            
            $
            21.92
            
            
            NIS
                118.00
            
            
            NIS
                97.20**2005**First
                Quarter
            
            $
            26.56
            
            $
            22.24
            
            
            NIS
                115.00
            
            
            NIS
                98.07Second
                Quarter
            
            $
            24.65
            
            $
            18.08
            
            
            NIS
                108.90
            
            
            NIS
                82.97Third
                Quarter
            
            $
            19.49
            
            $
            15.19
            
            
            NIS
                90.27
            
            
            NIS
                67.93Fourth
                Quarter
            
            $
            19.43
            
            $
            17.03
            
            
            NIS
                89.41
            
            
            NIS
                79.29





54





**Most
                recent six months****2006**April*
            
            $
            16.60
            
            $
            15.22
            
            
            NIS
                82.22
            
            
            NIS
                70.33March
            
            $
            21.49
            
            $
            17.63
            
            
            NIS101.10
            
            
            NIS
                94.42February
            
            $
            19.93
            
            $
            17.90
            
            
            NIS
                91.96
            
            
            NIS
                85.23January
            
            $
            20.20
            
            $
            18.75
            
            
            NIS
                95.19
            
            
            NIS
                84.49**2005**December
            
            $
            19.06
            
            $
            18.16
            
            
            NIS
                88.90
            
            
            NIS
                84.80November
            
            $
            18.89
            
            $
            17.19
            
            
            NIS
                89.41
            
            
            NIS
                81.15October
            
            $
            19.43
            
            $
            17.03
            
            
            NIS
                87.21
            
            
            NIS
                79.29






*Through
      April 25, 2006.




55







**B.   
      Plan of Distribution**




Not
      applicable




**C.   
      Markets**




Our
      ordinary shares are listed for quotation on the Nasdaq National Market under
      the
      symbol “RDWR”.




**D.   
      Selling** Shareholders




Not
      applicable




**E.   
      Dilution**




Not
      applicable




**F.   
      Expenses** of the
      Issue




Not
      applicable







56






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




**A.** **Share
      Capital** ****




Not
      applicable




**B.** **Memorandum** and
      Articles of Association




*Set
      out below is a description of certain provisions of our Memorandum of
      Association and Articles of Association, and of the Israeli Companies Law
      related to such provisions. This description is only a summary and does not
      purport to be complete and is qualified by reference to the full text of the
      Memorandum and Articles which are incorporated by reference to exhibits to
      this
      Annual Report and by Israeli law.*




We
      were
      first registered under Israeli law on May 16, 1996 as a private company, and
      on
      November 18, 1999 became a public company. Our registration number with the
      Israeli registrar of companies is 52-004437-1.




**Objects
      and Purposes**




Pursuant
      to our articles of association, our object is to engage, directly or indirectly,
      in any lawful undertaking or business whatsoever, including, without limitation,
      as stipulated in our Memorandum of Association, which was filed with the Israeli
      registrar of companies.




**Shares;** **Transfer** **of Shares**




Our
      registered capital is divided into 30,000,000 ordinary shares of nominal (par)
      value NIS 0.10 each. There are no other classes of shares. All of our
      outstanding shares are fully paid and non-assessable. The shares do not entitle
      their holders to preemptive rights and fully paid ordinary shares may be freely
      transferred pursuant to our articles of association unless such transfer is
      restricted or prohibited by another instrument.




**Dividend
      and** **Liquidation** **Rights**




Dividends
      on our ordinary shares may be paid only out of profits and other surplus, as
      defined in the Companies Law, as of the end of the most recent financial
      statements or as accrued over a period of two years, whichever is higher. Our
      board of directors is authorized to declare dividends, provided that there
      is no
      reasonable concern that payment of the dividend will prevent us from satisfying
      our existing and foreseeable obligations as they become due, and provided
      further that our shareholders approved the final dividend declared by the board,
      in an amount not to exceed the board’s recommendation. In the event of our
      liquidation, after satisfaction of liabilities to creditors, our assets will
      be
      distributed to the holders of ordinary shares in proportion to their respective
      holdings. This liquidation right may be affected by the grant of preferential
      dividends or distribution rights to the holders of a class of shares with
      preferential rights that may be authorized in the future.




**Voting,** **Shareholders'** **Meetings and Resolutions**




We
      have
      two types of general shareholder meetings: the annual general meeting and the
      extraordinary general meeting. An annual general meeting must be held once
      in
      every calendar year, but not more than 15 months after the last annual general
      meeting. The Board of Directors may convene an extraordinary general meeting
      whenever it thinks fit, and is obliged to do so upon the request of any of:
      two
      directors or one fourth of the serving directors; one or more shareholders
      who
      have at least 5% of the issued share capital and at least 1% of the voting
      rights; or one or more shareholders who have at least 5% of the voting rights.




Under
      the
      Companies Law, shareholder meetings generally require prior notice of not less
      than 21 days. The Companies Law also provides that the record date for the
      participation of shareholders of a company whose shares are traded or registered
      outside of Israel such as us may generally be no more than 40 but no less than
      28 days prior to the meeting, provided that notice for said meeting is given
      prior to the record date. A shareholder may vote in person or by proxy, or,
      if
      the shareholder is a corporate body, by its representative.




57


Holders
      of ordinary shares have one vote for each ordinary share held on all matters
      submitted to a vote of shareholders. A shareholder may only vote the shares
      for
      which all calls have been paid, except in separate general meetings of a
      particular class.




These
      voting rights may be affected by the grant of any special voting rights to
      the
      holders of a class of shares with preferential rights that may be authorized
      in
      the future. The quorum required for an ordinary meeting of shareholders consists
      of at least two shareholders present in person or by proxy who hold or represent
      between them at least 35% of the outstanding voting shares unless otherwise
      required by applicable rules. A meeting adjourned for lack of a quorum generally
      is adjourned to the same day in the following week at the same time and place
      or
      any time and place as the Chairman may designate with the consent of a majority
      of the voting power represented at the meeting and voting on the matter
      adjourned. At such reconvened meeting the required quorum consists of any two
      members present in person or by proxy.




Under
      the
      Companies Law, unless otherwise provided in the articles of association or
      applicable law, all resolutions of the shareholders require a simple majority
      of
      the shares present, in person or by proxy, and voting on the matter. However,
      our articles of association require approval of at least 75% of the shares
      present and voting to increase our share capital or to change its structure,
      grant any special rights to the holders of a class of shares with preferential
      rights or change such rights previously granted or remove directors from office.




Subject
      to the Companies Law, a resolution in writing signed by the holders of all
      of
      our ordinary shares entitled to vote at a meeting of shareholders or to which
      all such shareholders have given their written consent will be sufficient to
      adopt the resolution in lieu of a meeting.




**General** **Duties** **of Shareholders**




Under
      the
      Companies Law, each and every shareholder has a duty to act in good faith in
      exercising his rights and fulfilling his obligations towards the company and
      other shareholders and refrain from abusing his power in the company, such
      as in
      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 certainrelated
                partytransactionsand
                actions which require shareholder approval pursuant to the Companies
                Law.




In
      addition, each and every shareholder has the general duty to refrain from
      depriving rights of other shareholders.




Furthermore,
      any controlling shareholder, any shareholder who knows that it possesses the
      power to determine the outcome of a shareholder vote and any shareholder that,
      pursuant to the provisions of the articles of association, has the power to
      appoint or to prevent the appointment of an office holder in the company or
      any
      other power toward the company is under a duty to act in fairness towards the
      company. The Companies Law does not describe the substance of this duty of
      fairness. These various shareholder duties may restrict the ability of a
      shareholder to act in what the shareholder perceives to be its own best
      interests.




**Restrictions
      on Non-Israeli Residents**




The
      ownership or voting of our ordinary shares by non-residents of Israel, except
      with respect to citizens of countries which are in a state of war with Israel,
      is not restricted in any way by our Memorandum of Association or Articles of
      Association or by the laws of the State of Israel.




**Mergers
      and** **Acquisitions** **under Israeli Law**




There
      are
      no specific provisions of our memorandum or articles of association that would
      have an effect of delaying, deferring or preventing a change in control of
      us or
      that would operate only with respect to a merger, acquisition or corporate
      restructuring involving us (or any of our subsidiaries). However, certain
      provisions of the Companies Law may have such effect.




58


The
      Israeli Companies Law includes provisions that allow a merger transaction and
      requires that each company that is party to a merger approve the transaction
      by
      its board of directors and a vote of the majority of its shares, voting on
      the
      proposed merger at a shareholders’ meeting. For purposes of the shareholder
      vote, unless a court rules otherwise, the merger will not be deemed approved
      if
      shares, representing a majority of the voting power present at the shareholders
      meeting and which are not held by the other party to the merger (or by any
      person who holds 25% or more of the voting power of the right to appoint 25%
      or
      more of the directors of the other party), vote against the merger. Upon the
      request of a creditor of either party of the proposed merger, the court may
      delay or prevent the merger if it concludes that there exists a reasonable
      concern that as a result of the merger, the surviving company will be unable
      to
      satisfy the obligations of any of the parties to the merger. In addition, a
      merger may not be completed unless at least (i) 50 days have passed from the
      time that a proposal of the merger has been filed with the Israeli Registrar
      of
      Companies by each merging company and (ii) 30 days have passed since the merger
      was approved by the shareholders of each merging company.




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




The
      Companies Law also provides that an acquisition of shares of a public company
      must be made by means of tender offer if as a result of the acquisition the
      purchaser would become a 25% or greater shareholder of the company and there
      is
      no 25% or greater shareholder in the company. Similarly,
      the Companies Law provides that an acquisition of shares in a public company
      must be made by means of a tender offer if as a result of the acquisition the
      purchaser would become a 45% or greater shareholder of the company, unless
      there
      is already a 45% or greater shareholder of the company. These requirements
      do
      not apply if, in general, the acquisition (1) was made in a private placement
      that received shareholder approval, (2) was from a 25% or greater shareholder
      of
      the company which resulted in the acquirer becoming a 25% or greater shareholder
      of the company, or (3) was from a 45% or greater shareholder of the company
      which resulted in the acquirer becoming a 45% or greater shareholder of the
      company. The tender offer must be extended to all shareholders, but the offeror
      is not required to purchase more than 5% of the company's outstanding shares,
      regardless of how many shares are tendered by shareholders. The tender offer
      may
      be consummated only if (i) at least 5% of the company’s outstanding shares will
      be acquired by the offeror and (ii) the number of shares tendered in the offer
      exceeds the number of shares whose holders objected to the offer.




If,
      as a
      result of an acquisition of shares, the acquirer will hold more than 90% of
      a
      company’s outstanding shares, the acquisition must be made by means of a tender
      offer for all of the outstanding shares. If less than 5% of the outstanding
      shares are not tendered in the tender offer, all the shares that the acquirer
      offered to purchase will be transferred to it. The Companies Law provides for
      appraisal rights if any shareholder files a request in court within three months
      following the consummation of a full tender offer. If more than 5% of the
      outstanding shares are not tendered in the tender offer, then the acquiror
      may
      not acquire shares in the tender offer that will cause his shareholding to
      exceed 90% of the outstanding shares.




Finally,
      Israeli tax law treats stock-for-stock acquisitions between an Israeli company
      and a foreign company less favorably than does U.S. tax law. For example,
      Israeli tax law subjects a shareholder who exchanges his ordinary shares for
      shares in another corporation to taxation on half the shareholder’s shares two
      years following the exchange and on the balance four years thereafter even
      if
      the shareholder has not yet sold the new shares.




59


**Modification
      of Class Rights**




Our
      articles of association provide that the rights attached to any class (unless
      otherwise provided by the terms of such class), such as voting, rights to
      dividends and the like, may be varied by written consent of holders of
      seventy-five percent of the issued shares of that class, or by adoption by
      the
      holders of seventy-five percent of the shares of that class at a separate class
      meeting. Subject thereto, the conditions imposed by our articles of association
      governing changes in the rights of any class of shares, are no more stringent
      than is required by Israeli law.




**Board
      of Directors**




According
      to the Companies Law and our articles of association, the management of our
      business is vested in our board of directors. Our articles of association
      provide that the board of directors shall consist of not less than five and
      not
      more than nine directors. In accordance with our articles of association, our
      board of directors (other than our external directors) is divided into three
      classes with each class serving until the third annual meeting following their
      election, as more fully described in Item 6C under “Staggered Board”. There is
      no requirement under our articles or Israeli law for directors to retire on
      attaining a specific age. Our articles do not require directors to hold our
      ordinary shares to qualify for election.




The
      board
      of directors may exercise all such powers and may take all such actions that
      are
      not specifically granted to our shareholders. As part of its powers, our board
      of directors may cause the company to borrow or secure payment of any sum or
      sums of money for the purposes of the Company, at such times and upon such
      terms
      and conditions as it thinks fit, including the grants of security interests
      on
      all or any part of the property of the company. In addition, the Companies
      Law
      requires that transactions between a company and its office holders (which
      term
      includes directors) or that benefit its office holders, including arrangements
      as to the compensation of office holders, be approved as provided for in the
      Companies Law and the company's articles of association, as more fully described
      in Item 6C under “Approval of Specified Related Party Transactions Under Israeli
      Law”.




A
      resolution proposed at any meeting of the board of directors shall be deemed
      adopted if approved by a majority of the directors present and voting on the
      matter.




**Exculpation,
      Insurance and Indemnification**




*Exculpation
      of Office Holders*




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




*Insurance
      of Office Holders*




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




·
            A
                breach of his duty of care to us or to another
                person;




·
            A
                breach of his duty of loyalty to us, provided that the office holder
                acted
                in good faith and had reasonable cause to assume that his act would
                not
                prejudice our interests; or




·
            A
                financial liability imposed upon him in favor of another
                person.




*Exculpation
      and Indemnification of Office Holders*




Under
      the
      Companies Law, we may indemnify any of our office holders against the following
      obligations and expenses imposed on the office holder with respect to an act
      performed in the capacity of an office holder:




60




·
            A
                financial liability imposed on him in favor of another person by
                a court
                judgment, including a settlement or an arbitration award approved
                by the
                court. Such indemnification may be approved (i) after the liability
                has
                been incurred or (ii) in advance, provided that our undertaking to
                indemnify is limited to events that our board of directors believes
                are
                foreseeable in light of our actual operations at the time of providing
                the
                undertaking and to a sum or criterion that our board of directors
                determines to be reasonable under the circumstances;




·
            Reasonable
                litigation expenses, including attorney’s fees, expended by the office
                holder as a result of an investigation or proceeding instituted against
                him by a competent authority, provided that such investigation or
                proceeding concluded without the filing of an indictment against
                him or
                the imposition of any financial liability in lieu of criminal proceedings
                other than with respect to a criminal offense that does not require
                proof
                of criminal intent; and




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




*Limitations
      on Insurance and Indemnification*




The
      Companies Law provides that a company may not indemnify an office holder, or
      enter into an insurance contract which would provide coverage for any monetary
      liability incurred as a result of any of the following:




·
            A
                breach by the office holder of his duty of loyalty unless, with respect
                to
                indemnification or insurance coverage, the office holder acted in
                good
                faith and had a reasonable basis to believe that the act would not
                prejudice the company;




·
            A
                breach by the office holder of his duty of care if the breach was
                done
                intentionally or recklessly unless the breach was done
                negligently;




·
            Any
                act or omission done with the intent to derive an illegal personal
                benefit; or




·
            Any
                fine levied against the office
                holder.




In
      addition, under the Companies Law, indemnification of, and procurement of
      insurance coverage for, our office holders must be approved by our audit
      committee and our board of directors and, if the beneficiary is a director,
      by
      our shareholders.




We
      currently hold directors and officers liability insurance for the benefit of
      our
      office holders. In general, we submit the renewal of our policy to the approvals
      of our audit committee, board of directors and shareholders, in that order,
      every year. In addition, we provide our directors and officers indemnification
      pursuant to the terms of a Letter of Indemnification, be substantially in the
      form approved by our shareholders [(See Exhibit 4.4 in Item 19 for the form
      of
      such letter).




**C.
      Material Contracts**




For
      a
      summary of our material contracts, see Item 7 - *“Related
      Party Transactions* ”,
      and
      see Item 5 - *“Business
      Combination - acquisition of V-Secure”.*




61




**Exchange
      Controls**




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




**Taxation**




**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.**




**Israeli
      Tax Considerations**




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




*General
      Corporate Tax Structure*




Generally,
      Israeli companies are subject to “Corporate Tax” on their taxable income. On
      July 25, 2005, the Knesset (Israeli Parliament) approved the Law of the
      Amendment of the Income Tax Ordinance (No. 147), 2005, which prescribes, among
      others, a gradual decrease in the corporate tax rate in Israel to the following
      tax rates: in 2006 - 31%, in 2007 - 29%, in 2008 - 27%, in 2009 - 26% and in
      2010 and thereafter - 25%. However, the effective tax rate payable by a company
      which derives income from an approved enterprise (as further discussed below)
      may be considerably less.




*Stamp* *Duty*




The
      Israeli Stamp Duty on Documents Law, 1961, or the Stamp Duty Law, provides
      that
      any document (or part thereof) that is signed in Israel or that is signed
      outside of Israel and refers to an asset or other thing in Israel or to an
      action that is executed or will be executed in Israel, is subject to a stamp
      duty, generally at a rate of between 0.4% and 1% of the value of the subject
      matter of such document. De facto, it has been common practice in Israel not
      to
      pay such stamp duty unless a document is filed with a governmental authority.
      An
      amendment to the Stamp Duty Law that came into effect on June 1, 2003,
      determines, among other things, that stamp duty on most agreements shall be
      paid
      by the parties that signed such agreement, jointly or severally, or by the
      party
      that undertook under such agreement to pay the stamp duty. As a result of the
      aforementioned amendment to the Stamp Duty Law, the Israeli tax authorities
      have
      approached many companies in Israel and requested disclosure of all agreements
      signed by such companies after June 1, 2003, with the aim of collecting stamp
      duty on such agreements. The legitimacy of the aforementioned amendment to
      the
      Stamp Duty Law and of said actions by the Israeli tax authorities are currently
      under review by the Israeli High Court of Justice.




Based
      on
      advice from counsel, we believe that we may only be required to pay stamp duty
      on documents signed on or after August 2004. However, we cannot assure you
      that
      the tax authorities or the courts will accept such view.




Under
      an
      order published in December 2005, the requirement to pay the stamp duty was
      terminated with respect to agreements signed after January 1, 2006.




*Tax
      Benefits Under the Law for the Encouragement of Capital Investments,
      1959* ****




62




***The
      law before the amendment of 2005***




The
      Law
      for the Encouragement of Capital Investments, 1959, as amended (effective as
      of
      April 1, 2005) (the “Investments Law”), provides that a proposed capital
      investment in eligible facilities may, upon application to the Investment Center
      of the Ministry of Industry and Commerce of the State of Israel, be designated
      as an approved enterprise. The Investment Center bases its decision as to
      whether or not to approve an application, among other things, on the criteria
      set forth in the Investments Law and regulations, the then prevailing policy
      of
      the Investment Center, and the specific objectives and financial criteria of
      the
      applicant. Each certificate of approval for an approved enterprise relates
      to a
      specific investment program delineated both by its financial scope, including
      its capital sources, and by its physical characteristics, e.g *.* ,
      the
      equipment to be purchased and utilized pursuant to the program.




The
      Investments Law provides that an approved enterprise is eligible for tax
      benefits on taxable income derived from its approved enterprise programs. The
      tax benefits under the Investments Law also apply to income generated by a
      company from the grant of a usage right with respect to know-how developed
      by
      the approved enterprise, income generated from royalties, and income derived
      from a service which is auxiliary to such usage right or royalties, provided
      that such income is generated within the approved enterprise’s ordinary course
      of business. If a company has more than one approval or only a portion of its
      capital investments are approved, its effective tax rate is the result of a
      weighted average of the applicable rates. The tax benefits under the Investments
      Law are not, generally, available with respect to income derived from products
      manufactured outside of Israel. In addition, the tax benefits available to
      an
      approved enterprise are contingent upon the fulfillment of conditions stipulated
      in the Investments Law and regulations and the criteria set forth in the
      specific certificate of approval, as described above. In the event that a
      company does not meet these conditions, it would be required to refund the
      amount of tax benefits, plus a consumer price index linkage adjustment and
      interest.




The
      Investments Law also provides that an approved enterprise is entitled to
      accelerated depreciation on its property and equipment that are included in
      an
      approved enterprise program.




Taxable
      income of a company derived from an approved enterprise is subject to corporate
      tax at the maximum rate of 25%, rather than the regular corporate tax rate,
      for
      the benefit period. This period is ordinarily seven years commencing with the
      year in which the approved enterprise first generates taxable income, and is
      limited to twelve years from commencement of production or 14 years from the
      date of approval, whichever is earlier.




A
      company
      may elect to receive an alternative package of benefits. Under the alternative
      package of benefits, a company’s undistributed income derived from the approved
      enterprise will be exempt from corporate tax for a period of between two and
      ten
      years from the first year the company derives taxable income under the program,
      depending on the geographic location of the approved enterprise within Israel,
      and such company will be eligible for a reduced tax rate for the remainder
      of
      the benefits period **.** A
      company
      that has elected the alternative package of benefits, such as us, that
      subsequently pays a dividend out of income derived from the approved enterprise
      during the tax exemption period will be subject to corporate tax in respect
      of
      the amount distributed, including any taxes thereon, at the rate which would
      have been applicable had it not elected the alternative package of benefits,
      generally 10%-25%, depending on the percentage of the company’s ordinary shares
      held by foreign shareholders. The dividend recipient is subject to withholding
      tax at the rate of 15% applicable to dividends from approved enterprises, if
      the
      dividend is distributed during the tax exemption period or within twelve years
      thereafter. The company must withhold this tax at source.




A
      company
      that has an approved enterprise program is eligible for further tax benefits
      if
      it qualifies as a foreign investors’ company. A foreign investors’ company is a
      company which more than 25% of its share capital and combined share and loan
      capital is owned by non-Israeli residents. A company that qualifies as a foreign
      investors’ company and has an approved enterprise program is eligible for tax
      benefits for a ten-year benefit period. As specified above, depending on the
      geographic location of the approved enterprise within Israel, income derived
      from the approved enterprise program may be exempt from tax on its undistributed
      income for a period of between two to ten years, and will be subject to a
      reduced tax rate for the remainder of the benefits period. The tax rate for
      the
      remainder of the benefits period will be 25%, unless the level of foreign
      investment exceeds 49%, in which case the tax rate will be 20% if the foreign
      investment is more than 49% and less than 74%; 15% if more than 74% and less
      than 90%; and 10% if 90% or more.




63




Subject
      to applicable provisions concerning income under the alternative package of
      benefits, dividends paid by a company are considered to be attributable to
      income received from the entire company and the company’s effective tax rate is
      the result of a weighted average of the various applicable tax rates, excluding
      any tax-exempt income. Under the Investments Law, a company that has elected
      the
      alternative package of benefits is not obliged to distribute retained profits,
      and may generally decide from which year’s profits to declare dividends. We
      currently intend to reinvest any income derived from our approved enterprise
      program and not to distribute such income as a dividend.




The
      Investment Center has granted us an approval to establish an approved enterprise
      program under the Investments Law, at our facilities in Tel Aviv and Jerusalem.




The
      current benefits for an approved enterprise program in Jerusalem provide that
      income derived from the approved enterprise program allocated to the approved
      enterprise in Jerusalem is tax exempt for ten years commencing with the year
      in
      which the approved enterprise first generates taxable income and will be taxed
      at a reduced company tax rate of up to 25% (rather than the regular corporate
      tax rate).




The
      current benefits for an approved enterprise program in Tel Aviv provide that
      income derived from the approved enterprise program and allocated to our Tel
      Aviv facility will be tax exempt for a period of two years and will be subject
      to a reduced tax rate, depending on the level of foreign investment, for an
      additional period of five to eight years.




As
      mentioned above, the Investment Center’s approval is for establishing an
      approved enterprise program in both Tel Aviv and Jerusalem. The approval
      provides for the allocation of tax benefits between our facilities in Tel Aviv
      and Jerusalem such that the income derived from the approved enterprise program
      shall be allocated pro-rata between the aforementioned facilities based on
      the
      expenses borne by each facility. However, since all our manufacturing and part
      of our research and development facilities are located in Jerusalem, the
      Investment Center determined the method of allocation of tax benefits between
      our facilities in Jerusalem and Tel Aviv as follows: The method of allocation
      of
      the tax benefits between our facilities in Tel Aviv and Jerusalem will be based
      on the number of research and development employees in each of the facilities,
      provided, however that the average salary for such employees in our Jerusalem
      facility will not be less than 85% of the average salary of such employees
      in
      our Tel Aviv facility. In the years that such condition is not fulfilled, the
      method of allocation will be as follows: (i) 50% of our income will be allocated
      between our Jerusalem facility and our Tel Aviv facility, pro-rata according
      to
      the number of employees engaged in research and development or manufacturing
      activities in each facility; and (ii) 50% of our income will be allocated
      between our Jerusalem facility and our Tel Aviv facility, pro-rata according
      to
      the salaries paid to the employees engaged in research and development or
      manufacturing activities in each facility. The Israeli government may reduce
      or
      eliminate tax benefits available to approved enterprise programs in the future.
      We cannot assure you that our approved program and the benefits thereunder
      shall
      continue in the future at its current level or at any level - see Item 3 (Risks
      relating to Location in Israel) **.**




In
      2004,
      the Company began to utilize the above mentioned tax benefits, and they are
      scheduled to gradually expire through 2013. As of December 31, 2005, retained
      earnings included approximately $19,925,000 in tax-exempt income earned by
      the
      Company’s "Approved Enterprise". The Company has decided not to declare
      dividends out of such tax-exempt income. Accordingly, no deferred income taxes
      have been provided on income attributable to the Company’s "Approved
      Enterprise".




If
      the
      retained tax-exempt income is distributed, it would be taxed at the corporate
      tax rate applicable to such profits as if the Company had not elected the
      alternative tax benefits (currently between 10% - 25%) and an income tax
      liability of approximately between $2,000,000 to $5,850,000 would be
      incurred.




Income
      from sources other than the “Approved Enterprise” will be subject to the tax at
      the regular rate.




During
      2004, the Company's production facilities in Israel (Tel-Aviv and Jerusalem)
      have been granted an expansion program to its Approved Enterprise status by
      the
      Investment Center. The
      Company applied for an amendment to this expansion program, according to which
      it requested an enlargement to this expansion program, neutralization of certain
      assets and an approval that the benefits period from such expansion program
      will
      commence in 2006. The Investment Center has not yet approved this application.
      If the Investment Center will not approve the above application, the company
      will apply for a new program under the 2005 amendment to the Investment Law,
      as
      described below.





64




**The
      2005 Amendment to the Investments Law**







A
      recent
      amendment to the Law, which has been published on April 1, 2005 (the
“Amendment") has changed certain provisions of the Law. As a result of the
      Amendment, a company is no longer obliged to acquire Approved Enterprise status
      in order to receive the tax benefits previously available under the Alternative
      Benefits provisions, and therefore generally there is no need to apply to the
      Investment Center for this purpose (Approved Enterprise status remains mandatory
      for companies seeking grants). Rather, the 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 out by the Amendment. A
      company is also granted a right to approach the Israeli Tax Authority for a
      pre-ruling regarding their eligibility for benefits under the
      Amendment.





Tax
      benefits are available under the Amendment to production facilities (or other
      eligible facilities), which are generally required to derive more than 25%
      of
      their business income from export (referred to as a “Benefited Enterprise”). In
      order to receive the tax benefits, the Amendment states that the company must
      make an investment in the Benefited Enterprise exceeding a certain percentage
      or
      a minimum amount specified in the Law. Such investment may be made over a period
      of no more than three years ending at the end of the year in which the company
      requested to have the tax benefits apply to the Benefited Enterprise (the "Year
      of Election"). Where the company requests to have the tax benefits apply to
      an
      expansion of existing facilities, then 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 this case, the minimum
      investment required in order to qualify as a Benefited Enterprise is required
      to
      exceed a certain percentage or a minimum amount of the company’s production
      assets before the expansion.





The
      duration of tax benefits is subject to a limitation of the earlier of 7 to
      10
      years from the Commencement Year, or 12 years from the first day of the Year
      of
      Election. The tax benefits granted to a Benefited Enterprise are determined,
      as
      applicable to its geographic location within Israel, according to one of the
      following new tax routes, which may be applicable to us:




·
            Similar
                to the currently available alternative route, exemption from corporate
                tax
                on undistributed income for a period of two to ten years, depending
                on the
                geographic location of the Benefited Enterprise within Israel, and
                a
                reduced corporate tax rate of 10% to 25% for the remainder of the
                benefits
                period, depending on the level of foreign investment in each year.
                Benefits may be granted for a term of seven to ten years, depending
                on the
                level of foreign investment in the company. If the company pays a
                dividend
                out of income derived from the Benefited Enterprise during the tax
                exemption period, such income will be subject to corporate tax at
                the
                applicable rate (10%-25%). The company is required to withhold tax
                at the
                source at a rate of 15% from any dividends distributed from income
                derived
                from the Benefited Enterprise; and




·
            A
                special tax route, which enables companies owning facilities in certain
                geographical locations in Israel to pay corporate tax at the rate
                of 11.5%
                on income of the Benefited Enterprise. The benefits period is ten
                years.
                Upon payment of dividends, the company is required to withhold tax
                at
                source at a rate of 15% for Israeli residents and at a rate of 4%
                for
                foreign residents.




Generally,
      a company that is Abundant in Foreign Investment (as defined in the Investments
      Law) is entitled to an extension of the benefits period by an additional five
      years, depending on the rate of its income that is derived in foreign
      currency.




65


The
      Amendment changes the definition of “foreign investment” in the Investments Law
      so that the definition now requires a minimal investment of NIS 5 million by
      foreign investors. Furthermore, such definition now also includes the purchase
      of shares of a company from another shareholder, provided that the company’s
      outstanding and paid-up share capital exceeds NIS 5 million. Such changes to
      the
      aforementioned definition will take effect retroactively from 2003.




The
      Amendment will apply to approved enterprise programs in which the year of
      election under the Investments Law is 2004 or later, unless such programs
      received approval from the Investment Center on or prior to December 31, 2004,
      in which case the Amendment provides that terms and benefits included in any
      certificate of approval already granted will remain subject to the provisions
      of
      the law as they were on the date of such approval.




Should
      we
      elect to utilize tax benefits under the Amendment to the law, any such tax
      exempt profits might be subject to future taxation on the corporate level upon
      distribution to shareholders by a way of dividend or liquidation. Accordingly,
      we may be required to recognize deferred tax liability with respect to such
      tax
      exempt profits.




A
      substantial portion of our taxable operating income is derived from our approved
      enterprise program and we expect that a substantial portion of any taxable
      operating income that we may realize in the future will be also derived from
      such program. There is no assurance that our Jerusalem facility and Tel Aviv
      facility will continue to enjoy such status in the future.




*Tax
      Benefits for Research and Development*




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




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




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




·
            Deduction
                of purchases of know-how and patents over an eight-year period for
                tax
                purposes;




·
            Right
                to elect, under specified conditions, to file a consolidated tax
                return
                with additional related Israeli Industrial Companies;




·
            Accelerated
                depreciation rates on equipment and buildings; and




·
            Deductions
                over a three-year period of expenses involved with the issuance and
                listing of shares on the Tel Aviv Stock Exchange or, on or after
                January
                1, 2003, on a recognized stock market outside of
                Israel.




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 owned by an Industrial
      Company, 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.




66




*Special
      Provisions Relating to Taxation Under Inflationary Conditions*




Under
      the
      Income Tax (Inflationary Adjustments) Law,
      1985, or the
      Adjustments Law, results for tax purposes are measured in real terms, in
      accordance with the changes in the Israeli Consumer Price Index ("Israeli CPI").
      Accordingly, until 2002, results for tax purposes were measured in terms of
      earnings in NIS after certain adjustments for increases in the Israeli CPI.
      Commencing in taxable year 2003, the Company has elected to measure its taxable
      income and file its tax return under the Israeli Income Tax Regulations
      (Principles Regarding the Management of Books of Account of Foreign Invested
      Companies and Certain Partnerships and the Determination of Their Taxable
      Income), 1986. Such an elective obligates the Company for three years.
      Accordingly, commencing taxable year 2003, results for tax purposes are measured
      in terms of earnings in dollar. We have submitted a request to the Israeli
      tax
      authorities to extend the effect of the above regulations on our company for
      2006.




*Capital
      Gains Tax on Sales of Our Ordinary Shares*




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




Generally, until
      the
      2006 tax year, capital gains tax was imposed on Israeli resident individuals at
      a rate
      of 15% on real gains derived on or after January 1, 2003, from the sale of
      shares in, among others, Israeli companies publicly traded on Nasdaq or on
      a
      recognized stock exchange or regulated market in a country that has a treaty
      for
      the prevention of double taxation with Israel (such as Radware). This tax rate
      was contingent upon the shareholder not claiming a deduction for financing
      expenses in connection with such shares (in
      which
      case the gain was generally be taxed at a rate of 25%) ,
      and did
      not apply to: (i) the sale of shares to a relative (as defined in the
      Israeli Income Tax Ordinance); (ii) the sale of shares by dealers in securities;
      (iii) the sale of shares by shareholders that report in accordance with the
      Inflationary Adjustments Law (that
      were taxed at corporate tax rates for corporations and at marginal tax rates
      for
      individuals) ;
      or
      (iv) the sale of shares by shareholders who acquired their shares prior to
      an initial public offering (that may be subject to a different tax arrangement).




As
      of
      January 1, 2006, the tax rate applicable to capital gains derived from the
      sale
      of shares, whether listed on a stock market or not, is 20% for Israeli
      individuals, unless such shareholder claims a deduction for financing expenses
      in connection with such shares, in which case the gain will generally be taxed
      at a rate of 25%. Additionally, if such shareholder is considered a “material
      shareholder” at any time during the 12-month period preceding such sale, i.e.,
      such shareholder holds directly or indirectly, including with others, at least
      10% of any means of control in the company, the tax rate shall be 25%. Israeli
      companies are subject to the Corporate Tax rate on capital gains derived from
      the sale of shares, unless such companies were not subject to the Adjustments
      Law (or certain regulations) at the time of publication of the aforementioned
      amendment to the Tax Ordinance that came into effect on January 1, 2006, in
      which case the applicable tax rate is 25%. However, the foregoing tax rates
      do
      not apply to: (i) dealers in securities; and (ii) shareholders who acquired
      their shares prior to an initial public offering (that may be subject to a
      different tax arrangement).




The
      tax
      basis of shares acquired prior to January 1, 2003 will be determined in
      accordance with the average closing share price in the three trading days
      preceding January 1, 2003. However, a request may be made to the tax authorities
      to consider the actual adjusted cost of the shares as the tax basis if it is
      higher than such average price.




Non-Israeli
      residents are exempt from Israeli capital gains tax on any gains derived from
      the sale of shares of Israeli companies publicly traded on a recognized stock
      exchange or regulated market outside of




67


Israel,
      provided however that such capital gains are not derived from a permanent
      establishment in Israel, such shareholders are not subject to the Adjustments
      Law, and such shareholders did not acquire their shares prior to an initial
      public offering. However, non-Israeli corporations will not be entitled to
      such
      exemption if an Israeli resident (i) has a controlling interest of 25% or more
      in such non-Israeli corporation, or (ii) is the beneficiary or is entitled
      to
      25% or more of the revenues or profits of such non-Israeli corporation, whether
      directly or indirectly.




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




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




*Taxation
      of Non-Resident Holders of Shares*




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 is withheld at the source at the following rates: (i)
      for
      dividends distributed prior to January 1, 2006 - 25%; (ii) for dividends
      distributed on or after January 1, 2006 - 20%, or 25% for a shareholder that
      is
      considered a “material shareholder” at any time during the 12-month period
      preceding such distribution, 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 Treaty U.S. Resident is 25%. However, under the Investments Law, dividends
      generated by an Approved Enterprise (or Benefited Enterprise) are taxed at
      the
      rate of 15%. Furthermore, dividends not generated by an Approved Enterprise
      (or
      Benefited Enterprise) paid to a U.S. corporation holding at least 10% of our
      issued voting power during
      the part of the tax year which precedes the date of payment of the dividend
      and
      during the whole of its prior tax year ,
      are
      generally taxed at a rate of 12.5%.




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




**United
      States Federal Income Tax Considerations**




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




·
            A
                citizen or resident of the United States for U.S. tax purposes;




·
            A
                corporation or partnership (or other entity taxable as a corporation
                or
                partnership for U.S. federal income tax purposes) created or organized
                in
                the United States or under the laws of the United States or any political
                subdivision thereof;




·
            An
                estate, the income of which is subject to United States federal income
                tax
                regardless of its source; or




68




·
            A
                trust (i) if, in general a court within the United States is able
                to
                exercise primary supervision over its administration and one or more
                U.S.
                persons have the authority to control all of its substantial decisions,
                or
                (ii) that has in effect a valid election under applicable U.S. Treasury
                regulations to be treated as a U.S.
                person.




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




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




·
            Are
                broker-dealers or insurance companies;




·
            Have
                elected mark-to-market accounting;




·
            Are
                tax-exempt organizations or retirement plans;




·
            Are
                financial institutions or “financial services entities”;




·
            Hold
                their shares as part of a straddle, “hedge” or “conversion transaction”
                with other investments;




·
            Acquired
                their shares upon the exercise of employee stock options or otherwise
                as
                compensation;




·
            Are,
                or hold their shares through, partnerships or other pass-through
                entities;




·
            Own
                directly, indirectly or by attribution at least 10% of our voting
                power;
                or




·
            Have
                a functional currency that is not the U.S. dollar.




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




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




*Taxation
      of Ordinary Shares*




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




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




69




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




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




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




70


*Passive
      Foreign Investment Company Status* .
      We will
      be a passive foreign investment company (a “PFIC”) if (taking into account
      certain “look-through” rules with respect to the income and assets of our
      subsidiaries) either 75 percent or more of our gross income in a taxable year
      is
      passive income or the average percentage (by value) of our passive assets during
      the taxable year is at least 50 percent. If we were a PFIC, each U.S. Holder
      would (unless it made one of the elections discussed below on a timely basis)
      be
      taxable on gain recognized from the disposition of our ordinary shares
      (including gain deemed recognized if the ordinary shares are used as security
      for a loan) and upon receipt of certain distributions with respect to our
      ordinary shares as if such income had been recognized ratably over the U.S.
      Holder’s holding period for the ordinary shares. The U.S. Holder’s income for
      the current taxable year would include (as ordinary income) amounts allocated
      to
      the current year and to any period prior to the first day of the first taxable
      year for which we were a PFIC. Tax would also be computed at the highest
      ordinary income tax rate in effect for each other period to which income is
      allocated, and an interest charge on the tax as so computed would also apply.
      Additionally, if we were a PFIC, U.S. Holders who acquire our ordinary shares
      from decedents (other than nonresident aliens) dying before 2010 would be denied
      the normally-available step-up in basis for such shares to fair market value
      at
      the date of death and, instead, would have a tax basis in such shares equal
      to
      the decedent’s basis, if lower.




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




As
      indicated above, we will be a PFIC for any tax year if the average percentage
      (by value) of our assets held for the production of, or that produce, passive
      income is at least 50 percent. We reasonably believe that we were not a PFIC
      for
      our tax year ended December 31, 2005.




It
      is
      possible that the Internal Revenue Service will attempt to treat us as a PFIC
      for 2005 or prior years. The tests for determining PFIC status are applied
      annually and it is difficult to make accurate predictions of future income
      and
      assets, which are relevant to this determination. Accordingly, there can be
      no
      assurance that we will not become a PFIC in 2006 or in subsequent years.




U.S.
      Holders who hold our ordinary shares during a period when we are a PFIC will
      be
      subject to the foregoing rules, even if we cease to be a PFIC, subject to
      certain exceptions for U.S. Holders who made a QEF election or the
      mark-to-market election.




Although
      a U.S. Holder normally is not permitted to make a retroactive QEF election
      for a
      foreign corporation, a retroactive election may be made for a taxable year
      of
      the U.S. Holder (the “retroactive election year”) if the U.S. Holder (i)
      reasonably believed that, as of the date the QEF election was due, the foreign
      corporation was not a PFIC for its taxable year that ended during the
      retroactive election year and (ii) filed a protective statement with respect
      to
      the foreign corporation, applicable to the retroactive election year, in which
      the U.S. Holder described the basis for its reasonable belief and extended
      the
      period of limitation on the assessment of taxes determined under Sections 1291
      through 1298 of the Code with respect to the foreign corporation (PFIC related
      taxes) for all taxable years of the shareholder to which the protective
      statement applies.




71




**U.S.
      Holders are urged to consult their tax advisors about the PFIC rules, including
      eligibility for and the manner and advisability of making, the QEF election
      (or
      a “protective” QEF election) or the mark-to market
      election.**




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




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




·
            Such
                item is effectively connected with the conduct by the Non-U.S. Holder
                of a
                trade or business in the United States and, in the case of a resident
                of a
                country which has a treaty with the United States, such item is
                attributable to a permanent establishment or, in the case of an
                individual, a fixed place of business, in the United
                States;




·
            The
                Non-U.S. Holder is an individual who holds the ordinary shares as
                a
                capital asset and is present in the United States for 183 days or
                more in
                the taxable year of the disposition and does not qualify for an exemption;
                or




·
            The
                Non-U.S. Holder is subject to tax pursuant to the provisions of United
                States tax law applicable to U.S.
                expatriates.




*Information
      Reporting and Back-up Withholding*




U.S.
      Holders generally are subject to information reporting requirements with respect
      to dividends paid in the United States on ordinary shares and proceeds paid
      from
      the sale, exchange, redemption or other disposition of ordinary shares. Under
      the Code, a U.S. Holder may be subject, under certain circumstances, to backup
      withholding currently at a rate of up to 28% with respect to dividends paid
      on
      our ordinary shares and proceeds paid from the sale, exchange, redemption or
      other disposition of ordinary shares unless the holder provides proof of an
      applicable exemption or correct taxpayer identification number and otherwise
      complies with applicable requirements of the backup withholding
      rules.




A
      holder
      of ordinary shares who does not provide a correct taxpayer identification number
      may be subject to penalties imposed by the IRS. Amounts withheld under the
      backup withholding rules are not an additional tax and may be refunded or
      credited against the holder’s federal income tax liability, provided the
      required information is furnished to the IRS.




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




**F.   
      Dividends and Paying Agents**




Not
      applicable.




**G.   
      Statement** by
      Experts




Not
      applicable.




**H.   
      Documents** on
      Display




We
      are
      subject to the informational requirements of the Securities Exchange Act of
      1934, as amended, applicable to foreign private issuers and fulfill the
      obligations with respect to such requirements by filing reports with the
      Securities and Exchange Commission. You may read and copy any document we file
      with the Securities and Exchange Commission without charge at the Securities
      and
      Exchange Commission’s public reference room at 450
      Fifth
      Street, N.W., Washington,
      D.C. 20549. Copies of such material may be obtained by mail from the Public
      Reference Branch of the Securities and Exchange Commission at such address,
      at
      prescribed rates. Please call the Securities and Exchange Commission at
      1-800-SEC-0330 for further information on the public reference room. Such
      materials are also available free of charge at the website of the Securities
      and
      Exchange Commission at www.sec.gov.




72


As
      a
      foreign private issuer, we are exempt from the rules under the Exchange Act
      prescribing the furnishing and content of proxy statements, and our officers,
      directors and principal shareholders are exempt from the reporting and
“short-swing” profit recovery provisions contained in Section 16 of the Exchange
      Act. In addition, we are not required under the Exchange Act to file periodic
      reports and financial statements with the Securities and Exchange Commission
      as
      frequently or as promptly as United States companies whose securities are
      registered under the Exchange Act.




In
      accordance with Rule 4350(a)(1) of the Rules of Corporate Governance of The
      Nasdaq Stock Market, Inc., we have received an exemption from the requirement
      to
      distribute an annual report to our shareholders prior to our annual meeting
      of
      shareholders. The basis for the exemption is that the generally accepted
      business practice in Israel, where we are incorporated, is not to distribute
      an
      annual report to shareholders. We post our Annual Report on Form 20-F on our
      web
      site (www.radware.com) as soon as practicable following the filing of the Annual
      Report on Form 20-F with the Securities and Exchange Commission.




**I.    
      Subsidiary** Information




Not
      applicable.






73




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




We
      are
      exposed to market risk, including movements in interest rates and foreign
      currency exchange rates. Our primary market risk exposure occurs because we
      generate most of our revenues in U.S. dollars and incur a portion of our
      expenses in NIS and in Euro. In 2004 we began selling to some European countries
      in Euro.




We
      do not
      presently engage in any hedging or other transactions intended to manage risks
      relating to foreign currency exchange rate or interest rate fluctuations. As
      of
      December 31, 2005, we did not own any market risk sensitive instruments, except
      for the following: Approximately 6% of our investment portfolio is invested
      in a
      structured note with guaranteed principal and changing interest. An increase
      in
      short-term interest rates will negatively affect the income received from this
      note. We may in the future undertake hedging or other similar transactions
      or
      invest in market risk sensitive instruments if our management determines that
      it
      is necessary to offset these risks.




Approximately
      40% of our investment portfolio is invested in high-rated marketable securities,
      mainly U.S. government agency bonds and corporate bonds. Since these investments
      carry fixed interest rates, interest income over the holding period is not
      sensitive to changes in interest rates.






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




Not
      applicable.




74


**PART** **II**






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




Not
      applicable.




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




The
      effective date of the registration statement (No. 333-10752) for our initial
      public offering of our ordinary shares, NIS 0.1 par value, was September 29,
      1999. The offering commenced on October 5, 1999, and terminated after the sale
      of all the securities registered. The managing underwriter of the offering
      was
      Salomon Smith Barney. We registered 4,025,000 ordinary shares in the offering,
      including shares issued pursuant to the exercise of the underwriters'
      over-allotment option. Of such shares, we sold 3,500,000 ordinary shares at
      an
      aggregate offering price of $63.0 million ($18.00 per share) and certain selling
      shareholders sold an aggregate of 525,000 ordinary shares at an aggregate
      offering price of $9.45 million ($18.00 per share). Under the terms of the
      offering, we incurred underwriting discounts of $4.41 million. We also incurred
      estimated expenses of $1.82 million in connection with the offering. None of
      the
      expenses consisted of amounts paid directly or indirectly to any of our
      directors, officers, general partners or their associates, any persons owing
      ten
      percent or more of any class of our equity securities, or any of our affiliates.
      The net proceeds that we received as a result of the offering were approximately
      $56.8 million. None of the use of proceeds consisted of amounts paid directly
      or
      indirectly to any of our directors, officers, general partners or their
      associates, any persons owning ten percent or more of any class of our equity
      securities, or any of our affiliates.




In
      January 2000, we raised net proceeds of approximately $60.0 million in a public
      offering of our ordinary shares.




The
      net
      proceeds of the two offerings are kept in short-term and long-term bank deposits
      and in marketable securities.






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




(a)
      Disclosure Controls and Procedures.




Our
      Chief
      Executive Officer, or CEO, and Chief Financial Officer, or CFO, are responsible
      for establishing and maintaining our disclosure controls and procedures. These
      controls and procedures were designed to ensure that information relating to
      the
      Company and its subsidiaries required to be disclosed in the reports that we
      file under the Securities Exchange Act of 1934, as amended, is recorded,
      processed, summarized and reported within the time periods specified in the
      rules and forms of the SEC. We evaluated these disclosure controls and
      procedures under the supervision of our CEO and CFO as of December 31, 2005.
      Based on this evaluation, our CEO and CFO concluded that our disclosure controls
      and procedures are effective in timely alerting them to information required
      to
      be disclosed in the reports to the SEC.




(b)
      Internal Control Over Financial Reporting.




There
      were no changes in the Company’s internal control over financial reporting that
      occurred during the year ended December 31, 2005 that have materially affected,
      or are reasonably likely to materially affect, our internal control over
      financial reporting.






**ITEM
      16.** **RESERVED** **** ****




75


**ITEM
      16A.    Audit Committee Financial Expert**




Our
      board
      of directors has determined that Messrs. Chris McCleary and Yiftach Atir,
      members of our Audit Committee, are financial experts as defined in the
      applicable regulations, and has determined that such members are “independent”
as this term is defined in the NASDAQ Listing Standards.




**ITEM
      16B.    Code of Ethics**




On
      February 2, 2004 our board of directors adopted our Code of Ethics, a code
      that
      applies to all directors, officers and employees of the Company, including
      our
      Chief Executive Officer and President, Chief Financial Officer, Director of
      Finance and Corporate Controller. On January 30, 2005, our board modified the
      Code of Conduct and Ethics. Our Code of Conduct and Ethics (as amended) has
      been
      posted on our Internet website,
      http://www.radware.com/content/company/investorrelations.




**ITEM
      16C.    Principal Accountant Fees and
      Services**




In
      the
      annual meeting held on December 11, 2005 our shareholders re-appointed Kost,
      Forer, Gabbay & Kasierer, a member of Ernst & Young Global (“Ernst &
Young”), to serve as our independent auditors until
      the
      next annual meeting .




Ernst
      & Young billed the following fees to us for professional services in each of
      the last two fiscal years:






Year
                Ended December 31,2005
            
            2004($
                in thousands)Audit
                Fees
            
            
            108
            
            
            60Audit-Related
                Fees
            
            
            23
            
            
            5Tax
                Fees
            
            
            23
            
            
            55All
                Other Fees
            
            
            -
            
            
            -Total
            
            
            154
            
            
            120





"Audit
      Fees" are the aggregate fees billed for the audit of our annual financial
      statements, statutory audits and services that are normally provided in
      connection with statutory and regulatory filings or engagements.




“Audit-Related
      Fees" are the aggregate fees billed for assurance and related services that
      are
      reasonably related to the performance of the audit or review of our financial
      statements and are not reported under Audit Fees.




“Tax
      Fees" are the aggregate fees billed for professional services rendered for
      tax
      compliance, tax advice on actual or contemplated transactions and tax planning
      such as assistance with tax audits and tax advice.




“All
      Other Fees” are the aggregate fees billed for products and services provided by
      Ernst & Young other than as described above.






*Audit
      Committee's pre-approval policies and procedures*




Our
      Audit
      Committee oversees our independent auditors. See also the description under
      the
      heading "Board Practices" in Item 6. *“Directors,
      Senior Management and Employees”.* In 2003
      our Audit Committee also adopted a policy requiring management to obtain the
      Committee's approval before engaging our independent auditors to provide any
      other audit or permitted non-audit services to us or our subsidiaries. Pursuant
      to this policy, which is designed to assure that such engagements do not impair
      the independence of our auditors, and which is discussed and approved at the
      end
      of each calendar year, the Audit Committee pre-approves annually a catalog
      of
      specific audit and non-audit services in the categories Audit Service,
      Audit-Related Service and Tax Consulting Services that may be performed by
      our
      auditors. In addition, the Audit Committee limited the aggregate amount in
      fees
      our auditors may receive during the 2006 fiscal year for non-audit services
      in
      certain categories, unless pre- approved. Our
      Director of Legal




76


Affairs
      and Director of Finance review all individual management requests to engage
      our
      independent auditors as a service provider in accordance with this catalog
      and,
      if the requested services are permitted pursuant to the catalog, approve the
      request accordingly. We inform the Audit Committee about these approvals on
      a
      quarterly basis. Services that are not included in the catalog require
      pre-approval by the Audit Committee on a case-by-case basis. Our Audit Committee
      is not permitted to approve any engagement of our auditors if the services
      to be
      performed either fall into a category of services that are not permitted by
      applicable law or the services would be inconsistent with maintaining the
      auditors' independence.




**ITEM
      16D.    Exemptions From The Listing Standards For Audit
      Committees**





Not
      applicable.




**ITEM
      16E.    Purchases Of Equity Securities By The Issuer And
      Affiliated Purchasers**





Not
      applicable.







77


**PART** **III**






**ITEM
      17.**  **FINANCIAL
      STATEMENTS**






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






**ITEM
      18.**  **FINANCIAL
      STATEMENTS**






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






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






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




Exhibit
                No.
            Exhibit1.1
            Memorandum
                of Association*1.2
            Articles
                of Association**4.1
            Lease
                Agreement for the Company’s Headquarters**4.2
            Lease
                Agreement for the Company’s Mahwah office***4.3
            Distributor
                Agreement with Bynet Data Communications Ltd.***4.4
            Form
                of Directors and Officers Indemnity Deed4.5
            Asset
                Purchase Agreement with V-Secure Technologies Inc.10
            Consent
                of Independent Auditors12.1
            Certification
                of the Chief Executive Officer pursuant to 17 CFR 240.13a-14(a),
                as
                adopted pursuant to § 302 of the Sarbanes-Oxley
                Act12.2
            Certification
                of the Chief Financial Officer pursuant to 17 CFR 240.13a-14(a),
                as
                adopted pursuant to § 302 of the Sarbanes-Oxley
                Act13.
            Certification
                of the Chief Executive Officer pursuant to 18 U.S.C. § 1350, as adopted
                pursuant to § 906 of the Sarbanes-Oxley Act.13.2
            Certification
                of the Chief Financial Officer pursuant to 18 U.S.C. § 1350, as adopted
                pursuant to § 906 of the Sarbanes-Oxley
                Act.




*
      Incorporated by reference to the Registration Statement on Form F-1 (File No.
      333-10752).


**
      Incorporated by reference to the Annual Report on Form 20-F for the year ended
      December 31, 2000. An amendment to the Articles of Association is
      attached.


***
      Incorporated by reference to the Annual Report on Form 20-F for the year ended
      December 31, 2001.







78




SIGNATURE




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




RADWARE
                LTD.By:
            /s/Yehuda
                ZisapelChairman
                of the Board of DirectorsDate:
                April 26, 2006






79




**RADWARE
        LTD. AND ITS SUBSIDIARIES**
 
 
 **CONSOLIDATED
        FINANCIAL STATEMENTS**
 
 
 **AS
        OF DECEMBER 31, 2005**
 
 
 **U.S.
        DOLLARS IN THOUSANDS**
 
 
 
 
 **INDEX**
 
 
 **Page****Report
                  of Independent Registered Public Accounting Firm**
              **F2****Consolidated
                  Balance Sheets**
              **F3
                  - F4****Consolidated
                  Statements of Income**
              **F5****Statements
                  of Changes in Shareholders' Equity**
              **F6****Consolidated
                  Statements of Cash Flows**
              **F7****Notes
                  to Consolidated Financial Statements**
              **F8
                  - F32**
 
 
 
 
 
 -
        - - - -
        - - - - - - - -
 
  
   
 
 
 **REPORT
        OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**
 
 **To
        the Shareholders of**
 
 **RADWARE
        LTD.**
 
 
 We
        have
        audited the accompanying consolidated balance sheets of Radware Ltd. ("the
        Company") and its subsidiaries as of December 31, 2004 and 2005, and the
        related
        consolidated statements of income, statements of changes in shareholders'
        equity
        and the consolidated statements of cash flows for each of the three years
        in the
        period ended December 31, 2005. These financial statements are the
        responsibility of the Company's management. Our responsibility is to express
        an
        opinion on these financial statements based on our audits.
 
 
 We
        conducted our audits in accordance with the standards of the Public Company
        Accounting Oversight Board (United States). Those standards require that
        we plan
        and perform the audit to obtain reasonable assurance about whether the financial
        statements are free of material misstatement. We were not engaged to perform
        an
        audit of the Company's internal control over financial reporting. Our audits
        included consideration of internal control over financial reporting as a
        basis
        for designing audit procedures that are appropriate in the circumstances,
        but
        not for the purpose of expressing an opinion on the effectiveness of the
        Company's internal control over financial reporting. Accordingly, we express
        no
        such opinion. An audit also includes examining, on a test basis, evidence
        supporting the amounts and disclosures in the financial statements, assessing
        the accounting principles used and significant estimates made by management,
        and
        evaluating the overall financial statement presentation. We believe that
        our
        audits provide a reasonable basis for our opinion.
 
 
 In
        our
        opinion, the financial statements referred to above present fairly, in all
        material respects, the consolidated financial position of the Company and
        its
        subsidiaries at December 31, 2004 and 2005, and the consolidated results
        of
        their operations and their cash flows for each of the three years in the
        period
        ended December 31, 2005, in conformity with U.S. generally accepted accounting
        principles.
 
 
 
 
 Tel-Aviv,
                  Israel
              KOST
                  FORER GABBAY & KASIERERJanuary
                  29, 2006
              A
                  Member of Ernst & Young Global
 
 -
              F2 -
 
 **RADWARE
              LTD. AND ITS SUBSIDIARIES**
  **CONSOLIDATED
        BALANCE SHEETS**
 
 **U.S.
        dollars in thousands**
 
 
 **December
                  31,****2004**
              
              **2005**ASSETSCURRENT
                  ASSETS:Cash
                  and cash equivalents
              
              $
              8,792
              
              $
              56,263Current
                  maturity of long-term bank deposit
              
              
              64,892
              
              
              -Bank
                  deposit
              
              
              -
              
              
              10,195Available-for-sale
                  marketable securities
              
              
              30,170
              
              
              14,717Held-to-maturity
                  marketable securities
              
              
              5,166
              
              
              45,726Trade
                  receivables (net of allowance for doubtful accounts of $ 1,060
                  and
                $ 1,006
                  in 2004 and 2005, respectively) *)
              
              
              13,166
              
              
              14,661Other
                  receivables and prepaid expenses
              
              
              1,332
              
              
              1,451Inventories
              
              
              4,094
              
              
              5,254Totalcurrent assets
              
              
              127,612
              
              
              148,267LONG-TERM
                  INVESTMENTS:Structured
                  note
              
              
              9,224
              
              
              9,458Available-for-sale
                  marketable securities
              
              
              12,477
              
              
              11,399Held-to-maturity
                  marketable securities
              
              
              26,320
              
              
              16,735Severance
                  pay fund
              
              
              1,921
              
              
              2,178Totallong-term investments
              
              
              49,942
              
              
              39,770PROPERTY
                  AND EQUIPMENT, NET
              
              
              4,452
              
              
              5,968LONG-TERM
                  DEFERRED TAXES AND OTHER LONG-TERM ASSETS
              
              
              671
              
              
              1,075INTANGIBLE
                  ASSETS, NET
              
              
              564
              
              
              2,813GOODWILL
              
              
              -
              
              
              6,454Totalassets
              
              $
              183,241
              
              $
              204,347
 
 *)
                  Includes
                      balances in the amount of $ 1,004 and $ 1,447 with related
                      parties as of
                      December 31, 2004 and 2005, respectively (see also Note
                      13a).
 
 
 The
        accompanying notes are an integral part of the consolidated financial
        statements.
  -
            F3 -
 
 **RADWARE
            LTD. AND ITS SUBSIDIARIES**
  **CONSOLIDATED
        BALANCE SHEETS**
 
 **U.S.
        dollars in thousands, except share and per share data**
 
 
 **December
                  31,****2004**
              
              **2005**LIABILITIES
                  AND SHAREHOLDERS' EQUITYCURRENT
                  LIABILITIES:Trade
                  payables *)
              
              $
              5,075
              
              $
              5,329Deferred
                  revenues
              
              
              9,888
              
              
              12,424Other
                  payables and accrued expenses
              
              
              4,962
              
              
              6,509Totalcurrent liabilities
              
              
              19,925
              
              
              24,262ACCRUED
                  SEVERANCE PAY
              
              
              2,399
              
              
              2,659COMMITMENTS
                  AND CONTINGENT LIABILITIESSHAREHOLDERS'
                  EQUITY:Share
                  capital:Ordinary
                  shares of NIS 0.1 par value:
                Authorized
                  - 30,000,000 shares as of December 31, 2004 and 2005; Issued and
                  outstanding - 18,488,530 and 19,061,760 shares as of December 31,
                  2004 and 2005, respectively
              
              
              457
              
              
              470Additional
                  paid-in capital
              
              
              145,439
              
              
              153,010Deferred
                  stock based compensation
              
              
              -
              
              
              (67
              )Accumulated
                  other comprehensive loss
              
              
              (52
              )
              
              (404
              )Retained
                  earnings
              
              
              15,073
              
              
              24,417Totalshareholders' equity
              
              
              160,917
              
              
              177,426Totalliabilities and shareholders' equity
              
              $
              183,241
              
              $
              204,347
 
 
 *) See
        Note
        13a for balances with related parties.
 
 The
        accompanying notes are an integral part of the consolidated financial
        statements.
 
  -
            F4 -
 
 **RADWARE
            LTD. AND ITS SUBSIDIARIES**
   **CONSOLIDATED
        STATEMENTS OF INCOME**
 
 **U.S.
        dollars in thousands, except per share data**
 
 
 **Year
                  ended December 31,****2003**
              
              **2004**
              
              **2005**Revenues
                  *)
              
              $
              54,780
              
              $
              68,439
              
              $
              77,584Cost
                  of revenues *)
              
              
              9,854
              
              
              12,184
              
              
              14,896Gross
                  profit
              
              
              44,926
              
              
              56,255
              
              
              62,688Operating
                  expenses: *)Research
                  and development, net
              
              
              8,398
              
              
              10,342
              
              
              13,017Sales
                  and marketing
              
              
              29,753
              
              
              31,898
              
              
              40,002General
                  and administrative
              
              
              4,120
              
              
              4,493
              
              
              5,244Totaloperating expenses
              
              
              42,271
              
              
              46,733
              
              
              58,263Operating
                  income
              
              
              2,655
              
              
              9,522
              
              
              4,425Financial
                  income, net
              
              
              3,740
              
              
              4,565
              
              
              5,159Income
                  before income taxes
              
              
              6,395
              
              
              14,087
              
              
              9,584Income
                  taxes
              
              
              -
              
              
              341
              
              
              240Income
                  before minority interest in losses (earnings) of a
                  subsidiary
              
              
              6,395
              
              
              13,746
              
              
              9,344Minority
                  interest in losses (earnings) of a subsidiary
              
              
              (40
              )
              
              34
              
              
              -Net
                  income
              
              $
              6,355
              
              $
              13,780
              
              $
              9,344Basic
                  net earnings per share
              
              $
              0.37
              
              $
              0.77
              
              $
              0.50Diluted
                  net earnings per share
              
              $
              0.34
              
              $
              0.70
              
              $
              0.47
 
 *) See
        Note
        13b for transactions with related parties.
 
  The
        accompanying notes are an integral part of the consolidated financial
        statements.
  -
              F5 -
 
 **RADWARE
              LTD. AND ITS SUBSIDIARIES**
 
 **STATEMENTS
        OF CHANGES IN SHAREHOLDERS' EQUITY**
 **U.S.
        dollars in thousands, except share data**
 
 **Number
                  of**
                **outstanding
                  Ordinary**
                **shares**
              
              **Share**
                **capital**
              
              **Additional
                  paid-in**
                **capital**
              
              **Deferred**
                **stock
                  based compensation**
              
              **Treasury**
                **shares,
                  at cost**
              
              **Accumulated**
                **other
                  comprehensive**
                **income
                  (loss)**
              
              **Retained
                  earnings**
                **(accumulated
                  deficit)**
              
              **Total**
                **comprehensive
                  income (loss)**
              
              **Total**Balance
                  as of January 1, 2003
              
              
              17,014,114
              
              $
              424
              
              $
              132,005
              
              $
              (98
              )
              $
              (254
              )
              $
              89
              
              $
              (4,809
              )
              
              
              
              $
              127,357Retirement
                  of 32,700
                Ordinary
                  shares of treasury stock
              
              
              -
              
              
              (1
              )
              
              -
              
              
              -
              
              
              254
              
              
              -
              
              
              (253
              )
              
              
              
              
              -Issuance
                  of shares upon exercise of stock options and upon purchase of shares
                  under
                  ESPP
              
              
              690,069
              
              
              16
              
              
              6,547
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              
              
              
              6,563Amortization
                  of deferred stock based compensation
              
              
              -
              
              
              -
              
              
              -
              
              
              98
              
              
              -
              
              
              -
              
              
              -
              
              
              
              
              
              98Comprehensive
                  income:Unrealized
                  losses from available-for-sale securities, net
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              (127
              )
              
              -
              
              $
              (127
              )
              
              (127
              )Net
                  income
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              6,355
              
              
              6,355
              
              
              6,355Total
                  comprehensive income
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              $
              6,228Balance
                  as of December 31, 2003
              
              
              17,704,183
              
              
              439
              
              
              138,552
              
              
              -
              
              
              -
              
              
              (38
              )
              
              1,293
              
              
              
              
              
              140,246Issuance
                  of shares upon exercise of stock options and upon purchase of shares
                  under
                  ESPP
              
              
              784,347
              
              
              18
              
              
              6,887
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              
              
              
              6,905Comprehensive
                  income:Unrealized
                  losses from available-for-sale securities, net
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              (14
              )
              
              -
              
              $
              (14
              )
              
              (14
              )Net
                  income
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              13,780
              
              
              13,780
              
              
              13,780Total
                  comprehensive income
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              $
              13,766Balance
                  as of December 31, 2004
              
              
              18,488,530
              
              
              457
              
              
              145,439
              
              
              -
              
              
              -
              
              
              (52
              )
              
              15,073
              
              
              
              
              
              160,917Issuance
                  of shares upon exercise of stock options and upon purchase of shares
                  under
                  ESPP
              
              
              573,230
              
              
              13
              
              
              7,298
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              
              
              
              7,311Deferred
                  stock based compensation
              
              
              -
              
              
              -
              
              
              125
              
              
              (125
              )
              
              -
              
              
              -
              
              
              -
              
              
              
              
              
              -Amortization
                  of deferred stock based compensation
              
              
              -
              
              
              -
              
              
              -
              
              
              58
              
              
              -
              
              
              -
              
              
              -
              
              
              
              
              
              58Warrants
                  issued in respect of business combination
              
              
              -
              
              
              -
              
              
              148
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              
              
              
              148Comprehensive
                  income:Unrealized
                  losses from available-for-sale securities, net
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              (352
              )
              
              -
              
              $
              (352
              )
              
              (352
              )Net
                  income
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              9,344
              
              
              9,344
              
              
              9,344Total
                  comprehensive income
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              $
              8,992Balance
                  as of December 31, 2005
              
              
              19,061,760
              
              $
              470
              
              $
              153,010
              
              $
              (67
              )
              $
              -
              
              $
              (404
              )
              $
              24,417
              
              
              
              
              $
              177,426
 
 The
        accompanying notes are an integral part of the consolidated financial
        statements.
 
 -
              F6 -
 
 **RADWARE
              LTD. AND ITS SUBSIDIARIES**
 **CONSOLIDATED
        STATEMENTS OF CASH FLOWS**
 
 **U.S.
        dollars in thousands**
 **Year
                  ended December 31,****2003**
              
              **2004**
              
              **2005**Cash
                  flows from operating activities:Net
                  income
              
              $
              6,355
              
              $
              13,780
              
              $
              9,344Adjustments
                  to reconcile net income to net cash provided by operating
                  activities:Depreciation
                  and amortization
              
              
              1,509
              
              
              1,429
              
              
              1,921Amortization
                  of deferred stock based compensation
              
              
              98
              
              
              -
              
              
              58Minority
                  interest in earnings (losses) of a subsidiary
              
              
              40
              
              
              (34
              )
              
              -Amortization
                  of premiums, accretion of discounts and accrued interest on
                  available-for-sale and held-to-maturity marketable securities,
                  net
              
              
              214
              
              
              318
              
              
              (475
              )Accrued
                  interest on bank deposits and structured note
              
              
              (184
              )
              
              791
              
              
              1,468Accrued
                  severance pay, net
              
              
              106
              
              
              288
              
              
              3Decrease
                  (increase) in long-term deferred taxes
              
              
              -
              
              
              (350
              )
              
              20Increase
                  in trade receivables, net
              
              
              (995
              )
              
              (3,476
              )
              
              (1,495
              )Decrease
                  (increase) in other receivables and prepaid expenses
              
              
              63
              
              
              (243
              )
              
              (119
              )Increase
                  in inventories
              
              
              (10
              )
              
              (1,096
              )
              
              (1,160
              )Increase
                  in trade payables
              
              
              1,673
              
              
              790
              
              
              245Increase
                  in deferred revenues
              
              
              1,768
              
              
              2,830
              
              
              2,536Increase
                  (decrease) in other payables and accrued expenses
              
              
              (1,678
              )
              
              123
              
              
              1,547Other
              
              
              1
              
              
              1
              
              
              (43
              )Net
                  cash provided by operating activities
              
              
              8,960
              
              
              15,151
              
              
              13,850Cash
                  flows from investing activities:Purchase
                  of property and equipment *)
              
              
              (1,311
              )
              
              (2,369
              )
              
              (3,626
              )Proceeds
                  from sale of property and equipment
              
              
              -
              
              
              16
              
              
              297Investment
                  in other long-term assets
              
              
              15
              
              
              (225
              )
              
              (24
              )Purchase
                  of available-for-sale marketable securities
              
              
              (5,586
              )
              
              (21,281
              )
              
              (86
              )Purchase
                  of held-to-maturity marketable securities
              
              
              -
              
              
              (31,320
              )
              
              (31,962
              )Proceeds
                  from sale and redemption of available-for-sale marketable debt
                  securities
              
              
              20,137
              
              
              13,369
              
              
              16,265Proceeds
                  from redemption of held-to-maturity marketable debt
                  securities
              
              
              -
              
              
              -
              
              
              1,462Investment
                  in long-term bank deposits
              
              
              (12,754
              )
              
              (2,890
              )
              
              -Proceeds
                  from maturity of long-term bank deposit
              
              
              -
              
              
              -
              
              
              62,995Investment
                  in bank deposit
              
              
              -
              
              
              -
              
              
              (10,000
              )Increase
                  in holdings in a subsidiary
              
              
              (350
              )
              
              (335
              )
              
              -Payment
                  for the acquisition of V-Secure (1)
              
              
              -
              
              
              -
              
              
              (9,011
              )Net
                  cash provided by (used in) investing activities
              
              
              151
              
              
              (45,035
              )
              
              26,310Cash
                  flows from financing activities:Proceeds
                  from exercise of stock options and from purchase of shares under
                  ESPP
              
              
              6,563
              
              
              6,905
              
              
              7,311Net
                  cash provided by financing activities
              
              
              6,563
              
              
              6,905
              
              
              7,311Increase
                  (decrease) in cash and cash equivalents
              
              
              15,674
              
              
              (22,979
              )
              
              47,471Cash
                  and cash equivalents at the beginning of the year
              
              
              16,097
              
              
              31,771
              
              
              8,792Cash
                  and cash equivalents at the end of the year
              
              $
              31,771
              
              $
              8,792
              
              $
              56,263(1)Payment
                  for the acquisition of V-Secure:Estimated
                  fair value of assets acquired at the date of acquisition:Acquired
                  technology
              
              $
              -
              
              $
              -
              
              $
              1,772Customers
                  relationship
              
              
              -
              
              
              -
              
              
              542Deferred
                  compensation cost
              
              
              -
              
              
              -
              
              
              400Goodwill
              
              
              -
              
              
              -
              
              
              6,297$-
              
              
              
              
              $
              -
              
              $
              9,011Supplemental
                  disclosure of cash flow activities:Cash
                  paid during the year for:Taxes
              
              $
              -
              
              $
              1,494
              
              $
              -
  *) See
        Note
        13b for transactions with related parties.
 
 The
        accompanying notes are an integral part of the consolidated financial
        statements.
  -
              F7 -
 
 **RADWARE
              LTD. AND ITS SUBSIDIARIES**
  **NOTE
                  1:-**
              **GENERAL**
 
 a.
              Radware
                  Ltd. ("the Company"), an Israeli corporation, and its subsidiaries,
                  commenced operations in April 1997. The Company is engaged in the
                  development, manufacture and sale of Application-smart networking
                  solutions that provide end-to-end availability, performance and
                  security
                  of mission critical networked applications. The Company's products
                  are
                  marketed worldwide.
 
 b.
              The
                  Company established wholly-owned subsidiaries in the United States,
                  France, Germany, Singapore, the United Kingdom, Japan, Korea, Canada,
                  Switzerland and Italy. In addition, the Company established branches
                  and
                  representative offices in China, India and Taiwan. In Australia,
                  the
                  Company held approximately 83% of its Australian subsidiary as
                  of January
                  1, 2004; the additional 17% was purchased by the Company during
                  2004 for a
                  total amount of $ 335.  The
                  Company's subsidiaries are engaged primarily in sales, marketing
                  and
                  support activities.
 c.
              The
                  Company depends on a single supplier to supply certain components
                  for the
                  production of its products. If this supplier fails to deliver or
                  delays
                  the delivery of the necessary components, the Company will be required
                  to
                  seek alternative sources of supply. A change in suppliers could
                  result in
                  manufacturing delays, which could cause a possible loss of sales
                  and,
                  consequently, could adversely affect the Company's results of operations
                  and financial position.
 
 d.
              The
                  Company relies upon independent distributors (which are considered
                  to be
                  end-users) to market and sell its products to customers. A loss
                  of a major
                  distributor, or any event negatively affecting such distributor's
                  financial condition, could cause a material adverse effect on the
                  Company's results of operations and financial position (see also
                  Note
                  11b).
 As
                  of December 31, 2005 one single customer (a distributor) represented
                  16%
                  of the trade receivables balance. As of December 31, 2004, no single
                  customer represented more than 10% of the trade receivables balance.
 
 e.
              Business
                  combination - acquisition of V-Secure Technologies (US) Inc.
                  ("V-Secure"):
 
 In
                  December 2005, the Company acquired the business of V-Secure which
                  included the acquisition of its technology, customer relationship
                  and
                  goodwill. The total consideration for the acquisition was $ 9,168,
                  out of
                  which an amount of $ 9,011 was paid in cash; amount valuated as $ 148
                  was paid by issuance of fully vested warrants to V-Secure to purchase
                  45,454 Ordinary shares of the Company, at an exercise price of
                  $ 22 per
                  share. The remaining balance is related to acquisition costs
                  payable.
 
 Additional
                  cash consideration of $ 6,000 (earn-out) is payable contingent
                  upon
                  meeting a certain technological milestone in regards to the integrated
                  product of the Company and V-Secure by June 28, 2006. Resolution
                  of the
                  contingent with payment of the consideration will result in recording
                  additional goodwill.
 
 The
                  Company plans to integrate V-Secure and the Company’s technology in order
                  to provide advanced technology solutions to its
                  customers.
 
  -
              F8 -
 
 **RADWARE
              LTD.**  **AND
              ITS SUBSIDIARIES**
 
 **NOTES
              TO CONSOLIDATED FINANCIAL STATEMENTS**
 **U.S.
              dollars in thousands**
  
 **NOTE
                  1:-**
              **GENERAL
                  (Cont.)**
 
 The
                  purchase price was allocated to the identifiable intangible assets
                  acquired (which have been valuated by management using a third
                  party
                  valuation specialist) based upon their estimated fair values as
                  follows:
 
 Acquired
                  technology
              
              $
              1,772Customers
                  relationship
              
              
              542Goodwill
              
              
              6,454Total
                  intangible assets
              
              
              8,768Deferred
                  compensation cost
              
              
              400Total
                  consideration
              
              $
              9,168
 
 The
                  deferred compensation cost was curved-out of the goodwill and represents
                  incentive to former employees of V-Secure that will remain with
                  the
                  Company for periods of no less than 12 to 24 months. Such deferred
                  compensation cost will be amortized over the employment period,
                  and will
                  be recorded as compensation costs. Any amount not used for bonuses
                  will be
                  returned to V-Secure, and will increase the
                  goodwill.
 
 The
                  acquisition of V-Secure was accounted for under the purchase method
                  of
                  accounting.
 
 In
                  accordance with Statement of Financial Accounting Standards No.
                  142,
                  "Goodwill and Other Intangible Assets" ("SFAS No. 142"), goodwill
                  arising
                  from the acquisition will not be amortized. In lieu of amortization,
                  the
                  Company is required to perform an annual impairment review. If
                  the Company
                  determines, through the impairment review process, that goodwill
                  has been
                  impaired, it will record the impairment charge in its statement
                  of income.
                  The Company will also assess the impairment of goodwill whenever
                  events or
                  changes in circumstances indicate that the carrying value may not
                  be
                  recoverable.
 
 Unaudited
                  pro-forma results:
 
 The
                  following represents the unaudited pro-forma results of operations
                  of
                  V-Secure and the Company's consolidated statements of income for
                  the years
                  ended December 31, 2004 and 2005, assuming that V-Secure's acquisition
                  occurred on January 1, of each year:
 
 **Year
                  ended****December
                  31,****2004**
              
              
              **2005**
 **Unaudited****Total
                  consolidated**Revenues
              
              $
              69,069
              
              $
              78,145Net
                  income
              
              $
              9,747
              
              $
              5,033Diluted
                  net earning per share
              
              $
              0.49
              
              $
              0.25
 
 
  -
              F9 -
 
 **RADWARE
              LTD.**  **AND
              ITS SUBSIDIARIES**
 
 **NOTES
              TO CONSOLIDATED FINANCIAL STATEMENTS**
 **U.S.
              dollars in thousands, except per share
              data**
  
 **NOTE
                  2:-**
              **SIGNIFICANT
                  ACCOUNTING POLICIES**
 
 The
        consolidated financial statements are prepared according to accounting
        principles generally accepted in the United States ("U.S. GAAP").
 
 a.
              Use
                  of estimates:
 
 The
        preparation of financial statements in conformity with generally accepted
        accounting principles requires management to make estimates and assumptions
        that
        affect the amounts reported in the financial statements and accompanying
        notes.
        Actual results could differ from those estimates.
 
 b.
              Financial
                  statements in U.S. dollars:
 
 A
        majority of the revenues of the Company and its subsidiaries are generated
        in
        U.S. dollars ("dollar"). In addition, a substantial portion of the Company's
        and
        its subsidiaries' costs is incurred in dollars. The Company's management
        believes that the dollar is the primary currency of the economic environment
        in
        which the Company and its subsidiaries operate. Thus, the functional and
        reporting currency of the Company and its subsidiaries is the
        dollar.
 
 Accordingly,
        monetary accounts maintained in currencies other than the dollar are remeasured
        into U.S. dollars in accordance with Statement of the Financial Accounting
        Standard Board No. 52 "Foreign Currency Translation" ("SFAS No. 52"). All
        transactions gains and losses from the remeasurement of monetary balance
        sheet
        items are reflected in the consolidated statements of operations as financial
        income or expenses, as appropriate.
 
 c.
              Principles
                  of consolidation:
 
 The
        consolidated financial statements include the accounts of the Company and
        its
        subsidiaries. Intercompany balances and transactions have been eliminated
        upon
        consolidation.
 d.
              Cash
                  equivalents:
 
 Cash
        equivalents are short-term highly liquid investments that are readily
        convertible to cash with original maturities of three months or
        less.
 
 e.
              Marketable
                  securities:
 
 The
        Company accounts for investments in marketable debt securities in accordance
        with Statement of Financial Accounting Standard No. 115, "Accounting for
        Certain
        Investments in Debt and Equity Securities" ("SFAS No. 115"). Management
        determines the appropriate classification of its investments in debt and
        equity
        securities at the time of purchase and reevaluates such determinations at
        each
        balance sheet date.
  -
            F10 -
 
 **RADWARE
            LTD.**  **AND
            ITS SUBSIDIARIES**
 
 **NOTES
            TO CONSOLIDATED FINANCIAL STATEMENTS**
 **U.S.
            dollars in thousands**
  
 **NOTE
                  2:-**
              **SIGNIFICANT
                  ACCOUNTING POLICIES
                  (Cont.)**
 
 Debt
        securities are classified as held-to-maturity when the Company has the positive
        intent and ability to hold the securities to maturity and are stated at
        amortized cost. The amortized cost of held-to-maturity securities is adjusted
        for amortization of premiums and accretion of discounts to maturity. Such
        amortization and decline in value judged to be other than temporary and interest
        are included in financial income, net. As of December 31, 2005, no impairment
        has been identified.
 
 Debt
        securities that are designated as available-for-sale are stated at fair value,
        with unrealized gains and losses reported in accumulated other comprehensive
        income (loss), a separate component of shareholders' equity. Realized gains
        and
        losses on sales of investments, as determined on a specific identification
        basis, are included in financial income, net. The Company has the positive
        ability to hold the securities to maturity. As of December 31, 2005, no
        impairment has been identified.
 
 f.
              Inventories:
 
 Inventories
        are stated at the lower of cost or market value. Inventory write-offs are
        provided to cover risks arising from slow-moving items, technological
        obsolescence, excess inventories, discontinued products and market prices
        lower
        than cost. As of December 31, 2004 and 2005, the provision for inventory
        write-offs amounted to $ 430 and $ 846, respectively.
 
 Cost
        is
        determined as follows:
 
 Raw
        materials and components - using the "first-in, first-out" method.
 Work-in-progress
        and finished products:
 Raw
        materials and components - using the "first-in, first-out" method.
 Subcontracting
        costs - on the basis of direct subcontractors costs with the addition of
        allocable costs.
 
 g.
              Current
                  maturity of long-term bank deposit:
 
 Current
        maturity of long-term bank deposit consisted of a three-year bank deposit
        in
        U.S. dollars that bore interest at the rate of 4.8% and matured during 2005.
        The
        deposit was presented at cost, including accrued interest.
 
 h.
              Bank deposit:  Bank
                  deposit is a deposit with a maturity of more than three months
                  but less
                  than one year. The deposit is in U.S. dollars and bears interest
                  at a rate
                  of 3.6%. The bank deposit is presented at its cost, including accrued
                  interest.
 
 i.
              Structured
                  note:
 
 Structured
                  note as of December 31, 2005, consists of a callable structured
                  note
                  ("Structured Note") with a maturity of eight years. The Structured
                  Note
                  bears interest of 8% in its first year, and starting from its second
                  year,
                  it bears interest that varies inversely with changes of the three-month
                  USD LIBOR-rate.
  -
            F11 -
 
 **RADWARE
            LTD.**  **AND
            ITS SUBSIDIARIES**
 
 **NOTES
            TO CONSOLIDATED FINANCIAL STATEMENTS**
 **U.S.
            dollars in thousands**
  
 **NOTE
                  2:-**
              **SIGNIFICANT
                  ACCOUNTING POLICIES
                  (Cont.)**
 
 As
        of
        December 31, 2005, the Structured Note amounted to $ 9,458. Interest income
        resulting from investment in the Structured Note is accounted for based on
        the
        guidelines provided in EITF No. 96-12, "Recognition of Interest
        Income and Balance Sheet Classification of Structured Notes". Under EITF
        No.
        96-12, the retrospective interest method is used for recognizing interest
        income.
  j.
              Property
                  and equipment, net:
 
 Property
        and equipment are stated at cost, net of accumulated depreciation. Depreciation
        is calculated by the straight-line method over the estimated useful lives
        of the
        assets at the following annual rates:
 **%**Computer,
                  software and peripheral equipment
              15-33Office
                  furniture and equipment
              7-15Motor
                  vehicles
              15Leasehold
                  improvements
              Over
                  the shorter of the term of
                the
                  lease or the life of the asset
 
 k.
              Impairment
                  of long-lived assets:
 
 The
        Company's and its subsidiaries' long-lived assets and certain identifiable
        intangibles are reviewed for impairment in accordance with SFAS No. 144,
        "Accounting for the Impairment or Disposal of Long-Lived Assets" 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 the future undiscounted
        cash
        flows expected to be generated by the assets. If such assets are considered
        to
        be impaired, the impairment to be recognized is measured by the amount by
        which
        the carrying amount of the assets exceeds the fair value of the assets. As
        of
        December 31, 2005, no impairment losses have been identified.
 l.
                Goodwill:
 
 Goodwill
        represents excess of the costs over the fair value of net assets of businesses
        acquired. Under SFAS No. 142, goodwill is not amortized. SFAS No. 142 requires
        goodwill to be tested for impairment on adoption and at least annually
        thereafter or between annual tests in certain circumstances, and written
        down
        when impaired, rather than being amortized as previous accounting standards
        required. Goodwill is tested for impairment by comparing the fair value with
        its
        carrying value. Fair value is determined using discounted cash flows and
        market
        multiples. Goodwill purchased in the acquisition of V-Secure was recorded
        in
        December 2005; therefore no annual impairment test was performed in
        2005.
 
 m.
              Intangible
                  assets:
 
 Intangible
        assets are amortized over their useful life using a method of amortization
        that
        reflects the pattern in which the economic benefits of the intangible assets
        are
        consumed or otherwise used up, in accordance with SFAS No. 142. Accordingly,
        acquired technology and customer relationship are amortized over six
        years.
  -
            F12 -
 
 **RADWARE
            LTD.**  **AND
            ITS SUBSIDIARIES**
 
 **NOTES
            TO CONSOLIDATED FINANCIAL STATEMENTS**
 **U.S.
            dollars in thousands**
  
 **NOTE
                  2:-**
              **SIGNIFICANT
                  ACCOUNTING POLICIES
                  (Cont.)**
 
 n.
              Revenue
                  recognition:
 
 The
        Company and its subsidiaries generate revenues mainly from selling their
        products and from post-contract customer support primarily through distributors
        and resellers, all of which are considered end-users.
 
 Revenues
        from product sales are recognized when delivery has occurred, persuasive
        evidence of an agreement exists, the fee is fixed or determinable, no further
        obligation exists and collectability is probable.
 
 Revenues
        in arrangements with multiple deliverables are recognized under the "residual
        method" when Vendor Specific Objective Evidence ("VSOE") of fair value exists
        for all undelivered elements, no VSOE exists for the delivered elements,
        and all
        other revenue recognition criteria are satisfied. VSOE for post-contract
        customer support is determined based on the price when it is sold separately
        in
        similar arrangements. The price may vary in the territories and vertical
        markets
        in which the Company conducts business. Price is determined by using a
        consistent percentage of the Company's product price lists.
 
 Revenue
        derived from post-contract customer support, which represents mainly software
        subscription, unit replacement and security update service, is recognized
        ratably over the contract period, which is typically one year.
 
 Revenues
        from training and installation, which are considered as not essential to
        the
        functionality of the product, included in multiple elements arrangements
        are
        recognized at the time they are rendered.
 
 The
        Company and its subsidiaries provide a provision for product returns and
        stock
        rotation based on their experience with historical sales returns, analysis
        of
        credit memo data and other known factors, in accordance with Statement of
        Financial Accounting Standard No. 48, "Revenue Recognition When Right of
        Return
        Exists" ("SFAS No. 48").
 
 Deferred
        revenue includes unearned amounts received under post-contract customer
        support.
 o.
                Warranty
                    costs:
 
 The
        Company generally offers a one year warranty for all of its products. A
        provision for warranty costs is provided at the time revenues are recognized,
        for estimated material costs during the warranty period based on the Company's
        experience.
  -
            F13 -
 
 **RADWARE
            LTD.**  **AND
            ITS SUBSIDIARIES**
 
 **NOTES
            TO CONSOLIDATED FINANCIAL STATEMENTS**
 **U.S.
            dollars in thousands**
  
 **NOTE
                  2:-**
              **SIGNIFICANT
                  ACCOUNTING POLICIES
                  (Cont.)**
 
 p.
              Accounting
                  for stock-based compensation:
 
 The
        Company has elected to follow Accounting Principles Board Opinion No. 25,
        "Accounting for Stock Issued to Employees" ("APB No. 25") and FASB
        Interpretation No. 44, "Accounting for Certain Transactions Involving Stock
        Compensation" ("FIN No. 44") in accounting for its employee stock option
        plans
        and its non-compensatory Employee Share Purchase Plans ("ESPP"). Under APB
        No.
        25, when the exercise price of an employee stock option is equivalent to,
        or is
        above the market price of the underlying stock on the date of grant, no
        compensation expense is recognized.
 
 The
        Company adopted the disclosure provisions of Financial Accounting Standards
        Board Statement No. 148, "Accounting for Stock-Based Compensation - Transition
        and Disclosure" ("SFAS No. 148"), which amended certain provisions of SFAS
        No.
        123, "Accounting for Stock-Based Compensation" ("SFAS No. 123") to provide
        alternative methods of transition for an entity that voluntarily changes
        to the
        fair value based method of accounting for stock-based employee compensation,
        effective as of the beginning of the fiscal year. The Company continues to
        apply
        the provisions of APB No. 25, in accounting for stock-based compensation.
 
 Pro
        forma
        information regarding net income and net earnings per share is required by
        SFAS
        No. 123, and has been determined as if the Company had accounted for its
        employee stock options under the fair value method of that statement. The
        fair
        value for these options was estimated at the grant date using a Black-Scholes
        formula for option pricing model with the following weighted-average assumptions
        for each of the three years ended December 31, 2003, 2004 and 2005: risk-free
        interest rates of 2.5%, 2.5% and 4.5%, respectively; dividend yields of 0%
        for
        each year; a volatility factor of the expected market price of the Company's
        Ordinary shares of 149%, 75% and 41%, respectively; and a weighted-average
        expected life of the option of 2.5, 2.5 and 3.5 years,
        respectively.
 
 The
        Black-Scholes options pricing-model was used to estimate the fair value of
        the
        ESPP compensation. Assumptions were not provided due to
        immateriality.
 
 For
        purposes of pro forma disclosures, the estimated fair values of the options
        are
        amortized to expense over each option's vesting period.
 
  -
              F14 -
 
 **RADWARE
              LTD.**  **AND
              ITS SUBSIDIARIES**
 
 **NOTES
              TO CONSOLIDATED FINANCIAL STATEMENTS**
 **U.S.
              dollars in thousands**
   
 **NOTE
                  2:-**
              **SIGNIFICANT
                  ACCOUNTING POLICIES
                  (Cont.)**
 
 Pro
        forma
        information under SFAS No. 123:
 **Year
                  ended December 31,****2003**
              
              **2004**
              
              **2005**Net
                  income as reported
              
              $
              6,355
              
              $
              13,780
              
              $
              9,344Add
                  - stock-based compensation expenses included in reported net
                  income-intrinsic value
              
              
              98
              
              
              -
              
              
              58Deduct
                  - stock-based compensation expense determined under fair value
                  method
              
              
              (7,626
              )
              
              (7,520
              )
              
              (6,082
              )Pro
                  forma net income (loss)
              
              $
              (1,173
              )
              $
              6,260
              
              $
              3,320Basic
                  net earnings per share as reported
              
              $
              0.37
              
              $
              0.77
              
              $
              0.50Diluted
                  net earnings per share as reported
              
              $
              0.34
              
              $
              0.70
              
              $
              0.47Pro
                  forma basic net earnings (loss) per share
              
              $
              (0.07
              )
              $
              0.35
              
              $
              0.18Pro
                  forma diluted net earnings (loss) per share
              
              $
              (0.07
              )
              $
              0.32
              
              $
              0.17
 
 On
        December 16, 2004, the Financial Accounting Standards Board (FASB) issued
        Statement No. 123 (revised 2004), "Share-Based Payment" ("SFAS No. 123(R)"),
        which is a revision of SFAS No. 123. Generally, the approach in SFAS 123(R)
        is
        similar to the approach described in Statement 123. However, SFAS No. 123
        permitted, but did not require, share-based payments to employees to be
        recognized based on their fair values while SFAS No. 123(R) requires all
        share-based payments to employees to be recognized based on their fair values.
        SFAS No. 123(R) also revises, clarifies and expands guidance in several areas,
        including measuring fair value, classifying an award as equity or as a liability
        and attributing compensation cost to reporting periods. SFAS No. 123(R) will
        be
        effective for periods commencing January 1, 2006. SFAS No. 123(R) permits
        public
        companies to adopt its requirements using one of two methods:
 
 (i)
              a
                  "modified prospective" method in which compensation cost is recognized
                  beginning with the effective date (a) based on the requirements
                  of
                  Statement SFAS No. 123(R) for all share-based payments granted
                  after the
                  effective date and (b) based on the requirements of SFAS No. 123
                  for all
                  awards granted to employees prior to the effective date of SFAS
                  No. 123(R)
                  that remain unvested on the effective
                  date.
 
 (ii)
              a
                  "modified retrospective" method which includes the requirements
                  of the
                  modified prospective method described above, but also permits entities
                  to
                  restate prior periods based on the amounts previously recognized
                  under
                  SFAS No. 123 for purposes of pro forma disclosures.
 
 The
        Company plans to adopt SFAS No. 123(R) using the “modified prospective”
method.
 
  -
              F15 -
 
 **RADWARE
              LTD.**  **AND
              ITS SUBSIDIARIES**
 
 **NOTES
              TO CONSOLIDATED FINANCIAL STATEMENTS**
 **U.S.
              dollars in thousands, except per share
              data**
   
 **NOTE
                  2:-**
              **SIGNIFICANT
                  ACCOUNTING POLICIES
                  (Cont.)**
 
 In
        March
        2005, the SEC released SEC Staff Accounting Bulletin No. 107, "Share-Based
        Payment" ("SAB 107"). SAB 107 provides the SEC staff's position regarding
        the
        application of SFAS 123(R) and contains interpretive guidance related to
        the
        interaction between SFAS 123(R) and certain SEC rules and regulations, and
        also
        provides the SEC staff's views regarding the valuation of share-based payment
        arrangements for public companies. SAB 107 highlights the importance of
        disclosures made relating to the accounting for share-based payment
        transactions. The Company is currently reviewing the effect of SAB 107 and
        SFAS
        No. 123(R) on its financial position, results of operations and cash flows.
        Had
        the Company adopted SFAS No. 123(R) and SAB 107 in prior periods, management
        estimates the impact of those standards would have approximated the impact
        of
        SFAS No. 123 as described above. The Company expects that the adoption of
        SFAS
        No. 123(R) and SAB 107 will have a material effect on its financial position
        and
        results of operations.
 
 q.
              Research
                  and development costs:
 
 Research
        and development costs are charged to the statement of income, as
        incurred.
 
 r.
              Basic
                  and diluted net earnings per share:
 
 Basic
        net
        earnings per share are computed based on the weighted average number of Ordinary
        shares outstanding during each year. Diluted net earnings per share are computed
        based on the weighted average number of Ordinary shares outstanding during
        each
        year, plus dilutive potential Ordinary shares considered outstanding during
        the
        year, in accordance with Statement of Financial Standard No. 128, "Earnings
        per
        Share" ("SFAS No. 128").
 
 The
        weighted average number of shares related to outstanding anti dilutive options
        excluded from the calculation of diluted earnings per share was 213,492 and
        709,972 for the years ended December 31, 2004 and 2005,
        respectively.
 
 s.
              Income
                  taxes:
 
 The
        Company and its subsidiaries account for income taxes in accordance with
        Statement of Financial Accounting Standards No. 109, "Accounting for Income
        Taxes" ("SFAS No. 109"). This 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. The Company and its
        subsidiaries provide a valuation allowance, if necessary, to reduce deferred
        tax
        assets to their estimated realizable value.
 
 t.
              Concentrations
                  of credit risks:
 
 Financial
        instruments that potentially subject the Company and its subsidiaries to
        concentrations of credit risk consist principally of cash and cash equivalents,
        bank deposits, marketable securities, trade receivables and structured
        note.
 
 The
        majority of the Company's and its subsidiaries' cash and cash equivalents,
        and
        bank deposits are invested in major banks in the United States and in the
        United
        Kingdom in U.S. dollars. Management believes that the financial institutions
        that hold the Company's investments are financially sound and accordingly,
        minimal credit risk exists with respect to these investments. Such deposits
        in
        the United States may be in excess of insured limits and are not insured
        in
        other jurisdictions.
 
  -
              F16 -
 
 **RADWARE
              LTD.**  **AND
              ITS SUBSIDIARIES**
 
 **NOTES
              TO CONSOLIDATED FINANCIAL STATEMENTS**
 **U.S.
              dollars in thousands, except share
              data**
   
 **NOTE
                  2:-**
              **SIGNIFICANT
                  ACCOUNTING POLICIES
                  (Cont.)**
 
 The
        Company's marketable securities include investments in U.S. government
        debentures; foreign banks and government debentures, corporate debentures
        and
        auction rate securities. Management believes that those corporations and
        governments are financially sound and that the portfolios are well-diversified,
        and accordingly, minimal credit risk exists with respect to these marketable
        securities. Moreover, the Company’s investment policy, limits the amount the
        Company may invest in any one type of investment, thereby reducing credit
        risk
        concentration.
 The
        trade
        receivables of the Company and its subsidiaries are mainly derived from sales
        to
        customers located primarily in the United States, Europe, the Middle East,
        Africa and Asia Pacific. The Company performs ongoing credit evaluations
        of its
        customers. An allowance for doubtful accounts is determined with respect
        to
        those amounts that the Company has determined to be doubtful of collection.
        In
        certain circumstances **,** the
        Company may require from the customers letters of credit, other collateral
        or
        additional guarantees.
 
 As
        of
        December 31, 2004 and 2005, the Company and its subsidiaries had no
        off-balance-sheet concentration of credit risk such as foreign exchange
        contracts, option contracts or other foreign hedging arrangements.
 
 u.
              Severance
                  pay:
 
 The
        Company's liability for severance pay for its Israeli employees is calculated
        pursuant to the Israeli Severance Pay Law based on the most recent salary
        of the
        employees multiplied by the number of years of employment, as of the balance
        sheet date. Employees are entitled to one month's salary for each year of
        employment or a portion thereof. The Company's liability for all of its Israeli
        employees is fully provided by monthly deposits with insurance policies and
        by
        an accrual.
 
 The
        deposited funds include profits accumulated up to the balance sheet date.
        The
        deposited funds may be withdrawn only upon the fulfillment of the obligation
        pursuant to the Israeli Severance Pay Law or labor agreements. The value
        of the
        deposited funds is based on the cash surrendered value of these policies,
        and
        includes immaterial profits.
 
 Severance
        expenses for the years ended December 31, 2003, 2004, and 2005, amounted
        to
        approximately $ 434, $ 774 and $ 405, respectively.
 
 v.
              Fair
                  value of financial instruments:
 
 The
        following methods and assumptions were used by the Company and its subsidiaries
        in estimating fair value and disclosures for financial instruments:
 
 The
        carrying amount reported in the balance sheet of cash and cash equivalents,
        trade receivables, other receivables and prepaid expenses, bank deposits,
        trade
        payables and other payables and accrued expenses approximates their fair
        values
        due to the short-term maturities of such instruments.
 
 The
        fair
        values for marketable securities are based on quoted market prices and do
        not
        significantly differ from carrying amounts (see also Note 3).
  -
            F17 -
 
 **RADWARE
            LTD.**  **AND
            ITS SUBSIDIARIES**
 
 **NOTES
            TO CONSOLIDATED FINANCIAL STATEMENTS**
 **U.S.
            dollars in thousands**
  
 **NOTE
                  2:-**
              **SIGNIFICANT
                  ACCOUNTING POLICIES
                  (Cont.)**
 
 The
        carrying amount of the Company's structured note is estimated by discounting
        the
        future cash flows using the future prospected interest rates for deposits
        of
        similar terms and maturities. The carrying amount of the structured note
        does
        not significantly differ from its fair value.
 
 w.
              Advertising
                  expenses:
 
 Advertising
        expenses are charged to the statements of income as incurred.
 
 x.
              Impact
                  of recently issued Accounting
                  Standards:
 
 In
        November 2004, the FASB issued Statement of Financial Accounting Standard
        No.
        151, "Inventory Costs, an Amendment of ARB No. 43, Chapter 4." ("SFAS No.
        151").
        SFAS No. 151 amends Accounting Research Bulletin ("ARB") No. 43, Chapter
        4, to
        clarify that abnormal amounts of idle facility expense, freight handling
        costs
        and wasted materials (spoilage) should be recognized as current-period charges.
        In addition, SFAS No. 151 requires that the allocation of fixed production
        overheads to the costs of conversion be based on the normal capacity of the
        production facilities. SFAS No. 151 is effective for inventory costs incurred
        during fiscal years beginning after June 15, 2005. The Company does not expect
        that the adoption of SFAS No. 151 will have a material effect on its financial
        position or results of operations.
 
 In
        May
        2005, the FASB issued Statement of Financial Accounting Standard No. 154
        ("SFAS
        154"), "Accounting Changes and Error Corrections", a replacement of APB No.
        20,
        "Accounting Changes" and SFAS No. 3, "Reporting Accounting Changes in Interim
        Financial Statements". SFAS 154 provides guidance on the accounting for and
        reporting of accounting changes and error corrections. APB No. 20 previously
        required that most voluntary changes in accounting principles be recognized
        by
        including in net income for the period of the change the cumulative effect
        of
        changing to the new accounting principle. SFAS 154 requires retroactive
        application to prior periods' financial statements of a voluntary change
        in
        accounting principles unless it is impracticable. SFAS 154 is effective for
        accounting changes and corrections of errors made in fiscal years beginning
        after December 15, 2005.
 
 On
        December 16, 2004, the Financial Accounting Standards Board (FASB) issued
        Statement No. 123 (revised 2004), "Share-Based Payment" ("SFAS No. 123(R)"),
        which is a revision of SFAS No. 123. SFAS No. 123(R) will be effective for
        periods commencing January 1, 2006 (see also p above).
 
 y.
              Reclassification:
 
 Certain
        amounts from prior years have been reclassified to conform to the current
        year's
        presentation. The reclassification had no effect on previously reported net
        income, shareholders' equity or cash flows.
 
  -
            F18 -
 
 **RADWARE
            LTD.**  **AND
            ITS SUBSIDIARIES**
 
 **NOTES
            TO CONSOLIDATED FINANCIAL STATEMENTS**
 **U.S.
            dollars in thousands**
  
 **NOTE
        3:-**  **MARKETABLE
        SECURITIES**
 
 The
        Company invests in marketable debt securities, which are classified as
        available-for-sale and held-to-maturity investments. The following is a summary
        of marketable debt securities:
  **December
                  31,****2004**
              **2005****Amortized**
              
              
              **Unrealized**
              
              
              **Market**
              
              
              **Amortized**
              
              
              **Unrealized**
              
              
              **Market****cost**
              
              
              **losses**
              
              
              **value**
              
              
              **cost**
              
              
              **losses**
              
              
              **value**Available-for-sale:U.S.
                  Government debentures
              
              $
              9,004
              
              $
              (20
              )
              $
              8,984
              
              $
              6,035
              
              $
              (114
              )
              $
              5,921Foreign
                  banks andgovernment
                  debentures
              
              
              2,988
              
              
              (4
              )
              
              2,984
              
              
              8,376
              
              
              (196
              )
              
              8,180Corporate
                  debentures
              
              
              9,426
              
              
              (28
              )
              
              9,398
              
              
              3,859
              
              
              (94
              )
              
              3,765Auction
                  rate securities
              
              
              21,281
              
              
              -
              
              
              21,281
              
              
              8,250
              
              
              -
              
              
              8,250Totalavailable-for-salemarketable
                  securities
              
              $
              42,699
              
              $
              (52
              )
              $
              42,647
              
              $
              26,520
              
              $
              (404
              )
              $
              26,116Held-to-maturity:U.S.
                  Government debentures
              
              $
              31,486
              
              $
              (345
              )
              $
              31,141
              
              $
              62,461
              
              $
              (1,304
              )
              $
              61,157
 
 
 The
        unrealized losses on available-for-sale debt securities included in other
        comprehensive income, as a separate component of shareholders' equity, totaled
        to $ 52 and $ 404 as of December 31, 2004 and 2005, respectively.
 
 The
        unrealized losses on the Company's investments in held-to-maturity securities
        and in available-for-sale securities are a result of interest rate increases.
        Since the Company has the ability and intent to hold these investments until
        a
        recovery of fair value, which may be until maturity, the Company does not
        consider these investments to be other-than-temporarily impaired as of December
        31, 2005.
 
 The
        amortized cost and estimated fair value of available-for-sale and
        held-to-maturity investments as of December 31, 2004 and 2005, by contractual
        maturity, are as follows:
 
 **December
                  31,****2004**
              
              **2005****Amortized
                  cost**
              
              **Market
                  value**
              
              **Amortized
                  cost**
              
              **Market
                  value**Available-for-sale:Matures
                  in one year
              
              $
              30,192
              
              $
              30,170
              
              $
              14,832
              
              $
              14,717Matures
                  in one to three years
              
              
              10,331
              
              
              10,251
              
              
              8,966
              
              
              8,69240,523
              
              
              40,421
              
              
              23,798
              
              
              23,409Matures
                  in three to five years
              
              
              2,176
              
              
              2,226
              
              
              2,722
              
              
              2,707$
              42,699
              
              $
              42,647
              
              $
              26,520
              
              $
              26,116Held-to-maturity:Matures
                  in one year
              
              $
              5,166
              
              $
              5,158
              
              $
              45,726
              
              $
              44,784Matures
                  in one to three years
              
              
              26,320
              
              
              25,983
              
              
              16,735
              
              
              16,373$
              31,486
              
              $
              31,141
              
              $
              62,461
              
              $
              61,157
  -
            F19 -
 
 **RADWARE
            LTD.**  **AND
            ITS SUBSIDIARIES**
 
 **NOTES
            TO CONSOLIDATED FINANCIAL STATEMENTS**
 **U.S.
            dollars in thousands**
  
 **NOTE
        4:-**  **INVENTORIES**
 **December
                  31,****2004**
              
              **2005**Raw
                  materials and components
              
              $
              414
              
              $
              515Work-in-progress
              
              
              1,878
              
              
              2,457Finished
                  products
              
              
              1,802
              
              
              2,282$
              4,094
              
              $
              5,254
 
 **NOTE
        5:-**  **PROPERTY
        AND EQUIPMENT**
  Cost:Computer,
                  software and peripheral equipment
              
              $
              8,933
              
              $
              12,001Office
                  furniture and equipment
              
              
              998
              
              
              1,152Motor
                  vehicles
              
              
              341
              
              
              166Leasehold
                  improvements
              
              
              636
              
              
              68910,908
              
              
              14,008Accumulated
                  depreciation:Computer,
                  software and peripheral equipment
              
              
              5,398
              
              
              7,020Office
                  furniture and equipment
              
              
              484
              
              
              514Motor
                  vehicles
              
              
              302
              
              
              144Leasehold
                  improvements
              
              
              272
              
              
              3626,456
              
              
              8,040Depreciated
                  cost
              
              $
              4,452
              
              $
              5,968
 
 Depreciation
        expenses for the years ended December 31, 2003, 2004 and 2005 were $ 1,475,
        $ 1,381 and $ 1,856, respectively.
 
 **NOTE
                  6:-**
              **INTANGIBLE
                  ASSETS**
 a.
              Intangible
                  assets:
   **December
                  31,****2004**
              
              
              **2005**Cost:Acquired
                  technology
              
              $
              -
              
              $
              1,772Customers
                  relationship
              
              
              647
              
              
              1,189647
              
              
              2,961Accumulated
                  amortization:Acquired
                  technology
              
              
              -
              
              
              -Customers
                  relationship
              
              
              83
              
              
              14883
              
              
              148Amortized
                  cost
              
              $
              564
              
              $
              2,813
 
 Amortization
                  expenses for the years ended December 31, 2003, 2004 and 2005,
                  were $ 34,
                  $ 49 and $ 65,
                  respectively.
  -
            F20 -
 
 **RADWARE
            LTD.**  **AND
            ITS SUBSIDIARIES**
 
 **NOTES
            TO CONSOLIDATED FINANCIAL STATEMENTS**
 **U.S.
            dollars in thousands**
  
 **NOTE
                  6:-**
              **INTANGIBLE
                  ASSETS****(Cont.)**
 
 b.
              Estimated
                  amortization expenses for the years
                  ended:
 
 **December
                  31,**2006
              
              $
              4502007
              
              
              4502008
              
              
              4512009
              
              
              4512010
              
              
              450Total
              
              $
              2,252
 
 **NOTE
                  7:-**
              **OTHER
                  PAYABLES AND ACCRUED
                  EXPENSES**
   **December
                  31,****2004**
              
              
              **2005**Employees
                  and payroll accruals
              
              $
              2,565
              
              $
              3,257Accrued
                  expenses
              
              
              1,781
              
              
              2,941Provision
                  for warranty costs
              
              
              196
              
              
              190Other
              
              
              420
              
              
              121$
              4,962
              
              $
              6,509
 
 
 **NOTE
                  8:-**
              **COMMITMENTS
                  AND CONTINGENT LIABILITIES**
 
 a.
              Operating
                  leases:
 
 The
        Company and its subsidiaries rent their facilities under various operating
        lease
        agreements, which expire on various dates, the latest of which is in 2009.
        Aggregate minimum rental payments under non-cancelable operating leases as
        of
        December 31, 2005, are as follows:
 
 2006
              
              $
              1,6742007
              
              
              1,0932008
              
              
              2642009
              
              
              123$
              3,154
 
 Total
        rent expenses for the years ended December 31, 2003, 2004 and 2005, were
        approximately $ 1,552, $ 1,554 and $ 1,768, respectively (see also
        Note 13b).
 
 b.
            Litigation: 
 In
        December 2001, the Company, its Chairman, its President and Chief Executive
        Officer, and its Chief Financial Officer were named as defendants in a class
        action lawsuit alleging violations of the federal securities laws, in the
        United
        States District Court, Southern District of New York.
 
  -
            F21 -
 
 **RADWARE
            LTD.**  **AND
            ITS SUBSIDIARIES**
 
 **NOTES
            TO CONSOLIDATED FINANCIAL STATEMENTS**
 **U.S.
            dollars in thousands**
  
 **NOTE
                  8:-**
              **COMMITMENTS
                  AND CONTINGENT LIABILITIES
                  (Cont.)**
 
 The
        essence of the lawsuit is that the defendants issued and sold the Company's
        Ordinary shares pursuant to the Registration Statement for the September
        30,
        1999, Initial Public Offering ("IPO") without disclosing to investors that
        certain underwriters in the offering had solicited and received excessive
        and
        undisclosed commissions from certain investors.
 
 The
        lawsuit also alleges that the Registration Statement for the IPO failed to
        disclose that the underwriters allocated Company shares in the IPO to customers
        in exchange for the customers' promises to purchase additional shares in
        the
        aftermarket at predetermined prices above the IPO price, thereby maintaining,
        distorting and/or inflating the market price for the shares in the aftermarket.
        The action seeks damages in an unspecified amount.
 
 On
        October 9, 2002, the Court dismissed the individual defendants from the case
        without prejudice, based upon Stipulations of Dismissal filed by the plaintiffs
        and the individual defendants.
 
 On
        February 19, 2003, the Court denied the motion to dismiss with respect to
        the
        Company. On October 13, 2004, the Court certified a class in six of the
        approximately 300 other nearly identical actions and noted that the decision
        is
        intended to provide strong guidance to all parties regarding class certification
        in the remaining cases. Plaintiffs have not yet moved to certify a class
        in the
        Company's case. The Company approved a settlement agreement and related
        agreements which set forth the terms of a settlement between the Company,
        the
        individual defendants, the plaintiff class and the vast majority of the other
        approximately 300 issuer defendants (the “Issuers”).
 
 Among
        other provisions, the settlement provides for a release of the Company and
        the
        individual defendants for the conduct alleged in the action to be wrongful.
        The
        Company would agree to undertake certain responsibilities, including agreeing
        to
        assign away, not assert, or release certain potential claims the Company
        may
        have against its underwriters. The settlement agreement also provides a
        guaranteed recovery of $ 1 billion to plaintiffs for the cases relating to
        all
        of the approximately 300 issuers. To the extent that the underwriter defendants
        settle all of the cases for at least $ 1 billion, no payment will be required
        under the Issuers' settlement agreement. To the extent that the underwriter
        defendants settle for less than $ 1 billion, the issuers are required to
        make up
        the difference. The Company's management, based upon the opinions of the
        Company's legal advisors handling the claim, anticipates that any potential
        financial obligation of the Company to plaintiffs pursuant to the terms of
        the
        settlement agreement and related agreements will be covered by existing
        insurance. On February 15, 2005, the court granted preliminary approval of
        the
        settlement agreement, subject to certain modifications consistent with its
        opinion. Those modifications have been made. On March 20, 2006, the Underwriter
        Defendants submitted objections to the settlement to the Court. The Court
        held a
        hearing regarding these and other objections to the settlement at a fairness
        hearing on April 24, 2006, but has not yet issued a ruling. There is no
        assurance that the court will grant final approval to the settlement. If
        the
        settlement agreement is not approved and the Company is found liable, the
        Company’s management is unable to estimate or predict the potential damages that
        might be awarded, whether such damages would be greater than the Company’s
        insurance coverage, and whether such damages would have a material impact
        on the
        Company’s results of operations, cash flows or financial condition in any future
        period.
 
 
  -
              F22 -
 
 **RADWARE
              LTD.**  **AND
              ITS SUBSIDIARIES**
 
 **NOTES
              TO CONSOLIDATED FINANCIAL STATEMENTS**
 **U.S.
              dollars in thousands**
   **NOTE
                  8:-**
              **COMMITMENTS
                  AND CONTINGENT LIABILITIES
                  (Cont.)**
 
 From
        time
        to time, the Company becomes involved in legal proceedings and claims which,
        arise in the ordinary course of business. The Company considers that the
        ultimate liability with respect to any known actions will not materially
        affect
        the business, financial position, results of operations or cash flows of
        the
        Company.
 
 **NOTE
        9:-**  **SHAREHOLDERS'
        EQUITY**
 
 The
        Company's shares are listed for trade on the NASDAQ National Market and since
        April 2004 on the Tel-Aviv Stock Exchange, both under the symbol
        "RDWR".
 a.
                Treasury stock:
 In
        November 2002, the Company's Board of Directors authorized the repurchase
        of up
        to 1,500,000 shares of the Company's Ordinary shares or $ 10,000 in the open
        market, subject to normal trading restrictions. On December 19, 2002, the
        Company received court approval, which is required under Israeli law under
        certain conditions, as specified in the law. During 2002, the Company purchased
        32,700 of its own Ordinary shares for total consideration of $ 254. During
        2003, according to a resolution of the Company's Board of Directors, all
        the
        shares held as treasury stock were retired.
 
 b.
              Stock
                  Option Plans:
 
 Under
        the
        Company's Key Employee Share Incentive Plan (1997) and the Directors and
        Consultants Option Plan ("the Plans"), options may be granted to officers,
        directors, employees and consultants of the Company or its subsidiaries.
        The
        options expire sixty two months from the grant date. The options vest primarily
        over four years. Any options, which are forfeited or not exercised before
        expiration, become available for future grants.
 
 Pursuant
        to the Plans, the Company reserved for issuance 7,474,484 Ordinary shares.
        The
        Company approved in December 2005 an increase of 571,669 Ordinary shares
        reserved for option grants under the Plans. In addition, the Company approved
        an
        additional increase of 60,000 Ordinary shares reserved for the purpose of
        option
        grants to directors. As of December 31, 2005, an aggregate of 510,299 Ordinary
        shares of the Company are still available for future grants.
 
 A
        summary
        of the Company's options activity and related information is as
        follows:
   **Year
                  ended December 31,****2003**
              **2004**
              **2005****Number**
                **of
                  options**
              
              
              **Weighted**
                **average**
                **exercise**
                **price**
              
              
              **Number**
                **of
                  options**
              
              
              **Weighted**
                **average**
                **exercise**
                **price**
              
              
              **Number**
                **of
                  options**
              
              
              **Weighted**
                **average**
                **exercise**
                **price**Outstanding
                  at the beginning of year
              
              
              3,664,062
              
              $
              10.03
              
              
              3,951,840
              
              $
              11.12
              
              
              3,902,433
              
              $
              13.21Granted
              
              
              1,099,420
              
              $
              14.05
              
              
              1,112,933
              
              $
              19.10
              
              
              1,007,250
              
              $
              18.80Exercised
              
              
              (593,467
              )
              $
              9.95
              
              
              (669,865
              )
              $
              8.93
              
              
              (503,591
              )
              $
              12.15Forfeited
              
              
              (218,175
              )
              $
              10.80
              
              
              (492,475
              )
              $
              15.62
              
              
              (351,712
              )
              $
              18.06Outstanding
                  at the end of year
              
              
              3,951,840
              
              $
              11.12
              
              
              3,902,433
              
              $
              13.21
              
              
              4,054,380
              
              $
              14.31Exercisable
                  at the end of year
              
              
              1,137,657
              
              $
              10.93
              
              
              1,251,679
              
              $
              10.24
              
              
              1,428,575
              
              $
              9.52
 
  -
            F23 -
 
 **RADWARE
            LTD.**  **AND
            ITS SUBSIDIARIES**
 
 **NOTES
            TO CONSOLIDATED FINANCIAL STATEMENTS**
 **U.S.
            dollars in thousands, except share data**
  
 
 **NOTE
        9:-** **SHAREHOLDERS'
        EQUITY (Cont.)**
 
 The
        following table summarizes information about options outstanding and exercisable
        as of December 31, 2005:
 
 **Range
                  of exercise**
                **price**
              
              **Options
                  outstanding**
                **as
                  of**
                **December
                  31, 2005**
              
              **Weighted**
                **average**
                **remaining**
                **contractual**
                **life
                  (months)**
              
              **Weighted
                  average**
                **exercise**
                **price**
              
              **Options
                  exercisable**
                **as
                  of**
                **December
                  31, 2005**
              
              **Weighted
                  average exercise price of options exercisable**$0.03
              
              5,000
              
              2
              
              $0.03
              
              5,000
              
              $0.03$8
                  -
                  11
              
              1,743,172
              
              14.33
              
              $9.24
              
              1,341,449
              
              $8.99$15
                  - 18.68
              
              1,809,074
              
              46.5
              
              $16.82
              
              43,125
              
              $16.00$20
                  - 25.30
              
              497,134
              
              48.94
              
              $23.04
              
              39,001
              
              $21.634,054,380
              
              
              
              $14.31
              
              1,428,575
              
              $9.52
 
 The
        weighted average fair values of the options granted during 2003, 2004 and
        2005
        were $ 10.5, $ 8.6 and $ 7.1 respectively.
 
 The
        Company has recorded deferred stock compensation for options issued with
        an
        exercise price below the fair market value of the Ordinary shares; the deferred
        stock compensation has been amortized and recorded as compensation expense
        ratably over the vesting period of the options. Compensation expense of
        approximately $ 98, $ 0 and $ 58 were recognized for the years
        ended December 31, 2003, 2004 and 2005, respectively.
 c.
                Employee
                    Share Purchase Plans:
 The
        Company's Board of Directors adopted three Employee Share Purchase Plans
        ("the
        Purchase Plans" or "ESPP"), which provide for the issuance of a maximum of
        750,000, 200,000 and 300,000 Ordinary shares, respectively. Eligible employees
        can have up to 10% of their salaries withheld, up to certain maximums, to
        be
        used to purchase the Company's Ordinary shares. The Purchase Plans are
        implemented with purchases every six months. The price of an Ordinary share
        purchased under the Purchase Plans is equal to 85% of the lower of the fair
        market value of the Ordinary share at the commencement date of each offering
        period or on the semi-annual purchase date pursuant to the Plans. During
        2005,
        69,639 shares were issued under the Purchase Plans for aggregate consideration
        of $ 1,161. As of December 31, 2005, the Company decided to terminate
        the ESPP.
 
 d.
              Dividends:
 
 Dividends,
        if any, will be paid in NIS. Dividends paid to shareholders outside Israel
        may
        be converted to U.S. dollars on the basis of the exchange rate prevailing
        at the
        date of the conversion. The Company does not intend to pay cash dividends
        in the
        foreseeable future.
 
 
  -
              F24 -
 
 **RADWARE
              LTD.**  **AND
              ITS SUBSIDIARIES**
 
 **NOTES
              TO CONSOLIDATED FINANCIAL STATEMENTS**
 **U.S.
              dollars in thousands, except share
              data**
   
 
 **NOTE
                  10:-**
              **TAXES
                  ON INCOME**
 
 a.
              Israeli
                  income taxes:
 
 1.
              Measurement
                  of taxable income:
 
 Commencing
        in taxable year 2003, the Company has elected to measure its taxable income
        and
        file its tax return under the Israeli Income Tax Regulations (Principles
        Regarding the Management of Books of Account of Foreign Invested Companies
        and
        Certain Partnerships and the Determination of Their Taxable Income), 1986.
        Such
        an elective obligates the Company for three years. Accordingly, commencing
        taxable year 2003, results for tax purposes are measured in terms of earnings
        in
        dollars. The Company has elected to extend the term of the abovementioned
        taxable measurement by another year.
 
 2.
              Tax
                  rates:
 
 On
        July
        25, 2005, the Knesset (Israeli Parliament) approved the Law of the Amendment
        of
        the Income Tax Ordinance (No. 147), 2005, which prescribes, among others,
        a
        gradual decrease in the corporate tax rate in Israel to the following tax
        rates:
        in 2006 - 31%, in 2007 - 29%, in 2008 - 27%, in 2009 - 26% and in 2010 and
        thereafter - 25%.
 
 The
        amendment is not expected to have a material effect on the Company's financial
        position and results of operations.
 
 3.
              Tax
                  benefits under the Law for the Encouragement of Capital Investments,
                  1959:
 
 The
        Company's production facilities in Israel (Tel-Aviv and Jerusalem) have been
        granted an "Approved Enterprise" status under the above law. According to
        the
        provisions of such Israeli law, the Company has been granted the "Alternative
        Benefit Plan", under which the main benefits are tax exemption and reduced
        tax
        rate. Therefore, the Company's income derived from Approved Enterprise and
        allocated to the Tel Aviv facility will be entitled to a tax exemption for
        a
        period of two years and to an additional period of five to eight years with
        reduced tax rates of 10%-25% (based on percentage of foreign ownership).
        Income
        allocated to the Jerusalem facility will be exempt from tax for a period
        of up
        to 10 years, provided that the Company meets certain criteria. The duration
        of
        tax benefits is subject to a limitation of the earlier of 12 years from
        commencement of production, or 14 years from the approval date. The Company
        began to utilize such tax benefits in 2004 and these tax benefits are scheduled
        to gradually expire through 2013.
 
 As
        mentioned above, the approval, which the Investment Center granted the Company,
        is for establishing an Approved Enterprise program in Tel-Aviv and Jerusalem,
        Israel. The income derived from the "Approved Enterprise" program shall be
        allocated between the facilities in Tel-Aviv and Jerusalem based on a mechanism
        as determined by the Investment Center.
 
  -
            F25 -
 
 **RADWARE
            LTD.**  **AND
            ITS SUBSIDIARIES**
 
 **NOTES
            TO CONSOLIDATED FINANCIAL STATEMENTS**
 **U.S.
            dollars in thousands**
  
 
 **NOTE
                  10:-**
              **TAXES
                  ON INCOME (Cont.)**
 
 The
        entitlement to the above benefits is conditional upon the Company's fulfilling
        the conditions stipulated by the above law, regulations published hereunder
        and
        the letters of approval for the specific investments in "Approved Enterprises".
        In the event of failure to comply with these conditions, the benefits may
        be
        partially or fully canceled and the Company may be required to refund the
        amount
        of the benefits, in whole or in part, including interest.
 
 As
        of
        December 31, 2005, retained earnings included approximately $ 23,400 in
        tax-exempt income earned by the Company's "Approved Enterprise". The Company
        has
        decided not to declare dividends out of such tax-exempt income. Accordingly,
        no
        deferred income taxes have been provided on income attributable to the Company's
        "Approved Enterprise".
 
 If
        the
        retained tax-exempt income is distributed, it would be taxed at the corporate
        tax rate applicable to such profits as if the Company had not elected the
        alternative tax benefits (currently between 10% - 25%) and an income tax
        liability of approximately up to $ 5,850 would be incurred by the
        Company.
  Income
        from sources other than the "Approved Enterprise" will be subject to the
        tax at
        the regular rate.
 
 During
        2004, the Company's production facilities in Israel (Tel-Aviv and Jerusalem)
        have been granted an expansion program to its Approved Enterprise status
        by the
        Investment Center. The Company applied for an amendment to this expansion
        program, according to which it requested an enlargement to this expansion
        program, neutralization of certain assets and an approval that the benefits
        period from such expansion program will commence in 2006. The Investment
        Center
        has not yet approved this application. If the Investment Center will not
        approve
        the above application, the company will apply for a new program under the
        2005
        amendment to the Investment Law, as described below.
 
 A
        recent
        amendment to the law, which has been officially published effective as of
        April
        1, 2005 ("the Amendment") has changed certain provisions of the law. As a
        result
        of the Amendment, a company is no longer obliged to implement an Approved
        Enterprise status in order to receive the tax benefits previously available
        under the Alternative Benefits provisions, and therefore there is no need
        to
        apply to the Investment Center for this purpose (Approved Enterprise status
        remains mandatory for companies seeking grants). Rather, 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 out by the Amendment.
        A company is also granted a right to approach the Israeli Tax Authorities
        for a
        pre-ruling regarding their eligibility for benefits under the
        Amendment.
 
  -
            F26 -
 
 **RADWARE
            LTD.**  **AND
            ITS SUBSIDIARIES**
 
 **NOTES
            TO CONSOLIDATED FINANCIAL STATEMENTS**
 **U.S.
            dollars in thousands**
  
 
 **NOTE
                  10:-**
              **TAXES
                  ON INCOME (Cont.)**
 
 Tax
        benefits are available under the Amendment to production facilities (or other
        eligible facilities), which are generally required to derive more than 25%
        of
        the company's business income from export. In order to receive the tax benefits,
        the Amendment states that a company must make an investment in the Benefited
        Enterprise exceeding a minimum amount specified in the law. Such investment
        may
        be made over a period of no more than three years ending at the end of the
        year
        in which the company requested to have the tax benefits apply to the Benefited
        Enterprise ("the Year of Election"). Where a company requests to have the
        tax
        benefits apply to an expansion of existing facilities, then 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
        this
        case, the minimum investment required in order to qualify as a Benefited
        Enterprise is required to exceed a certain percentage of the company's
        production assets before the expansion. The duration of tax benefits is subject
        to a limitation of the earlier of 7 years from the Commencement Year, or
        12
        years from the first day of the Year of Election.
 
 Should
        the Company elect to utilize tax benefits under the Amendment to the law,
        than
        any such tax exempt profits might be subject to future taxation on the corporate
        level upon distribution to shareholders by a way of dividend or liquidation.
        Accordingly the Company may be required to recognize deferred tax liability
        with
        respect to such tax exempt profits.
 
 4.
              Tax
                  assessments:
 
 In
        2004,
        the Company received final tax assessments from the Israeli Tax Authorities
        for
        the tax years 1999 through 2002.
 
 5.
              Stamp
                  duty:
 
 An
        amendment of the Stamp Duty on Documents Law, 1961, or the Stamp Duty Law,
        came
        into effect on June 1, 2003 determining, among other things, that the Stamp
        Duty
        on most agreements shall be paid by the parties that signed such agreement,
        jointly or severally, or by the party that undertook under such agreement
        to pay
        the Stamp Duty. The Stamp Duty Law determined that a document (or part thereof)
        that is signed in Israel or relates to an asset or obligation in Israel would
        be
        subject to a tax rate between 0.4% and 1% of the value of the subject matter
        of
        such document. Based on advice from the Company's legal counsel, the Company's
        management believes that adequate provision has been provided to cover such
        an
        exposure.
 
 Under
        an
        order published in December 2005, the said requirement to pay stamp duty
        was
        cancelled with respect to documents signed on or after January 1,
        2006.
  -
            F27 -
 
 **RADWARE
            LTD.**  **AND
            ITS SUBSIDIARIES**
 
 **NOTES
            TO CONSOLIDATED FINANCIAL STATEMENTS**
 **U.S.
            dollars in thousands**
  
 
 **NOTE
                  10:-**
              **TAXES
                  ON INCOME (Cont.)**
 
 b.
              Taxes
                  on income are comprised as follows:
 
 **Year
                  ended December 31,****2003**
              
              **2004**
              
              **2005**Current
                  taxes
              
              $
              -
              
              $
              428
              
              $
              304Taxes
                  in respect of prior years
              
              
              -
              
              
              803
              
              
              -Increase
                  in deferred taxes
              
              
              -
              
              
              (890
              )
              
              (64
              )$-
              
              
              
              
              $
              341
              
              $
              240Domestic
              
              $
              -
              
              $
              1,576
              
              $
              203Foreign
              
              
              -
              
              
              (1,235
              )
              
              37$-
              
              
              
              
              $
              341
              
              $
              240
 
 c.
              Deferred
                  income taxes:
 
 Deferred
        income taxes reflect the net tax effects of temporary differences between
        the
        carrying amounts of assets and liabilities for financial reporting purposes
        and
        the amounts used for income tax purposes. Significant components of the
        Company's and its subsidiaries' deferred tax liabilities and assets are as
        follows:
 
 **December
                  31,****2004**
              
              
              **2005**Deferred
                  tax assets:Net
                  operating loss carryforwards of subsidiaries
              
              $
              1,500
              
              $
              954Tax
                  benefit related to employee stock option exercises
              
              
              2,156
              
              
              2,538Net
                  deferred tax asset before valuation allowance
              
              
              3,656
              
              
              3,492Valuation
                  allowance
              
              
              (2,766
              )
              
              (2,538
              )Net
                  deferred tax asset
              
              $
              890
              
              $
              954
 
 d.
              Foreign:
 
 The
        Company's U.S. subsidiary has estimated total available carryforward tax
        losses
        of approximately $ 2,400 to offset against future taxable profit between
        2011 and 2024. As of December 31, 2005, the Company recorded a deferred tax
        asset of $ 954 relating to the available net carryforward tax losses.
 
 Utilization
        of U.S. net operating losses may be subject to substantial annual limitation
        due
        to the "change in ownership" provisions of the Internal Revenue Code of 1986
        and
        similar state provisions. The annual limitation may result in the expiration
        of
        net operating losses before utilization.
 
 The
        Company has provided valuation allowances in respect of deferred tax assets
        resulting from tax benefits related to employee stock option exercises, which
        will be credited to additional paid-in capital when realized. Management
        currently believes that it is more likely than not that those deferred tax
        deductions will not be realized in the foreseeable future.
 
  -
              F28 -
 
 **RADWARE
              LTD.**  **AND
              ITS SUBSIDIARIES**
 
 **NOTES
              TO CONSOLIDATED FINANCIAL STATEMENTS**
 **U.S.
              dollars in thousands**
   
 
 **NOTE
                  10:-**
              **TAXES
                  ON INCOME (Cont.)**
 
 e.
                A
                    reconciliation between the theoretical tax expense, assuming
                    all income is
                    taxed at the statutory tax rate applicable to income of the Company
                    and
                    the actual tax expense as reported in the statement of operations
                    is as
                    follows:
 
 **Year
                  ended December 31,****2003**
              
              **2004**
              
              **2005**Income
                  before taxes, as reported in the consolidated statements of
                  income
              
              $
              6,395
              
              $
              14,087
              
              $
              9,584Statutory
                  tax rate
              
              
              36
              %
              
              35
              %
              
              34
              %Theoretical
                  tax expenses on the above amount at the Israeli statutory tax
                  rate
              
              $
              2,302
              
              $
              4,930
              
              $
              3,259Decrease
                  in taxes resulting from "Approved Enterprise" benefits (1)
              
              
              -
              
              
              (4,762
              )
              
              (2,746
              )Tax
                  adjustment in respect of different tax rate of foreign subsidiary
              
              
              13
              
              
              52
              
              
              (22
              )Non-deductible
                  expenses
              
              
              632
              
              
              893
              
              
              528Deferred
                  taxes on losses for which valuation allowance was provided
              
              
              (2,733
              )
              
              (1,470
              )
              
              (632
              )Income
                  taxes in respect of prior years
              
              
              -
              
              
              803
              
              
              -Other
              
              
              (214
              )
              
              (105
              )
              
              (147
              )Actual
                  tax expense
              
              $
              -
              
              $
              341
              
              $
              240(1)Per
                  share amounts (basic) of the tax benefit resulting from the
                  exemption
              
              $
              -
              
              $
              0.26
              
              $
              0.15Per
                  share amounts (diluted) of the tax benefit resulting from the
                  exemption
              
              $
              -
              
              $
              0.24
              
              $
              0.14
 
 f.
                  Income before income taxes is comprised as
                    follows:
 **Year
                  ended December 31,****2003**
              
              
              **2004**
              
              
              **2005**Domestic
              
              $
              5,155
              
              $
              12,461
              
              $
              7,601Foreign
              
              
              1,240
              
              
              1,626
              
              
              1,983Income
                  before income taxes
              
              $
              6,395
              
              $
              14,087
              
              $
              9,584
 
  -
              F29 -
 
 **RADWARE
              LTD.**  **AND
              ITS SUBSIDIARIES**
 
 **NOTES
              TO CONSOLIDATED FINANCIAL STATEMENTS**
 **U.S.
              dollars in thousands, except per share
              data**
   
 
 **NOTE
        11:-**  **GEOGRAPHIC
        INFOROMATION AND SELECTED STATEMENTS OF INCOME DATA**
 
 a.
                  Summary
                      information about geographic
                      areas:
 The
        Company operates in one reportable segment (see Note 1 for a brief description
        of the Company's business). The total revenues are attributed to geographic
        areas based on the location of the end-users.
 
 The
        following presents total revenues for the years ended December 31, 2003,
        2004
        and 2005 and long-lived assets as of December 31, 2004 and 2005:
 
 **Year
                  ended December 31,****2003**
              
              **2004**
              
              **2005**Revenues
                  from sales to customers located at:America
                  (principally the United States)
              
              $
              26,218
              
              $
              28,984
              
              $
              31,900EMEA
                  *)
              
              
              14,038
              
              
              20,450
              
              
              24,074Asia
                  Pacific
              
              
              14,524
              
              
              19,005
              
              
              21,610$
              54,780
              
              $
              68,439
              
              $
              77,584
  *)
                    Europe,
                          the Middle East and
                          Africa.
 **December
                  31,****2004**
              
              **2005**Long-lived
                  assets, by geographic region:America
              
              $
              1,246
              
              $
              1,609EMEA
              
              
              3,464
              
              
              6,755Asia
                  Pacific
              
              
              306
              
              
              417$
              5,016
              
              $
              8,781
 
 b.
              Major
                  customer data as a percentage of total
                  revenues:
 
 **Year
                  ended December 31,****2003**
              
              
              **2004**
              
              
              **2005**Customer
                  A
              
              
              11
              %
              
              11
              %
              
              16
              %
 
 
  -
              F30 -
 
 **RADWARE
              LTD.**  **AND
              ITS SUBSIDIARIES**
 
 **NOTES
              TO CONSOLIDATED FINANCIAL STATEMENTS**
 **U.S.
              dollars in thousands**
   
 
 **NOTE
                  12:-**
              **SELECTED
                  STATEMENTS OF INCOME DATA**
  a.
                    Financial
                        income
                        (expenses):
 
 **Year
                  ended December 31,****2003**
              
              **2004**
              
              **2005**Financial
                  income:Interest
                  on bank deposits
              
              $
              3,193
              
              $
              3,045
              
              $
              3,426Foreign
                  currency translation differences, net
              
              
              352
              
              
              784
              
              
              -Amortization
                  of premiums, accretion of discounts and interest on marketable
                  debt
                  securities, net
              
              
              645
              
              
              852
              
              
              2,8564,190
              
              
              4,681
              
              
              6,282Financial
                  expenses:Interest
                  and other bank charges
              
              
              (450
              )
              
              (116
              )
              
              (70
              )Foreign
                  currency translation differences, net
              
              
              -
              
              
              -
              
              
              (1,053
              )$
              3,740
              
              $
              4,565
              
              $
              5,159
 b.
              Net
                  earnings per share:
 
 The
        following table sets forth the calculation of basic and diluted net earnings
        per
        share:
 
 **Year
                  ended December 31,****2003**
              
              **2004**
              
              **2005**Numerator:Net
                  income available to shareholders of Ordinary shares
              
              $
              6,355
              
              $
              13,780
              
              $
              9,344Denominator:Denominator
                  for basic earnings per share - weighted average number of shares,
                  net of
                  treasury stock
              
              
              17,184,141
              
              
              17,995,207
              
              
              18,800,474Effect
                  of dilutive securities:Employee
                  stock options and ESPP
              
              
              1,481,999
              
              
              1,809,689
              
              
              1,271,718Denominator
                  for diluted net earnings per share - adjusted weighted average
                  number of
                  Ordinary shares
              
              
              18,666,140
              
              
              19,804,896
              
              
              20,072,192
 
 
 
  -
              F 31-
 
 **RADWARE
              LTD.**  **AND
              ITS SUBSIDIARIES**
 
 **NOTES
              TO CONSOLIDATED FINANCIAL STATEMENTS**
 **U.S.
              dollars in thousands, except share
              data**
   **NOTE
        13:-** **BALANCES
        AND TRANSACTIONS WITH RELATED PARTIES**
 Represents
          transactions and balances with other entities in which certain of the Company's
          shareholders have interest:
  a.
                    The
                        following related party balances are
                        included in the balance
                        sheets:
 **December
                  31,****2004**
              
              **2005**Trade
                  receivables
              
              $
              1,004
              
              $
              1,447Trade
                  payables
              
              $
              134
              
              $
              -
 
 b.
                    The
                        following related party transactions are
                        included in the statements of
                        income:
 **Year
                  ended December 31,****2003**
              
              **2004**
              
              **2005**Revenues
              
              $
              1,011
              
              $
              2,400
              
              $
              3,111Cost
                  of revenues - components (1)
              
              $
              349
              
              $
              -
              
              $
              -Operating
                  expenses, net - primarily rental, sub-contractors and communications
                  (2)
              
              $
              1,186
              
              $
              1,151
              
              $
              1,309Purchase
                  of property and equipment
              
              $
              47
              
              $
              466
              
              $
              377
  (1)
                    Represents
                          purchases of certain components for the Company's products,
                          mainly circuit
                          boards from a related party. On February 2, 2003, the purchase
                          agreement
                          with a related party was assigned to a third
                          party.  (2)
                    The
                        Company leases office space and purchases other miscellaneous
                        services
                        from certain companies, which are considered to be related
                        parties. In
                        addition, the Company subleases part of the office space
                        to related
                        parties and provides certain services to related
                        parties.
    -
                  F 31-