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, 2016, there were 11,586,228 ordinary shares, NIS 0.20 par value per share, outstanding.

 

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INTRODUCTION

 

Except for the historical information contained herein, the statements contained in this annual report on Form 20-F, or this Annual Report, are forward-looking statements, within the meaning of the Private Securities Litigation Reform Act of 1995, 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, or 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.

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^® is our only registered trademark. All other trademarks and trade names appearing in this Annual Report are owned by their respective holders.

Below are definitions of certain technical terms that are used throughout this Annual Report that are important for understanding this Annual Report.

GLOSSARY OF TECHNICAL INDUSTRY TERMS

 

 

 

 

 

 

 

 

NOTE REGARDING FORWARD-LOOKING STATEMENTS

This Annual Report contains express or implied “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995 and other U.S. Federal securities laws.

These forward-looking statements include, but are not limited to:

 

 

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 statements of operations data for the years ended December 31, 2016, 2015 and 2014 and the selected consolidated balance sheet data as of December 31, 2016 and 2015 from our audited consolidated financial statements and notes included in this Annual Report. Our selected consolidated statements of operations data for the years ended December 31, 2013 and 2012 and the selected consolidated balance sheet data as of December 31, 2014, 2013 and 2012, have been derived from 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, or 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.

Statement of Operations Data:		Year Ended December 31, (in thousands of U.S. dollars except share and per share data)
		2016				2015				2014				2013				2012
Revenues:
Products and related services		$	8,642			$	15,500			$	18,342			$	17,917			$	12,480
Projects			17,534				622				2,205
Warranty and Support			3,334				2,551				3,089				2,565				3,306
			29,510				18,673				23,636				20,482				15,786
Cost of revenues:
Products and related services			5,603				3,924				7,863				7,540				5,765
Projects			2,902				117				487				-				-
Warranty and Support			477				285				343				350				417
			8,982				4,326				8,693				7,890				6,182
Gross profit			20,528				14,347				14,943				12,592				9,604
Operating expenses:
Research and development			8,047				6,071				5,812				5,615				6,102
Less - royalty-bearing participation			1,693				1,582				1,664				1,537				1,567
Research and development, net			6,354				4,489				4,148				4,078				4,535
Sales and marketing, net			8,528				7,834				7,295				7,592				8,515
General and administrative			4,523				2,393				2,262				2,051				2,107
Total operating expenses			19,405				14,716				13,705				13,721				15,157
Operating income (loss)			1,123				(369	)			1,238				(1,129	)			(5,553	)
Financial income (expenses), net			816				(433	)			(332	)			(291	)			(314	)
Income (loss) before taxes on income			1,939				(802	)			906				(1,420	)			(5,867	)
Taxes on income			(24	)			(121	)			(180	)			---				(120	)
Net income (loss)			1,915				(923	)			726				(1,420	)			(5,987	)
Basic net income (loss) per ordinary share		$	0.18			$	(0.11	)		$	0.09			$	(0.19	)		$	(0.93	)
Weighted average number of ordinary shares used to compute basic net income (loss) per ordinary share			10,406,897				8,572,681				8,088,974				7,340,056				6,442,068
Diluted net income (loss) per ordinary share		$	0.18			$	(0.11	)		$	0.08			$	(0.19	)		$	(0.93	)
Weighted average number of ordinary shares used to compute diluted net income (loss) per ordinary share			10,779,547				8,572,681				8,592,387				7,340,056				6,442,068
Balance Sheet Data:
Working capital		$	38,854			$	9,643			$	10,062			$	7,762			$	5,194
Total assets		$	54,568			$	20,135			$	20,318			$	19,645			$	19,867
Shareholders' equity		$	40,143			$	9,863			$	10,262			$	7,499			$	4,997
Share capital		$	523			$	372			$	361			$	335			$	251

 

                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)
March (through March 24, 2017)			3.693				3.614
February 2017			3.768				3.659
January 2017			3.860				3.769
December 2016			3.867				3.787
November 2016			3.876				3.799
October 2016			3.856				3.778
September 2016			3.786				3.746

On March 24, 2017, the daily representative rate of exchange between the NIS and U.S. dollar as published by the Bank of Israel was NIS 3.646 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 daily rate of exchange during the relevant period as published by the Bank of Israel:

Year		Average (NIS)
2017 (through March 24, 2017)			3.740
2016			3.841
2015			3.884
2014			3.577
2013			3.609
2012			3.858

 

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

 

Investing in our ordinary shares involves a high degree of risk.  You should carefully consider the risks described below before investing in our ordinary shares.

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.

 

 

Risks Related to Our Business and Our Industry

 

     Our business is dependent on a limited number of significant customers, and the loss of our significant customers could harm our results of operations.

     Our business is dependent on a limited number of significant customers. For example, our two largest customers accounted for approximately 79% of our revenue in fiscal 2016 and 57% in fiscal 2015. The loss of any significant customer, a significant decrease in business from any such customer or a reduction in customer revenue due to adverse changes in the terms of our contractual arrangements, market conditions, customer circumstances or other factors could harm our results of operations and financial condition. Revenue from individual customers may fluctuate from time to time based on the commencement, scope and completion of projects or other engagements, the timing and magnitude of which may be affected by market or other conditions.

A reduction in some CSPs' revenues and profitability, which could lead them to decrease their investment in capital equipment and infrastructure, may in turn affect our revenues and results of operations. A continued slowdown in our customers' investment in capital equipment and infrastructure might 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 NFV transformation, 4G cellular, Triple Play networks, VoLTE, 5G and IoT. During the last few years, some of the CSPs have experienced a reduction in their revenues from subscribers and lower profitability, which affected their spending budget, and this trend may continue. 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.

 Our future success also depends upon the increased utilization of our solutions by next-generation network operators and specifically virtualized networks, who may not adopt our technology.

 During the last few years, developments in the communications industry such as the impact of general global economic conditions, industry consolidation, emergence of new competitors, commoditization of voice services, the plans of CSPs to shift, transform and adapt their network operations to the NFV and changes in the regulatory environment, have had a material 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. Over the last few years, 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.

 

Past and future economic conditions, including turmoil in the financial and credit markets, may adversely affect our business.

The recent economic environment may have 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 business, financial condition, results of operations and liquidity. In addition, any disruption in the ability of our customers to access liquidity could lead them 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, may 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 we may incur losses.

Our plans to focus most of our sales efforts on tier 1 and other leading CSPs in the North American and European markets may not be successful.

With the recognition of our technological leadership in the service assurance for NFV we have enhanced our presence in North America and Western Europe, where a significant share of the NFV activity is expected to take place. Although our selection in 2015 by AT&T Services, Inc., a top-tier leading North American mobile operator, or AT&T, is expected to significantly help open doors to a relatively untapped market for us, we may not be successful in expanding our business in said markets as we plan.

Our expectation that the NFV market will continue gaining momentum during 2017 and thereafter may not materialize.

We believe that the majority of the industry’s leading CSPs will transform their network to the NFV or are at the very least, evaluating their transformation to NFV. Our expectation is that the NFV market will continue to gain momentum during year 2017 and thereafter. However, our expectations may not be correct, and the actual pace of NFV transformation may take longer than we anticipate, or may not occur at all. If the NFV market does not continue to grow, our business, financial condition and results of operations may suffer.

 We have a history of net losses and may not achieve or sustain profitability in the future.

We have a history of net losses. Although we were profitable in 2016 and in 2014, in 2015 we incurred a net loss of $0.9 million. We may not continue to 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 market for our products is characterized by changing technology, and its 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, network infrastructure, changing customer requirements, evolving industry standards and frequent new product introductions. These changes could reduce or shift the market for our products or require us to develop new products and to keep adapting them, in order to remain up to date with our customers' requirements. For example, in light of the development of the NFV, LTE, VoLTE and 3G networks, we developed and launched the MaveriQ in 2014, which replaced our previous OmniQ hardware-based solutions. In addition to that, we enhanced our solutions to support NFV as we saw during 2015 and 2016, an increased interest from CSPs using NFV-capable solutions for service assurance and CEM.

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 and market new and enhanced products successfully and on a timely basis, will be significant factors in our ability to remain competitive. 

In addition, a 2014 cooperation agreement called OSSii aimed to facilitate interoperability between network management systems from different vendors. If this initiative succeeds, it could lead to a decreased need for our probe-based solutions, as network elements could supply the performance and quality measurements provided by our probe-based solutions. As a result, we cannot quantify the impact of new product introductions on our future operations.

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 the past we experienced, and may also 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;
	·	seasonal factors that may affect capital spending by customers, such as the varying fiscal year-ends of customers;
	·	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 revenues consist of variable costs, which include hardware purchasing, packaging, royalties to the Israel Innovation Authority, or the Innovation Authority of the Israeli Ministry of Economy and Industry (the successor of the Office of Chief Scientist), or the MoE, license fees paid to third parties and import taxes, recurring and non-recurring write-off of inventory, importation taxes, warranty expenses, subcontractors’ expenses and of fixed costs which include facilities' payments, employees' salaries and related costs and overhead expenses. A major part of our costs of sales is relatively variable, and the costs are determined based on our anticipated revenue. We believe, therefore, that quarter-to-quarter comparisons of our operating results may not be a reliable indication of future performance.

 

 

Our revenues in any quarter 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.

 

We may experience a delay in generating or recognizing revenues for several reasons, including due to revenue recognition accounting requirements. In many cases, we cannot recognize revenue from an order prior to customer acceptance, which may take three to 12 months from the commencement of the project. Therefore, a major part of the revenue of a fiscal quarter is derived from the backlog of orders under delivery, and generally is not tied to the date of a customer's order or the delivery date.

 

Our revenues for a specific quarter may also be difficult to predict and may be affected if we experience a non-linear sales pattern. We generally experience significantly higher levels of sales orders towards the end of a quarter, as a result of customers submitting their orders late in the quarter. Furthermore, orders received towards the end of the quarter are usually not delivered within the same quarter, and are usually 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 for that quarter could be adversely affected.

 

Due to the factors described above, as well as other unanticipated factors, in future quarters our results of operations could fail to meet any guidance we may give to the public from time to time or the expectations of public market analysts or investors. If this occurs, the price of our ordinary shares may fall.

We expect our gross margins to vary over time, and we may not be able to sustain or improve upon our recent level of gross margins, which may have a material adverse effect on our future profitability.

 

We may not be able to sustain or improve upon our recent level of gross margins. Our gross margins 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
	·	increases in warranty costs.

 

Further deterioration in gross margins, due to these or other factors, may have a material adverse effect on our business, financial condition and results of operations.

 

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

 

 Our sales derived from emerging market countries may be materially adversely affected by economic, exchange rates, regulatory and political developments in those countries.

 

In parallel to our increased sales focus going forward in North America, Western Europe and additional developed markets, in 2017 we plan to continue to generate revenue from various emerging market countries. As these countries represent a portion of our existing business and our expected growth, economic or political turmoil in these countries could materially adversely affect our revenues and results of operations. Our investments in emerging market countries may also be subject to risks and uncertainties, including unfavorable taxation treatment, exchange rates, 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.

Any reversal or slowdown in the 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 resolutions of these uncertainties.

 

Our inventory may become obsolete or unusable.

 

We hold some hardware equipment in inventory. Changes in our business 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 portion of our inventory is located on our customers' premises, either as spare parts or 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.

 

Most of our customers usually require a detailed and comprehensive evaluation process before they order our products. Our sales process may be subject to delays that may significantly decrease our revenues and which could result in the eventual cancellations of some sale opportunities.

 

We derive all of our revenues from the sale of products and related services for CSPs. As common practice in our industry, 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. As a result, the sales cycle generally takes between three to six months for small transactions, and between nine 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 are further lengthened, or such continued delays result in the eventual cancellation of any sale opportunities, it may have a material adverse effect on our business, financial condition and results of operations.

 

We have experienced periods of growth and consolidation of our business. If we cannot adequately manage our business, our results of operations may suffer.

Throughout 2016, we substantially increased the size of our workforce and we may continue to increase our workforce, in North America and possibly in other regions during 2017 in order to enable us to meet our projections for 2017 and beyond. There is no guarantee that these efforts to increase our work force will have a positive effect on our business. Future growth or consolidation may place a significant strain on our managerial, operational and financial resources.

 

We cannot be sure that we have made adequate allowances for the costs and risks associated with possible expansion and consolidation of our business, or that our systems, procedures and managerial controls will be adequate to support our operations. Any delay in implementing, or transitioning to, new or enhanced systems, procedures or controls may adversely affect our ability to record and report financial and management information on a timely and accurate basis. We believe that significant growth may require us to hire additional personnel. Competition for qualified personnel can be intense in the areas where we operate, and the processes of locating, training and successfully integrating qualified personnel into our operations can be lengthy and expensive. If we are unable to successfully manage our expansion, we may not succeed in expanding our business, our expenses may increase and our results of operations may be adversely affected.

In addition, employees 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. Furthermore, we believe that our future success will largely depend upon our ability to attract, incentivize and retain highly skilled personnel.

 

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 service assurance and CEM solutions. We expect that competition will increase in the future, both with respect to products and solutions that we currently offer and products and solutions that we are developing.  Moreover, manufacturers of data communications and telecommunications equipment which are current and potential partners of ours, may in the future incorporate into their products capabilities similar to ours, which would reduce the demand for our products.  

 

Some 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.

In July 2015, NetScout Systems Inc. announced that it had completed the acquisition of Danaher Corporation's communications business, which includes Tektronix Communications, enabling it to expand its network performance monitoring and security monitoring capabilities. This transaction resulted in NetScout Systems Inc. holding a very significant market share, making it a stronger competitor, and may as a result have a negative impact on our competitive environment.

 

Our non-competition agreements with our employees may not be enforceable under Israeli law. 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 generally enter into non-competition agreements with our key employees. 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 for a limited period. Under applicable Israeli law, we may be unable to enforce these agreements or any part thereof against our Israeli employees. If we cannot enforce our non- competition agreements against our Israeli (or any other) employees, then we may be unable to prevent our competitors from benefiting from the expertise of these former employees, which could impair our business, results of operations and ability to capitalize on our proprietary information.

 

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 an extent upon the continuing services of our executive officers and other key employees, including our Chief Executive Officer, Mr. Yaron Ravkaie, the Chief Executive Officer of our U.S. subsidiary, Radcom, Inc., or RADCOM US, Mr. Eyal Harari, and our Vice President of Research and Development, Mr. Hilik Itman. 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.

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.

 

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 CSPs 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 CSPs, we may be required to agree to such terms and conditions, which may decrease our revenues and/or increase the time it takes to convert orders into revenues, and could result in a material adverse effect on our business, financial condition and results of operations.

 

The complexity and scope of the solutions we provide to larger CSPs 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 CSPs is increasing. The larger and more complex such projects are, the greater the operational risks associated with such projects. These risks include failure to deliver successfully our solution, the 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, such as the project we have for AT&T, 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 and support agreements which may affect 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, or the extended maintenance agreements. 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 under 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, financial condition and results of operations.

 

We depend on limited sources for key components and if we are unable to obtain these components when needed, we may experience delays in delivering our products.

 

We currently obtain key components for our products from a limited number of suppliers. We have one long-term contract with a supplier of hardware and servers, which is a major supplier in its field. The agreement is scheduled to expire during 2017, with a one-year extension option. We do not have long-term supply contracts with any of our other existing suppliers. This presents the following risks:

 

	·	delays in delivery could interrupt and delay delivery 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; and
	·	suppliers could discontinue the supply of components used in our products. This may require us to modify our products, which may cause delays in product shipments and/or delivery, increased production costs and increased product prices.

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, non-disclosure 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 certain suppliers with access to sensitive information. We currently have two pending patent applications and we are in the process of filing additional patent applications. However, we have no registered patents and these measures may not be adequate to protect our technology from third-party infringement. Additionally, effective intellectual property protection may not be available in every country in which we offer, or intend to offer, our products.

 

 

We may expand our business or enhance our technology through partnerships and 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 may be 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, financial condition and results of operations could be adversely affected. As of the date of this Annual Report, we have not proceeded with such acquisitions.

 

Because we received grants from the Innovation Authority, we are subject to ongoing restrictions.

 

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.

 

 

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/or 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. Furthermore, in some cases we may compete, or buy third party components from other companies who compete, with some of these companies controlled by Zohar Zisapel and/or Yehuda Zisapel.

For more information, see "Item 7.B- Major Shareholders and Related Party Transactions—Related Party Transactions" and "Item 10.B- Fiduciary Duties of Shareholders."

 

While we are headquartered in Israel, approximately 98% of our sales in 2016, 93% of our sales in 2015 and 86% of our sales in 2014 were generated outside of Israel, including in North America, Europe, Asia and South America. Our international sales will be limited if we cannot continue to establish and maintain relationships with international distributors and resellers, set up additional foreign operations, expand international sales channel management, hire additional personnel, develop relationships with international CSPs 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:

· ·	legal and cultural differences in the conduct of business; 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 including additional labor laws, particularly in Brazil and India, 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 and resellers for indirect sales;
·	tariffs and other trade barriers;
·	economic and political instability in foreign markets;
·	wars, acts of terrorism and political unrest;
·	language and cultural barriers;
·	lack of integration of foreign operations;
·	currency fluctuations;
·	variations in effective income tax rates among countries where we conduct business;
·	potential foreign and domestic tax consequences and withholding taxes that limit the repatriation of earnings;
·	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;
·	laws and business practices favoring local competitors;
·	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 have a material adverse effect on our business, results of operations, and financial condition. The continuing weakness in foreign economies could have a significant negative effect on our future operating results.

 

Because our revenues are generated primarily in foreign currencies (mostly in U.S. dollars but also in other currencies), but a significant portion of our expenses are incurred in New Israeli Shekels, our results of operations may be seriously harmed by currency fluctuations.

 

We sell in markets throughout the world and most of our revenues are generated in U.S. dollars. We also generate revenues in Brazilian Real, or BRL, Euro and other currencies. Financing activities are also made in U.S. 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 as well as between other currencies 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.

 

 

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. Also, as a portion of our revenues is denominated in BRL, devaluation in this currency may cause financial expenses related to our intercompany short term balances. 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.

 

Rules of the U.S. Securities and Exchange Commission, or the SEC , adopted pursuant to Section 404, or Section 404, of the Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act, require us to include a report of management on our internal control over financial reporting in our annual report, that contains an assessment by management of the effectiveness of our internal control over financial reporting. In addition, because the public float of our shares exceeded $75 million at June 30, 2016, our independent registered public accounting firm is required to attest to and report on the effectiveness of our internal control over financial reporting. Our management or our auditors may not conclude that our internal control over financial reporting is 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, our auditors or we may identify material weaknesses or significant deficiencies in our assessments of our internal control over financial reporting. Failure to maintain effective internal control over financial reporting could result in investigation or sanctions by regulatory authorities and could have an adverse effect on our business, financial condition and results of operations, and investor confidence in our reported financial information

If we determine that we are not in compliance with Section 404, we may be required to implement new internal controls and 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 have a material adverse effect on our business, financial condition, results of operations, financial reporting or financial results and could result in our conclusion that our internal controls over financial reporting are not effective.

The market price of our ordinary shares has and may continue to fluctuate widely, which could adversely affect us and our shareholders.

 

From January 1, 2016 to March 24, 2017, our ordinary shares have traded on the NASDAQ Capital Market, or the NASDAQ, as high as $21.89 and as low as $11.29 per share. As of March 24, 2017, the closing price of our ordinary shares on NASDAQ was $21.20 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 global 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;
	·	announcements by us or our competitors of technological innovations or new and enhanced products;
	·	announcements by us or our competitors of significant contracts or capital commitments;
	·	actual or anticipated variations in our competitors quarterly operating results, and 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;

	·	regulatory changes that impact our pricing of products and services and competition in our markets;
	·	acquisitions or strategic alliances by us or others in our industry;
	·	changes in estimates of our performance or recommendations by financial analysts;
	·	operating results that vary from the expectations of financial analysts and investors;
	·	changes in our shareholder base;
	·	changes in status of our intellectual property rights;
	·	future sales of our ordinary shares;
	·	fluctuations in the trading volume of our ordinary shares; and
	·	addition or departure of key personnel.

 

In addition, the stock market in general, and the market for Israeli and technology companies in particular, has been highly volatile. Many of these factors are beyond our control and may materially adversely affect the market price of our ordinary shares, regardless of our performance. Shareholders may not be able to resell their ordinary shares following periods of volatility because of the market's adverse reaction to such volatility.

 

From time to time we may choose to raise financing.  If adequate funds are not available on terms favorable to us or to our shareholders, our operations and growth strategy may be affected.

From time to time we may choose 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. If adequate funds are not available on terms favorable to us or to our shareholders, our operations and growth strategy may be affected.

  

The trading volume of our shares is relatively low and it may be low in the future.

 

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 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 neighboring Arab countries, the Hamas militant group and the Hezbollah. Any hostilities involving Israel or the interruption or curtailment of trade between Israel and its trading partners could adversely affect our operations and results of operations. Since October 2000, there have been increasing occurrences of terrorist violence. In 2006, a conflict between Israel and the Hezbollah in Lebanon resulted in thousands of rockets being fired from Lebanon into Israel. In 2008, Israel engaged in an armed conflict with Hamas in the Gaza Strip, which involved missile strikes against Israel and negatively affected business conditions in Israel. In 2012 and 2014, Israel experienced a similar armed conflict, resulting in hundreds of rockets being fired from the Gaza Strip. Ongoing and revived hostilities or other Israeli political or economic factors, such as, an interruption of operations at the Tel Aviv airport, could prevent or delay shipments of our components or products. If continued or resumed, these hostilities may negatively affect business conditions in Israel in general and our business in particular. In the event that hostilities disrupt the ongoing operation of our facilities or the airports and seaports on which we depend to import and export our supplies and product candidates, our operations may be materially adversely affected. 

In addition, since 2010 political uprisings and conflicts in various countries in the Middle East, including Egypt and Syria, are affecting the political stability of those countries. It is not clear how this instability will develop and how it will affect the political and security situation in the Middle East. This instability has raised concerns regarding security in the region and the potential for armed conflict. Any potential future conflict could also include missile strikes against parts of Israel, including our offices and facilities. Such instability may lead to deterioration in the political and trade relationships that exist between the State of Israel and certain other countries. Any armed conflicts, terrorist activities or political instability in the region could adversely affect business conditions, could harm our results of operations and could make it more difficult for us to raise capital. Parties with whom we do business may sometimes decline to travel to Israel during periods of heightened unrest or tension, forcing us to make alternative arrangements when necessary in order to meet our business partners face to face. Several countries, principally in the Middle East, still restrict doing business with Israel and Israeli companies, and additional countries may impose restrictions on doing business with Israel and Israeli companies if hostilities in Israel or political instability in the region continues or increases. Similarly, Israeli companies are limited in conducting business with entities from countries that are considered to be in a state of war with Israel, including Iran, Lebanon and Syria. In addition, the political and security situation in Israel may result in parties with whom we have agreements involving performance in Israel claiming that they are not obligated to perform their commitments under those agreements pursuant to force majeure provisions in such agreements.

 

 Although the Israeli government has in the past covered the reinstatement value of certain damages that were caused by terrorist attacks or acts of war, we cannot assure you that this government coverage will be maintained or, if maintained, will be sufficient to compensate us fully for damages incurred and the government may cease providing such coverage or the coverage might not suffice to cover potential damages. Any losses or damages incurred by us could have a material adverse effect on our business. Any armed conflicts or political instability in the region would likely negatively affect business conditions generally and could harm our results of operations.

 

Further, in the past, the State of Israel and Israeli companies have been subjected to economic boycotts. Several countries still restrict business with the State of Israel and with Israeli companies. These restrictive laws and policies may have an adverse impact on our operating results, financial conditions or the expansion of our business.

 

We currently benefit from government programs that may be discontinued or reduced.

 

We currently receive grants under Government of Israel programs. 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 develop 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 Innovation Authority."

 

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, or 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. Shareholders may request an appraisal in connection with a tender offer for a period of six months following the consummation of the tender offer, but the purchaser is entitled to stipulate that any tendering shareholder surrender its appraisal rights.

 

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.

 

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 45 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.

It may be difficult to effect service of process, assert U.S. securities laws claims and enforce U.S. judgments in Israel against us or our directors, officers and auditors named in this Annual Report.

 

We were incorporated in Israel. All of our directors reside outside of the United States, and most of our assets are located outside of the United States. Therefore, a judgment obtained against us, or any of these persons, including a judgment based on the civil liability provisions of the U.S. federal securities laws, may not be collectible in the United States and may not necessarily be enforced by an Israeli court. It also may be difficult for you to affect service of process on these persons in the United States or to assert U.S. securities law claims in original actions instituted in Israel. Additionally, it may be difficult for an investor, or any other person or entity, to initiate an action with respect to United States securities laws in Israel. Israeli courts may refuse to hear a claim based on an alleged violation of United States securities laws reasoning that Israel is not the most appropriate forum in which to bring such a claim. In addition, even if an Israeli court agrees to hear a claim, it may determine that Israeli law and not United States law is applicable to the claim. If United States law is found to be applicable, the content of applicable United States law must be proven as a fact by expert witnesses, which can be a time consuming and costly process. Certain matters of procedure will also be governed by Israeli law. There is little binding case law in Israel that addresses the matters described above. As a result of the difficulty associated with enforcing a judgment against us in Israel, you may not be able to collect any damages awarded by either a United States or foreign court.

 

As a foreign private issuer whose shares are listed on the NASDAQ, we may follow certain home country corporate governance practices instead of certain NASDAQ requirements.

As a foreign private issuer whose shares are listed on the NASDAQ, we are permitted to follow certain home country corporate governance practices instead of certain requirements of the NASDAQ Stock Market Rules. As a foreign private issuer listed on the NASDAQ, we may follow home country practice with regard to, among other things, the composition of the board of directors, compensation of officers, director nomination process and quorum at shareholders' meetings. In addition, we may follow home country practice instead of the NASDAQ requirement to obtain shareholder approval for certain dilutive events (such as for the establishment or amendment of certain equity-based compensation plans, an issuance that will result in a change of control of the company, certain transactions other than a public offering involving issuances of a 20% or more interest in the company and certain acquisitions of the stock or assets of another company).

Accordingly, our shareholders may not be afforded the same protection as provided under NASDAQ's corporate governance rules. For more information, see "Item 16G— Corporate Governance" below.

The rights and responsibilities of our shareholders are governed by Israeli law and differ in some respects from those under Delaware law.

Because we are an Israeli company, the rights and responsibilities of our shareholders are governed by our articles of association and by Israeli law. These rights and responsibilities differ in some respects from the rights and responsibilities of shareholders in a Delaware corporation. In particular, a shareholder of an Israeli company has a duty to act in good faith towards the company and other shareholders and to refrain from abusing his, her or its power in the company, including, among other things, in voting at the general meeting of shareholders on certain matters. Israeli law provides that these duties are applicable to shareholder votes on, among other things, amendments to a company's articles of association, increases in a company's authorized share capital, mergers and interested party transactions requiring shareholder approval. In addition, a shareholder who knows that it possesses the power to determine the outcome of a shareholders' vote or to appoint or prevent the appointment of a director or executive officer of the company has a duty of fairness towards the company. However, Israeli law does not define the substance of this duty of fairness. There is little case law available to assist in understanding the implications of these provisions that govern shareholder behavior.

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. We were incorporated in 1985 under the laws of the State of Israel, and 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 US. In 1996, we incorporated a wholly-owned subsidiary in Israel, RADCOM Investments (96) Ltd., or RADCOM Investments, located at our office in Tel Aviv, Israel. In 2010, we established a wholly-owned subsidiary in Brazil, RADCOM do Brasil Comercio, Importacao e Exportacao Ltda., or RADCOM Brazil. In 2012, we incorporated a wholly-owned subsidiary in India, RADCOM Trading India Private Limited, or RADCOM India.

 

B.	BUSINESS OVERVIEW

 

Overview

We are a leading provider of NFV-ready service assurance for CSPs. We have a strong track-record of innovation.

RADCOM’s solution - MaveriQ - continuously monitors network performance and quality of services, to optimize user experience for CSPs’ subscribers.

MaveriQ is the “first to market” software-based probe solution and is the first to support NFV networks.

 

In 2016, we have evolved our solution to meet the highest-level requirements of AT&T, the first CSP launching a full NFV eco-system. As new and existing customers seek to manage their existing networks while evaluating and deploying NFV-based architectures, we believe we are well positioned with both our advanced software-based solutions for service assurance and our growing industry track record. 

 

We specialize in solutions for next-generation mobile and fixed networks, including LTE, VoLTE, IMS, VoIP, WiFi, VoWiFi and mobile broadband, representing a market opportunity of over $1 billion.

MaveriQ enables CSPs to smoothly migrate their networks to NFV by monitoring and assuring both physical network and NFV-based network and consequentially, ‘hybrid’ networks. With the rate of transition between physical and virtualized networks taking place gradually, CSPs will need to manage ‘hybrid’ networks for the foreseeable future. As a result, service assurance solutions that provide service and network performance visibility in both physical and virtual environments, are expected to gain priority.

CSPs across the globe use our solutions to deliver high quality services, reduce churn, manage network performance, analyze traffic and enhance customer care. Our solutions incorporate cutting-edge technologies and a wealth of knowledge acquired by partnering with many of the industry’s leading CSPs for over two decades. Our carrier-grade solutions support both mobile and fixed networks and scale to terabit data bandwidths to enable big data analytics.

Our solutions deliver specialized capabilities for virtualized infrastructure and next-generation networks, such as LTE, LTE-A, VoLTE, IMS, VoIP, UMTS/GSM and mobile broadband and allow CSPs to monitor and proactively improve quality of experience for their subscribers. The key benefits of our solutions are:

·

advanced software-based architecture;

·

ease of deployment and management;

·

improved customer retention;

·

reduced subscriber churn rates;

·

improved service availability and quality;

 

 

·

unique ability to correlate session information and provide an end to end view;

·

greater ability to install the solution as a virtual network function for seamless integration into all NFV infrastructures;

·

scalability for next-generation services;

·

enhanced ability to collect all network packets for a complete and comprehensive view of the network and the customer experience;

·

increased operational efficiency and lower costs;

·

the inclusion of support for multiple protocols for end-to-end network coverage;

·

the existence of both network-wide views and drilldown to an individual subscriber level;

·

the support for terabyte networks;

·

accelerated deployment of new services and migration to NFV;

·

substantially quicker and smoother deployment of our solution;

·

real-time capabilities; and

·

end to end view of the customer experience.

Our software-based solutions enable CSPs to manage both existing physical networks and next-generation, NFV-based architectures. We recognized that CSPs would require a new approach for service assurance and CEM solutions in order to monitor huge volumes of data and support NFV-based network deployments. In February 2014, we launched our MaveriQ solution, which incorporates software-based probes, and which subsequently replaced our OmniQ hardware-based solution. During 2015 and 2016, we launched and substantially enhanced our NFV solution for service assurance and our CEM solution.

In December 2015, our MaveriQ solution was selected by AT&T for its next-generation virtualized network environment. AT&T’s deployment represents the first NFV networks of scale in the industry. We are now in the process of deploying our software-based NFV solution with AT&T, and we are leveraging this success in discussions with other CSPs that are looking to manage existing networks while evaluating their transformation to the next-generation NFV architectures.

Industry Background

 

Our Customers and the Markets for Our Solutions

 

We operate in a large market that is currently undergoing significant transformation with significant potential for growth. The customers in our market consist primarily of mobile and fixed CSPs who are responsible for providing mobile and fixed telecommunications services. Our solutions are used by multiple divisions within a CSP’s organization, including engineering, operations, marketing, management and customer care departments.

CSPs face many challenges in managing their network; from the rapid growth in mobile data traffic to complexities in managing services that are delivered across multiple vendor technologies. These challenges are intensifying with further traffic growth and the emergence of new technologies and services, such as M2M, the IoT and 5G. With the need to manage millions of various network elements and services from multiple vendors and technologies, deploying a service assurance and CEM solution is an essential part of a CSP’s network.

Similar to how virtualization has become widely deployed in many data centers and large enterprises, many CSPs are now looking to reduce costs and become more agile by transitioning from physical network elements to software-centric NFV architectures. NFV enables CSPs to replace dedicated physical network elements with software-based solutions that run-on standard, non-proprietary, third-party hardware. Although the pace of NFV transformation is uncertain, major CSPs are currently evaluating and/or moving parts of their network to support NFV. NFV and SDN are expected to play an important role in 5G networks. For instance, 5G will support diverse use cases optimized by dynamic network slicing using SDN and NFV architectures.

While NFV provides many benefits, transitioning infrastructure to NFV adds significant complexity when it comes to service assurance and CEM. Prior probe and management solutions were not designed for NFV. Whereas prior solutions focused on monitoring physical network devices, new solutions must broaden capabilities to monitor internal VM-to-VM communications between various virtualized network functions all hosted on the same server as well as communications between servers.

 

Our Strategy

 

Our objective is to be the market leader for service assurance solutions both for virtualized and hybrid networks. We plan to increase sales by leveraging our product leadership and innovation around software-based solutions and NFV, as well as take advantage of the experience gained from implementing the largest, most advanced NFV deployment to date (with AT&T). In addition, we also offer our solutions and expertise to new and existing tier 1 CSPs in our targeted geographical regions. We plan to maintain our technical advantage over competitors by further investing in our software-based solutions.

Key elements of our strategy include:

 

·

Targeting CSPs who are evaluating and/or migrating to NFV. The majority of the industry’s largest CSPs are either evaluating NFV or have started deploying virtualized solutions for their network functionality. We believe we are better positioned than competitors who offer service assurance and CEM solutions that do not support (or have not yet been deployed) in large-scale NFV environments. In order to transition to NFV, CSPs generally need to replace or upgrade their service assurance solution with a software that can support both existing networks as well as NFV-based architectures. Our solution, which monitors both existing networks and NFV, ensures a smooth migration and enables CSPs to future-proof their investment in a service assurance solution. Our selection in December 2015 by AT&T has been noted by many CSPs, as this CSP is well regarded in leading the industry. As a result, as other CSPs look for vendors to support their existing networks and NFV, we believe we are well positioned to leverage our vast experience in true software-based and fully virtualized service assurance in order to successfully expand our deployment base to other CSPs.

 

·

Investing in North America, Western Europe and developed markets. With our advanced deployment  and our growing reputation as a technology leader in the industry, we are expanding our presence in North America and Western Europe and engaging with selected CSPs in developed markets, a segment of the overall geographical market where we expect to see a large share of investments taking place around NFV. Accordingly, we are focusing our sales and marketing activities on these regions. We are specifically engaging tier 1-2 CSPs in those territories for potential opportunities and cross-country implementation of our solutions.

·

Targeting service providers migrating to LTE, VoLTE and 5G. We have begun to benefit from the deployments by leading service providers of VoLTE and LTE networks. We are seeing increased deployments of multiple technology (3G, LTE, IMS and Next Generation Network) networks, which involve greater complexity and require more sophisticated service assurance and CEM solutions than legacy networks. We believe that our ability to secure customers with deployments of our solution in multiple types of networks positions us to benefit from this trend.

·

We view ourselves as market leaders introducing to the market optimized costing models. As a true software-based company we offer our existing and potential customers an appealing commercial model that combines both predictable spending on capital and operating expenditures with lower spending on service assurance and CEM solutions, in comparison to the appliance-based legacy solutions our competition continues to offer. With our optimized commercial model, we offer our customers several alternatives that enable them to grow their business and traffic on the network without impacting their spending with the Company.

·

As NFV market leaders, we participate in key industry programs such as Intel Network Builders, Amdocs Network Cloud Service, OpenNFV Partner Program. Open Source MANO (OSM) and ECOMP (Enhanced Control, Orchestration, Management & Policy). The ECOMP platform was created by AT&T, committed to open source in February 2017 and is now part of ONAP (Open Network Automation Platform) which is the merger of Open Source ECOMP and Open-O, two of the leading open source MANO initiatives.

·	Drive business expansion and long term relationship with our install base. Our solutions are typically purchased initially for a specific purpose within a CSP. As other parts of a CSP’s organization seek to use our solution for other purposes, we benefit from additional sales. Furthermore, as CSPs upgrade and expand their networks, such as adding capacity or launching new services, our customers tend to purchase additional solutions from us assuring end-to-end monitoring of their subscribers' behavior.
·	Focus our analytics capabilities to enhance the business value of our solution. We aim to position our MaveriQ analytics as extending our business intelligence suite beyond standard reporting and dashboards to include advanced capabilities ranging from ad hoc querying, self-business intelligence (BI), multi-dimensional analyses, data mining, forecasting and optimization. We aim to have our MaveriQ analytics being used for improving core operations, customer experience management and marketing for discerning trends and creating forecasts, allowing the CSP to gain insights in real-time.

 

Products and Solutions

 

The MaveriQ solution is a comprehensive, next-generation probe-based customer and service assurance solution designed to enable CSPs to carry out end-to-end voice and data quality monitoring and to manage their networks and services. The MaveriQ solution offers users a full array of analysis and troubleshooting tools, delivering a comprehensive, integrated network service view that facilitates performance monitoring, fault detection and network and service troubleshooting.

MaveriQ is a software-only solution, with an inherent capability to deploy the entire solution on virtualized and/or bare metal servers using the same software. This enables customers to use MaveriQ on their physical and cloud infrastructures as they transition from legacy hardware based networks to NFV based virtualized networks.

The MaveriQ solution consists of a powerful and user-friendly central management module and a broad range of passive software-based probes used to gather transmission quality data from various types of networks and services, including VoIP, UMTS, LTE, IMS data and others. Signaling and media attributes and quality measurement 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 KPIs and KQIs.

The MaveriQ solution monitors multiple types of 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 MaveriQ solution offers the service provider full end-to-end visibility of the network across technologies. The MaveriQ solution displays performance and quality measurements from both the signaling and the user planes, based on a broad range of passive software based probes, which are installed on standard, non-proprietary third-party hardware that function together with the MaveriQ solution to deliver essential functionality.

This service assurance solution presents a seamless integration between traditional network monitoring and troubleshooting solutions, and it provides an advanced set of service assurance monitoring applications: network troubleshooting, network quality monitoring, service quality monitoring, customer quality of service monitoring, and customer service level agreements monitoring.

 

The MaveriQ solution is designed to enable CSPs 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 HSPA, LTE, VoLTE and IMS;
	·	migration of the network core to IP technology using IMS or SIGTRAN;
	·	successful delivery of advanced, complex services such as VoIP IMS and video conferencing; and
	·	pro-active 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.

 

CSPs use the MaveriQ solution for a wide array of use cases, such as the following:

Customer and Service Assurance

	·	Troubleshooting – the MaveriQ solution enables CSPs 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 – CSPs use the MaveriQ solution to analyze the behavior of network components and customer network usage to understand trends and performance level and optimization, with the goal of identifying faults before they compromise the end-user experience
	·	Fault detection – CSPs use the MaveriQ solution’s automatic fault detection and service KPIs to alert them to network problems as they arise.
	·	Pre-Mediation – the MaveriQ solution generates CDRs (call detail records) needed to feed third-party OSSs or other solutions.

Roaming and Interconnect Analysis

The MaveriQ solution can be used by CSPs to monitor their roaming and interconnect traffic. By identifying problematic links, CSPs are able to avoid revenue loss, to detect problems with specific roaming partners, and to manage interconnection KPIs.

Customer Experience Management, or CEM

The MaveriQ solution provides the visibility and invaluable data for CSPs to manage both network and service performance and to ensure quality of service for its subscribers. The MaveriQ solution monitors a wide range of measurement sessions that are meaningful to the end user. By analyzing these measurements in real time and applying business intelligence, the MaveriQ solution provides 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 solutions include the below:

·

Qinsight delivers rich, interactive dashboards and visualizations, with options to drill, sort, filter, and group the data on the fly with smart drag-and-drop capabilities. This lets the CSP filter through huge amounts of network and subscriber data to focus on specific areas for deep marketing insights. Qinsight also provides advanced data analytics: trending, forecasting, priority ranking, period over period, states and formulas as well as self-BI that provides the CSP a user-initiated, easy ad hoc dashboard creation and customization tool.

 

 

·

Marketing Analytics allows the CSP to understand usage patterns and data to build a plan and leverage the insight and data we provide from the network to build and update service profile, that better fits the needs of the customer, and to stay ahead of competitors. Marketing Analytics aggregates and correlates data from network, device, app and browsing usage, framing a comprehensive 360° view of the customer. This allows CSPs to deliver a truly personalized service, with adjusted subscriber plans, optimized device troubleshooting, enhanced upsell options, and more effectively marketed campaigns.

·

Customer Care Application, or QiCare, helps CSPs to reduce churn by monitoring and maintaining a high level of satisfaction for the individual subscriber, groups of subscribers, and the entire subscriber base. QiCare enables CSPs to view subscriber reports for individual subscribers and helps them to understand the subscriber's behavior and the quality of the different services being used online.

·

QVIP reports SLA for defined subscriber groups. In today's saturated telecom market, subscribers often abandon their CSP due to frustration over quality of service, with customer churn contributing to significant loss of revenue. RADCOM's QVIP application helps CSPs to monitor and maintain a high level of satisfaction for the individual subscriber, a group of subscribers and an entire network.

·

QRoam yields detailed roaming analysis, enabling service providers to continually verify the quality of service subscribers are receiving as they roam. Network issues are more rapidly resolved, and voice and data services are maintained at a high standard for all the CSP’s roaming subscribers as well as incoming roaming customers, increasing revenue rewards.

·

QMyHandset enables identification of problematic handsets, and provides analysis of the cause of the problem. By identifying problematic handsets, CSPs 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.

·

QCell analyzes performance quality, and QoE, by geographical cell and cell sector. QCell identifies underutilized or congested cells by location and time frame, letting you know where to realign or redistribute cell traffic. QCell also shows location-based service utilization for marketing statistics purposes.

The following table shows the breakdown of our consolidated sales for the fiscal years 2016, 2015 and 2014 by product line:

		Year ended December 31,
		2016				2015				2014
		(In thousands of U.S. dollars)
The MaveriQ (including OmniQ)		$	28,841			$	18,498			$	23,023
Others		$	669			$	175			$	613
Total		$	29,510			$	18,673			$	23,636

 

 

Sales and Marketing Organization

 

We sell to customers throughout the world mainly via direct channels but also via indirect channels.

 

Direct channels: Most of our sales are made through a direct channel, whereby our customers (the end-users) can enter into an agreement directly with us. During 2016, this direct channel was used mainly in North America, South America and Asia.

In North America we operate through RADCOM US, which primarily sells our products to end-users directly. 

In Brazil we operate through RADCOM Brazil, which primarily sells our products to end-users in the Brazilian market directly.

In India, we operate through RADCOM India, which primarily provides marketing services and customer support worldwide. Our products are sold to the end-users directly by RADCOM Ltd.

We have regional sales support offices in China and Singapore. These offices support our distributors and direct sales in these regions. 

Indirect channels: In several markets we sell our products through independent distributors and resellers who market communications-related hardware and software products. 

We continue to search for new distributors and resellers to penetrate new geographical markets and new customers, and to better serve our target markets.

 

Our distributors, agents and resellers serve as a local representative in certain countries as part of our sales, marketing and support team. They help sell, deploy and service our solutions, offer technical support in the end-user's native language, and attend to customer needs during local business hours.

 

Geographic Markets: The table below indicates the approximate breakdown of our revenue by territory, based on the location of the end-customer:

 

		Year ended December 31, (in millions of U.S. dollars)												Year ended December 31, (in percentages)
		2016				2015				2014				2016				2015				2014
North America			19.2				1.0				1.9				65.1				5.4				8.1
Europe			0.9				1.2				3.2				3.1				6.4				13.5
Asia (Excluding Philippines)			0.3				0.6				0.8				1.0				3.1				3.6
Philippines			5.0				8.1				3.5				16.9				43.2				15.0
South America (Excluding Brazil)			0.8				2.4				4.2				2.7				13.2				17.9
Brazil			2.5				3.5				6.5				8.5				18.7				27.3
Others			0.8				1.9				3.5				2.7				10.0				14.6
Total revenues			29.5				18.7				23.6				100	%			100	%			100	%

 

 

Competition

The markets for our products are competitive, and we expect that competition will continue in the future, both with respect to products that we are currently offering and products that we are developing. Our principal competitors include Anritsu, Astelia, Empirix, Ericsson, Exfo, Huawei, NetScout, Nokia, Polystar  and Viavi. In addition to these competitors, we expect competition from established and emerging communications, network management and test equipment companies. Many of our 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. Furthermore, the transition to NFV and software-based solutions could possibly open the market to new competitors or bring in competitors from adjacent markets. For more information, see "Item 3.D - Risks Related to Our Business and Our Industry."

In July 2015, NetScout Systems Inc. announced that it had completed the acquisition of Danaher Corporation's communications business, which includes Tektronix Communications. Each of NetScout and Tektronix have a significant share in the markets for our products, and the competitive landscape pursuant to this purchase where two significant players have combined into one player, may change significantly. We believe that this may also open new opportunities for us, mainly due to potential new prospects with their install base.

 

We believe that we are differentiated from our competitors in six main areas:

·

our leadership in providing full service assurance solutions for NFV networks;

·

the advanced technology (such as real-time processing, big data support and high capacity performance that underlies our solutions);

·

the multi-technology correlation capabilities that supports all major technologies – 3G, 4G, LTE, IMS, VoLTE and VoIP -  within the same solution;

·

our solution being full software-based providing cost-efficiency, rapid deployment times and agility in development;

·

Support for both physical and NFV networks to allow CSPs who have yet to transform to the NFV, to accelerate NFV deployments and smoothly transition from physical infrastructure whilst using the same solutions; and

·

proven flexibility and responsiveness in a dynamic customer and technology environment.

In addition, CSPs are facing strong competition both from other CSPs and from over-the-top, or  OTT, players who are offering more and more similar services. In order to fight for the end customers’ satisfaction, CSPs will need to gain deeper insight into customer behavior, enabling them to tailor processes based on customer preferences.

Following our strategic deployment with AT&T, we believe that we are considered the most advanced vendor in the market for Service Assurance solutions for NFV and Hybrid implementations. 

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 our strategic goal list to establish 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 Original Equipment Manufacturer, or OEM, partners. In addition, we routinely contact our customers to solicit feedback and promote full usage of our solutions. We may provide our customers with a free warranty period which includes bug-fixing and a hardware warranty on our products.  After the initial warranty period, we offer extended warranties which can be purchased for multi-year periods. Generally, the cost of the extended warranty is an annual maintenance fee based on a percentage of the overall cost of the product.

 

·

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 the sale of 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. This strategy is advantageous in terms of the time zone, culture and language. For example, in our Brazil and India offices we established local support teams responsible for first level engagements with customers (tier 1).

·

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, technical training 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, may be highest in a certain 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.

 

Development Facilities

Our corporate office and development facilities are located in Tel Aviv, Israel, and consist primarily of software development, testing, quality control and installation. 

Research and Development

 

In 2016, most of our research and development efforts focused on the development for the NFV. We expect to continue to invest significant efforts in research and development for the NFV in 2017.

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 costs.  

We intend to continue developing products that meet key industry standards, to support important protocols as they emerge and maintain our technology leadership.

 

Our gross research and development costs were approximately $8.0 million in 2016, $6.1 million in 2015 and $5.8 million in 2014, representing 27.3%, 32.5% and 24.6% of our sales, respectively.  Aggregate research and development expenses funded by the Innovation Authority were approximately $1.7 million in 2016, $1.6 million in 2015 and $1.7 million in 2014. For more information on the Innovation Authority, see "Innovation Authority" below. We expect to continue to invest significant resources in research and development.

 

As of December 31, 2016, our research and development staff consisted of 72 employees in Israel and six employees in India an increase of 27 employees compared to December 31, 2015. A significant part of our Research and development activities take place at our facilities in Tel Aviv.  We occasionally use independent subcontractors for portions of our development projects.

 

Innovation Authority

 

 

 

In May 2010, we received a notice from the Innovation Authority regarding alleged miscalculations in the amount of royalties paid by us to the Innovation Authority for the years 1992 through 2009. See "Item 3.D. Risk Factors – Risks related to our Business and Our Industry" - because we received grants from the Innovation Authority, we are subject to ongoing restrictions as detailed above.

 

Binational Industrial Research and Development Foundation

 

We received from the Israel-U.S. Binational Industrial Research and Development Foundation, or 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, 2016, our contingent liability to the BIRD Foundation for funding received was approximately $366,000. We have not received grants from the BIRD Foundation since 1996. 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.

Indian Subsidiary and China Office Funding

In April 2012 and in April 2014, the MoE approved our application for funding to help set up our Indian subsidiary and China office, respectively, as part of a designated grant plan for the purpose of setting up and establishing a marketing agency in India and China. 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 and China, based on the approved budget for the plan for a period of three years.

We are obligated to pay to the MoE, over a period of five years commencing as of the lapse of the third year anniversary of the grant, royalties of 3% of increased sales in the target market, with respect to the year during which the grant was approved (2012 for India, and 2014 for China), over a period of five years but not more than the total linked amount of the grant received.

The total amount of marketing grants that the Company has received from the MoE as of December 31, 2016, with respect to our offices in China and our subsidiary in India, is $619,000. As of December 31, 2016, no liability had been accrued.

 

 

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 a registered trademark for the name Omni-Q^®. We currently have two pending patent applications in the United States, and we are in the process of filing additional patent applications.  In addition, we usually enter into non-disclosure and confidentiality agreements with our employees, distributors, sales representatives and with suppliers and sub-contractors who have access to sensitive information.

 

Employees

 

As of December 31, 2016, we have a total of 192 employees, out of which 133 employees are located in Israel, 8 employees of Radcom US are located in the United States, 11 employees of RADCOM Brazil are located in Brazil, 28 employees of RADCOM India are located in India and 12 employees in total are located in Germany, Spain, Singapore, China and UK, collectively. Of the 133 employees located in Israel, 72 were employed in research and development, 3 in operations (including assembly), 44 in sales and marketing and customer support, and 14 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 11 employees located in the Brazil, 9 were employed in sales, marketing and customer support and 2 were employed in administration and management. Of the 28 employees located in India, 6 were employed in research and development, and 20 sales, marketing, product and customer support and 2 were employed in administration. Of the 12 employees located in Germany, Spain, Singapore, China and UK, 11 were employed in sales, marketing and customer support and 1 was 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. All of our 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 certain provisions of collective bargaining agreements among the Histadrut (General Federation of Labor in Israel), or the Histadrut, and the Coordinating Bureau of Economic Organizations (including the Industrialists' Association), or the CBEO, that are applicable to our Israeli employees by virtue of expansion orders of the Israeli Ministry of Economy (formerly known as the Ministry of Industry, Trade and Labor), 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.

 

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 employees of RADCOM 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 17.3% of the employee's base salary.  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 that varies from 3% - 58% of the employee's base salary.

In India, we provide benefits in form of health coverage, education fund, house rent allowance and life insurance fund, in an amount equal to 25% of the employee’s salary.

C.	ORGANIZATIONAL STRUCTURE

 

In January 1993, we established RADCOM US, 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 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 US	New Jersey
RADCOM Investments	Israel
RADCOM Brazil	Brazil
RADCOM India	India

For more information, see "Item 7.B—Major Shareholders and Related Party Transactions—Related Party Transactions" below.

 

D.	PROPERTY, PLANTS AND EQUIPMENT

 

We currently lease an aggregate of approximately 22,830 square feet of office space in Tel Aviv, Israel, from affiliates of our principal shareholders.

 

This space includes our development facilities, which consist primarily of programming, documenting, quality control, testing and bug fixing, as well as from time to time, installation of software components on third party hardware.

 

In 2016, we extended our lease agreement and expanded the square feet we lease, and the aggregate annual lease and maintenance payments for the Tel Aviv premises were approximately $588,000 of which approximately $571,000 was paid to affiliates of our principal shareholders. In the extension to the lease agreement we entered in 2016, the lessor committed to participate and reimburse renovation expenses of up to $730,000.   In 2016, we subleased approximately 646 square feet of our Tel Aviv premises, to unrelated parties, and our aggregate annual lease payments for such premises were approximately $3,000. We may, in the future, lease additional space from affiliated parties.  

We also lease an aggregate of approximately 2,850 square feet of office space in Paramus, New Jersey, from an affiliate of our principal shareholders, and subleased approximately 1,260 square feet of such space to a related party. In 2016, our aggregate annual lease payments for such premises were approximately $57,000, and we received approximately $24,000 from the related party for the sub-lease.

 

We also lease an aggregate of approximately 1,480 square feet of office space in Brazil, 785 square feet in India, 400 square feet in Singapore, and 100 square feet in China. The aggregate annual lease payments for those premises in 2016 were approximately $49,000, $89,000, $11,000 and $4,000 respectively.

 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.

 

Overview

 

We provide Service Assurance solutions for CSPs. Our world leading, innovative solutions are uniquely positioned to fulfill the CSPs’ ongoing needs to monitor their networks (fixed and mobile) and assure the delivery of a quality service to their subscribers; both on NFV networks and non-virtual networks.

 

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 financing activities are made in U.S. dollars. Accordingly, we consider the U.S. dollar to be our functional currency and our consolidated financial statements are prepared in dollars.

As we evaluate our growth prospects and manage our operations for the future, we believe that the adoption of NFV by leading CSPs will be a major engine of our growth. 

We continue to believe that a main part of our growth will be the continue deployment of LTE, VoLTE, Triple Play and 3G networks.

 

	·		We focused on leveraging our AT&T NFV implementation and our value proposition to leading tier 1 and other carriers in North America, Western Europe and selected carriers from other developed markets;
	·		In parallel, in developing markets, including South America, Eastern Europe and Asia, we targeted customers rolling out  LTE, IMS, 3G and VoIP services; this included expanding our business with our key existing customers and other carries in those territories;
	·		We pursued strategic partnerships, including OEM partnerships, and teaming agreements; and
	·		We took part and continue to take part in leading technology programs for NFV, including Open Source Mano (OSM) and AT&T’s Enhanced Control, Orchestration, Management, and Policy (ECOMP) platform (now ONAP - Open Network Automation Platform due to consolidation with Open-O initiative).

 

 

In February 2014, we officially launched and started selling MaveriQ, our new software-based solutions. The MaveriQ solutions replaced our OmniQ solutions, which was our hardware-based solutions. Our transition from hardware-based solutions to software-based solutions and the NFV solution has contributed to our 2016 results. We believe that our leading NFV-ready solutions will be the leading factor of our revenues in 2017.

Revenues. In general, our revenues are derived from sales of our products and solutions, projects of fixed price contracts, to a lesser extent, from sales of extended warranty and support services. Revenues consist of gross sales, less discounts and refunds, when applicable.

 

Cost of revenues.  Cost of revenues consists of labor and related costs, including costs incurred in the developments and customizations for projects, bill of materials, purchase of hardware and royalties for software components from third parties, deployment costs, support, warranty expenses, packaging, import taxes, allocation of overhead expenses, recurring and non-recurring write-off of inventory and others, impairment of indirect taxes, subcontractors’ expenses, shipping and handling costs, license fees paid to third parties and royalties to the Innovation Authority and share-based compensation. As part of our plan to reduce product cost and improve flexibility, we shifted during the last two years to a model whereby we install our software-based solutions on standard, non-proprietary third-party hardware that functions together with our software to deliver the product's essential functionality.

The cost of revenues increased mainly due to cost of projects, that comprised mainly of employees' salaries and related costs incurred in the development and customization of the Company’s solution as well as cost of third party hardware related to the products and related services revenue.

 

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 third parties’ solutions into our own.  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 retrieving additional reports and related information.  Most of our solutions consist of a software installed on standard off the shelf hardware, that function together to deliver the product's essential functionality. Since in most cases there are no incremental hardware costs associated with the sale of the add-on software, the gross margins on these sales are higher.

 

Research and Development expenses, Net.  Research and development expenses, net consist primarily of salaries and related expenses, including share-based compensation, and, to a lesser extent, payments to subcontractors and for materials and overhead expenses. The allocation of overhead expenses consists of a variety of costs, including rent, office and associated expenses (including telecommunications expenses). The methodology for allocating these expenses depends on the nature of the expense.  Costs of rent and associated costs are based on the square meters used by the R&D department while the other expenses are allocated based on headcount.  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 Innovation Authority.

 

Sales and Marketing expenses, Net.  Sales and marketing expenses, net consist primarily of salaries and related expenses, including share-based compensation, commissions to representatives, advertising, trade shows, promotional expenses, domestic and international travels, web site maintenance, write-offs and overhead expenses, net of grants received from the MoE.

 

 

General and Administrative Expenses. General and administrative expenses consist primarily of salaries and related expenses including share-based compensation, and related personnel expenses for executives, 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 Income (Expenses), Net.   Financial income (expenses), net, in 2016 and 2015, consist primarily of interest earned on bank deposits, bank charges, and gains and losses from the exchange rate differences, including of monetary balance sheet items denominated in non-U.S. dollar currencies.

 

Summary of Our Financial Performance for the Fiscal Year Ended 2016 Compared to the Fiscal Year Ended 2015

 

 For the year ended December 31, 2016, our revenues were $29.5 million, compared with $18.7 million in 2015, reflecting an increase of approximately 58.0%. On an operating basis, the Company provided $9.5 million in cash from operating activities during 2016, compared to $1.9 million provided during 2015. The Company's net income for the year ended December 31, 2016 was $1.9 million, compared with a net loss of $0.9 million for 2015. In 2016, the Company increased revenues by approximately 58% compared to 2015, increased its cost of revenues by approximately 108%, and increased its operating expenses by approximately 32%, compared to 2015.

As of December 31, 2016, our cash and cash equivalents totaled $42.9 million, compared with $8.7 million as of December 31, 2015. The improvement in our cash and cash equivalents in 2016 was mainly due to the payments of approximately $19.2 million received from Amdocs Software Systems Limited, or Amdocs, under the AT&T engagement and the net proceeds of $21.3 million received from our follow-on public offering completed in 2016.

Our 2016 net income includes non-cash expenses due to share-based compensation that totaled $2.5 million.

 

Our cost of revenues increased relatively more than our revenues, which resulted in a decrease of our gross margin to 70% in 2016 compared with 77% in 2015. The increase in our cost of revenues was due to cost of  developments and customizations incurred in  projects, mainly salaries, costs of third party hardware and inventory write-offs.

Reportable Segments

 

Management receives sales information by customers 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.

 

 

A.	OPERATING RESULTS

Financial Data for Year Ended December 31, 2016 compared with Year Ended December 31, 2015

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

 

		Year ended December 31,
		2016				2015
Revenues			100	%			100	%
Cost of revenues			30.4				23.2
Gross profit			69.6				76.8
Operating expenses:
Research and development			27.3				32.5
Less royalty-bearing participation			5.7				8.5
Research and development, net			21.6				24.0
Sales and marketing ,net			28.9				42.0
General and administrative			15.3				12.8
Total operating expenses			65.8				78.8
Operating income (loss)			3.8				(2.0	)
Financial income (expenses), net			2.8				(2.3	)
Income (loss) before taxes on income			6.6				(4.3	)
Taxes on income			(0.1	)			(0.7	)
Net income (loss)			6.5				(5.0	)

 

For more information, see "Item 7.B—Major Shareholders and Related Party Transactions—Related Party Transactions".

Revenues by product line
		Year ended December 31, (In millions of U.S. dollars)												% Change
		2016				2015				2014				2016 vs. 2015				2015 vs. 2014
The MaveriQ (including the Omni-Q family)			28.8				18.5				23.0				56				(20	)
Others			0.7				0.2				0.6				250				(67	)
Total revenues			29.5				18.7				23.6				58				(21	)

 

Revenues per geographic region, based on the location of the end-customer

 

		Year Ended December 31, (in millions of U.S. dollars)												Year Ended December 31, (as percentages)
		2016				2015				2014				2016				2015				2014
North America			19.2				1.0				1.9				65.1				5.4				8.1
Europe			0.9				1.2				3.2				3.1				6.4				13.5
Asia (Excluding Philippines)			0.3				0.6				0.8				1.0				3.1				3.6
Philippines			5.0				8.1				3.5				16.9				43.2				15.0
South America (Excluding Brazil)			0.8				2.4				4.2				2.7				13.2				17.9
Brazil			2.5				3.5				6.5				8.5				18.7				27.3
Other			0.8				1.9				3.5				2.7				10.0				14.6
Total revenues			29.5				18.7				23.6				100	%			100	%			100	%

 

In 2016, the Company had two customers in the United States and the Philippines that amounted to $18.3 million and $5 million, respectively, of the total consolidated revenues. In 2015, the Company had two customers, one in the Philippines and one in Brazil, which amounted to $8.1 million and $2.7 million, respectively, of the total consolidated revenues.

 

Cost of Revenues and Gross Profit
		Year Ended December 31, (in millions of U.S. dollars)
		2016				2015				2014
Cost of revenues – Products and related services			5.6				3.9				7.9
Cost of revenues - Projects			2.9				0.1				0.5
Cost of revenues – Warranty and support			0.5				0.3				0.3
Total Cost of revenues			9.0				4.3				8.7
Gross profit			20.5				14.3				14.9

 Cost of Revenues.  During 2016, our gross profit as a percentage of revenues, calculated to include variable costs, which include purchasing, packaging, royalties to the Innovation Authority, license fees paid to third parties recurring, warranty expenses and non-recurring write-off of inventory and import taxes, was 70% compared to 78% in 2015, which reflected the increase in our cost of revenues , mainly salaries cost relating to the developments and customizations for projects, costs of third party hardware and inventory write-offs.

 

The cost of products and related services as part of our cost of revenues also include employees' salaries and related costs and overhead expenses of approximately $2 million for 2016, and $1.5 million for 2015.  Our cost of revenues included an expense of $118,000 for share-based compensation in 2016, and $33,000 for share-based compensation in 2015.  

The following table provides the operating costs and expenses of the Company in 2016, 2015 and 2014, as well as the percentage change of such expenses in 2016 compared to 2015.

		Year ended December 31, (in millions of U.S. dollars)												% Change 2016 vs 2015				% Change 2015 vs. 2014
		2016				2015				2014
Research and development			8.0				6.1				5.8				31.1				5.2
Less royalty-bearing participation			1.7				1.6				1.7				6.3				(5.9	)
Research and development, net			6.4				4.5				4.1				42.2				9.8
Sales and marketing, net			8.5				7.8				7.3				9.0				6.8
General and administrative			4.5				2.4				2.3				87.5				4.3
Total operating expenses			19.4				14.7				13.7				32.0				7.3

 

 

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

 

                Sales and Marketing Expenses, Net.  Sales and marketing expenses increased from approximately $7.8 million in 2015 to approximately $8.5 million in 2016. The increase in our sales and marketing expenses from 2015 to 2016 is mainly attributable to an increase in the number of employees (includes recruitment fees) and subcontractors. As a percentage of total revenues, sales and marketing expenses in 2016 and 2015 were 28.9% and 42%, respectively. Our sales and marketing expenses included an expense of $199,000 for share-based compensation in 2016 and $380,000 for share-based compensation in 2015

 

General and Administrative Expenses.  General and administrative expenses increased from approximately $2.4 million in 2015 to approximately $4.5 million in 2016. The increase in our general and administrative expenses from 2015 to 2016 is mainly attributable to an increase in the share-based compensation and increase in salary and related expenses.  As a percentage of total revenues, general and administrative expenses in 2016 and 2015 were 15.3% and 12.8%, respectively. Our general and administrative expenses included approximately $1.5 million for share-based compensation in 2016 and $467,000 for share-based compensation in 2015.  

 

 Financial Income (Expenses), Net. In 2016, the financial income, net, was approximately $816,000 compared to financial expenses, net, of approximately $433,000 in 2015. The change in our financial expenses, net from 2015 to 2016 is attributable to an increase in foreign currency translation income of $989,000 and an increase of $260,000 in interest income due to higher cash balances in 2016.

 

Financial Data for Year Ended December 31, 2015 compared with Year Ended December 31, 2014

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

		Year ended December 31,
		2015				2014
Revenues			100	%			100	%
Cost of Revenues			23.2				36.8
Gross profit			76.8				63.2
Operating expenses:
Research and development			32.5				24.6
Less royalty-bearing participation			8.5				7.1
Research and development, net			24.0				17.5
Sales and marketing ,net			42.0				30.9
General and administrative			12.8				9.6
Total operating expenses			78.8				58.0
Operating income (loss)			(2.0	)			5.2
Financial income (expenses), net			(2.3	)			(1.4	)
Income (loss) before taxes on income			(4.3	)			3.8
Taxes on income			(0.7	)			(0.8	)
Net income (loss)			(5.0	)			3.0

 

For more information, see "Item 7.B—Major Shareholders and Related Party Transactions—Related Party Transactions".

 

		Year Ended December 31, (in millions of U.S. dollars)								Year Ended December 31, (as percentages)
		2015				2014				2015				2014
Europe			1.2				3.2				6.4				13.5
North America			1.0				1.9				5.4				8.1
Asia (Excluding Philippines)			0.6				0.8				3.1				3.6
Philippines			8.1				3.5				43.2				15.0
South America (Excluding Brazil)			2.4				4.2				13.2				17.9
Brazil			3.5				6.5				18.7				27.3
Other			1.9				3.5				10.0				14.6
Total revenues			18.7				23.6				100	%			100	%

In 2015, the Company had two customers, one in the Philippines and one in Brazil, that amounted to $8.1 million and $2.7 million, respectively, of the total consolidated revenues. During 2014, the Company had three customers, one in each of Brazil, the Philippines and Israel, that amounted to $5.2 million, $3.5 million and $2.8 million, respectively, of the total consolidated revenues.

 

Cost of Revenues and Gross Profit.

 

During 2015, our gross profit as a percentage of revenues, calculated to include variable costs, which include purchasing, packaging, royalties to the Innovation Authority, license fees paid to third parties recurring and non-recurring write-off of inventory and import taxes, was 77% compared to 63% in 2014.

 

The fixed costs of our cost of revenues also include employees' salaries and related costs and overhead expenses of approximately $1.5 million for 2015 and $2.1 million for 2014.  Our cost of revenues included an expense of $33,000 for share-based compensation in 2015 and $12,000 for share-based compensation in 2014.

 

Our gross profit in 2015 and 2014 was 77% and 63%, respectively, which reflected the decrease in our cost of revenues due to our transition to a software based probe and the usage of third party hardware.

 

 

Operating Costs and Expenses

 

Research and Development expenses. Research and development expenses, gross, increased from $5.8 million in 2014 to $6.1 million in 2015. As a percentage of total revenues, research and development expenses, gross, increased from 24.6% in 2014 to 32.5% in 2015. The increase in our gross research and development expenses from $5.8 million in 2014 to $6.1 million in 2015 is attributable partially to the increase in the number of employees and related expenses. As of December 31, 2015, we employed 51 research and development engineers, compared to 46 as of December 31, 2014. 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 $529,000 for share-based compensation in 2015 and $178,000 for share-based compensation in 2014.

 

 Sales and Marketing expenses, net.  Sales and marketing expenses increased from approximately $7.3 million in 2014 to approximately $7.8 million in 2015. The increase in our sales and marketing expenses from 2014 to 2015 is mainly attributable to an increase in commissions to third parties. As a percentage of total revenues, sales and marketing expenses in 2015 and 2014 were 42% and 30.9%, respectively. Our sales and marketing expenses included an expense of $380,000 for share-based compensation in 2015 and $146,000 for share-based compensation in 2014.  

 

 

 Financial Expenses, Net. Financial expenses, net, increased to approximately $433,000 in 2015 compared to approximately $332,000 in 2014. The increase in our financial expenses, net from 2014 to 2015 is attributable to an increase in foreign currency translation expenses of $101,000.

Taxes on Income.  During 2015, we recorded tax expenses of $121,000, compared to $180,000 in 2014, reflecting withholding taxes that were due on payments from certain customers in Central America and Asia.

Impact of Inflation and Foreign Currency Fluctuations

 

Most of our revenues are generated in U.S. dollars and the financing activities are made in U.S. dollars. We also generate revenues in BRLs, Euros and other currencies; however, we consider the U.S. dollar to be our functional currency. A portion of our revenues is denominated in BRLs, and in the future additional revenues may be denominated in currencies other than U.S. dollars.

Since a significant portion of our expenses is in NIS, as we pay our Israeli employees' salaries in NIS, the dollar cost of our operations is influenced by the exchange rates between the NIS and the dollar. Fluctuations in exchange rates between the U.S. dollar, the BRL, Euro, and other currencies in which we generate revenue, and the U.S. dollar, may also have an effect on our results of operations. With respect to 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.

 

Effective 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 business activities.

 

 

B.	LIQUIDITY AND CAPITAL RESOURCES

 

 

In previous years, we generated losses attributable to our operations, excluding 2014 where we generated gains.  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 a major shareholder all of which are no longer relevant. 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 the pipeline for 2017. Without derogating from the foregoing estimate regarding our existing capital resources and cash flows from operations, we may decide to raise additional funds in 2017.  We believe that, if required, we will be able to raise additional capital or reduce discretionary spending to provide the required liquidity beyond the next twelve months.

 

Net Cash provided by Operating Activities. Net cash provided by (used in) operating activities was approximately $9.5 million in 2016, $1.9 million in 2015 and $3.4 million in 2014. The positive net cash flow in 2016 was primarily due to net income of $1.9 million, share-based compensation and restricted shares of approximately $2.5 million, a decrease in inventory of $0.8 million, an increase in the trade payables of $1.3 million, an increase in deferred revenue and advances from customers of $1.2 million and an increase in employees and payroll accrued of $1 million. The positive net cash flow in 2015 was primarily due to a decrease in trade receivables of $1.1 million, share-based compensation and restricted shares of approximately $1.4 million and an increase in deferred revenue and advances from customers of $0.7 million. This was partially offset by an increase of approximately $1.3 million in other accounts receivable and prepaid expenses and net loss of $0.9 million.

 

The trade receivables and days of sales outstanding, or DSO, are primarily impacted by payment terms, the variations in the levels of shipment in the quarter, and collections performance.  Trade receivables for 2016 increased to $4.4 million from $3.7 million in 2015, reflecting mainly new projects. We believe that continued expansion of our business, may require continued investments in working capital as many customers require commercial terms which result in longer payment terms.

The decrease in inventories in 2016 was mainly due to the decrease in inventory delivered to customers for which revenue criteria have been met and recognized, and due to non-cash write off due to old inventory that became obsolete, of approximately $498,000.

 

Net Cash Provided by Financing Activities.  In 2016, net cash provided by financing activities totaled approximately $25.7 million, including net proceeds received from follow-on public offering completed in May 2016 of $21.3 million, exercise of options of $3.3 million and exercise of warrants of approximately $1.1. In 2015, net cash provided by financing activities totaled approximately $813,000, including exercise of options of $733,000 and exercise of warrants of $80,000. In 2014, net cash provided by financing activities totaled approximately $1.1 million, including exercise of options of $1.7 million, repayment of short term bank credit, net of $0.6 million and exercise of warrants of $21,000. 

Public offering

During May 2016, we raised a net amount of $21.3 million in a public offering after deducting underwriters' discounts, commissions and other offering expenses, or the “2016 Public Offering”, by issuance of ordinary shares. Under the 2016 Public Offering we issued 2,090,909 ordinary shares for an aggregate purchase price of $23 million, or $11.00 per ordinary share (this price per share is the public offering price of the 2016 Public Offering). The investors in the 2016 Public Offering included our controlling shareholder and our former Chairman of our Board of Directors, Mr. Zohar Zisapel, who purchased 200,000 ordinary shares at the public offering price. We have an effective registration statement on Form F-3 and may use it in the future to raise additional funds.

Investments

 

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 the RAD-BYNET Group (as described under Item 7.B).  The pricing of the transactions with respect to such leases was determined based on negotiations between the parties. Members of our audit committee of the Board of Directors, or the Audit Committee, Board of Directors and management reviewed the pricing of the leases and confirmed that these leases 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.

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

 

 

In April 2012 and in April 2014, the MoE approved our application for funding to help set up our Indian subsidiary and China office respectively as part of a designated grant plan for the purpose of setting up and establishing a marketing agency in India and China.  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 and China, based on the approved budget for the plan for a period of three years.

We are obligated to pay to the MoE, royalties of 3% on the increased sales in the target market, with respect to the year during which the grant was approved (2012 for India, and 2014 for China), over a period of five years but not more than the total linked amount of the grant received. As of December 31, 2016, we have no contingent obligation to pay the MoE any royalties. For additional information, see "Item 4.B—Information on the Company—Business Overview—Israeli Ministry of Economy."

Critical Accounting Policies and Estimates

The preparation of Consolidated 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 and related services are recognized when persuasive evidence of an agreement exists, delivery of the product has occurred, the fee is fixed or determinable, and collectability is reasonably assured. Our products contain software components and non-software components that function together to deliver the product's essential functionality.

 

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-sized deals usually include acceptance criteria and since the delivery of such projects can take on average between six to18 months revenue recognition for such projects is delayed.

 

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.

Revenues from fixed price contracts (Projects) that require significant customization, integration and installation are recognized based on ASC 605-35, "Construction-Type and Production-Type Contracts", using the percentage-of-completion method of accounting based on a percentage that incurred labor effort to date bears, to total projected labor effort. The amount of revenue recognized is based on the total fees under the arrangement and the percentage of completion achieved. Provisions for estimated losses on uncompleted contracts are made in the period in which such losses are first determined, in the amount of the estimated loss on the entire contact. During the year ended December 31, 2016, 2015 and 2014, the Company recognized revenues of $17.5 million, $622,000 and $2.2 million from such contracts.

 

Under our selling arrangements, we usually provide a one-year warranty, which includes bug fixing and a hardware warranty, or the Warranty, for our products. 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.  

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 revenues. 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 our 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.

 

Inventory also includes amounts with respect to inventory delivered to customers for certain projects but for which revenue criteria have not been met yet.

 

Share-based compensation. Our accounts for share-based compensation are in accordance with ASC 718 “Compensation – Stock-based Compensation”, or ASC 718, which requires us to estimate the fair value of share-based payment awards on the grant date using an option-pricing model.

We recognize compensation expenses for the value of the awards granted based on the accelerated attribution method over the requisite service period of each of the awards.

Forfeitures recorded per occurrence. ASC 718 allows entities to make an accounting policy election to either estimate forfeitures or recognize forfeitures as they occur. We elected an accounting policy of recording forfeitures as they occur.

We selected the Black-Scholes option-pricing model as the most appropriate fair value method for our stock options awards. This option-pricing model requires a number of assumptions, of which the most significant are the expected stock price volatility and the expected option term. Expected volatility was calculated based upon actual historical stock price movements over the most recent periods ending on the grant date, equal to the expected option term, as management believes that this is the best indicator of future volatility. The expected term was generated by running the Monte Carlo model pursuant to which historical post-vesting forfeitures and suboptimal exercise factor is estimated by using historical option exercise information. The suboptimal exercise factor is the ratio by which the stock price must increase over the exercise price before employees are expected to exercise their stock options. The expected term of the options granted is derived from the output of the options valuation model and represents the period of time that options granted are expected to be outstanding. The risk-free interest rate is based on the yield from U.S. treasury bonds with an equivalent term to the expected life of the options. Historically the Company has not paid dividends and in addition has no plans in the foreseeable future to pay dividends, and therefore use an expected dividend yield of zero in the option pricing model.

Determining the fair value of share-based awards at the grant date requires the exercise of judgment.

 

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 2016, we saw an increased interest in NFV capable service assurance solutions and in parallel to continued demand for traditional service assurance solutions. We also saw an increased interest in wider CEM systems.

 

We expect that the NFV market will continue to gain momentum during 2017 and beyond. Key benefits that CSPs will derive from NFV include faster time-to-market, enablement of new services, automatic scaling of resources up and down to fit the network’s dynamic nature, and significantly lower costs (both capital expenditures and operating expenses).

 

Many leading CSPs have commercial LTE offerings. Mobile data services are becoming a significant revenue source for CSP.

Customer experience is a major driver for CSPs to invest in solutions that enable to them to better monitor and proactively offer resolution and upgrade of quality of service.

The competition in the CSPs’ market 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.

 

E.	OFF–BALANCE SHEET ARRANGEMENTS

 

None.

 

F.	TABULAR DISCLOSURE OF CONTRACTUAL OBLIGATIONS

 

The following table of our material contractual obligations as of December 31, 2016, 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				4-5 Years				More than 5 years
						(in thousands of U.S. dollars)
Operating leases obligation (1)		$	2,992			$	847				1,430				715				--
Open purchase orders (2)			123				123				--				--				--
Other long-term commitments (3)			479				--				--				--				--
Total		$	3,594			$	970				1,430				715				--

             (1) Represents operating lease costs, consisting of leases for facilities and vehicles.

 

(3) 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 obligation for accrued severance pay under Israel's Severance Pay Law as of December 31, 2016, was approximately $3,267,000, of which approximately $2,788,000 was funded through deposits in severance pay funds, leaving a net obligation of approximately $479,000.  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% and 5% of the revenues derived from products incorporating know-how developed from research and development grants from the Innovation Authority and BIRD Foundation, respectively. As of December 31, 2016, our contingent liability to the Innovation Authority in respect of grants received was according to our records approximately $43.6 million, and our contingent liability to the BIRD Foundation in respect of funding received was approximately $366,000. 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.

 

For additional information, see "Item 4.B—Information on the Company—Business Overview—Israeli Innovation Authority", and "Item 4.B—Information on the Company—Business Overview—Binational Industrial Research and Development Foundation."

We are also obligated to pay to the MoE royalties of 3% on the increased sales in the target market derived in India, with respect to the year during which the grant was approved (2012), over a period of five years but not more than the total linked amount of the grant received by us. As of December 31, 2016, no liability was accrued.

Effect of Recent Accounting Pronouncements

See note 2, Significant Accounting policies, in Notes to the Consolidated Financial Statements in Item 18 of part II of this Report, for a full description of recent accounting pronouncements, including the expected dates of adoption and estimated effects on financial condition and results of operations.

 

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
Rachel (Heli) Bennun		63		Executive Chairman of our Board of Directors
Uri Har (1)(2)(3)(4)(5)		80		Director
Irit Hillel (1)(2)(4)(5)		54		Director
Matty Karp (2)(4)(5)		67		Director
Zohar Zisapel		68		Director
Yaron Ravkaie		48		Chief Executive Officer
Eyal Harari		40		Chief Executive Officer of RADCOM US*
Ran Vered		38		Chief Financial Officer**
Hilik Itman		44		Vice President, Research and Development
Harel Givon		44		Chief Business Officer***
Rami Amit		51		Chief Technology Officer and Head of Product****
Keren Rubanenko		40		Vice President Professional Services ****

(1) External Director, pursuant to the Israeli Companies Law.

(2) Independent Director, under NASDAQ Stock Market Rules, or the NASDAQ Listing Rules.

(3) Chairman of Audit and Compensation Committees.

(4) Audit Committee Member.

(5) Compensation Committee Member.

(*) Eyal Harari, who was our Chief Operating Officer, was appointed as our Chief Executive Officer of RADCOM US effective as of December 14, 2016.

(**) Effective June 5, 2016, Ran Vered was appointed and acted as our Chief Financial Officer replacing Mr. Uri Birenberg who resigned from his role as Chief Financial Officer effective as of August 31, 2016.

(***) Effective June 15, 2016, Harel Givon was appointed as our Chief Business Officer.

(****) Effective February 1, 2017, Rami Amit was appointed as our Chief Technology Officer and Head of Product.

(*****) Effective April 3, 2016, Keren Rubanenko was appointed as our Vice President Professional Services.

 

Ms. Rachel (Heli) Bennun has served as a director since December 2012 and was appointed as our Executive Chairman of our Board of Directors in September  2015. In addition, Ms. Bennun served as a consultant to the Company’s management for almost four years, beginning January 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), or 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), or 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.

Mr. Uri Har has served as a director since September 2006. 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.

Ms. Irit Hillel has served as a director since October 2007. She has spent the last 20 years as an entrepreneur and senior executive in digital media, technology and investment firms. She currently serves as Venture Partner at HP Tech Ventures, the corporate venture arm of HP Inc. (Nasdaq: HPQ), leading partnerships and strategic investments in early stage technology startups. She is also a board member of Imagesat NV. From 2005 until 2008 she was Managing Director at Magnolia Capital Partners, managing the operations in Israel of Thomas Weisel Partners and Nomura, 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. Zohar Zisapel, a co-founder of our Company, has served as our Chairman of the Board from inception in 1985 until September, 2015. Mr. Zisapel co-founded RAD Data Communications Ltd., a privately-held voice and data communications company and part of the RAD Group, a family of independent networking and telecommunications companies, and was its CEO from 1982 until 1998 and Chairman from 1998 until 2012. Mr. Zisapel is the Chairman of Ceragon Networks Ltd. (NASDAQ: CRNT), and director of Amdocs Ltd (NASDAQ: DOX) and as chairman or director 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. Yaron Ravkaie, has been our Chief Executive Officer since January 2016. Prior to joining our company, Mr. Ravkaie served during 2015 as the Chief Business Officer of RR Media Ltd. (NASDAQ: RRM). Prior to serving at RR Media Ltd., Mr. Ravkaie served as the President of the Mobile Financial Services Division in Amdocs Ltd. (NASDAQ: DOX) for two years executing an M&A and a successful post-merger integration with a global organization offering mobile payments and mobile commerce. From 2008 through 2012, Mr. Ravkaie served as President of the AT&T division, the largest in Amdocs., running sales, client management, strategy, projects, programs, long-term outsourcing and managed services activities. Mr. Ravkaie joined Amdocs. in 1998 and, after a brief stint in the Israel Development Center he relocated to the U.S., where he performed various director and vice president roles. Mr. Ravkaie served for nine years in information systems, industrial engineering and logistics with the Israeli Air Force as a Major. Mr. Ravkaie holds an M.B.A. from the University of Beersheba and a B.Sc. in Industrial Engineering & Management from the Technion, Haifa.

 

Mr. Eyal Harari, CEO of RADCOM US 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, then the Senior Director of RADCOM's Product Management department, the Vice President of Products and Marketing, then Chief Operating Officer and finally in his current position since the end of 2016. 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. Ran Vered, our Chief Financial Officer, joined us in June 2016. Prior to joining our Company, Ran was Director of Finance for the Amdocs EMEA Division, from 2011 to 2016. Before 2011, Ran held various financial roles at Amdocs, was co-founder and CFO of an investment fund, deputy corporate controller at Nur Macroprinters and served as an auditor for KPMG. Ran received an M.B.A in Finance from Tel Aviv University and a B.A. in Business Administration and Accounting from the College of Management, and is certified in Israel as a CPA.

 

Mr. Hilik Itman, our Vice President of Research and Development joined us in 1997 as a software engineer, and was appointed to his current position in 2014. Mr. Itman led the R70S software development, and also led the MaveriQ development during the company’s transition from hardware based products, to software based probe products. Mr. Itman holds a B.A. in Mathematics and Computer Science from the Open University.

Harel Givon, our Chief Business Officer, joined us in June 2016. Prior to joining our Company, Harel served as Head of Sales for Amdocs’ EMEA Division and before that held several senior customer business executive roles within Amdocs. Within his 13 year tenure at Amdocs, Mr. Givon held several senior finance and corporate development roles and spent several years in Canada and The Netherlands. Mr. Givon received an M.B.A. in Finance from Tel Aviv University and Bachelor of Laws (LL.B.) from the Bar Ilan University.

 

Rami Amit, our Chief Technology Officer and Head of Product, joined us in February 1, 2017. Prior to joining our Company and from 2013 to 2017, Mr. Amit served as director engineering in the Cisco NFV BU, which included worldwide deployments by many tier1 customers. Mr. Amit was a major contributor to the vision of the evolution to virtualization in that space. Prior to that Mr. Amit held several chief technology officer positions, he was the Chief Technology Officer for Jungo, a leading software  provider, founded Surf&Call Solutions, which was later acquired by CosmoCom and was the first employee of the VoIP industry pioneer, VocalTec, in which he is considered as one of the early inventors of VoIP, building the first ever VoIP gateway shown in public in the mid 1990s and leading many of the VoIP technologies we all use today on a daily basis. Mr. Amit received an electrical engineering degree from the Tel Aviv University.

Keren Rubanenko, our VP Professional Services, joined us in April, 2016. Prior to joining our Company, Mrs. Rubanenko was VP Operation and R&D – Surveillance Division at NICE Systems from November 2011 to March 2015. Before 2011, Keren was Associate Vice President, Voice Domain Product Unit at Comverse Network Systems. Mrs. Rubanenko received a B.A. in Business Administration from the College of Management in Rishon LeZion.

 

Ms. Bennun is the life partner of Mr. Zohar Zisapel. Otherwise, there are no family relationships between any of the directors or executive officers named above.

 

B.	COMPENSATION

 

The bonus paid to our CEO is based on a formula, that includes the aggregation of three independent components, both measurable and non-measurable, and which was approved for our CEO for 2016, by our shareholders on August 16, 2016.

The bonus and commission payments made to our other officers, are based on the achievements of goals and objectives that are set and communicated at the beginning of each year, and which are made in accordance with our compensation policy, as approved by our shareholders from time to time.

 

The cash compensation paid to our independent directors and external directors (other than to our Executive Chairman, as of September 10, 2015), is an annual fee of NIS 21,127 (currently equivalent to approximately $5,800) and a per meeting attendance fee of NIS 1,223 (currently equivalent to approximately $340), 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.

On October 18, and October 26, 2015, our compensation committee and our Board of Directors approved, and on December 30 2015, our shareholders approved, a monthly salary of NIS 25,000 to be paid to our Executive Chairman, for the scope of the services that she provides to our company as the Executive Chairman.

 

 

On June 7, 2016, our Compensation Committee and Board of Directors, and on August 16, 2016 our shareholders approved a cash bonus of $80,000 to Ms. Rachel (Heli) Bennun, the Executive Chairman of our Board of Director for her special contribution to the success of the Company’s recent equity offering and the Company’s material management restructuring process.

 

 

 

Share Option Plans

 

The Company measures the compensation expense for all share-based payments (including employee stock options) at fair value, in accordance with ASC 718. We recorded an expense of $2.5 million for share-based compensation plans during 2016. During 2016, we granted options to purchase a total of 281,800 ordinary shares, and 216,300 RSUs, which will result in ongoing accounting charges that will significantly reduce our net income. See Notes 2(l) and 9(b) of the Notes to the Consolidated Financial Statements for further information.

As of March 24, 2017, we have under the 2003 Plan and the 2013 Plan a total of 652,539 outstanding options to purchase ordinary shares and 207,578 unvested RSUs.

 

Pursuant to Rule 5615(a)(3) of the NASDAQ Listing Rules, we 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, we have adopted share option plans and material amendments thereto by action of our Board of Directors, without shareholder approval. See also "Item 16G—Corporate Governance."

Compensation Policy

C.	BOARD PRACTICES

 

Terms of Office

 

 

External Directors

 

We are subject to the provisions of the Israeli Companies Law.

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".  

 

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:

·

a majority of the shares of non-controlling shareholders and shareholders who do not have a personal interest in the election of the candidate (other than a personal interest that is unrelated to a relationship with the controlling shareholders) voted at the meeting, voted in favor of the external director's election; or

·

the total number of shares of non-controlling shareholders and shareholders who do not have a personal interest in the election of the candidate (other than a personal interest that is unrelated to a relationship with the 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 subject to the shareholders’ approval, for up to two additional three year terms. In certain special situations, the term may be extended beyond these periods. 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, of which all the external directors are to be members. At our 2016 annual general meeting, held on August 16, 2016, our shareholders approved the re-election of Mr. Uri Har and Ms. Irit Hillel as our external directors, each for a fourth three-year term.  Both Mr. Uri Har and Ms. Irit Hillel qualify as external directors under the Israeli Companies Law, and both are members of the Company's Audit Committee and Compensation Committee.

 

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" requirements 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, the replacement of our independent auditors, and to pre-approve audit engagement fees and all permitted non-audit services and fees.

Israeli Companies Law Requirements

 

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.  Our independent directors are Irit Hillel, Uri Har and Matty Karp.

  

In addition: (1)  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 (2) 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.

 

The function of the audit committee is to determine if there are any irregularities in the management of our business and if there are any, to 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, overseeing the activities of the internal auditor, determining whether the internal auditor has the requisite tools and resources required to perform his role, and reviewing his work plan; and to regulate the company's 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.  All related party transactions have been approved in accordance with this requirement.

 

Compensation Committee

 

NASDAQ Requirements

 

Under the NASDAQ Listing Rules, a listed company is required to have a compensation committee comprised solely of independent directors. Our Compensation Committee consists of Uri Har (Chairman), Irit Hillel 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.

 

 

As stated in our Compensation Committee Charter, the purpose of the Compensation Committee is to review and approve, or, where required under the Israeli Companies Law or appropriate at the Compensation Committee's discretion, recommend to the Audit Committee of the Board of Directors (the "Audit Committee") and/or the Board of Directors for approval, the compensation policy for "office holders" (office holder is defined in the Israeli Companies Law as a director, the chief executive officer, the chief financial officer and any manager who is directly subordinate to the chief executive officer) of the Company, the compensation policy for executive officers of the Company (including renewal and reassessment thereof) who are not "office holders" of the Company within the meaning of the Israeli Companies Law, but who are defined as such according to the NASDAQ Listing Rules (as defined below), the compensation (including exculpation, indemnification and insurance) of such office holders, and the administration of the Company's equity-based plans.

Israeli Companies Law Requirements

 

Under 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.

 

The Israeli Companies Law provides that our compensation policy must serve as the basis for the decisions concerning the financial terms of employment or engagement of executives and directors, including exculpation, insurance, indemnification or any monetary payment or obligation of payment in respect of employment or engagement. The compensation policy must be approved (or reapproved) not longer than every three years, and relate to certain factors, including advancement of the company’s objective, business plan and its long term strategy and creation of appropriate incentives for office holders. It must also consider, among other things, the company’s risk management, size and nature of its operations. The compensation policy must furthermore consider the following additional factors:

 

	·	the knowledge, skills, expertise and accomplishments of the relevant office holder;
	·	the office holder’s roles and responsibilities and prior compensation agreements with him or her;
	·	the relationship between the terms offered and the average compensation of the other employees of the company, including those employed through human resource companies;
	·	the impact of disparities in salary upon work relationships in the company;
	·	the possibility of reducing variable compensation at the discretion of the Board of Directors or the possibility of setting a limit on the exercise value of non-cash variable equity-based compensation; and
	·	as to severance compensation, the period of service of the office holder, the terms of his or her compensation during such service period, the company’s performance during that period of service, the person’s contributions towards the company’s achievement of its goals and the maximization of its profits and the circumstances under which the person is leaving the company.

The compensation policy must also include the following principles:

	·	the link between variable compensation and long-term performance and measurable criteria;
	·	the relationship between variable and fixed compensation, and the ceiling for the value of variable compensation;
	·	the conditions under which a director or executive would be required to repay compensation paid to him or her if it was later shown that the data upon which such compensation was based was inaccurate and was required to be restated in the company’s financial statements;
	·	the minimum holding or vesting period for variable, equity-based compensation; and
	·	maximum limits for severance compensation.

On July 11, 2016, our Compensation Committee and Board of Directors approved an amended compensation policy for Executive Officers and Directors, and our shareholders approved such compensation policy on August 16, 2016.

 

 

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.