**UNITED
STATES**


**SECURITIES
AND EXCHANGE COMMISSION**


**Washington,
D.C. 20549**




**FORM
20-F**




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




**OR**





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


****


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




**OR**




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


****


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




**Commission
file number 0-30324**




**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:


**18,488,021
Ordinary Shares, NIS 0.1 par value per share**




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


x Yes o No




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


o Item 17 x Item
18










**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.




**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®” and “Synapps Architecture®” and we have trademark
applications pending for “CID – Content
Inspection DirectorTM”, “UpLinkTM”, “RadwareTM”, “DefenseProTM”, “StringMatch
EngineTM” and “APSolute TM ”. All
other trademarks and tradenames appearing in this annual report are owned by
their respective holders.




1


**TABLE
OF CONTENTS**
**Page****PART
      I**
    **4**ITEM
      1. Identity of Directors, Senior Management and Advisors
    4ITEM
      2. Offer Statistics and Expected Timetable
    4ITEM
      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*
    *24**D.
      Property, Plants and Equipment*
    *25*ITEM
      5. Operating and Financial Review and Prospects
    26ITEM
      6. Directors, Senior Management and Employees
    35*A.
      Directors and Senior Management*
    *35**B.
      Compensation*
    *37**C.
      Board Practices*
    *38**D.
      Employees*
    *43**E.
      Share Ownership*
    *44*ITEM
      7. Major Shareholders and Related Party Transactions
    47*A.
      Major Shareholders*
    *47**B.
      Related Party Transactions*
    *47**C.
      Interests of Experts and Counsel*
    *48*ITEM
      8. Financial Information
    49*A.
      Consolidated Statements and other Financial Information*
    *49**B.
      Significant Changes*
    *50*ITEM
      9. The Listing
    51*A.
      Listing Details*
    *51**B.
      Plan of Distribution*
    *53**C.
      Markets*
    *53**D.
      Selling Shareholders*
    *53*

2
*E.
      Dilution*
    *53**F.
      Expenses of the Issue*
    *53*ITEM
      10. Additional information
    54*A.
      Share Capital*
    *54**B.
      Memorandum and Articles of Association*
    *54**C.
      Material Contracts*
    *58**D.
      Exchange Controls*
    *59**E.
      Taxation*
    *59**F.
      Dividends and Paying Agents*
    *68**G.
      Statement by Experts*
    *68**H.
      Documents on Display*
    *68**I.
      Subsidiary Information*
    *68*ITEM
      11. Quantitative and Qualitative Disclosures about Market
Risk
    69ITEM
      12. Description of Securities other than Equity Securities
    69**PART
      II**
    **70**ITEM
      13. Defaults, Dividend Averages and Delinquencies
    70ITEM
      14. Material Modifications to the Rights of Security Holders and Use of
      Proceeds
    70ITEM
      15. Controls and Procedures
    70ITEM
      16. Reserved
    70**PART
      III**
    **73**ITEM
      17. Financial Statements
    73ITEM
      18. Financial Statements
    73ITEM
      19. Exhibits
    73


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, 2002, 2003 and 2004 and the balance sheet data as at December
31, 2003 and 2004 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, 2000 and 2001 and the
balance sheet data for the years ended December 31, 2000, 2001 and 2002 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 2N and 11B 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,****2000**
    
    **2001**
    
    **2002**
    
    **2003**
    
    **2004****(US
      $ in thousands, except per share data)****Statement
      of Operations Data:**Revenues
    
    $
    38,353
    
    $
    43,327
    
    $
    43,663
    
    $
    54,780
    
    $
    68,439Cost
      of revenues
    
    
    6,123
    
    
    7,709
    
    
    7,946
    
    
    9,854
    
    
    12,184Gross
      profit
    
    
    32,230
    
    
    35,618
    
    
    35,717
    
    
    44,926
    
    
    56,255Operating
      expenses:Research
      and development
    
    
    5,465
    
    
    8,293
    
    
    7,809
    
    
    8,398
    
    
    10,342Sales
      and Marketing
    
    
    24,622
    
    
    29,986
    
    
    30,019
    
    
    29,753
    
    
    31,898General
      and administrative
    
    
    3,127
    
    
    4,543
    
    
    4,219
    
    
    4,120
    
    
    4,493Total
      operating expenses
    
    
    33,214
    
    
    42,822
    
    
    42,047
    
    
    42,271
    
    
    46,733Operating
      profit (loss)
    
    
    (984
    )
    
    (7,204
    )
    
    (6,330
    )
    
    2,655
    
    
    9,522Financial
      income, net
    
    
    7,434
    
    
    6,312
    
    
    4,240
    
    
    3,740
    
    
    4,565Income
      (loss) before taxes on income
    
    
    6,450
    
    
    (892
    )
    
    (2,090
    )
    
    6,395
    
    
    14,087Taxes
      on income
    
    
    (387
    )
    
    (389
    )
    
    -
    
    
    -
    
    
    (341
    )Loss
      in respect of an investment in an affiliate
    
    
    -
    
    
    (6,333
    )
    
    -
    
    
    -
    
    
    -Minority
      interest in losses (earnings) of a subsidiary
    
    
    23
    
    
    37
    
    
    (23
    )
    
    (40
    )
    
    34Net
      income (loss)
    
    $
    6,086
    
    $
    (7,577
    )
    $
    (2,113
    )
    $
    6,355
    
    $
    13,780Basic
      net earnings (loss) per ordinary share
    
    $
    0.38
    
    $
    (0.46
    )
    $
    (0.13
    )
    $
    0.37
    
    $
    0.77Diluted
      net earnings (loss) per ordinary share
    
    $
    0.35
    
    $
    (0.46
    )
    $
    (0.13
    )
    $
    0.34
    
    $
    0.70




5





**Year
      ended**
    
    **Year
      ended**
    
    **Year
      ended**
    
    **Year
      ended**
    
    **Year
      ended****December
      31,**
    
    **December
      31,**
    
    **December
      31,**
    
    **December
      31,**
    
    **December
      31,****2000**
    
    **2001**
    
    **2002**
    
    **2003**
    
    **2004****(in
      thousands)**Weighted
      average number of ordinary shares used in computing basic net earnings
      (loss) per ordinary share (in thousands)
    
    
    15,874
    
    
    16,423
    
    
    16,655
    
    
    17,184
    
    
    17,995Weighted
      average number of ordinary shares used in computing diluted net earnings
      (loss) per ordinary share (in thousands)
    
    
    17,602
    
    
    16,423
    
    
    16,655
    
    
    18,666
    
    
    19,805




**December
      31,****2000**
    
    **2001**
    
    **2002**
    
    **2003**
    
    **2004****(US
      $ in thousands)****Balance
      Sheet Data:**Cash
      and cash equivalents, short-termbank
      deposits and marketablesecurities
      and current maturities of long-term bank deposits
    
    $
    130,824
    
    $
    125,680
    
    $
    52,274
    
    $
    62,882
    
    $
    109,020Long-term
      bank deposits andmarketable
      securities
    
    
    —
    
    
    —
    
    
    73,027
    
    
    76,139
    
    
    48,021Working
      capital
    
    
    132,418
    
    
    124,911
    
    
    50,690
    
    
    60,477
    
    
    107,687Total
      assets
    
    
    150,095
    
    
    144,461
    
    
    142,998
    
    
    158,114
    
    
    183,241Shareholders’
      equity
    
    
    135,931
    
    
    128,938
    
    
    127,357
    
    
    140,246
    
    
    160,917





**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 2004 and 2003, we incurred losses in 2002 and 2001. We had
net income of approximately $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. In 2000, we had net income of approximately $6.1 million. 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 82%. As a
result any decrease in Sales will have a significant effect on our
profitability.




Our net
profit for 2004 derives also from financial income in an amount of approximately
$4.6 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.




Our
revenues may not grow or continue at their current level. 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


****


**Volatility
of the market for our products, including deterioration of the economy
worldwide, slow-down in expenditures by service providers,
e-commerce** and **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 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 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.




**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 and implementation periods of our products.




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 2005 because of the slowdown in business
activities during the summer months in Europe, and that our sales during the
fourth quarter of 2005 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.




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




The
Application Switching 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 Switching 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 Switching solutions does not continue to grow, we may not be
able to sell enough of our products to maintain and increase
profitability.




7


****


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




The
Application Switching solutions 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 Switching solutions market include: Cisco Systems, Inc., Nortel
Networks Coro., F5 Networks, Inc. and Foundry Networks, Inc. In addition, we
face new 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 Switching
solutions and emerge as significant competitors. For example, 3Com Systems, Inc.
became a competitor in the IPS market by acquiring Tipping Point Technologies,
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.




**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 Switching 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 Switching 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.




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 2003, we introduced a new security switch, the
DefensePro. During 2004 we have invested and plan to continue to invest in 2005,
in creating and increasing market acceptance of this product and other products
in the field of Application Switching and Application Security. There is no
assurance that we will be successful in marketing and selling the DefensePro
product, or other new products, that the revenues from the sales of DefensePro
will justify the investment, or that the sales of DefensePro will continue to
increase.




8


****


**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 our 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 and implementation periods, 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. Prospective
customers generally must make a significant commitment of resources to test and
evaluate our products and to integrate them into larger systems. 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
Switching solutions. This expansion has required, and may continue to require,
managerial, operational and financial resources.




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. 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.




9


****


**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.




**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.




10


****


**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 thenew
European governmental regulations, including environmentalstandards,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 of
the European
Parliament on the Restriction of the Use of Certain Hazardous Substances in
Electrical and
Electronic Equipment, known as the RoHS Directive, will take effect on July 1,
2006 and requires
that certain of our products be modified to meet this regulation. 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 will be required to record a
compensation expense in connection with share based compensation, and, as a
result, our profitability may be reduced significantly.**




On
December 16, 2004, the Financial Accounting Standards Board (FASB) issued
Statement No. 123 (revised 2004), Share-Based Payment ("SFAS No. 123R"), 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, as of the third quarter of
2005, all share-based payments to employees to be recognized as a compensation
expense based on their fair values. SFAS No. 123R 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. 123R 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 ad 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. 123R 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®”
and “Synapps Architecture®”. We also have trademark applications pending for
“CID – Content Inspection DirectorTM”,
“UpLinkTM”, “RadwareTM”, “DefenseProTM”, “StringMatch EngineTM” and
“APSolute 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 and for our method for load balancing by global proximity used in our
WSD product. 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
an settling the claim.




11


****


**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.




**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. 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.




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




We
currently offer our products in over 50 countries in addition to North America.
We intend to enter additional geographic markets to expand our sales efforts
worldwide. In fiscal years 2003 and 2004, our sales outside the Americas
represented approximately 52% and 58%, 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.




**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.




12




**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
March 30, 2005, Mr. Yehuda Zisapel, Chairman of our board of directors,
beneficially owns an aggregate of 2,545,877 ordinary shares, representing
approximately 13.7% of the ordinary shares outstanding as of March 30, 2005 and
options to purchase 60,000 ordinary shares, of which none are vested. Roy
Zisapel, Mr. Yehuda Zisapel’s son, is our Chief Executive Officer, President and
a director. Roy Zisapel owns 439,803 ordinary shares and options to purchase
800,000 ordinary shares, of which 400,000 are fully vested as of March 30, 2005. **** 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
reasonably believe we were not a PFIC for our 2004 tax year.  It is
possible that the Internal Revenue Service will attempt to treat us as a PFIC
for 2004 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 2005 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.”









**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 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.




13


****


**Most
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, Meir Moshe, our Chief Financial Officer, 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 2004, we began selling in Euros in some European countries
and intend to expand sales in Euros to additional 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 2004, the value of the dollar decreased in relation to the NIS
by 1.6%, the inflation rate in Israel was 1.1%, and the value of the dollar
decreased in relation to the Euro by 7.4%. As a result, during 2004, we had an
increase in expenses (as a result of the increase in the Euro exchange rate),
which was offset by the increase 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.




**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
with regard to our Jerusalem facility, 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. The applicable law
regarding “Approved Enterprise” programs will expire on March 31, 2005, unless
its terms are extended. Accordingly, requests for new programs or expansions
that are not approved on or before March 31, 2005 will not confer any tax
benefits, unless the term of the law is extended. On January 12, 2005, a bill
was submitted to the Israeli parliament providing for certain changes to the
applicable law regarding “approved enterprise” programs. Among others, the bill
introduces changes to both the criteria and procedure for obtaining approved
enterprise status for an investment program, and changes to the grants and tax
benefits afforded in certain circumstances to approved enterprises. The proposed
amendment is expected to apply to new investment programs following the
enactment of the bill into law. In order to enact the bill as legislation, the
bill must be approved by the Israeli parliament and published. The bill was
approved by the Israeli parliament on March 29, 2005. However, since the final
law has yet to be published, we and our shareholders face uncertainties as to
the potential consequences of the final law. Because we cannot predict
whether, and to what extent, the bill will eventually be enacted into law, we
and our shareholders face uncertainties as to the potential consequences of the
bill. 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.




14


****


**We
may be required to pay stamp duty on agreements executed by us after June 1,
2003. 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. 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. 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.




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




**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.




15


****


**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 North
America 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 Switching solutions that provide
end-to-end availability, performance and security of mission critical networked
applications. Radware’s integrated Application Infrastructure, Application
Security and End-to-End Connectivity solutions enable enterprises and carriers
to deliver their mission critical applications successfully over critical points
in the network.




Our
Application Switching solutions enable customers to manage their network
infrastructure, bypass systems failures, scale their application performance,
and and secure their Internet protocol (“IP”) traffic. Our products improve the
productivity of 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 and IDC.




**Solution
Architecture, Management and Products**




All
Radware products are powered by an Application Switch platform. Ranging from
multi-Gigabit processing power to Branch platforms, Radware’s Application
Switches address the capacity requirements of organizations of all sizes.
SynApps - a unified Layer 4-7 Operating System, provides comprehensive
application aware services across the entire product suite. SynApps 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, SynApps Architecture
meets application demands across application infrastructure server farms, and
connectivity and security layers of the network.





Radware
SynApps is a modular operating system, combining key application aware services:
Advanced Health Monitoring, Traffic Redirection and Load Balancing, Bandwidth
Management, Web Compression, SSL acceleration, Intrusion Prevention and DoS
Protection. With Radware SynApps, enterprises and carriers can address existing
and emergent application service requirements across server farms, security and
connectivity layers.





*SynApps
Operating System Services include:*





**Advanced
Health Monitoring** continuously checks the health of all network resources detecting failures in
real time and automatically redirects traffic to the highest performing
resources to guarantee full application availability and fault tolerant
operations. 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, HTTPS, FTP, RADIUS, RTSP, while enabling the
configuration of customized checks by device, transaction path and content.





17


****


**Traffic
Redirection and Load Balancing** intelligently distributes traffic across network devices, optimizing the
utilization of site-wide resources to accelerate application performance. Using
an extensive array of Traffic Redirection algorithms to dispatch traffic -
including cyclic distribution, least users, least packets and least bytes -
SynApps Traffic Redirection enables maximum utilization of IT infrastructure
capacities across farms, local and global sites. By attaining high resource
utilization, Traffic Redirection enables seamless service scaling, while
reducing additional resource deployment requirements for economical service
growth. 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.





**Bandwidth
Management** offers
comprehensive control over bandwidth resource allocation, to prioritize all
network traffic and guarantee service levels for mission critical applications.
Integrated Bandwidth management policies enable the classification of traffic by
user, applications, and service pricing models for the configuration and full
enforcement of premium services, and differentiating application performance by
business requirements, while regulating site-wide bandwidth consumption and
costs.





**Web
Compression** accelerates
application delivery by reducing the amount of data transmitted. Web compression
reduces bandwidth consumption and accelerates content delivery to end users





**SSL
(Secure Socket Layer) service acceleration** enables
reliable and optimized transactions by offloading and accelerating SSL
processing from web servers.





**Intrusion
Prevention** automatically secures applications network resources from over 1,700 malicious
attack signatures and viruses. 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.





**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.




***Configware
Insite***




The
common application management tool which runs across Radware products is
Configware Insite. Configware Insite’s unified administration allows users to
control and monitor IP application performance across the enterprise. Configware
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, Configware Insite lets users draw their
network, configure Radware Intelligent Application Switching devices and set-up
the SynApps Services (as described above) to address end-to-end IP application
service requirements. Configware 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.




18





Configware
Insite provides real-time and historical views of all Radware Application
Switching devices and SynApps 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. Configware 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.




**Application
Switch Platforms**




All
Radware products are powered by our Application Switch platform. Ranging from
the multi-Gigabit Application Switch III to Branch platform - the Application
Switching hardware offers scalable and flexible throughput performance that meet
the end-to-end requirements of enterprises and carriers.





In August
2000, we released the Application Switch 1, a new hardware platform for our
products. The Application Switch is based on a multi-layered switching
architecture, and enhances the performance of our products. In September 2001,
we released the Application Switch II, which provides higher capacity for
application switching and can make comprehensive Layer 4-7 switching decisions,
at Gigabit speeds, based upon specific applications, destination requests or
actual content passing through it. In February 2003, we released Application
Switch III, our high-end hardware platform. Application Switch III is the
industry's first 10 Gigabit Ethernet Layer 4-7 Switch, offering three times the
capacity and five times the processing power of Application Switch
II.




In order
to expand the product offering to include entry level application switching,
Radware introduced its Branch platform in September 2003 to ensure availability,
performance and security for remote and branch offices.




In
December 2003, with the introduction of DefensePro, Radware also introduced the
StringMatch Engine – a dedicated security
hardware accelerator which runs on the DefensePro Intrusion Prevention Switch
product.




****Our
product line consists of the following products, all of which are based on the
SynApps architecture described above:





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




*·*
    *FireProof®*provides full availability, redundancy and maximized operation of security
      tools such as firewalls, VPNs and IDSs across the
  network.




·
    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.




·
    *DefenseProTM*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.




·
    *CertainT
      ® 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.




·
    *Content
      Inspection Director*TM
      provides fault tolerant and fully optimized anti-virus scanning and
      content filtering for trusted and cost effective content security. By
      redirecting end-user requests, when appropriate, to cache servers which
      store, or cache, content previously retrieved from the Internet, Content
      Inspection Director optimizes performance, improving response time and
      conserving bandwidth.




19




·
    *Peer
      Director®*controls,
      manages and optimizes Internet Routing. Peer Director enables service
      providers and large enterprises to control their Internet routing by
      enforcing policies on traffic redirection across the various Internet
      links. Administration and Internet connectivity costs are reduced,
      Internet performance is improved and administrators are empowered with
      better control of their connectivity links.




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 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 Updates and
Custom Filters.




**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, ISPs 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 2004,
approximately 42% of our sales were in the Americas (principally in the United
States) and 58% were outside the Americas, of which approximately 30% 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
2004 **.**




For the
years ended December 31, 2004 and December 31, 2003 one single customer (a
distributor) accounted for 11% of our sales. For the year ended December 31,
2002, no single customer accounted for more than 10% of our sales. As of
December 31, 2004, no single customer represented more than 10% of the trade
receivables balance. As of December 31, 2003, one single customer represented
15% 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, 2004, we employed a total of 45 sales managers and
sales staff in the Americas with locations in various states. We also employed
55 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 Intelligent Application
Switching solutions. We seek to build upon our marketing and branding efforts
globally to achieve greater worldwide sales. Our sales force and 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 advertising campaigns. 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, Citrix Systems, Inc., Oracle Corporation, BEA Systems, Inc., BMC
Software Inc., Aladdin Knowledge Systems Ltd., Secure Computing Corporation,
Quest Software, Inc., Microsoft Corporation, WatchGuard Technologies Inc.. and
Hewlett Packard Company.




20


**


*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 80 employees worldwide as of December 31,
2004, 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 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 upgrades, 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.




As of
December 31, 2004, our research and development staff consisted of 108
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 software
engineers. In addition, we have a hardware and infrastructure group responsible
for the development of the Radware platforms/infrastructure serving all product
groups, which consists of a group leader, team leaders, and hardware and
software 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.




21


****


**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.




**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®” and “Synapps Architecture®” and we have trademark
applications pending for “CID – Content Inspection DirectorTM”, “UpLinkTM”,
“RadwareTM”, “DefenseProTM”, “StringMatch EngineTM” and “APSolute 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 and for our method
for load balancing by global proximity used in our WSD product, 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.




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, 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.




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. We settled the lawsuit in March 2005.




22


****


**Competition**




Our
industry is characterized by intense competition. Our principal competitors in
the sale of Application Switching solutions include Cisco Systems, Inc., Nortel
Networks Corporation, and Foundry 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 IPS space. Such competitors include 3Com Systems, Inc.,
Internet Security Systems, Inc., and Juniper Networks, 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 Switching solution into existing products.




We
believe that our success will depend primarily on our ability to provide more
technologically advanced and cost-effective Application Switching 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 incorporating know-how developed 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.




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 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
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 to 120%, 150% or
300% of the grant, depending on the portion of the total manufacturing volume
that is performed outside of Israel. Effective April 1, 2003, the 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 the full amount by way of royalties. In 2004,
we applied, together with another company, to obtain a grant from the Chief
Scientist under the “joint R&D project”. The Chief Scientist approved the
maximum grant to the project of approximately $0.2 million. Under the “joint
R&D project” track there is no royalty commitment but other limitations of
the 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.




23





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 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 prior approval of the Chief Scientist
or additional information or representations in respect of certain of such
events. For this purpose, “control” is defined as the ability to direct the
activities of a company other than any ability arising solely from serving as an
officer or director of the company. A person is presumed to have control if such
person holds 50% or more of the means of control of a company. “Means of
control” refers to voting rights or the right to appoint directors or the chief
executive officer. An “interested party” of a company includes a holder of 5% or
more of its outstanding share capital or voting rights, its chief executive
officer and directors, someone who has the right to appoint its chief executive
officer or at least one director, and a company with respect to which any of the
foregoing interested parties owns 25% or more of the outstanding share capital
or voting rights or has the right to appoint 25% or more of the directors.
Accordingly, any non-Israeli who acquires 5% or more of our ordinary shares will
be required to notify the Office of the Chief Scientist that it has become an
interested party and to sign an undertaking to comply with the Research and
Development Law.





Draft
legislation was submitted in December 2004 by the Israeli government proposing
an amendment to the Research and Development Law to make it more compatible with
the global business environment by, among other things, relaxing restrictions on
the transfer of manufacturing rights outside Israel and on the transfer of Chief
Scientist funded know-how outside of Israel. As described above, currently, the
Research and Development Law permits the Chief Scientist to approve the transfer
of manufacturing rights outside Israel, in consideration of payment of higher
royalties. The proposed amendments further permit the Chief Scientist, among
other things, to approve the transfer of manufacturing rights outside Israel in
exchange for an import of different manufacturing into Israel as a substitute,
in lieu of the increased royalties. The proposed amendment further enables,
under certain circumstances and subject to the Chief Scientist’s prior approval,
the transfer of Chief Scientist-funded know-how outside Israel, in consideration
of payment of a portion of the sale price (according to certain formula
calculated in proportion to the Chief Scientist’s “investment” in the recipient
minus depreciation), or in exchange for know-how and cooperation in research and
development with non-Israeli companies, without any additional payment to the
Chief Scientist. Currently, the proposed amendment is pending, awaiting
discussion in the Finance Committee of the Israeli parliament (the “Knesset")
and there can be no certainty as to if and when such proposed draft legislation
will actually be finalized into 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 North
America. We also have subsidiaries in Australia, France, Germany, the United
Kingdom, Italy, Japan, Singapore, Korea and Canada. We have also established
representative offices in China and Taiwan 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.
    Canada




24





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:




AB-NET
      Communications Ltd.
      Axerra
      Networks Inc.
      BYNET
      Data
      Communications
      Ltd.
      BYNET
      Electronics Ltd.
      BYNET
      SEMECH (outsourcing) Ltd.
      Bynet
      Software Systems Ltd.
      Bynet
      System Applications Ltd.
    Ceragon
      Networks Ltd.
      
      Infogate
      On Line Ltd.
      Modules
      Inc.
      RAD-Bynet
      Properties and Services (1981) Ltd.
      RADCOM
      Ltd.
      RAD
      Data
      Communications
      Ltd.
    WISAIR
      Inc.
      Sanrad
      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 30,785 square feet of leased
office space in Tel Aviv, Israel. The lease expires in October 2005, and we have
extended the lease for an additional period of two years for reduced rent. 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.The sublease with respect to the remaining 3,332 square
feet expires in January 2006. In the United States, we lease approximately
10,201  square
feet in Mahwah, New Jersey from an affiliate. The lease will expire on April 20,
2006. We also lease 5,496 square feet
from an unaffiliated party in Costa Mesa, California. The lease expires at the
end of March
2009. We also
lease 3,024 square feet in Dallas, TX. The 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.




25




**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 our new 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, 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.




In
previous years, 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.
The stock-based compensation is being amortized to operating expenses over the
vesting period of the individual options. As of December 31, 2003 the stock
based compensation was completely amortized, and operating expenses in 2004 do
not include such amortization since no options were granted in 2004 at exercise
prices determined to be below market value.




On
December 16, 2004, the Financial Accounting Standards Board (FASB) issued
Statement No. 123 (revised 2004), Share-Based Payment ("SFAS No. 123R"), 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 third quarter of 2005, based on their fair
values. SFAS No. 123R 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 adoption
of SFAS No. 123R may have a significant effect on the Company's results of
operations.




26





SFAS No.
123R 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. 123R for all share-based payments granted after the effective
date and (b) based on the requirements of SFAS No. 123R for all awards granted
to employees prior to the effective date of SFAS No. 123R 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. 123R for purposes of pro forma disclosures either (a) all prior periods
presented or (b) prior interim periods of the year of adoption. The Company has
not determined yet which method it will adopt.




*Loss
in respect of an investment* . Until
2002, we invested in convertible debentures of a development stage company. In
2001, the investment balance was written-off and a provision with respect to
expected closing costs was recorded. The provision was utilized during
2002.




*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 and 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, 32% for the 2006
tax year and 30% for the 2007 tax year and thereafter, and are subject to
capital gains tax at a rate of 25% for capital gains (other than gains deriving
from the sale of listed securities) derived after January 1, 2003. However, 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. We may incur, for accounting purposes, tax
expenses in 2005 which we anticipate to be less than a rate of 10%. The tax
expenses might be higher than the actual tax payments due to exercise of non
qualified options by our employees, since the tax benefit resulting from the
exercise of such stock options will be credited to additional paid-in-capital,
when probable.




*Market
trends.* The
general deterioration of the economy worldwide and economic uncertainty in the
telecommunications market 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 it slightly grew. 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.




We intend
to continue our investment in the marketing and branding of our IPS products
which we released a year 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.




27


****


**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 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:




·
    Revenue
      recognition;




·
    Accounting
      for doubtful accounts;




·
    Inventory
      valuation; 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 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 consistent percentage of the product
price.




Revenue
derived from post-contract customer support, which represents mainly software
subscription and unit replacement, 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 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.





28


*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.




*Legal
contingencies.* As
discussed in “Item 8 – Financial Information” under the caption “Legal
Proceedings,” in December
2001, we were was 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. As of
December 31, 2003, management had accrued its estimate of the probable costs for
the resolution of this complaint. 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. 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, 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. Judge
Scheindlin ruled that the issuer defendants and the plaintiffs must submit a
revised settlement agreement which provides for a mutual bar of all contribution
claims by the settling and non-settling parties and does not bar the parties
from pursuing other claims. The underwriter defendants will have an opportunity
to object to the revised settlement agreement. There is no assurance that the
parties to the settlement will be able to agree to a revised settlement
agreement consistent with the court’s opinion, or that the court will grant
final approval to the settlement to the extent the parties reach agreement. If
the settlement agreement is not approved and the Company is found liable, we are
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 our results of operations,
cash flows or financial condition in any future period.




29


****


**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
      31,2001
    
    2002
    
    2003
    
    2004Revenues
    
    
    100.0
    %
    
    100.0
    %
    
    100.0
    %
    
    100.0
    %Cost
      of revenues
    
    
    17.8
    
    
    18.2
    
    
    18.0
    
    
    17.8Gross
      profit
    
    
    82.2
    
    
    81.8
    
    
    82.0
    
    
    82.2Operating
      expenses:Research
      and development
    
    
    19.1
    
    
    17.9
    
    
    15.3
    
    
    15.1Sales
      and Marketing
    
    
    69.2
    
    
    68.7
    
    
    54.3
    
    
    46.6General
      and administrative
    
    
    10.5
    
    
    9.7
    
    
    7.6
    
    
    6.6Total
      operating expenses
    
    
    98.8
    
    
    96.3
    
    
    77.2
    
    
    68.3Operating
      profit (loss)
    
    
    (16.6
    )
    
    (14.5
    )
    
    4.8
    
    
    13.9Financial
      income, net
    
    
    14.6
    
    
    9.7
    
    
    6.9
    
    
    6.7Income
      (loss) before taxes on income
    
    
    (2.0
    )
    
    (4.8
    )
    
    11.7
    
    
    20.6Taxes
      on income
    
    
    (0.9
    )
    
    —
    
    
    —
    
    
    (0.5
    )Loss
      in respect of an investment in an affiliate
    
    
    (14.6
    )
    
    —
    
    
    —
    
    
    —Minority
      interest in losses (earnings) of a subsidiary
    
    
    0.1
    
    
    —
    
    
    (0.1
    )
    
    —Net
      income (loss)
    
    
    (17.4
    )%
    
    (4.8
    )%
    
    11.6
    %
    
    20.1
    %





**Executive
Summary**–**Year Ended December 31,
2004**




Sales in
2004 were approximately $68.4 million. This is the second year in a row with a
25% increase in sales, compared with sales of approximately $54.8 million in
2003 and approximately $43.7 million in 2002. The cost of sales as percentage of
revenues remained at a similar level for 2002, 2003 and 2004. In order to
increase market acceptance of our new products and to strengthen our branding
and market penetration in certain regions, we decided to increase our operating
expenses throughout the year. Our sales increased at a higher rate than the
increase of our operating expenses. As a result, there was a sequential increase
in our operating profit in each quarter of 2004. In 2004 our operating profit
increased by more than 250% to $9.5 million, compared to $2.7 million in 2003.
The financial income increased due to the increase in our cash, increase in
interest rates and an increase in foreign currency translation differences. Such
difference resulted mainly from the increase in the value of the Euro relative
to the Dollar during 2004.




In 2005
we intend to 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 2004.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, 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.




30


**


*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. We expect the R&D expenses to increase in 2005 due to the
recruitment of additional personnel.




*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. We anticipate
increasing sales and marketing expenses for 2005 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 $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 increase in cash, 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.




**Year
Ended December 31, 2003 Compared with Year Ended December 31,
2002**




*Sales.* Sales in
2003 were approximately $54.8 million, an increase of approximately 25% compared
with sales of approximately $43.7 million in 2002. The growth in sales during
2003 is primarily attributable to the expansion of our sales and marketing
activities, the introduction of new products and a new platform, and a slight
improvement in the market environment and corporate spending.




*Cost
of Sales.* Cost of
sales was approximately $9.9 million in 2003, compared with cost of sales of
approximately $7.9 million in 2002. This increase is primarily attributable to
the increase in sales. Cost of sales were 18.0% in 2003, similar to the cost of
sales level of 18.2% in 2002. Manufacturing costs for our new platform released
in 2003 are higher than the costs for older platforms. The gross margin for this
platform, however, remains the same as a result of higher pricing.




*Research
and Development Expenses.* Research
and development expenses were approximately $8.4 million in 2003, an increase of
7.5% compared with research and development expenses of approximately $7.8
million in 2002. The increase is primarily due to new hiring of R&D
personnel, and 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.




31


**


*Sales
and Marketing Expenses.* Sales
and marketing expenses were approximately $29.8 million in 2003, a slight
decrease of 1% compared with sales and marketing expenses of approximately $30.0
million in 2002. During 2003, we maintained flat expenses in sales and
marketing, utilizing the investment in our sales and marketing infrastructure
during previous years.




*General
and Administrative Expenses.* General
and administrative expenses were approximately $4.1 million in 2003, a
decrease of approximately 2.3% compared
with general and administrative expenses of approximately $4.2 million in 2002.
This decrease is primarily attributable to the decrease in our doubtful debts
expense.




*Financing
Income, Net.* Financing income, net was approximately $3.7 million in 2003, a
decrease of approximately 12% compared
with financing income, net of approximately $4.2 million in 2002. This decrease
is primarily attributable to the reduction in the interest rate in the markets.
As a result, we received lower interest income on part of our cash and cash
equivalents and short-term and long-term investments derived primarily from the
cash we raised in our public offerings in 1999 and 2000.


****


**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 2005 to 2009 (some with
renewal options). Our future minimum payments under non-cancelable operating
lease agreements at December 31, 2004, 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
    
    
    4,058
    
    
    1,682
    
    
    1,986
    
    
    390
    
    
    -Total
      contractual cash obligations
    
    
    4,058
    
    
    1,682
    
    
    1,986
    
    
    390
    
    
    -


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 $1,682 thousand for 2005.
Our aggregate rent expenses paid under our lease obligations for 2004 were
approximately $1,554 thousand. Capital expenditures for the years ended December
31, 2002, 2003 and 2004 were approximately $1.3 million, $1.3 million and $2.4
million, respectively. These expenditures were mainly comprised of machinery and
equipment, including a CRM (Customer Relationship Management) system, computers,
lab equipment and testing tools. We currently do not have significant capital
spending or purchase commitments, but we may have capital spending consistent
with possible growth in our operations, infrastructure and personnel. During
2004 we generated cash (which was further invested in long-term marketable
securities) in a net amount of approximately $18.0 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.




Net cash
provided by operating activities was approximately $15.2 million for the year
ended December 31, 2004, compared with $ 9.0 million for the year ended December
31, 2003 and $1.1 million for the year ended December 31, 2002. Net cash
provided by operating activities for the years 2004 and 2003 increased primarily
due to our increasing operating profit as a result of our increasing sales, and
in 2003 also due to improvement in collections. 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 operating activities for the year 2002 consisted primarily
of net loss plus a decrease in inventories and in deferred
revenues.




32





Net cash
used in investing activities was approximately $23.8 million for the year ended
December 31, 2004, compared to net cash provided by investing activities of
approximately $0.2 million for the year ended December 31, 2003, and to net cash
provided by investing activities of approximately $14.5 million for the year
ended December 31, 2002. Cash was used in 2004 mainly to purchase long-term
marketable securities and 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.
Cash was provided in 2002 mainly from the sale of short-term bank deposits and
the sale of marketable securities, partially offset by the purchase of long-term
bank deposits.




Net cash
provided by financing activities was $6.9 million for the year ended December
31, 2004, 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).* Net cash
provided by financing activities for the year ended December 31, 2003 was $6.6
million, generated from options exercised by our employees under the Key
Employee Share Option Plan and Employee Stock Purchase Plans. Net cash provided
by financing activities for the year ended December 31, 2002 was $0.2 million,
generated from options exercised by our employees under the Key Employee Share
Option Plan and Employee Stock Purchase Plans, and partially offset by the
repurchase of our shares in the amount of $0.3 million in accordance with our
Stock Repurchase Plan.




On
October 28, 2002, our board of directors authorized a stock repurchase program
of up to 1.5 million ordinary shares or $10 million (the “Repurchase Program”).
The Repurchase Plan was approved by an Israeli court in December 2002. In the
year ended December 31, 2002 we purchased 32,700 ordinary shares for a total of
$0.3 million, under the Stock Repurchase Plan.




As of
December 31, 2004, we had cash and cash equivalents, including short-term and
long-term bank deposits and marketable securities of approximately $157.0
million, as compared to approximately $139.0 million as of December 31, 2003.
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.




**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 agreement 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.




33


****


**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 %**1999
    
    
    1.32000
    
    
    0.02001
    
    
    1.42002
    
    
    6.52003
    
    
    (1.9
    )2004
    
    
    1.1




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.




**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 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. We have no
debt.




34




**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)
    
    62
    
    Chairman
      of the Board of DirectorsRoy
      Zisapel(2)
    
    34
    
    Chief
      Executive Officer, President and DirectorMeir
      Moshe
    
    51
    
    Chief
      Financial OfficerDavid
      G. Hubbard
    
    52
    
    President,
      Radware Inc.Vered
      Raviv-Schwarz
    
    35
    
    General
      Counsel and SecretarySharon
      Trachtman
    
    38
    
    Vice
      President, MarketingAmir
      Peles
    
    33
    
    Vice
      President, Chief Technology OfficerAsaf
      Ronen
    
    31
    
    Vice
      President, Research and DevelopmentYiftach
      Atir(1)(3)(4)
    
    55
    
    DirectorAvigdor
      Willenz(1)(3)(4)
    
    48
    
    DirectorChristopher
      McCleary (4)(5)
    
    52
    
    DirectorLiora
      Katzenstein (2)(4)
    
    49
    
    DirectorKenneth
      E. Sichau (4) (6)
    
    50
    
    DirectorHagen
      Hultzsch (6)
    
    64
    
    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
2005.


(6)
Nominated until the next annual meeting and therefore is not a part of any
class.




**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.




35




**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.




**David
Hubbard** has
served as President of Radware Inc. (President Americas) since May 2004. Mr.
Hubbard has a 25 year track record of Sales and Strategic Marketing of
WAN/Server/Storage networking solutions to Global 2000 enterprises. Mr. Hubbard
was previously VP/GM QLogic Corporation SAN Switch Division, Sr. VP
Sales/Marketing INRANGE Technologies WAN Switch division, Sr. VP Sales/Marketing
Computerm Corporation, Sr. Director Marketing at Computer Network Technology,
and held various senior executive positions at Digital Equipment Corporation.
Mr. Hubbard began his career in Canada with a B.Sc. Electrical Engineering
degree in computerization from the University New Brunswick.




**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.




**Sharon
Trachtman** has
served as our Vice President of Marketing since September 1997. From November
1994 to September 1997, Ms. Trachtman was a product line marketing manager for
Scitex Corporation. Ms. Trachtman has a B.A. degree in computer science and
philosophy from Bar Ilan University.




**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 Research and Development (1982) 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 UC
Laser 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 has a BGS from the University of Kentucky.




36


****


**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 AG, 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.




Mr. Chris
McCleary, Mr. Yiftach Atir, Mr. Avigdor Willenz, Prof. Liora Katzenstein, Mr.
Kenneth Sichau and Dr. Hagen Hultzsch qualify as independent directors under the
current Nasdaq National Market requirements.


****


**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 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, 2004. 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.




37




**Salaries,
      fees, commissions and bonuses**
    
    **Pension,
      retirement**
      **and
      other similar benefits**All
      directors and officers as a group, consisting of 12
persons
    
    $
    1,129,000
    
    $
    158,000





As of
March 30, 2005, our directors and officers as a group, consisting of 12 persons,
held options to purchase an aggregate of 1,832,500 ordinary shares. Other than
reimbursement for expenses and grant of options to purchase shares of the
Company, we do 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 ordinary shares for each year of service. This grant was approved by
our shareholders.




During
2004, we granted to our directors and officers options to purchase 210,000
ordinary shares, in the aggregate, at a weighted average exercise price of
$19.19. The options expire sixty-two months after grant.


****


**Board
Practices**




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.




**Nasdaq
National Market**




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, companies quoted on Nasdaq are required,
among others, to have an audit committee with at least three independent
directors. For additional information on our Audit Committee see the caption
titled “Audit Committee” and “Our Committees” below.




**Israeli
Companies Law**




We are
subject to the provisions of the Israeli Companies Law and the regulations
adopted thereunder.




**Our
Committees**




**Audit
Committee**




*Nasdaq
Requirements*




As
described above, under the current 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. The Audit Committee has adopted a charter.




The Audit
Committee of the Board of Directors assists the board in fulfilling its
responsibility for oversight of the quality and integrity of our accounting,
auditing and financial reporting practices and financial statements and the
independence qualifications and performance of our independent auditors. The
Audit Committee also has the sole authority and responsibility to select,
evaluate and, where appropriate, replace the independent auditors (or to
nominate the independent auditors for stockholder 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 2004. Mr. Yiftach Atir, Prof. Liora
Katzenstein, Mr. Christopher McCleary and Mr. Avigdor Willenz attended all of
the Audit Committee meetings. Mr. Kenneth Sichau joined the Audit Committee in
the beginning of 2005. For additional information on our Audit Committee see the
caption titled “Our Committees” below.




38




*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.




Under the
Companies Law, the duty of the audit committee is (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.




*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 .




**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 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.




39




The term
affiliation includes:




·
    An
      employment relationship;




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




·
    Control;
      and




·
    Service
      as an office holder, excluding service as an office holder during the
      three month period in which the company first offers its shares to the
      public.




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.




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.




**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. We have appointed Mr. Gideon Duvshani, CPA, as our internal
auditor.




40


****


**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;




·
    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.




41




*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.




*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.




**Staggered
Board**




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. 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
    
    2005
    
    Christopher
      McCleary




Mr.
Kenneth Sichau and Dr. Hagen Hultzsch were nominated by the Board of Directors
until the next annual meeting of shareholders.




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.




42





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.




**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, 2004, we had 361 employees worldwide, of whom 160 ** were
based in Israel, 100 were based in the United States and 101 were based in our
other subsidiaries and offices. Of these 361 employees, 108 were employed in
research and development, 191 were employed in sales, technical support and
marketing, and 62 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.


****


43


****


**Share
Ownership**




The
following table sets forth certain information regarding the ownership of our
ordinary shares by our directors and officers as of April 10, 2005. The
percentage of outstanding ordinary shares is based on 18,650,583 ordinary shares
outstanding as of April 10, 2005.




**Name**
    
    **Number
      of ordinary shares**
    
    **Percentage
      of outstanding ordinary shares**Yehuda
      Zisapel
    
    
    2,545,877
    
    
    13.7
    %Roy
      Zisapel
    
    
    839,803
    (1)
    
    4.5
    %All
      directors and executive officers as a group
      (12
      persons) (2)(3)
    
    
    3,962,995
    
    
    21.2
    %





(1) Consists
of 439,803 shares and 400,000 options which are fully vested or will be vested
in the 60 days following the date of this Annual Report.





(2)  
Consists of 3,102,995 shares and 860,000 options which are fully vested or which
will be fully vested within the next 60 days.





(3)  
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, 2004, 6,311,690 ordinary
shares have been reserved for option grants under the plan, of which we have
granted options to purchase 6,308,647 ordinary shares, at a weighted average
exercise price of $10.07 per ordinary share. We intend to grant further options
under our share option plan to our executive officers and employees, however, in
light of the new accounting standard of SFAS No. 123R we may amend our option
plan, reduce the number of options granted to the employees or suggest
alternative compensation schemes. The annual shareholders meeting held on
September 13, 2004 approved an increase in the number of ordinary shares
reserved for option grants under the plan, in an amount equal to 3% of the our
issued and outstanding stock for the year 2005.




Our share
option plan is administered by the compensation committee of our board of
directors. Under Section 112 of the Companies Law, the compensation committee
may only advise our board of directors with regard to the grant of options, and
the actual grant is carried out by 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.




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 selected by
the share incentive committee. The trustee will not release the options or
ordinary shares to the option holder before the second anniversary of the
registration of the options in the name of the trustee on behalf of the option
holder. 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.




44





In order
to comply with the provisions of Section 102 of the Israeli Income Tax Ordinance
[New Version], 1961 (the “Ordinance”), which were 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.




**1999
Employee Stock Purchase Plan**




We
adopted an Employee Stock Purchase Plan effective as of May 1, 2000. The purpose
of the employee stock purchase plan is to align employee and shareholder
long-term interests by facilitating the purchase of our ordinary shares by
employees and to enable employees to develop and maintain significant ownership
of ordinary shares. The Stock Purchase Plan applies only to employees of our
U.S. subsidiary, Radware Inc. The employee stock purchase plan is intended to
comply with the requirements of Section 423 of the Internal Revenue Code, and to
assure the participants of the tax advantages provided thereby. The number of
our ordinary shares available for issuance under the employee stock purchase
plan is limited to 750,000 ordinary shares. All employees of the company or its
designated subsidiaries who have at least one year of service and work more than
20 hours per week and five months in a calendar year will be eligible to
participate in the employee stock purchase plan, other than employees who are
"highly compensated" within the meaning of Section 414(q) of the Code and
employees who are five percent or more stockholders of the company or any parent
or subsidiary of the company. Currently only employees of our U.S. subsidiary,
Radware Inc., have been designated to participate in the plan.




Pursuant
to the employee stock purchase plan, each eligible employee will be permitted to
purchase ordinary shares up to two times per calendar year through regular
payroll deductions in an aggregate amount equal to 1% to 10% of the employee's
base pay, as elected by the employee, for each payroll period. The initial
offering period commenced on November 15, 2000 and ended on November 14, 2002.
Each subsequent offering period will have a duration of approximately two years.
Each purchase period will have a duration of approximately six
months.




As of the
last day of each purchase period ending within an offering period, participating
employees will be able to purchase ordinary shares with payroll deductions for a
purchase price equal to the lesser of: 85% of the fair market value of the
ordinary shares on the date the offering period begins; and 85% of the fair
market value of the ordinary shares on the last day of the purchase
period.




**2001
Employee Stock Purchase Plan**




We
adopted an additional employee stock purchase plan effective as of November 29,
2001. The terms and conditions of the 2001 Employee Stock Purchase Plan are
similar to the 1999 Employee Stock Purchase Plan. The number of our ordinary
shares available for issuance under the employee stock purchase plan is limited
to 200,000 ordinary shares. The initial offering period commenced on
November 15, 2001 and ended on the last trading day on or prior to the
second anniversary of the commencement date. Each subsequent offering period
will have a duration of approximately two years. Each purchase period will have
a duration of approximately six months. **




45


****


**2002
Employee Stock Purchase Plan**




We
adopted an additional Employee Stock Purchase Plan effective as of November 26,
2002, which was applied to the employees of the Company in Israel. The terms and
conditions of the 2002 Employee Stock Purchase Plan are similar to the 1999 and
2001 Employee Stock Purchase Plan, with certain variations resulting from the
fact that it complies with Israeli tax law, unlike the 1999 and 2001 plans which
are used for the employees of our U.S. subsidiary and comply with U.S. tax laws.
The number of our ordinary shares available for issuance under the employee
stock purchase plan is limited to 300,000 ordinary shares. The initial offering
period commenced on November 30, 2002 and ended on the last trading day on or
prior to the second anniversary of the commencement date. A new offering period
commenced in November 2004. Each subsequent offering period will have a duration
of approximately two years. Each purchase period will have a duration of
approximately six months.




46




**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 10, 2005, by each person or entity
known to own beneficially more than 5% of our outstanding ordinary shares based
on information provided to us by the holders or disclosed in public filings with
the Securities and Exchange Commission. 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)
    
    2,545,877
    
    13.7%


(1)
Includes 463,400  ordinary
shares owned of record by Carm-AD Ltd., an Israeli company, which is controlled
by Yehuda Zisapel.


****


**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.




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, to the extent necessary, 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 $357 thousand in
2004.




**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 30,785
square feet. The monthly rent amounts to approximately $44 thousand. The lease
expires in October 2005, and was renewed, under more favorable terms and lower
rent for an additional period of two years. We also lease additional 3,821
square feet in the building under the same lease agreement and sublease this
area to an affiliated company of ours and to another company, back-to-back. We
entered into an agreement with RAD Data Communications, Inc, pursuant to which
we will lease approximately 10,201  square
feet in Mahwah, New Jersey, consisting of 5,940 square feet of office space and
4,261  square
feet of
warehouse space, in consideration for annual rent of approximately $18 thousand
(including taxes and management fees). The lease expires on April 20,
2006. ******




47


****


**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 $2,325 thousand during 2004. In addition to the sales under the
Distribution Agreement, during 2004 we sold products in the ordinary course of
business to other members of the RAD Group for a total of $75 thousand.




**Founders’
Agreement**




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


****


**Interests
of Experts and Counsel**




Not
applicable




48




**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.
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. It is anticipated that any potential
financial obligation of Radware 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. Its carriers are solvent, and we are not aware of any
uncertainties as to the 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. On
February 15, 2005, the court granted preliminary approval of the settlement
agreement, subject to certain modifications consistent with its opinion. Judge
Scheindlin ruled that the issuer defendants and the plaintiffs must submit a
revised settlement agreement which provides for a mutual bar of all contribution
claims by the settling and non-settling parties and does not bar the parties
from pursuing other claims. There will be a conference with Judge Scheindlin on
April 14, 2005 to discuss the status of the revised settlement agreement. The
underwriter defendants will have an opportunity to object to the revised
settlement agreement. There is no assurance that the parties to the settlement
will be able to agree to a revised settlement agreement consistent with the
court’s opinion, or that the court will grant final approval to the settlement
to the extent the parties reach agreement. 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.




49





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. The
settlement agreement does not have a material affect on the
Company.




From time
to time, we are involved in routine trade litigation.




We are
not subject to any additional material legal proceedings.


****


**Significant
Changes**




We are
not aware of any significant changes bearing upon our financial condition since the date of the
audited consolidated financial statements included in this annual report.




50




**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****2000**
    
    $
    67.44
    
    $
    14.94
    
    
    —**2001**
    
    $
    21.94
    
    $
    7.63
    
    
    —**2002**
    
    $
    12.95
    
    $
    6.5
    
    
    —
  **Quarterly
      High and Low****2003**First
      Quarter
    
    $
    10.3
    
    $
    7.97
    
    
    —Second
      Quarter
    
    $
    18.15
    
    $
    10.89
    
    
    —Third
      Quarter
    
    $
    22.89
    
    $
    15.44
    
    
    —Fourth
      Quarter
    
    $
    28.54
    
    $
    18.74**2004**First
      Quarter
    
    $
    32.42
    
    $
    22.83
    
    
    —Second
      Quarter
    
    $
    28.22
    
    $
    14.94
    
    
    NIS 
       82.62
    
    
    NIS
      69.60Third
      Quarter
    
    $
    22
    
    $
    16.45
    
    
    NIS  
      98.76
    
    
    NIS
      74.43Fourth
      Quarter
    
    $
    27.19
    
    $
    21.92
    
    
    NIS
      118.00
    
    
    NIS
      97.20




51






**Most
      recent six months****2005**April
      1-10
    
    $
    23.42
    
    $
    24.65
    
    
    NIS
      108.90
    
    
    NIS
      101.40March
    
    $
    26.56
    
    $
    23.46
    
    
    NIS
      115.00
    
    
    NIS
      102.70February
    
    $
    25.88
    
    $
    22.24
    
    
    NIS
      112.30
    
    
    NIS  
      98.07January
    
    $
    25.28
    
    $
    22.64
    
    
    NIS
      114.90
    
    
    NIS 
       99.91**2004**December
    
    $
    27.19
    
    $
    24.88
    
    
    NIS
      118.00
    
    
    NIS
      107.80November
    
    $
    25.41
    
    $
    23.62
    
    
    NIS
      112.40
    
    
    NIS
      101.60October
    
    $
    24.7
    
    $
    21.92
    
    
    NIS
      110.80
    
    
    NIS  
      97.20




52


****


**Plan
of Distribution**




Not
applicable


****


**Markets**




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


****


**Selling
Shareholders**




Not
applicable


****


**Dilution**




Not
applicable


****


**Expenses
of the Issue**




Not
applicable




53





**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**





The
company has two types of general shareholder meetings: the annual general
meeting and the extraordinary general meeting. An annual general meeting must be
held once in every calendar year, but not more than 15 months after the last
annual general meeting. 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 be no more than 40 but no less than 4 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.




54





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 actionswhich require shareholder approvalpursuant 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.




55





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.




56


****


**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.


57


**


*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:




·
    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;




·
    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.


****


**Material
Contracts**




For a
summary of our material contracts, see Item 7 – *“Related
Party Transactions* ”.




58
 
 ****
 **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**




**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.




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




*General
Corporate Tax Structure*




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




*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.




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




59


**


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




The Law
for the Encouragement of Capital Investments, 1959, as amended (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 Investments
Law will expire on March 31, 2005, unless its term will be extended.
Accordingly, requests for new programs or expansions that are not approved on or
before March 31, 2005 will not confer any tax benefits, unless the term of the
law will be extended. On January 12, 2005, a bill was submitted to the Israeli
parliament providing for certain changes to the Investments Law. Among others,
the bill introduces changes to both the criteria and procedure for obtaining
approved enterprise status for an investment program, and changes to the grants
and tax benefits afforded in certain circumstances to approved enterprises. The
proposed amendment is expected to apply to new investment programs following the
enactment of the bill into law. In order to enact the bill as legislation, the
bill must be approved by the Israeli parliament and published.  The bill
was approved by the Israeli parliament on March 29, 2005. However, since the
final law has yet to be published, we and our shareholders face uncertainties as
to the potential consequences of the final law. Because we cannot predict
whether, and to what extent, the bill will eventually be enacted into
law, we and our
shareholders face uncertainties as to the potential consequences of the
bill.




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, regardless of whether
the dividend is converted into foreign currency.




60





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.




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 six 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), for one additional year. The six-year tax exemption period may be
extended to ten years, without an additional year of reduced tax rate, if the
approved enterprise applies to the Investment Center for recognition as a “High
Technology” facility and this status is recognized.




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) **.**




61





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, 2004, retained
earnings included approximately $13,600 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 $1,400 to $3,400 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.




We expect
that a substantial portion of any taxable operating income that we may realize
in the future will be derived from our approved enterprise 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.




62




*Special
Provisions Relating to Taxation Under Inflationary Conditions*




Under the
Income Tax (Inflationary Adjustments) Law, 1985
("the Israeli 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.




*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,
capital gains tax is imposed on Israeli residents at a rate of 15% on real gains
derived on or after January 1, 2003, from the sale of shares in, 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 is contingent upon the
shareholder not claiming a deduction for financing expenses in connection with
such shares (in which
case the gain will generally be taxed at a rate of 25%) , and
does 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
will be taxed at corporate tax rates for corporations and at marginal tax rates
for individuals) ; or
(iv) the sale of shares by shareholders who acquired their shares prior to
an initial public offering (that may be subject to a different tax arrangement).
The tax basis of shares acquired prior to January 1, 2003 will be determined in
accordance with the average closing share price in the three trading days
preceding January 1, 2003. However, a request may be made to the tax authorities
to consider the actual adjusted cost of the shares as the tax basis if it is
higher than such average price.




Non-Israeli
residents are exempt from Israeli capital gains tax on any gains derived from
the sale of shares of Israeli companies publicly traded on a recognized stock
exchange or regulated market outside of Israel, provided however that such
capital gains are not derived from a permanent establishment in Israel and
provided that 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.




63




*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 at the rate of up to 25% is withheld at source, unless a
different rate is provided in a treaty between Israel and the shareholder’s
country of residence. Under the U.S.-Israel Tax Treaty, the maximum tax on
dividends paid to a holder of ordinary shares who is a Treaty U.S. Resident is
25%. However, under the Investments Law, dividends generated by an Approved
Enterprise are taxed at the rate of 15%. Furthermore, dividends not generated by
an Approved Enterprise paid to a U.S. 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




·
    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;




64




·
    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.




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.




65





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.




*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.




66





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, 2004.




It is
possible that the Internal Revenue Service will attempt to treat us as a passive
foreign investment company for 2004 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 2005 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. U.S. Holders should consult their tax advisors regarding the
advisability of filing a protective statement in light of our use of an
alternate valuation method for purposes of determining our status as a PFIC for
our 2002 tax year.




**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.




67




*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.


****


**Dividends
and Paying Agents**




Not
applicable.


****


**Statement
by Experts**




Not
applicable.


****


**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.




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.


****


**Subsidiary**
Information





Not
applicable.




68




**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. On
December 31, 2004, 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.




69





**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 deposit until June 2005 at an interest
rate of 4.8% in a structured note, in short-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, 2004.
Based on this evaluation, our CEO and CFO concluded that our disclosure controls
and procedures are effective in timely alerting them to information required to
be disclosed in our periodic reports to the SEC.




(b)
Internal Control Over Financial Reporting.




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




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


****


70


****


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




Our board
of directors has determined that Mssrs. Chris McCleary and Yiftach Atir, members
of our Audit Committee, are financial experts as defined in the applicable
regulations.




**ITEM
16B. Code of Ethics**




On
February 2, 2004 our board 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.




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




In the
annual meeting held on September 13, 2004 our shareholders re-appointed Kost,
Forer, Gabbay & Kasierer, a member of Ernst & Young Global (“Ernst &
Young”), to serve as our independent auditors for the 2004 fiscal year.




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


Year
      Ended December 31,2004
    
    2003($
      in thousands)Audit
      Fees
    
    
    60
    
    
    50Audit-Related
      Fees
    
    
    5
    
    
    20Tax
      Fees
    
    
    55
    
    
    47Total
    
    
    120
    
    
    117

"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.




*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, 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 2005 fiscal year for non-audit
services in certain categories, unless pre- approved.




71


Our
Director of Legal 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.


****


72


****


**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.***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 Act13.1
    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.




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




73




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 13,
      2005




74










**RADWARE
LTD. AND ITS SUBSIDIARIES**





**CONSOLIDATED
FINANCIAL STATEMENTS**





**AS
OF DECEMBER 31, 2004**





**U.S.
DOLLARS IN THOUSANDS**





**INDEX**








**Page****Report
      of Independent Registered Public Accounting Firm**
    **F2****Consolidated
      Balance Sheets**
    **F3
      - F4****Consolidated
      Statements of Operations**
    **F5****Statements
      of Changes in Shareholders' Equity**
    **F6****Consolidated
      Statements of Cash Flows**
    **F7****Notes
      to Consolidated Financial Statements**
    **F8
      - F28**


**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, 2003 and 2004, and the related
consolidated statements of operations, shareholders' equity and cash flows for
each of the three years in the period ended December 31, 2004. 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
audit 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, 2003 and 2004, and the consolidated results of
their operations and their cash flows for each of the three years in the period
ended December 31, 2004, in conformity with U.S. generally accepted accounting
principles.





Tel-Aviv,
      Israel
    KOST
      FORER GABBAY & KASIERERJanuary
      30, 2005
    A
      Member of Ernst & Young Global





-F2-


**RADWARE
LTD. AND ITS SUBSIDIARIES**
 **CONSOLIDATED
BALANCE SHEETS**





**U.S.
dollars in thousands**








**December
      31,****2003**
    
    **2004**ASSETSCURRENT
      ASSETS:Cash
      and cash equivalents
    
    $
    31,771
    
    $
    30,073Current
      maturity of long-term bank deposit
    
    
    —
    
    
    64,892Short-term
      available-for-sale marketable securities
    
    
    31,111
    
    
    8,889Short-term
      held-to-maturity marketable securities
    
    
    —
    
    
    5,166Trade
      receivables (net of allowance for doubtful accounts of $ 669
      and
      $ 1,060
      in 2003 and 2004, respectively) *)
    
    
    9,690
    
    
    13,166Other
      receivables and prepaid expenses
    
    
    1,089
    
    
    1,332Inventories
    
    
    2,998
    
    
    4,094Totalcurrent assets
    
    
    76,659
    
    
    127,612LONG-TERM
      INVESTMENTS:Long-term
      bank deposits
    
    
    72,017
    
    
    9,224Long-term
      available-for-sale marketable securities
    
    
    4,122
    
    
    12,477Long-term
      held-to-maturity marketable securities
    
    
    —
    
    
    26,320Severance
      pay fund
    
    
    1,435
    
    
    1,921Totallong-term investments
    
    
    77,574
    
    
    49,942PROPERTY
      AND EQUIPMENT, NET
    
    
    3,479
    
    
    4,452INTANGIBLE
      ASSETS, NET, LONG-TERM DEFERRRED TAXES
      AND
      OTHER LONG-TERM ASSETS
    
    
    402
    
    
    1,235Totalassets
    
    $
    158,114
    
    $
    183,241





*)  Includes
balances in the amount of $ 202 and $ 1,004 with related parties as of December
31, 2003 and 2004, respectively (see also Note 12a).





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 data**




**December
      31,****2003**
    
    **2004**LIABILITIES
      AND SHAREHOLDERS' EQUITYCURRENT
      LIABILITIES:Trade
      payables *)
    
    $
    4,285
    
    $
    5,075Deferred
      revenues
    
    
    7,058
    
    
    9,888Other
      payables and accrued expenses
    
    
    4,839
    
    
    4,962Totalcurrent liabilities
    
    
    16,182
    
    
    19,925ACCRUED
      SEVERANCE PAY
    
    
    1,625
    
    
    2,399MINORITY
      INTEREST
    
    
    61
    
    
    —COMMITMENTS
      AND CONTINGENT LIABILITIESSHAREHOLDERS'
      EQUITY:Share
      capital:Ordinary
      shares of NIS 0.1 par value:
      Authorized
      - 30,000,000 shares as of December 31, 2003 and 2004; Issued and
      outstanding - 17,704,183 and 18,488,530 shares as of December 31,
      2003 and 2004, respectively
    
    
    439
    
    
    457Additional
      paid-in capital
    
    
    138,552
    
    
    145,439Accumulated
      other comprehensive loss
    
    
    (38
    )
    
    (52
    )Retained
      earnings
    
    
    1,293
    
    
    15,073Totalshareholders' equity
    
    
    140,246
    
    
    160,917Totalliabilities and shareholders' equity
    
    $
    158,114
    
    $
    183,241





*)  See Note
12a 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 OPERATIONS**


****


**U.S.
dollars in thousands, except per share data**








**Year
      ended December 31,****2002**
    
    **2003**
    
    **2004**Revenues
      *)
    
    $
    43,663
    
    $
    54,780
    
    $
    68,439Cost
      of revenues *)
    
    
    7,946
    
    
    9,854
    
    
    12,184Gross
      profit
    
    
    35,717
    
    
    44,926
    
    
    56,255Operating
      expenses: *)Research
      and development
    
    
    7,809
    
    
    8,398
    
    
    10,342Sales
      and marketing
    
    
    30,019
    
    
    29,753
    
    
    31,898General
      and administrative
    
    
    4,219
    
    
    4,120
    
    
    4,493Totaloperating expenses
    
    
    42,047
    
    
    42,271
    
    
    46,733Operating
      income (loss)
    
    
    (6,330
    )
    
    2,655
    
    
    9,522Financial
      income, net
    
    
    4,240
    
    
    3,740
    
    
    4,565Income
      (loss) before income taxes
    
    
    (2,090
    )
    
    6,395
    
    
    14,087Income
      taxes
    
    
    —
    
    
    —
    
    
    341Income
      (loss) before minority interest in losses (earnings) of a
      subsidiary
    
    
    (2,090
    )
    
    6,395
    
    
    13,746Minority
      interest in losses (earnings) of a subsidiary
    
    
    (23
    )
    
    (40
    )
    
    34Net
      income (loss)
    
    $
    (2,113
    )
    $
    6,355
    
    $
    13,780Basic
      net earnings (loss) per share
    
    $
    (0.13
    )
    $
    0.37
    
    $
    0.77Diluted
      net earnings (loss) per share
    
    $
    (0.13
    )
    $
    0.34
    
    $
    0.70





*) See Note
12b 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
      compensation**
    
    **Treasury**
      **shares,
      at cost**
    
    **Accumulated**
      **other
      comprehensive**
      **income
      (loss)**
    
    **Retained
      earnings**
      **(accumulated
      deficit)**
    
    **Total**
      **comprehensive
      income (loss)**
    
    **Total**Balance
      as of January 1, 2002
    
    
    16,520,836
    
    $
    413
    
    $
    131,615
    
    $
    (394
    )
    $
    —
    
    $
    —
    
    $
    (2,696
    )
    
    
    
    $
    128,938Repurchase
      of shares, net
    
    
    (32,700
    )
    
    —
    
    
    —
    
    
    —
    
    
    (254
    )
    
    —
    
    
    —
    
    
    
    
    
    (254
    )Issuance
      of shares upon exercise of stock options and upon purchase of shares under
      ESPP
    
    
    525,978
    
    
    11
    
    
    401
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    
    
    
    412Amortization
      of deferred stock compensation
    
    
    —
    
    
    —
    
    
    (11
    )
    
    296
    
    
    —
    
    
    —
    
    
    —
    
    
    
    
    
    285Comprehensive
      loss:Unrealized
      gains from available-for-sale securities, net
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    89
    
    
    —
    
    $
    89
    
    
    89Net
      loss
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    —
    
    
    (2,113
    )
    
    (2,113
    )
    
    (2,113
    )Total
      comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    (2,024
    )Balance
      as of December 31, 2002
    
    
    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 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
    
    
    
    
    $
    160,917








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,****2002**
    
    **2003**
    
    **2004**Cash
      flows from operating activities:Net
      income (loss)
    
    $
    (2,113
    )
    $
    6,355
    
    $
    13,780Adjustments
      to reconcile net income (loss) to net cash provided by operating
      activities:Depreciation
      and amortization
    
    
    1,721
    
    
    1,509
    
    
    1,429Amortization
      of deferred stock compensation
    
    
    285
    
    
    98
    
    
    —Minority
      interest in earnings (losses) of a subsidiary
    
    
    23
    
    
    40
    
    
    (34
    )Amortization
      of premiums, accretion of discounts and accrued interest on
      available-for-sale and held-to-maturity marketable securities,
      net
    
    
    (197
    )
    
    214
    
    
    318Accrued
      interest on bank deposits
    
    
    (1,727
    )
    
    (184
    )
    
    791Accrued
      severance pay, net
    
    
    36
    
    
    106
    
    
    288Increase
      in long-term deferred taxes
    
    
    —
    
    
    —
    
    
    (350
    )Increase
      in trade receivables, net
    
    
    (827
    )
    
    (995
    )
    
    (3,476
    )Decrease
      (increase) in other receivables and prepaid expenses
    
    
    22
    
    
    63
    
    
    (243
    )Decrease
      (increase) in inventories
    
    
    1,793
    
    
    (10
    )
    
    (1,096
    )Increase
      in trade payables
    
    
    71
    
    
    1,673
    
    
    790Increase
      in deferred revenues
    
    
    1,081
    
    
    1,768
    
    
    2,830Increase
      (decrease) in other payables and accrued expenses
    
    
    926
    
    
    (1,678
    )
    
    123Other
    
    
    4
    
    
    1
    
    
    1Net
      cash provided by operating activities
    
    
    1,098
    
    
    8,960
    
    
    15,151Cash
      flows from investing activities:Purchase
      of property and equipment *)
    
    
    (1,335
    )
    
    (1,311
    )
    
    (2,369
    )Proceeds
      from sale of property and equipment
    
    
    10
    
    
    —
    
    
    16Proceeds
      from short-term bank deposits
    
    
    59,862
    
    
    —
    
    
    —Investment
      in other long-term assets
    
    
    (72
    )
    
    15
    
    
    (225
    )Purchase
      of available-for-sale marketable securities
    
    
    (1,818
    )
    
    (5,586
    )
    
    —Purchase
      of held-to-maturity marketable securities
    
    
    —
    
    
    —
    
    
    (31,320
    )Proceeds
      from redemption of available-for-sale marketable debt
      securities
    
    
    17,457
    
    
    20,137
    
    
    13,369Investment
      in long-term bank deposits
    
    
    (57,352
    )
    
    (12,754
    )
    
    (2,890
    )Investment
      in an affiliate
    
    
    (2,251
    )
    
    —
    
    
    —Increase
      in holdings in a subsidiary
    
    
    —
    
    
    (350
    )
    
    (335
    )Net
      cash provided by (used in) investing activities
    
    
    14,501
    
    
    151
    
    
    (23,754
    )Cash
      flows from financing activities:Proceeds
      from exercise of stock options and from purchase of shares under
      ESPP
    
    
    412
    
    
    6,563
    
    
    6,905Repurchase
      of shares, net
    
    
    (254
    )
    
    —
    
    
    —Net
      cash provided by financing activities
    
    
    158
    
    
    6,563
    
    
    6,905Increase
      (decrease) in cash and cash equivalents
    
    
    15,757
    
    
    15,674
    
    
    (1,698
    )Cash
      and cash equivalents at the beginning of the year
    
    
    340
    
    
    16,097
    
    
    31,771Cash
      and cash equivalents at the end of the year
    
    $
    16,097
    
    $
    31,771
    
    $
    30,073Supplemental
      disclosure of cash flow activities:Cash
      paid during the year for:Taxes
    
    $
    —
    
    $
    —
    
    $
    1,494





*) See Note
12b for transactions with related parties.





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




-F7-
 
  **RADWARE
LTD. AND ITS SUBSIDIARIES**
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 
 **U.S.
dollars in thousands**


**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 intelligent application switching
      solutions, enabling security improved performance and continuous
      availability of all 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 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.





All of
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 such 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
      10b).




**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.


-F8-
 
 **RADWARE
LTD. AND ITS SUBSIDIARIES**




**NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 
 **U.S.
dollars in thousands**







**NOTE
      2:-**
    **SIGNIFICANT
      ACCOUNTING POLICIES (Cont.)**





b.
    Financial
      statements in U.S. dollars:





A
majority of the revenues of the Company and its subsidiaries is generated in
U.S. dollar ("dollar"). In addition, a substantial portion of the Company's and
its subsidiaries' costs are 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.





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, 2004, 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 the consolidated statement of operations. As of December
31, 2004, no material impairment has been identified.


-F9-
 
  **RADWARE
LTD. AND ITS SUBSIDIARIES**
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 
 **U.S.
dollars in thousands**
 **NOTE
      2:-**
    **SIGNIFICANT
      ACCOUNTING POLICIES (Cont.)**
 
 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, 2003 and 2004 provision for inventory write-offs
amounted to $ 188 and $ 234, 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.
    Long-term
      bank deposits and current maturity of long-term bank
deposit:
 
 Bank
      deposit with maturity of more than one year is included in long-term
      investments. Long-term bank deposit as of December 31, 2004, consists of a
      callable structured note ("Structured Note") with a maturity of nine
      years. The Structured Note bears interest of 8% in its first year, and
      starting from its second year, it bears interest that will vary inversely
      with changes of three-months LIBOR-rate.
 
 As of
December 31, 2004, the Structured Note amounted to $ 9,224. Interest income
resulting from investment in a Structured Note is accounted 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.
 
 Current
maturity of long-term bank deposit consists of a three years bank deposit in
U.S. dollars that bears interest at the rate of 4.8% and matures within less
than one year from the date of the balance sheet. The deposit is presented at
cost, including accrued interest.
 As of
December 31, 2004, the bank deposit amounted to $ 64,892.
 
 h.
    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
    20-33Office
      furniture and equipment
    7-15Motor
      vehicles
    15Leasehold
      improvements
    Over
      the shorter of the term of
      the
      lease or the life of the asset
 -F10-
  **RADWARE
LTD. AND ITS SUBSIDIARIES**
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 
 **U.S.
dollars in thousands**





**NOTE
      2:-**
    **SIGNIFICANT
      ACCOUNTING POLICIES (Cont.)**





i.
    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, 2004, no impairment losses have been identified.





j.
    Revenue
      recognition:





The
Company and its subsidiaries generate revenues mainly 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 consistent
percentage of the product price.





Revenue
derived from post-contract customer support, which represents mainly software
subscription and unit replacement, 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 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.





-F11-
 
 **RADWARE
LTD. AND ITS SUBSIDIARIES**
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 
 **U.S.
dollars in thousands**








**NOTE
      2:-**
    **SIGNIFICANT
      ACCOUNTING POLICIES (Cont.)**





k.
    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. A tabular reconciliation of the changes in the Company's aggregate
product warranty liability was not provided due to immateriality.





l.
    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 (loss) and net earnings (loss) 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 and Scholes option pricing model with the following
weighted-average assumptions for each of the three years ended December 31,
2002, 2003 and 2004: risk-free interest rates of 2.5% for each year, dividend
yields of 0% for each year; a volatility factor of the expected market price of
the Company's Ordinary shares of 37.5%, 149% and 75%, respectively; and a
weighted-average expected life of the option of 2.5 years for each
year.





The Black
and 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 the option's vesting period.




-F12-
 
 **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,****2002**
    
    **2003**
    
    **2004**Net
      income (loss) as reported
    
    $
    (2,113
    )
    $
    6,355
    
    $
    13,780Add
      - stock-based compensation expenses included in reported net
      income-intrinsic value
    
    
    285
    
    
    98
    
    
    —Deduct
      - stock-based compensation expense determined under fair value method
    
    
    (7,274
    )
    
    (7,626
    )
    
    (7,520
    )Pro
      forma net income (loss)
    
    $
    (9,102
    )
    $
    (1,173
    )
    $
    6,260Basic
      net earnings (loss) per share as reported
    
    $
    (0.13
    )
    $
    0.37
    
    $
    0.77Diluted
      net earnings (loss) per share as reported
    
    $
    (0.13
    )
    $
    0.34
    
    $
    0.70Pro
      forma basic net earnings (loss) per share
    
    $
    (0.55
    )
    $
    (0.07
    )
    $
    0.35Pro
      forma diluted net earnings (loss) per share
    
    $
    (0.55
    )
    $
    (0.07
    )
    $
    0.32





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. The adoption of SFAS No.
123(R) may have a significant effect on the Company's results of operations.
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(R) 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(R) for purposes of pro
forma disclosures either (a) all prior periods presented or (b) prior interim
periods of the year of adoption. The Company has not determined yet which method
it will adopt.








F-13
 **RADWARE
LTD. AND ITS SUBSIDIARIES**
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 
 **U.S.
dollars in thousands**




**NOTE
      2:-**
    **SIGNIFICANT
      ACCOUNTING POLICIES (Cont.)**





m.
    Research
      and development costs:





Research
and development costs are charged to the statement of operations, as
incurred.





n.
    Basic
      and diluted net earnings (loss) per share:





Basic net
earnings (loss) per share are computed based on the weighted average number of
Ordinary shares outstanding during each year. Diluted net earnings (loss) per
share is 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 diluted options
excluded from the calculation of diluted earnings (loss) per share was 213,492
for the year ended December 31, 2004.





o.
    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.





p.
    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,
marketable securities, trade receivables and long-term bank
deposits.





The
majority of the Company's and its subsidiaries' cash and cash equivalents and
long-term 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.





The
Company's marketable securities include investments in debentures of
corporations, U.S. government; foreign banks and governments and commercial
debentures. 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.





-F14-









**RADWARE
LTD. AND ITS SUBSIDIARIES**
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 
 **U.S.
dollars in thousands**


**NOTE
      2:-**
    **SIGNIFICANT
      ACCOUNTING POLICIES (Cont.)**





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, 2003 and 2004, 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.





q.
    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, 2002, 2003, and 2004, amounted to
approximately $ 261, $ 434 and $ 774, respectively.





r.
    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 and trade payables 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).





The
carrying amount of the Company's long-term bank deposits is estimated by
discounting the future cash flows using the current interest rates for long-term
bank deposit and future prospected interest rates regarding callable Structured
Note for deposits of similar terms and maturities. The carrying amount of the
long-term bank deposit does not significantly differ from its fair
value.





s.
    Advertising
      expenses:





Advertising
expenses are charged to the statements of operations as incurred.





-F15-


**RADWARE
LTD. AND ITS SUBSIDIARIES**
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 
 **U.S.
dollars in thousands**








**NOTE
      2:-**
    **SIGNIFICANT
      ACCOUNTING POLICIES (Cont.)**





t.
    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." ("SAFS 151").
SFAS 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 151 requires that the allocation of fixed production overhead
costs to the costs of conversion be based on the normal capacity of the
production facilities. SAFS 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 151 will have a material effect on its financial position or
results of operations.





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 (see also Note 2(l)).





**NOTE
      3:-**
    **MARKETABLE
      SECURITIES AND ACCRUED INTEREST**





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,****2003**
    
    **2004****Amortized**
    
    **Unrealized**
    
    **Market**
    
    **Amortized**
    
    **Unrealized**
    
    **Market****cost**
    
    **losses**
    
    **value**
    
    **cost**
    
    **losses**
    
    **value**Available-for-sale:U.S.
      Government debentures
    
    $
    7,563
    
    $
    (10
    )
    $
    7,553
    
    $
    9,004
    
    $
    (20
    )
    $
    8,984Foreign
      banks and government
      debentures
    
    
    8,828
    
    
    (14
    )
    
    8,814
    
    
    2,988
    
    
    (4
    )
    
    2,984Commercial
      debentures
    
    
    2,878
    
    
    (3
    )
    
    2,875
    
    
    —
    
    
    —
    
    
    —Corporate
      debentures
    
    
    16,002
    
    
    (11
    )
    
    15,991
    
    
    9,426
    
    
    (28
    )
    
    9,398Totalavailable-for-sale
      marketable
      securities
    
    $
    35,271
    
    $
    (38
    )
    $
    35,233
    
    $
    21,418
    
    $
    (52
    )
    $
    21,366





Held-to-maturity:U.S.
      Government debentures
    
    $
    -
    
    $
    -
    
    $
    -
    
    $
    31,486
    
    $
    (345
    )
    $
    31,141





The
unrealized losses on available-for-sale debt securities included in other
comprehensive (income) loss, as a separate component of shareholders' equity,
totaled to $ 38 and $ 52 as of December 31, 2003 and 2004,
respectively.





The
unrealized losses on the Company's investments in held-to-maturity securities
and in available-for-sale securities are caused due to 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, 2004.


-F16-


**RADWARE
LTD. AND ITS SUBSIDIARIES**
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 
 **U.S.
dollars in thousands**




**NOTE
      3:-**
    **MARKETABLE
      SECURITIES AND ACCRUED INTEREST (Cont.)**





The
amortized cost and estimated fair value of available-for-sale and
held-to-maturity investments as of December 31, 2003 and 2004, by contractual
maturity, are as follows:





**December
      31,****2003**
    
    **2004****Amortized
      cost**
    
    **Market
      value**
    
    **Amortized
      cost**
    
    **Market
      value**Available-for-sale:Matures
      in one year
    
    $
    31,147
    
    $
    31,111
    
    $
    8,911
    
    $
    8,889Matures
      in one to three years
    
    
    4,124
    
    
    4,122
    
    
    10,331
    
    
    10,25135,271
    
    
    35,233
    
    
    19,242
    
    
    19,140Matures
      in three to five years
    
    
    —
    
    
    —
    
    
    2,176
    
    
    2,226$
    35,271
    
    $
    35,233
    
    $
    21,418
    
    $
    21,366





Held-to-maturity:Matures
      in one year
    
    $
    —
    
    $
    —
    
    $
    5,166
    
    $
    5,158Matures
      in one to three years
    
    
    —
    
    
    —
    
    
    26,320
    
    
    25,983$
    —
    
    $
    —
    
    $
    31,486
    
    $
    31,141








**NOTE
      4:-**
    **INVENTORIES**





**December
      31,****2003**
    
    **2004**Raw
      materials and components
    
    $
    439
    
    $
    414Work-in-progress
    
    
    1,395
    
    
    1,878Finished
      products
    
    
    1,164
    
    
    1,802$
    2,998
    
    $
    4,094





-F17-




**RADWARE
LTD. AND ITS SUBSIDIARIES**


**NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 
 **U.S.
dollars in thousands**






**NOTE5:-**
    **PROPERTY
      AND EQUIPMENT**





**December
      31,****2003**
    
    **2004**Cost:Computer,
      software and peripheral equipment
    
    $
    6,904
    
    $
    8,933Office
      furniture and equipment
    
    
    809
    
    
    998Motor
      vehicles
    
    
    383
    
    
    341Leasehold
      improvements
    
    
    478
    
    
    6368,574
    
    
    10,908Accumulated
      depreciation:Computer,
      software and peripheral equipment
    
    
    4,302
    
    
    5,398Office
      furniture and equipment
    
    
    297
    
    
    484Motor
      vehicles
    
    
    280
    
    
    302Leasehold
      improvements
    
    
    216
    
    
    2725,095
    
    
    6,456Depreciated
      cost
    
    $
    3,479
    
    $
    4,452





Depreciation
expenses for the years ended December 31, 2002, 2003 and 2004 were $ 1,721,
$ 1,475 and $ 1,381, respectively.








**NOTE
      6:-**
    **OTHER
      PAYABLES AND ACCRUED EXPENSES**





**December
      31,****2003**
    
    **2004**Employees
      and payroll accruals
    
    $
    1,438
    
    $
    2,565Accrued
      expenses
    
    
    2,184
    
    
    1,781Provision
      for warranty costs
    
    
    497
    
    
    196Other
    
    
    720
    
    
    420$
    4,839
    
    $
    4,962





-F18-
 
 **RADWARE
LTD. AND ITS SUBSIDIARIES**
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 
 **U.S.
dollars in thousands**


**NOTE
      7:-**
    **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, 2004, are as follows:





2005
    
    $
    1,6822006
    
    
    1,1312007
    
    
    8552008
    
    
    2552009
    
    
    135$
    4,058




Total
rent expenses for the years ended December 31, 2002, 2003 and 2004, were
approximately $ 1,541, $ 1,552 and $ 1,554, respectively (see also Note
12b).





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 complaint alleging violations of the
federal securities laws, in the United States District Court, Southern District
of New York.




The
essence of the complaint 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
complaints also allege 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.





-F19-




**RADWARE
LTD. AND ITS SUBSIDIARIES**


**NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 
 **U.S.
dollars in thousands**




**NOTE
      7:-**
    **COMMITMENTS
      AND CONTINGENT LIABILITIES (Cont.)**





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.





In March
2003, F5 Networks Inc., a competitor of the Company, filed a patent infringement
lawsuit against the Company and two other companies. In 2004 the Company and F5
reached a settlement agreement which did not have a material affect on the
Company.





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
      8:-**
    **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 a 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 6,311,690 Ordinary shares. As of
December 31, 2004, an aggregate of 3,043 Ordinary shares of the Company are
still available for future grant.


F-20


**RADWARE
LTD. AND ITS SUBSIDIARIES**


**NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 
 **U.S.
dollars in thousands**


**NOTE
      8:-**
    **SHAREHOLDERS'
      EQUITY (Cont.)**


The
Company approved an increase of 531,125 Ordinary shares reserved for option
grants under the Plans, equal to 3% of the Company's issued and outstanding
shares. In addition, the Company approved an additional increase of 90,000
Ordinary shares reserved for grant in 2004 for the purpose of option grants to
directors.





A summary
of the Company's options activity and related information is as
follows:




**Year
      ended December 31,****2002**
    
    
    **2003**
    
    
    **2004****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
    
    
    3,468,107
    
    $
    9.74
    
    
    3,664,062
    
    $
    10.03
    
    
    3,951,840
    
    $
    11.12Granted
    
    
    1,029,996
    
    $
    8.98
    
    
    1,099,420
    
    $
    14.05
    
    
    1,112,933
    
    $
    19.10Exercised
    
    
    (488,989
    )
    $
    0.14
    
    
    (593,467
    )
    $
    9.95
    
    
    (669,865
    )
    $
    8.93Forfeited
    
    
    (345,052
    )
    $
    18.00
    
    
    (218,175
    )
    $
    10.80
    
    
    (492,475
    )
    $
    15.62Outstanding
      at the end of year
    
    
    3,664,062
    
    $
    10.03
    
    
    3,951,840
    
    $
    11.12
    
    
    3,902,433
    
    $
    13.21Exercisable
      at the end of year
    
    
    653,524
    
    $
    9.41
    
    
    1,137,657
    
    $
    10.93
    
    
    1,251,679
    
    $
    10.24


The
following table summarizes information about options outstanding and exercisable
as of December 31, 2004:


**Range
      of exercise**
      **price**
    
    
    **Options
      outstanding**
      **as
      of**
      **December
      31, 2004**
    
    
    **Weighted**
      **average**
      **remaining**
      **contractual**
      **life
      (months**)****
    ****
      ****
      ****
      ****
    
    **Weighted
      average**
      **exercise**
      **price**
    
    
    **Options
      exercisable**
      **as
      of**
      **December
      31, 2004**
    
    
    **Weighted
      average exercise price of options exercisable**
  $0.03
    
    
    5,000
    
    
    13.97
    
    $
    0.03
    
    
    —
    
    $
    —$8 -
      $ 11
    
    
    2,099,775
    
    
    27.11
    
    $
    9.29
    
    
    1,024,354
    
    $
    8.97$15
      - $ 18
    
    
    1,370,674
    
    
    42.61
    
    $
    16.34
    
    
    227,325
    
    $
    16.00$20
      - $ 24
    
    
    348,034
    
    
    51.50
    
    $
    21.93
    
    
    —
    
    $
    —$25.3
    
    
    78,950
    
    
    61.97
    
    $
    25.30
    
    
    —
    
    $
    —3,902,433
    
    
    
    
    $
    13.21
    
    
    1,251,679
    
    $
    10.24





All of
the options granted to employees and directors in 2002, 2003 and 2004, have an
exercise price equal to the fair market value of the share at the grant date.
The weighted average fair values of the options granted during 2002, 2003 and
2004 were $ 2.30, $ 10.5 and $ 8.6, respectively.





The
Company has recorded deferred share compensation for options issued with an
exercise price below the fair market value of the Ordinary shares; the deferred
share compensation has been amortized and recorded as compensation expense
ratably over the vesting period of the options. Compensation expense of
approximately $ 285, $ 98 and $ 0 were recognized for the years ended December
31, 2002, 2003 and 2004, respectively.


-F21-




**RADWARE
LTD. AND ITS SUBSIDIARIES**
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 
 **U.S.
dollars in thousands**
 **NOTE
      8:-**
    **SHAREHOLDERS'
      EQUITY (Cont.)**


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 net income withheld, up to certain maximums, to be
used to purchase the Company's Ordinary shares. The Purchase Plans are
implemented with purchases every six-month period. The price of Ordinary share
purchased under the Purchase Plans will be 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 2004,
114,482 shares were issued under the Purchase Plans for an aggregate
consideration of $ 924. As of December 31, 2004, an aggregate of 987,692
Ordinary shares of the Company are available for future grants.





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.







**NOTE
      9:-**
    **TAXES
      ON INCOME**





a.
    Israeli
      income taxes:




1.
    Measurement
      of taxable income:




Under the
Income Tax (Inflationary Adjustments) Law, 1985
("the Israeli 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.





2.
    Tax
      rates:





On
June 29, 2004, the Israeli Government approved the Amendment to the Income
Tax Ordinance (No. 140 and Temporary Provision), 2004, which progressively
reduces the tax rates applicable to companies from 35% in 2004 to a rate of 30%
in 2007.





-F22-







**RADWARE
LTD. AND ITS SUBSIDIARIES**


**NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 
 **U.S.
dollars in thousands**




**NOTE
      9:-**
    **TAXES
      ON INCOME (Cont.)**





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 they 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.





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, 2004, retained earnings included approximately $ 13,600 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 $ 1,400 through $ 3,400 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.





4.
    Tax
      assessments:





In
      2004, the Company received final tax assessments from the Israeli Tax
      Authorities for the tax years 1999 through
2002.


-F23-








**RADWARE
LTD. AND ITS SUBSIDIARIES**


**NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 
 **U.S.
dollars in thousands**








**NOTE
      9:-**
    **TAXES
      ON INCOME (Cont.)**





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 determines, 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.





b.
    Taxes
      on income (tax benefits) are comprised as
follows:





**Year
      ended December 31,****2002**
    
    **2003**
    
    **2004**Current
      taxes
    
    $
    —
    
    $
    —
    
    $
    428Taxes
      in respect of prior years
    
    
    —
    
    
    —
    
    
    803Deferred
      taxes
    
    
    —
    
    
    —
    
    
    (890
    )$
    —
    
    $
    —
    
    $
    341Domestic
    
    $
    —
    
    $
    —
    
    $
    1,576Foreign
    
    
    —
    
    
    —
    
    
    (1,235
    )$
    —
    
    $
    —
    
    $
    341








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,****2003**
    
    **2004**Deferred
      tax assets:Net
      operating loss carryforwards of subsidiaries
    
    $
    2,733
    
    $
    1,500Tax
      benefit related to employee stock option exercises
    
    
    1,317
    
    
    2,156Net
      deferred tax asset before valuation allowance
    
    
    4,050
    
    
    3,656Valuation
      allowance
    
    
    (4,050
    )
    
    (2,766
    )Net
      deferred tax asset
    
    $
    —
    
    $
    890Foreign
    
    $
    —
    
    $
    890


-F24-





**RADWARE
LTD. AND ITS SUBSIDIARIES**


**NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 
 **U.S.
dollars in thousands**





**NOTE
      9:-**
    **TAXES
      ON INCOME (Cont.)**





The
Company's U.S. subsidiary has estimated total available carryforward tax losses
of $ 3,750 to offset against future taxable profit between 2011 and 2023. As of
December 31, 2004, the Company recorded a deferred tax asset of $ 890 relating
to the available net carryforward tax losses. A valuation allowance for deferred
tax assets, related to carryforward losses at the amount of $ 1,525 was recorded
due to the uncertainty of the tax asset's future realization.





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.





d.
    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**Income
      before taxes, as reported in the consolidated statements of
      operation
    
    $
    6,395
    
    $
    14,087Statutory
      tax rate
    
    
    36
    %
    
    35
    %Theoretical
      tax expenses on the above amount at the Israeli statutory tax
      rate
    
    $
    2,302
    
    $
    4,930Decrease
      in taxes resulting from "Approved Enterprise" benefits (1)
    
    
    —
    
    
    (4,762
    )Tax
      adjustment in respect of foreign subsidiary different tax
    rate
    
    
    13
    
    
    52Non-deductible
      expenses
    
    
    632
    
    
    893Deferred
      taxes on losses for which valuation allowance was provided
    
    
    (2,733
    )
    
    (1,470
    )Income
      taxes in respect of prior years
    
    
    —
    
    
    803Other
    
    
    (214
    )
    
    (105
    )Actual
      tax expense
    
    $
    —
    
    $
    341(1) 
      Per share amounts (basic) of the tax benefit
      resulting
      from the exemption
    
    $
    —
    
    $
    0.26Per
      share amounts (diluted) of the tax benefit
      resulting
      from the exemption
    
    $
    —
    
    $
    0.24


In
      2002, the main reconciling items between the statutory tax rate of the
      Company and its subsidiaries (36%) and the effective tax rate (0%) are
      tax-exempt income, carryforward tax losses and other deferred taxes for
      which a full valuation allowance was
provided.


-F25-





**RADWARE
LTD. AND ITS SUBSIDIARIES**


**NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 
 **U.S.
dollars in thousands**


**NOTE
      9:-**
    **TAXES
      ON INCOME (Cont.)**





e.
    Income
      (loss) before taxes on income is comprised as
follows:





**Year
      ended December 31,****2002**
    
    **2003**
    
    **2004**Domestic
    
    $
    675
    
    $
    5,155
    
    $
    12,461Foreign
    
    
    (2,765
    )
    
    1,240
    
    
    1,626Income
      (loss) before taxes on income
    
    $
    (2,090
    )
    $
    6,395
    
    $
    14,087





**NOTE
      10:-**
    **GEOGRAPHIC
      INFOROMATION AND SELECTED STATEMENTS OF OPERATIONS
  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, 2002, 2003
and 2004 and long-lived assets as of December 31, 2003 and 2004:





**Year
      ended December 31****2002**
    
    **2003**
    
    **2004**Revenues
      from sales to unaffiliated customers:America
      (principally the United States)
    
    $
    21,641
    
    $
    26,218
    
    $
    28,984EMEA
      *)
    
    
    11,731
    
    
    14,038
    
    
    20,450Asia
      pacific
    
    
    10,291
    
    
    14,524
    
    
    19,005$
    43,663
    
    $
    54,780
    
    $
    68,439





*)
    Europe,
      Middle East and Africa.





**Year
      ended December 31****2003**
    
    **2004**Long-lived
      assets, by geographic region:America
    
    $
    1,067
    
    $
    1,246EMEA
    
    
    2,162
    
    
    2,900Asia
      pacific
    
    
    250
    
    
    306$
    3,479
    
    $
    4,452




b.
    Major
      customer data as a percentage of total
revenues:





**Year
      ended December 31,****2002**
    
    **2003**
    
    **2004**Customer
      A
    
    
    8
    %
    
    11
    %
    
    11
    %


.


-F26-


**RADWARE
LTD. AND ITS SUBSIDIARIES**


**NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 
 **U.S.
dollars in thousands**




**NOTE
      11:-**
    **SELECTED
      STATEMENTS OF OPERATIONS DATA**





a.
    Financial
      income (expenses):





**Year
      ended December 31,****2002**
    
    **2003**
    
    **2004**Financial
      income:Interest
      on bank deposits
    
    $
    2,274
    
    $
    3,193
    
    $
    3,045Foreign
      currency translation differences, net
    
    
    292
    
    
    352
    
    
    784Amortization
      of premiums, accretion of discounts and accrued interest on marketable
      debt securities, net
    
    
    2,016
    
    
    645
    
    
    8524,582
    
    
    4,190
    
    
    4,681Financial
      expenses:Interest
      and other bank charges
    
    
    (342
    )
    
    (450
    )
    
    (116
    )$
    4,240
    
    $
    3,740
    
    $
    4,565






b.
    Net
      earnings (loss) per share:





The
following table sets forth the calculation of basic and diluted net earnings
(loss) per share:





**Year
      ended December 31,****2002**
    
    **2003**
    
    **2004**Numerator:Net
      income (loss) available to shareholders of Ordinary shares
    
    $
    (2,113
    )
    $
    6,355
    
    $
    13,780Denominator:Denominator
      for basic earnings (loss) per share - weighted average number of Ordinary
      shares, net of treasury stock
    
    
    16,654,784
    
    
    17,184,141
    
    
    17,995,207Effect
      of dilutive securities:Employee
      stock options and ESPP
    
    
    *)
      —
    
    
    1,481,999
    
    
    1,809,689Denominator
      for diluted net earnings (loss) per share - adjusted weighted average
      number of shares
    
    
    16,654,784
    
    
    18,666,140
    
    
    19,804,896





*)  Antidilutive.





-F27-


**RADWARE
LTD. AND ITS SUBSIDIARIES**
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 
 **U.S.
dollars in thousands**




**NOTE
12:-**  **RELATED
PARTIES BALANCES AND TRANSACTIONS**





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,****2003**
    
    **2004**Trade
      receivables
    
    $
    202
    
    $
    1,004Trade
      payables (1)
    
    $
    198
    
    $
    134




b.
    The
      following related party transactions are included in the statements of
      operations:





**Year
      ended December 31,****2002**
    
    **2003**
    
    **2004**Revenues
    
    $
    1,331
    
    $
    1,011
    
    $
    2,400Cost
      of revenues - components (1)
    
    $
    3,374
    
    $
    349
    
    $
    —Operating
      expenses, net - primarily rental, sub-contractors and communications
      (2)
    
    $
    1,460
    
    $
    1,036
    
    $
    1,009Purchase
      of property and equipment
    
    $
    31
    
    $
    47
    
    $
    466





(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.







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