20-F 1 zk1312881.htm 20-F zk1312881.htm


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, 2012
 
OR
 
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from __________ to __________
 
OR
 
o
SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
Date of event requiring this shell company report ____________
 
Commission file number 0-29452
 
RADCOM LTD.
(Exact Name of Registrant as Specified in its Charter)
 
N/A
(Translation of Registrant’s Name into English)
 
Israel
(Jurisdiction of Incorporation or Organization)
 
24 Raoul Wallenberg Street, Tel-Aviv 69719, Israel
(Address of Principal Executive Offices)
 
Gilad Yehudai: (+972) 77-7745-060 (tel), (+972) 3-647-4681 (fax)
24 Raoul Wallenberg Street, Tel Aviv 69719, Israel
(Name, Telephone, E-mail and/or Facsimile Number and Address of Company Contact Person)
 
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
Ordinary Shares, NIS 0.20 par value per share
 
NASDAQ Capital Market
 
Securities registered or to be registered pursuant to Section 12(g) of the Act:    None
 
Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act:  None
 
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:  As of December 31, 2012, there were 6,449,780 Ordinary Shares, NIS 0.20 par value per share, outstanding.
 
 
 

 
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  
 
Yes o No x
 
If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.  
 
Yes o No x
 
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  
 
Yes x No  o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  
 
Yes x No o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.  See definition of "accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange Act.  (Check one):
 
Large Accelerated Filer o    Accelerated Filer o     Non-Accelerated Filer x
 
Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements included in this filing:
 
U.S. GAAP x
 
International Financial Reporting Standards as issued by the International Accounting Standards Board o
 
Other o
 
If "Other" has been checked in response to the previous question, indicate by check mark which financial statement item the registrant elected to follow.
 
Item 17 o
 
Item 18 o

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

 
 
INTRODUCTION
 
Except for the historical information contained herein, the statements contained in this annual report on Form 20-F (this "Annual Report") are forward-looking statements, within the meaning of the Private Securities Litigation Reform Act of 1995, with respect to our business, financial condition and results of operations.  Actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including all the risks discussed in "Item 3.D—Key Information — Risk Factors" and elsewhere in this Annual Report.
 
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 regarding future events and are based on assumptions and are subject to risks and uncertainties.  Except as required by applicable law, including the securities laws of the United States, we do not intend to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.
 
As used in this Annual Report, the terms "we," "us," "our," "RADCOM" and the "Company" mean RADCOM Ltd. and its subsidiaries, unless otherwise indicated.
 
Omni-Q™, GearSet™, and Wirespeed™ are our trademarks.  All other trademarks and trade names appearing in this Annual Report are owned by their respective holders.
 
 
3

 
 
TABLE OF CONTENTS
 
PART I
 
 
6
6
6
  A.  SELECTED FINANCIAL DATA 6
  B.  CAPITALIZATION AND INDEBTEDNESS 8
  C.  REASONS FOR THE OFFER AND USE OF PROCEEDS 8
  D.  RISK FACTORS 8
26 
 
A. HISTORY AND DEVELOPMENT OF THE COMPANY
26
 
B.  BUSINESS OVERVIEW
26
 
C.  ORGANIZATIONAL STRUCTURE
32
 
D.  PROPERTY, PLANTS AND EQUIPMENT
41
41
41
 
A.  OPERATING RESULTS
45
 
B.   LIQUIDITY AND CAPITAL RESOURCES
50
 
C.   RESEARCH AND DEVELOPMENT, PATENTS AND LICENSES
55
 
D.  TREND INFORMATION
55
 
E.   OFF–BALANCE SHEET ARRANGEMENTS
56
 
F.   TABULAR DISCLOSURE OF CONTRACTUAL OBLIGATIONS
56
57
 
A.  DIRECTORS AND SENIOR MANAGEMENT
57
 
B.   COMPENSATION
59
 
C.   BOARD PRACTICES
61
 
D.   EMPLOYEES
65
 
E.   SHARE OWNERSHIP (TO UPDATE BEFORE FILING)
65
67
 
A.  MAJOR SHAREHOLDERS
67
 
B.   RELATED PARTY TRANSACTIONS
68
 
C.   INTERESTS OF EXPERTS AND COUNSEL
69
70
 
A.  CONSOLIDATED STATEMENTS AND OTHER FINANCIAL INFORMATION
70
 
B.   SIGNIFICANT CHANGES
70
70
 
A.  OFFER AND LISTING DETAILS
70
 
B.  PLAN OF DISTRIBUTION
71
 
C.  MARKETS
71
 
D.  SELLING SHAREHOLDERS
71
 
E.   DILUTION
71
 
F.   EXPENSES OF THE ISSUE
72
72
 
A.  SHARE CAPITAL
72
 
B.   MEMORANDUM AND ARTICLES OF ASSOCIATION
72
 
C.   MATERIAL CONTRACTS
79
 
E.   TAXATION
80
 
F.   DIVIDENDS AND PAYING AGENTS
88
 
G.   STATEMENT BY EXPERTS
88
 
H.   DOCUMENTS ON DISPLAY
88
 
I.    SUBSIDIARY INFORMATION
88
88
89
 
 
4

 
 
 
 
5

 
 
PART I

ITEM 1.      IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS
 
Not applicable.

 
ITEM 2.      OFFER STATISTICS AND EXPECTED TIMETABLE
 
Not applicable.
 
ITEM 3.      KEY INFORMATION
 
                    A.       SELECTED FINANCIAL DATA
 
We have derived the following selected consolidated financial data as of December 31, 2012, 2011 and 2010 and for each of the years ended December 31, 2012, 2011 and 2010 from our consolidated financial statements and notes included in this Annual Report.  The selected consolidated financial data as of December 31, 2009 and 2008 and for the years ended December 31, 2009 and 2008 have been derived from previously published audited consolidated financial statements not included in this Annual Report.  We prepare our consolidated financial statements in accordance with U.S. generally accepted accounting principles ("U.S. GAAP").
 
You should read the selected consolidated financial data together with "Item 5—Operating and Financial Review and Prospects" and our consolidated financial statements and related notes included elsewhere in this Annual Report.  All references to "dollar," "dollars" or "$" in this Annual Report are to the "U.S. dollar" or "U.S. dollars."  All references to "NIS" are to the New Israeli Shekels.
 
 
6

 
 
   
Year Ended December 31,
 
   
(in thousands of U.S. dollars – except weighted average number of ordinary shares, and basic and diluted income (loss) per ordinary share)
 
   
2012
   
2011
   
2010
   
2009
   
2008
 
       
Statement of Operations Data:
                             
Revenues:
                             
Products
  $ 12,480     $ 19,199     $ 16,770     $ 9,190     $ 12,480  
Services
    3,306       2,788       2,403       2,728       2,758  
      15,786       21,987       19,173       11,918       15,238  
Cost of revenues:
                                       
Products
    5,765       6,074       6,052       3,469       5,523  
Services
    417       606       434       590       502  
      6,182       6,680       6,486       4,059       6,025  
Gross profit
    9,604       15,307       12,687       7,859       9,213  
Operating expenses:
                                       
Research and development
    6,102       5,866       4,310       4,223       6,506  
Less - royalty-bearing participation
    1,567       1,235       1,424       1,633       2,113  
Research and development, net
    4,535       4,631       2,886       2,590       4,393  
                                         
Sales and marketing
    8,515       9,962       6,971       5,835       7,486  
                                         
General and administrative
    2,107       2,234       1,538       1,643       2,818  
                                         
Total operating expenses
    15,157       16,827       11,395       10,068       14,697  
                                         
Operating (loss) income
    (5,553 )     (1,520 )     1,292       (2,209 )     (5,484 )
                                         
Financing income (expenses), net
    (314 )     (384 )     (722 )     (440 )     (309 )
      (120 )     ---       ---       ---       ---  
                                         
Net (loss) income
    (5,987 )     (1,904 )     570       (2,649 )     (5,793 )
Basic net (loss) income per ordinary share
  $ (0.93 )   $ (0.30 )   $ 0.11     $ (0.52 )   $ (1.16 )
Weighted average number of ordinary shares used to compute basic net income (loss) per ordinary share
    6,442,068       6,367,560       5,373,515       5,081,986       4,995,586  
                                         
Diluted net (loss) income per ordinary share
  $ (0.93 )   $ (0.30 )   $ 0.10     $ (0.52 )   $ (1.16 )
Weighted average number of ordinary shares used to compute diluted net (loss) income per ordinary share
    6,442,068       6,367,560       5,947,310       5,081,986       4,995,586  
                                         
Balance Sheet Data:
                                       
Working capital
  $ 5,194     $ 10,670     $ 11,144     $ 2,972     $ 6,194  
Total assets
  $ 18,997     $ 21,345     $ 21,386     $ 13,440     $ 17,841  
Shareholders’ equity
  $ 4,997     $ 10,392     $ 10,903     $ 2,640     $ 4,985  
Share capital
  $ 251     $ 250     $ 234     $ 177     $ 176  

 
7

 

Exchange Rate Information
 
The following table shows, for each of the months indicated the high and low exchange rates between the NIS and the U.S. dollar, expressed as NIS per U.S. dollar and based upon the daily representative rate of exchange as published by the Bank of Israel:
 
Month
 
High (NIS)
   
Low (NIS)
 
April 2013 (through April 19)
   
3.633
     
3.618
 
March 2013
   
3.733
     
3.637
 
February 2013
   
3.708
     
3.682
 
January 2013
   
3.791
     
3.714
 
December 2012
   
3.835
     
3.726
 
November 2012
   
3.952
     
3.857
 
October 2012
   
3.895
     
3.792
 

On April 19, 2013 the daily representative rate of exchange between the NIS and U.S. dollar as published by the Bank of Israel was NIS 3.629 to $1.00.
 
The following table shows, for each of the periods indicated, the average exchange rate between the NIS and the U.S. dollar, expressed as NIS per U.S. dollar, calculated based on the average of the representative rate of exchange on the last day of each month during the relevant period as published by the Bank of Israel:
 
 Year
 
Average (NIS)
 
2013 (through April 19)
   
3.693
 
2012
   
3.858
 
2011
   
3.582
 
2010
   
3.732
 
2009
   
3.927
 
2008
   
3.568
 
 
The effect of exchange rate fluctuations on our business and operations is discussed in "Item 5.A—Operating and Financial Review and Prospects—Operating Results—Impact of Inflation and Foreign Currency Fluctuations."
 
                    B.       CAPITALIZATION AND INDEBTEDNESS
 
Not applicable.
 
                    C.       REASONS FOR THE OFFER AND USE OF PROCEEDS
 
Not applicable.
 
                    D.       RISK FACTORS
 
   Our business, operating results and financial condition could be seriously harmed due to any of the following risks, among others.  If we do not successfully address the risks to which we are subject, we could experience a material adverse effect on our business, results of operations and financial condition and our share price may decline.  We cannot assure you that we will successfully address any of these risks.
 
 
8

 
 
Risks Related to Our Business and Our Industry
 
We have a history of net losses and may not achieve or sustain profitability in the future.
 
Although in 2010 we generated net income, in the years 2012, 2011 and 2009 we incurred losses of $6 million, $1.9 million and $2.6 million, respectively. We may not be profitable in the future, which could materially affect our cash and liquidity and could adversely affect the value and market price of our shares.
 
The general slowdown in the telecommunications industry, including in the sectors of the industry that we target (primarily 3G and 4G cellular and triple-play networks), materially and adversely affected our revenues and results of operations in 2012.  A continued slowdown would further materially and adversely affect our revenues and results of operations.
 
Our future success is dependent upon the continued growth of the telecommunications industry as well as the specific sectors that we target, which currently include 3G and 4G cellular and triple-play networks. A global slowdown in the telecommunications industry had an adverse impact on our business in the first half of 2012. The global telecommunications industry, as well as the various sectors within the industry, is evolving rapidly, and it is difficult to predict its potential growth rate or future trends in technology development. The deregulation, privatization and economic globalization of the worldwide telecommunications market that have resulted in increased competition and escalating demand for new technologies and services may not continue in a manner favorable to us or our business strategies. In addition, the growth in demand for Internet and data services and the resulting need for high speed or enhanced telecommunications equipment may not continue at its current rate or at all.
 
Our future success depends upon the increased utilization of our monitoring solutions by next-generation network operators and telecommunications equipment vendors. Industry-wide network equipment and infrastructure development driving the demand for our products and services was delayed during 2012 by a variety of factors and may further be delayed or prevented in 2013 by a variety of factors, including costs, regulatory obstacles or the lack of, or reduction in, consumer demand for advanced telecommunications products and services. Telecommunications equipment vendors and network operators may not develop new technology or enhance current technology. Further, any such new technology or enhancements may not lead to greater demand for our products.
 
During 2012, developments in the communications industry, such as the impact of general global economic conditions, industry consolidation, emergence of new competitors, commoditization of voice services and changes in the regulatory environment ,had a material adverse effect on our existing and/or potential customers, and may continue to have such an effect in the future. In the past, these conditions reduced the high growth rates that the communications industry had previously experienced, and caused the market value, financial results, prospects and capital spending levels of many communications companies to decline.  During 2012, the telecommunications industry experienced significant financial pressures that caused many in the industry to cut expenses and limit investment in capital intensive projects, and in some cases, led to restructurings. Although we are unable to determine what the full effects of the recent economic downturn will be, it has led, mainly during the first half of 2012, and may continue to lead to significant adverse consequences for our customers and our business.
 
During adverse conditions in the business environment for telecommunications companies, service providers often need to control operating expenses and capital investment budgets, which can affect our business.  For example, the recent business climate for communication companies resulted in slowed customer buying decisions and price pressures that increased pressure on our ability to generate revenue. During 2012, these adverse market conditions had a negative impact on our business by decreasing new customer engagements, as well as by decreasing the level of discretionary spending under contracts with existing customers. In addition, the slowdown in the buying decisions of service providers has extended our sales cycle period and limited our ability to forecast our flow of new contracts. In addition, weakness in the end-user market could negatively affect the cash flow of our distributors and resellers who could, in turn, delay paying their obligations to us. This increased our credit risk exposure and caused delays in our recognition of revenues on future sales to these customers. During 2012, these events harmed our business, operating results and financial condition. Further deterioration could materially and adversely affect our business, operating results and financial condition.
 
 
9

 

Recent and future economic conditions, including turmoil in the financial and credit markets, may adversely affect our business.
 
The recent economic and credit environment had a significant negative impact on business around the world. The impact of these conditions on the technology industry and our major customers has been quite severe. Conditions may continue to be depressed, or may be subject to further deterioration which could lead to a further reduction in consumer and customer spending overall, which could have an adverse impact on sales of our products. A disruption in the ability of our significant customers to access liquidity could cause serious disruptions or an overall deterioration of their businesses, which could lead to a significant reduction in their orders of our products and the inability or failure on their part, to meet their payment obligations to us, any of which could have a material adverse effect on our results of operations and liquidity.  In addition, any disruption in the ability of customers to access liquidity could lead customers to request longer payment terms from us or long-term financing of their purchases from us.  If we are unable to grant extended payment terms when requested by customers, our sales could decrease.  Granting extended payment terms or a significant adverse change in a customer’s financial and/or credit position, would have an immediate negative effect on our cash balance, and could require us to assume greater credit risk relating to that customer’s receivables, or could limit our ability to collect receivables related to purchases by that customer. As a result, we may have to defer recognition of revenues, our reserves for doubtful accounts and write-offs of accounts receivable may increase and our losses may increase.

Our freedom to operate our business is limited as a result of certain restrictive covenants contained in our credit facility with the First International Bank of Israel, one of which we currently do not comply with.

In September 2012, we secured a short-term line of credit of $1.5 million from the First International Bank of Israel. In order to secure our obligations to the bank, we pledged and granted to the bank a first priority floating charge on all of our assets and a first priority fixed charge on certain other assets (namely, rights for uncalled and/or unpaid share capital, including goodwill rights, and rights for insurance). We refer to the agreement relating to such charges as the Pledge. The Pledge contains a number of customary restrictive terms and covenants that limit our operating flexibility, such as (1) limitations on the creation of additional liens, and on the sale or transfer of certain of our assets, and (2) the ability of the bank to accelerate repayment in certain events, such as breach of covenants, liquidation, or a reduction in Messrs. Zohar Zisapel’s and Yehuda Zisapel’s joint ownership of the Company below 30%. The Pledge's restrictive terms and covenants may hinder our future operations or the manner in which we operate our business, which could have a material adverse effect on our business, financial condition or results of operations. One of the covenants we undertook was that our shareholder's equity, as reflected in our reported financial statements, would not be less than 32% of our total assets as reflected in the applicable balance sheet. As of December 31, 2012, we failed to meet the requirements of this covenant. The bank requested that we rectify the situation, and agreed to provide us with a cure period until July 15, 2013.  We may fail to cure such breach and the bank may demand that we immediately repay the $1.5 million, which will create a substantial burden on our cash balances and harm our ongoing operation.

Our projected cash flows may not be sufficient to meet our obligations.

            If our cash flow does not meet or exceed our current projections, then our ability to pay our obligations could be materially impaired. We believe that our existing capital resources and cash flows from operations will be adequate to satisfy our expected liquidity requirements to meet our operating obligations, as they come due at least through the next twelve months. However, if our actual sales and spending differ materially from our projections, we may be required to raise capital, borrow additional funds or reduce discretionary spending in order to provide the required liquidity.  We cannot assure you that our business will generate sufficient cash flows or that future capital raising or borrowings will be available to us in amounts and on terms sufficient to enable us to fund our liquidity needs. Our ability to continue as a going concern is substantially dependent on the successful execution of our sales and spending projections.
 
 
10

 
 
As noted above, although in 2010 we generated net income, in 2012, 2011 and in the years prior to 2010, we generated significant losses attributable to our operations. We have managed our liquidity during this time through a series of cost reduction initiatives, expansion of our sales into new markets, private placement transactions, a bank credit line, shareholder loans and a venture capital loan. While we believe that our existing capital resources and cash flows from operations will be adequate to satisfy our expected liquidity requirements at least through the next twelve months, there is no assurance that, if required, we will be able to raise additional capital or reduce discretionary spending to provide the required liquidity in order to continue as a going concern.
 
We have a history of quarterly fluctuations and unpredictability in our results of operations and expect these fluctuations to continue. This may cause our share price to fluctuate and/or to decline.
 
In 2012, we experienced, and expect to experience in the future, significant fluctuations in our quarterly results of operations. Factors that may contribute to fluctuations in our quarterly results of operations include:
 
 
·
the variation in size and timing of individual purchases by our customers;
  
·
the absence of long-term customer purchase contracts;
 
·
seasonal factors that may affect capital spending by customers, such as the varying fiscal year-ends of customers and the reduction in business during the summer months, particularly in Europe;
 
·
the relatively long sales cycles for our products;
  
·
the request for longer payment terms from us or long-term financing of customers’ purchases from us, as well as additional conditions tied to such payment terms;
  
·
competitive conditions in our markets;
  
·
the timing of the introduction and market acceptance of new products or product enhancements by us and by our customers, competitors and suppliers;
  
·
changes in the level of operating expenses relative to revenues;
  
·
product quality problems;
  
·
supply interruptions;
  
·
changes in global or regional economic conditions or in the telecommunications industry;
  
·
delays in or cancellation of projects by customers;
  
·
changes in the mix of products sold;
  
·
the size and timing of approval of grants from the Government of Israel; and
  
·
foreign currency exchange rates.
 
Our costs of sales consist of variable costs, which include hardware production, packaging, royalties to the Chief Scientist, license fees paid to third parties and import taxes, and of fixed costs which include facilities’ payments, employees’ salaries and related costs and overhead expenses.  The majority of our costs of sales is relatively fixed, and the costs are determined based on our anticipated revenue. We believe, therefore, that period-to-period comparisons of our operating results may not be a reliable indication of future performance.
 
Our revenues in any period generally have been, and may continue to be, derived from a relatively small number of orders with relatively high average revenues per order. Therefore, the loss of any order or a delay in closing a transaction could have a more significant impact on our quarterly revenues and results of operations, than on those of companies with relatively high volumes of sales or low revenues per order. Our products generally are shipped within 15 to 30 days after orders are received, however revenue recognition is often deferred. Although we had a substantial backlog of orders at the end of 2012, this has not always been the case in the past and there is no assurance that this will continue to be the situation in future quarters.
 
 
11

 
 
We may experience a delay in generating or recognizing revenues for a number of reasons and based on revenue recognition accounting requirements. While we are usually able to ship orders within 15-30 days of a customer’s order, in order to recognize revenue from an order, we often need to pass customer acceptance, which may take on average 6 to12 months. Therefore, a major part of the revenue of a fiscal quarter is derived from the backlog of shipped orders and generally is not tied to the date of a customer’s order or the shipment date.
 
Our revenues for a particular period may also be difficult to predict and may be affected if we experience a non-linear (back-end loaded) sales pattern during the period.  We generally experience significantly higher levels of sales towards the end of a period, as a result of customers submitting their orders late in the period. Such non-linearity in shipments can increase costs, as irregular shipment patterns result in periods of underutilized capacity and periods when overtime expenses may be incurred, and also lead to additional costs associated with inventory planning and management. Furthermore, orders received towards the end of the period may not ship within the period due to our manufacturing lead times. These orders are booked within the quarter, but only recognized as revenue at a later stage.
 
If our revenues in any quarter remain level or decline in comparison to any prior quarter, our financial results could be materially adversely affected.  In addition, if we do not reduce our expenses in a timely manner in response to level or declining revenues, our financial results for that quarter could be materially adversely affected.
 
Since 2010, the relative portion of medium-to-large sized deals started to increase. This trend continued with greater vigor in 2011 and 2012. As a result, payment terms became longer by an average of 2 months, the deployment process became longer and more complex and our right to collect payment more often became subject to certain conditions, extending the time that elapsed between the date of an initial sale and full revenue recognition and collection.
 
Due to the factors described above, as well as other unanticipated factors, in future quarters our results of operations could fail to meet the expectations of public market analysts or investors. If this occurs, the price of our ordinary shares may fall, as was the case in 2012.
 
We expect our gross margins to vary over time and our recent level of gross margins may not be sustainable or improved, which may have a material adverse effect on our future profitability.
 
Our recent level of gross margins may not be sustainable or improved and may be adversely affected by numerous factors, including:
 
 
·
increased price competition;
 
·
local sales taxes which may be incurred for direct sales;
 
·
increased industry consolidation among our customers, which may lead to decreased demand for and downward pricing pressure on our products;
 
·
changes in customer, geographic or product mix;
 
·
our ability to reduce and control production costs;
 
·
increases in material or labor costs;
 
·
excess inventory and inventory holding costs;
 
·
obsolescence charges;
  
·
reductions in cost savings due to changes in component pricing or charges incurred due to inventory holding periods if parts ordering does not correctly anticipate product demand;
 
·
changes in distribution channels;
 
·
losses on customer contracts; and
 
·
increased warranty costs.
 
Further deterioration in gross margins, due to these or other factors, may have a material adverse effect on our results of operations.
 
 
12

 
 
The market for our products is characterized by changing technology, requirements, standards and products, and we may be materially adversely affected if we do not respond promptly and effectively, to such changes.
 
The telecommunications market for our products is characterized by rapidly changing technology, changing customer requirements, evolving industry standards and frequent new product introductions, certain changes of which could reduce the market for our products or require us to develop new products. For example, the LTE (Long Term Evolution) network required us to develop a new product which was launched in 2011, our Omni-Q for LTE networks, in order to keep current with customer requirements.
 
 New or enhanced telecommunications and data communications-related products developed by other companies could be incompatible with our products.  Therefore, our timely access to information concerning, and our ability to anticipate, changes in technology and customer requirements and the emergence of new industry standards, as well as our ability to develop, manufacture and market new and enhanced products successfully and on a timely basis, will be significant factors in our ability to remain competitive. For example, many of our strategic initiatives and investments are aimed at meeting the requirements of application providers of 3G and LTE cellular and triple-play networks. If networking evolves toward greater emphasis on application providers, we believe that we have positioned ourselves well relative to our key competitors. If networking does not evolve toward greater emphasis on application providers, however, our initiatives and investments in this area may be of no or limited value. As a result, we cannot quantify the impact of new product introductions on our future operations.
 
Our sales derived from emerging market countries may be materially adversely affected by economic, regulatory and political developments in those countries.
 
We generate sales from various emerging market countries. As sales from these countries represent a significant portion of our total sales, and as these countries represent a significant portion of our expected growth, economic or political turmoil in these countries could materially adversely affect our sales and results of operations. During 2012, such regulatory limitations delayed our ability to recognize revenue from certain customers. Our investments in emerging market countries may also be subject to risks and uncertainties, including unfavorable taxation treatment, exchange controls, challenges in protecting our intellectual property rights, nationalization, inflation, currency fluctuations, or the absence of, or unexpected changes in, regulation as well as other unforeseeable operational risks.

Our growing international presence exposes us to risks associated with varied and changing political, cultural, legal and economic conditions worldwide.  
 
We are affected by risks associated with conducting business internationally. We maintain development facilities in Israel, and have operations in North America, Europe, Latin America and Asia. We obtain significant revenues from customers in Latin America and Asia and our strategy is to continue to broaden and expand into those markets. Conducting business internationally exposes us to certain risks inherent in doing business in international markets, including:
 
 
·
legal and cultural differences in the conduct of business;
 
·
difficulties in staffing and managing foreign operations;
 
·
longer payment cycles;
 
·
difficulties in collecting accounts receivable and withholding taxes that limit the repatriation of earnings;
 
·
difficulties in complying with varied legal and regulatory requirements across jurisdictions, including additional labor laws, particularly in Brazil;
 
·
political instability;  
 
·
variations in effective income tax rates among countries where we conduct business;
 
·
fluctuations in foreign currency exchange rates; and
 
·
laws and business practices favoring local competitors;
 
One or more of these factors could have a material adverse effect on our international operations, which could harm our results of operations and financial condition.
 
 
13

 
 
Our inventory may become obsolete or unusable.
 
We make advance purchases of various component parts in relatively large quantities to ensure that we have an adequate and readily available supply. Our failure to accurately project our needs for these components and the demand for our products that incorporate them, or changes in our business strategy or technology that reduce our need for these components, could result in these components becoming obsolete prior to their intended use or otherwise unusable in our business. This would result in a write-off of inventories for these components. In addition, a substantial portion of our inventory is located at customers as it has not yet been accepted in accordance with the terms of their orders and therefore, has not yet been recognized as revenue, making the control of such inventory more difficult.
 
 Any reversal or slowdown in deregulation of telecommunications markets could materially harm the markets for our products.
 
Future growth in the markets for our products will depend, in part, on the continued privatization, deregulation and the restructuring of telecommunications markets worldwide, as the demand for our products is generally higher when a competitive environment exists. Any reversal or slowdown in the pace of this privatization, deregulation or restructuring could materially harm the markets for our products.  Moreover, the consequences of deregulation are subject to many uncertainties, including judicial and administrative proceedings that affect the pace at which the changes contemplated by deregulation occur, and other regulatory, economic and political factors.  Furthermore, the uncertainties associated with deregulation have in the past, and could in the future, cause our customers to delay purchasing decisions pending the resolution of these uncertainties.
 
Many of our customers require a lengthy, detailed and comprehensive evaluation process before they order our products. Our sales process has been subject to delays that have significantly decreased our revenues and which could result in the eventual cancellations of some sale opportunities.
 
We derive substantially all of our revenues from the sale of products and related services for telecommunications service providers. The purchase of our products represents a relatively significant capital expenditure for our customers. As a result, our products generally undergo a lengthy evaluation process before we can sell them. In recent years, our customers have been conducting a more stringent and detailed evaluation of our products and decisions are subject to additional levels of internal review. This trend has intensified recently as part of the recent economic environment. As a result, the evaluation process has significantly lengthened. This evaluation process generally takes between 3 to 6 months for small transactions, and between 9 to 18 months for large transactions. The following factors, among others, affect the length of the approval process:
 
 
·
the time involved for our customers to determine and announce their specifications;
 
·
the time required for our customers to process approvals for purchasing decisions;
 
·
the complexity of the products involved;
 
·
the technological priorities and budgets of our customers; and
 
·
the need for our customers to obtain or comply with any required regulatory approvals.
 
If customers continue to delay project approval, delays lengthen further, or such continued delays result in the eventual cancellation of any sale opportunities, it would harm our business and results of operations.
 
Our visibility of a portion of our future sales is limited due to the short lead time of customer orders.
 
As a result of the short lead time for some firm purchase orders that we receive from time to time, which usually do not require customer acceptance, we are unable to accurately forecast future revenues from these product sales. As a result, especially with respect to purchase orders of significant amounts, even dramatic fluctuations in revenue (whether increase or decrease) might not be detected until the very end of a financial quarter, which may not enable us to monitor costs in a timely manner to compensate for such fluctuations. 
 
 
14

 
 
We may undertake further reorganizations, which may adversely impact our operations, and we may not realize all of the anticipated benefits of our prior or any future reorganizations.
 
We continue to reorganize and transform our business to realign resources and achieve desired cost savings in an increasingly competitive market. Although during 2010 and 2011 we increased our work force, during 2009 and 2012 we undertook a series of reorganizations of our operations involving, among other things, the reduction of our workforce. If we continue to reduce our workforce in the future, we may incur additional reorganization and related expenses, which could have a material adverse effect on our business, financial condition or results of operations.
 
We have based our reorganization efforts on certain assumptions regarding the cost structure of our businesses. Our assumptions may or may not be correct, and we may also determine that further reorganizations will be needed in the future. We therefore cannot assure you that we will realize all of the anticipated benefits of the reorganizations or that we will not further reduce or otherwise adjust our workforce or exit, or dispose of, certain businesses. Any decision by management to further limit investment or to exit or dispose of businesses may result in the recording of additional reorganization charges, and might also adversely affect our ability to generate revenues from our business. As a result, the costs actually incurred in connection with the reorganization efforts may be higher than originally planned and may not lead to the anticipated cost savings and/or improved results.
 
In addition, employees, whether or not directly affected by reorganizations, may seek future employment with our business partners, customers or competitors. We cannot assure you that the confidential nature of our proprietary information will not be compromised by any such employees who terminate their employment with us. Further, we believe that our future success will depend in large part upon our ability to attract, incentivize and retain highly skilled personnel. We may have difficulty attracting and retaining such personnel as a result of a perceived risk of future workforce reductions.
 
Our non-competition agreements with our employees may not be enforceable.  If any of these employees leaves us 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 our key and other employees in Israel.  These agreements prohibit those employees, while they work for us and for a specified length of time after they cease to work for us, from directly competing with us or working for our competitors.  Under current U.S. and Israeli law, we may not be able to enforce these non-competition agreements.  If 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.  In addition, we have non-competition agreements with employees outside of Israel, and we cannot guarantee that such agreements are enforceable under applicable law.
 
Our business could be harmed if we were to lose the services of one or more members of our senior management team, or if we are unable to attract and retain qualified personnel.
 
Our future growth and success depends to a significant extent upon the continuing services of our executive officers and other key employees. We do not have long-term employment agreements with any of our employees. Competition for qualified management and other high-level telecommunications industry personnel is intense, and we may not be successful in attracting and retaining qualified personnel. If we lose the services of any key employees, we may not be able to manage our business successfully or to achieve our business objectives.
 
 
15

 
 
Our success also depends on our ability to identify, attract and retain qualified technical, sales, finance and management personnel. We have experienced, and may continue to experience, difficulties in hiring and retaining candidates with appropriate qualifications. If we do not succeed in hiring and retaining candidates with appropriate qualifications, our revenues and product development efforts could be harmed.
 
We may lose significant market share as a result of intense competition in the markets for our existing and future products.
 
Many companies compete with us in the market for network testing and service monitoring solutions.  We expect that competition will increase in the future, both with respect to products that we currently offer and products that we are developing.  Moreover, manufacturers of data communications and telecommunications equipment, which are current and potential customers of ours, may in the future incorporate into their products capabilities similar to ours, which would reduce the demand for our products.  In addition, affiliates of ours that currently provide services to us may, in the future, compete with us.
 
Many of our existing and potential competitors have substantially greater resources, including financial, technological, engineering, manufacturing and marketing and distribution capabilities, and several of them may enjoy greater market recognition than us. We may not be able to compete effectively with our competitors. A failure to do so could adversely affect our revenues and profitability.
 
We are dependent upon the success of distributors who are under no obligation to distribute our products.
 
We are dependent upon our distributors for their active marketing and sales efforts for the distribution of our products. Outside of North America, Brazil, Singapore, India and China, many of our distributors are the only entities engaged in the distribution of our products in their respective geographical areas.  Typically, arrangements with our distributors do not prevent such distributors from distributing competing products, or require them to distribute our products in the future and, therefore, our distributors may not give a high priority to marketing and supporting our products. Additionally, our results of operations could be materially adversely affected by changes in the financial situation, business or marketing strategies of our distributors.  Any such changes could occur suddenly and rapidly.
 
We may lose customers and/or distributors on whom we currently depend and we may not succeed in developing new distribution channels.
 
Our seven largest distributors accounted for approximately 38.51% of our sales in 2012, 43.9% of our sales in 2011 and 41.8% of our sales in 2010. In 2012, no individual distributor accounted for more than 10% of the total respective consolidated revenues. If we terminate or lose any of our distributors or if they downsize significantly, we may not be successful in replacing them on a timely basis, or at all.  Any changes in our distribution and sales channels, particularly the loss of a major distributor or our inability to establish effective distribution and sales channels for new products, will impact our ability to sell our products and result in a loss of revenues.
 
Our large customers have substantial negotiating leverage, which may require that we agree to terms and conditions that may have an adverse effect on our business.
 
Large telecommunications providers have substantial purchasing power and leverage in negotiating contractual arrangements with us. These customers may require us to develop additional features and may impose penalties on us for failure to deliver such features on a timely basis, or failure to meet performance standards. As we seek to sell more products to large service providers, we may be required to agree to these less advantageous terms and conditions, which may decrease our revenues and/or increase the time it takes to convert orders into revenues, resulting in an adverse effect on our results of operations.
 
 
16

 
 
The complexity and scope of the solutions we provide to larger service providers is increasing. Larger projects entail greater operational risk and an increased chance of failure.
 
The complexity and scope of the solutions and services we provide to larger service providers is increasing. The larger and more complex such projects are, the greater the operational risks associated with such projects. These risks include failure to fully integrate our products into the service provider’s network with third party products and complex environments, and our dependence on subcontractors and partners for the successful and timely completion of such projects. Failure to complete a larger project successfully could expose us to potential contractual penalties, claims for breach of contract and in extreme cases, to cancellation of the entire project, or increase the difficulty in collecting payment and recognizing revenues from such project.
 
We could be subject to claims under our warranties and extended maintenance agreements and product recalls, which could be very expensive and harm our financial condition.
 
Products as complex as ours sometimes contain undetected errors.  These errors can cause delays in product introductions or require design modifications.  In addition, we are dependent on other suppliers for key components that are incorporated in our products.  Defects in systems in which our products are deployed, whether resulting from faults in our products or products supplied by others, due to faulty installation or any other cause, may result in customer dissatisfaction, product returns and, potentially, product liability claims being filed against us. Our warranties permit customers to return defective products for repair. The warranty period is mostly for one year but could be extended either in the initial purchase of our product or after the initial warranty period ends (“extended maintenance agreements”). During the past few years, customer returns have not been substantial. Any failure of a system in which our products are deployed (whether or not our products are the cause), any product recall or product liability claims with any associated negative publicity, could result in the loss of, or delay in, market acceptance of our products and harm to our business. In addition, under the warranty and extended maintenance agreements we need to meet certain service levels and if we fail to meet them we may be exposed to penalties.
 
We incorporate open source technology in our products, which may expose us to liability and have a material impact on our product development and sales.
 
Some of our products utilize open source technologies. These technologies are licensed to us on varying license structures. These licenses pose a potential risk to products in the event they are inappropriately integrated. In the event that we have not, or do not in the future, properly integrate software that is subject to such licenses into our products, we may be required to disclose our own source code to the public, which could enable our competitors to eliminate any technological advantage that our products may have over theirs. Any such requirement to disclose our source code or other confidential information related to our products could, therefore, materially adversely affect our competitive advantage and impact our business results of operations and financial condition.
 
We depend on limited sources for key components and if we are unable to obtain these components when needed, we will experience delays in manufacturing our products.
 
We currently obtain key components for our products from either a single supplier or a limited number of suppliers.  We do not have long-term supply contracts with any of our existing suppliers.  This presents the following risks:
 
 
·
Delays in delivery or shortages in components could interrupt and delay manufacturing and result in cancellations of orders for our products.
  
·
Suppliers could increase component prices significantly and with immediate effect.
 
·
We may not be able to locate alternative sources for product components.
  
·
Suppliers could discontinue the manufacture or supply of components used in our products.  This may require us to modify our products, which may cause delays in product shipments, increased manufacturing costs and increased product prices.
 
·
We may be required to hold more inventory than would be immediately required in order to avoid problems from shortages or discontinuance.
 
We have experienced delays and shortages in the supply of components on more than one occasion in the past. This resulted in delays in our delivering products to our customers.
 
 
17

 
 
We depend on a limited number of independent manufacturers, which reduces our ability to control our manufacturing process.
 
We rely on a limited number of independent manufacturers, some of which are small, privately held companies, to provide certain assembly services to our specifications. We do not have any long-term supply agreements with any third-party manufacturers. If our access to such assembly services is reduced or interrupted, our business, financial condition and results of operations could be adversely affected until we are able to establish sufficient assembly services from alternative sources. Alternative manufacturing sources may not be able to meet our future requirements, and existing or alternative sources may not continue to be available to us at favorable prices.

New regulations related to conflict minerals may force us to incur additional expenses and may damage our relationship with certain customers.

The Dodd-Frank Wall Street Reform and Consumer Protection Act contains provisions to improve transparency and accountability concerning the supply of certain minerals and derivatives referred to as “conflict minerals” which may originate from the conflict zones of the Democratic Republic of Congo (DRC) and adjoining countries. As a result, in August 2012 the SEC established new annual disclosure and reporting requirements for those companies who use “conflict” minerals in their products, whether or not the products are manufactured by third parties. These new requirements will require due diligence efforts for the 2013 calendar year, with initial disclosure requirements beginning in May 2014. We are currently examining whether we will be subject to these new disclosure requirements, as the types of minerals covered by these rules are present in electronic devices, and consequently we believe we may be subject to these new disclosure requirements.

If we are subject to these new requirements, we will incur additional costs associated with complying with the disclosure requirements, such as costs related to determining the source of any conflict minerals used in our products. As these new requirements are implemented, they could affect the pricing, sourcing and availability of minerals used in the manufacture of components in our devices, and in turn could affect the costs and availability of such components. Our supply chain is complex and we may be unable to verify the origins for all metals used in our products. We may also encounter challenges with our customers and stakeholders if we are unable to certify that our products are conflict free.
 
Our proprietary technology is difficult to protect, and unauthorized use of our proprietary technology by third parties may impair our ability to compete effectively.
 
Our success and ability to compete depend in large part upon protecting our proprietary technology.  We rely upon a combination of contractual rights, software licenses, trade secrets, copyrights, nondisclosure agreements and technical measures to establish and protect our intellectual property rights in our products and technologies.  In addition, we sometimes enter into non-competition, non-disclosure and confidentiality agreements with our employees, distributors, sales representatives and manufacturers’ representatives and certain suppliers with access to sensitive information.  However, we have no registered patents, and these measures may not be adequate to protect our technology from third-party infringement.  Additionally, effective trademark, patent and trade secret protection may not be available in every country in which we offer, or intend to offer, our products.
 
 
18

 
 
We may expand our business or enhance our technology through acquisitions that could result in diversion of resources and extra expenses. This could disrupt our business and adversely affect our financial condition.
 
Part of our growth strategy is to selectively pursue partnerships and acquisitions that provide us access to complementary technologies and accelerate our penetration into new markets. The negotiation of acquisitions, investments or joint ventures, as well as the integration of acquired or jointly developed businesses or technologies, could divert our management’s time and resources. Acquired businesses, technologies or joint ventures may not be successfully integrated with our products and operations. We may not realize the intended benefits of any acquisition, investment or joint venture and we may incur future losses from any acquisition, investment or joint venture.
 
 In addition, acquisitions could result in, among other things:
 
 
·
substantial cash expenditures;
  
·
potentially dilutive issuances of equity securities;
  
·
the incurrence of debt and contingent liabilities;
 
·
a decrease in our profit margins; and
 
·
amortization of intangibles and potential impairment of goodwill.
 
If we implement our growth strategy by acquiring other businesses, and this disrupts our operations, our business may suffer.
 
Because we received grants from the Israeli Office of the Chief Scientist, we are subject to ongoing restrictions.
 
We received royalty-bearing grants from the Office of the Chief Scientist of the Israeli Ministry of Industry, Trade and Labor (the "Chief Scientist"), for research and development programs that meet specified criteria. In addition to our obligation to pay to the Chief Scientist royalties on revenues from products developed pursuant such programs or deriving therefrom (and related services), our ability to transfer such resulting know-how, especially outside of Israel, is limited, regardless of whether the royalties were fully paid. Any non-Israeli citizen, resident or entity that, among other things, (i) becomes a holder of 5% or more of our share capital or voting rights, (ii) is entitled to appoint one or more of our directors or our chief executive officer, or (iii) serves as one of our directors or as our chief executive officer (including holders of 25% or more of the voting power, equity or the right to nominate directors in such direct holder, if applicable), is required to notify the Chief Scientist of the same and to undertake to the Chief Scientist to observe the law governing the grant programs of the Chief Scientist, the principal restrictions of which are the transferability limits described above.  For more information, see "Item 4.B—Information on the Company—Business Overview—Israeli Office of the Chief Scientist."
 
We may be subject to litigation and other claims, including, without limitation, infringement claims or claims that we have violated intellectual property rights, which could seriously harm our business.
 
Third parties may from time to time assert against us infringement claims or claims that we have violated a patent or infringed a copyright, trademark or other proprietary right belonging to them.  If such infringement were found to exist, we might be required to modify our products or intellectual property or to obtain a license or right to use such technology or intellectual property.  Any infringement claim, even if not meritorious, could result in the expenditure of significant financial and managerial resources.
 
Additionally, in May 2010, we received a notice from the Chief Scientist regarding alleged miscalculations in the amount of royalties paid by us to the Chief Scientist for the years 1992 through 2009 and the basis revenues of which the Company has to pay royalties. We believe that all royalties due to the Chief Scientist from the sale of products developed with funding provided by the Chief Scientist during such years were properly paid or were otherwise accrued as of December 31, 2012. During 2011 we reviewed with the Chief Scientist these alleged miscalculation differences and now await further instructions. Currently we are unable to assess the merits of the aforesaid arguments raised by the Chief Scientist. If such royalties were not properly paid or otherwise accrued, any such differences could result in the expenditure of significant financial resources.
 
 
19

 
 
Yehuda Zisapel and Zohar Zisapel beneficially own, in aggregate, approximately 41% of our ordinary shares and, therefore, have significant influence over the outcome of matters requiring shareholder approval, including the election of directors.
 
As of April 19, 2013, Yehuda Zisapel and Zohar Zisapel (the Chairman of our Board of Directors), who are brothers, may be deemed to beneficially own an aggregate of 2,748,213 ordinary shares, including options and warrants exercisable for 178,986 ordinary shares that are exercisable within 60 days of April 19, 2013, representing approximately 41% of our outstanding ordinary shares.  As a result, despite the fact that each one of them, to our knowledge, operates independently from the other with respect to his respective shareholding of our shares, Yehuda Zisapel and Zohar Zisapel have significant influence over the outcome of various actions that require shareholder approval, including the election of our directors.  In addition, Yehuda Zisapel and Zohar Zisapel may be able to delay or prevent a transaction in which shareholders might receive a premium over the prevailing market price for their shares and prevent changes in control or in management.
 
We engage in transactions, and may compete with, companies controlled by Yehuda Zisapel and Zohar Zisapel, which may result in potential conflicts.
 
We are engaged in, and expect to continue to be engaged in, numerous transactions with companies controlled by Yehuda Zisapel and Zohar Zisapel.  We believe that such transactions are beneficial to us and are generally conducted upon terms that are no less favorable to us than would be available from unaffiliated third parties. Nevertheless, these transactions may result in a conflict of interest between what is best for us and the interests of the other parties in such transactions. In addition, several products of such affiliated companies may be used in place of our products, and it is possible that direct competition between us and one or more of such affiliated companies may develop in the future.  Moreover, opportunities to develop, manufacture, or sell new products (or otherwise enter new fields) may arise in the future and may be pursued by one or more affiliated companies instead of with us. This could materially adversely affect our business and results of operations.
 
If we fail to adapt appropriately to the challenges associated with operating internationally, the expected growth of our business may be impeded and our operating results may be affected.
 
While we are headquartered in Israel, approximately 91% of our sales in 2012, 98% of our sales in 2011 and 95% of our sales in 2010 were generated outside of Israel, including in North America, Europe, Asia, South America and Australia. Our international sales will be limited if we cannot establish and maintain relationships with international distributors, set up additional foreign operations, expand international sales channel management, hire additional personnel, develop relationships with international service providers and operate adequate after-sales support internationally.
 
Even if we are able to successfully expand our international operations, we may not be able to maintain or increase international market demand for our products. Our international operations are subject to a number of risks, including:
 
·
challenges in staffing and managing foreign operations due to the limited number of qualified candidates, employment laws and business practices in foreign countries, any of which could increase the cost and reduce the efficiency of operating in foreign countries;
·
our inability to comply with import/export, environmental and other trade compliance and other regulations of the countries in which we do business, together with unexpected changes in such regulations;
·
insufficient measures to ensure that we design, implement and maintain adequate controls over our financial processes and reporting in the future;
·
our failure to adhere to laws, regulations and contractual obligations relating to customer contracts in various countries;
·
our inability to maintain a competitive list of distributors for indirect sales;
·
tariffs and other trade barriers;
·
economic instability in foreign markets;
·
wars, acts of terrorism and political unrest;
·
language and cultural barriers;
·
lack of integration of foreign operations;
·
currency fluctuations;
·
potential foreign and domestic tax consequences;
·
technology standards that differ from those on which our products are based, which could require expensive redesign and retention of personnel familiar with those standards;
·
longer accounts receivable payment cycles and possible difficulties in collecting payments, which may increase our operating costs and hurt our financial performance; and
·
failure to meet certification requirements.
 
Any of these factors could harm our international operations and negatively affect our business, results of operations and financial condition. The continuing weakness in these economies or other foreign economies could have a significant negative effect on our future operating results.
 
 
20

 
 
Because most of our revenues are generated in U.S. dollars but a significant portion of our expenses are incurred in New Israeli Shekels, our results of operations may be seriously harmed by currency fluctuations and inflation.
 
Although we sell in markets throughout the world, most of our revenues are generated in U.S. dollars, and the majority of our cost of revenues is incurred in transactions denominated in dollars. Accordingly, we consider the U.S. dollar to be our functional currency. However, a significant portion of our expenses is in NIS, mainly related to employee expenses. Therefore, fluctuations in exchange rates between the NIS and the U.S. dollar may have an adverse effect on our results of operations and financial condition. As of today we have not entered into any hedging transactions in order to mitigate these risks. We may also be exposed to this risk to the extent that the rate of inflation in Israel exceeds the rate of potential devaluation of the NIS in relation to the dollar or if the timing of such devaluation lags behind inflation in Israel. In either event, the dollar cost of our operations in Israel will increase and our dollar-measured results of operations will be adversely affected.
 
Moreover, as our revenues are currently denominated primarily in U.S. dollars, devaluation in the local currencies of our customers relative to the U.S. dollar could cause customers to default on payment. An increasing portion of our revenues is now denominated in Brazilian Real, and in the future additional revenues may be denominated in currencies other than U.S. dollars, thereby exposing us to gains and losses on non-U.S. currency transactions.
 
Any inability to comply with Section 404 of the Sarbanes-Oxley Act of 2002 regarding having effective internal control procedures may negatively impact the report on our financial statements to be provided by our independent auditors.
 
We are subject to the reporting requirements of the United States Securities and Exchange Commission (the "SEC").  The SEC, as directed by Section 404 ("Section 404") of the Sarbanes-Oxley Act of 2002 (the "Sarbanes-Oxley Act"), adopted rules requiring public companies to include a report of management on the company’s internal control over financial reporting in its annual report on Form 10-K or Form 20-F, as the case may be, that contains an assessment by management of the effectiveness of the company’s internal control over financial reporting.  In addition, if the public float of our shares were to exceed $75 million, the Company’s independent registered public accountants would be required to attest to and report on the effectiveness of the Company’s internal control over financial reporting.  Our management may not conclude that our internal controls over financial reporting are effective. Any of these possible outcomes could result in a loss of investor confidence in the reliability of our financial statements, which could negatively impact the market price of our shares. Further, we may identify material weaknesses or significant deficiencies in our assessments of our internal controls over financial reporting.  Failure to maintain effective internal controls over financial reporting could result in investigation or sanctions by regulatory authorities and could have a material adverse effect on our operating results, investor confidence in our reported financial information and the market price of our ordinary shares.
 
 
21

 

If we determine that we are not in compliance with Section 404, we may be required to implement new internal controls procedures and re-evaluate our financial reporting. We may experience higher than anticipated operating expenses as well as third party advisors fees during the implementation of these changes and thereafter. Further, we may need to hire additional qualified personnel in order for us to be compliant with Section 404. If we are unable to implement these changes effectively or efficiently, it could harm our operations, financial reporting or financial results and could result in our conclusion that our internal controls over financial reporting are not effective.
 
If we are characterized as a passive foreign investment company, our U.S. shareholders may suffer adverse tax consequences.
 
As more fully described below in "Item 10.E—Additional Information—Taxation—United States Federal Income Tax Considerations—Taxation of U.S. Holders of Ordinary Shares—Passive Foreign Investment Company Status," if for any taxable year, after taking into account certain look-through rules, 75% or more of our gross income is passive income, or at least 50% of the fair market value of our assets, averaged quarterly over our taxable year, that produce (or are held for the production of) passive income, we may be characterized as a passive foreign investment company ("PFIC") for U.S. federal income tax purposes.  The market capitalization approach has generally been used to determine the fair market value of the assets of a publicly traded corporation, although the U.S. Internal Revenue Service and the courts have accepted other valuation methods in certain valuation contexts.  If we are classified as a PFIC, our U.S. shareholders could suffer adverse United States tax consequences, including gain on the disposition of our ordinary shares being treated as ordinary income and any resulting U.S. federal income tax being increased by an interest charge.  Rules similar to those applicable to dispositions generally will apply to certain "excess distributions" in respect of our ordinary shares.  For our 2012 taxable year, we believe that we should not be classified as a PFIC.  However, there are no assurances that the IRS will agree with our conclusion or that we will not become a PFIC in 2013 or subsequent taxable years.  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.

The market price of our ordinary shares has and may continue to fluctuate widely, which has adversely affected and could adversely affect us and our shareholders.
 
From January 1, 2012 to April 19, 2013, our ordinary shares have traded on the NASDAQ Capital Market ("NASDAQ") as high as $5.72 and as low as 2.08 per share. As of April 19, 2013, the closing price of our ordinary shares on NASDAQ was $3.06 per share.  The market price of our ordinary shares has been and is likely to continue to be highly volatile and could be subject to wide fluctuations in response to numerous factors, including the following:
 
 
·
our results of operations;
 
·
market conditions or trends in our industry and the economy as a whole;
  
·
political, economic and other developments in the State of Israel and worldwide;
  
·
actual or anticipated variations in our quarterly operating results or those of our competitors;
  
·
announcements by us or our competitors of technological innovations or new and enhanced products;
  
·
changes in the market valuations of our competitors;
  
·
introductions of new products or new pricing policies by us or our competitors;
  
·
trends in the communications or software industries, including industry consolidation;
  
·
acquisitions or strategic alliances by us or others in our industry;
  
·
changes in estimates of our performance or recommendations by financial analysts;
  
·
changes in our shareholder base; and
  
·
additions or departures of key personnel.
 
 
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In addition, the stock market in general, and the market for Israeli and technology companies in particular, has been highly volatile.  Many of these factors are beyond our control and may materially adversely affect the market price of our ordinary shares, regardless of our performance.  Shareholders may not be able to resell their ordinary shares following periods of volatility because of the market’s adverse reaction to such volatility, and we may not be able to raise capital through an offering of securities, which would adversely affect our financial condition and our ability to maintain or expand our operations.
 
From time to time we may need to raise financing, and specifically in year 2013, the Company may consider raising additional funds.  If adequate funds are not available on terms favorable to us or to our shareholders, our operations and growth strategy will be materially adversely affected.

From time to time we may be required to raise financing in connection with our operations and growth strategy. We do not know whether additional financing will be available when needed, or whether it will be available on terms favorable to us. This may prove even more challenging due to the recent global economic downturn. If adequate funds are not available on terms favorable to us or to our shareholders, our operations and growth strategy will be materially adversely affected.
 
We may not satisfy NASDAQ’s requirements for continued listing.  If we cannot satisfy these requirements, NASDAQ could delist our ordinary shares.
 
Our ordinary shares are listed on NASDAQ under the symbol "RDCM". To continue to be listed on NASDAQ, we need to satisfy a number of conditions, including a minimum of $2.5 million in shareholders’ equity and a minimum bid price of at least $1.00 per share. On November 9, 2009, we received a NASDAQ Staff deficiency letter informing us that, as of September 30, 2009, our shareholders’ equity was $63,000 below the NASDAQ minimum requirement for continued listing. On November 17, 2009, Mr. Zohar Zisapel, our Chairman of the Board and largest shareholder, exercised warrants to purchase 20,313 ordinary shares at an exercise price of $3.20 per share for an aggregate purchase price of $65,000. Following Mr. Zisapel’s warrant exercise, our shareholders’ equity was above the $2.5 million minimum requirement. NASDAQ Staff informed us that it will continue to monitor our ongoing compliance with the minimum shareholders’ equity requirement.  Our shareholders’ equity as of December 31, 2012 was $5 million, and we believe that, as of the date of this Annual Report, our shareholders’ equity remains above the $2.5 million minimum requirement for continued listing.
 
In addition, beginning on November 17, 2008 our share price decreased below the $1.00 minimum bid price per share. However, due to the extraordinary market conditions, NASDAQ implemented a temporary suspension on the enforcement of the minimum $1.00 bid price listing requirement for continued listing until July 20, 2009. Our share price continued to be below the $1.00 minimum bid price per share until September 9, 2009.  Since September 9, 2009, and as of the date of this Annual Report, our share price has continued to be above the minimum $1.00 bid price. As of April 19, 2013, the closing price of our ordinary shares on NASDAQ was $3.06 per share.
 
We cannot assure you that we will be able to maintain compliance with the minimum shareholders’ equity requirement or the minimum bid requirement, or that we will be able to continue to meet the other continued listing requirements of NASDAQ in the future.  If we fail to comply with any of the continued listing requirements, we could be delisted from NASDAQ.  If we are delisted from the NASDAQ, trading in our ordinary shares may be conducted, if available, on the Over the Counter Bulletin Board Service or another medium. In the event of such delisting, an investor would likely find it significantly more difficult to dispose of, or to obtain accurate quotations as to the value of our ordinary shares, and our ability to raise future capital through the sale of our ordinary shares could be severely limited. In addition, in the event of such delisting, we may be required to comply with reporting obligations under the Israeli securities laws, in addition to the reporting obligations under the SEC rules, which  could distract our management and employees and increase our expenses.
 
 
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The trading volume of our shares has been low in the past and may be low in the future, resulting in lower than expected market prices for our shares.
 
Our shares have been traded at low volumes in the past and may be traded at low volumes in the future for reasons related or unrelated to our performance. This low trading volume may result in lesser liquidity and lower than expected market prices for our ordinary shares, and our shareholders may not be able to resell their shares for more than they paid for them.

Risks Related to Our Location in Israel
 
Conditions in Israel affect our operations and may limit our ability to produce and sell our products.
 
We are incorporated under Israeli law and our principal offices and manufacturing and research and development facilities are located in Israel. Accordingly, our operations and financial results could be adversely affected if political, economic and military events curtailed or interrupted trade between Israel and its present trading partners or if major hostilities involving Israel should occur in the Middle East.

Since the establishment of the State of Israel in 1948, a number of armed conflicts have taken place between Israel and its Arab neighbors. A state of hostility, varying in degree and intensity, has led to security and economic problems for Israel.  Since October 2000, there has been a high level of violence between the Palestinians and Israelis, which has strained Israel’s relationship with its Arab citizens, Arab countries and, to some extent, other countries around the world. In addition, Iran has threatened to attack Israel and is widely believed to be developing nuclear weapons. In 2011 and 2012, riots and popular uprisings in several countries in the Middle East have led to severe political instability in those countries. This instability may lead to deterioration of the political and trade relationships that exist between Israel and some of these countries.  In addition, this instability may affect the global economy and marketplace. We do not believe that the political and security situation has had a material impact on our business to date; however, there can be no assurance that this will be the case for future operations. 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, a significant downturn in the economic or financial condition of Israel or a significant increase in the rate of inflation. 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.

 Our results of operations may be negatively affected by the obligation of our personnel to perform military service.
 
All male adult citizens and permanent residents of Israel under the age of 51 are, unless exempt, obligated to perform military reserve duty annually.  Additionally, these residents are subject to being called to active duty at any time under emergency circumstances.  Some of our officers and employees are currently obligated to perform military reserve duty from time to time.  In the event of a military conflict, including the ongoing conflict with the Palestinians, these persons could be required to serve in the military for extended periods of time and on very short notice. The absence of a number of our officers and employees for significant periods could disrupt our operations and harm our business.  Given these requirements, we believe that we have operated relatively efficiently since beginning our operations. However, we cannot assess what the full impact of these requirements on our workforce or business would be if the situation with the Palestinians or any other adversaries changes, and we cannot predict the effect on our business operations of any expansion or reduction of these military reserve requirements.
 
We currently benefit from government programs that may be discontinued or reduced.
 
We currently receive grants under Government of Israel programs.  As of December 31, 2012, our contingent liability to the Chief Scientist in respect of research grants received was approximately $33.5 million.  In order to maintain our eligibility for these programs, we must continue to meet specific conditions and pay royalties with respect to grants received.  In addition, some of these programs restrict our ability to manufacture particular products outside of Israel or to transfer particular technology.  If we fail to comply with these conditions in the future, the benefits received could be canceled and we could be required to refund any payments previously received under these programs. These programs may be discontinued or curtailed in the future.  If we do not receive these grants in the future, we will have to allocate funds to product development at the expense of other operational costs.  If the Government of Israel discontinues or curtails these programs, our business, financial condition and results of operations could be materially adversely affected.  For more information, see "Item 4.B—Information on the Company—Business Overview—Israeli Office of the Chief Scientist."
 
 
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Provisions of Israeli law may delay, prevent or make difficult a merger or acquisition of us, which could prevent a change of control and depress the market price of our shares.
 
The Israeli Companies Law, 5759-1999 (the "Israeli Companies Law") generally requires that a merger be approved by a company’s board of directors and by a majority of the shares voting on the proposed merger.  Unless a court rules otherwise, a statutory merger will not be deemed approved if shares representing a majority of the voting power present at the shareholders meeting, and which are not held by the potential merger partner (or by any person who holds 25% or more of the shares of capital stock or the right to appoint 25% or more of the directors of the potential merger partner or its general manager), vote against the merger.  Upon the request of any creditor of a party to the proposed merger, a court may delay or prevent the merger if it concludes that there is a reasonable concern that, as a result of the merger, the surviving company will be unable to satisfy its obligations.  In addition, a merger may generally not be completed unless at least (i) 50 days have passed since the filing of the merger proposal with the Israeli Registrar of Companies by each of the merging companies, and (ii) 30 days have passed since the merger was approved by the shareholders of each of the parties to the merger.

Also, in certain circumstances 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 25% or greater or 45% or greater shareholder of the company (unless there is already a 25% or greater or a 45% or greater shareholder of the company, respectively). If, as a result of an acquisition, the acquirer would hold more than 90% of a company’s shares, the acquisition must be made by means of a tender offer for all of the shares.
 
Finally, Israeli tax law treats some acquisitions, such as stock-for-stock exchanges between an Israeli company and a foreign company, less favorably than do U.S. tax laws.  For example, Israeli tax law may, under certain circumstances, subject a shareholder who exchanges his ordinary shares for shares in another corporation to taxation prior to the sale of the shares received in such a stock-for-stock swap.
 
These provisions of Israeli corporate and tax law, and the uncertainties surrounding such law, may have the effect of delaying, preventing or making more difficult a merger with us or an acquisition of us.  This could prevent a change of control over us and depress our ordinary shares’ market price which otherwise might rise as a result of such a change of control.
 
It may be difficult to (i) effect service of process, (ii) assert U.S. securities laws claims and (iii) enforce U.S. judgments in Israel against directors, officers and auditors named in this Annual Report.
 
We are incorporated in Israel.   None of our executive officers or directors named in this Annual Report is a resident of the United States. A substantial portion of our assets and the assets of such persons are located outside of the United States.  Therefore, it may be difficult to enforce a judgment obtained in the United States against us or any of those persons or to effect service of process upon those persons.  It may also be difficult to enforce civil liabilities under U.S. federal securities laws in original actions instituted in Israel.
 
 
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ITEM 4.             INFORMATION ON THE COMPANY
 
                A.       HISTORY AND DEVELOPMENT OF THE COMPANY
 
Both our legal and commercial name is RADCOM Ltd., and we are an Israeli company.  RADCOM Ltd. was incorporated in 1985 under the laws of the State of Israel, and we commenced operations in 1991.  The principal legislation under which we operate is the Israeli Companies Law. Our principal executive offices are located at 24 Raoul Wallenberg Street, Tel Aviv 69719, Israel, and our telephone and fax numbers are 972-3-645-5055 and 972-3-647-4681, respectively.  Our website is www.radcom.com.  Information on our website and other information that can be accessed through it are not part of, or incorporated by reference into, this Annual Report.
 
In 1993, we established a wholly-owned subsidiary in the United States, RADCOM Equipment, Inc. ("RADCOM Equipment"), a New Jersey corporation, which serves as our agent for sales and service of our products in North America. RADCOM Equipment is located at 6 Forest Avenue, Paramus, New Jersey 07652, and its telephone number is (201) 518-0033.  In 1996, we incorporated a wholly-owned subsidiary in Israel, RADCOM Investments (96) Ltd. ("RADCOM Investments"), an Israeli company, located at our office in Tel Aviv, Israel; its telephone number is the same as ours (972-3-645-5055).  In 2001, we established a wholly-owned subsidiary in the United Kingdom, RADCOM (UK) Ltd., a United Kingdom corporation.  This company was dissolved on December 2, 2008.  In 2010, we established a wholly-owned subsidiary in Brazil, RADCOM do Brasil Comercio, Importacao E Exportacao Ltda., ("RADCOM Brazil"). RADCOM Brazil is located at 46 Rua Calcada Antares, Alphaville, Santana de Parnaiba, Sao Paulo,  and its telephone number is 55(11) 41537430.  In 2012, we incorporated a wholly-owned subsidiary in India, RADCOM Trading India Private Limited. ("RADCOM India"), an Indian company, located at Level 4, Rectangle 1,  Commercial Complex D-4,  Saket, New Delhi – 110017, and it’s telephone number is+91-11-4051-4079.
 
For a discussion of our capital expenditures, see "Item 5—Operating and Financial Review and Prospects."
 
                B.        BUSINESS OVERVIEW
 
Below are the definitions of certain technical terms that are used throughout this Annual Report that are important for understanding our business.
 
   
GLOSSARY
 
3G
 
3.5G
 
Third-generation digital cellular networks.
 
3.5 generation digital cellular networks.
 
4G
 
Fourth-generation digital cellular networks.
 
BSS
 
 
Business Support System. the components that a telephone operator uses to run its business operations that relate to the customer/subscriber usage; handles taking orders, processing bills, and collecting payments.
 
CDMA  
 
Code Division Multiple Access.  A digital wireless technology that uses a modulation technique in which many channels are independently coded for transmission over a single wideband channel.
 
CODEC
 
CODer/DECoder. Converts and compresses voice signals from their analog form to digital signals acceptable to modern digital PBXs and digital transmission systems. It then converts and decompresses those digital signals back to analog signals so that they can be heard and understood.
 
 
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CDMA2000 1X  (EV-DO)
 
A third-generation digital high-speed wireless technology for packet-based transmission of text, digitized voice, video, and multimedia that is the successor to CDMA.
 
CEM
 
GSM
 
Customer Experience Management.  A solution to support the strategy that focuses the operations and processes of a business around the needs of the individual customer. 
 
Global System for Mobile Communications. A digital wireless technology that is widely deployed in Europe and, increasingly, in other parts of the world.
 
GPRS
 
 
General Packet Radio Service.  A packet-based digital intermediate speed wireless technology based on GSM (2.5 generation)
     
IMS  
 
IP Multimedia Subsystem. An internationally recognized standard defining a generic architecture for offering Voice over IP and multimedia services to multiple-access technologies.
 
IPTV
 
 
 
Internet Protocol TV. Transmitting video in IP packets. Also called "TV over IP," IPTV uses streaming video techniques to deliver scheduled TV programs or video on demand (VOD).
 
LTE
 
 
 
 
 
NAS
 
 
 
Long Term Evolution. LTE is a set of enhancements to the Universal Mobile Telecommunications System (UMTS) which was introduced in 3rd Generation Partnership Project (3GPP) Release 8.  Much of 3GPP Release 8 focuses on adopting 4G mobile communications technology, including an all-IP flat networking architecture.
 
Network-Attached Storage.  File-level computer data storage connected to a computer network providing data access to heterogeneous network clients. NAS systems contain one or more hard disks, often arranged into logical, redundant storage containers or RAID arrays (redundant arrays of inexpensive/independent disks).
 
NGN 
 
Next Generation Network. General term for packet-based networks, whether wireline (Voice Over IP, Video Over IP, etc.) or 3G networks.
 
OSS
 
 
 
 
Operational Support System. A suite of programs that enables the enterprise to monitor, analyze and manage a network system. Used in general to mean a system that supports an organization’s network operations.
 
Protocol
 
A specific set of rules, procedures or conventions governing the format, means and timing of transmissions between two devices.
 
Session
 
A lasting connection between a user (or user agent) and a peer, typically a server, usually involving the exchange of many packets between the user’s computer and the server. A session is typically implemented as a layer in a network protocol.
 
RAN
 
Radio Access Network.  A part of a mobile telecommunication system. It implements a radio access technology. Conceptually, it sits between the mobile phone, and the core network.
 
 
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SBC
 
Single Board Computer.  A complete computer built on a single circuit board. The design is centered on a single or dual microprocessor with RAM, I/O and all other features needed to be a functional computer on the one board. The term "Single Board Computer" now generally applies to an architecture where the Single Board Computer is plugged into a backplane to provide for I/O cards.  SBCs are most commonly used in industrial situations in rack mount format for process control or embedded within other devices to provide control and interfacing.
 
SIGTRAN
 
 
The name, derived from signaling transport, of a defunct Internet Engineering Task Force (IETF) working group that produced specifications for a family of protocols that provide reliable datagram service and user layer adaptations for Signaling System 7 (SS7) and ISDN communications protocols. The SIGTRAN protocols are an extension of the SS7 protocol family and are used today together with IMS.
 
SIP
 
Session Initiation Protocol. A simple application layer signaling protocol for VoIP implementations. It is a textual client server based protocol and provides the necessary mechanisms so that end user systems and proxy servers can provide various different services.
 
TCP
 
Transmission Control Protocol is defined in IETF RFC793. TCP provides a reliable stream delivery and virtual connection service to applications through the use of sequenced acknowledgment with retransmission of packets when necessary. It is one of the core protocols of the Internet Protocol Suite. TCP is one of the two original components of the suite (the other being Internet Protocol, or IP), so the entire suite is commonly referred to as TCP/IP. Whereas IP handles lower-level transmissions from computer to computer as a message makes its way across the Internet, TCP operates at a higher level, concerned only with the two end systems, for example a Web browser and a Web server.
 
TD-SCDMA
 
Time Division Synchronous Code Division Multiple Access. A 3G mobile telecommunications standard, being pursued in the People’s Republic of China by the Chinese Academy of Telecommunications Technology (CATT).
 
Triple Play
 
A marketing term for the provisioning of the three services: high-speed Internet, television (Video on Demand or regular broadcasts) and telephone service over a single broadband connection.
 
UMTS
 
 
Universal Mobile Telecommunications Service. A third-generation digital high-speed wireless technology for packet-based transmission of text, digitized voice, video, and multimedia that is the successor to GSM.
 
VoIP
 
Voice Over IP. A telephone service that uses the Internet as a global telephone network.
 
WAP
 
Wireless Application Protocol.  Aims to provide Internet content and advanced telephony services to digital mobile phones, pagers and other wireless terminals. The protocol family works across different wireless network environments and makes web pages visible on low-resolution and low-bandwidth devices. WAP phones are "smart phones" allowing their users to respond to e-mail, access computer databases and to empower the phone to interact with Internet-based content and e-mail.
 
 
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Overview
 
We provide innovative service assurance and customer experience monitoring solutions for communications service providers and equipment vendors. We specialize in solutions for next-generation networks, both wireless and wireline. Our comprehensive, carrier strength solutions are used to prevent service provider revenue leakage and enable management of customer quality of experience. Our products facilitate network and service performance analysis, troubleshooting calls and sessions and pre-mediation with an OSS/BSS.
 
We believe that we can be differentiated from our competitors in three main areas: (1) the advanced technology that underlies our solutions, especially the multi-technology correlation capabilities of our Omni-Q solution and our R70S probe, each described below; and (2) our proven ability to be flexible and responsive in an environment of rapidly changing technology and customer requirements, evolving industry standards and frequent new product introductions; and (3) our determination to become an industry leader for next generation technologies.
 
During 2012 we continued a trend from 2010 of an increase in the relative portion of medium-to-large sized deals, reflecting our success in creating business relations with more Tier-I and Tier-II operators.
 
We currently offer the following solutions:
 
Service Assurance: Our Omni-Q is a unique, next-generation network service assurance solution. Going beyond traditional monitoring solutions, the Omni-Q offers users a full array of drilldown and troubleshooting tools, delivering a comprehensive, integrated network service view that facilitates performance monitoring, fault detection and network and service troubleshooting.
 
Our Omni-Q is a monitoring solution for multiple services such as voice, video and data, employing a comprehensive array of service and network performance and measurement methodologies to continuously analyze service performance and quality. With its enhanced correlation capabilities, the Omni-Q offers the service provider full end-to-end visibility of the network across technologies. The Omni-Q solution displays performance and quality measurements from both the signaling and the user planes, based on a broad range of active and non-intrusive hardware and software probes.
 
Our unique service assurance solution presents a seamless integration between traditional network monitoring and troubleshooting solutions, and an advanced set of service assurance monitoring applications. This set of powerful and intuitive applications added to our proven Omni-Q service assurance solution provides solutions for every aspect of the network. This scalable solution for service assurance supports a wide range of applications: network troubleshooting, network quality monitoring, service quality monitoring, customer experience management, customer quality of service monitoring and customer service level agreements monitoring.
 
The Omni-Q system consists of a powerful and user-friendly central management module and a broad range of intrusive and non-intrusive probes used to gather transmission quality data from various types of networks and services, including VoIP, UMTS, LTE, CDMA, IPTV, IMS data and others. Signaling and media attributes and quality measurement enhanced detail records ("eDRs") collected from the probes in the QManager (the central site-management software) are stored in the solution’s embedded database. These can then be used by either the QExpert (the Web-based analysis and reporting module) or the Dashboard (the Web-based user interface) to perform service performance analysis, drilldown and troubleshooting on key performance indicators ("KPIs") and key quality indicators ("KQIs").
 
Network analyzers: Our legacy network protocol analyzer product lines offer cellular, VoIP and data communications operators with standalone solutions for network testing, troubleshooting and analysis. Our network analyzers support over 700 protocols with multiple interfaces, allowing users to quickly and simply troubleshoot and analyze complex networks.
 
 
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Industry Background
 
Service providers deploy unified, packet-based platforms with broadband 3G and 4G technologies to enhance the value proposition of converged networks. These technologies allow service providers to offer new types of revenue-enhancing services, such as voice calls, video calls and mobile broadband, video streaming, music downloading and messaging solutions. Mainstream deployment of converged networks has begun and equipment vendors are under pressure to develop and improve the required technologies. Both types of our main market players (both equipment vendors and service providers) need sophisticated monitoring solutions.
 
Service providers need these solutions to reduce the time-to-market of new services while assuring the highest quality of experience to their customers. In today's market it is no longer enough to maintain the network performance and handle infrastructure faults, but it is essential to understand the real customer experience for the new services, to assure customer adoption of new services and avoid customer churn.  For these reasons, the demand for next-generation probe-based service assurance and monitoring systems is growing.
 
Our Customers and the Markets for Our Solutions
 
The key benefits of our solutions to markets and customers are described below:

For Service Providers:
 
 
·
improved quality, availability and network utilization and lower churn rates;
  
·
improved efficiency of human resources allocation due to the utilization of a unified monitoring solution, ensuring ease of use and reduced learning curves; and
 
·
decreased support costs through centralized management, ability to offer premium service level agreements ("SLAs") and level of experience ("LOE") results based on measurable parameters and all-inclusive, probe-based solutions.
 
For Developers: Reduced time-to-market, reduced development costs, automated testing and application versatility from research and development ("R&D") to quality assurance ("QA") through final testing and field service.
 
The market for our products consists primarily of the following types of end-users:
 
Telecommunications Service Providers (wireless and wireline) are organizations responsible for providing telecommunications services.  Our products are used by this group of end-users for three main categories: engineering and operation, marketing and management and customer support.
 
Labs of Telecommunication Service Providers.  This group of customers includes companies that buy specific equipment and networks from manufacturers, and provide services to their customers.  Our products may be used by these customers to evaluate the quality and performance of the equipment and networks and verify the conformance and interoperability between vendors.
 
Data Communications and Telecommunications Equipment Developers and Manufacturers.  This group of customers includes companies that develop, manufacture and market data communications and telecommunications equipment.
 
 
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Our Strategy
 
Our objective is to continue expanding our sales by offering tailored solutions to service providers in targeted geographical regions, by continuing to pursue our goal of establishing RADCOM as an industry leader, and by extending our partnering and channeling activities. Key elements of our strategy include:
 
·
In emerging regions, targeting UMTS and VoIP operators.  In many regions of Latin America, Eastern Europe, Africa and Asia, service providers continue to roll out UMTS and VoIP networks.  We believe this represents a significant opportunity for RADCOM. In 2012, approximately 52% of our sales were derived from these regions, compared to approximately 69% of our sales in 2011, and we expect these regions to continue to make significant contributions to our revenues in the future. To improve our ability to reach and support customers in emerging markets, we continue to expand our distributor network and to provide comprehensive support and also formed a new subsidiary in Brazil in 2010 and a new subsidiary in India in 2012.
 
·
In developed regions, targeting service providers migrating to LTE and IMS. In Europe and North America, we have begun to benefit from the migration of top-tier service providers to LTE and IMS activities and deployments, despite the fact that this market has been developing more slowly than initially expected. We are seeing the growing deployment of hybrid IMS/NGN networks, whose greater complexity dictates a need for more sophisticated monitoring solutions. We believe that our ability to secure initial customers with deployments of our solution in live LTE and IMS operational networks positions us to benefit from this trend in the future.
 
·
Investment in the RADCOM brand “Radically Better” approach and technological excellence of our solutions. In September 2012, we initiated a re-branding process both internally and towards third parties, including our customers and suppliers. The brand is known as the “Radically Better” brand. The philosophy behind this new brand is that the Company aims to be the best company for its subscribers, customers, distributors, employees and investors in the service assurance market segment. The brand also encompasses the view that RADCOM’s uniqueness is in delivering superior service assurance products to the market, and supporting them with the finest deployment and service execution. The brand’s marketing message is one of promising to be significantly better in the Company’s values: Radically better products, radically better service, radically better people, radically better performance. RADCOM’s products have always been differentiated by their advanced technology and their ability to offer comprehensive solutions in response to the industry’s most difficult problems. We intend to continue a high level of investment to maintain our technological edge in a dynamic environment. This includes hiring of skilled personnel and investing significant resources in training, retention and motivation of high quality personnel. Training programs cover areas such as technology, applications, development methodology and programming standards.
 
Products and Solutions
 
We categorize our products into two primary lines:  (i) the Omni-Q network monitoring solution and (ii) the Performer family.
 
The Omni-Q Network Monitoring Solution
 
The Omni-Q is a unique, comprehensive, next-generation probe-based service assurance solution, designed to enable telecommunications carriers to carry out end-to-end voice and data quality monitoring and to manage their networks and services.
 
The Omni-Q solution consists of a powerful and user-friendly central management server and a broad range of intrusive and non-intrusive probes, covering various networks and services, including IMS, VoIP, UMTS, CDMA, LTE and data. These probes are based on our R70S probe, enabling the Omni-Q to deliver full visibility at the session and application level (and not only at the single packet or message level), with full 7-layer analysis.
 
The Omni-Q is designed to enable service providers and vendors to succeed in their efforts to address significant technology challenges, including:

 
·
deployment of next-generation networks such as LTE,  high-speed downlink packet access and Triple Play;
 
·
integration of new architectures such as high-speed downlink packet access ("HSDPA"), high-speed uplink packet access ("HSUPA"), LTE, IMS, UMTS Release 6 and CDMA Rev’ A or evolution data voice ("EVDV");
 
·
migration of the network core to IP technology using IMS or SIGTRAN;
 
·
successful delivery of advanced, complex services such as VoIP, IPTV and video conferencing; and
 
·
proactive management of call quality on existing and next-generation service providers’ production networks, along with maintenance of high-availability, high-quality voice services over packet telephony.
 
 
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In general, telecommunications service providers (wireless and wireline) use Omni-Q for the following tasks:

Service Assurance:

 
·
Troubleshooting – the Omni-Q enables service providers to "drill down" to identify the source of specific problems, using tools ranging from call or session tracing to a full decoding of the call flow.
 
·
Performance monitoring – service providers use Omni-Q to analyze the behavior of network components and customer network usage to understand trends, performance level and optimization, with the goal of identifying faults before they compromise the end-user experience
 
·
Fault detection – service providers use Omni-Q’s automatic fault detection and service KPIs to alert them to network problems as they arise.
 
·
Pre-Mediation – Omni-Q generates CDRs needed to feed third-party OSSs or other solutions.
 
Roaming and Interconnect Analysis:

The Omni-Q can be used by service providers to monitor their roaming and interconnect traffic. By identifying problematic links, service providers are able to avoid revenue loss, to detect problems with specific roaming partners and to manage interconnection KPIs.

Customer Experience Management:

Customer Experience Management (CEM) gives insight into customer experience for mobile broadband and smartphones. Revenue-generating services require a well-managed network and mature service-delivery processes. Customers have high expectations of their communications services. Service providers need to know what customers are experiencing, even before the customers do, in order to retain their subscribers and maintain their profitability.

Omni-Q provides the visibility and invaluable data that the service provider needs in order to manage both network and service performance and to ensure quality of service for subscribers. Omni-Q monitors a wide range of measurement sessions that are meaningful to the end user, to provide this CEM. By analyzing these measurements in real time and applying business intelligence, Omni-Q provides realistic insight not only into the end user quality of experience but also into the corresponding quality of the service provider’s TCP/IP network.
 
The CEM solution includes:

 
·
Customer Care Application, or QiCare, helps service providers to reduce churn by monitoring and maintaining a high level of satisfaction for the individual subscriber, group of subscribers and entire subscriber base. QiCare enables service providers to view subscriber reports for individual subscribers and helps them to understand the subscribers behavior and the quality of the different services being used online.
 
 
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·
(QVIP) – Reports SLA for defined subscriber groups. In today's saturated telecom markets, subscribers often abandon their service provider due to frustration over quality of service, with customer churn contributing to significant loss of revenue.  RADCOM's QVIP application helps service providers to monitor and maintain a high level of satisfaction for the individual subscriber, a group of subscribers and an entire network.

 
·
(QMyHandset) enables identification of problematic handsets, and provides analysis of the cause of the problem. By identifying problematic handsets, operators can quickly make the required adjustments to their network to provide support for more handset models, thus improving the customer experience and hopefully preventing customer churn.
 
The Performer Family
 
The Performer family is an open platform that supports a wide range of test applications over a variety of technologies. We believe it is unique in the industry for its combination of strong hardware performance and flexible user-oriented software. With simplified control from a central console, the Performer hardware and software suite tests the quality and grade of service of real-world network environments.

The Network Consultant is an advanced cellular network analysis application that enables mobile operators to quickly verify subscriber connectivity and proactively monitor end-to-end network performance.  It gathers and processes data from multiple server links from the Radio Access Network, Core signaling, and Core IP.  It enables full drill-down analysis capabilities of the call session, voice calls and video calls. Using the Network Consultant, customers can zoom in and view the signaling and procedures on each interface separately, whether from an online or offline vantage point. Both RANalysis and eDiamond are different tools within the Cellular Performer applications family, each being deployed for different purposes.

The eDiamond is a new LTE smart analyzer providing a troubleshooting solution for LTE.  Our eDiamond is a tool to use for LTE integration, beginning from a protocol analyzer for an entry level LTE lab and up until troubleshooting LTE network deployments. Our eDiamond LTE smart analyzer provides an end-to-end view of network performance and correlates information detected in the different interfaces in one display, as well as drilling down to root cause analysis. Its wide range of features provides both online and offline working modes, end-to-end access, core interfaces troubleshooting and service level overviews.

The RANalysis is a solution that changes the way deep UMTS radio analysis is done, resulting in fast and easy RAN analysis in UMTS networks. With the number of services, mobile devices, and customers using wireless networks expected to grow every year, radio-optimization engineers need a long-term solution that can provide a quick and easy view of problems in wireless cells. RANalysis is an easy-to-use application that offers engineers rich functionality and focused reports. Based on a vast amount of detailed radio measurements, RANalysis supports the RAN optimization process, reduces the huge expenses involved in drive-testing and helps shorten radio troubleshooting turnaround time.
 
The following table shows the breakdown of our consolidated sales for the fiscal years 2012, 2011 and 2010 by product line:
 
   
Year ended December 31,
 
   
2012
   
2011
   
2010
 
   
(in thousands of U.S. dollars)
 
The Omni-Q family
  $ 15,205     $ 20,949     $ 17,489  
The Performer family and others
  $ 581     $ 1,038     $ 1,684  
Total
  $ 15,786     $ 21,987     $ 19,173  
 
 
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Sales and Marketing Organization
 
We sell to customers throughout the world via both direct and indirect channels.
 
Indirect channels: In several markets we sell our products through a network of independent distributors who market data communications-related hardware and software products. We currently have more than 30 independent distributors, some of whom have exclusive rights to sell our products in their respective geographical areas.  We have regional sales support offices in China, Singapore and Spain.  These offices support our distributors and direct sales in these regions. We continue to search for new distributors to penetrate new geographical markets or to better serve our target markets.
 
Our distributors serve as an integral part of our marketing and service network around the world. They are in charge of selling, deploying and servicing the system. In addition they offer technical support in the end-user’s native language, attend to customer needs during local business hours, organize user programs and seminars and, in some cases, translate our manuals and product and marketing literature into the local language.  We have a substantially standard contract with our distributors.  Based on this agreement, sales to distributors are generally final, and distributors have no right of return or price protection. The distributors do not need to disclose to us their customers’ names, prices or date of order. To the best of our knowledge, a distributor places an order with us after it receives an order from its end-user, and does not hold our inventory for sale. Usually, we are not a party to the agreements between distributors and their customers. Distributors may hold products for a demo or as repair parts in order to keep their service agreement with a customer. According to our agreement with the distributors, a distributor generally should buy at least one demo unit in order to present the equipment to its customers. This is a final sale, and there are no rights of return. The distributor cannot sell this demo equipment to the end-user; the license is only for the distributor. We do not consider this a benefit to the distributors, since we sell only the demo systems with a special software discount.
 
We focus a significant amount of our sales and marketing resources on our distributors, providing them with ongoing communications and support, and our employees regularly visit distributors’ sites. We organize annual distributors’ meetings to further our relationships with our distributors and familiarize them with our products. In addition, in conjunction with our distributors, we participate in the exhibitions of our products worldwide, place advertisements in local publications, encourage exposure in the form of editorials in communications journals and prepare direct mailings of flyers and advertisements.
 
Direct channels: In North America we operate through our wholly-owned U.S. subsidiary, RADCOM Equipment, which primarily sells our products to end-users directly or, in certain instances, through independent representatives. Although our Omni-Q network monitoring solution is also sold on a non-exclusive basis by sales representatives, for the most part it is sold directly by RADCOM Equipment. The independent representatives are compensated by us on a commission basis.  The activities of our representatives and our other sales and marketing efforts in North America are coordinated by RADCOM Equipment’s employees, who also provide product support to our North American customers.  The independent representatives do not hold any of our inventory, and they do not buy products from us. Our representatives locate customers, provide a demo if needed (in which case they use our demo equipment), and in some cases provide training to the end-users.  The customers submit orders directly to RADCOM Equipment, which invoices the end-user customers and collects payment directly, and then pays commissions to the representatives for the sales in their territories.  The commission ranges between 5% and 17%, depending on the agreement RADCOM Equipment has with the individual representative.
 
In 2010, we established a wholly owned Brazilian subsidiary, RADCOM Brazil, which primarily sells our products to end-users in the Brazilian market directly. Our products may also be sold to the end-users directly by RADCOM LTD or through independent representatives in a manner similar to the one deployed in North America. RADCOM Brazil’s employees engage primarily in the sales, marketing and customer support activities of our customers in Brazil.
 
 
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In 2012, we established a wholly owned Indian subsidiary, RADCOM India, which primarily provides marketing services and customer support in the Indian market. Our products are sold to the end-users directly by RADCOM LTD. RADCOM India’s employees engage primarily in marketing activities and customer support of our customers in India.

Since 2008, we have been increasing our sales through a direct channel, whereby our customers (the end-users) can enter into an agreement directly with us. In these situations, we sell directly to customers and collect payment directly from them. If a distributor is engaged in the sale, we pay the distributor a commission, which is normally calculated as a percentage of the sale price. During 2012, this direct channel was used in certain markets, mainly in North America, South America, Central America and Asia. In North America and Brazil this activity was performed by our wholly owned subsidiaries. We expect its use to continue to grow in future years, as direct agreements are increasingly required by our customers.
 
Geographic Markets: The table below indicates the approximate breakdown of our revenue by territory:
 
      Year ended December 31,
(in millions of U.S. dollars)
      Year ended December 31,
(in percentages)
 
      2012       2011        2010        2012        2011        2010   
Europe    
3.0
     
6.4
     
4.8
     
  19.0
     
   29.1
           25.0  
North America
    3.9       3.2       3.0       24.7       14.5       15.6  
Asia
    2.8       4.3       3.6       17.7       19.6       18.8  
South America (Excluding Brazil)
    2.8       2.3       2.1       17.7       10.5       10.9  
Brazil
    1.9       5.2       4.1       12.0       23.6       21.3  
Others
    1.4       0.6       1.6       8.9       2.7       8.4  
Total revenues
    15.8       22.0       19.2       100 %     100.0 %     100.0 %

Competition
 
The markets for our products are very competitive and we expect that competition will increase in the future, both with respect to products that we are currently offering and products that we are developing. Our principal competitors include JDSU (Agilent), Danaher (Tektronix), Tekelec, Astelia, Anritsu (Nettest), Commprove, Netscout, Osix, Exfo and Empirix. In addition to these competitors, we expect substantial competition from established and emerging communications, network management and test equipment companies. Many of these competitors have substantially greater resources than we have, including financial, technological, engineering, manufacturing, marketing and distribution capabilities, and some of them may enjoy greater market recognition than we do.
 
We believe that our competitive edge derives primarily from the advanced technology which underlies our probe-based solutions, and from our ongoing efforts to achieve superior customer satisfaction. Differentiated by the integration of high-performance active and non-intrusive probes with a relatively small footprint, our solution provides cost-effective, unified monitoring and analysis of high-capacity converged networks.
 
Customer Service and Support
 
We believe that providing a high level of customer service and support to end-users is essential to our success, and we have established a strategic goal of establishing RADCOM as an industry leader in customer satisfaction.  Investments that we are making to achieve this goal include:
 
 
·
Enhancement of support: We are dedicated to the provision of timely, effective and professional support for all our customers. On-call support is provided by our direct sales/support force as well as by our representatives, distributors and OEM partners. In addition, we routinely contact our customers to solicit feedback and promote full usage of our solutions. We provide all customers with a free one-year warranty, which includes bug-fixing solutions and a hardware warranty on our products.  After the initial warranty period, we offer extended warranties which can be purchased for one, two or three-year periods. Generally the cost of the extended warranty is based on a percentage of the overall cost of the product as an annual maintenance fee.
 
 
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·
Customer-oriented product development: with the goal of continuously enhancing our customer relationships, we meet regularly with customers, and use the feedback from these discussions to improve our products and guide our R&D roadmap.
 
 
·
Regional technical support: As selling a system and solutions requires a high level of technical skill, we decided to enhance our support with local experts located in our regional offices. For example, in our Brazil office we established a local support team responsible for first level engagements with customers, which is advantageous in terms of the time zone, culture and language.
 
Support of our representatives and distributors: we provide a high level of pre- and post-sale technical support to our distributors and representatives in the field. We use a broad range of channels to deliver this support, including help desks, websites, newsletters, technical briefs, E-Learning systems, technical seminars, and others.
 
Seasonality of Our Business
 
In addition to general market and economic conditions, such as overall industry consolidation, the pace of adoption of new technologies, and the general state of the economy, our orders are affected by our customers’ capital spending plans and patterns. Our orders, and to a lesser degree revenues, are typically highest in our fourth fiscal quarter when our customers have historically increased their spending to fully utilize their annual capital budgets. Consequently, our first quarter orders are usually lower compared to the last quarter of the previous year, and often are the lowest of the year.
 
Manufacturing and Suppliers
 
Our manufacturing facilities, which are located in Tel Aviv, Israel, consist primarily of final assembly, testing and quality control.  Electronic components and subassemblies are prepared by subcontractors according to our designs and specifications.  Certain components used in our products are presently available from, or supplied by, only one source and others are only available from limited sources.  In addition, some of the software packages that we include in our product line are being developed by unaffiliated subcontractors. The prices of the supplies we purchase from our vendors are relatively steady and not volatile. The manufacturing processes and procedures are generally ISO 9001:  2000 and ISO 14000 certified.
 
Research and Development
 
The industry in which we compete is subject to rapid technological developments, evolving industry standards, changes in customer requirements, and new product introductions and enhancements.  As a result, our success, in part, depends upon our ability, on a cost-effective and timely basis, to continue to enhance our existing products and to develop and introduce new products that improve performance and reduce total cost of ownership.  In order to achieve these objectives, we work closely with current and potential end-users, distributors and manufacturers' representatives and leaders in certain data communications and telecommunications industry segments, to identify market needs and define appropriate product specifications.  We intend to continue developing products that meet key industry standards and to support important protocol standards as they emerge.  Still, there can be no assurances that we will be able to successfully develop products to address new customer requirements and technological changes, or that such products will achieve market acceptance.
 
Our gross research and development costs were approximately $6.1 million in 2012, $5.9 million in 2011 and $4.3 million in 2010, representing 38.7%, 26.7% and 22.5% of our sales, respectively.  Aggregate research and development expenses funded by the Office of the Chief Scientist were approximately $1.6 million in 2012, $1.2 million in 2011 and $1.4 million in 2010. For more information on the Chief Scientist, see "Israeli Office of the Chief Scientist" below. We expect to continue to invest significant resources in research and development.
 
 
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As of December 31, 2012, our research and development staff consisted of 53 employees, a decrease of 3 employees compared to December 31, 2011.  Research and development activities take place at our facilities in Tel Aviv.  We occasionally use independent subcontractors for portions of our development projects.
 
Israeli Office of the Chief Scientist
 
From time to time we file applications for grants under programs of the Office of the Chief Scientist of the Israeli Ministry of Industry, Trade and Labor (the "Chief Scientist"). Grants received under such programs are repaid through a mandatory royalty based on revenues from products developed pursuant to such programs or deriving therefrom (and related services).  This government support is contingent upon our ability to comply with certain applicable requirements and conditions specified in the Chief Scientist’s programs, with the provisions of the Law for the Encouragement of Research and Development in Industry, 1984  and the regulations promulgated thereunder (the "R&D Law").
 
Under the R&D Law, research and development programs that meet the specified criteria and are approved by the Research Committee of the Chief Scientist (the "Research Committee") are usually eligible for grants of up to 50% of certain approved expenditures of such programs, as determined by the Research Committee.
 
In exchange, the recipient of such grants is required to pay the Chief Scientist royalties from the revenues derived from products developed pursuant such programs or deriving therefrom  (including ancillary services in connection with such products), usually up to an aggregate of 100% of the dollar-linked value of the total grants received in respect of such program, plus interest.  As of December 31, 2012, our royalty rate was 3.5%.
 
The R&D Law generally requires that the product developed under a program be manufactured in Israel.  However, following notification to the Chief Scientist (provided that the Research Committee did not  provide its objection), up to 10% of the manufacturing volume may be performed outside of Israel; furthermore, with the approval of the Chief Scientist, a greater portion of the manufacturing volume may be performed outside of Israel, in both cases provided that the grant recipient pays royalties at an increased rate, which may be substantial, and the aggregate repayment amount is increased, which increase might be up to 300% of the grant, depending on the portion of the total manufacturing volume that is performed outside of Israel.  The R&D Law further permits the Chief Scientist to approve the transfer of manufacturing rights outside of Israel in exchange for an import of different manufacturing into Israel as a substitute, in lieu of the increased royalties. The R&D Law also allows as part of its approval of the program 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 is a significant factor in the determination of the Chief Scientist as to whether to approve a program and the amount and other terms of benefits to be granted.   An increased royalty rate and repayment amount will be required in such cases.
 
The R&D Law also provides that know-how developed under an approved research and development program may not be transferred to another person or entity without the approval of the Research Committee.  Such approval is not required for the sale or export of any products resulting from such research or development. The Research Committee, under special circumstances, may approve the transfer of Chief Scientist-funded know-how outside of Israel, in the following cases: (a) if the grant recipient pays to the Chief Scientist a portion of the sale price paid in consideration of such funded know-how or in consideration for the sale of the grant recipient itself, as the case may be, which portion will not exceed six times the amount of the grants received by the grant recipient plus interest (or three times the amount of the grants received plus interest, in the event that the recipient of the know-how has committed to retain the R&D activities of the grant recipient in Israel after the transfer); (b) if the grant recipient receives know-how from a third party in exchange for its funded know-how; (c) if such transfer of funded know-how arises in connection with certain types of cooperation in research and development activities; or  (d) if such transfer of know-how arises in connection with a liquidation by reason of insolvency or receivership of the grant recipient.
 
 
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The R&D Law imposes reporting requirements with respect to certain changes in the ownership of a grant recipient.  The R&D Law requires the grant recipient and its controlling shareholders and foreign interested parties to notify the Chief Scientist of any change in control of the recipient or a change in the holdings of the means of control of the recipient that results in a non-Israeli becoming an interested party directly in the recipient, and requires the new interested party to undertake to the Chief Scientist to comply with the R&D Law.  In addition, the Chief Scientist may require additional information or representations in respect of certain of such events.  For this purpose, "control" is defined as the ability to direct the activities of a company other than any ability arising solely from serving as an officer or director of the company.  A person is presumed to have control if such person holds 50% or more of the means of control of a company.  "Means of control" refers to voting rights or the right to appoint directors or the chief executive officer.  An "interested party" of a company includes a holder of 5% or more of its outstanding share capital or voting rights, its chief executive officer and directors, someone who has the right to appoint its chief executive officer or at least one director, and a company with respect to which any of the foregoing interested parties owns 25% or more of the outstanding share capital or voting rights or has the right to appoint 25% or more of the directors.  Accordingly, any non-Israeli who acquires 5% or more of our ordinary shares will be required to notify the Chief Scientist that it has become an interested party and to sign an undertaking to comply with the R&D Law. Furthermore, the R&D Law imposes reporting requirements in the event that proceedings commence against the grant recipient, including under certain applicable liquidation, receivership or debtor's relief law or in the event that special officers, such as a receiver or liquidator, are appointed to the grant recipient.
 
Failure to meet the R&D Law’s requirements may subject us to mandatory repayment of grants received by us (together with interest and penalties), as well as expose us to criminal proceedings. In addition, the Government of Israel may from time to time audit sales of products which it claims incorporates technology funded through Chief Scientist programs which may lead to additional royalties being payable on additional products.
 
The funds available for Chief Scientist grants made out of the annual budget of the State of Israel were reduced in 1998, and the Israeli authorities have indicated in the past that the government may further reduce or abolish the Chief Scientist grants in the future.  Even if these grants are maintained, we cannot presently predict the amounts of future grants, if any, that we might receive.  In each of the last ten fiscal years, we have received such royalty-bearing grants from the Chief Scientist.  At December 31, 2012, our contingent liability to the Chief Scientist in respect of grants received was approximately $33.5 million.
 
In May 2010, we received a notice from the Chief Scientist regarding alleged miscalculations in the amount of royalties paid by us to the Chief Scientist for the years 1992 through 2009. We believe that all royalties due to the Chief Scientist from the sale of products developed with funding provided by the Chief Scientist during such years were properly paid or were otherwise accrued as of December 31, 2012. During 2011, we reviewed with the Chief Scientist these alleged miscalculation differences and now await further instructions. At this preliminary stage we are unable to assess the merits of the aforesaid arguments raised by the Chief Scientist.
 
Binational Industrial Research and Development Foundation
 
We received from the Israel-U.S. Binational Industrial Research and Development Foundation (the "BIRD Foundation") funding for the research and development of products.  We are obligated to pay royalties to the BIRD Foundation, with respect to sales of products based on technology resulting from research and development funded by the BIRD Foundation. Royalties to the BIRD Foundation are payable at the rate of 5% based on the sales of such products, up to 150% of the grant received, linked to the United States Consumer Price Index. As of December 31, 2012, our contingent liability to the BIRD Foundation for funding received was approximately $348,000.  We have not received grants from the BIRD Foundation since 1995.  Since 2003, we have not generated sales of products developed with the funds provided by the BIRD Foundation, and we have therefore not been required to pay royalties since such time.
 
 
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Israeli Ministry of Industry, Trade and Labor

The Government of Israel, through the Israeli Ministry of Industry, Trade and Labor (the "MITL"), encourages Israeli companies to broaden their business and exports to India. In April 2012 the MITL approved our application for funding to help set up our Indian subsidiary as part of a designated grant plan for the purpose of setting up and establishing a marketing agency in India. The grant is intended to cover up to 50% of the costs of the office establishment, logistics, expenses and hiring employees and consultants in India based on the approved budget for the plan for a period of 3 years.

We are obligated to pay to the MITL royalties of 3% from the revenues derived in India up to an aggregate of 100% of the dollar-linked value of the total grant for a period of up to 7 years from the last year of the plan. As of December 31, 2012, we have received a total of $55,000 in grants from the MITL.
 
Proprietary Rights
 
To protect our rights to our intellectual property, we rely upon a combination of trademarks, contractual rights, trade secret law, copyrights, non-disclosure agreements and technical measures to establish and protect our proprietary rights in our products and technologies.  We own registered trademarks for the names Omni-Q™, GearSet™, and Wirespeed™.  In addition, we sometimes enter into non-disclosure and confidentiality agreements with our employees, distributors, sales representatives and manufacturer’s representatives and with certain suppliers with access to sensitive information.  However, we have no registered patents or trademarks (except for those listed above).
 
Employees
 
As of December 31, 2012, we had 101 employees located in Israel, 8 employees of RADCOM Equipment located in the United States, 9 employees of RADCOM Brazil located in Brazil, 4 employees of RADCOM India located in India and 10 employees in total located in Spain, Singapore, Guatemala, China, Honduras and Paraguay collectively. Of the 101 employees located in Israel, 57 were employed in research and development, 7 in operations (including manufacturing and production), 27 in sales and marketing and customer support, and 10 in administration and management. Of the 8 employees located in the United States, 7 were employed in sales, marketing and customer support and 1 was employed in administration and management.  Of the 9 employees located in the Brazil, 8 were employed in sales, marketing and customer support and 1 was employed in administration and management. Of the 14 employees located in Spain, Singapore, Guatemala, Honduras, Paraguay, India and China, 11 were employed in sales, marketing and customer support and 3 were employed in administration and management. We consider our relations with our employees to be good and we have never experienced a strike or work stoppage.  As of December 31, 2012, all of our 132 employees located worldwide were permanent employees. All of our permanent employees have employment agreements and, with the exception of Brazil, none of them are represented by labor unions.

Although we are not a party to a collective bargaining agreement in Israel, we are subject to the provisions of the extension orders applicable to all employees in the Israeli market, including transportation allowance, annual recreation allowance, the lengths of the workday and workweek and mandatory general insurance pension. In addition, we may be subject to the provisions of the extension order applicable to the Metal, Electricity, Electronics and Software Industry.  Israeli labor laws are applicable to all of our employees in Israel.  These provisions and laws principally concern the length of the work day, minimum wages for workers, procedures for dismissing employees, determination of severance pay, leaves of absence (such as annual vacation or maternity leave), sick pay and other conditions of employment.
 
 
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In Israel, a general practice we follow is the contribution of funds on behalf of most of our permanent employees to an individual insurance policy known as "Managers’ Insurance" or a pension fund.  The contribution rates towards such Managers’ Insurance are above and beyond the legal requirement. This policy provides a combination of savings plan, disability insurance and severance pay benefits to the insured employee.  It provides for payments to the employee upon retirement or death and accumulates funds on account of severance pay, if any, to which the employee may be legally entitled upon termination of employment.  Each participating employee contributes an amount equal to up to 7% of such employee’s base salary, and we contribute between 13.3% and 15.8% of the employee’s base salary.  Full-time employees who are not insured in this way, if any, are entitled to a savings account, to which each of the employee and the employer makes a monthly contribution of 5% of the employee’s base salary, and on top of such contributions we are required to contribute additional contributions for severance liability as provided by law (4.18% during 2012 and 5.00% for 2013).  

Effective January 1, 2012, our employment agreements with new employees in Israel are in accordance with Section 14 of the Israeli Severance Pay Law – 1963, which provide that our contributions to severance pay fund shall cover our entire severance obligation. Upon termination, the release of the contributed amounts from the fund to the employee shall relieve us from any further severance obligation and no additional payments shall be made by us to the employee. As a result, the related obligation and amounts deposited on behalf of such obligation are not stated on the balance sheet, as we are legally released from severance obligation to employees once the amounts have been deposited, and we have no further legal ownership on the amounts deposited.  Consequently, effective from January 1, 2012, we increased our contribution to the deposited funds to cover the full amount of the employees' salaries.

We also provide our permanent employees with an Education Fund, to which each participating employee contributes an amount equal to 2.5% of such employee’s base salary and we contribute an amount equal to 7.5% of the employee’s base salary (generally up to a certain ceiling provided in the Israeli Income Tax Regulations).  In the United States we provide benefits in the form of health, dental, vision and disability coverage, in an amount equal to 14.49% of the employee’s base salary.  All Israeli employers, including us, are required to provide certain increases in wages as partial compensation for increases in the Israeli Consumer Price Index ("CPI").  The specific formula for such increases varies according to the general collective agreements reached among the Manufacturers’ Association and the Histadrut.  Israeli employees and employers also are required to pay pre-determined sums which include a contribution to national health insurance to the Israel National Insurance Institute, which provides a range of social security benefits.
 
In Brazil, we provide benefits in the form of health coverage, including health, vision and dental coverage, in an amount equal to up to 20% of the employee’s base salary.
  
                C.          ORGANIZATIONAL STRUCTURE
 
In January 1993, we established our wholly-owned subsidiary in the United States, RADCOM Equipment, which conducts the sales, marketing and customer support of our products in North America.  In July 1996, we incorporated a wholly-owned subsidiary in Israel, RADCOM Investments, for the purpose of making various investments, including the purchase of securities.  In 2002, we established a wholly-owned Representative Office in China, which conducts the marketing for our products in China In 2010, we established RADCOM Brazil, our wholly-owned subsidiary in Brazil, which conducts the sales, marketing and customer support of our products in Brazil. In 2012, we established RADCOM India, our wholly-owned subsidiary in India, which conducts the sales, marketing and customer support of our products in India. The following is a list of our subsidiaries, each of which is wholly-owned:
 
Name of Subsidiary
Jurisdiction of Incorporation
RADCOM Equipment
New Jersey
RADCOM Investments
Israel
RADCOM Brazil
Brazil
RADCOM India
India
 
 
40

 
 
Yehuda Zisapel and Zohar Zisapel are co-founders and principal shareholders of the Company.  Individually or together, they are also founders, directors and principal shareholders of several other privately and publicly held high technology and real estate companies, who together with us and the other subsidiaries and affiliates, are known as the "RAD-BYNET Group".  In addition to engaging in other businesses, members of the RAD-BYNET Group are actively engaged in designing, manufacturing, marketing and supporting data communications and telecommunications products. Some of the products of members of the RAD-BYNET Group are complementary to, and have been and are currently used in connection with, our products. For more information, see "Item 7.B—Major Shareholders and Related Party Transactions—Related Party Transactions" below.
 
                D.          PROPERTY, PLANTS AND EQUIPMENT
 
We do not own any real property. We currently lease an aggregate of approximately 17,481 square feet of office space in Tel Aviv, Israel, which includes approximately 16,630 square feet leased from affiliates of our principal shareholders. This space includes our manufacturing facilities, which consist primarily of final assembly, testing and quality control of materials, wiring, subassemblies and systems.  In 2012, the aggregate annual lease and maintenance payments for the Tel Aviv premises were approximately $500,000, of which approximately $375,000 was paid to affiliates of our principal shareholders.  We may, in the future, lease additional space from affiliated parties.  

We also lease an aggregate of approximately 4,600 square feet of office space in Paramus, New Jersey, from an affiliate of our principal shareholders, and subleased approximately 500 square feet of such space to a related party. In 2012, our aggregate annual lease payments for such premises were approximately $87,570, and we received $10,080 from the related party for the sub-lease.

We believe that our offices and facilities are adequate for our current needs and that suitable additional or substitute space will be available when needed.
 
 ITEM 4A.            UNRESOLVED STAFF COMMENTS
 
Not applicable.
 
ITEM 5.               OPERATING AND FINANCIAL REVIEW AND PROSPECTS
 
The following discussion of our financial condition and results of operations should be read in conjunction with the consolidated financial statements and the related notes included elsewhere in this Annual Report.
 
This discussion contains forward-looking statements regarding future events and our future results that are subject to the safe harbors created under the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended (the "Exchange Act").  These statements are based on current expectations, estimates, forecasts and projections about the industries in which we operate and the beliefs and assumptions of our management.  Words such as "expects," "anticipates," "targets," "goals," "projects," "intends," "plans," "believes," "seeks," "estimates," "continues," "may," variations of such words, and similar expressions are intended to identify such forward-looking statements. In addition, any statements that refer to projections of our future financial performance, our anticipated growth and trends in our businesses, and other characterizations of future events or circumstances are forward-looking statements.  Readers are cautioned that these forward-looking statements – including those identified below, as well as certain factors – including, but not limited to, those set forth in "Item 3.D—Key Information—Risk Factors" – are only predictions and are subject to risks, uncertainties, and assumptions that are difficult to predict. Although we believe the expectations reflected in the forward-looking statements contained in this Annual Report are reasonable, we cannot guarantee future results, levels of activity, performance or achievements.    We assume no duty to update any of these forward-looking statements after the date of this Annual Report to conform our prior statements to actual results or revised expectations, except as otherwise required by law.
 
 
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Overview
 
We provide innovative service assurance solutions for communications services providers and equipment vendors. We specialize in solutions for next-generation networks, both wireless and wireline. Our comprehensive, carrier strength solutions are used to prevent service provider revenue leakage and enable management of customer care. Our products facilitate fault management, network service performance analysis, troubleshooting and pre-mediation with an OSS/BSS.
 
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 U.S.GAAP.  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 1991. 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 infrastructures.
 
Most of our revenues are generated in U.S. dollars and the majority of our cost of revenues is incurred in transactions denominated in dollars. Accordingly, we consider the U.S. dollar to be our functional currency and our consolidated financial statements are prepared in dollars.
 
               Our business improved from the middle of 2009 until the end of 2011, following the recovery after the severe impact of the global economic slowdown. During 2012, especially during the first half of the year, the telecommunications market experienced a slowdown which affected the spending budget of telecommunications carriers. As we evaluate our growth prospects and manage our operations for the future, we continue to believe that the leading indicator of our growth will be the deployment of 3G and LTE cellular, Voice over IP and Triple Play networks.  Since 2010, we have focused our sales efforts on targeted emerging markets, in which operators are rolling out 3G and LTE cellular and Voice over IP networks, and on developed markets currently introducing Triple Play services based on the IMS platform and mobile broadband services. These market segments continued to grow in 2011, after the global economic slowdown, but experienced a slowdown in 2012, especially during the first half of the year, which slowed down the capital spending of our customers. We observed an improvement in the telecommunications market during the second half of 2012 and are expecting the market to continue to grow in 2013 and beyond, helping us to continue to improve our business.
 
Since 2010, we followed a three-pronged sales strategy designed to expand our sales pipeline and revenues:
 
 
·
In emerging markets, including South America, Central America, Eastern Europe, Africa and Asia, our strategy has been to target customers rolling out 3G Cellular and Voice Over IP services.
 
·
In developed markets, including Europe and North America, we have been targeting the IMS activities and deployments of top-tier wireline service providers, and the LTE & mobile broadband networks of wireless operators.
 
·
To improve our ability to penetrate targeted customers in all regions, we have pursued strategic partnering relationships, including OEM partnerships and teaming agreements and distribution agreements.

During 2012 we continued a trend, which started in 2008, of an increase in the relative portion of medium-to-large sized deals, reflecting our success in creating business relations with more Tier-I and Tier-II operators. As a result, the average deal size increased, payment terms became longer and our right to collect payment became subject to certain conditions, extending the time that elapsed between the date of an initial sale and full revenue recognition. These changes created fluctuations in our quarterly results and decreased the correlation between our bookings and revenues within any given quarter.
 
 
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Revenues. In general, our revenues are derived from sales of our products and, to a lesser extent, from sales of extended warranty services. Product revenues consist of gross sales of products, less discounts and refunds.
 
Cost of sales.  Cost of sales consists primarily of our manufacturing costs, deployment costs, warranty expenses, packaging, import taxes, allocation of overhead expenses, license fees paid to third parties and royalties to the Chief Scientist. As part of our plan to reduce product cost and improve manufacturing flexibility, we shifted several years ago to a subcontracting model for the manufacturing of our products.  Currently, the functions performed by us are the planning and integration of other companies’ solutions into our products, while the subcontractors purchase most of the component parts, assemble the product and test it. These functions can be divided as follows:
 
RADCOM
Subcontractor
Planning
Purchasing component parts
Integration
Assembly
 
Testing
 
We provide certain of our subcontractors a non-binding rolling forecast every quarter for the coming year, and submit binding purchase orders quarterly for material needed in the next quarter.  Purchase orders are generally filled within three months of placing the order.  We are charged by the unit, which ensures that unnecessary charges for reimbursements are minimal.  We are not required to reimburse subcontractors for losses that are incurred in providing services to us, and there are no minimum purchase requirements in our subcontracting arrangements.  If we change components in our products, however, and the subcontractor already bought components based on a purchase order, we would reimburse the subcontractor for any expenses incurred relating to the subcontractor’s disposal of such components.  The subcontracting arrangements are generally governed by one-year contracts that are automatically renewable and that can be terminated by either party upon ninety days’ written notice.
 
Our gross profit is affected by several factors, including the introduction of new products, price erosion due to increasing competition, the number of people that we have in operations, deployment and in customer support, the bargaining power of larger clients, product mix and integration of other companies’ solutions into our own. During the initial launch and manufacturing ramp-up of a new product, our gross profit is generally lower as a result of manufacturing inefficiencies during that period. As the difficulties in manufacturing new products are resolved and the volume of sales of such products increases, our gross profit generally improves. In addition, we attempt to implement engineering and other improvements to our solutions to reduce their cost. Most of our products consist of a combination of hardware and software.  Following an initial purchase of a product, a customer can add additional functions by purchasing software packages.  These packages may add functions to the product such as providing additional testing data or adding the ability to test equipment based on different transmission technologies.  Since there are no incremental hardware costs associated with the sale of the add-on software, the gross margins on these sales are higher. Our strategy is to continue to increase our percentage of direct sales, such as in Brazil and India, as mentioned above.
 
Research and Development.  Research and development costs consist primarily of salaries and, to a lesser extent, payments to subcontractors and for raw materials and overhead expenses.  We use raw materials to build prototypes of our products.  These prototypes have no value since they cannot be sold or otherwise capitalized as inventory.  The allocation of overhead expenses consists of a variety of costs, including rent and office expenses (including telecommunications expenses). The methodology for allocating these expenses depends on the nature of the expense.  Costs such as rent and associated costs are based on the square meters used by the R&D department.  There has been no change in methodology from year to year.  The R&D expenses have been partially offset by royalty-bearing grants from the Chief Scientist.
 
 
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Sales and Marketing.  Sales and marketing expenses consist primarily of salaries, commissions to representatives, advertising, trade shows, promotional expenses, web site maintenance and overhead 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, other general corporate expenses and overhead expenses.
 
Financial Expenses, Net.  Financial expenses, net, in 2012, consisted primarily of interest earned on bank deposits, interest paid on bank loans and gains and losses from the exchange rate differences of monetary balance sheet items denominated in non-U.S. dollar currencies. In 2011, financial expenses, net, consisted primarily of interest earned on bank deposits and gains and losses from the exchange rate differences of monetary balance sheet items denominated in non-U.S. dollar currencies.
 
Summary of Our Financial Performance for the Fiscal Year Ended 2012 Compared to the Fiscal Year Ended 2011
 
For the year ended December 31, 2012 our revenues were $15.8 million compared with $22.0 million in 2011, a decrease of 28%. On an operating basis, the Company burned $2.4 million of cash from operating activities during 2012, compared to a burn of $3.4 million during 2011.  The Company’s net loss for the year ended December 31, 2012 was $6.0 million compared with a $1.9 million net loss for 2011. The lower decrease in operating cash during 2012 compared to 2011, even though there was a substantial increase in the net loss, is primarily as a result of improved collection from customers and a lower increase in inventories.
 
As of December 31, 2012, our cash and cash equivalents totaled $1.5 million, compared with $2.9 million as of December 31, 2011. The decrease was primarily as a result of our operating loss during 2012, which was a result of a decrease in our revenues while maintaining a relatively high level of expenses which reflected our strategic investment in expanding our direct sales capabilities by developing our offices in Singapore, India and Brazil, our investment in sales and R&D activities. In addition, our cash decreased as a result of short term deposits provided to secure bonds to certain customers. This was offset by an increase in cash due to the credit facilities and loans received.
 
During 2011 and 2012 we continued a trend of an increase in the relative portion of medium-to-large sized deals, reflecting our success in creating business relations with more Tier-I and Tier-II operators. This was especially true in 2011 where we received in parallel a substantial amount of large sized deals, causing a delay in revenue recognition. In parallel, we executed during 2012 several cost reduction processes, resulting in a decrease by 10% of our operating expenses. As a result our net losses during 2012 increased to $6.0 million compared with $1.9 million net losses for 2011.
 
Reportable Segments
 
Management receives sales information by product groups and by geographical regions.    Research and development, sales and marketing, and general and administrative expenses are reported on a combined basis only (i.e. they are not allocated to product groups or geographical regions).  Because a measure of operating profit or loss by product groups or geographical regions is not presented to management due to shared resources we have concluded that we operate in one reportable segment.
 
 
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                A.          OPERATING RESULTS
 
The following table sets forth, for the periods indicated, certain financial data expressed as a percentage of sales:
      Year Ended December 31,  
   
2012
   
2011
   
2010
 
Sales
    100 %     100.0 %     100.0 %
Cost of sales
    39.2       30.4       33.8  
Gross profit
    60.8       69.6       66.2  
Operating expenses:
                       
Research and development
    38.7       26.7       22.5  
Less royalty-bearing participation
    9.9       5.6       7.4  
Research and development, net
    28.7       21.1       15.1  
Sales and marketing
    53.9       45.4       36.3  
General and administrative
    13.3       10.1       8.0  
Total operating expenses
    96.0       76.6       59.4  
Operating  income (loss)
    (35.2 )     (7.0 )     6.8  
Financial loss, net
    (2.0 )     (1.7 )     (3.8 )
Net income (loss)
    (37.9 )     (8.7 )     3.0  
 
Financial Data for Year Ended December 31, 2012 Compared with Year Ended December 31, 2011

Revenues
                 
   
Year Ended December 31,
   
% Change
   
% Change
 
   
(in millions of U.S. dollars)
   
2012 vs.
   
2011 vs.
 
   
2012
   
2011
   
2010
   
2011
   
2010
 
The Omni-Q family
    15.2       20.9       17.5       (27 )     19  
The Performer family and others
    0.6       1.1       1.7       (45 )     (35 )
Total revenues
    15.8       22.0       19.2       (28 )     15  

Revenues.  In 2012, our revenues decreased by 28% compared to 2011, as a result of two main factors. First reason is the slowdown in the telecommunications market that we encountered in 2012, especially during the first half of the year. The operating margins of the telecommunications operators were lower in 2012 due to increasing competition, which resulted in delays in their capital spending. Second reason is the trend of increasing our average deal size from small deals to medium and large-sized deals, which was especially strong during 2011 and continued in 2012. The increased complexity that characterizes larger deals led to longer sales cycles and an increase in conditional payment terms and acceptance criteria, which in turn led to longer time delays between the date of receiving orders and full revenue recognition, which is for such deals is an average of 9 to 18 months. As a result, during 2012 we were unable to recognize several large deals received in 2011 and 2012 that were not fully delivered, causing a decrease in revenues by 28% compared to 2011.
 
In 2012, our revenues from warranty services increased by 19% compared to 2011.  This increase is attributed mainly to the ongoing increases in our customer base over the last few years, while maintaining a high rate of customer warranty renewals.
 
 
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Our sales network includes RADCOM Equipment, our wholly-owned subsidiary in the United States, RADCOM Brazil, our wholly-owned subsidiary in Brazil, RADCOM India, our wholly-owned subsidiary in India, as well as independent representatives, and more than 30 independent distributors in over 30 other countries. During 2012 we experienced a decrease in sales in Europe, mainly as a result of the economic slowdown in that region which caused a reduction in capital spending. In addition, our sales in Brazil decreased mainly as a result of large-sized deals with longer execution cycles that led to delay in revenue recognition. The table below shows the sales breakdown by territory:
 
     
Year Ended December 31,
(in millions of U.S. dollars)
     
Year Ended December 31,
(as percentages)
 
      2012        2011        2010        2012        2011        2010   
Europe
    3.0       6.4       4.8       19.0 %     29.1 %     25.0 %
North America
    3.9       3.2       3.0       24.7       14.5       15.6  
AsiaAsia
    2.8       4.3       3.6       17.7       19.6       18.8  
South America (Excluding Brazil)
      2.8       2.3       2.1          17.7       10.5       10.9  
Brazil
     1.9       5.2       4.1        12.0       23.6       21.3  
Other
      1.4       0.6       1.6        8.9       2.7       8.4  
Total revenues
    15.8       22.0       19.2       100 %     100.0 %     100.0 %
 
During 2012 and 2011, no single customer accounted for more than 10% of our sales. In 2010, one customer in Brazil accounted for approximately 13% of our sales.

Cost of Sales and Gross Profit
 
   
Year ended December 31,
 
   
(in millions of U.S. dollars)
 
   
2012
   
2011
   
2010
 
Cost of sales - Product
    5.8       6.1       6.1  
Cost of sales - Services
    0.4       0.6       0.4  
Total Cost of sales
    6.2       6.7       6.5  
Gross profit
    9.6       15.3       12.7  

Cost of sales.  During 2012, profitability on our variable costs, which include hardware production, packaging, royalties to the Chief Scientist, license fees paid to third parties and import taxes was 75% compared to 75% in 2011.
 
Since our cost of sales consists of both variable costs and fixed costs, our gross profits in 2012 decreased, and were 61%, compared to 70% in 2011, which reflected the decrease in our revenues for the year.

Our cost of sales consisted of fixed costs, which include employees’ salaries and related costs and overhead expenses, of approximately $2.2 million for 2012 compared to $2.0 million in 2011.  This increase is due to the increase in the number of employees that provide deployment services and customer support, which are allocated to the cost of sales. Our cost of sales included an expense of $14,000 for share-based compensation in 2012 and $27,000 for share-based compensation in 2011.
 
 
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Operating Costs and Expenses
 
The following table provides the operating costs and expenses of the Company in 2012, 2011 and 2010, as well as the percentage change of such expenses in 2012 compared to 2011 and in 2011 compared to 2010:

   
Year ended December 31,
(in millions of U.S. dollars)
             
   
2012
   
2011
   
2010
   
% Change
2012 vs. 2011
   
% Change
2011 vs. 2010
 
Research and development
    6.1       5.8       4.3       4       34.9  
Less royalty-bearing participation
    1.6       1.2       1.4       26.9       (14.3 )
Research and development, net
    4.5       4.6       2.9       (2.1 )     58.6  
Sales and marketing
    8.5       10.0       7.0       (14.5 )     42.9  
General and administrative
    2.1       2.2       1.5       (5.7 )     46.7  
Total operating expenses
    15.1       16.8       11.4       (9.9 )     47.3  

Research and Development. Research and development expenses, gross, increased from $5.8 million in 2011 to $6.1 million in 2012. As a percentage of total revenues, research and development expenses, gross, increased from 26.7% in 2011 to 38.7% in 2012. The increase in our gross research and development expenses from 2011 to 2012 is attributable to an increase in the average number of employees and related expenses by the amount of $0.3 million. As of December 31, 2012, we employed 53 research and development engineers, compared to 56 as of December 31, 2011, however the average number of employees was higher in 2012 compared to 2011. We believe that our research and development efforts are a key element of our strategy and are essential to our success. An increase or a decrease in our total revenue would not necessarily result in a proportional increase or decrease in the levels of our research and development expenditures, which could affect our operating margin. Our research and development costs included an expense of $205,000 for share-based compensation in 2012 and $218,000 for share-based compensation in 2011.
 
Sales and Marketing.  Sales and marketing expenses decreased from approximately $10.0 million in 2011 to approximately $8.5 million in 2012. The decrease in our sales and marketing expenses from 2011 to 2012 is mainly attributable to a decrease in the number of employees and related expenses by the amount of $0.8 million, mainly for employees in Israel, as a result of our decision to perform certain cost cutting measures. The decrease in our sales and marketing expenses is also attributable to decrease in commissions in amount of $0.2 million due to the decrease in revenues, decrease in travel abroad and conferences in amount of $0.4 million and decrease in office expenses in an amount of $0.1 million. As a percentage of total revenues, sales and marketing expenses in 2012 and 2011 were 53.9% and 45.3%, respectively. Our sales and marketing expenses included an expense of $167,000 for share-based compensation in 2012 and $231,000 for share-based compensation in 2011.  
 
                General and Administrative.  General and administrative expenses decreased from approximately $2.2 million in 2011 to approximately $2.1 million in 2012. As a percentage of total revenues, general and administrative expenses in 2012 and 2011 were 13.3% and 10.2%, respectively. Besides the share-based compensation related to the grant to directors, our general and administrative expenses included $218,000 for share-based compensation in 2012 and $249,000 for share-based compensation in 2011.  
 
Financial Expenses, Net.  In 2012, we recorded financial expenses, net, of approximately $314,000 compared to $384,000 in 2011. This decrease mainly relates to a decrease in exchange rate translation adjustments.

Taxes on Income. During 2012 we recorded tax expenses of $120,000, reflecting withholding taxes that were due on payments from certain customers in Central America.

Financial Data for the Year Ended December 31, 2011 Compared with the Year Ended December 31, 2010
 
Revenues.  In 2011, our revenues increased by 14.6% compared to 2010, reflecting the recovery from the global economic slowdown and the increased pressure on the telecom networks felt by telecom companies in response to the increasing usage of mobile data applications. The trend, which started in 2008, of increasing our average deal size from small deals to medium and large-sized deals continued in 2011. However, the increased complexity that characterizes larger deals led to longer sales cycles and an increase in conditional payment terms, which in turn led to longer time delays between the date of receiving orders and full revenue recognition, currently on an average of 9 to 18 months.
 
 
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One customer in Brazil accounted for approximately 13% of our sales in 2010. During 2011 no single customer accounted for more than 10% of our sales. During 2011 the relative increase of sales in South America was larger than other geographical areas reflecting the high level of marketing efforts together with the market need in this region which led to a significant increase in sales.
 
Cost of sales.   During 2011, profitability on our variable costs, which include hardware production, packaging, royalties to the Chief Scientist, license fees paid to third parties and import taxes were 75% compared to 74% in 2010. This slight improvement was mainly due to the reduction of our manufacturing costs of our hardware, mainly by introducing during 2010 our new R70S probe platform.
 
In 2011, our gross margins were 70%, the same as our target, compared to 66% in 2010, which reflected the increase in our revenues for the year.
 
Our cost of sales consisted of fixed costs, which include employees’ salaries and related costs and overhead expenses, of approximately $2.0 million for 2011 compared to $1.6 million in 2010.  This increase is due to the increase of post-sale support that we provided, which is allocated to the cost of sales. Our cost of sales included an expense of $27,000 for share-based compensation in 2011 and $5,000 for share-based compensation in 2010
 
Research and Development.   Research and development expenses, gross, increased from $4.3 million in 2010 to $5.8 million in 2011. As a percentage of total revenues, research and development expenses, gross, increased from 22.5% in 2010 to 26.7% in 2011. The increase in our gross research and development expenses from 2010 to 2011 is mainly attributable to an increase in the number of employees and related expenses by the amount of $1.2 million offset by a decrease of $0.1 million in materials and sub-contractors and a decrease of $0.2 million in office expenses. As of December 31, 2011, we employed 56 research and development engineers, compared to 44 as of December 31, 2010. We believe that our research and development efforts are a key element of our strategy and are essential to our success and we intend to further increase our commitment to research and development. An increase or a decrease in our total revenue would not necessarily result in a proportional increase or decrease in the levels of our research and development expenditures, which could affect our operating margin. Our research and development costs included an expense of $218,000 for share-based compensation in 2011 and $10,000 for share-based compensation in 2010. This increase was mainly a result of the change in the Company’s vesting period in most of the options granted during 2011 from four years to one year, which accelerated the share-based compensation cost and a higher weighted average exercise price of options granted during 2011 compared to options granted during 2010.
 
Sales and Marketing.   Sales and marketing expenses increased from approximately $7.0 million in 2010 to approximately $10.0 million in 2011. The increase in our sales and marketing expenses from 2010 to 2011 is mainly attributable to an increase in the number of employees and related expenses by the amount of $2.6 million, of which $1.4 million relates to employees in offices outside of Israel mainly in Brazil and $0.8 million relates to employees in Israel. As a percentage of total revenues, sales and marketing expenses in 2011 and 2010 were 45.3% and 36.4%, respectively. Our sales and marketing expenses included an expense of $231,000 for share-based compensation in 2011 and $36,000 for share-based compensation in 2010.  This increase was mainly a result of the change in the Company’s vesting period in most of the options granted during 2011 from four years to one year which accelerated the share-based compensation cost and a higher weighted average exercise price of options granted during 2011 compared to options granted during 2010.
 
General and Administrative.  General and administrative expenses increased from approximately $1.5 million in 2010 to approximately $2.2 million in 2011. This increase is mainly attributed to the decrease in provision for bad debts done in 2010 totaling approximately $595,000. As a percentage of total revenues, general and administrative expenses in 2011 and 2010 were 10% and 8%, respectively. Besides the share-based compensation related to the grant to directors, our general and administrative expenses included $249,000 for share-based compensation in 2011 and $103,000 for share-based compensation in 2010.  This increase was mainly a result of the change in the Company’s vesting period in most of the options granted during 2011 from four years to one year which accelerated the share-based compensation cost and a higher weighted average exercise price of options granted during 2011 compared to options granted during 2010.
 
 
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Financial Expenses, Net.  In 2011, we recorded financial expenses, net, of approximately $384,000 compared to $722,000 in 2010. The decrease in financial expenses is attributable mainly to the loan from Plenus, which was re-paid in 2010 and change in the fair value of warrant and interest and accretion of discount on the loan, all of which don’t exist in 2011. This decrease is offset in part by an increase in exchange translation by foreign currency fluctuations of $322,000.
 
Impact of Inflation and Foreign Currency Fluctuations
 
Most of our revenues are generated in U.S. dollars and the majority of our cost of revenues is incurred in transactions denominated in dollars. Accordingly, we consider the U.S. dollar to be our functional currency. Since we pay the salaries of our Israeli employees in NIS, the dollar cost of our operations is influenced by the exchange rates between the NIS and the dollar.  While we incur some expenses in NIS, inflation in Israel will have a negative effect on our profits for contracts under which we are to receive payment in dollars or dollar-linked NIS, unless such inflation is offset on a timely basis by a devaluation of the NIS in relation to the dollar. For our Brazilian subsidiary, the functional currency has been determined to be their local currency. Assets and liabilities are translated at year-end exchange rates and statements of income items are translated at average exchange rates prevailing during the year. Such translation adjustments are recorded as a separate component of accumulated other comprehensive loss in shareholders' equity.
 
Inflation in Israel has occasionally exceeded the devaluation of the NIS against the dollar or we have faced the strengthening of the value of the NIS against the U.S. dollar. In the first half of 2011, the value of the NIS expressed in dollar terms increased, raising our Israeli-based costs as expressed in dollars.  Under these conditions, we experienced higher dollar costs for our operations in Israel, adversely affecting our dollar-measured results of operations. This trend was reversed during the second half of 2011 and during the first 3 Quarters of 2012.  During the last Quarter last Quarter of 2012 the trend returned. Based on our budget for 2013, we expect that an increase of NIS 0.1 to the exchange rate of the NIS to U.S. dollar will decrease our expenses expressed in dollar terms by $40,000 per quarter and vice versa.
 
Because exchange rates between the NIS and the dollar fluctuate continuously, exchange rate fluctuations will have an impact on our profitability and period-to-period comparisons of our results.  The effects of foreign currency re-measurements are reported in our financial statements as financial income or expense.
 
Effective Corporate Tax Rate
 
Israeli companies are generally subject to corporate tax at the rate of 24% for the 2011 tax year and 25% for the 2012 tax year. Following an amendment to the Israeli Income Tax Ordinance New Version, 1961 (the “Tax Ordinance”), which came into effect on January 1, 2012, the Corporate Tax rate is scheduled to remain at a rate of 25% for future tax years. Israeli companies are generally subject to capital gains tax at the corporate tax rate.
 
Our effective corporate tax rate may exceed the Israeli tax rate.  Our U.S. and Brazilian subsidiaries will generally be subject to applicable federal, state, local and foreign taxation, and we may also be subject to taxation in the other foreign jurisdictions in which we own assets, have employees or conduct activities.
 
We recorded a valuation allowance at December 31, 2012 for all of our deferred tax assets.  Based on the weight of available evidence, it is more likely than not that all of our deferred tax assets will not be realized.
 
 
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                B.          LIQUIDITY AND CAPITAL RESOURCES
 
We have financed our operations through cash generated from operations, the proceeds of our 1997 initial public offering, our 2004, 2008 and 2010 private placement transactions, a venture lending loan secured in 2008, a bank credit facility received in 2012 and a loan from our major shareholder which was received in November, 2012. Cash and cash equivalents at December 31, 2012, 2011, 2010 were approximately $1.5 million, $2.9 million, and $5.7 million, respectively.
 
We generated significant losses attributable to our operations. We have managed our liquidity during this time through a series of cost reduction initiatives, expansion of our sales into new markets, private placement transactions, a venture capital loan, a bank credit facility and a loan from our major shareholder. We believe that our existing capital resources and cash flows from operations will be adequate to satisfy our expected liquidity requirements through the next twelve months. Our foregoing estimate is based on, among other things, our current backlog and on the pipeline for 2013. Without derogating from the foregoing estimate regarding our existing capital resources and cash flows from operations being adequate to satisfy our expected liquidity requirements through the next twelve months, we may decide to raise additional funds in 2013. There is no assurance that, if required, we will be able to raise additional capital or reduce discretionary spending to provide the required liquidity in order to continue as a going concern.
 
Net Cash Used in Operating Activities. Net cash used in operating activities was approximately $(2.5) million in 2012, $(3.3) million in 2011 and $(2.5) million in 2010.  The negative net cash flow in 2012 was primarily due to a net loss of approximately $6.0 million and deferred revenues and decrease of approximately $0.8 million in trade payables. This was partially offset by the following: increase of $1 million in advances from customers, decrease of $0.8 million in other current assets, decrease of approximately $2.0 million in trade receivables and non-cash share options compensation of $0.7 million. The negative net cash flow in 2011 was primarily due to a net loss of approximately $1.9 million, an increase of $1.8 million in other current assets, increase of $2.7 million in inventories and a decrease of approximately $0.5 million in other payables and accrued expenses This was partially offset by the following: decrease of approximately $1.4 million in trade receivables, and non-cash share options compensation of $0.8 million. The negative net cash flow in 2010 was primarily due to an increase of $2.6 million in trade receivables, an increase of $1.1 million in other current assets and an increase of $1.1 million in inventories. This was partially offset by the following: net income of approximately $0.6 million, an increase of approximately $1.6 million in trade payables, an increase in share options compensation of $0.6 million and an increase in value of warrants granted to Plenus of $0.5 million.
 
The trade receivables and days of sales outstanding ("DSO") are primarily impacted by payment terms, shipment linearity in the quarter and collections performance.  Trade receivables for 2012 decreased to $3.3 million from $5.4 million for 2011, reflecting the lower sales and the shortening of our DSOs due to our ability to collect certain long overdue amounts. However, we believe that continued expansion of our business, particularly in emerging markets, may require continued investments in working capital as many customers require commercial terms which result in longer payment terms.
  
The decrease in other current assets in 2012 was primarily a result of a decrease in indirect tax advances paid in Brazil in amount of $0.7 million and decrease in prepaid expenses in the amount of $0.1 million, mainly related to deferred revenues.
 
Net Cash Used in Investing Activities.  Our investing activities generally consist of the purchase of equipment, however in 2012 we invested in short term deposits in the amount of $1.4 million, which was required in order to secure bonds provided to certain customers, and only $66,000 for the purchase of equipment.  In 2011 and 2010, our investing activities only consisted of the purchase of equipment.  Net cash used in investing activities in 2012, 2011 and 2010 totaled approximately $1.5 million $103,000 and $56,000, respectively.  
 
Net Cash Provided by /(Used in) Financing Activities.  In 2012, net cash provided by financing activities totaled approximately $2.6 million, including $1 million short term credit from a bank, $1.5 million short terms loans from a bank and from Mr. Zohar Zisapel and exercise of options of $45,000. In 2011, net cash provided by financing activities totaled approximately $0.8 million, including the exercise of options of $144,000 and warrants of $623,000. In 2010, net cash provided in financing activities totaled approximately $5.0 million, including the $5.4 million from the private placement as described below under "Private Placement - 2010", and exercise of options of $643,000 and warrants of $353,000 which was offset by approximately $(1.3 million) repayment of the venture loan. 
 
 
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Private Placements
 
Private Placement - 2010
 
During October and November 2010, we raised $5.5 million in a private placement, or the 2010 PIPE, of ordinary shares and warrants.  Under the 2010 PIPE transaction, we issued 643,277 ordinary shares for an aggregate purchase price of $5.5 million, or $8.55 per ordinary share (this price per share was based on the average closing price of our ordinary shares on the thirty trading days prior to the execution date of the definitive agreement, minus a discount of 12%).  The investors in the 2010 PIPE also included Zohar Zisapel, our Chairman.  We also issued to the investors warrants to purchase up to 214,426 ordinary shares at an exercise price of $10.69 per share (the price per share paid in the transaction plus 25%).  The warrants are exercisable for three years from the closing date of the 2010 PIPE. As part of the 2010 PIPE, we filed with the SEC a resale registration statement covering the shares purchased in the 2010 PIPE (including the shares underlying the warrants). Our net proceeds from the offering were approximately $5.4 million. If the warrants are exercised in full for cash, we would realize proceeds before expenses, in the amount of $2.3 million. As of December 31, 2012, no warrants were exercised.
 
Loans
 
Venture Loan from Plenus
 
In April 2008, we closed a $2.5 million venture loan from Plenus, a leading Israeli venture-lending firm. The loan was for a period of three years, and with a 10% rate of interest per annum. In addition, we granted Plenus a warrant to purchase our ordinary shares in the amount of $450,000. The warrant was exercisable for a period of five years, and its exercise price is $2.56 per share (this price per share reflects a four-for-one reverse share split which we affected in June 2008). The exercise price (and consequently the number of shares to be issued) is subject to certain adjustments should we issue additional shares or convertible securities at an effective price per share which is lower than the exercise price.  Other adjustments to the exercise price include M&A transactions, payment or distribution of certain dividends, subdivision or combination of outstanding shares.  The warrant was fully exercised in September 2010.  We also granted Plenus registration rights in respect of the shares underlying the warrant. In connection with the loan from Plenus, we granted Plenus a fixed charge over our intellectual property assets and a floating charge over our assets. RADCOM Equipment Inc., our U.S. subsidiary, granted Plenus a security interest over its assets, and our subsidiaries provided Plenus with guarantees with respect to the loan. On September 7, 2010 we repaid the remainder of the loan amount to Plenus, seven months in advance of the scheduled maturity date and all floating charges were removed.

Credit Facility from First International Bank of Israel
 
In September 2012, we secured a short-term line of credit of $1.5 million from the First International Bank of Israel. In order to secure our obligations to the bank, we pledged and granted to the bank a first priority floating charge on all of our assets and a first priority fixed charge on certain other assets (namely, rights for uncalled and/or unpaid share capital, including goodwill rights, and rights for insurance).  We refer to the agreement relating to such charges as the Pledge. The Pledge contains a number of customary restrictive terms and covenants that limit our operating flexibility, such as (1) limitations on the creation of additional liens, and on the sale or transfer of certain of our assets, and (2) the ability of the bank to accelerate repayment in certain events, such as breach of covenants, liquidation, or a reduction in Messrs. Zohar Zisapel’s and Yehuda Zisapel’s joint ownership of the Company below 30%. The Pledge's restrictive terms and covenants may hinder our future operations or the manner in which we operate our business, which could have a material adverse effect on our business, financial condition or results of operations. One of the covenants we undertook was that our shareholder's equity, as reflected in our reported financial statements, would not be less than 32% of our total assets as reflected in the applicable balance sheet. As of December 31, 2012, we failed to meet the requirements of this covenant. The bank requested that we rectify the situation, and agreed to provide us with a cure period until July 15, 2013.  We may fail to cure such breach and the bank may demand that we immediately repay the $1.5 million, which will create a substantial burden on our cash balances and harm our ongoing operation. We anticipate that we will be profitable in 2013, thereby increasing our shareholder's equity, which should enable us to meet the terms of the covenant. In addition, we believe that, if needed, the bank will provide us with an additional extension in order to meet the terms of our covenants to the bank. We are also in advanced negotiations to raise additional funds in a private placement, which should help us to improve our shareholder's equity in order to satisfy the terms of our covenants to the bank.  There is no assurance that we will be successful in raising such funds.
 
 
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Loan Agreement with Mr. Zohar Zisapel
 
In November 2012, we secured a loan of up to NIS 3 million from Mr. Zohar Zisapel, our Chairman of the Board and our largest shareholder to finance our operations.  The term of the loan was until March 31, 2013, and Mr. Zisapel has informed us that he has agreed to waive his right to claim the repayment of the loan until June 30, 2013. The loan is interest-free, but the amount of principal required to be repaid is linked to the Israeli CPI. The average Israeli CPI has increased each year from 2010 through 2012 by 3.34%, 1.96% and 1.63% respectively.  As of April 19, 2013, we owe Mr. Zisapel NIS 2,893,000 pursuant to the terms of the loan.
 
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 risks such as foreign currency and interest rate fluctuations.
 
Impact of Related Party Transactions
 
We have entered into a number of agreements with certain companies, of which Yehuda Zisapel and Zohar Zisapel are co-founders, directors and/or principal shareholders (collectively, the "RAD-BYNET Group").  Of these agreements, the office space leases with affiliates of the RAD-BYNET Group are material to our operations.  The distribution agreement with BYNET ELECTRONICS Ltd., which was material to our business, was terminated during 2012.  The pricing of the transactions was determined based on negotiations between the parties.  Members of our Board of Directors and management reviewed the pricing of the leases and the distribution agreement and confirmed that these agreements were not different from terms that 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 on certain issues than what may be available from unaffiliated third parties. In the event that the transactions with members of the RAD-BYNET Group are terminated and we enter into similar transactions with unaffiliated third parties, that flexibility may no longer be available to us. For more information, see "Item 7.B—Major Shareholders and Related Party Transactions—Related Party Transactions" below.

In October and November 2010, we completed a PIPE in which we raised $5.5 million from certain investors, including our Chairman, Mr. Zohar Zisapel (who invested $1.0 million). For more information, see " — Private Placements" above.

Please see " — Loans — Loan Agreement with Mr. Zohar Zisapel” above, for information relating to the loan from Mr. Zohar Zisapel.

Please see "Item 5.F—Operating and Financial Review and Prospects—Tabular Disclosure of Contractual Obligations" below for a discussion of our material commitments for capital expenditures.
 
Government Grants and Related Royalties
 
The Government of Israel, through the Chief Scientist, encourages research and development projects pursuant to the R&D Law and the regulations promulgated thereunder.  We may receive from the Chief Scientist up to 50% of certain approved research and development expenditures for particular projects.  We recorded grants from the Chief Scientist totaling approximately $1.6 in 2012, $1.2 million in 2011, and $1.4 million in 2010. Pursuant to the terms of these grants, we are obligated to pay royalties of 3.5% of revenues derived from sales of products (and related services) funded with these grants.  In the event that a project funded by the Chief Scientist does not result in the development of a product which generates revenues, we would not be obligated to repay the grants we received for the product’s development.  Royalties’ expenses relating to the Chief Scientist grants included in the cost of sales for years ended December 31, 2012, 2011 and 2010 were $562,000, $759,000 and$793,000, respectively. The total research and development grants that we have received from the Chief Scientist as of December 31, 2012 were $33.4 million.  For projects authorized since January 1, 1999, the repayment interest rate is LIBOR. As of December 31, 2012, the accumulated interest was $9.8 million, the accumulated royalties paid to the Chief Scientist were $9.7 million and our contingent liability to the Chief Scientist in respect of grants received was according to our records approximately $33.5 million.  For additional information, see "Item 4.B—Information on the Company—Business Overview—Israeli Office of the Chief Scientist."
 
 
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We are also obligated to pay royalties to the BIRD Foundation, with respect to sales of products based on technology resulting from research and development funded by the BIRD Foundation. Royalties to the BIRD Foundation are payable at the rate of 5% based on the sales of such products, up to 150% of the grant received, linked to the United States Consumer Price Index.  As of December 31, 2012, we had a contingent obligation to pay the BIRD Foundation aggregate royalties in the amount of approximately $348,000.  For additional information, see "Item 4.B—Information on the Company—Business Overview—Binational Industrial Research and Development Foundation."

In April 2012, the MITL approved our application for funding to help set up our Indian subsidiary as part of a designated grant plan for the purpose of setting up and establishing a marketing agency in India.  The grant is intended to cover up to 50% of the costs of the office establishment, logistics, expenses and hiring of employees and consultants in India, based on the approved budget for the plan for a period of 3 years. We are obligated to pay to the MITL royalties of 3% from the revenues derived in India up to an aggregate of 100% of the dollar-linked value of the total grant for a period of up to 7 years from the last year of the plan. As of December 31, 2012, we had a contingent obligation to pay the MITL aggregate royalties in the amount of approximately $55,000.  For additional information, see "Item 4.B—Information on the Company—Business Overview—Israeli Ministry of Industry, Trade and Labor."

Critical Accounting Policies and Estimates
 
The preparation of financial statements and related disclosures in conformity with U.S. GAAP requires us to make judgments, assumptions, and estimates that affect the amounts reported in the Consolidated Financial Statements and accompanying notes. Note 2 to the Consolidated Financial Statements describes the significant accounting policies and methods used in the preparation of the Consolidated Financial Statements. The accounting policies described below are significantly affected by critical accounting estimates. Such accounting policies require significant judgments, assumptions, and estimates used in the preparation of the Consolidated Financial Statements, and actual results could differ materially from the amounts reported based on these policies.
 
Revenue recognition. Revenues from sales of products are recognized when persuasive evidence of an agreement exists, delivery of the product has occurred, the fee is fixed or determinable and collectability is probable.
 
Products are typically considered delivered upon shipment. In instances where final acceptance of the product is specified by the customer, and the acceptance is deemed substantive, revenue is deferred until all acceptance criteria have been met. Our arrangements generally do not include any provisions for cancellation, termination or refunds that would significantly impact recognized revenue. Large-size deals usually include acceptance criteria and since the delivery of such projects can take on average between 9-18 months, revenue recognition for such projects is delayed.
 
 
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Our revenues are generated from sales to independent distributors and direct customers. We have a contract that is standard in substance with our distributors. Based on this contract, sales to distributors are final and distributors have no rights of return or price protection. We are not a party to the agreements between distributors and their customers, however we recognize our revenue on a "sale through" basis and therefore, revenues from these distributors are deferred until all revenue recognition criteria of the sale to the end customer are met.

We also generate sales through independent representatives. These representatives do not hold any of the Company's inventories, and they do not buy products from us. We invoice the end-user customers directly, collect payment directly and then pay commissions to the representative for the sales in their territory.
 
We account for revenue recognition under the guidance of ASU No. 2009-13, "Revenue Recognition (Topic 605): Multiple-Deliverable Revenue Arrangements". ASU No. 2009-13 establishes a selling price hierarchy for determining the selling price of a deliverable in a sale arrangement.  The selling price for each deliverable is based on vendor-specific objective evidence ("VSOE") if available, third-party evidence ("TPE") if VSOE is not available, or estimated selling price ("ESP") if neither VSOE or TPE is available. ASU No. 2009-13 requires that arrangement consideration be allocated at the inception of the arrangement to all deliverables using the relative selling price method. The relative selling price method allocates any discount in the arrangement proportionately to each deliverable on the basis of the deliverable's selling price.
 
Under our selling arrangements, we provide a one-year warranty, which includes bug fixing and a hardware warranty ("Warranty") for all of our products. Accordingly, we record an appropriate provision for Warranty in accordance with ASC 450 "Contingencies" (see Note 2j). After the Warranty period initially provided with our products, we may sell extended warranty contracts on a standalone basis, which include bug fixing and a hardware warranty. Revenue related to extended warranty contracts is recognized pursuant to ASC 605-20-25, "Separately Priced Extended Warranty and Product Maintenance Contracts."  Pursuant to this provision, revenue related to separately priced product maintenance contracts is deferred and recognized over the term of the maintenance period.  
 
The customer may purchase an extended warranty with the initial sale. In such cases, revenues attributable to the extended warranty are deferred at the time of the initial sale and recognized ratably over the extended contract warranty period.
  
Deferred revenues and advances from customers. Represent mainly the unrecognized fees collected for extended warranty services or fees collected for products for which revenue has not yet been recognized.
 
Allowance for doubtful accounts.  We maintain an allowance for doubtful accounts for losses that may result from the failure of our customers to make required payments. We estimate this allowance based on our judgment as to our ability to collect outstanding receivables. We form this judgment based on an analysis of significant outstanding invoices, the age of the receivables, our historical collection experience and current economic trends. If the financial condition of our customers were to deteriorate, resulting in their inability to make payments, we would need to increase the allowance for doubtful accounts.
 
Inventories.  Inventory is written down based on excess and obsolete inventories determined primarily by future demand forecasts. Inventory write-downs are measured as the difference between the cost of the inventory and market, based upon assumptions about future demand and are charged to the provision for inventory, which is a component of our cost of sales. At the point of the loss recognition, a new, lower cost basis for that inventory is established, and subsequent changes in facts and circumstances do not result in the restoration or increase in that newly established cost basis.
 
If there were to be a sudden and significant decrease in demand for our products, or if there were a higher incidence of inventory obsolescence because of rapidly changing technology and customer requirements, we could be required to increase our inventory write-downs and gross margin could be adversely affected. Inventory and supply chain management remain areas of focus as we balance the need to maintain supply chain flexibility, to help ensure competitive lead times with the risk of inventory obsolescence.
 
 
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In addition, we add to the cost of finished products and work in process held in inventory the overhead from our manufacturing process.  If these estimates change in the future, the amount of overhead allocated to cost of revenues would change.

Inventory also includes amounts with respect to inventory delivered to customers but for which revenue criteria have not been met yet.
 
Share option plans. Share-based compensation cost is measured at the grant date based on the value of the award and is recognized as expense over the requisite service periods. We estimate the fair value of employee stock options using a Black-Scholes valuation model. We recognize compensation costs using the graded vesting attribution method that results in an accelerated recognition of compensation costs, in comparison to the straight line method.
 
The fair value of an award is affected by our stock price on the date of grant and other assumptions, including the estimated volatility of our stock price over the term of the awards and the estimated period of time that we expect employees to hold their stock options. Actual historical changes in the market value of the Company’s shares were used to calculate the volatility assumption, as management believes that this is the best indicator of future volatility.

Determining the fair value of share-based awards at the grant date requires the exercise of judgment. In addition, the exercise of judgment is also required in estimating the amount of share-based awards that are expected to be forfeited. If actual results differ significantly from these estimates, share-based compensation expense and our results of operations could be materially affected.
 
The SEC staff does not expect the "simplified" method to be used when sufficient information regarding exercise behavior, such as historical exercise data or exercise information from external sources, becomes available. We currently use the simplified method and expect to continue using such method until historical exercise data will provide sufficient information to develop expected life assumption.
 
                C.          RESEARCH AND DEVELOPMENT, PATENTS AND LICENSES
 
See "Item 4.B—Information on the Company—Business Overview—Research and Development," "Item 4.B—Information on the Company—Business Overview—Proprietary Rights", and "Item 5—Operating and Financial Review and Prospects—Research and Development" and "Item 5.A—Operating and Financial Review and Prospects—Operating Results".
 
                D.          TREND INFORMATION
 
During 2012 we saw a growing demand for service assurance solutions; however the slowdown in the telecommunications industry caused longer decision processes and put a hold on certain budgets. Our brand became more appreciated in our market segment which led us to be exposed to more business opportunities, upon some of which we were able to capitalize, mainly during the second half of 2012. This is not reflected in our 2012 financial reports due to the long delivery cycle of large-size projects, leading to a delay in revenue recognition.
 
The rollout of data services over 3G and 3.5G cellular networks also reached developing countries. In developed countries, a majority of networks started LTE pilots while many leading service providers have commercial LTE offerings. Mobile data cards and other mobile data services are becoming a significant revenue source for cellular operators and we see an increased demand for our solutions for this segment.
 
 
 
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There is a clear global trend of government regulations that are opening communication markets to competition. In each major deregulated market, generally at least three service providers compete in each service segment. This competition drives increased spending on the marketing of next-generation services, and therefore increased usage, which itself increases the potential need for service assurance solutions. As services become more technologically complex and their volumes increase, service quality becomes an issue that must be addressed.
 
As part of this increase in competition, we have begun to see rapid adoption of SIGTRAN technology to lower the operational cost for signaling networks and to handle the increased network traffic. This move helps service providers justify the move to NGN solutions and increases our addressable market.
 
The growing demand for service assurance solutions in emerging markets which was attributable, among other things, to recent rollouts of NGN networks, VoIP-based voice services, 3G & LTE mobile networks and other advanced technologies, generated a significant demand for RADCOM’s products in Latin America and Asia.
 
                E.          OFF–BALANCE SHEET ARRANGEMENTS
 
None.
 
                F.          TABULAR DISCLOSURE OF CONTRACTUAL OBLIGATIONS
 
The following table of our material contractual obligations as of December 31, 2012, summarizes the aggregate effect that these obligations are expected to have on our cash flows in the periods indicated:
 
   
Payments due by period
 
 
Contractual Obligations
 
Total
   
Less than
1 year
   
1-3
years
   
3-5
years
   
More than
5 years
 
         
(in thousands of U.S. dollars)
 
Property Leases                                  
  $
2,213
    $
641
    $
1,572
     
--
     
--
 
Open Purchase Orders (1)
   
346
     
346
     
--
     
--
     
--
 
Operating Leases                                  
   
74
     
74
     
--
     
--
     
--
 
Severance Pay (2)
   
3,518
     
-- 
     
-- 
     
--
     
--
 
Total                                  
  $
6,581
    $
1,91
    $
1,572
     
--
     
--
 

(1) Open purchase orders. We purchase components from a variety of suppliers and use several contract manufacturers, to provide manufacturing services for our products. During the normal course of business, in order to manage manufacturing lead times and help assure adequate component supply, we enter into agreements with contract manufacturers and suppliers that allow them to procure inventory based upon criteria, as defined by our requirements. In certain instances, we provide a non-binding forecast every 12 months, and we submit binding purchase orders quarterly for material needed in the next quarter. These agreements allow us the option to cancel, reschedule and adjust our requirements based on our business needs prior to firm orders being placed. There are no penalties incurred for not taking delivery; however, if we alter the components in our products when the manufacturer has already purchased components based on a purchase order, we reimburse the manufacturer for any losses incurred relating to the manufacturer’s disposal of such components. Consequently, only a portion of our reported purchase commitments arising from these agreements are firm, non-cancelable and unconditional commitments, and are included in the table above.
 
 
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(2) In addition to the obligations noted above, we have potential liability for severance pay for Israeli employees, which is calculated pursuant to Israeli severance pay law, based on the most recent monthly salary of the employees multiplied by the number of years of employment as of the balance sheet date.  After completing one full year of employment, our Israeli employees are entitled to one month’s salary for each year of employment or a portion thereof.  Our total contingent liability at December 31, 2012 was $3,518,000.  Of this amount, $428,000 is unfunded.  The timing of payment of this liability is dependent on timing of the departure of the employees and whether they leave of their own will, or are dismissed.

In addition, we are required to pay royalties of 3.5% of the revenues derived from products incorporating know-how developed from research and development grants from the Chief Scientist. As of December 31, 2012, our contingent liability to the Chief Scientist in respect of grants received was according to our records approximately $33.5 million, and our contingent liability to the BIRD Foundation in respect of funding received was approximately $348,000. If we do not generate revenues from products incorporating know-how developed within the framework of these programs, we will not be obligated to pay royalties under these programs.

We are also obligated to pay to the MITL royalties of 3% from the revenue growth derived in India up to an aggregate of 100% of the dollar-linked value in respect of the actual funding received by us. As of December 31, 2012 no liability was accrued.
 
ITEM 6.                DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES
 
                A.         DIRECTORS AND SENIOR MANAGEMENT
 
The following table lists our current directors and executive officers:

Name
 
Age
 
Position
Zohar Zisapel (5)        
 
64
 
Chairman of our Board of Directors
David Ripstein                                         
 
46
 
President, Chief Executive Officer
Gilad Yehudai                                         
 
44
 
Chief Financial Officer
Eyal Harari                                         
 
37
 
Vice President, Products and Marketing
Yuval Porat                                         
 
54
 
Vice President, Research and Development
Miki Shilinger                                         
 
58
 
Vice President, Operations
Uri Har (1)(2)(3)(4)(5)(6)               
 
76
 
Director
Irit Hillel (1)(2)(4)(5)(6)      
 
50
 
Director
Matty Karp (2)(4)(6)              
 
64
 
Director
Rachel (Heli) Bennun    
 
59
 
Director
 
(1) External Director, pursuant to the Companies Law
(2) Independent Director, pursuant to the NASDAQ Listing Rules
(3) Chairman of Audit Committee
(4) Audit Committee Member
(5) Nominating Committee Member
(6) Compensation Committee Member
 
 
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Mr. Zohar Zisapel, a co-founder of our Company, has served as our Chairman of the Board since our inception in 1985. Mr. Zisapel is also the Chairman of Ceragon Networks Ltd. (NASDAQ: CRNT), and a director of two other public companies, Amdocs Ltd. (NYSE: DOX) and Silicom Ltd. (NASDAQ and TASE: SILC), as well as a director or Chairman of several private companies. Mr. Zisapel has a B.Sc. degree and an M.Sc. degree in electrical engineering from the Technion - Israel Institute of Technology and an M.B.A. degree from Tel-Aviv University.
 
Mr. David Ripstein, our President and Chief Executive Officer since April 1, 2007, joined RADCOM in 2000 as General Manager of the Quality Management Unit, a position under which he formed and executed RADCOM’s service quality management strategy and spearheaded the development of its differentiating R70 technology platform.  In 2002, Mr. Ripstein was nominated to head the Company’s R&D and marketing activities.  In May 2006, Mr. Ripstein was appointed as RADCOM’s Chief Operating Officer.  Prior to joining RADCOM, Mr. Ripstein served for 11 years as an officer of an elite R&D unit within the Israel Defense Forces (IDF) Intelligence Division, and then co-founded two startups:  Firebit, a provider of ISP security service solutions, and Speedbit, a developer of Internet download acceleration tools.  Mr. Ripstein earned B.Sc. and M.Sc. degrees in Electronic Engineering from the Technion - Israel Institute of Technology.
 
Mr. Gilad Yehudai, our Chief Financial Officer, joined us in May 2011. Prior to joining us, Mr. Yehudai was the VP Finance of DSP Group Inc. (NASDAQ: DSPG) from November 2007 to April 2011. Previously, Mr. Yehudai served as CFO of CogniTens Ltd., where he managed five rounds of fundraising and an acquisition process, and as Controller of Cimatron Ltd. (NASDAQ: CIMT). Mr. Yehudai holds a B.A. in Accounting and Economics and an M.B.A. in Finance and Information Systems from the Tel-Aviv University, and is certified in Israel as a CPA.
 
Mr. Eyal Harari, our Vice President of Products and Marketing, has been with us since 2000.  Mr. Harari began in the Development side of RADCOM in 2000 as a software R&D group manager, later becoming the Director of Product Management for VoIP Monitoring Solutions, and finally the Senior Director of RADCOM’s Product Management department.  Before joining us, Mr. Harari served from 1995 in the Communication, Computers & Electronics Corps of the Israel Defense Forces, managing large-scale software projects.  Mr. Harari received a B.A. in Computer Science from the Open University of Tel Aviv, and also holds an M.B.A. from Tel-Aviv University and an LL.M in Business Law from Bar Ilan University.
 
Mr. Yuval Porat, our Vice President of Research and Development, joined us in July 2008.  Prior to joining RADCOM, he was the founder, board member and Vice President of Research and Development of PacketLight Networks for 10 years.  Prior to his tenure at PacketLight, Mr. Porat led the Research and Development at HyNEX that was acquired by Cisco.  Mr. Porat holds both a B.Sc. and an M.Sc. in Electrical Engineering from Tel Aviv University.
 
Mr. Miki Shilinger, our Vice President of Operations, joined us in June 1999.  From May 1997 to May 1999 he was Director of Purchasing and Logistics for Tadiran – Telematics Ltd., an Israeli company involved in the marketing, development and production of systems for the location of vehicles, cargo and people.  Prior to that Mr. Shilinger was a Director of Logistics at Galtronics Ltd., one of the leading companies in the manufacture of portable antennas for cellular systems.  Prior to that Mr. Shilinger was the owner of a Management Information Systems Consulting firm implementing ERP Systems.  Mr. Shilinger has a B.Sc. degree in Industry and Management from Ben-Gurion University.
 
Mr. Uri Har has served as a director since October 2007. He was the Director General of the Electronics and Software Industries Association of Israel from 1984 until 2006.  Prior to that, Mr. Har served for 26 years in engineering and managerial positions in the Israeli Navy where his last assignment was the Israeli Naval Attache in the United States and Canada. Among his various positions in the Israeli Navy, he served for three years (1977 - 1980) as Head of the Budget and Comptroller Department.  He holds a B.Sc. degree and a M.Sc. degree in Mechanical Engineering from the Technion - Israel Institute of Technology.
 
 
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Ms. Irit Hillel has served as a director since October 2007. She has spent the last 18 years as an entrepreneur and senior executive in digital media, technology and financial services firms. She currently operates as an early investor and co-founder of two internet and mobile startups, and is on the advisory board of BioGaming. From 2005 until 2010 she was Partner at Magnolia Capital Partners, providing investment banking services to Israeli high tech and healthcare companies. In 2008 to 2009 she served as Head of Interactive at Animation Lab, a JVP 3D feature animation company. Ms. Hillel served as Head of Mattel Interactive Europe, bringing to market some of Europe’s best-selling computer game titles.  Previously, Ms. Hillel founded and served as EVP business development and board director for PrintPaks, acquired by Mattel Inc. (NYSE: MAT) in 1997. Prior experience also includes VP at Power Paper Ltd., Advisor to Hewlett Packard Co. (NYSE: HPQ), and Investment Manager at Columbia Savings in Beverly Hills, California. Ms. Hillel has an M.B.A. degree from the Anderson Graduate School of Business at UCLA, and a B.Sc. in Mathematics and Computer Science from Tel Aviv University.

Mr. Matty Karp has served as a director since December 2009. He is the managing partner of Concord Ventures, an Israeli venture capital fund focused on Israeli early stage technology companies, which he co-founded in 1997. From 2007 to 2008 he served as the Chairman of Israel Growth Partners Acquisition Corp.  From 1994 to 1999, he served as the Chief Executive Officer of Kardan Technologies, a technology investment company, and continued to serve as a director until October 2001. From 1994 to 1997, he served as the President of Nitzanim Venture Fund, an Israeli venture capital fund focused on early-stage high technology companies. From 1987 to 1994, he served in numerous positions at Elbit Systems Ltd. (NASDAQ and TASE: ESLT). Mr. Karp has served as a director of a number of companies, including: Galileo Technology, which was acquired by Marvell Technology Group (NASDAQ: MRVL); Accord Networks which was acquired by Polycom (NASDAQ: PLCM); Saifun Semiconductors, which merged with Spansion and El Al Israel Airlines (TASE: ELAL).  Mr. Karp received a B.S., cum laude, in Electrical Engineering from the Technion - Israel Institute of Technology and is a graduate of the Harvard Business School Advanced Management Program.
 
                Ms. Rachel (Heli) Bennun has served as a director since December 2012. Ms. Bennun has over 25 years of professional experience in hi-tech companies. In 1988, Ms. Bennun co-founded Arel Communications & Software Ltd. (formerly NASDAQ:ARLC) ("Arel"), a company focused on offering integrated video, audio and data-enabled conferencing solutions, including real time Interactive Distance Learning. Ms. Bennun served as Arel’s CEO and CFO from 1988 until 1998, during which time Arel went public on the NASDAQ (1994).  In addition, Ms. Bennun served as a director of Arel from 1988 until 1998 and as the vice-chairman of Arel's board of directors from 1998 until 2001. In 1996, Ms. Bennun co-founded ArelNet Ltd. (formerly TASE: ARNT) ("ArelNet"), a pioneer in the field of Voice over IP. Ms. Bennun served as ArelNet’s CEO from 1998 until 2001, during which time ArelNet went public on the TASE.  In 2004, Ms. Bennun resumed her position as ArelNet's CEO and a director, until ArelNet was acquired by Airspan Network Inc. in 2005.  From 2006 until 2009, Ms. Bennun served as the CEO and director of OrganiTech USA, Inc. (PINK:ORGT), a pioneer in the Cleantech industry. Ms. Bennun holds an M.Sc and B.Sc. degree in industrial and management engineering from Ben-Gurion University.
 
Ms. Bennun is the domestic partner of Mr. Zohar Zisapel. Otherwise, there are no family relationships between any of the directors or executive officers named above.
 
               B.           COMPENSATION
 
The aggregate direct remuneration paid to all of our directors and officers as a group (10 persons) for the year ended December 31, 2012 was approximately $1.09 million in salaries, bonus, commissions and directors’ fees. This amount includes approximately $195,000 that was set aside or accrued to provide pension, retirement or similar benefits. These amounts do not include the expense of share-based compensation as per ASC Topic 718. During 2012, our directors and officers received, in the aggregate, options to purchase 190,000 ordinary shares under our 2003 Share Option Plan (the "2003 Plan"). These options have an average exercise price of $3.46 per share and expire five to seven years from the grant date.
 
 
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As of December 31, 2012, our current directors and officers as a group held options to purchase an aggregate of 746,623 ordinary shares of the Company. All of these options were granted under the 2003 Plan. The directors are reimbursed for expenses and receive cash and equity compensation, which terms are detailed below.
 
In addition, on September 20, 2010, the Audit Committee of our Board of Directors (the "Audit Committee") and our Board of Directors, and on November 1, 2010, our shareholders, approved cash compensation and equity compensation for our independent directors and external directors in the following amounts:(i) an annual fee of NIS 18,300 (currently equivalent to approximately $5,041) and a per meeting attendance fee of NIS 1,060 (currently equivalent to approximately $292), which amounts are subject to adjustment for changes in the Israeli CPI and changes in the amounts payable pursuant to Israeli law from time to time and (ii) an annual grant of options (under the 2003 Plan) to purchase 10,000 ordinary shares.  The options will be fully vested and immediately exercisable on the applicable date of grant and will expire on the earlier of seven years or 180 days from the date of such director’s termination or resignation from office. The exercise price per share of the options will be equal to the closing price per share of our ordinary shares on NASDAQ on the applicable date of grant, which initially was November 1, 2010, the date of our 2010 annual general meeting.  The exercise price of the options granted on November 1, 2011 was $4.39 per share, which was the closing price per share of the ordinary shares on the NASDAQ on such date.  The exercise price of the options granted on November 1, 2012 was $2.71 per share, which was the closing price per share of the ordinary shares on NASDAQ on such date. The term of such compensation arrangement shall be for three years commencing on November 1, 2010.  If the shareholders approve any change to the terms of the 2003 Plan with respect to external directors, within the meaning of the Israeli Companies Law, who are not independent directors, within the meaning of the rules of the SEC and NASDAQ, during the term of the plan, such new terms shall apply equally to the independent directors. 
 
In addition, on September 20, 2010, our Audit Committee and our Board of Directors, and on November 1, 2010, our shareholders approved the annual grant of options to purchase 30,000 ordinary shares to Mr. Zohar Zisapel.  The terms of the options are the same as those described in the above paragraph.  The term of such compensation arrangement shall be for three years commencing on November 1, 2010.

In addition, on October 22, 2012 our Audit Committee and our Board of Directors, and on December 17, 2012, our shareholders, approved to pay Ms. Rachel (Heli) Bennun, for her services to the Company as a director, cash compensation in an amount equal to the compensation of our other directors (other than our Chairman), as described above, and a grant of options (under the 2003 Plan) to purchase 10,000 ordinary shares.  The options were fully vested and immediately exercisable on the applicable date of grant, which was December 17, 2012, the date of our 2012 annual general meeting.  The options expire on the earlier of seven years or 180 days from the date of such director’s termination or resignation from office.  The exercise price of the options is $2.56 per share, which was the closing price per share of the ordinary shares on the NASDAQ on December 17, 2012. If Ms. Bennun is subsequently reelected at our 2013 annual general meeting of shareholders and our shareholders approve at such meeting (or prior to such meeting) new compensation terms for our directors (other than the Chairman), Ms. Bennun will receive the same compensation as the other directors (other than the Chairman), subject to applicable law.
 
Share Option Plans

Until recently, we had the following two share option plans for the granting of options to our employees, officers, directors and consultants:  (i) the International Employee Stock Option Plan, which expired on September 30, 2008 and (ii) the 2003 Plan, which expired on December 21, 2012. On April 3, 2013 our Board of Directors adopted our 2013 Stock Option Plan (the "2013 Plan"), which expires on April 2, 2023.  As of April 22, 2013, we have not granted any options under the 2013 Plan.  Options granted under our option plans generally vest over a period of between one and four years, and generally expire five to seven years from the date of grant, subject to the discretion of our Board of Directors, which has the authority to deviate from such parameters in respect of specific grants.  The share option plans are administered either by our Board of Directors or, subject to applicable law, by our Compensation Committee, which has the discretion to make all decisions relating to the interpretation and operation of the options plans, including determining who will receive an option award and the terms and conditions of the option awards. On January 28, 2013, our Board of Directors resolved to increase the number of outstanding shares reserved under the 2003 Plan, by 758,167.
 
 
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The Company measures compensation expense for all share-based payments (including employee stock options) at fair value, in accordance with ASC 718 "Compensation – Stock based compensation". We recorded an expense of $672,000 for share-based compensation plans during 2012. During 2012 we granted options to purchase a total of 303,600 ordinary shares which will result in ongoing accounting charges that will significantly reduce our net income. See Notes 2(j) and 12(b) of the Notes to the Consolidated Financial Statements for further information.

As of April 19, 2013, we have granted options to purchase a total of 2,758,296 ordinary shares under all of the Company’s share option plans, of which options to purchase 651,442 ordinary shares have been exercised and options to purchase 16,251 and 987,015 ordinary shares under the International Employee Stock Option Plan and the 2003 Plan, respectively, remain outstanding.
 
In August 2006, we elected, pursuant to Rule 5615(a)(3) of the NASDAQ Listing Rules, to follow our home country practice in lieu of the NASDAQ Listing Rules with respect to the approvals required for the establishment and for material amendments to our share option plans. Consequently, the establishment of share option plans and material amendments thereto is now subject to the approval of our Board of Directors, and is no longer subject to our shareholders’ approval. See also "Item 16G—Corporate Governance."
 
                C.          BOARD PRACTICES
 
Terms of Office
 
Our current Board of Directors is comprised of Zohar Zisapel, Uri Har, Irit Hillel, Matty Karp and Rachel (Heli) Bennun. Our directors are elected by the shareholders at the annual general meeting of the shareholders, except in certain cases where directors are appointed by the Board of Directors and their appointment is later ratified at the first meeting of the shareholders thereafter.  Our non-external directors serve until the next annual general meeting. The three year term of office for our external directors, Mr. Har and Ms. Hillel, expires in 2013.  None of our directors have service contracts with the Company relating to their serving as a director, and none of the directors will receive benefits upon termination of their position as a director. For a description of our compensation of directors see "Item 6.B—Directors, Senior Management and Employees—Compensation."
 
External Directors
 
We are subject to the provisions of the Israeli Companies Law, 5759-1999 (the "Israeli Companies Law"), which became effective on February 1, 2000, superseding most of the provisions of the Israeli Companies Ordinance (New Version), 5743-1983.

Under the Israeli Companies Law and the regulations promulgated pursuant thereto, Israeli public companies, namely companies whose shares have been offered to the public or are publicly traded, are required to appoint at least two natural persons as “external directors”.  A person may not be appointed as an external director if the person, or a relative, partner or employer of the person, or any entity under the person’s control, has or had, on or within the two years preceding the date of the person’s appointment to serve as an external director, any affiliation with the company to whose board the external director is proposed to be appointed; with the controlling shareholder of such company or with any entity controlling or controlled by such company or by the controlling shareholder of such company. The term “affiliation” includes an employment relationship, a business or professional relationship maintained on a regular basis, control and service as an office holder (which term includes a director).
 
 
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An individual is not permitted to be appointed as an external director: (1) in a company that does not have a 25% shareholder, if he has an affiliation (as such term is defined in the Israeli Companies Law) with any person who, at the time of appointment, is the chairman, the chief executive officer, the chief financial officer or a 5% shareholder of the company; or (2) if he or his relative, partner, employer or supervisor or an entity he controls has other than negligible business or professional relations with any of the persons with whom he may not be affiliated.  No person may serve as an external director if the person, the person’s relative, spouse, employer or any entity controlling or controlled by the person, has a business or professional relationship with someone with whom affiliation is prohibited, even if such relationship is not maintained on a regular basis, except negligible relationships.  A public company, entity controlling or entity under common control with the company may not grant an external director, his spouse or child, any benefit, and may not appoint him, his spouse or child, to serve as an officer of the company or of an entity under common control with the company, may not employ or receive professional services in consideration from him or an entity controlled by him unless two years have passed as of the end of service as external director in the company, and regarding a relative who is not a spouse or child – one year as of the end of service as external director.
 
In addition, no person may serve as an external director if the person’s position or other business activities create, or may create, a conflict of interest with the person’s responsibilities as an external director or interfere with the person’s ability to serve as an external director or if the person is an employee of the Israel Securities Authority or of an Israeli stock exchange. If, at the time of election of an external director, all other directors are of the same gender, the external director to be elected must be of the other gender. Following the Amendment Date, if, at the time external directors are to be appointed, all current members of the board of directors who are not controlling shareholders or relatives of such shareholders are of the same gender, then at least one external director must be of the other gender.
 
Pursuant to the Israeli Companies Law, (1) an external director must have either “accounting and financial expertise” or “professional qualifications” (as such terms are defined in regulations promulgated under the Israeli Companies Law) and (2) at least one of the external directors must have “accounting and financial expertise.” Our external directors are Mr. Uri Har and Ms. Irit Hillel. We have determined that Ms. Hillel has the requisite “accounting and financial expertise” and that Mr. Har has the requisite “professional qualifications.”

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

 
  ·
at least a majority of the shares of non-controlling shareholders voted at the meeting vote in favor of the external director’s election; or
 
  ·
the total number of shares of non-controlling shareholders that voted against the election of the external director does not exceed two percent of the aggregate number of voting rights in the company.

The initial term of an external director is three years and may be extended for up to two additional three year terms.  In certain special situations, the term may be extended beyond these periods.  Reelection of an external director is effected through one of the following mechanisms: (1) the board of directors proposed the reelection of the nominee and the election was approved by the shareholders by the majority required to appoint external directors for their initial term; or (2) a shareholder holding 1% or more of the voting rights proposed the reelection of the nominee, and the reelection is approved by a majority of the votes cast by the shareholders of the company, excluding the votes of controlling shareholders and those who have a personal interest in the matter as a result of their relations with the controlling shareholders, provided that the aggregate votes cast in favor of the reelection by such non-excluded shareholders constitute more than 2% of the voting rights in 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 and the compensation committee, which are both required to be comprised of all the external directors.  Mr. Uri Har and Ms. Irit Hillel were elected to serve as external directors for an initial three-year term at our 2007 annual general meeting of shareholders, held on October 24, 2007.  At our 2010 annual general meeting, held on November 1, 2010, our shareholders approved the re-election of Mr. Uri Har and Ms. Irit Hillel as our external directors, each for a second three-year term. Both Uri Har and Irit Hillel qualify as external directors under the Israeli Companies Law, and both are members of the Company’s Audit Committee, Nominating Committee and Compensation Committee.
 
 
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Audit Committee
 
                NASDAQ Requirements
 
Our ordinary shares are listed on NASDAQ, and we are subject to the NASDAQ Listing Rules applicable to listed companies. Under the current NASDAQ Listing Rules, a listed company is required to have an audit committee consisting of at least three independent directors, all of whom are financially literate and one of whom has accounting or related financial management expertise. Uri Har, Irit Hillel and Matty Karp qualify as independent directors under the current NASDAQ requirements, and each is a member of the Audit Committee. Irit Hillel is our "audit committee financial expert." In addition, we have adopted an Audit Committee charter, which sets forth the Audit Committee’s responsibilities.
 
As stated in our Audit Committee charter, the Audit Committee assists our Board of Directors in fulfilling its responsibility for oversight of the quality and integrity of our accounting, auditing and financial reporting practices and financial statements and the independence qualifications and performance of our independent auditors.  The Audit Committee also has the authority and responsibility to oversee our independent auditors, to recommend for shareholder approval the appointment and, where appropriate, replacement of our independent auditors and to pre-approve audit engagement fees and all permitted non-audit services and fees.

                Israeli Companies Law Requirements
 
Audit committee

Under the Israeli Companies Law, the board of directors of a public company is required to appoint an audit committee, which must be comprised of at least three directors and include all of the external directors.  The majority of the members of the audit committee are required to be "independent" (as such term is defined in the Israeli Companies Law) and the chairman of the audit committee is required to be an external director.  The Israeli Companies Law defines "independent directors" as either external directors or directors who: (1) meet the requirements of an external director, other than the requirement to possess accounting and financial expertise or professional qualifications, with audit committee confirmation of such; (2) have been directors in the company for an uninterrupted duration of less than 9 years (and any interim period during which such person was not a director which is less than 2 years shall not be deemed to interrupt the duration); and, (3) were classified as such by the company.   In addition, the following are disqualified from serving as members of the audit committee: the chairman of the board, the controlling shareholder and his relatives, any director employed by the company or by its controlling shareholder or by an entity controlled by the controlling shareholder, a director who regularly provides services to the company or to its controlling shareholder or to an entity controlled by the controlling shareholder, any director who derives most of its income from the controlling shareholder, and any director who derives his salary primarily from a controlling shareholder.
  
In addition: (1) the chairman of the audit committee must be an external director, (2) all audit committee decisions must be made by a majority of the committee members, of which the majority of members present are independent and external directors, and (3) any person who is not eligible to serve on the audit committee is further restricted from participating in its meetings and votes, unless the chairman of the audit committee determines that such person’s presence is necessary in order to present a certain matter, provided however, that company employees who are not controlling shareholders or relatives of such shareholders may be present in the meetings but not in the actual votes and likewise, company counsel and secretary who are not controlling shareholders or relatives of such shareholders may be present in meetings and decisions if such presence is requested by the audit committee.
 
 
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The function of the audit committee is to review irregularities in the management of our business and recommend remedial measures. The audit committee is also required, under the Israeli Companies Law, to approve certain related party transactions. In addition, the responsibilities of the audit committee shall also include classifying company transactions as extraordinary transactions or non-extraordinary transactions and as material or non-material transactions, in which an officer has an interest (which will have the effect of determining the kind of corporate approvals required for such transaction), assessing the proper function of the company’s internal audit regime and determining whether its internal auditor has the requisite tools and resources required to perform his role and to regulate the companies rules on employee complaints, reviewing the scope of work of the company’s independent accountants and their fees, and implementing a whistleblower protection plan with respect to employee complaints of business irregularities.
 
An audit committee of a public company may not approve a related-party transaction under the Israeli Companies Law unless at the time of such approval, the external directors are serving as members of the audit committee and at least one of them is present at the meeting at which such approval is granted.
 
Compensation committee
 
NASDAQ Requirements
 
Under the current NASDAQ Listing Rules, a listed company is required to have a compensation committee comprised solely of independent directors. Our compensation committee consists of Irit Hillel (Chairman), Uri Har and Matty Karp, each of whom satisfies the independence requirements under the current NASDAQ Listing Rules.  The Company has adopted a compensation committee charter, which sets forth the responsibilities of the compensation committee.  The compensation committee is responsible for, among other things, assisting the Board of Directors in the reviewing and approving the compensation structure and policy, including all forms of compensation relating to our directors and executive officers.
 
Israeli Companies Law Requirements
 
Under a recent amendment to the Israeli Companies Law, the board of directors of a public company must establish a compensation committee. The compensation committee must consist of at least three directors who satisfy certain independence qualifications. Under the Israeli Companies Law, the role of the compensation committee is to recommend to the board of directors, for ultimate shareholder approval by a special majority, a policy governing the compensation of office holders based on specified criteria, to review modifications to the compensation policy from time to time, to review its implementation and to approve the actual compensation terms of office holders prior to approval by the board of directors.
 
Internal auditor

Under the Israeli Companies Law, the board of directors of a public company must also appoint an internal auditor proposed by the audit committee.  The duty of the internal auditor is to examine, among other things, whether the company’s conduct complies with applicable law and orderly business procedure.  Under the Israeli Companies Law, the internal auditor may not be an interested party, an office holder or an affiliate, or a relative of an interested party, an office holder or affiliate, nor may the internal auditor be the company’s independent accountant or its representative. An interested party is defined in the Israeli Companies Law as a 5% or greater shareholder, any person or entity that has the right to designate at least one director or the general manager of the company and any person who serves as a director or as a general manager.
 
Mr. Yisrael Gewirt, who is a partner of Fahn Kanne & Co., a member of Grant Thornton, serves as our internal auditor.
 
 
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Exculpation, Indemnification and Insurance of Directors and Officers
 
We have agreed to exculpate and indemnify our office holders to the fullest extent permitted under the Israeli Companies Law. We have also purchased a directors and officers liability insurance policy.  For information regarding exculpation, indemnification and insurance of directors and officers under applicable law and our articles of association, see "Item 10.B—Additional Information—Memorandum and Articles of Association."
 
Management Employment Agreements
 
We maintain written employment agreements with all of our employees.  These agreements provide, among other matters, for monthly salaries, our contributions to Managers’ Insurance and an Education Fund and severance benefits.  Most of our agreements with our key employees are subject to termination by either party upon the delivery of notice of termination as provided therein.
 
Nominating Committee
 
The nominees to our Board of Directors are recommended to our Board of Directors by our Nominating Committee. Such nominees are then approved by our Board of Directors, including a majority of our independent directors. The written procedures addressing the nominating process were approved by our Board of Directors. Zohar Zisapel, Uri Har and Irit Hillel constitute our Nominating Committee. The Nominating Committee is responsible for, among other things, assisting our Board of Directors in identifying prospective director nominees and recommending nominees for each annual meeting of shareholders to our Board of Directors.

                D.          EMPLOYEES
 
As of December 31, 2012, we had 101 employees located in Israel, 8 employees of RADCOM Equipment located in the United States, 9 employees of RADCOM Brazil located in Brazil, 4 employees of RADCOM India located in India and 10 employees in total located in Spain, Singapore, Guatemala, China, Honduras and Paraguay collectively. Of the 101 employees located in Israel, 57 were employed in research and development, 7 in operations (including manufacturing and production), 27 in sales and marketing and customer support, and 10 in administration and management. Of the 8 employees located in the United States, 7 were employed in sales, marketing and customer support and 1 was employed in administration and management.  Of the 9 employees located in the Brazil, 8 were employed in sales, marketing and customer support and 1 was employed in administration and management. Of the 14 employees located in Spain, Singapore, Guatemala, Honduras, Paraguay, India and China, 11 were employed in sales, marketing and customer support and 3 were employed in administration and management. We consider our relations with our employees to be good and we have never experienced a strike or work stoppage.  As of December 31, 2012, all of our 132 employees located worldwide were permanent employees. All of our permanent employees have employment agreements and, with the exception of Brazil, none of them are represented by labor unions.  As of December 31, 2011, we had 101 employees located in Israel, 9 employees of RADCOM Equipment located in the United States, 11 employees of RADCOM Brazil located in Brazil and 11 employees in total located in Spain, Singapore, Guatemala, India and China, collectively.  As of December 31, 2010, we had 91 employees located in Israel, 7 employees of RADCOM Equipment located in the United States and 11 employees in total located in Spain, Singapore, Brazil, India and China, collectively.  

For more information, see "Item 4.B—Information on the Company—Business Overview—Employees."
 
                E.          SHARE OWNERSHIP
 
The following table sets forth certain information regarding the beneficial ownership of our ordinary shares by our directors and officers as of April 19, 2013. The percentage of outstanding ordinary shares is based on 6,464,719 ordinary shares(3)(7) outstanding as of April 19, 2013. Except for Messrs. Zohar Zisapel and David Ripstein, none of our executive officers or directors beneficially owns 1% or more of our outstanding ordinary shares.
 
 
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Name
 
Number of Ordinary Shares Beneficially Owned(1)
   
Percentage of Outstanding Ordinary Shares Beneficially Owned(2)(3)
 
Zohar Zisapel
   
2,285,883
(4)
   
34.4
%
David Ripstein
   
144,000
(5)
   
2.3
%
All directors and executive officers as a group, except Zohar Zisapel and David Ripstein (8 persons)
   
285,457
(6)
   
4.3
%
_______________________
(1)
Except as otherwise noted and subject to applicable community property laws, each person named in the table has sole voting and investment power with respect to all ordinary shares listed as owned by such person.  Shares beneficially owned include shares that may be acquired pursuant to options to purchase ordinary shares that are exercisable within 60 days of April 19, 2013.
 
(2)
For determining the percentage owned by each person or group, ordinary shares for each person or group includes ordinary shares that may be acquired by such person or group pursuant to options to purchase ordinary shares that are exercisable within 60 days of April 19, 2013.
 
(3)
The number of outstanding ordinary shares does not include 5,189 shares held by RADCOM Equipment, Inc., a wholly owned subsidiary and 30,843 shares that were repurchased by us.
 
(4)
Includes (i) 1,992,673 ordinary shares held of record by Mr. Zohar Zisapel, (ii) 44,460 ordinary shares held by RAD Data Communications Ltd. ("RDC"), an Israeli company, (iii) 13,625 ordinary shares held by Klil & Michael Holdings (93) Ltd., an Israeli company wholly owned by Mr. Zohar Zisapel, (iv) 56,139 ordinary shares held of record by Lomsha Ltd., an Israeli company wholly owned by Mr. Zohar Zisapel, (v) 140,000 ordinary shares issuable upon exercise of options, with an average exercise price per share of $5.76, expiring between the years 2013 and 2018, and (vi) 38,986 ordinary shares issuable upon exercise of warrants, with an exercise price per share of $10.69, expiring in October 2013.  The options and warrants listed above are exercisable currently or within 60 days of April 19, 2013. Mr. Zohar Zisapel is a principal shareholder and Chairman of the Board of Directors of RDC.  Mr. Zohar Zisapel and his brother, Mr. Yehuda Zisapel, have shared voting and dispositive power with respect to the shares held by RDC.  This information is based on information provided by Mr. Zohar Zisapel.
 
(5)
Comprised of 144,000 ordinary shares issuable upon exercise of options at an average exercise price per share of 2.84, which expire between the years 2013 and 2017 and are all exercisable within 60 days of April 19, 2013.
 
(6)
 
Each of the directors and executive officers not separately identified in the above table beneficially owns less than 1% of our outstanding ordinary shares (including options or warrants held by each such party, which are vested or shall become vested within 60 days of April 19, 2013) and have, therefore, not been separately disclosed. The amount of shares is comprised of 285,457 ordinary shares issuable upon exercise of options and warrants exercisable within 60 days of April 19, 2013.
 
(7)
On May 6, 2008, our shareholders approved a one-to-four reverse share split, which we affected in June 2008.
 
For a description of our share option plans for the granting of options to our employees see "Item 6.B—Directors, Senior Management and Employees—Compensation—Share Option Plans."
 
 
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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 19, 2013, by each person or entity known to own beneficially 5% or more of our outstanding ordinary shares based on information provided to us by the holders or disclosed in public filings with the SEC. The voting rights of our major shareholders do not differ from the voting rights of other holders of our ordinary shares. As of April 19, 2013, our ordinary shares had a total of 37 holders of record, of which 18 were registered with addresses in the United States. We believe that the number of beneficial owners of our shares is substantially greater than the number of record holders, because a large portion of our ordinary shares is held of record in broker "street name." As of April 19, 2013, U.S. holders of record held approximately 70% of our outstanding ordinary shares.
 
Name