**As filed with the United States Securities and Exchange Commission onJune 29, 2005**

 

**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**WASHINGTON, D.C. 20549**

 

**FORM 20-F**

 

**Annual Report pursuant to Section13 or 15(d) of**

**the Securities Exchange Act of1934**

 

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

 

**Commission file number 0-27466**

 

**NICE-SYSTEMS LTD.**

(Exact name of Registrant as specified in its charter and translationof Registrant’s name into English)

 

**Israel**

(Jurisdiction of incorporation or organization)

 

**8 Hapnina Street, P.O. Box 690, Ra’anana 43107, Israel**

(Address of principal executive offices)

 

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

 
| **Title of  Each  Class** | ** ** | **Name of  Each Exchange  On Which Registered** |
|---------------------------|------------|-------------------------------------------------|
| ** **                | ** ** | ** **                                      |
| **None**                  |       | **None**                                        |

 

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

 

**American Depositary Shares, each representing**

**one Ordinary Share, par value one**

**New Israeli Shekel per share**

(Title of Class)

 

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

 

**None**

(Title of Class)

 

Indicate thenumber of outstanding shares of each of the issuer’s classes of capital orcommon stock as of the close of the period covered by the annual report:   **18,160,535 Ordinary Shares,par value NIS 1.00 Per Share**

 

Indicate bycheck mark whether the registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days:

 

Yes   ý     No   o

 

Indicate by check mark whichfinancial statements the registrant has elected to follow:

 

Item 17   o     Item 18  ý

 

 

----

 

**PRELIMINARY NOTE**

 

**This annual report contains historical information and forward-lookingstatements within the meaning of The Private Securities Litigation Reform Actof 1995 with respect to NICE’s business, financial condition and results of operations.  The words “anticipate,” “believe,” “estimate,”“expect,” “intend,” “may,” “plan,” “project” and “should” and similarexpressions, as they relate to NICE or its management, are intended to identifyforward-looking statements.  Suchstatements reflect the current views and assumptions of NICE with respect tofuture events and are subject to risks and uncertainties.  Many factors could cause the actual results,performance or achievements of NICE to be materially different from any futureresults, performance or achievements that may be expressed or implied by suchforward-looking statements, including, among others, changes in generaleconomic and business conditions, changes in currency exchange rates andinterest rates, difficulties or delays in absorbing and integrating acquiredoperations, products, technologies and personnel, changes in business strategyand various other factors, both referenced and not referenced in this annualreport.  These risks are more fullydescribed under Item 3, “Key Information – Risk Factors” of this annualreport.  Should one or more of theserisks or uncertainties materialize, or should underlying assumptions proveincorrect, actual results may vary materially from those described herein asanticipated, believed, estimated, expected, intended, planned orprojected.  NICE does not intend orassume any obligation to update these forward-looking statements. **

 

In this annualreport, all references to “NICE,” “we,” “us” or “our” are to NICE Systems Ltd.,a company organized under the laws of the State of Israel, and its wholly ownedsubsidiaries, NICE Systems Inc., NICE Systems GmbH, NICE Systems Canada Ltd.,NICE CTI Systems UK Ltd., STS Software Systems (1993) Ltd., NiceEye BV, NICESystems S.A.R.L., NICE APAC Ltd., NiceEye Ltd., Racal Recorders, Ltd. NICEInteractive Solutions India Private Ltd., Nice Systems Latin America,Inc.and Nice Japan Ltd.

 

In this annualreport, unless otherwise specified or unless the context otherwise requires,all references to “$” or “dollars” are to U.S. dollars and all references to “NIS”are to New Israeli Shekels.  Except asotherwise indicated, the financial statements of and information regarding NICEare presented in U.S. dollars.

 

----

 

**TABLE OF CONTENTS**

 
| **PART I**                     | ** ** |
|--------------------------------|------------|
| Item 1.                        |       | Identity of Directors, Senior Management  and Advisers |   |
| Item 2.                        |       | Offer Statistics and Expected Timetable |   |
| Item 3.                        |       | Key Information |   |
| Item 4.                        |       | Information  on the Company |   |
| Item 5.                        |       | Operating  and Financial Review and Prospects |   |
| Item 6.                        |       | Directors,  Senior Management and Employees |   |
| Item 7.                        |       | Major  Shareholders and Related Party Transactions |   |
| Item 8.                        |       | Financial  Information |   |
| Item 9.                        |       | The  Offer and Listing |   |
| Item  10.                      |       | Additional  Information |   |
| Item  11.                      |       | Quantitative  and Qualitative Disclosures About Market Risk |   |
| Item  12.                      |       | Description  of Securities Other than Equity Securities |   |
|                           |       |   |   |
| **PART II**                    |       |
| Item  13.                      |       | Defaults,  Dividend Arrearages and Delinquencies |   |
| Item  14.                      |       | Material  Modifications to the Rights of Security Holders and Use of Proceeds |   |
| Item  15.                      |       | Controls  and Procedures |   |
| Item  16A.                     |       | Audit  Committee Financial Expert |   |
| Item  16B.                     |       | Code  of Ethics |   |
| Item  16C.                     |       | Principal  Accountant Fees and Services |   |
| Item  16D.                     |       | Exemptions  from the Listing Standards for Audit Committees |   |
| Item  16E.                     |       | Purchases  of Equity Securities by the Issuer and Affiliated Purchasers |   |
|                           |       |   |   |
| **PART III**                   |       |
| Item  17.                      |       | Financial  Statements |   |
| Item  18.                      |       | Financial  Statements |   |
| Item  19.                      |       | Exhibits |   |
| Index to  Financial Statements |       |

 

----

 

**PART I**

 

**Item 1****.  Identity of Directors,Senior Management and Advisers.**

 

NotApplicable.

 

**Item 2****.  Offer Statistics andExpected Timetable.**

 

NotApplicable.

 

**Item 3****.  Key Information.**

 

**Selected Financial Data**

 

The followingselected consolidated financial data as of December 31, 2003 and 2004 and forthe years ended December 31, 2002, 2003 and 2004 have been derived from ouraudited consolidated financial statements. These financial statements have beenprepared in accordance with generally accepted accounting principles in theUnited States, or U.S. GAAP, and audited by Kost, Forer, Gabbay & Kasierer,a member of Ernst & Young Global. The consolidated selected financial dataas of December 31, 2000, 2001 and 2002 and for the years ended December 31,2000 and 2001 has been derived from other consolidated financial statements notincluded in this annual report and have also been prepared in accordance withU.S. GAAP and audited by Kost, Forer, Gabbay & Kasierer, a member of Ernst& Young Global. The selected consolidated financial data set forth belowshould be read in conjunction with and are qualified by reference to Item 5, “Operatingand Financial Review and Prospects” and the consolidated financial statementsand notes thereto and other financial information included elsewhere in thisannual report. 

 

On March 31,2004, we sold the net assets of our COMINT/DF military-related business to ELTASystems Ltd (“ELTA”) for $4 million in cash. The net assets sold include theintellectual property, fixed assets, inventory, and contracts related to theCOMINT/DF product line which includes high performance spectral surveillanceand direction finding systems that detect, identify, locate, monitor and recordtransmission sources. The COMINT/DF business is therefore treated as adiscontinued operation in our financial statements.

 

In 2002, 2003and 2004, the COMINT/DF business generated revenues of approximately $7.2million, $6.5 million and $0.8 million, respectively, and net income ofapproximately $1.4 million, $1.5 million and $3.2 million (including gain ondisposition), respectively.

 

2

----

 
| ** **                                                                                            | ** ** | **Year Ended December 31,**                               | ** **   |
|-------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------|--------------|
| ** **                                                                                            | ** ** | **2000**                                                  | ** **   | **2001** | ** ** | **2002** | ** ** | **2003** | ** ** | **2004** | ** ** |
| ** **                                                                                            | ** ** | **(in thousands of U.S. dollars, except per share data)** | ** **   |
| **OPERATING DATA:**                                                                                   |       |                                                      |         |   |   |   |   |   |   |   |   |
| Revenues                                                                                              |       |                                                      |         |   |   |   |   |   |   |   |   |
| Products                                                                                              |       | N/A                                                       |         | $ | 99,395 |   | $ | 127,896 |   | $ | 168,055 |   | $ | 182,616 |   |
| Services                                                                                              |       | N/A                                                       |         | 14,474 |   | 27,445 |   | 56,203 |   | 70,027 |   |
| Total revenues                                                                                        |       | 144,479                                                   |         | 113,869 |   | 155,341 |   | 224,258 |   | 252,643 |   |
| Cost of revenues                                                                                      |       |                                                      |         |   |   |   |   |   |   |   |   |
| Products                                                                                              |       | N/A                                                       |         | 47,781 |   | 55,453 |   | 64,231 |   | 64,432 |   |
| Services                                                                                              |       | N/A                                                       |         | 19,446 |   | 26,054 |   | 42,084 |   | 49,876 |   |
| Total cost of revenues                                                                                |       | 69,438                                                    |         | 67,227 |   | 81,507 |   | 106,315 |   | 114,308 |   |
| Gross profit                                                                                          |       | 75,041                                                    |         | 46,642 |   | 73,834 |   | 117,943 |   | 138,335 |   |
| Operating expenses:                                                                                   |       |                                                      |         |   |   |   |   |   |   |   |   |
| Research and development, net                                                                         |       | 19,002                                                    |         | 18,843 |   | 17,122 |   | 22,833 |   | 24,866 |   |
| Selling and marketing                                                                                 |       | 34,048                                                    |         | 33,719 |   | 38,743 |   | 53,701 |   | 62,172 |   |
| General and administrative                                                                            |       | 27,900                                                    |         | 26,788 |   | 23,806 |   | 29,840 |   | 31,269 |   |
| Other special charges                                                                                 |       | 7,646                                                     |         | 17,862 |   | 29,092 |   | 7,082 |   | — |   |
| Total operating expenses                                                                              |       | 88,596                                                    |         | 97,212 |   | 108,763 |   | 113,456 |   | 118,307 |   |
| Operating income (loss)                                                                               |       | (13,555                                                   | )            | (50,570 | ) | (34,929 | ) | 4,487 |   | 20,028 |   |
| Financial income, net                                                                                 |       | 6,188                                                     |         | 4,254 |   | 3,992 |   | 2,034 |   | 3,556 |   |
| Other income (expenses), net                                                                          |       | 53                                                        |         | (4,846 | ) | (4,065 | ) | 292 |   | 54 |   |
| Income (loss) before taxes on income                                                                  |       | (7,314                                                    | )            | (51,162 | ) | (35,002 | ) | 6,813 |   | 23,638 |   |
| Taxes on income                                                                                       |       | 273                                                       |         | 198 |   | 350 |   | 1,205 |   | 2,319 |   |
| Net income (loss) from continuing  operations                                                         |       | (7,587                                                    | )            | (51,360 | ) | (35,352 | ) | 5,608 |   | 21,319 |   |
| Net income (loss) from discontinuing  operations                                                      |       | 2,268                                                     |         | 4,565 |   | 1,370 |   | 1,483 |   | 3,236 |   |
| Net income (loss)                                                                                     |       | $                                                         |  (5,319 | ) | $ |  (46,795 | ) | $ |  (33,982 | ) | $ |  7,091 |   | $ |  24,555 |   |
| Basic earnings (loss) per share:                                                                      |       |                                                      |         |   |   |   |   |   |   |   |   |
| Continuing operations                                                                                 |       | $                                                         | (0.62        | ) | $ | (3.94 | ) | $ | (2.56 | ) | $ | 0.35 |   | $ | 1.22 |   |
| Discontinued operations                                                                               |       | 0.19                                                      |         | 0.35 |   | 0.10 |   | 0.09 |   | 0.18 |   |
| Net earnings (loss)                                                                                   |       | $                                                         | (0.43        | ) | $ | (3.59 | ) | $ | (2.46 | ) | $ | 0.44 |   | $ | 1.40 |   |
| Weighted average number of shares used in  computing basic earnings (loss) per share (in thousands)   |       | 12,317                                                    |         | 13,047 |   | 13,795 |   | 16,038 |   | 17,497 |   |
| Diluted earnings (loss) per share:                                                                    |       |                                                      |         |   |   |   |   |   |   |   |   |
| Continuing operations                                                                                 |       | $                                                         | (0.62        | ) | $ | (3.94 | ) | $ | (2.56 | ) | $ | 0.33 |   | $ | 1.14 |   |
| Discontinued operations                                                                               |       | 0.19                                                      |         | 0.35 |   | 0.10 |   | 0.09 |   | 0.17 |   |
| Net earnings (loss)                                                                                   |       | $                                                         | (0.43        | ) | $ | (3.59 | ) | $ | (2.46 | ) | $ | 0.42 |   | $ | 1.31 |   |
| Weighted average number of shares used in  computing diluted earnings (loss) per share (in thousands) |       | 12,317                                                    |         | 13,047 |   | 13,795 |   | 16,781 |   | 18,703 |   |

 

3

----

 
| ** **                | ** ** | **At December 31,** | ** ** |
|---------------------------|------------|---------------------|------------|
| ** **                | ** ** | **2000**            | ** ** | **2001** | ** ** | **2002** | ** ** | **2003** | ** ** | **2004** | ** ** |
| ** **                | ** ** | ** **          | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **BALANCE SHEET DATA:**   |       |                |       |   |   |   |   |   |   |   |   |
| Working capital           |       | $                   | 117,837    |   | $ | 70,572 |   | $ | 79,583 |   | $ | 56,174 |   | $ | 51,428 |   |
| Total assets              |       | 251,489             |       | 210,012 |   | 236,288 |   | 249,415 |   | 298,319 |   |
| Total debt                |       | —              |       | — |   | 24 |   | — |   | — |   |
| Shareholders’ equity |       | 208,577             |       | 167,018 |   | 154,536 |   | 176,831 |   | 222,871 |   |
|                           |            |                     |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

**Exchange Rate Information**

 

The followingtable shows, for each of the months indicated, the high and low exchange ratesbetween New Israeli Shekels and U.S. dollars, expressed as shekels per U.S.dollar and based upon the daily representative rate of exchange as reported bythe Bank of Israel: 

 
| **Month**     | ** ** | **High** | ** ** | **Low** | ** ** |
|---------------|------------|----------|------------|---------|------------|
| May 2005      |       | NIS      | 4.416      |    | NIS        | 4.348 |   |
| April 2005    |       | 4.395    |       | 4.360   |       |
| March 2005    |       | 4.379    |       | 4.299   |       |
| February 2005 |       | 4.392    |       | 4.357   |       |
| January 2005  |       | 4.414    |       | 4.352   |       |
| December 2004 |       | 4.374    |       | 4.308   |       |
|               |            |          |            |         |            |  |  |

 

The followingtable shows, for periods indicated, the average exchange rate between NewIsraeli Shekels and U.S. dollars, expressed as shekels per U.S. dollar,calculated based on the average of the exchange rates on the last day of eachmonth during the relevant period as reported by the Bank of Israel:  

 
| **Year** | ** ** | **Average** | ** ** |
|----------|------------|-------------|------------|
| 2004     |       | NIS         | 4.483      |   |
| 2003     |       | 4.512       |       |
| 2002     |       | 4.736       |       |
| 2001.    |       | 4.220       |       |
| 2000.    |       | 4.068       |       |
|          |            |             |            |  |

 

On June 27,2005, the exchange rate was 4.541 NIS per U.S. dollar as reported by the Bankof Israel.

 

The effect ofexchange rate fluctuations on our business and operations is discussed in Item5,  “Operating and Financial Review andProspects.”  

 

4

----

 

**Capitalizationand Indebtedness**

 

Notapplicable.

 

**Reasonsfor the Offer and Use of Proceeds**

 

Notapplicable.  

 

**Risk Factors**

 

***General Business Risks Relating to OurBusiness Portfolio and Structure***

 

**The markets in which we operate are characterized by rapidtechnological changes and frequent new products and service introductions.  We may not be able to keep up with theserapid technological and other changes.**

 

We areoperating in several markets, each characterized by rapidly changing technologyand evolving industry standards.  Theintroduction of products embodying new technology and the emergence of newindustry standards can render existing products obsolete and unmarketable andcan exert price pressures on existing products. We anticipate that a number of existing and potential competitors willbe introducing new and enhanced products that could adversely affect thecompetitive position of our products. Our most significant market is the market for voice recording platformsand related enhanced applications (or Voice Platforms and Applications). VoicePlatforms and Applications are utilized by entities operating in the contactcenter, trading floor, public safety and air traffic control segments tocapture, store, retrieve and analyze recorded data. The market for our VoicePlatforms and Applications is, in particular, characterized by a group ofhighly competitive vendors that are introducing rapidly changing competitiveofferings around evolving industry standards. 

 

Our ability toanticipate changes in technology and industry standards and to successfullydevelop and introduce new, enhanced and competitive products, on a timelybasis, in all the markets where we operate, will be a critical factor in ourability to grow and be competitive.  As aresult, we expect to continue to make significant expenditures on research anddevelopment, particularly with respect to new software applications, which arecontinuously required in all our business areas. The convergence of voice and datanetworks and wired and wireless communications could require substantialmodification and customization of our current products and business models, aswell as the introduction of new products. Further, customer acceptance of these new technologies may be slowerthan we anticipate.  We cannot assure youthat the market or demand for our products will grow as rapidly as we expect,or if at all, that we will successfully develop new products or introduce newapplications for existing products, that such new products and applicationswill achieve market acceptance or that the introduction of new products ortechnological developments by others will not render our productsobsolete.  In addition, our products mustreadily integrate with major third party security, telephone, front-office andback-office systems.  Any changes tothese third party systems could require us to redesign our products, and anysuch redesign might not be possible on a timely basis or achieve marketacceptance.  Our inability to developproducts that are competitive in technology and

 

5

----

 

price andresponsive to customer needs could have a material adverse effect on ourbusiness, financial condition and results of operations.

 

**Our business could be materially adversely affected as a result of therisks associated with acquisitions and investments.  In particular, we may not succeed in makingadditional acquisitions or be effective in integrating such acquisitions.**

 

As part of ourgrowth strategy, we have made a number of acquisitions and have made minorityinvestments in complementary businesses, products or technologies. Wefrequently evaluate the tactical or strategic opportunity available related tocomplementary businesses, products or technologies.  The process of integrating an acquiredcompany’s business into our operations and/or of investing in new technologies,may result in unforeseen operating difficulties and large expenditures and mayabsorb significant management attention that would otherwise be available forthe ongoing development of our business. Other risks commonly encountered with acquisitions include the effect ofthe acquisition on our financial and strategic position and reputation, thefailure of the acquired business to further our strategies, the inability tosuccessfully integrate or commercialize acquired technologies or otherwiserealize anticipated synergies or economies of scale on a timely basis and thepotential impairment of acquired assets. Moreover, there can be no assurance that the anticipated benefits of anyacquisition or investment will be realized. Future acquisitions or investments contemplated and/or consummated couldresult in potentially dilutive issuances of equity securities, the incurrence ofdebt and contingent liabilities, and amortization expenses related tointangible assets, any of which could have a material adverse effect on ouroperating results and financial condition. There can be no assurance that wewill be successful in making additional acquisitions or effective inintegrating such acquisitions into our existing business.  In addition, if we consummate one or moresignificant acquisitions in which the consideration consists, in whole or in part,of ordinary shares or American Depositary Shares (ADSs), representing ourordinary shares, shareholders would suffer dilution of their interests in us.We have also invested in companies which can still be considered in thestart-up or development stages. These investments are inherently risky as themarket for the technologies or products they have under development aretypically in the early stages and may never materialize. We could lose ourentire initial investment in these companies. 

 

**We have expanded into new markets and may not be able to manage ourexpansion and anticipated growth effectively.**

 

We haveestablished a sales and service infrastructure in India by recruiting sales andservice personnel in order to bring about further growth in revenue in the AsiaPacific market.  Also, since 2002 we havebeen expanding our presence in Europe (mainly in the United Kingdom) and in theMiddle East and Africa (the EMEA region) through organic growth and through ouracquisition of Thales Contact Solutions (or TCS).  The growth in our business in the EMEA regionis still in its early stage, and in particular, we are just beginning todevelop our digital video business in the EMEA region. We expect continuedgrowth, particularly in connection with the enhancement and expansion of ouroperations in the EMEA region, as well as in the Asia Pacific region.  We may establish additional operations withinthese regions where

 

6

----

 

growthopportunities are projected to warrant the investment. However, we cannotassure you that our revenues will increase as a result of this expansion orthat we will be able to recover the expenses we incurred in effecting theexpansion.  Our failure to effectivelymanage our expansion of our sales, marketing, service and support organizationscould have a negative impact on our business. To accommodate our global expansion, we are continuously implementingnew or expanded business systems, procedures and controls.  There can be no assurance that theimplementation of such systems, procedures, controls and other internal systemscan be completed successfully.

 

**We depend upon outsourcers for the manufacture of our key products. Thefailure of our product manufacturers to meet our quality or deliveryrequirements would likely have a material adverse effect on our business,results of operations and financial condition.**

 

In 2002, weentered into a manufacturing agreement with Flextronics Israel Ltd., asubsidiary of Flextronics, a global electronics manufacturing services company.  Under this agreement, Flextronics provides uswith a comprehensive manufacturing solution that covers all aspects of themanufacture of our products from order receipt to product shipment, includingpurchasing, manufacturing, testing, configuration, and delivery services.  This agreement covered all our products.  In addition, in connection with theacquisition of TCS, we entered into a contract manufacturing agreement withInstem Technologies Ltd, a UK company, pursuant to which Instem manufacturesall ex-TCS products. Similarly, in connection with the acquisition ofDictaphone’s Communications Recordings Systems division (or CRS), we assumed acontract manufacturing agreement with Dictaphone’s EMS division pursuant towhich EMS manufactures all ex-CRS products. As a result of these arrangements,we are now fully dependent on Flextronics, Instem and EMS to process orders andmanufacture our products.  Consequently,the manufacturing process of our products is not in our control. 

 

We may fromtime to time experience delivery delays due to the inability of Flextronics,Instem and EMS to consistently meet our quality or delivery requirements and wemay experience production interruptions if any of Flextronics, Instem or EMS isfor any reason unable to continue the production of our products.  Should we have on-going performance issueswith our contract manufacturers, the process to move from one contractor toanother is a lengthy and costly process that could affect our ability toexecute customer shipment requirements and/or might negatively affect revenueand/or costs.  If these manufacturers orany other manufacturer were to cancel contracts or commitments with us or failto meet the quality or delivery requirements needed to satisfy customer ordersfor our products, we could lose time-sensitive customer orders and havesignificantly decreased quarterly revenues and earnings, which would have amaterial adverse effect on our business, results of operations and financialcondition.

 

**If we lose our key suppliers, our business may suffer.**

 

Certaincomponents and subassemblies that are used in the manufacture of our existingproducts are purchased from a single or a limited number of suppliers.  In the event that any of these suppliers areunable to meet our requirements in a timely manner, we may experience aninterruption in production until an alternative source of supply can beobtained.  Any disruption,

 

7

----

 

or any otherinterruption of a supplier’s ability to provide components to us, could resultin delays in making product shipments, which could have a material adverseeffect on our business, financial condition and results of operations.  In addition, some of our major suppliers useproprietary technology and software code that could require significantredesign of our products in the case of a change in vendor.  Further, as suppliers discontinue theirproducts, or modify them in manners incompatible with our current use, or usemanufacturing processes and tools that could not be easily migrated to othervendors, we could have significant delays in product availability, which wouldhave a significant adverse impact on our results of operations and financialcondition.     Although we generallymaintain an inventory for some of our components and subassemblies to limit thepotential for an interruption and we believe that we can obtain alternativesources of supply in the event our suppliers are unable to meet ourrequirements in a timely manner, we cannot assure you that our inventory andalternative sources of supply would be sufficient to avoid a materialinterruption or delay in production and in availability of spare parts. 

 

**If we lose our key personnel or cannot recruit additional personnel,our business may suffer. **

 

If our growthcontinues, we will be required to hire and integrate new employees. Recruitingand retaining qualified engineers and computer programmers to perform researchand development and to commercialize our products, as well as qualified personnelto market and sell those products, are critical to our success.  As of December 31, 2004, approximately 25% ofour employees were devoted to research and product development and 26% weredevoted to marketing and sales.   Therecan be no assurance that we will be able to successfully recruit and integratenew employees.  Competition for highlyskilled employees may again become high in the technology industry.  We may also experience personnel changes as aresult of our move from multimedia recording equipment towards businessperformance solutions.  An inability toattract and retain highly qualified employees may have an adverse effect on ourability to develop new products and enhancements for existing products and tosuccessfully market such products, all of which would likely have a materialadverse effect on our results of operations and financial position.  Our success also depends, to a significantextent, upon the continued service of a number of key management, sales,marketing and development employees, the loss of whom could materiallyadversely affect our business, financial condition and results of operations.

 

**Operating internationally exposes us to additional and unpredictablerisks.**

 

We sell ourproducts throughout the world and intend to continue to increase ourpenetration of international markets.  In2000, 2001, 2002, 2003 and 2004, approximately 97%, 98%, 98%, 99% and 99%,respectively, of our total sales were derived from sales to customers outsideof Israel, and approximately 55%, 48%, 52%, 50% and 44%, respectively, of ourtotal sales were made to customers in North America.  A number of risks are inherent ininternational transactions. Our future results could be materially adverselyaffected by a variety of factors including changes in exchange rates, generaleconomic conditions, regulatory requirements, tax structures or changes in taxlaws, and longer payment cycles in the countries in our geographic

 

8

----

 

areas ofoperations. International sales and operations may be limited or disrupted bythe imposition of governmental controls and regulations, export licenserequirements, political instability, trade restrictions, changes in tariffs anddifficulties in managing international operations.  We cannot assure you that one or more ofthese factors will not have a material adverse effect on our internationaloperations and, consequently, on our business, financial condition and resultsof operations. 

 

**Inadequate intellectual property protections could prevent us fromenforcing or defending our intellectual property and we may be subject toliability in the event our products infringe on the proprietary rights of thirdparties and we are not successful in defending such claims.**

 

Our success isdependent, to a significant extent, upon our proprietary technology.  We currently own 20 patents (including 11 inthe United States) to protect our technology and we have over 100 applicationspending in the United States and other countries.  We currently rely on a combination of patent,trade secret, copyright and trademark law, together with non-disclosure andnon-competition agreements, as well as third party licenses to establish andprotect the technology used in our systems. However, we cannot assure you that such measures will be adequate toprotect our proprietary technology, that competitors will not develop productswith features based upon, or otherwise similar to our systems, or that thirdparty licenses will be available to us or that we will prevail in anyproceeding instituted by us in order to enjoin competitors from selling similarproducts.  Although we believe that ourproducts do not infringe upon the proprietary rights of third parties, wecannot assure you that one or more third parties will not make a contrary claimor that we will be successful in defending such claim.    

 

From time totime, we receive “cease and desist” letters alleging patent infringements.  No formal claims or other actions have beenfiled with respect to such alleged infringements, except for claims filed byDictaphone (which have since been settled and dismissed) and Witness Systems(described under “—Legal Proceedings” in Item 8 below).  We believe that none of these allegations hasmerit.  We cannot assure you, however,that we will be successful in defending against the claims that have beenasserted or any other claims that may be asserted.  We also cannot assure you that such claimswill not have a material adverse effect on our business, financial condition,or operations.  Defending infringementclaims or other claims could involve substantial costs and diversion ofmanagement resources.  In addition, tothe extent we are not successful in defending such claims, we may be subject toinjunctions with respect to the use or sale of certain of our products or toliabilities for damages and may be required to obtain licenses which may not beavailable on reasonable terms.    

 

**We face potential product liability claims against us.**

 

Our productsfocus specifically on organizations’ business-critical operations.  We may be subject to claims that our productsare defective or that some function or malfunction of our products caused orcontributed to property, bodily or consequential damages.  We minimize this risk by incorporatingprovisions into our distribution and standard sales agreements that aredesigned to limit our exposure to potential claims of liability.  We carry product liability

 

9

----

 

insurance inthe amount of $20,000,000 per occurrence and $20,000,000 overall perannum.  No assurance can be given thatall claims will be covered either by the contractual provisions limitingliability or by the insurance, or that the amount of any individual claim or allclaims will be covered by the insurance or that the amount of any individualclaim or all claims in the aggregate will not exceed policy coveragelimits.  A significant liability claimagainst us could have a material adverse effect on our results of operationsand financial position.

 

**We face risks relating to government contracts.**

 

We sell ourproducts to, among other customers, governments and governmental entities.  These sales are subject to special risks,such as delays in funding, termination of contracts or sub-contracts at theconvenience of the government, termination, reduction or modification ofcontracts or sub-contracts in the event of changes in the government’s policiesor as a result of budgetary constraints, and increased or unexpected costsresulting in losses or reduced profits under fixed price contracts.  Although to date we have not experienced anymaterial problems in our performance of government contracts, or in the receiptof payments in full under such contracts, we cannot assure you that we will notexperience problems in the future.

 

**The markets in which we operate are highly competitive and we may beunable to compete successfully. **

 

The market forour products and related services, in general, is highly competitive.  Additionally, some of our principalcompetitors such as Witness Systems, Inc. and Verint Systems, Inc. may havesignificantly greater resources and larger customer bases than do we.  We have seen evidence of deep price reductionsby our competitors and expect to continue to see such behavior in the future,which, if we are required to match such discounting, will adversely affect ourgross margins and results of operations. To date, we have been able to manage our product design and componentcosts.  However, there can be noassurance that we will be able to continue to achieve reductions in componentand product design costs.  Further, therelative and varying rates of increases or decreases in product price and costcould have a material adverse impact on our earnings.

 

We areexpanding the scope of our Voice Platforms and Applications to EnterprisePerformance Management solutions, with a focus on analytic software solutionsthat are based on voice and data content analysis. The market for such contentanalysis applications is still in its early phases. Successful positioning ofour products is a critical factor in our ability to maintain growth.Furthermore, new potential entrants from the traditional enterprise businessintelligence and business analytics sector may decide to develop recording andcontent analysis capabilities and compete with us in this emerging opportunity.As a result, we expect to continue to make significant expenditures onmarketing. We cannot ensure that the market awareness or demand for our newproducts will grow as rapidly as we expect, or if at all, that we willsuccessfully develop new products or introduce new applications for existingproducts, that such new products and applications will achieve marketacceptance or that the introduction of new products or technologicaldevelopments by others will not adversely impact the demand for our products.

 

10

----

 

The recentexpansion of Voice over Internet Protocol (or VoIP) into contact centers andtrading floors may allow one or more of our competitors to take a leadershipposition with respect to this new technology. Strategic partners may change their vendor preference as a result or maydevelop embedded VoIP recording as part of the VoIP switch or networkinginfrastructure. We cannot assure you that our products or existing partnershipswill ensure sustainable leadership.

 

With respectto the market for digital video products and applications (or Video Platformsand Applications), our Video Platforms and Applications are utilized byentities in the CCTV security, gaming and retail industries to capture, storeand analyze digital video and related data. The market for our Video Platforms and Applications is highlycompetitive and includes products offering a broad range of features andcapacities. We compete with a number of large, established manufacturers ofvideo recording systems and distributors of similar products, as well as newemerging competitors. The price per channel of digital recording systems hasdecreased throughout the market in recent years, primarily due to competitivepressures. We cannot assure you that the price per channel of digital recordingsystems will not continue to decrease or that our gross profit will not decreaseas a result.

 

With respectto the public safety part of our business, our ability to succeed depends onour ability to develop an effective network of distributors to the mid-lowsegment of the public safety market, while facing pricing pressures and low barriersto entry.  We face significantcompetition from other well-established competitors, including CVDS Inc.,VoicePrint Inc. and others.  Prices havedecreased throughout the market in recent years, primarily due to competitivepressures.  We cannot assure you thatprices will not continue to decrease or that our gross profit will not decreaseas a result.   We believe that ourability to sell and distribute our Voice Platforms and Applications in thepublic safety market depends on the success of our marketing, distribution andproduct development initiatives. We cannot assure you that we will besuccessful in these initiatives. 

 

**Continuing adverse conditions in the information technology sector maylead to a decreased demand for our Voice Platforms and Applications and mayharm our business, financial condition and results of operations. **

 

Our operatingresults may be materially adversely affected as a result of recent unfavorableeconomic conditions and reduced information technology spending, particularlyin the product segments in which we compete. In particular, many enterprises, telecommunications carriers and serviceproviders have reduced spending in connection with contact centers, and manyfinancial institutions have reduced spending related to trading floors.  These trends may adversely affect the growthof sales of new applications. If these industry-wide conditions persist, theymay have a material adverse impact on our business, financial condition andresults of operations. 

 

11

----

 

**We depend on certain key strategic partners for sales of ourproducts.  If our relationship with thesepartners is for any reason impaired, our business and results of operationswill likely suffer.**

 

We haveagreements in place with many distributors, dealers and resellers to market andsell our products and services in addition to our direct sales force.  We derive a significant percentage of ourrevenues from one or more of our channel partners.  Our financial results could be materiallyadversely affected if our contracts with channel partners were terminated, ifour relationship with channel partners were to deteriorate or if the financialcondition of our channel partners were to weaken. Our top channel partner accountedfor approximately 23%, 20% and 19% of our revenues in 2002, 2003 and 2004,respectively. Our competitors’ ability to penetrate these strategicrelationships, particularly our relationship with Avaya Inc., our largestglobal distribution partner and one of the leading global providers ofenterprise business communication platforms in voice, e-business and data, mayresult in a significant reduction of sales through that partner.  

 

In addition,as our market opportunities change, we may have increased reliance onparticular channel partners, which may negatively impact gross margins. Therecan be no assurance that we will be successful in maintaining or expandingthese channels.  If we are notsuccessful, we may lose sales opportunities, customers and market share.  In addition, there can be no assurance thatour channel partners will not develop or market products or services incompetition with us in the future. 

 

**We depend on the success of the NiceLog system and related products.**

 

We aredependent on the success of the NiceLog system and related products to maintainprofitability.  In 2002, 2003 and 2004,approximately 82%, 75% and 78%, respectively, of our revenues were generatedfrom sales of NiceLog systems and related products and we anticipate that suchproducts will continue to account for a significant portion of our sales in thenext several years.  A significantdecline in sales of NiceLog systems and related products, or a significantdecrease in the profit margin on such products, could have a material adverseeffect on our business, financial condition or results of operations. 

 

**We may be unable to develop strategic alliances and marketingpartnerships for the global distribution of our Video Platforms andApplications, which may limit our ability to successfully market and sell theseproducts.**

 

We believethat developing marketing partnerships and strategic alliances is an importantfactor in our success in marketing our Video Platforms and Applications and inpenetrating new markets for such products. However, unlike our Voice Platforms and Applications, we have onlyrecently started to develop a number of strategic alliances for the marketingand distribution of our Video Platforms and Applications. We cannot assure youthat we will be able to develop such partnerships or strategic alliances onterms that are favorable to us, if at all.  Failure to develop such arrangements that are satisfactory to us maylimit our ability to successfully market

 

12

----

 

and sell ourVideo Platforms and Applications and may have a negative impact on our businessand results of operations. 

 

**We may be unable to commercialize new video content analysisapplications.**

 

We arecurrently in the process of developing and commercializing new video contentanalysis applications that will enable real-time detection of securitythreats.  The market for such videocontent analysis applications is still in an early phase.  In addition, because this is a newopportunity for changing security procedures and represents a transition toproactive security management, we are not able to predict the pace at whichsecurity organizations will adopt this technology, if at all.  Successful positioning of our products is acritical factor in our ability to maintain growth.  New potential entrants to the market maydecide to develop video content analysis capabilities and compete with us inthis emerging opportunity.  As a result,we expect to continue to make significant expenditures on marketing.  We cannot assure you that a market for theseproducts will develop as rapidly as we expect or at all, that we willsuccessfully develop new products or introduce new applications for existingproducts, that new products or applications will meet market expectations andneeds, that we will be successful in penetrating these markets and in marketingour products or that the introduction of new products or technologicaldevelopments by others will not adversely impact the demand for our video contentanalysis applications. 

 

**If the pace of spending by the U.S. Department of Homeland Security isslower than anticipated, our security business will likely be adverselyaffected, perhaps materially.**

 

The market forour security solutions in CCTV continuous recording, public safety and lawenforcement is highly dependent on the spending cycle and spending scope of theUnited States Department of Homeland Security, as well as local, state andmunicipal governments and security organizations in international markets.  We cannot be sure that the spending cyclewill materialize and that we will be positioned to benefit from the potentialopportunities. 

 

***Risks Relating to Israel***

 

**Our business may be impacted by inflation and NIS exchange ratefluctuations.**

 

Exchange ratefluctuations between the United States dollar and the NIS may negatively affectour earnings.  A substantial majority ofour revenues and a substantial portion of our expenses are denominated in U.S.dollars.  However, a significant portionof the expenses associated with our Israeli operations, including personnel andfacilities related expenses, are incurred in NIS.  Consequently, inflation in Israel will havethe effect of increasing the dollar cost of our operations in Israel, unless itis offset on a timely basis by a devaluation of the NIS relative to the U.S.dollar.  We cannot predict any futuretrends in the rate of inflation in Israel or the rate of devaluation of the NISagainst the U.S. dollar.  If the U.S.dollar cost of our operations in Israel increases, our dollar-measured resultsof operations will be adversely affected.

 

13

----

 

**We are subject to the political, economic and military conditions inIsrael.**

 

Ourheadquarters, research and development and main manufacturing facilities arelocated in the State of Israel, and we are directly affected by the political,economic and military conditions to which Israel is subject.  Since the establishment of the State ofIsrael in 1948, a number of armed conflicts have taken place between Israel andits Arab neighbors. A state of hostility, varying in degree and intensity, hasled to security and economic problems for Israel. Since October 2000, there hasbeen a high level of violence between Israel and the Palestinians, which hasaffected Israel’s relationship with several Arab countries. Any armed conflictsor political instability in the region could negatively affect local businessconditions and harm our results of operations. We cannot predict the effect onthe region of the increase in the degree of violence between Israel and thePalestinians.  Furthermore, severalcountries restrict doing business with Israel and Israeli companies, andadditional companies may restrict doing business with Israel and Israelicompanies as a result of an increase in hostilities.  Our products are heavily dependent uponcomponents imported from, and most of our sales are made to, countries outsideof Israel. Accordingly, our operations could be materially adversely affectedif trade between Israel and its present trading partners were interrupted orcurtailed.

 

Some of ourofficers and employees are currently obligated to perform annual militaryreserve duty.  Additionally, in the eventof a military conflict, including the ongoing conflict with the Palestinians,these persons could be required to serve in the military for extended periodsof time. We cannot assess the full impact of these requirements on ourworkforce or business and we cannot predict the effect on us of any expansionor reduction of these obligations. 

 

**Service and enforcement of legal process on us and our directors andofficers may be difficult to obtain.**

 

Service ofprocess upon our directors and officers, most of whom reside outside the UnitedStates, may be difficult to obtain within the United States.  Furthermore, since the majority of our assetsand most of our directors and officers are located outside the United States,any judgment obtained in the United States against us or these individuals orentities may not be collectible within the United States.

 

There is doubtas to the enforceability of civil liabilities under the Securities Act of 1933and the Securities Exchange Act of 1934 in original actions instituted inIsrael.  However, subject to certain timelimitations and other conditions, Israeli courts may enforce final judgments ofUnited States courts for liquidated amounts in civil matters, includingjudgments based upon the civil liability provisions of those Acts. 

 

**We depend on the availability of government grants and taxbenefits. **

 

We derive andexpect to continue to derive significant benefits from various programs andlaws in Israel including tax benefits relating to our “Approved Enterprise”programs and certain grants from the Office of the Chief Scientist of theMinistry of Industry, Trade and Labor, or OCS, for research anddevelopment.  To be eligible for thesegrants, programs and tax

 

14

----

 

benefits, wemust continue to meet certain conditions, including making certain specifiedinvestments in fixed assets and conducting the research, development andmanufacturing of products developed with such OCS grants in Israel (unless aspecial approval has been granted for performing manufacturing activitiesoutside Israel).  From time to time, theIsraeli Government has discussed reducing or eliminating the availability ofthese grants, programs and benefits and there can be no assurance that theIsraeli Government’s support of grants, programs and benefits willcontinue.  Pursuant to an amendment toIsraeli regulations, income from two of our “Approved Enterprises” is exemptfrom income tax for only two years. Following this two-year period, the “Approved Enterprise” will be subjectto corporate tax at a reduced rate of 10-25% (based on the percentage offoreign ownership in each taxable year) for the following eight years.  Income from the other two “ApprovedEnterprises” is tax exempt for four years. Following this four-year period, the “Approved Enterprises” are subjectto corporate tax at a reduced rate of 10-25% (based on the percentage offoreign ownership in each taxable year) for the following six years.  If grants, programs and benefits available tous or the laws under which they were granted are eliminated or their scope isreduced, or if we fail to meet the conditions of existing grants, programs orbenefits and are required to refund grants or tax benefits already received(together with interest and certain inflation adjustments), our business,financial condition and results of operations could be materially adverselyaffected. 

 

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

 

The Israeli Stamp Duty on Documents Law, 1961 (the “Stamp Duty Law”),provides that most documents signed by Israeli companies are subject to a stampduty, generally at a rate of between 0.4% and 1% of the value of the subjectmatter of such document. De facto, it has been common practice in Israel not topay such stamp duty unless a document is filed with a governmental authority orwith the courts. As a result of an amendment to the Stamp Duty Law that cameinto effect on June 1, 2003, the Israeli tax authorities have approached manycompanies in Israel (including us) and requested the disclosure of allagreements signed by such companies after June 1, 2003 with the aim ofcollecting stamp duty on such agreements. The legitimacy of the aforementioned amendment to the Stamp Duty Law andof said actions by the Israeli tax authorities are currently under review bythe Israeli High Court of Justice.  Basedon advice from our Israeli counsel, we believe that we may only be required topay stamp duty on documents signed on or after August 2004. However, we cannotgive any assurance that the tax authorities or the courts will accept suchview. Although at this stage it is notyet possible to evaluate the effect, if any, on us of the amendment to theStamp Duty Law, the same could materially adversely affect our results ofoperations in the future.

 

In January 2005, an order was signed in accordance with which the saidrequirement to pay stamp duty is cancelled with effect from January 1,2008.  

 

15

----

 

***Risks Related to our Ordinary Shares and ADSs***

 

**Our share price is volatile and may decline.**

 

Numerousfactors, some of which are beyond our control, may cause the market price ofour ordinary shares or our ADSs, each of which represents one ordinary share,to fluctuate significantly.  Thesefactors include, among other things, announcements of technologicalinnovations, development of or disputes concerning our intellectual propertyrights, customer orders or new products by us or our competitors, currencyexchange rate fluctuations, earnings releases by us or our competitors, marketconditions in the industry and the general state of the securities markets,with particular emphasis on the technology and Israeli sectors of thesecurities markets. 

 

**Our operating results in one or more future periods may fluctuatesignificantly and may cause our share price to be volatile.**

 

The salescycle for our products and services is variable, typically ranging between afew weeks to several months from initial contact with the potential client tothe signing of a contract.  Frequently,sales orders accumulate towards the latter part of a given quarter.  Looking forward, given the lead time requiredby our contract manufacturer, if a large portion of sales orders are receivedlate in the quarter, we may not be able to deliver products within the quarterand thus such sales will be deferred to a future quarter. There can be noassurance that such deferrals will result in sales in the near term, or at all.  Thus, delays in executing client orders mayaffect our revenue and cause our operating results to vary widely.  Additionally, as a high percentage of ourexpenses, particularly employee compensation, is relatively fixed, a variationin the level of sales, especially at or near the end of any quarter, may have amaterial adverse impact on our quarterly operating results.

 

In addition,our quarterly operating results may be subject to significant fluctuations dueto other factors, including the timing and size of orders and shipments tocustomers, variations in distribution channels, mix of products, new productintroductions, competitive pressures and general economic conditions.  It is difficult to predict the exact mix ofproducts for any period between hardware, software and services as well aswithin the product category between audio platforms and related applications,digital video and communications intelligence. Because a significant portion of our overhead consists of fixed costs,our quarterly results may be adversely impacted if sales fall below management’sexpectations.  In addition, the period oftime from order to delivery of our Audio and Video Platforms and Applicationsis short, and therefore our backlog for such products is currently, and is expectedto continue to be, small and substantially unrelated to the level of sales insubsequent periods.  As a result, ourresults of operations for any quarter may not necessarily be indicative ofresults for any future period.  Due toall of the foregoing factors, in some future quarters our sales or operatingresults may be below our forecasts and the expectations of public marketanalysts or investors.  In such event,the market price of our ordinary shares and ADSs would likely be materiallyadversely affected. 

 

16

----

 

**Item 4.****    Information on the Company.**

 

**History and Development of the Company**

 

Our legal andcommercial name is NICE-Systems Ltd. We are a company limited by sharesorganized under the laws of the State of Israel.  We were originally incorporated as NICENeptun Intelligent Computer Engineering Ltd. on September 28, 1986 and renamedNICE-Systems Ltd. on October 14, 1991. Our principal executive offices are located at 8 Hapnina Street, P.O.Box 690, Ra’anana 43107, Israel and the telephone number at that location is+972-9-775-3030.  Our agent for servicein the United States is our subsidiary, NICE Systems Inc., 301 Route 17 North,Rutherford, New Jersey 07070.

 

**Business Overview**

 

NICE offerssolutions that consist of multimedia capture, multimedia content analysis andapplications. These solutions enable our customers to extract insight fromunstructured interactions by capturing the interactions and analyzing thecontent, thereby enabling improved business decisions or improved securityoperations. We offer our solutions as products or system solutions to variousvertical markets in two major sectors: 1) the Enterprise Interaction sector; and 2) the Public Safety andSecurity sector.

 

**1) EnterpriseInteraction Solutions**

 

***Markets***

 

The overallmarket for products that enable users to extract insight from interactionsthrough digital voice recording, contact center management products andperformance management products has experienced steady growth in recent yearsas a result of the increase in the use of telephones to obtain information, toinitiate business and consumer contacts, to provide services such as bankingand insurance, and to sell products through contact centers.

 

Users of ourenterprise interaction solutions include financial institutions, such asbrokerage and trading houses; contact centers within the enterprise, such astelemarketing, customer service, telebanking and teleinsurance facilities andother departments in the enterprise that can benefit from analyzing customerinteractions, such as marketing, operations and legal.

 

17

----

 

*FinancialInstitutions*.  Financial institutions conduct a substantial portion of their businessover the telephone and are increasingly relying upon their ability to record,store and retrieve voice data of transactions in a timely, reliable andefficient manner. Brokers and dealers record and store recordings oftransactions to provide back-up and verification of such transactions and toguard against risks posed by lost or misinterpreted voice communications orfraud. Our customers in the financial institutions market include ABN AMROBank, American Express, Bank of America, Barclays, CIBC Oppenheimer, Citibank,Deutsche Bank, Dresdner Bank, First Chicago NBD, JP Morgan Chase, GoldmanSachs, Lehman Brothers, Morgan Stanley, Sydney Futures Exchange and TokyoMitsubishi Bank.

 

*ContactCenters*.   Manyenterprises are increasingly using dedicated contact centers as their maincontact point with their customers. These contact centers are processing andmanaging high volumes of incoming and outgoing customer interactions. Contactcenters have been used extensively in such fields as financial services(banking, credit cards, insurance, investments), telecommunications, retail,health care and travel services. Typically, the contact center is the primary “hub”within an organization for placing or receiving a large volume of customerinteractions. Customer service representatives are talking with customersabout  issues such as reservations,product information, account information, and problem resolution. As theimportance of the contact center increases and more functions and capabilitieshave been combined, a parallel industry has emerged. This industry creates andsupports the systems, software and services that are designed to make theseenterprises and the contact center activities within the enterprises efficient,effective and well matched to the broader corporate mission of the enterprise.Also, it is increasingly expected that the contact center be the “eyes and ears”of the enterprise in the market and a prime source of information for thevarious enterprise departments, such as marketing, sales, legal, finance andoperations. The global contact center market is using voice recording solutionsand related applications to enable storage of the details of telephone ordersand other transactions, supervision of contact center operators and campaigns,and evaluation of salespersons’ efficiency, customer service and training. Itis also increasingly being used to extract insight from the recordedinteractions to solve business issues and increase the overall enterpriseperformance. Users of the NICE Perform, NiceUniverse and NiceLog system in thismarket include AllSec, American Express, Blue Cross Blue Shield, Citibank, DHL,Federal Express, Ford Credit, Home Depot, IBM, Liberty Mutual, National Bank ofCanada, Nextel, Nokia, PRC, Spectramind, Telecom New Zealand, Time Warner,Vodafone, Wipro, WPS and Wynn Resorts. 

 

**Sales andMarketing; Strategic Relationships**

 

We market,distribute and service our Enterprise Interaction Solutions worldwide, throughleading suppliers of complementary products, such as Avaya, independent dealersthat predominantly specialize in the voice recording market and contact centerand enterprise applications, as well as through our own sales and technicalsupport force in the United States, Canada, Germany, the United Kingdom,France, Spain, Hong Kong, Japan, Singapore, India and Israel.  Most of the sales made by our sales force aremade to our distributors, who then install the systems and provide day-to-daysupport to end-users.

 

18

----

 

In the Financial Trading segment, we have established marketing, salesand support arrangements with leading suppliers of complementary products.These companies market and distribute our products to their customers either asstand-alone systems or as integrated components of their own systems, asfollows:

 

•              AnOEM agreement with IPC Information Systems, Inc. IPC, a leading provider ofintegrated communications solutions to the financial services community, hasembedded a NiceLog platform customized for IPC into IPC’s Alliance MX productline and sells this product as an integral part of the IPC product.

 

•              AnOEM agreement with Etrali S.A., a telecom integrator serving the financialcommunity. Etrali is a European leader of dealer-board systems for tradingrooms. Etrali and NICE have closely integrated our products for dealing rooms,which are distributed globally by Etrali S.A.

 

•              Amarketing and developer support agreement with BT Syntegra, British Telecom’sselling and integration company in the trading floor segment.

 

In the Contact Center segment, we have entered into global distributionagreements as well as alliances and development programs for integration andensuring compatibility of products with leading vendors, as follows:

 

•              Aglobal partnership with Avaya Inc. Avaya is the leading global provider ofenterprise business communication platforms in voice, e-business and data.Avaya and its business partners (or sales partners or dealers) are co-sellingour enterprise interaction solutions to their customers globally. 

 

•              Amarketing and technical collaboration with Dimension Data, IBM, Philips andSiemens. 

 

•              AnOEM and developer support agreement with Alcatel.

 

•              Analliance program with Aspect Telecommunications to ensure the compatibility ofour contact center product line with Aspect’s automatic call distributionsystems and to promote this integration through Aspect’s marketing materials.

 

•              Technicalcollaboration and development programs with Cisco, Concerto, Ericsson, Genesys,Mitel, NEC, Nortel, Philips and Rockwell.

 

•              Productintegrations with Siebel Systems and Amdocs (Clarify Inc.) in the CRM Space.These integrations with leading CRM providers enable customers to capture andenhance their customers’ entire experience in the contact center from start tofinish and to more tightly integrate the functionality delivered by ourproducts into their business environment. 

 

19

----

 

***Products***

 

Our enterpriseinteraction solutions include recording, monitoring, quality management andbusiness performance management solutions which are designed to captureinteractions, analyze them and take action based on this analysis to drive theenterprise performance. They also protect businesses and customers againstrisks posed by lost or misinterpreted voice or data transmissions and captureand improve contact center agent performance and the customers’experience.  

 

Interactioncapture units (known as voice recorders or loggers) are systems that captureand record large volumes of voice data transmitted over multiple telephone orother communication lines and allow users to retrieve and playback specificcommunication data. Traditional voice recorders were based on analogreel-to-reel technology, which limited an organization’s ability to store andretrieve data efficiently, and which could not interface with digital computerand telecommunication networks. In the early 1990s, analog reel-to-reelrecorders began to be replaced with analog VHS-based products and, more recently,by digital products, including those based on magnetic disk, optical disk ordigital audio tapes (or DAT). Organizations’ growing needs to record, process and store large amountsof voice data resulted in the introduction of digitally-based voice recordingsystems characterized by increased performance and improved systemeconomics.  Digital multi-channelrecording systems enable simultaneous recording and logging of a large numberof channels, while enabling a large number of users to process voice datasimultaneously. Digital systems’ advantages over traditional analog systemsinclude the immediate random access to recorded data, open connectivity andcompact size of both the recording unit and storing and archiving media.Advanced, industry-standard, digital voice recording systems employing computertelephony integration (or CTI) technologies allow for integration of therecording and retrieval functions with organizations’ computer andtelecommunications networks, thereby delivering maximum business benefits,increased user efficiency, and wider access for larger numbers of users.  The demand for sophisticated CTI digitalvoice recording systems is increasing as a result of the increased demand fordigital recording systems, particularly in the contact center market and theconversion by the large installed base of analog systems to digital technology,specifically in the financial institutions, public safety and air trafficcontrol markets.

 

Today’sbusiness is characterized by increasing reliance upon interactions conductedvia telephony and web-based communications. These means of communication arebecoming an important and strategic dimension of business across a broadspectrum of markets. In these business environments, a great deal of informationlies hidden within the ever-growing quantities of unstructured multimediainteractions. This information can provide decision makers throughout theenterprise with insights into their marketplace and customer base, and directaccess to key business scenarios. Many of these capabilities are not availablewith traditional transactional-based analytics tools. They are of great valueto organizations constantly searching for better ways to understand theirmarket dynamics and customer intent, while operating within the limitations oftraditional surveying and data analysis techniques and growing regulatoryrequirements. 

 

20

----

 

NICE Performis our flagship enterprise product. It is an integrated suite of solutions thatoffers innovative ways for organizations to generate insight from interactionsto enhance performance. NICE Perform combines multiple data sources in a fullyintegrated architecture with a centralized data warehouse, allowinginteroperability of all the data sources to address a variety of businessissues with a high level of accuracy. The data sources include word spotting,emotion detection, talk pattern analysis, customer surveys, CTI analysis,application activities and business data. With a set of advanced engines, NICEPerform provides multi-dimensional analytics of these data sources.State-of-the-art visualization techniques enable analysts and executives toquickly and easily identify trends, deviations and situations requiringimmediate action. All these capabilities are implemented in an advancedapplication suite that is underpinned by a new series of powerful high densitycapture and archiving platforms that provide cost-effective reliable processingof multimedia interactions in a format optimized for multi-dimensionalanalytics. 

 

Whileproviding critical statistical data, NICE Perform goes beyond the scope oftransactional analytics to help decision makers understand customer intent andmarket dynamics, identify current and future trends early enough for proactivemanagement of challenges, opportunities and changes, and enhance corporategovernance throughout the enterprise. For example, marketing executives canmore effectively track marketing campaigns, analyze causes of success or failure,and quickly adapt to changing market conditions. Finance and legal executivescan ensure that company policies are adhered to in all phone conversationsacross the organization, thereby avoiding costly legal action by spotting andcorrecting irregularities before they become problems.

 

NICE Performalso contains all of the contact center quality management capabilities ofNiceUniverse described below. In addition, NICE Perform includes advancedonline coaching capabilities. These enable supervisors to coach the contactcenter agents in order to improve their skills and to empower those agents andcover immediate knowledge dispersal matters as needed by the differentdepartments, such as marketing or order administration.  

 

NiceUniverse,introduced in February 1998, is a comprehensive quality management solutionused to evaluate agent performance and to raise the level of customer servicein contact centers through advanced voice and desktop screen recordingtechnologies. The NiceUniverse system provides objective evaluation tools andhelps identify training requirements for contact center agents, includingreal-time monitoring for instant access to live customer interactions andenhanced reporting and administration features. NiceUniverse uses a CTI that integrateswith automatic call distributions (or ACDs). This enables NiceUniverse tomonitor and record agent sessions (voice and screen) on a user-defined scheduleand store them in compressed digital format. Sessions are later retrieved bythe reviewers from their network PCs or thin clients, and agent performance isgraded using customized on-screen templates. From these templates and otherdata, NiceUniverse generates detailed reports, statistics and graphs to helpidentify training requirements and set relevant benchmarks for contact centeragents.

 

NiceLog, ourdigital voice recording system, is a computer telephony integratedmulti-channel voice recording and retrieval system. NiceLog is an openarchitecture system based on PC architecture and advanced audio compressiontechnology that performs continuous, reliable

 

21

----

 

recordings ofup to thousands of analog and digital telephone lines, as well as radiochannels, and enables simultaneous access by multiple users. NiceLog can beused either as a stand-alone unit or as part of a highly expandable andscaleable system comprised of several seamlessly integrated units. Each NiceLogunit can simultaneously record, monitor, archive and playback. The NiceLog Systemincludes client and web applications that enable users to access the system,these applications communicated with the voice servers using the TCP/IPcommunication protocol and can run on Windows 98/Me, Windows NT, Windows 2000and Windows XP operating systems. The system can connect to telecommunicationinterfaces such as T1, E1, ISDN and analog trunks as well as other morespecialized interfaces. The modular design of the NiceLog system makes it apowerful voice management tool that can be expanded to satisfy customers’ needsby integrating it with additional NiceLog units on the same local area network,or LAN. 

 

Our patentedVoIP Capture Unit builds on our NiceLog technology to provide a completesolution to audio storage in Voice over Internet protocol (VoIP) telephonyenvironments. The VoIP Capture Unit provides an IP-recording platform with awide range of scaleable recording solutions that supports the leading telephonyvendors. Our VoIP Capture Units are fully integrated with the NICE productportfolio, making all our applications available for use over VoIP. NICE VoIPLoggers can serve alongside other logger types in a mixed VoIP/non-VoIPenvironment with the same familiar application software; users are unaware ofthe voice capture method being used.

 

NICE VoIPCapture Units can use both packet sniffing and active recording methods forrecording VoIP sessions. NICE VoIP active recording solutions integrate withleading vendors such as Avaya, offering centralized recording of distributedenvironments and other benefits.

 

NiceLog’scentral storage option, NICE Storage Center, can integrate with variousenterprise storage networks (SAN, NAS or DAS) for long term or medium termvoice storage. Central storage sites can hold the entire voice recording from allthe organization’s different sites thus reducing management costs andredundancy. The retrieval process for voice on the central site is fullyautomatic. 

 

NiceCall FocusII is a voice recording system that records up to 32 input channels andprovides up to 66,000 hours of on-line voice storage capacity (using NICE’s ACAcompression) and supports wide range of archiving devices for long-term storageoptions. NiceCall Focus II offers a wide range of connectivity to PABX andRadio systems and is built on the successful legacy of NiceCall Focus which wasintroduced in 2001. NiceCall Focus II provides organizations that have arelatively small number of input channels, such as public safety agencies, witha competitively priced yet technologically advanced digital recording productthat offers many of the connectivity and processing features of NiceLog.NiceCall Focus II is being targeted primarily at public safety facilities,including 911 emergency centers and utilities, as well as small bank branches,financial trading sites, and contact centers.

 

22

----

 

**2) PublicSafety and Security Solutions**

 

***Markets***

 

The overallmarket for public safety and security solutions is comprised of voice platformsand applications, digital videoplatforms and applications, and lawfulinterception****products. Themarket has experienced steady growth over the last few years driven bycontinued governmental response to the dangers of terrorism, public disturbanceand general heightened awareness of the need for enhanced security withinenterprises. 

 

**a) Voice Platforms and Applications**

 

Users of ourvoice platforms and applications include public safety and transportationagencies, such as police, fire and ambulance departments, air traffic controlcenters and intelligence agencies.

 

*Public Safety and Emergency Services*.* *These organizations includepolice, fire, ambulance, coastguard, mountain rescue and other similar publicand private bodies that respond to calls for assistance from the public.  In most cases, local, state or federal lawrequires that all communications traffic be recorded in order that evidence canbe provided in courts of law, and in order that the public safety body canverify that it is following prescribed processes and meeting performancestandards.  Our customers in the publicsafety market include: Chicago Police Department, Indiana State Police, LosAngeles Police Department, New Jersey State Police, New York Police Department,Seattle Fire Department, U.S. Department of Defense, Hampshire Police – U.K.and Hertfordshire Police – U.K. 

 

*Public Transport Agencies*. These organizationsinclude rail, bus and mass transit metro systems.  They use large-scale, distributed, fixed andmobile communications networks in order to provide command and controlcapabilities between the mobile units and one or more control rooms.  In the event of an incident, they arerequired to be able to produce recordings of all associated communicationstraffic. Many of these organizations are implementing the latest generation ofdigital trunked radio systems according to one of the several internationalstandards, such as TETRA, Tetrapol or APCO25, and the recording system isrequired to interface to these radio systems in order to capture and identifyall radio traffic. Our customers in the public transportation market includeauthorities like Singapore Mass Transit Authority and Railtrack – U.K. 

 

*Air Traffic Control (or ATC).*The ATC marketis a traditional user of voice recording systems due to mandatory requirementsfor the recording of voice communications and radio transmissions. ATC centersare evaluating the need to upgrade their voice communications recording andarchiving systems by installing digital voice loggers. NiceLog was selected bythe FAA as the voice recording system to be installed in over 800 ATC centersin the United States. NiceLog and Wordnet have also been selected by ICAO andother ATC authorities in Austria, Canada, China, Croatia, Cyprus, Hong Kong,Hungary, Iceland, Israel, Japan, Kazakhstan, the Maldive Islands, theNetherlands, Norway, Poland, Romania, Switzerland and Turkey. 

 

23

----

 

*Intelligence Agencies*.  Law enforcement and intelligence agenciescollect large amounts of information in various media for analysis andevaluation, although only a small portion of that information is valuable.Intelligence agencies require sophisticated multi media recording systems thatenable the recording, retrieval and processing of the information gathered forpurposes of analysis and evaluation. Users who have installed NiceLog or Wordnet systems, either as standalone systems or in combination with other systems, include intelligenceagencies in more than twenty countries.

 

**b) Digital Video Platforms and Applications**

 

The market fordigital video platforms, which provide continuous video surveillance andrecording for security protection purposes, is currently unfolding as closedcircuit television, or CCTV, applications shift from traditional analogrecorders to digital recorders. Users of our digital video recording systemsinclude correctional facilities, banks, telecommunication data-center hostingcenters, retail stores, casinos, transportation companies and city centers.

 

Customers forour products include the Atlanta Hartsfield International Airport, Bally’scasino in Atlantic City, Bank of England, Casino Cosmopol in Sweden, ChaseManhattan, Dallas Fort Worth International Airport, Dell Computer Corporation,European Space Agency, the Helsinki Railway Station - Finland, the MetropolitanNashville Airport Authority, Toronto Pearson International Airport, andcorrectional facilities in Brooklyn, New York, and Rush City, Minnesota. 

 

**c) Lawful Interception**

 

The marketcomprised of law enforcement agencies, internal security and intelligenceorganizations is undergoing rapid changes. In parallel to the growth in thenumber and severity of threats, new telecommunications services andapplications are utilized by public agencies, which need sophisticatedsolutions to intercept and analyze the intelligence information collected bythese services and applications.

 

Additionally,governments are adopting new legislation and regulating new standards in orderto assist the organizations that deal with intelligence. According to theselegislations and regulations, telecom service providers are required to installsystems that will enable the interception of certain communications and deliverthem in real time to the monitoring agencies.

 

24

----

 

***Sales and Marketing; Strategic Relationships***

 

In the publicsafety market, we distribute our products worldwide through a network of over100 national and local independent dealers and distributors that also provideinstallation and maintenance services.

 

•              Amarketing agreement with Motorola Inc. for the co-marketing and resale of ourrange of products for the public safety market in North American andinternational markets.  This relationshipincludes the appointment of NICE as the only authorized Dimetra ApplicationPartner for Motorola’s trunked radio solutions.

 

•              Wealso market and sell systems through major regional or global partners, such asAlcatel, BT, Damovo, Marconi, Nokia and Siemens.

 

In the ATCmarket, we have been awarded contracts for installation of NiceLog systems onthe basis of bids submitted to ATC authorities by Denro Systems, Inc. (part ofNorthrup Grumman, Inc.) and others that incorporated NiceLog as the voicerecording system as part of their proposal. Pursuant to an agreement datedAugust 1995 between the FAA and Denro, NiceLog was selected as the voicerecording system to be installed in various ATC centers in the United States.We provide NiceLog cards (including software) to Denro and Denro assembles andinstalls them. 

 

We have adedicated sales organization for the NiceVision digital video recording system.We use a network of dealers and security systems integrators for the sale,installation and support of our solutions. In North America we work through keypartners such as Anixter, Diebold and Siemens Building Technologies.  In EMEA we work with system integrators, suchas Siemens, Surveillance Group and Thales Security. Recently, we have alsoagreed on a collaboration with IBM and Cisco in the area of digital videosurveillance.

 

We have adedicated sales and marketing organization for the NiceTrack system for lawfulinterception. We market the system worldwide through our direct sales force andthrough distributors.

 

***Products***

 

**a) Voice Platforms and Applications**

 

Through theacquisition of TCS, NICE provides first responders and air traffic controlorganizations with a full range of recording features for voice, radio andtrunked radio, including on-line access to hundreds of hours of recording for aquick response time, a choice of different types of archiving media, and adubbing capability to edit calls on-line for courtroom presentations. Thesystem enables the organizations to re-construct scenarios, investigate and improveperformance. Our products are currently being used in a significant number ofair traffic control facilities, including FAA and NAV Canada, as well as largepolice departments, transportation companies and emergency services command andcontrol centers.

 

25

----

 

The underlyingvoice recording platforms used in the public safety marketplace are similar tothe products described above.  Theirprimary use is to record and replay voice conversations and associated data inorder to be able to reconstruct and analyze incidents that have occurred.However, there are some significant technical differences owing to the need inmany cases to capture not only voice traffic coming into and out of the publicservice command and control center, e.g., a 911 center, but also the radiotraffic that is occurring between the command and control center and the fieldpersonnel.  Hence the technicalinterfaces and architecture of the products are often different from thoserequired for commercial environments.

 

The othermajor difference is that there may be the need to replay and analyze multipleconversations that occurred in connection with an event in order to fullyanalyze it.  For example, it may benecessary to replay, in synchronism, many different radio channels, togetherwith the radio dispatch conversations, together with the telephoneconversations from multiple callers.  

 

Our offeringto the public safety market ranges in size and complexity from small,single-site single-recorder systems to large, multi-site, multi-recordersystems integrated with trunked radio and computer-aided dispatch systems.Below is a description of the ex-TCS product lines that are primarily offeredto the public safety market.

 

# **Mirra is asmall recording system that is particularly suited to simple recordingapplications in which it can record up to 32 channels of voice traffic from awide variety of analogue and digital interfaces.  Mirra has been designed to be simple toinstall, operate and maintain and has been sold to many local, city and statepublic safety organizations that have a single site operation.  Digitized voice and associated data arestored onto DVD disks that provide a robust and long-term archive medium.  Mirra’s design avoids using an internal harddisk for the operating system and consequently it starts-up very rapidly andavoids the maintenance liabilities associated with hard disks.**

# ** **

# **Tienna is alarge recorder that is designed to form part of a “Renaissance” solution.  Renaissance solutions are used when thecustomer has a complex requirement typically involving multiple recorders,multiple sites and dual-redundant components in order to provide very highperformance and resilience.  Tienna canprovide up to 480 channels per unit and multiple units can be interconnected toform a system of many thousands of ports. Tienna is unique in that it provides dynamic channel allocation betweenthe active ports on the recorder and a greater number of channels on thenetworks to which it is connected.  Thisprovides a more efficient use of the system’s resources than a permanent 1:1connection of channels to ports.  Tiennacontains internal hard disks for short-term storage but relies upon theRenaissance Centralized Mass Storage Unit (or CMSU) for all medium andlong-term storage and for archiving onto tapes.**

# ** **

Renaissancesolutions can incorporate combinations of Wordnet and Tienna recorders, as wellas the CMSU, calls database and replay server. These components operate together in a networked configuration toprovide a complete recording solution and can be fully duplicated in order toprovide very high levels of redundancy and reliability. Since March 2005,Wordnet is no

 

26

----

 

longer generallyavailable for sales, and we offer NiceLog as a replacement to the Wordnetcustomers and partners.

 

**b) Digital Video Platforms and Applications**

 

Our NiceVisionproduct line consists of the NiceVision Pro, NiceVision Harmony, NiceVisionAlto and NiceVision NVSAT. NiceVision is a state-of-the-art digital video andaudio recording system that provides continuous CCTV, recording, archiving, anddebriefing capabilities that meet the needs of today’s demanding securityenvironment, including central banks, Fortune 500 companies, transportationfacilities, prisons, and casinos. 

 

The NiceVisionPro is a premium solution designed for high-end applications requiringhigh-frame rate and/or a large number of cameras in a campus environment.  Typical environments for the NiceVision Proare airports, casinos and ground transportation facilities. The NiceVision Proaccommodates 96 video channels in one single box and can handle storage devicesin the range of tera-bytes. These devices are of two types: disk based on-linestorage (internal drives or external RAIDs) and tape-based off-line juke boxdevices.

 

The NiceVisionHarmony is a mid-range digital video recording solution designated for sitesaccommodating a large number of cameras yet requiring a variety of frame ratesper channel, spanning from single frames per second to full frame rate, whenrequired. Typical environments for the NiceVision Harmony are retail shops,certain bank facilities and corporate buildings. The NiceVision Harmony catersfor 64 video channels with a preset frame rate shared between groups ofchannels. The NiceVision Harmony can also support large storage devices likethe NiceVision Pro. 

 

The NiceVisionAlto is a mid range product that can support eight to 32 video channels usingvariable frame rates and resolutions. Typical environments for the NiceVisionAlto are distributed sites that require high image quality and adjustable levelof service to meet different networking channels. The NiceVision Alto runscontent analytics to support smart monitoring.

 

The NiceVisionNVSAT is a small scale unit that supports four to eight video channels. It isdesigned for distributed architectures, where it serves as a smart Codecproviding high image quality, level of service and content analytics.

 

**c) Lawful Interception**

 

The NiceTrackproduct line provides law enforcement agencies, internal security services andintelligence organizations with end-to-end solutions for the interception,delivery, monitoring, collection and advanced analysis of telecommunicationinteractions. In order to create a full perspective of threats, NiceTrackproducts handle both telephony and Internet data on the same platform. Theworking environment provides intelligence analysts with a broad intelligenceperspective to ensure that crucial information is always delivered to decisionmakers and operational staff in real-time. NiceTrack also features an openarchitecture design that offers government agencies the flexibility they needto build an effective intelligence platform

 

27

----

 

customized and localized tosuit specific operational requirements and methodologies. 

 

NiceTrack, asa lawful interception solution, is fully compliant with the internationalstandards defined by ETSI (under various European legislations) and TIA (underthe CALEA legislation).

 

**DictaphoneAcquisition**

 

We completedthe acquisition of Dictaphone’s Communications Recordings Systems division (orCRS) on June 1, 2005. CRS is a leading provider of recording, liability andquality management systems for first responders, critical facilities, contactcenters and financial trading floors.

 

CRS’s majorproducts are marketed under the Freedom® trademark. The products include:

 

•      FreedomEnterprise, which combines state-of-the-art recording technology for full-timeor selective recording with advanced tools for optimizing contact centerperformance in virtually any telephony environment: circuit-switched telephony,VoIP and hybrid environments.

 

•      FreedomFT, which provides high-level fault-tolerant recording, with a design thateliminates single points of failure and ensures that recordings are capturedand accessible when required. 

 

•      FreedomrDT, which works with the Motorola or M/A-COM trunked radio system to record radiocommunications dynamically and capture trunked radio data. It is a solutionaimed at the 9-1-1 first responder market.

 

CRS operatedin most of our existing markets, including contact centers, first respondersand financial markets. Most of CRS’s activity has been in the first respondersector, while we have had a stronger position in the contact center andfinancial market sectors. Most of the division’s operations are concentrated inthe United States, with some activity in Europe. At the time of the acquisitionby us, CRS had approximately 8,000 customers, including the City of Miami,Comcast, Credit Suisse, Verizon and the U.S. Army. 

 

We intend tocontinue to support the range of CRS Freedom products for up to five years, andwhile we will not actively seek to expand the sales of these solutions, we areprepared to meet any market demand for them. At the same time, we will continueto develop our range of solutions for the various market sectors, taking intoconsideration the requirements of the CRS customer base.

 

**DiscontinuedOperation - COMINT/DF**

 

On March 31,2004, we sold the net assets of our COMINT/DF military-related business to ELTASystems Ltd (“ELTA”) for $4 million in cash. The net assets sold include the

 

28

----

 

intellectual property, fixedassets, inventory, and contracts related to the COMINT/DF product line whichincludes high performance spectral surveillance and direction finding systemsthat detect, identify, locate, monitor and record transmission sources. TheCOMINT/DF business is therefore treated as a discontinued operation in ourfinancial statements.

 

In 2002, 2003and 2004, the COMINT/DF business generated revenues of approximately $7.2million, $6.5 million and $0.8 million, respectively, and net income ofapproximately $1.4 million, $1.5 million and $3.2 million (including gain ondisposition), respectively.

 

**Manufacturing and Source of Supplies**

 

Our products are built in accordance with industry standardinfrastructure and are PC compatible. The hardware elements in our products arebased primarily on standard commercial off-the-shelf components and utilizeproprietary in-house developed circuit cards and algorithms and digitalprocessing techniques and software. In the fourth quarter of 2002, we startedselling “software only” solutions for use on standard servers.

 

Prior to the first quarter of 2002, our manufacturing operationsconsisted primarily of final assembly and testing of components andsubassemblies. We manufactured our products in our facility in Ra’anana, Israeland our special NiceLog systems in our facilities in Ra’anana and Sunnyvale,California. 

 

During thefirst quarter of 2002, however, we began implementation of a contractmanufacturing agreement with Flextronics Israel Ltd., a subsidiary of a globalelectronics manufacturing services (or EMS) company.  Under this agreement, Flextronics provides uswith a turnkey manufacturing solution including order receipt purchasing, manufacturing,testing and configuration.  Thisagreement covers all of our product lines, including our voice recording familyof products, our video product lines, our upgrade lines and our spare parts andRMA. We believe this outsourcing agreement provides us with a number of costadvantages due to Flextronic’s large-scale purchasing power, and greater supplychain flexibility. We completed the transfer to Flextronics of the productionfor all our products during the second half of 2002.

 

Some of thecomponents we use have a single approved manufacturer while others have two ormore options for purchasing. In addition, for some of the components andsubassemblies we maintain an inventory to limit the potential for interruption.We also carry out relationships directly with some of the more significantmanufacturers of our components. Although certain components and subassemblies we use in our existingproducts are purchased from a limited number of suppliers, we believe that wecan obtain alternative sources of supply in the event that such suppliers areunable to meet our requirements in a timely manner.

 

We also have acontract manufacturing agreement with Instem Technologies Ltd, a U.K. company,entered into by TCS prior to its acquisition by NICE. Under this agreementInstem is the manufacturer of all ex-TCS products. This manufacturing facilityis located in the United Kingdom. We also have a contract manufacturingagreement with Dictaphone’s EMS division

 

29

----

 

entered intoby us simultaneously with the acquisition of CRS. Under this agreement EMS isthe manufacturer of all ex-CRS products. This manufacturing facility is locatedin the United States.

 

Qualitycontrol is conducted at various stages at our manufacturing outsourcers’facilities and at their subcontractors’ facilities.  We generate reports to monitor ouroperations, including statistical reports that track the performance of ourproducts from production to installation. This comprehensive data allows us to trace failure and to performcorrective actions accordingly.

 

We havequalified for and received the ISO-9001:2000 quality standard for all of ourproducts.

 

**Service and Support**

 

We havefocused on building a strong service and support organization for all oursystems and have focused on rendering the various regions in which we operateto be as self sufficient as possible. Our dealers, as well as othertelecommunications companies that market our products, are primarilyresponsible for supporting the day-to-day requirements of the end-users, whilewe provide technical support to such dealers and partners.  In order to support our direct customers andpartners, we established three regional support centers, the largest of whichis in Denver, Colorado, to support our U.S. customers and partners, as well asone in Hong Kong to support APAC customers, dealers and partners, and one inthe U.K. to support EMEA customers, dealers and partners. We maintain at ourheadquarters a staff of highly skilled customer service engineers that offer supportto our dealers or partners that offer direct support to our customers. Theseservice engineers, as well as additional service engineers located in ouroffices in the United States, EMEA and APAC, provide first class field servicesand support worldwide. We maintain regular training sessions for our dealersand installation support as well.

 

Following ouracquisition of TCS in November 2002, we have increased our revenues fromservices while successfully integrating the ex-TCS services group.  We now have a consolidated support groupdelivering services to both NICE and ex-TCS business partners andcustomers.   

 

Our systemsare generally sold with a warranty for repairs of hardware and software defectsand malfunctions, the term of which is usually one year after shipment.  Longer warranty periods are applicable tosales in certain international and government markets. Extended warranty andservice coverage is provided in certain instances and is usually made availableto customers through our distributors on a contractual basis for an additionalcharge. Our customers may purchase a renewable maintenance agreement from ourdealers or directly from us. The maintenance agreements generally provide formaintenance, upgrades of standard system software and on-site repair orreplacement. 

 

For ourtelecommunications monitoring systems, we provide first and second tier serviceand support either directly using our support organization or indirectlythrough local companies working closely with the law enforcement agencies.

 

30

----

 

**Research and Development**

 

We believethat the development of new products and the enhancement of existing productsare essential to our future success. Therefore, we intend to continue to devotesubstantial resources to research and new product development, and tocontinuously improve our systems and design processes in order to reduce thecost of our products. Our research and development efforts have been financedthrough our internal funds and programs sponsored through the Government ofIsrael. We believe our research and development effort has been an importantfactor in establishing and maintaining our competitive position. Grossexpenditures on research and development in 2002, 2003 and 2004 wereapproximately $23.4 million, $26.4 million and $27.5 million, respectively, ofwhich approximately  $1.6 million, $1.3million and $1.3 million, respectively, were derived from third-party funding,and $4.6 million, $2.3 million and $1.3 million, respectively, were capitalizedsoftware development costs. 

 

In  2004, we were qualified to participate in sixprograms funded by the Office of the Chief Scientist, or OCS, of the IsraeliMinistry of Industry, Trade and Labor to develop generic technology relevant tothe development of our products.  We areeligible to receive grants constituting between 20% and 66% of certain researchand development expenses relating to these programs.  As opposed to the standard type of OCS grants(described below), the grants under these programs are not required to berepaid. However, the restrictions of the Research and Development Law describedbelow apply to these programs. In 2002, 2003 and 2004, we received a total of$1.4 million, $1.4 million and $0.8 million, respectively, and we anticipatereceiving approximately $1.0 million in 2005, from these programs. 

 

We areeligible to receive grants from the OCS under its “standard” program,constituting up to 50% of certain research and development expenses, for theresearch and development of approved technology. Under the terms of thisprogram, we would be required to pay a royalty of 3% to 5% of the net sales ofproducts incorporating technology developed in, and related services resultingfrom, a project funded by the OCS. The royalties are required to be paidbeginning with the commencement of sales of such products and ending when 100%to 150% of the grant is repaid in New Israeli Shekels, or NIS, linked to theU.S. dollar plus LIBOR interest. In 2002, 2003 and 2004, we received no grants and incurred no royaltyobligations under this program, and we have no further royalty obligations tothe OCS.

 

The Researchand Development Law generally requires that the product developed under anOCS-funded program be manufactured in Israel. However, upon the approval of theOCS, some of the manufacturing volume may be performed outside of Israel,provided that the grant recipient pays royalties at an increased rate, whichmay be substantial, and the aggregate repayment amount is increased to 120%,150% or 300% of the grant, depending on the portion of the total manufacturingvolume that is performed outside of Israel. Effective April 1, 2003, theResearch and Development Law also allows for the approval of grants in cases inwhich the applicant declares that part of the manufacturing will be performedoutside of Israel or by non-Israeli residents and the research committee isconvinced that doing so is essential for the execution of the program.  This declaration will be a significant factorin the determination of the Office of the Chief Scientist whether to approve aprogram and the amount and other terms of

 

31

----

 

benefits to be granted.  For example, the increased royalty rate andrepayment amount will be required in such cases.

 

The Researchand Development Law also provides that know-how developed under an approvedresearch and development program may not be transferred to third parties inIsrael without the approval of the Office of the Chief Scientist.  Such approval is not required for the sale orexport of any products resulting from such research or development. TheResearch and Development Law further provides that the know-how developed underan approved research and development program may not be transferred to anythird parties outside Israel.

 

The Researchand Development Law imposes reporting requirements with respect to certainchanges in the ownership of a grant recipient. The law requires the grant recipient and its controlling shareholdersand interested parties to notify the Office of the Chief Scientist of anychange in control of the recipient or a change in the holdings of the means ofcontrol of the recipient that results in a non-Israeli becoming an interestedparty directly in the recipient and requires the new interested party toundertake to the Office of the Chief Scientist to comply with the Research andDevelopment Law.  In addition, the rulesof the Office of the Chief Scientist may require prior approval of the Officeof the Chief Scientist or additional information or representations in respectof certain of such events. For this purpose, “control” is defined as theability to direct the activities of a company other than any ability arisingsolely from serving as an officer or director of the company.  A person is presumed to have control if suchperson holds 50% or more of the means of control of a company.  “Means of control” refers to voting rights orthe right to appoint directors or the chief executive officer.  An “interested party” of a company includes aholder of 5% or more of its outstanding share capital or voting rights, itschief executive officer and directors, someone who has the right to appoint itschief executive officer or at least one director, and a company with respect towhich any of the foregoing interested parties owns 25% or more of theoutstanding share capital or voting rights or has the right to appoint 25% ormore of the directors.  Accordingly, anynon-Israeli who acquires 5% or more of our ordinary shares or ADSs will berequired to notify the Office of the Chief Scientist that it has become aninterested party and to sign an undertaking to comply with the Research andDevelopment Law. 

 

The fundsavailable for Office of the Chief Scientist grants out of the annual budget ofthe State of Israel were reduced in recent years, and the Israeli authoritieshave indicated in the past that the government may further reduce or abolishOffice of the Chief Scientist grants in the future.  Even if these grants are maintained, wecannot presently predict what would be the amounts of future grants, if any,that we might receive.  

 

In June 2005,an amendment to the Research and Development Law came into effect, which isintended to make it more compatible with the global business environment by, amongother things, relaxing restrictions on the transfer of manufacturing rightsoutside Israel and on the transfer of OCS-funded know-how outside of Israel.The amendment permits the OCS to approve the transfer of manufacturing rightsoutside Israel in exchange for an import of different manufacturing into Israelas a substitute, in lieu of the increased royalties. The amendment furtherpermits, under certain circumstances and subject to the OCS’s prior approval,the transfer

 

32

----

 

of OCS-fundedknow-how outside Israel, in the following cases: (a) the subject company paysto the OCS a portion of the sale price paid in consideration for such fundedknow-how; (b) the subject company receives know-how from a third party inexchange for its funded know-how; or (c) such transfer of funded know-howarises in connection with certain types of cooperation in research anddevelopment activities.

 

**Intellectual Property**

 

We currentlyrely on a combination of trade secret, patent, copyright and trademark law,together with non-disclosure and non-compete agreements, to establish and/orprotect the technology used in our systems. We hold the following eleven issuedU.S. patents: 

 

•                  No. 5,861,959titled “Facsimile Long Term Storage and Retrieval System”

•                  No. 5,937,029titled “Data Logging System Employing M[N + 1] Redundancy” 

•                  No. 6,122,665titled “Communication Management System” 

•                  No. 6,046,824titled “CIF – Facsimile Long Term Storage and Retrieval System” 

•                  No. 6,330,025titled “Digital Video Logging System” 

•                  No. 6,542,602titled “Telephone Call Monitoring System”

•                  No. 5,353,168titled “Recording and Reproduction System using Time Division Multiplexing” 

•                  No. 6,871,229titled “Storing on a Computer Network-Based Telephone Session Performed Througha Computer Network”

•                  No. 6,865,604titled “Extracting a Computer Network-Based Telephone Session Performed Througha Computer Network”

•                  No. 6,888,004titled “Restoring a Portion of a Communication Session Transmitted Over aComputer Network”

•                  No. 6,856,343titled “Digital Video Logging System” 

 

We currentlyhave nine other patents issued in additional countries and over 100 patentapplications pending in the United States and other countries.  We believe that the improvement of existingproducts, and the development of new products are important in establishing andmaintaining a competitive advantage. We believe that the value of our productsis dependent upon our proprietary software and hardware continuing to be “tradesecrets” or subject to copyright or patent protection. We generally enter intonon-disclosure and non-compete agreements with our employees andsubcontractors. However, there can be no assurance that such measures willprotect our technology, or that others will not develop a similar technology oruse technology in products competitive with those offered by us. Although webelieve that our products do not infringe upon the proprietary rights of thirdparties, there can be no assurance that one or more third parties will not makea contrary claim or that we will be successful in defending such claim.

 

From time totime, we receive “cease and desist” letters claiming patent infringements.However, no formal claims or other actions have been filed with respect to suchalleged infringement, except for claims filed by Dictaphone (which have sincebeen settled and

 

33

----

 

dismissed) andWitness Systems.  We believe that none ofthese has merit.  We cannot assure you,however, that we will be successful in defending such claims, if asserted, orthat infringement claims or other claims, if asserted, will not have a materialadverse effect on our business, financial condition and results of operations.  Defending infringement claims or other claimscould involve substantial costs and diversion of management resources.  In addition, to the extent we are notsuccessful in defending such claims, we may be subject to injunctions withrespect to the use or sale of certain of our products or to liabilities fordamages and may be required to obtain licenses which may not be available onreasonable terms.  

 

We own thefollowing trademarks in different countries: 3600 ViewTM,Agent@homeTM, Executive Connect®, Executive Insight®, Experience Your Customer®,Freedom®, Investigator®, Lasting LoyaltyTM, Listen Learn Lead®, Mirra®,Universe®, My UniverseTM, NICE®, NiceAdvantage®, NICE AnalyzerTM, NiceCallTM,NiceCall FocusTM, NiceCLSTM, NiceCMSTM, NICE FeedbackTM, NiceFixTM, NiceGuardTM, NICELearningTM, NICE LinkTM, NiceLog®, NICE Playback OrganizerTM, Renaissance®,ScreenSenseTM, NiceScreenTM, NiceSoft®, NICE Storage CenterTM, NiceTrackTM,NiceUniverse®, NiceUniverse LIVETM, NiceVision®, NiceVision HarmonyTM, NiceVisionMobileTM, NiceVision ProTM, NiceVision VirtualTM, NiceVision® NVSATTM, NiceVision®AltoTM, NiceWatchTM, Secure Your VisionTM, Scenario ReplayTM, Tienna®, Wordnet®,NICE PerformTM, NICE InformTM, TRUNKNET® and Last Message ReplayTM. Applicationsto register certain of these marks have been filed in certain countries,including Australia, Brazil, the European Union, Germany, Great Britain,Israel, Japan, Mexico, Argentina and the United States. Some of suchapplications have matured to registrations. 

 

**Regulation**

 

The export ofcertain defense products from Israel, such as our NiceTrack products, requiresa permit from the Defense Sales and Exports branch of the Israeli Ministry ofDefense, or SIBAT. In 2004, only a small portion of our sales were subject tosuch permit requirements. To date, we have encountered no difficulties inobtaining such permits. However, the Ministry of Defense notifies us from timeto time not to conduct business with specific countries that are undergoingpolitical unrest, violating human rights or exhibiting hostility towardIsrael.  We may be unable to obtainpermits for our defense products we could otherwise sell in particularcountries in the future.  

 

**Competition**

 

The market forour enterprise interaction solutions is highly competitive and includesnumerous products offering a broad range of features and capacities. As themarket is still developing, we anticipate that a number of our existing andpotential competitors will be introducing new and enhanced products. Some ofour competitors in the digital voice recording and quality management forcontact center agent monitoring businesses include Autonomy (formerly e-talk),Verint Systems Inc. (formerly Comverse Infosys), a subsidiary of ComverseTechnology Inc., and Witness Systems Inc.

 

We believethat competition in the sale of our enterprise interaction solutions is basedon a number of factors, including system performance and reliability, theability to integrate with a

 

34

----

 

variety ofother computer and communications systems, marketing and distribution capacity,price and service and support. We believe that the wide range of featuresprovided by the NiceLog system and related applications, their wide connectivityand compatibility with telephone and computer networks and their ease of usecreate a competitive advantage to the NiceLog and such related applicationscompared to other similar systems currently being offered on the market.  

 

There areseveral small competitors who have products that compete with our videoplatform and applications. Our main competitors in this market are Dallmeier,Fast, Pelco, Verint Systems,  andVisionwave.

 

In the publicsafety market, there are a number of competitors providing solutions, includingASC Telecom, AudioSoft, CVDS, Cybertech, Mercom, Voiceprint and WestonDigital.  

 

There are anumber of competitors in the telecommunications monitoring market, havingproducts competing with our NiceTrack system, the major ones being RaytheonCompany, Siemens and Verint Systems Inc. We believe that our solution offersinnovations that provide law enforcement agencies the tools and capabilitiesthey require to meet the challenges of today’s advanced telecommunicationsworld, as well as being price competitive.

 

**OrganizationalStructure**

 

The followingis a list of all of our significant subsidiaries, including the name, countryof incorporation or residence, and the proportion of our ownership interest ineach. 

 

| **Name of Subsidiary**                         | ** ** | **Country of  Incorporation or  Residence** | ** ** | **Percentage of  Ownership  Interest** | ** ** |
|------------------------------------------------|------------|---------------------------------------------|------------|----------------------------------------|------------|
| NICE Systems, Inc.                             |       | United States                               |       | 100                                    | %          |
| NICE Systems GmbH                              |       | Germany                                     |       | 100                                    | %          |
| NICE Systems Canada Ltd.                       |       | Canada                                      |       | 100                                    | %          |
| NICE CTI Systems UK Ltd.                       |       | United Kingdom                              |       | 100                                    | %          |
| STS Software Systems (1993) Ltd.*              |       | Israel                                      |       | 100                                    | %          |
| NICE APAC Ltd.                                 |       | Hong Kong                                   |       | 100                                    | %          |
| NiceEye BV*                                    |       | Netherlands                                 |       | 100                                    | %          |
| NiceEye Ltd.*                                  |       | Israel                                      |       | 100                                    | %          |
| Nice Systems S.A.R.L.                          |       | France                                      |       | 100                                    | %          |
| Racal Recorders Ltd.                           |       | United Kingdom                              |       | 100                                    | %          |
| Nice Interactive Solutions India Private  Ltd. |       | India                                       |       | 100                                    | %          |
| Nice Japan Ltd.                                |       | Japan                                       |       | 100                                    | %          |
| Nice Systems Latin America, Inc.               |       | United States                               |       | 100                                    | %          |

 

----

* Inactive

 

35

----

 

**Property, Plants and Equipment**

 

Our executiveoffices and engineering, research and development operations are located in Ra’anana,Israel, where we occupy approximately 126,000 square feet of space, pursuant toa lease expiring in 2008.  This lease maybe terminated by us at any time from the year 2006, subject to certainconditions. The annual rent and maintenance fee for the facility isapproximately $2.7 million linked to the changes in the U.S. consumer priceindex.  We have various offices and otherfacilities in North America and in several other countries, as described below.

 

Our NorthAmerican facilities consist of:

 

•                  Our NorthAmerican headquarters in Rutherford, New Jersey, which occupy approximately25,000 square feet, with a monthly rental of approximately $66,000.  We also have a warehouse facility in Lyndhurst,New Jersey, which occupies approximately 6,000 square feet, with a monthlyrental of approximately $7,000; 

 

•                  Our office inSan Diego, California, which occupies approximately 6,250 square feet, with amonthly rental of approximately $17,500 (subleased in its entirety  to a third party); 

 

•                  Our office inChicago, Illinois, which occupies approximately 1,000 square feet, with amonthly rental of approximately $3,000;

 

•                  Our office inDenver, Colorado, which occupies approximately 30,775 square feet, with amonthly rental of approximately $58,000; 

 

•                  Our office inLas Vegas, Nevada, which occupies approximately 3,000 square feet, with amonthly rental of approximately $8,000 (subleased in its entirety  to a third party); and

 

•                  Our office inNew York, New York, which occupies approximately 4,300 square feet, with amonthly rental of approximately $10,000.

 

Ourinternational facilities consist of: 

 

•                  Our office inFrankfurt, Germany, which occupies approximately 2,850 square feet, with amonthly rental of approximately $4,500; 

 

•                  Our office inLondon, UK which occupies approximately 1,430 square feet, with a monthlyrental of approximately $21,000; 

 

•                  Our office inSouthampton, UK which occupies approximately 34,249 square feet, with a monthlyrental of approximately $66,000;

 

•                  Our office inDublin, Ireland, which occupies approximately 750 square feet, with a monthlyrental of approximately $2,200;

 

•                  Our office inParis, France which occupies approximately 1,916 square feet, with a monthlyrental of approximately  $5,700; 

 

36

----

 

•                  Our office inHong Kong, which occupies approximately 4,810 square feet, with a monthlyrental of approximately $11,426;

 

•                  Our office inTokyo, which occupies approximately 1,485 square feet, with a monthly rental ofapproximately $6,428; and

 

•                  Our office inBangalore, which occupies approximately 1,047 square feet, with a monthlyrental of approximately $687.

 

We believethat our existing facilities are adequate to meet our current and foreseeableneeds. 

 

**Item 5****. Operating and Financial Review and Prospects.**

 

We may fromtime to time make written or oral forward-looking statements, including infilings with the United States Securities and Exchange Commission (“SEC”), inreports to shareholders and in press releases and investor webcasts. You canidentify these forward-looking statements by use of words such as “strategy”, “expects”,“continues”, “plans”, “anticipates”, “believes”, “may”, “estimates”, “intends”,“projects”, “goals”, “targets”, and other words of similar meaning.  You can also identify them by the fact thatthey do not relate strictly to historical or current facts.

 

We cannotassure you that any forward-looking statement will be realized, although webelieve we have been prudent in our plans and assumptions.  Achievement of future results is subject torisks, uncertainties and inaccurate assumptions.  Should known or unknown risks or uncertaintiesmaterialize, or should underlying assumptions prove inaccurate, actual resultscould vary materially from those anticipated, estimated or projected.  Investors should bear this in mind as theyconsider forward-looking statements and whether to invest or remain invested inNICE Systems Ltd.’s securities. The forward-looking statements relate to, amongother things: operating results; anticipated cash flows; gross margins;adequacy of resources to fund operations; our ability to maintain our averageselling prices despite the aggressive marketing and pricing strategies of ourcompetitors; our ability to maintain and develop profitable relationships withour key distribution partners, one of which constitutes 19% of our revenues;the financial strength of our key distribution partners; and the market’sacceptance of our technologies, products and solutions.

 

In connectionwith the “safe harbor” provisions of the Private Securities Litigation ReformAct of 1995, we are identifying important factors that, individually or in theaggregate, could cause actual results and outcomes to differ materially fromthose contained in any forward-looking statements made by us; any suchstatement is qualified by reference to the following cautionarystatements.  Please read the sectionbelow entitled “Factors That May Affect Future Results” to review conditionsthat we believe could cause actual results to differ materially from thosecontemplated by the forward-looking statements. You should understand that itis not possible to predict or identify all risk factors.  Consequently, you should not consider thefollowing to be a complete discussion of all potential risks or uncertainties.Readers are cautioned not to place undue reliance on these forward-lookingstatements, which reflect our view only as of the date of this annual report.Except as required by law, we undertake no

 

37

----

 

obligation to update theseforward-looking statements to reflect future events or circumstances or theoccurrence of unanticipated events.

 

The followingdiscussion and analysis of our financial condition and results of operationsshould be read in conjunction with our consolidated financial statements andthe related notes and other financial information included elsewhere in thisannual report.

 

# **Overview**

# ** **

We develop, marketand support integrated, scalable multimedia digital recording platforms,enhanced software applications and related professional services. Thesesolutions capture and analyze unstructured (non-transaction) data, and convertit into actionable knowledge for business and security performance managementapplications.  Our solutions capturemultiple forms of interaction, including voice, fax, email, web chat, radio,and video transmissions over wireline, wireless, packet telephony, terrestrialtrunk radio and data networks. The markets from which we currently derive themajority of our revenues and expect to continue to do so in the future arehighly competitive.

 

Our productsare based on two types of recording platforms - audio and video - and are used primarilyin contact centers, trading floors, public safety organizations,transportation, corporate security, gaming and correctional facilities as wellas various government and intelligence agencies. 

 

Ourdevelopment efforts for our recording platforms are aimed at addressing severaltrends we see developing in the industry. The trend towards the proliferation of voice over IP-based networks isleading to a greater requirement for VoIP recording capabilities in financialtrading, contact centers and public safety environments.   The continued trend towards replacing analogvideo recording with digital video recording is leading to the need for networkapplications in the video recording area. 

 

We also seethe continuation of a trend towards requirements for multimedia recordingcapabilities, particularly in contact centers (voice, fax, email, chat screen)and public safety (voice, radio, video, data) markets. We are beginning to seethis same trend developing in the financial trading sector, and we expect someHomeland Security initiatives in areas such as border control, criticalinfrastructure security, first responder communications and lawful interceptionto require multimedia capture platforms as well.

 

Our softwareapplications enable our customers to capture, store, retrieve and analyzeunstructured data (multimedia interactions) and combine them with data fromother systems to create actionable knowledge that can be distributed viareports and alerts to all relevant parties to improve performance. 

 

There isgrowing demand from our customers for software applications that will leveragethe wealth of unstructured data captured by the recording platform to improveoverall performance.  In turn, as theseenhanced software applications are being added, customers are

 

38

----

 

considering our systems “missioncritical”.   We see an opportunity forapplications that analyze the content of unstructured interactions in contactcenters for quality monitoring and contact center management as well as forenterprise-wide process improvement and business performance management.  We see a trend towards more softwareapplications in the financial trading environment for compliance monitoring anddispute management to improve business performance.  We see similar trends happening in digitalvideo recording.  We expect video contentanalysis applications to become increasingly important to building, campus,city center, and infrastructure perimeter security, loss prevention in casinos,retail and warehousing, as well as various homeland security applications toenable proactive security management.

 

We expect tosee an increase in the demand for VoIP recording products, networked videosecurity solutions, and multimedia recording solutions as well as an increasein the proportion of software from quality monitoring and multimediainteraction analytics applications in our product revenue mix and a gradualincrease in the amount of professional services and maintenance revenues.

 

Our productsare sold primarily through a global network of distributors, system integratorsand strategic partners; a portion of product sales and most services are solddirectly to end-users.  One distributoraccounted for approximately 19%, 20% and 23% of revenues in 2004, 2003 and2002, respectively. 

 

**Acquisitions**

 

Theacquisitions we have made were accounted for as purchases, and, accordingly,the purchase price for each acquisition was allocated to the assets acquiredand liabilities assumed based on their respective fair values. The results ofoperations related to each acquisition are included in our consolidatedstatement of operations from the date of acquisition.  The following are details for each of theseacquisitions:

 

•                  On June 1, 2005, we consummated an agreementto acquire the assets and assume certain liabilities of Dictaphone’sCommunications Recording Systems business for approximately $38.5 million.Dictaphone’s CRS business is a leading provider of liability and qualitymanagement systems for first responders, critical facilities, contact centersand financial trading floors. 

 

Among the assets we acquired in the transaction are all of Dictaphone’srights to receive any damage award or other economic benefit with respect to aviolation of any of the rights related to the intellectual property ofDictaphone’s CRS business arising prior to the closing of the transaction.

 

•                  In November2002, we consummated an agreement to acquire certain assets and liabilities ofThales Contact Solutions (or TCS), a developer of customer-facing technologyfor public safety, financial trading and customer contact centers, based in theUnited Kingdom.  TCS was a unit of ThalesGroup, one of Europe’s premier electronics companies. In connection with theacquisition, we paid an initial $29.9

 

39

----

 

million incash and issued 2,187,500 ordinary shares to Thales Group at a fair marketvalue of $18.1 million calculated at the date of closing.  As of June 2, 2005, Thales Group holdsapproximately****4.6% of our outstanding shares. In June 2005, Mr.Timothy Robinson, one of the two Thales executives who were elected to ourBoard of Directors in November 2002, resigned from our Board.  The acquisition agreement required one nomineeof Thales to resign upon the sale of more than half of the shares issued toThales in the acquisition.

 

In the fourthquarter of 2002, we recorded a current liability of $2.8 million and along-term liability of $13.5 million reflecting obligations under a long-termcontract we assumed in the TCS acquisition. In the second quarter of 2003 we completed negotiations to terminatethis contract as of November 2004 and to amend the terms in the interim. Underthe terms of the amended contract, the cost to the Company was $5.2 millionless than the amount provided at the acquisition date and consequently, TCSacquisition goodwill was reduced by this amount. 

 

Under theterms of the agreement, the cash portion of the purchase price was subject todownward adjustment based on the value of net assets at closing and the fullyear 2002 sales of TCS.  Based on ourcalculation of the actual value of net assets acquired and 2002 sales of TCS,we reduced the cash portion of the purchase price as of December 31, 2002by $12.8 million. This amount was presented on our balance sheet as aRelated Party Receivable as of December 31, 2002.**** Thus, the adjustedpurchase price paid, including $4.5 million of capitalized acquisition costs,was recorded as $39.7 million.  Of the$12.8 million adjustment referred to above, Thales paid us $6.6 million inMarch 2003. 

 

Thalesdisputed our calculation of the net asset value at closing and the matter wassubmitted in September 2003 to binding arbitration by an Independent Accountant,in accordance with the terms of the acquisition agreement.  The Independent Accountant determined ahigher net asset value at closing than our calculation of the actual value ofnet assets acquired in the amount of $2.2 million. This additional amount wasrecorded as additional goodwill in the fourth quarter of 2003. The remainingRelated Party Receivable as at December 31, 2003 of $ 4.0 million was paid inJanuary 2004.

 

Also under theterms of the agreement, contingent cash payments of up to $10.0 million in2003, $7.5 million in 2004, and $7.5 million in 2005 would be due if certainfinancial performance criteria are met as part of a three-year earn-outprovision related to the sale of a particular product in 2002 through 2004.  The relevant criteria for 2002 through 2004were not met and therefore no contingent payments will be made under theagreement. 

 

Under theterms of the agreement, the cash portion of the purchase price was subject toadjustment mechanisms and indemnities related to the assets sold to us. OnSeptember 8, 2004, we notified Thales of claims in respect of such priceadjustment mechanisms, mainly relating to uncollected receivables andinventory. NICE and

 

40

----

 

Thales signeda settlement agreement in respect of such claims on February 24, 2005,according to which Thales paid us a total indemnity amount of $2.6 million.

 

•                  In April 2000,we acquired all of the outstanding capital stock of Centerpoint Solutions Inc.(CPS) for $3.0 million in cash and the issuance of 200,000 ADSs of NICE ofwhich 50,000 were deemed target shares contingent upon the achievement ofcertain objectives, which were not met. CPS was a developer of internet-based applications for statisticalmonitoring, digital recording and automatic customer surveys for contactcenters.

 

In November2002, we entered into a settlement agreement with Doug Chapiewski, the soleshareholder of CPS, in respect of allegations made against NICE andNICE-Centerpoint Solutions, Inc. of misrepresentation, breach of contract andsecurities fraud in connection with the acquisition of CPS.  The terms of the settlement agreement, whichincluded 50,000 shares, resulted in a charge to Other Expense, Net of $3.5million. In December 2003, we received $300,000 from our insurers in respect ofthe settlement. 

 

**OtherDevelopments**

 

•                  We sold the netassets of our COMINT/DF military-related business to ELTA Systems Ltd (“ELTA”)for $4.0 million on March 31, 2004. The net assets sold include the intellectualproperty, fixed assets, inventory, and contracts related to the COMINT/DFproduct line which includes high performance spectral surveillance anddirection finding systems that detect, identify, locate, monitor and recordtransmission sources. The COMINT/DF business is therefore treated as adiscontinued operation in our financial statements.  In 2002, 2003 and 2004, the COMINT/DFbusiness generated revenues of approximately $7.2 million, $6.5 million and$0.8 million, respectively, and net income of approximately $1.4 million, $1.5million and $3.2 million (including gain on disposition), respectively.

 

**Off-BalanceSheet Transactions**

 

We have notengaged in nor been a party to off-balance sheet transactions.

 

# **Critical AccountingPolicies**

 

Our discussionand analysis of our financial condition and results of operations are based onour consolidated financial statements, which have been prepared in accordancewith generally accepted accounting principles in the United States (“US GAAP”).Our significant accounting principles are presented within Note 2 to ourConsolidated Financial Statements.  Whileall the accounting policies impact the financial statements, certain policiesmay be viewed to be critical. These policies are those that are most importantto the portrayal of our financial condition and results of operations. Actualresults could differ from those estimates discussed below.

 

41

----

 

Managementbelieves that the significant accounting policies which affect its moresignificant judgments and estimates used in the preparation of the consolidatedfinancial statements and are the most critical to aid in fully understandingand evaluating our reported results include the following:

 

•                  Revenuerecognition

•                  Allowance fordoubtful accounts

•                  Inventoryvaluation

•                  Impairment oflong-lived assets

•                  Deferred incometaxes

•                  Contingencies

 

***Revenue Recognition.*****We derive our revenue primarily from twosources: product revenues, which include hardware and software sales, andservice revenues, which include, support and maintenance, installation,consulting and training revenue.  Revenuerelated to sales of our products is generally recognized when persuasiveevidence of an agreement exists; the product has been delivered and title andrisk of loss have passed to the buyer; the sales price is fixed ordeterminable; no further obligations exist; and collectibility isprobable.  Sales agreements with specificacceptance terms are not recognized as revenue until the customer has confirmedthat the product or service has been accepted. 

 

Revenues frommaintenance and professional services are recognized ratably over the contractperiod or as services are performed.

 

Forarrangements with multiple elements, we allocate revenue to each component ofthe arrangement using the residual value method based on Vendor SpecificObjective Evidence (“VSOE”) of the undelivered elements. This means that wedefer the arrangement fee equivalent to the fair value of the undeliveredelements until these elements are delivered. Our VSOE used to allocate thesales price to maintenance is based on the renewal percentage.

 

To assess theprobability of collection for revenue recognition, we have an establishedcredit policy that determines, by way of mathematical formulae based on thecustomers’ financial statements and payment history, the level of open accountthat is deemed probably collectible for each customer. These credit limits arereviewed and revised periodically on the basis of new customer financialstatement information and payment performance.    

 

We record aprovision for estimated sales returns and allowances on product sales in thesame period as the related revenues are recorded.  We base these estimates on the historicalsales returns ratio and other known factors. Actual returns could be different from our estimates and currentprovisions for sales returns and allowances may need to be increased.

 

***Allowance forDoubtful Accounts****.*We evaluate the collectibility of our accounts receivable based on acombination of factors.  In circumstanceswhere we are aware of a specific customer’s inability to meet its financialobligations to us, we record a specific allowance against amounts due to reducethe net recognized receivable to the amount we reasonably believe will be

 

42

----

 

collected.  For all other customers, we recognizeallowances for doubtful accounts based on the length of time the receivablesare past due. Insured balances are not reserved.  If the financial condition of one of oursignificant customers or our customers in general should deteriorate, ourrevenue growth may be limited and additional allowances may be required.

 

***Inventory valuation*.**At each balance sheet date, we evaluate our inventory balance for excessquantities and obsolescence.  Thisevaluation includes analyses of sales levels by product line and projections offuture demand.   In addition, we writeoff inventories that are considered obsolete. Remaining inventory balances are adjusted to the lower of cost or marketvalue. If future demand or market conditions are less favorable than ourprojections, additional inventory write-downs may be required and would bereflected in cost of sales in the period the revision is made. 

 

During 2002 wecompleted the outsourcing of the manufacture of our audio and video productplatforms.  Under this arrangement, wetake ownership of inventories at the conclusion of the manufacturing process,such inventories representing finished goods or spare parts.   As we largely manufacture to order, we donot tend to accumulate finished goods. We are, however, liable to purchase above a certain level, which is basedon a historical level of orders to the contract manufacturer, excess raw materialand subassembly inventories from the contract manufacturer deemed obsolete orslow-moving.  We monitor the levels ofthe contract manufacturer’s relevant inventories periodically and, if required,will write-off such deemed excess or obsolete inventory.

 

***Impairment oflong-lived assets*.** Our long-lived assets includeproperty and equipment, investment in affiliates, goodwill and other intangibleassets.  The fair value of the investmentin affiliates is dependent upon the performance of the companies in which wehave invested.  In assessing potentialimpairment of these investments, we consider this factor as well as theforecast financial performance of the investees and other pertinentinformation.  We record an investmentimpairment charge when we believe that the investment has experienced a declinein value that is other than temporary.  During 2002, we recognized $229,000 ofimpairment losses related to our investment in affiliates.  As of December 31, 2004, the carrying valueof the Company’s investments in affiliates was $1.2 million.

 

In assessingthe recoverability of our property and equipment, goodwill and other intangibleassets, we must make assumptions regarding the estimated future cash flows andother factors to determine the fair value of the respective assets.  If these estimates or their relatedassumptions change in the future, we may be required to record impairmentcharges for these assets. 

 

In June 2001,the Financial Accounting Standards Board issued SFAS No. 142 “Goodwill and OtherIntangible Assets”. SFAS No. 142 addresses the initial recognition andmeasurement of intangible assets acquired in a business combination and theaccounting for goodwill and other intangible assets subsequent to theiracquisition. SFAS No. 142 provides that intangible assets with finite usefullives will be amortized and that goodwill and intangible assets with indefinitelives will not be amortized, but rather will be tested at least annually forimpairment. We adopted SFAS No. 142 beginning January 1, 2002.  Upon adoption of SFAS No. 142, wediscontinued

 

43

----

 

the amortization of recordedgoodwill, which was approximately $3.4 million on an annual basis at thattime.  We performed an impairment test ofour goodwill as of January 1, 2002 under the transitional provisions of SFASNo. 142; our test did not indicate an impairment of goodwill.  We confirmed that we have only one reportingunit (the Company) to which we allocated all recorded goodwill, as well as allassets and liabilities.

 

By October 1,2002, our stock price had declined significantly from January 1, 2002, at whichpoint our market capitalization, based on our stock price, was below bookvalue.  The price of our ADSs on January2, 2002 was $17.04 per ADS and declined to $8.47 per ADS on October 1,2002.  We determined the fair value ofthe Company based on relative market multiples for comparable businesses and adiscounted cash flow model.  Thisevaluation indicated that an impairment might exist.  We then performed Step 2 under SFAS No. 142in which an amount of the impairment loss, if any, must be measured.  Four categories of intangible assets wereidentified as being separable from goodwill in accordance with SFAS No. 141 **“**Business Combinations**.”** These included: trade names; an in-place distribution network;technology based intangible assets and maintenance contracts.  In valuing the NICE trade name a relief fromroyalty method was used.  Under thismethod, the value of a trade name reflects the savings realized by owning thetrade name.  The value of the intangibleasset under the relief from royalty method is dependent upon the followingfactors: the selected royalty rate, the revenues expected to be generated fromthe underlying intellectual property, the discount rate and the expected lifeof the intellectual property.   The valueof our distribution network was determined through the use of the costapproach.  Using this method, the valueof the distribution network is estimated as the after-tax direct costs that apotential acquirer would avoid spending in recreating a similar functionaldistribution network.  The value of theintangible asset under the cost method is dependent upon the estimated directcost of establishing a new distributor relationship.  Qualifying technology-based intangible assetsconsist of current and core technology and technologies that were underdevelopment at the valuation date.  The currentand core technology was valued using a derivation of the income approach,namely the excess earnings method.  Thismethod is used to analyze the earnings contribution of an intangible asset.Under this method, the excess earnings that an intangible asset generates arecalculated over the intangible asset’s expected life and discounted to thepresent to calculate the fair value of the intangible asset.  Excess earnings are defined as the residualearnings after providing for appropriate returns on the other identifiedcontributing assets.  The value under theexcess earnings method is dependent upon the following factors: the expectedrevenues generated by the intangible asset, the expected after-tax earnings onthose revenues, the charges (or returns) required on other contributing assetsand the discount rate. Our maintenance contracts, which are intangible assetsunder the contractual-legal criterion of SFAS No. 141, were valued using theexcess earnings method.  In determiningthe applicable discount rate to be used to estimate the fair value of our netassets, we calculated a market-derived rate based on the estimated weightedaverage cost of capital for the Company. In determining the cost of equity forthe Company, we used a standard methodology based on the capital asset pricingmodel and analyzed selected guideline companies, industry data and factorsspecific to NICE. We expect to use a similar decision process in the future.

 

Followingthese analyses, we compared the carrying amount of goodwill to the implied

 

44

----

 

fair value of the goodwill anddetermined that an impairment loss existed. A non-cash charge totaling $28.3million was recorded in the fourth quarter of 2002 to write down goodwill toits fair value under the caption “Goodwill impairment”.  The valuation of long-lived assets requiressignificant estimates and assumptions. These estimates contain management’s best estimates, using appropriateand customary assumptions and projections at the time.  If different estimates or projections wereused, it is reasonably possible that our analysis would have generatedmaterially different results.

 

In the fourthquarter of 2004, we performed our annual test on the remaining goodwill perSFAS No. 142 requirements applying the same methodologies as those used inthe prior year. No additional impairment was found to exist.   

 

We willcontinue to perform an impairment test at least annually and on an interimbasis should circumstances indicate that an impairment loss may exist.  The outcome of such testing may lead to therecognition of an impairment loss.

 

***Deferred incometaxes*.**  Werecord income taxes using the asset and liability approach.  Deferred income tax assets and liabilitiesare recognized for future tax consequences attributable to differences betweenthe financial statement carrying amounts of existing assets and liabilities andtheir respective income tax bases, and net operating loss and tax creditcarryforwards.** **Ourfinancial statements contain fully reserved tax assets which have arisen as aresult of net operating losses, primarily incurred in 2001 and 2002, as well asother temporary differences between book and tax accounting.  Significant management judgment is requiredin determining our provision for income taxes, our deferred tax assets andliabilities and any valuation allowance recorded against our net deferred taxassets. We have considered future taxable income, prudent and feasible taxplanning strategies and other available evidence in determining the need for avaluation allowance.  We evaluate all ofthese factors to determine whether it is more likely than not that some portionor all of the deferred income tax assets will not be realized.  As a result of uncertainty of realization oflosses in future periods, we have continued to record a full valuationallowance, which was approximately $9.4 million as at December 31, 2004.  The establishment and amount of the valuationallowance requires significant estimates and judgment and can materially affectour results of operations.  If therealization of deferred tax assets in the future is considered more likely thannot, an adjustment to the deferred tax assets would increase net income in theperiod such determination was made.  

 

Our effectivetax rate may vary from period to period based on changes in estimated taxableincome or loss, changes to the valuation allowance, changes to state or foreigntax laws, future expansion into geographic areas with varying country, stateand local income tax rates, deductibility of certain costs and expenses by jurisdictionand as a result of acquisitions, divestitures and reorganizations.

 

***Contingencies*.**  From time to time, we are defendant orplaintiff in various legal actions, which arise in the normal course ofbusiness.  We are required to assess thelikelihood of any adverse judgments or outcomes to these matters as well aspotential ranges of probable losses.  Adetermination of the amount of reserves required for these contingencies, ifany, which would be

 

45

----

 

charged to earnings, is madeafter careful and considered analysis of each individual action together withour legal advisors.  The requiredreserves may change in the future due to new developments in each matter or changesin circumstances, such as a change in settlement strategy.  A change in the required reserves wouldaffect our earnings in the period the change is made. 

 

# **Results ofOperations**

 

The followingtable sets forth selected consolidated income statement data for NICE for eachof the three years ended December 31, 2004, 2003 and 2002 expressed as apercentage of total revenues. Figures may not add due to rounding.

 
| ** **                                      | ** ** | **2002** | ** ** | **2003** | ** ** | **2004** | ** ** |
|-------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Revenues                                        |       |     |       |     |       |     |       |
| Products                                        |       | 82.3     | %          | 74.9     | %          | 72.3     | %          |
| Services                                        |       | 17.7     |       | 25.1     |       | 27.7     |       |
|                                            |       | 100.0    |       | 100.0    |       | 100.0    |       |
| Cost of revenues                                |       |     |       |     |       |     |       |
| Products*                                       |       | 43.4     |       | 38.2     |       | 35.3     |       |
| Services*                                       |       | 94.9     |       | 74.9     |       | 71.2     |       |
|                                            |       | 52.5     |       | 47.4     |       | 45.2     |       |
|                                            |       |     |       |     |       |     |       |
| Gross Profit                                    |       | 47.5     |       | 52.6     |       | 54.8     |       |
|                                            |       |     |       |     |       |     |       |
| Operating expenses                              |       |     |       |     |       |     |       |
| Research and development, net                   |       | 11.0     |       | 10.2     |       | 9.8      |       |
| Selling and marketing                           |       | 24.9     |       | 23.9     |       | 24.7     |       |
| General and administrative                      |       | 15.3     |       | 13.3     |       | 12.4     |       |
| Restructuring and other                         |       | (0.1     | )          | 0.8      |       | 0.0      |       |
| In-process research and  development            |       | 0.8      |       | 0.0      |       | 0.0      |       |
| Legal settlement                                |       | 0.0      |       | 2.3      |       | 0.0      |       |
| Amortization of acquired  intangibles           |       | 0.0      |       | 0.0      |       |     |       |
| Goodwill - impairment and other                 |       | 18.0     |       | 0.0      |       | 0.0      |       |
| Total operating expenses                        |       | 70.0     |       | 50.6     |       | 46.9     |       |
|                                            |       |     |       |     |       |     |       |
| Operating income (loss)                         |       | (22.5    | )          | 2.0      |       | 7.9      |       |
| Financial income, net                           |       | 2.6      |       | 0.9      |       | 1.4      |       |
| Other income (expenses), net                    |       | (2.6     | )          | 0.1      |       | 0.0      |       |
|                                            |       |     |       |     |       |     |       |
| Income (loss) before taxes                      |       | (22.5    | )          | 3.0      |       | 9.3      |       |
| Taxes on income                                 |       | 0.2      |       | 0.5      |       | 0.9      |       |
|                                            |       |     |       |     |       |     |       |
| Net income (loss) from continuing  operations   |       | (22.8    | )          | 2.5      |       | 8.4      |       |
| Net income (loss) from  discontinued operations |       | 0.9      |       | 0.7      |       | 1.3      |       |
| Net income (loss)                               |       | (21.9    | )          | 3.2      |       | 9.7      |       |

 

----

* percent of related revenue

 

46

----

 

***YEARS ENDED DECEMBER 31, 2004 and 2003***

 

***REVENUES***

 

Our totalrevenues rose approximately 13% to $252.6 million in 2004 from $224.3 millionin 2003. Enterprise Interaction Solutions revenues were $194.1 million in 2004,an increase of 13% from the prior year, and revenues from sales to the publicsafety and security market were $58.5 million, an increase of 11% from the prioryear.  We believe that our growth inrevenues was due principally to market share gains in these markets and marketgrowth.  

 

| ** **           | ** ** | **Years Ended December 31,** | ** ** | **$**      | ** ** | **%**      | ** ** |
|----------------------|------------|------------------------------|------------|------------|------------|------------|------------|
| ** **           | ** ** | **2003**                     | ** ** | **2004**   | ** ** | **Change** | ** ** | **Change** | ** ** |
|                 |       |                         |       |       |       |       |       |   |   |
| Product Revenues     |       | $                            | 168.1      |       | $          | 182.6      |       | 14.5 |   | 8.6 | % |
| Service Revenues     |       | 56.2                         |       | 70.0       |       | 13.8       |       | 24.6 |   |
|                 |       |                         |       |       |       |       |       |   |   |
| ***Total Revenues*** | ** ** | **$**                        | **224.3**  | ** ** | **$**      | **252.6**  | ** ** | **28.3** | ** ** | **12.6** | **%** |

 

The increasein product revenues was due primarily to higher sales of our audio recordingplatforms and applications to contact centers/trading floors and public safetyinstitutions.  There can be no assurancethat we will continue to experience market share gains, or that our newproducts will be broadly accepted, or that given weak fiscal spending, we willcontinue to report growth in our platform and related software applications.

 

The increasein services revenues was generated by an increasing portion of our installedbase engaging us for maintenance services and higher installation and trainingrevenues related mainly to the increase in product sales to the enterprisemarket.  Service revenues represented 28%of total revenues compared with approximately 25% in 2003.  Although we typically generate lower profitmargins on services than on products, our strategy is to continue to grow ourglobal services business, which we believe increases the competitiveness of ourproduct offerings, and thus expect services to represent a growing portion oftotal revenues in the future. Our long-term target is for services to representapproximately 30% of total revenues.  

 

Revenues in2004 in the Americas, which includes the United States, Canada and Latin andSouth America, rose 3% to $121.6 million from $118.6 million in 2003.  The increase was largely attributable tohigher post-contract support. Sales to Europe, Middle East and Africa (“EMEA”)rose 26% to $93.2 million in 2004 from $73.8 million in 2003.  The increase was due mainly to higher salesto the enterprise market and post-contract support.  Sales to Asia-Pacific (“APAC”) increased 19%to $37.8 million in 2004 from $31.8 million in 2003 due mainly to higher salesto the enterprise market in the region.

 

47

----

 

***COST OFREVENUES:***

 

| ** **                   | ** ** | ** **                   | ** ** | ** ** | ** ** | ** ** | ** ** |
|------------------------------|------------|------------------------------|------------|------------|------------|------------|------------|
| ** **                   | ** ** | **Years Ended December 31,** | ** ** | **$**      | ** ** | **%**      | ** ** |
| ** **                   | ** ** | **2003**                     | ** ** | **2004**   | ** ** | **Change** | ** ** | **Change** | ** ** |
|                         |       |                         |       |       |       |       |       |   |   |
| Cost of Product Revenues     |       | $                            | 64.2       |       | $          | 64.4       |       | 0.2 |   | 0.3 | % |
| Cost of Service Revenues     |       | 42.1                         |       | 49.9       |       | 7.8        |       | 18.5 |   |
|                         |       |                         |       |       |       |       |       |   |   |
| ***Total Cost of Revenues*** | ** ** | **$**                        | **106.3**  | ** ** | **$**      | **114.3**  | ** ** | **8.0** | ** ** | **7.5** | **%** |

 

The slightincrease in cost of product revenues was due mainly to the higher salesvolume.  The increase in cost of servicesrevenue was due principally to higher labor, subcontractor and material costsassociated with the growth in product installations and maintenance contracts.

 

***GROSS PROFIT***

 
| ** **                             | ** ** | **Years Ended December 31,** | ** ** | **$**      | ** ** | **%**      | ** ** |
|----------------------------------------|------------|------------------------------|------------|------------|------------|------------|------------|
| ** **                             | ** ** | **2003**                     | ** ** | **2004**   | ** ** | **Change** | ** ** | **Change** | ** ** |
|                                   |       |                         |       |       |       |       |       |   |   |
| Gross Profit on Product Revenues       |       | $                            | 103.9      |       | $          | 118.2      |       | 14.3 |   | 13.8 | % |
| *as a percentage of product  revenues* | * *   | *61.8*                       | *%*        | *64.7*     | %          |       |       |   |   |
| Gross Profit on Service Revenues       |       | 14.1                         |       | 20.1       |       | 6.0        |       | 42.6 |   |
| *as a percentage of service  revenues* | * *   | *25.1*                       | *%*        | *28.8*     | %          |       |       |   |   |
|                                   |       |                         |       |       |       |       |       |   |   |
| ***Total Gross Profit***               | ** ** | **$**                        | **117.9**  | ** ** | **$**      | **138.3**  | ** ** | **20.4** | ** ** | **17.3** | **%** |
| *as a percentage of total  revenues*   | * *   | *52.6*                       | *%*        | *54.8*     | %          |       |       |   |   |

 

Theimprovement in gross profit on product revenues was due primarily to the highersales volume, product cost reductions and a higher proportion of software inthe product mix. The improvement in gross profit margin on services revenuereflects improved staff utilization and efficiencies.   On a forward-looking basis, we expect ourgross margins to increase gradually to the extent that we are successful inrealizing the benefit of a growing proportion of software applications in ourproduct revenue mix, higher volume and improved efficiencies in our globalservice operations.

 

***EXPENSES***

 
| ** **                    | ** ** | **Years Ended December 31,** | ** ** | **$**    | ** ** | **%**      | ** ** |
|-------------------------------|------------|------------------------------|------------|----------|------------|------------|------------|
| ** **                    | ** ** | **2003**                     | ** ** | **2004** | ** ** | **Change** | ** ** | **Change** | ** ** |
|                          |       |                         |       |     |       |       |       |   |   |
| Research and development, net |       | $                            | 22.8       |     | $          | 24.9       |       | 2.1 |   | 9.2 |   |
| Selling and marketing         |       | 53.7                         |       | 62.2     |       | 8.5        |       | 15.8 |   |
| General and administrative    |       | 29.8                         |       | 31.3     |       | 1.5        |       | 5.0 |   |
|                               |            |                              |            |          |            |            |            |  |  |  |  |

 

***Research andDevelopment, Net***. Research and development expense, before capitalization of softwaredevelopment costs and grants, increased to $27.5 million in 2004 from $26.4million in 2003 and represented 10.9% and 11.8% of revenues in 2004 and 2003,respectively.  The increase in grossoutlays was due mainly to the increase of R&D labor costs.

 

48

----

 

Softwaredevelopment costs capitalized were $1.3 million in 2004 compared with $2.3million in 2003. Amortization of capitalized software development costs,included in cost of product revenues, was $4.1 million and $5.7 million in 2004and 2003, respectively. 

 

***Selling andMarketing Expenses.***  The increase in selling and marketingexpenses was due primarily to an increase in our corporate and regional salesand marketing efforts and higher sales commissions resulting mainly from theincrease in sales.  Selling and marketingexpenses represented 24.6% of total revenues in 2004 compared with 23.9% in2003.  We expect that we will continue toleverage our global sales and distribution infrastructure and will increase ourcorporate and regional marketing efforts in the future.  

 

***General andAdministrative Expenses.***  The increase in general and administrativeexpenses in 2004 was due principally to increase in labor costs anddepreciation expenses.  General andadministrative expenses represented 12.4% of total revenues in 2004 comparedwith 13.3% in 2003. On a forward-looking basis, general and administrativeexpenses, while increasing on an absolute dollar basis, are expected to declineas a percentage of total revenues.  

 

***OTHER SPECIALCHARGES:***

 
| ** **       | ** ** | **Years Ended December 31,** | ** ** | ** ** | ** ** |
|------------------|------------|------------------------------|------------|------------|------------|
| ** **       | ** ** | **2003**                     | ** ** | **2004**   | ** ** | **$  Change** | ** ** |
|             |       |                         |       |       |       |   |   |
| Restructuring    |       | $                            | 1.9        |       | 0.0        |   | (1.9 | ) |
| Legal Settlement |       | 5.2                          |       | 0.0        |       | (5.2 | ) |
| ** **       | ** ** | **$**                        | **7.1**    | ** ** | **0.0**    | ** ** | **(7.1** | **)** |

 

***Restructuring****.*  In December 2002 we adopted a restructuring plan, which involved thephased reduction of approximately 75 of our 1,077 staff members andconsolidation of certain offices.  Someof the involuntary reductions were effected in December 2002 and, in accordancewith SFAS No. 146, a liability of $282,000 was recorded as of December 31, 2002related to those terminations. This liability was utilized as of June 30, 2003.The remaining reductions in force and facility closures were implemented during2003.  We included in our results for2003 costs of approximately $1.9 million, which related primarily toinvoluntary terminations and facility closures. 

 

***Legal Settlement****.* In June 2000, Dictaphone Corporation,one of our competitors, filed a patent infringement claim relating to certaintechnology embedded in some of our products. The claim was for damages for past infringement and enjoinment of any continuedinfringement of Dictaphone patents.  Inthe fourth quarter of 2003, we reached a settlement with Dictaphone in whichboth parties agreed to dismiss all claims and counterclaims connected with theaforementioned patent infringement claim. The terms of the settlement call forus to pay Dictaphone $10 million of which approximately $4.8 million was paidby our insurance carrier in December 2003 and the balance was paid by us,except for the final installment in the amount of $333,335.  This amount is required to be paid by us byJune 30, 2005, subject to certain events

 

49

----

 

which could result in a reducedpayment by us. As a result, a charge of approximately $5.2 million was recordedin the last quarter of 2003.  Thecompanies also agreed to grant each other a worldwide, royalty-free, perpetuallicense to certain of their patents including the disputed patents. Thecompanies further agreed to enter into enforcement proceedings with respect toboth companies’ patent portfolios and to share any proceeds from theseactions.  As a result of our acquisitionof the CRS division of Dictaphone on June 1, 2005, the agreement with respectto patents was terminated since we acquired the relevant patents.

 

***FINANCIAL ANDOTHER INCOME***

 
| ** **             | ** ** | **Years Ended December 31,** | ** ** | **$**    | ** ** | **%**      | ** ** |
|------------------------|------------|------------------------------|------------|----------|------------|------------|------------|
| ** **             | ** ** | **2003**                     | ** ** | **2004** | ** ** | **Change** | ** ** | **Change** | ** ** |
|                   |       |                         |       |     |       |       |       |   |   |
| Financial income       |       | $                            | 2.0        |     | $          | 3.6        |       | 1.4 |   | 70.0 | % |
| Other income (expense) |       | 0.3                          |       | 0.1      |       | (0.2       | )          | -66.7 |   |
|                        |            |                              |            |          |            |            |            |  |  |  |  |

 

***Financial Income,Net***.  The increase in financial income, net reflects a higher average cash balance andhigher prevailing average interest rates in 2004 compared with 2003. 

 

#### ***OtherIncome (Expense), Net****.** *Other income, net was $0.1 million in 2004 compared with$0.3 million in 2003. In 2003, we recorded $0.3 million of income reflectingamounts received from our insurance carrier in respect of the Chapiewskisettlement.  In 2004, other incomerepresented a capital gain recognized upon the disposal of fixed assets.  

 

***Taxes on Income***.  In 2004, we recorded a provision for incometaxes of $2.3 million compared with $1.2 million in 2003. The increase wasprimarily related to operating profits recorded at certain distributionsubsidiaries.

 

***Net Income (Loss)from Continuing Operations***. Net income fromcontinuing operations was $21.3 million in 2004 compared with $5.6 million in2003. The increase in 2004 resulted primarily from the increase in revenues andgross margin.

 

***Net Income fromDiscontinued Operations*. **As discussed above under “OtherDevelopments”, on March 31, 2004 we sold the assets of our COMINT/DFmilitary-related business to ELTA for $4 million in cash. Net income from thisdiscontinued operation was approximately $3.2 million (including gain ondisposition) and $1.5 million for 2004 and 2003, respectively.

 

***YEARS ENDED DECEMBER 31, 2003 and 2002    ***

 

***REVENUES***

 

Total revenuesfrom the enterprise market were $171.4 million in 2003, an increase of 41% fromthe prior year.  Total revenues from thepublic safety and security market were $52.8 million, an increase of 60% fromthe prior year.  We believe that ourgrowth in revenue was due principally to market share gains in the enterpriseand public safety and security markets following the acquisition of TCS inNovember 2002, and continued penetration of our digital

 

50

----

 

video platform in the securitymarket.

 
| ** **           | ** ** | **Years Ended December 31,** | ** ** | **$**      | ** ** | **%**      | ** ** |
|----------------------|------------|------------------------------|------------|------------|------------|------------|------------|
| ** **           | ** ** | **2002**                     | ** ** | **2003**   | ** ** | **Change** | ** ** | **Change** | ** ** |
|                 |       |                         |       |       |       |       |       |   |   |
| Product Revenues     |       | $                            | 127.9      |       | $          | 168.1      |       | $ | 40.2 |   | 31.4 | % |
| Service Revenues     |       | 27.4                         |       | 56.2       |       | 28.8       |       | 105.1 |   |
|                 |       |                         |       |       |       |       |       |   |   |
| ***Total Revenues*** | ** ** | **$**                        | **155.3**  | ** ** | **$**      | **224.3**  | ** ** | **$** | **69.0** | ** ** | **44.4** | **%** |

 

The increasein product revenues was due primarily to higher sales of our audio recordingplatforms and applications to enterprise and public safety markets relatedmainly to the inclusion for a full year of the operations of TCS and marketshare gains.  

 

The increasein services revenues reflects an increasing portion of our installed baseengaging us for maintenance services and higher installation and trainingrevenues related mainly to the increase in product sales to enterprisemarket.    

 

Revenues in2003 in the Americas rose 36% to $118.6 million from $86.9 million in2002.  The increase was largelyattributable to higher sales of enterprise solution and post-contract support.Sales to EMEA rose 55% to $73.8 million in 2003 from $47.7 million in2002.  The increase was due mainly to theinclusion for a full year of the operations of TCS and favorable currencymovements.  Sales to APAC increased 54%to $31.8 million in 2003 from $20.7 million in 2002 due mainly to higher salesto the enterprise market in Japan, Australia/New Zealand and India.

 

***COST OFREVENUES:***

 
| ** **                   | ** ** | **Years Ended December 31,** | ** ** | **$**      | ** ** | **%**      | ** ** |
|------------------------------|------------|------------------------------|------------|------------|------------|------------|------------|
| ** **                   | ** ** | **2002**                     | ** ** | **2003**   | ** ** | **Change** | ** ** | **Change** | ** ** |
|                         |       |                         |       |       |       |       |       |   |   |
| Cost of Product Revenues     |       | $                            | 55.5       |       | $          | 64.2       |       | $ | 8.7 |   | 15.7 | % |
| Cost of Service Revenues     |       | 26.1                         |       | 42.1       |       | 16.0       |       | 61.3 |   |
|                         |       |                         |       |       |       |       |       |   |   |
| ***Total Cost of Revenues*** | ** ** | **$**                        | **81.5**   | ** ** | **$**      | **106.3**  | ** ** | **$** | **24.8** | ** ** | **30.4** | **%** |

 

The increasein cost of product revenues in 2003 was due mainly to higher sales volume. Theincrease in cost of services revenue was due principally to higher labor,subcontractor and material costs associated with the inclusion of TCSactivities for a full year and with the growth in product installations andmaintenance contracts.

 

51

----

 

***GROSS PROFIT***

 
| ** **                             | ** ** | **Years Ended December 31,** | ** ** | **$**      | ** ** | **%**      | ** ** |
|----------------------------------------|------------|------------------------------|------------|------------|------------|------------|------------|
| ** **                             | ** ** | **2002**                     | ** ** | **2003**   | ** ** | **Change** | ** ** | **Change** | ** ** |
|                                   |       |                         |       |       |       |       |       |   |   |
| Gross Profit on Product Revenues       |       | $                            | 72.4       |       | $          | 103.9      |       | $ | 31.5 |   | 43.5 | % |
| *as a percentage of product  revenues* | * *   | *56.6*                       | *%*        | *61.8*     | %          |       |       |   |   |
| Gross Profit on Service Revenues       |       | 1.4                          |       | 14.1       |       | 12.7       |       | 100.0 | + |
| *as a percentage of service  revenues* | * *   | *5.1*                        | *%*        | *25.1*     | %          |       |       |   |   |
|                                   |       |                         |       |       |       |       |       |   |   |
| ***Total Gross Profit***               | ** ** | **$**                        | **73.8**   | ** ** | **$**      | **117.9**  | ** ** | **$** | **44.1** | ** ** | **59.8** | **%** |
| *as a percentage of total  revenues*   | * *   | *47.5*                       | *%*        | *52.6*     | %          |       |       |   |   |

 

Theimprovement in gross profit on product revenues was due primarily to the highersales volume, product cost reductions and a higher proportion of software inthe product mix. Gross profit margin on services revenue was 25% in 2003compared with 5% in 2002 reflecting improved staff utilization andefficiencies.   

 

***EXPENSES***

 
| ** **                    | ** ** | **Years Ended December 31,** | ** ** | **$**    | ** ** | **%**      | ** ** |
|-------------------------------|------------|------------------------------|------------|----------|------------|------------|------------|
| ** **                    | ** ** | **2002**                     | ** ** | **2003** | ** ** | **Change** | ** ** | **Change** | ** ** |
|                          |       |                         |       |     |       |       |       |   |   |
| Research and development, net |       | $                            | 17.1       |     | $          | 22.8       |       | $ | 5.7 |   | 33.3 | % |
| Selling and marketing         |       | 38.7                         |       | 53.7     |       | 15.0       |       | 38.8 |   |
| General and administrative    |       | 23.8                         |       | 29.8     |       | 6.0        |       | 25.2 |   |
|                               |            |                              |            |          |            |            |            |  |  |  |  |  |

 

***Research andDevelopment, Net***. Research and development expense, before capitalization of softwaredevelopment costs and grants, increased to $26.4 million in 2003 from $23.4million in 2002 and represented 11.8% and 15.0% of revenues in 2003 and  2002, respectively.  The increase in gross outlays was due mainlyto the inclusion for a full year of acquired TCS R&D activities and of theimpact of the appreciation of the New Israel Shekel to the US dollar on R&Dlabor costs, as approximately 80% of our R&D staff is based in Israel.

 

Softwaredevelopment costs capitalized were $2.3 million in 2003 compared with $4.6million in 2002. Net research and development expense increased 33% in 2003 to$22.8 million from $17.1 million in 2002.  Amortization of capitalized software development costs, included in costof product revenues, was $5.7 million and $4.3 million in 2003 and 2002,respectively. 

 

***Selling andMarketing Expenses.***  The increase in selling and marketing expenseswas due primarily to the inclusion for a full year of the activities of TCS andhigher sales commissions resulting mainly from the increase in sales.  

 

***General andAdministrative Expenses.***  The increase in general and administrativeexpenses in 2003 was due principally to the inclusion of TCS administrativecosts for a full year, higher corporate insurance premiums and the impact ofthe appreciation of the New Israel Shekel to the US dollar on labor andfacility costs only partly offset by lower additions to doubtful debt reserves.

 

52

----

 

***OTHER SPECIALCHARGES:***

 
| ** **                           | ** ** | **Years Ended December 31,** | ** ** | **$**      | ** ** |
|--------------------------------------|------------|------------------------------|------------|------------|------------|
| ** **                           | ** ** | **2002**                     | ** ** | **2003**   | ** ** | **Change** | ** ** |
|                                 |       |                         |       |       |       |   |   |
| Restructuring                        |       | $                            | (0.1       | )          | $          | 1.9 |   | $ | 2.0 |   |
| In-process research and  development |       | 1.3                          |       | 0.0        |       | (1.3 | ) |
| Goodwill - Impairment and other      |       | 27.9                         |       | 0.0        |       | (27.9 | ) |
| Legal Settlement                     |       | 0.0                          |       | 5.2        |       | 5.2 |   |
| ** **                           | ** ** | **$**                        | **29.1**   | ** ** | **$**      | **7.1** | ** ** | **$** | **(22.0** | **)** |

 

***Restructuring****.* As described above, in December 2002 we adopted a restructuring planwhich involved the phased reduction of approximately 75 of our 1,077 staffmembers and consolidation of certain offices. Some of the involuntary reductions were effected in December 2002 and,in accordance with SFAS No. 146, a liability of $282,000 was recorded as ofDecember 31, 2002 related to those terminations. This liability was utilized asof June 30, 2003. The remaining reductions in force and facility closures wereimplemented during 2003.  We included inour results for 2003 costs of approximately $1.9 million, which related primarilyto involuntary terminations and facility closures.  Restructuring related charges for 2002of  $0.1 million consisted of the$282,000 expense noted above offset by a reduction of $400,000 to the accrualremaining from the 2001 restructuring plan. 

 

***In-process Researchand Development****.** ***In2002, in connection with the acquisition of TCS and in accordance with SFAS No.2 “Accounting for Research and Development Costs”, a portion of the purchaseprice, $1.3 million, was allocated to purchased in-process research anddevelopment.  As part of the process ofanalyzing this acquisition, we made a decision to buy three technologies thathad not yet been commercialized rather than develop those technologiesinternally.  In doing so, we consideredour internal research resource allocation and our progress on comparabletechnology, if any.  At the date of theacquisition, technological feasibility had not yet been established for thein-process research and development projects and they had no alternative futureuse.  Accordingly, the fair valueallocated to these technologies, which was based on an analysis of thediscounted excess earnings that the intangible assets generate over theirexpected lives, was immediately expensed at acquisition. 

* *

***Goodwill Impairment andOther****.** ***Duringthe fourth quarter of 2002 we performed our annual impairment test of acquiredintangible assets as prescribed by SFAS No. 142. Our stock price had declinedsignificantly from January 1, 2002, at which point our market capitalization,based on our stock price, was below book value.   We determined the fair value of the Companybased on relative market multiples for comparable businesses and a discountedcash flow model.  This evaluationindicated that an impairment loss might exist. We then performed Step 2 under SFAS No. 142 and compared the carryingamount of goodwill to the implied fair value of the goodwill and determinedthat an impairment loss existed.  Anon-cash charge totaling $28.3 million was recorded in the fourth quarter of 2002to write down the goodwill recorded primarily in the acquisitions of SCI, CPSand STS to its fair value.  

 

53

----

 

In the fourthquarter of 2003, we performed our annual test on the remaining goodwill per SFASNo. 142 requirements applying the same methodologies as those used in theprior year. No additional impairment was found to exist.     As of December 31, 2003, we had $32.1million of non-amortizable goodwill and other intangible assets.

 

***Legal Settlement****.* As described above, in June 2000,Dictaphone Corporation, one of our competitors, filed a patent infringementclaim relating to certain technology embedded in some of our products.  The claim was for damages for pastinfringement and enjoinment of any continued infringement of Dictaphonepatents.  In the fourth quarter of 2003,we reached a settlement with Dictaphone in which both parties agreed to dismissall claims and counterclaims connected with the aforementioned patentinfringement claim. The terms of the settlement call for us to pay Dictaphone$10 million of which approximately $4.8 million was paid by our insurancecarrier in December 2003 and the balance was paid by us, except for the finalinstallment in the amount of $333,335. This amount is required to be paid by us by June 30, 2005, subject tocertain events which could result in a reduced payment by us. As a result, acharge of approximately $5.2 million was recorded in the last quarter of2003.  The companies also agreed to granteach other a worldwide, royalty-free, perpetual license to certain of theirpatents including the disputed patents. The companies further agreed to enterinto enforcement proceedings with respect to both companies’ patent portfoliosand to share any proceeds from these actions. As a result of our acquisition of the CRS division of Dictaphone on June1, 2005, the agreement with respect to patents was terminated since we acquiredthe relevant patents.

 

***FINANCIAL ANDOTHER INCOME***

 
| ** **             | ** ** | **Years Ended December 31,** | ** ** | **$**    | ** ** | **%**      | ** ** |
|------------------------|------------|------------------------------|------------|----------|------------|------------|------------|
| ** **             | ** ** | **2002**                     | ** ** | **2003** | ** ** | **Change** | ** ** | **Change** | ** ** |
|                   |       |                         |       |     |       |       |       |   |   |
| Financial income       |       | $                            | 4.0        |     | $          | 2.0        |       | $ | (2.0 | ) | (50.0 | )% |
| Other income (expense) |       | (4.1                         | )          | 0.3      |       | 4.4        |       | 107.3 |   |
|                        |            |                              |            |          |            |            |            |  |  |  |  |  |

 

***Financial Income,Net***.  The decrease in financial income, net reflects lower prevailing average interest ratesand lower net foreign exchange gains realized in 2003 compared with 2002. 

 

#### ***OtherIncome (Expense), Net****.** *In 2002, we recorded expenses of $3.5 million related tothe settlement of claims by Douglas Chapiewski, the former sole shareholder ofCPS, $335,000 representing the cost of moving our North American headquartersto a different facility, and $229,000 to write-off our long-term investment inEspro Ltd. In 2003, we recorded $300,000 of income reflecting amounts receivedfrom our insurance carrier in respect of the Chapiewski settlement.

 

***Taxes on Income***.  In 2003, we recorded a provision for incometaxes of $1.2 million compared with $0.4 million in 2002. The increase wasprimarily related to changes in the tax law in Israel in 2003 and operating profitsrecorded at certain distribution subsidiaries.

 

***Net Income (Loss)from Continuing Operations***. Net income fromcontinuing operations was $5.6 million in 2003 compared with a net loss of$35.4 million in 2002. The increase in

 

54

----

 

2003 resulted primarily fromthe increase in revenues and gross margin, and the inclusion of $7.1 million ofother special charges in 2003 compared with $29.1 million in 2002.

 

***Net Income fromDiscontinued Operations*. **As discussed above under “OtherDevelopments”, on March 31, 2004 we sold the assets of our COMINT/DFmilitary-related business to ELTA for $4 million in cash. Net income from thisdiscontinued operation was approximately $1.5 million and $1.4 million for 2003and 2002, respectively.

 

### **Liquidity and Capital Resources**

 

We havehistorically financed our operations through cash generated from operations andsales of equity securities.  Generally,we invest our excess cash in instruments that are highly liquid, investment gradesecurities.  At December 31, 2004, we hadapproximately $165.9 million of cash and cash equivalents and short andlong-term investments compared with $107.3 million at December 31, 2003 and$68.6 million at December 31, 2002. The increase in 2004 was due to higher netincome in 2004 and the proceeds from the issuance of shares upon the exerciseof stock options and under our employee share purchase plan. The increase in2003 from 2002 was due mainly to net income versus net loss in 2002. 

 

Cash providedby operating activities of continuing operations was $44.3 million and  $36.9 million in 2004 and 2003, respectively,compared with $16.7 million in 2002. The improvement in 2004 compared with 2003was primarily attributable to higher net operating income. The improvement in2003 compared with 2002 was primarily attributable to our moving from a netoperating loss to a net operating income position. Also contributing to theincrease in cash provided by operating activities was our continued improvementin accounts receivable day’s sales outstanding (or DSO) to 67 days at December31, 2004 compared to 74 days at December 31, 2003 and 112 days at December 31,2002. This improvement was primarily attributable to the implementation ofprocess change improvements and our credit policy. We expect to see our DSOlevels remain between 70 and 80 days as we continue to place particular focuson managing our working capital, particularly the level of accounts receivableday’s sales outstanding. In connection with the TCS acquisition, we recorded acurrent liability of $2.8 million and a long-term liability of $13.5 million in2002 reflecting obligations under a long-term contract assumed by NICE.   We reached agreement to terminate thiscontract in 2003 and amend the terms in the interim.  Under the terms of the amended contract, thecost to us is $5.2 million less than the amount provided at the November 2002acquisition date. 

 

Net cash used in investing activities from continuing operations was$72.3 million and $39.8 million in 2004 and 2003, respectively, compared with$28.2 million in 2002.  The increases in2004 and 2003 are mainly due to investments in marketable securities. Capitalexpenditures were $6.7 million in 2004, $5.5 million in 2003, and $5.3 millionin 2002.  Capital expenditures in 2003and 2004 included investment in back-office IT systems, equipment for researchand development and testing purposes, and general computer equipment. In 2002capital expenditures related primarily to investment in additional modules forour global ERP system including the implementation of the order management andfinancial systems modules at TCS’

 

55

----

 

Southamptonfacility following the acquisition, and equipment for research and developmentand demonstration purposes. As of December 31, 2004, we had no materialcommitment for capital expenditures. 

 

Net cashprovided by financing activities was $19.9 million, $12.1 million and $2.1million in 2004, 2003 and 2002 respectively, almost entirely as a result of netproceeds from the issuance of shares upon the exercise of stock options andunder our employee share purchase plan. As of December 31, 2004, we hadauthorized credit lines from banks in the amount of $139 million. Whenutilized, the credit lines will be denominated in dollars and will bearinterest at the rate of up to LIBOR + 1.5 % per year. An amount of $116 millionout of the total credit lines is secured by our marketable securities. Thereare no financial covenants associated with these credit lines. As of December31, 2004, $5.8 million of the $139 million referred to above was used for bankguarantees. 

 

We believethat based on our current operating forecast, the combination of existingworking capital, expected cash flows from operations and available credit lineswill be sufficient to finance our ongoing operations for the next twelvemonths. This belief takes into consideration the steps we have taken to limitcertain customer-related risks through insuring a significant portion of ouraccounts receivable and achieving ISO 9000-2001 certification to help ensurethe quality of our products and services, which in turn lowers our exposure tocertain commercial risks.  Depending uponour future growth, the success of our business initiatives and acquisitionopportunities, and our transition towards an enterprise software businessmodel, we will consider from time to time various financing alternatives andmay seek to raise additional capital to finance our strategic efforts throughdebt or equity financing, the sale of non-strategic assets or entry intostrategic arrangements.

 

Set forthbelow are our contractual obligations and other commercial commitments over themedium term as of December 31, 2004 ($ in thousands):

 

56

----

 
| ** **                          | ** ** | **Payments Due by Period** | ** ** |
|-------------------------------------|------------|----------------------------|------------|
| **Contractual Obligations**         | ** ** | **Total**                  | ** ** | **Less  than 1  year** | ** ** | **1- 3  years** | ** ** | **3-5  years** | ** ** | **More  than 5  years** | ** ** |
| Long-Term Debt                      |       |                       |       |   |   |   |   |   |   |   |   |
| Capital Lease Obligations           |       |                       |       |   |   |   |   |   |   |   |   |
| Operating Leases                    |       | 15,381                     |       | 5,842 |   | 8,929 |   | 610 |   |   |   |
| Unconditional Purchase  Obligations |       | 4,654                      |       | 2,887 |   | 1,623 |   | 144 |   |   |   |
| Other Long-Term Obligations         |       |                       |       |   |   |   |   |   |   |   |   |
| Total Contractual Cash  Obligations |       | 20,035                     |       | 8,729 |   | 10,552 |   | 754 |   |   |   |

 
| ** **                                | ** ** | ** **                    | ** ** | **Amount of Commitment Expiration Per  Period** | ** ** |
|-------------------------------------------|------------|-------------------------------|------------|-------------------------------------------------|------------|
| **Other Commercial  Commitments**         | ** ** | **Total  Amounts  Committed** | ** ** | **Less  than 1  year**                          | ** ** | **1- 3  years** | ** ** | **3-5  years** | ** ** | **More  than 5  years** | ** ** |
| Lines of Credit                           |       |                          |       |                                            |       |   |   |   |   |   |   |
| Standby Letters of Credit                 |       |                          |       |                                            |       |   |   |   |   |   |   |
| Guarantees – continuing  operations  |       | 2,254                         |       | 859                                             |       | 343 |   |   |   | 1,052 |   |
| Guarantees – discontinued  operation |       | 3,463                         |       | 3,463                                           |       |   |   |   |   |   |   |
| Standby Repurchase Obligations            |       |                          |       |                                            |       |   |   |   |   |   |   |
| Other Commercial Commitments              |       |                          |       |                                            |       |   |   |   |   |   |   |
| Total Commercial Commitments              |       | 5,717                         |       | 4,322                                           |       | 343 |   |   |   | 1,052 |   |

 

### **Qualitative and Quantitative DisclosureAbout Market Risk**

 

Market risksrelating to our operations result primarily from weak economic conditions inthe markets in which we sell our products and changes in interest rates andexchange rates.  To manage the volatilityrelated to the latter exposure, we may enter into various derivative

 

57

----

 

transactions.  Our objective is to reduce, where it isdeemed appropriate to do so, fluctuations in earnings and cash flows associatedwith changes in currency exchange rates. It is our policy and practice to use derivative financial instrumentsonly to manage exposures.  We do not usefinancial instruments for trading purposes and are not a party to any leveragedderivative.

 

###### ***Foreign Currency Risk****. *We conduct our business primarily in US dollars but also in thecurrencies of the United Kingdom, Canada, the European Union, Israel as well asother currencies.  Thus, we are exposedto foreign exchange movements, primarily in UK, European  and Israel currencies.  We monitor foreign currency exposure and,from time to time, may enter into various derivative transactions to preservethe value of sales transactions and commitments. 

###### ** **

###### ***Interest Rate Risk***. We invest in investment-grade US corporate bonds and dollar depositswith FDIC-insured US banks.  At least 80%of our securities investments are in corporate and US government agency bonds.Since these investments carry fixed interest rates and since our policy andpractice is to hold these investments to maturity, interest income over theholding period is not sensitive to changes in interest rates.  Up to 20% of our investment portfolio may beinvested in investment grade Callable Range Accrual Notes whose principal isguaranteed.  As of December 31, 2004, 10%of our investment portfolio consisted of such Notes.  The Notes are subject to interest rate,liquidity and price risks.  Since ourpolicy is to hold these investments to maturity or until called, the interestincome from these notes will not be effected by changes in their market valueor to liquidity risk.  However, asignificant increase in prevailing interest rates may effect whether or notinterest income is received for a particular period. As of December 31 2004, 10% of our investmentportfolio is invested in auction rate securities. Since our policy is to holdthese auction rate securities until their interest reset date, we facepotential capital loss if interest in the market rises dramatically during theholding period (up to 28 days).

 

**RecentlyIssued or Adopted Accounting Pronouncements**

 

On December16, 2004, the Financial Accounting Standards Board (FASB) issued Statement No.123 (revised 2004), “Share-Based Payment” (“Statement 123R”), which is arevision of FASB Statement No. 123, “Accounting for Stock-Based Compensation” (“Statement123”).  Generally, the approach inStatement 123R is similar to the approach described in Statement 123.  However, Statements 123 permitted, but notrequired, share-based payments to employees to be recognized based on theirfair values while Statement 123R requires all share-based payments to employeesto be recognized based on their fair values. Statement 123R also revises,clarifies and expands guidance in several areas, including measuring fair value,classifying an award as equity or as a liability and attributing compensationcost to reporting periods. The new Standard will be effective with respect tous in the first fiscal year beginning after June 15, 2005. The adoption ofStatement 123R will have a significant effect on our results ofoperations.  

 

In November2004, the FASB issued Statement of Financial Accounting Standard No. 151, “InventoryCosts, an Amendment of ARB No. 43, Chapter 4.” (“SFAS 151”). SFAS 151 amendsAccounting Research Bulletin (“ARB”) No. 43, Chapter 4, to clarify thatabnormal

 

58

----

 

amounts of idle facilityexpense, freight handling costs and wasted materials (spoilage) should berecognized as current-period charges. In addition, SFAS 151 requires that theallocation of fixed production overheads to the costs of conversion be based onthe normal capacity of the production facilities. SFAS 151 is effective forinventory costs incurred during fiscal years beginning after June 15, 2005. Wedo not expect that the adoption of SFAS 151 will have a material effect on ourfinancial position or results of operations.

 

### **Factors That May Affect Future Results**

 

We operateglobally in a dynamic and changing environment that involves numerous risks anduncertainties.  The following sectionlists some, but not all, of those risks and uncertainties that could causeactual results and outcomes to differ materially from those contained in anyforward-looking statement made by us or on our behalf.  Other risks and uncertainties that couldaffect actual results and outcomes are described in Item 3 of this Report under“Risk Factors.”

 

*New Accounting Pronouncements Require Us toChange the Way in Which We Account for Employee Stock Options*.Commencing with fiscal year 2006, we will be required by applicable accountingprinciples to record as expenses all share-based payments to employees based ontheir fair values.  This will result inincreased expenses in our statement of operations and a consequent reduction ofour net income and earnings per share. 

 

*The Overall EconomicEnvironment Continues to be Weak*.  Weare subject to the effects of general global economic and marketconditions.  Our operating results havebeen adversely affected as a result of unfavorable economic conditions andreduced information technology spending, particularly in the product segmentsin which we compete.  During 2002 and2003, and continuing through 2004, there was an increase in demand for our typeof products as customers allocated resources to enhance their recording andanalysis capabilities for compliance and risk management and for security.  However, customer purchase decisions may besignificantly affected by a variety of factors including trends in spending forinformation technology and enterprise software, market competition, and theviability or announcement of alternative technologies. If economic conditionscontinue to be weak, demand for our products could decrease resulting in lowerrevenues, profits and cash flows.  

 

*Our BusinessStrategy Continues to Evolve*. Historically we have supplied the hardware and some software forimplementing multimedia recording solutions. Our shift towards providing professional support services and anenterprise software business model has required and will continue to requiresubstantial change, potentially resulting in some disruption to ourbusiness.  These changes may includechanges in management and technical personnel; expanded or differing competitionresulting from entering the enterprise software market; increased need toexpand our distribution network to include system integrators which couldimpact revenues and gross margins, and, as our applications are sold either toour installed base or to new customers together with our recording platforms,the rate of adoption of our software applications by the market.

 

59

----

 

*We May ExperienceDifficulty Managing Changes in Our Business*. The changes in our business may place asignificant strain on our operational and financial resources.  We may experience substantial disruption fromchanges and could incur significant expenses and write-offs.  Failing to carefully manage expense andinventory levels consistent with product demand and to carefully manageaccounts receivable to limit credit risk, could materially adversely affect ourresults of operations.  

 

*Our Service Revenuesare Dependent on Our Installed Base of Customers*. We derive a significant portion of ourrevenues from services, which include maintenance, project management, supportand training.  As a result, if we lose amajor customer or if a support contract is delayed or cancelled, our revenueswould be adversely affected. In addition, customers who have accounted forsignificant services revenues in the past may not generate revenues in futureperiods.  Our failure to obtain newcustomers or additional orders from existing customers could also materiallyaffect our results of operations. 

 

*Risks Associatedwith Our Distribution Channels May Materially Adversely Affect Our FinancialResults*. Wehave agreements in place with many distributors, dealers and resellers tomarket and sell our products and services in addition to our direct salesforce.  We derive a significantpercentage of our revenues from one of our distributor channels and newchannels may, in the future, account for a significant percentage of our revenues.Our top channel partner accounted for approximately 19%, 20% and 23% of ourrevenues in 2004, 2003 and 2002, respectively. Our financial results could bematerially adversely affected if our contracts with channel partners wereterminated, if our relationship with channel partners were to deteriorate or ifthe financial condition of our channel partners were to weaken.  In addition, as our market opportunitieschange, we may have increased reliance on particular channel partners, whichmay negatively impact gross margins. There can be no assurance that we will besuccessful in maintaining or expanding these channels.  If we are not successful, we may lose salesopportunities, customers and market share. In addition, some of our channel partners are suppliers oftelecommunication infrastructure equipment. There can be no assurance that ourchannel partners will not develop or market VoIP, software applications andstorage products and services in competition with us in the future.

 

*Our Uneven Sales PatternsCould Significantly Impact Our Quarterly Revenues and Earnings*. The sales cycle for our products andservices is variable, typically ranging between a few weeks to several monthsfrom initial contact with the potential client to the signing of a contract.  Frequently, sales orders accumulate towardsthe latter part of a given quarter. Looking forward, given the lead-time required by our contractmanufacturer, if a large portion of sales orders are received late in thequarter, we may not be able to deliver products within the quarter and thussuch sales will be deferred to a future quarter. There can be no assurance thatsuch deferrals will result in sales in the near term, or at all.  Thus, delays in executing client orders mayaffect our revenue and cause our operating results to vary widely.  Additionally, as a high percentage of our expenses, particularly employee compensation,is relatively fixed, a variation in the level of sales, especially at or nearthe end of any quarter, may have a material adverse impact on ourquarterly operating results.

 

60

----

 

*Competitive Pricingand Difficulty Managing Product Costs Could Materially Adversely Affect OurRevenues and Earnings.* The market for our products and related services, in general, is highlycompetitive.  Additionally, some of ourprincipal competitors such as Witness Systems, Inc. and Verint Systems, Inc.may have significantly greater resources and larger customer bases than dowe.  We have seen evidence of deep pricereductions by our competitors and expect to continue to see such behavior inthe future, which, if we are required to match such discounting, will adverselyaffect our gross margins and results of operations. To date, we have been ableto manage our product design and component costs.  However, there can be no assurance that wewill be able to continue to achieve reductions in component and product designcosts.  Further, the relative and varyingrates of increases or decreases in product price and cost could have a materialadverse impact on our earnings. 

 

*Our Gross Marginsare Highly Dependent upon Our Product Mix*.  Itis difficult to predict the exact mix of products for any period betweenhardware, software and services as well as within the product category betweenaudio platforms and related applications and digital video. As each of ourproduct types and services have different gross margins, changes in the mix ofproducts in a period will have an impact, and perhaps a material impact, on ourgross profit and net income in that period.~~~~ 

 

*If Our Suppliers AreNot Able to Meet Our Requirements, We Could Have Decreased Revenues andEarnings:*

 

•                  In 2002, we migrated the manufacturing ofall of our key products to a contract manufacturer.  The TCS product line is also manufactured bya third party.  We may experiencedelivery delays due the inability of the outsourcers to consistently meet ourquality or delivery requirements.  Ifthese suppliers or any other supplier were to cancel contracts or commitmentswith us or fail to meet the quality or delivery requirements needed to satisfycustomer orders for our products, we could lose time-sensitive customer ordersand have significantly decreased quarterly revenues and earnings, which wouldhave a material adverse effect on our business, results of operations andfinancial condition. 

 

•                  Should we have on-going performance issueswith our contract manufacturers, the process to move from one contractor toanother is a lengthy and costly process that could affect our ability toexecute customer shipment requirements and /or might negatively affect revenueand/or costs.  

 

We depend on certain critical components in the production of ourproducts and parts.  Some of thesecomponents are obtained only from a single supplier and only in limitedquantities.  In addition, some of ourmajor suppliers use proprietary technology and software code that could requiresignificant redesign of our products in the case of a change in vendor.  Further, as suppliers discontinue theirproducts, or modify them in manners incompatible with our current use, or usemanufacturing processes and tools that could not be easily migrated to othervendors, we could have significant delays in product or spare parts availability,which would have a significant adverse impact on our results of operations andfinancial condition.

 

61

----

 

*UndetectedProblems in Our Products Could Directly Impair our Financial Results.*  If flaws in design, production, assembly ortesting of our products (by us or our suppliers) were to occur, we couldexperience a rate of failure in our products that would result in substantialrepair, replacement or service costs and potential liability and damage to ourreputation.  There can be no assurancethat our efforts to monitor, develop, modify and implement appropriate test andmanufacturing processes for our products will be sufficient to permit us toavoid a rate of failure in our products that results in substantial delays inshipment, significant repair or replacement costs or potential damage to ourreputation, any of which could have a material adverse effect on our business,results of operations and financial condition.  

 

*We May Experience Difficulty ManagingOperational Expansion*. We have recently established asales and service infrastructure in India by recruiting sales and servicepersonnel in order to bring about further growth in revenue in the Asia Pacificmarket and have expanded our professional services group to include businessconsultants.  We may establish additionaloperations where growth opportunities are projected to warrant the investment.However, we cannot assure you that our revenues will increase as a result ofthis expansion or that we will be able to recover the expenses we incurred ineffecting the expansion. Our failure to effectively manage our expansion of oursales, marketing, service and support organizations could have a negativeimpact on our business.  To accommodateour global expansion, we are continuously implementing new or expanded businesssystems, procedures and controls.  Therecan be no assurance that the implementation of such systems, procedures,controls and other internal systems can be completed successfully. 

 

*Changes in ForeignConditions Could Materially Adversely Affect our Financial Results*. Approximately half of our revenues arederived from sales outside the United States. Accordingly, our future resultscould be materially adversely affected by a variety of factors includingchanges in exchange rates,  generaleconomic conditions,  regulatoryrequirements, tax structures or changes in tax laws, and longer payment cyclesin the countries in our geographic areas of operations.

 

*Our Business CouldBe Materially Adversely Affected as a Result of the Risks Associated withAcquisitions and Investments*.  As part of our growth strategy,we have made a number of acquisitions and have made minority investments incomplementary businesses, products or technologies. We frequently evaluate thetactical or strategic opportunity available related to complementarybusinesses, products or technologies. The process of integrating an acquired company’s business into ouroperations and/or of investing in new technologies, may result in unforeseenoperating difficulties and large expenditures and may absorb significantmanagement attention that would otherwise be available for the ongoingdevelopment of our business.  Other riskscommonly encountered with acquisitions include the effect of the acquisition onour financial and strategic position and reputation; the failure of theacquired business to further our strategies, the inability to successfullyintegrate or commercialize acquired technologies or otherwise realize anticipatedsynergies or economies of scale on a timely basis and the potential impairmentof acquired assets.  Moreover, there canbe no assurance that the anticipated benefits of any acquisition or investmentwill be realized.  Future acquisitions orinvestments

 

62

----

 

contemplatedand/or consummated could result in potentially dilutive issuances of equitysecurities, the incurrence of debt and contingent liabilities, and amortizationexpenses related to intangible assets, any of which could have a materialadverse effect on our operating results and financial condition.  There can be no assurance that we will besuccessful in making additional acquisitions or effective in integrating suchacquisitions into our existing business. In addition, if we consummate one or more significant acquisitions inwhich the consideration consists, in whole or in part, of ordinary shares orAmerican Depositary Shares (ADSs), representing our ordinary shares,shareholders would suffer dilution of their interests in us. We have alsoinvested in companies, which can still be considered in the start-up ordevelopment stages. These investments are inherently risky as the market forthe technologies or products they have under development are typically in theearly stages and may never materialize. We could lose our entire initialinvestment in these companies. 

 

*We May Be Unable toKeep Pace with Rapid Industry, Technological and Market Changes*. The market for our products and servicesis subject to rapid technological change and new product introductions.  Current competitors and/or new marketentrants may develop new, proprietary products with features that couldadversely affect the competitive position of our products.  We may not successfully anticipate marketdemand for new products or services, or introduce them in a timely manner.  The convergence of voice and data networks,and wired and wireless communications could require substantial modificationand customization of our current products and business models, as well as theintroduction of new products.  Further,customer acceptance of these new technologies may be slower than weanticipate.  We may not be able tocompete effectively in these markets.  Inaddition, our products must readily integrate with major third party security,telephone, front-office and back-office systems.  Any changes to these third party systemscould require us to redesign our products, and any such redesign might not bepossible on a timely basis or achieve market acceptance.  Additional factors that may cause actualresults to differ materially from our expectations include industry specificfactors; our ability to continuously develop, introduce and deliver commerciallyviable products, solutions and technologies, and the market’s rate ofacceptance of the solutions we offer and our ability to keep pace with marketand technology changes and to compete successfully. 

 

*If Our AdvancedCompliance Recording Solutions Fail to Record Our Customers’ Interactions, WeMay be Subject to Liability and Our Reputation May be Harmed.* Manyof our customers use our solutions to record and to store recordings ofcommercial interactions.  Theserecordings are used to provide back-up and verification of transactions and toguard against risks posed by lost or misinterpreted voice communications.  These customers rely on our solutions torecord, store and retrieve voice data in a timely, reliable and efficientmanner.  If our solutions fail to recordour customer’s interactions or our customers are unable to retrieve storedrecordings when necessary, we may be subject to liability and our reputationmay be harmed.  Although we attempt tolimit any potential exposure through quality assurance programs, insurance andcontractual terms, we cannot assure you that we will eliminate or successfullylimit our liability for any failure of our recording and storagesolutions.  

 

63

----

 

*If We are Unable toMaintain the Security of Our Systems, Our Business, Financial Condition andOperating Results Could be Harmed*. The occurrence of or perception ofoccurrence of security breaches in the operation of our business or by thirdparties using our products could harm our business, financial condition andoperating results.  Some of our customersuse our products to compile and analyze highly sensitive or confidentialinformation.  We may come into contactwith such information or data when we perform service or maintenance functionsfor our customers.  While we haveinternal policies and procedures for employees in connection with performingthese functions, the perception or fact that any of our employees hasimproperly handled sensitive information of a customer or a customer’s customercould negatively impact our business. If, in handling this information we failto comply with our privacy policies or privacy and security laws, we couldincur civil liability to government agencies, customers and individuals whoseprivacy was compromised.  If personalinformation is received or used from sources outside the US, we could besubject to civil, administrative or criminal liability under the laws of othercountries.  In addition, third partiesmay attempt to breach our security or inappropriately use our products throughcomputer viruses, electronic break-ins and other disruptions.  If successful, confidential information,including passwords, financial information, or other personal information maybe improperly obtained and we may be subject to lawsuits and otherliability.  Any internal or externalsecurity breaches could harm our reputation and even the perception of securityrisks, whether or not valid, could inhibit market acceptance of our products. 

 

*Changes in Regulations Could MateriallyAdversely Affect Us*. Our business, results of operations and financial condition could bematerially adversely affected if laws, regulations or standards relating to ourproducts or us are newly implemented or changed.

 

*Changes in Israeli Government Benefit ProgramsCould Materially Adversely Affect Us*. We derive andexpect to continue to derive significant benefits from various programs andlaws in Israel including tax benefits relating to our “Approved Enterprise”programs and certain grants from the Office of the Chief Scientist, or OCS, forresearch and development.  To be eligiblefor these grants, programs and tax benefits, we must continue to meet certainconditions, including making certain specified investments in fixed assets andconducting the research, development and manufacturing of products developedwith such OCS grants in Israel (unless a special approval has been granted forperforming manufacturing outside Israel). Pursuant to an amendment to Israeli regulations, income from two of our “ApprovedEnterprises” is exempt from income tax for only two years.  Following this two-year period, the “ApprovedEnterprise” will be subject to corporate tax at a reduced rate of 10-25% (basedon the percentage of foreign ownership in each taxable year) for the followingeight years.  Income from the other two “ApprovedEnterprises” is tax exempt for four years. Following this four-year period, the “Approved Enterprises” are subjectto corporate tax at a reduced rate of 10-25% (based on the percentage offoreign ownership in each taxable year) for the following six years. On April1, 2005, an amendment to the applicable law regarding “Approved Enterprise”programs came into force. Pursuant to the amendment, a company’s facility willbe granted the status of “Approved Enterprise” only if it is proven to be anindustrial facility (as defined in such law) that contributes to the economicindependence of the Israeli economy and is a competitive facility thatcontributes to the Israeli gross domestic product. The amendment incorporatescertain changes to

 

64

----

 

both thecriteria and procedure for obtaining “Approved Enterprise” status for aninvestment program, and changes to the tax benefits afforded in certaincircumstances to “Approved Enterprises” under such law. The amendment willapply to Approved Enterprise programs in which the year of commencement ofbenefits under the law is 2004 or later, unless such programs received approvalfrom the applicable government authority prior to December 31, 2004 in whichcase the provisions of the amendment will not apply. If grants, programs andbenefits available to us or the laws under which they were granted areeliminated or their scope is further reduced, or if we fail to meet theconditions of existing grants, programs or benefits and are required to refundgrants or tax benefits already received (together with interest and certaininflation adjustments) or fail to receive approval for future ApprovedEnterprises, our business, financial condition and results of operations couldbe materially adversely affected.

 

*We May Have Exposure to Additional Income TaxLiabilities*. As a global corporation, we are subjectto income taxes both in Israel and various foreign jurisdictions.  Our domestic and international taxliabilities are subject to the allocation of revenues and expenses in differentjurisdictions and the timing of recognizing revenues and expenses.  Additionally, the amount of income taxes paidis subject to our interpretation of applicable laws in the jurisdictions inwhich we file.  From time to time, we aresubject to income tax audits.  While webelieve we comply with all applicable income tax laws, there can be noassurance that a governing tax authority will not have a differentinterpretation of the law and assess us with additional taxes.  Should we be assessed additional taxes, therecould be a material adverse affect on our results of operations and financialcondition.

 

**Item 6****.    Directors, Senior Management andEmployees.**

 

**Directors and Senior Management**

 

The followingtable sets forth, as of June 27, 2005, the name, age and position of each ofour directors and executive officers:

 
| **Name**                    | ** ** | **Age** | ** ** | **Position**                             |
|-----------------------------|------------|---------|------------|------------------------------------------|
| Ron Gutler(2)(4)            |       | 47      |       | Chairman of  the Board of Directors      |
|                        |       |    |       |                                     |
| Joseph  Atsmon(2)           |       | 56      |       | Vice-Chairman  of the Board of Directors |
|                        |       |    |       |                                     |
| Rimon  Ben-Shaoul(4)        |       | 59      |       | Director                                 |
|                        |       |    |       |                                     |
| Yoseph  Dauber(1)(4)        |       | 69      |       | Director                                 |
|                        |       |    |       |                                     |
| Dan Falk(1)(2)(3)(4)        |       | 60      |       | Director                                 |
|                        |       |    |       |                                     |
| John Hughes                 |       | 53      |       | Director                                 |
|                        |       |    |       |                                     |
| David  Kostman              |       | 40      |       | Director                                 |
|                        |       |    |       |                                     |
| Dr. Leora  Meridor(1)(2)(3) |       | 57      |       | Director                                 |

 

65

----

 
| **Name**           | ** ** | **Age** | ** ** | **Position**                                                              |
|--------------------|------------|---------|------------|---------------------------------------------------------------------------|
| Haim Shani         |       | 48      |       | Director and  Chief Executive Officer                                     |
|               |       |    |       |                                                                      |
| Dr. Shlomo  Shamir |       | 57      |       | President                                                                 |
|               |       |    |       |                                                                      |
| Ran Oz             |       | 38      |       | Corporate  Vice President and Chief Financial Officer                     |
|               |       |    |       |                                                                      |
| Koby  Huberman     |       | 47      |       | Corporate  Vice President, Strategic Alliances & Business Development |
|               |       |    |       |                                                                      |
| Yechiam  Cohen     |       | 48      |       | Corporate  Vice President, General Counsel and Corporate Secretary        |
|               |       |    |       |                                                                      |
| Zvi Baum           |       | 49      |       | Corporate  Vice President, General Manager Product Division               |
|               |       |    |       |                                                                      |
| Yoav  Zaltzman     |       | 47      |       | President,  Intelligence Solutions                                        |
|               |       |    |       |                                                                      |
| Doron  Eidelman    |       | 49      |       | Corporate  Executive Vice President, President NiceVision                 |
|               |       |    |       |                                                                      |
| Jim Park           |       | 48      |       | Corporate  Vice President & General Manager Public Safety             |
|               |       |    |       |                                                                      |
| Eran Gorev         |       | 40      |       | President  and Chief Executive Officer, NICE Systems Inc.                 |
|               |       |    |       |                                                                      |
| Eran Porat         |       | 42      |       | Corporate  Vice President, Finance                                        |

 

----

(1)   Member of the Internal Audit Committee.

(2)   Member of the Audit Committee.

(3)   Outside Director. See “— Outside Directors.”

(4)   Member of the Compensation Committee

 

Set forthbelow is a biographical summary of each of the above-named directors andexecutive officers of NICE.

 

**Ron Gutler** has been a director of NICE sinceMay 2001 and chairman of the board since May 2002.  Mr. Gutler is currently the chairman of G.J.E121 Promoting Investment Ltd., a real estate investment company. Between 2000and 2002, he managed the Blue Border Horizon Fund, a global macro fund.  Mr. Gutler is a former Managing Director anda Partner of Bankers Trust Company (currently part of Deutche Bank). Between1987 and 1999, he filled various positions with Bankers Trust. Mr. Gutlerheaded the Trading and Sales Activities in Asia, South America and EmergingEurope. He also established and headed the Israeli office of Bankers Trust. Mr.Gutler holds a Bachelor’s degree in economics and international relations and aMaster’s degree in Business Administration, cum laude, both from the HebrewUniversity, Jerusalem. 

 

**Joseph Atsmon** has been a director**of NICE since September 2001 and Vice-Chairman of the Boardsince May 2002.  Mr. Atsmon currentlyserves as a Director of Ceragon Networks

 

66

----

 

and of Radvision Ltd. From 1995until 2000, Mr. Atsmon served as Chief Executive Officer of TeledataCommunications Ltd., a public company acquired by ADC Telecommunications Inc.in 1998. Mr. Atsmon had a twenty-year career with Tadiran Ltd. In his last roleat Tadiran Ltd., Mr. Atsmon served as Corporate VP for business development.Prior to that, he served as President of various military communicationsdivisions. Mr. Atsmon received a B.Sc. in Electrical Engineering, suma cumlaude, from the Technion, Israel Institute of Technology. 

 

**Rimon Ben-Shaoul**  has been a director of NICE since September 2001.  Mr. Ben-Shaoul currently serves asco-Chairman, President, and CEO of Koonras Technologies Ltd., which he joinedon February 1, 2001. Koonras Technologies Ltd. is a technology investmentcompany controlled by Poalim Investments Ltd., a large Israeli holdingcompany.  Mr. Ben-Shaoul also serves asChairman of Nipson Digital Printing Systems PLC and Dor Chemicals Ltd. and as adirector of MIND C.T.I. Ltd., BVR Systems Ltd. and several private companies.In addition, he is the President and CEO of Polar Communications Ltd., whichmanages media and communication investments. Between 1997 and February 1, 2001,Mr. Ben-Shaoul was the President and CEO of Clal Industries and InvestmentsLtd., one of the largest holding companies in Israel with substantial holdingsin the high tech industry. During that time, Mr. Ben-Shaoul also served asChairman of the Board of Directors of Clal Electronics Industries Ltd., ScitexCorporation Ltd., and various other companies within the Clal Group. Mr.Ben-Shaoul also served as a director of ECI Telecom Ltd., Fundtech Ltd., CreoProducts, Inc., Nova Measuring Instruments Ltd., and other public and privatecompanies. From 1985 to 1997, Mr. Ben-Shaoul was President and CEO of Clal InsuranceCompany Ltd. and a director of the company and its various subsidiaries. Mr.Ben-Shaoul holds a bachelor’s degree in economics and a master’s degree inbusiness administration, both from Tel-Aviv University**.**

 

**Yoseph Dauber** has been a director of NICEsince April 2002. Until June 2002 Mr. Dauber was deputy chairman of the boardof Management and joint Managing Director of Bank Hapoalim and was responsiblefor the commercial division of the bank. During the years 1994-1996 and until6/ 2002 Mr. Dauber served as Chairman of Poalim American Express and of theIsracard Group. He now serves as a member of the Board of Bank Hapoalim. Mr.Dauber holds a Bachelor’s degree in Economics and Statistics from the HebrewUniversity of Jerusalem.

 

**Dan Falk**has been a director of NICE since January2002. Mr. Falk serves as a member of the boards of directors of OrbotechSystems Ltd., Attunity Ltd., Orad Hi Tech Systems Ltd., Netafim Ltd., PlastopilLtd., Visionix Ltd., ClickSoftware Technologies Ltd., Dmatek Ltd., Jacada Ltd.and Poalim Ventures 1 Ltd., all of which are Israeli companies, and OrmatTechnology Inc. In 1999 and 2000, Mr. Falkwas President and Chief Operating Officer of Sapiens International CorporationN.V.  From 1985 to 1999, Mr. Falk servedin various positions in Orbotech Systems Ltd., the last of which were ChiefFinancial Officer and Executive Vice President. From 1973 to 1985, he served inseveral executive positions in the Israel Discount Bank. Mr. Falk holds aBachelor’s degree in Economics and Political Science and a Master’s degree inBusiness Administration from the Hebrew University, Jerusalem. As describedabove, Mr. Falk serves on the board of directors of a number of companies, bothpublic and private and qualifies as an Outside Director of NICE underIsraeli law. See “— Outside Directors.” 

 

67

----

 

### **John Hughes** has been a director of NICE since November 2, 2002. Mr. Hughes iscurrently Chairman of Intec Telecom Systems plc and Executive Chairman ofParity Group plc. From December 2000 to July 2004, he held senior executivepositions at Thales Group, most recently as Executive Vice President and CEO ofallcivil activities for the Group. During the years 1997until 2000, he held positions with Lucent Technologies, and was President ofits GMS/UMTS division and in the years 1991 through 1997, Mr. Hughes served asDirector of Convex Global Field operations within the Hewlett Packard Company.Prior to that, Mr. Hughes held various positions with UK and US companies. Mr.Hughes holds a bachelor of science degree in Electrical and ElectronicEngineering from the University of Hertfordshire. 

### ** **

**David Kostman** has been a director of NICEsince January 2000.  Mr. Kostman iscurrently the Chief Executive Officer of Delta Galil USA Inc., a subsidiary ofDelta Galil Industries Ltd., a Nasdaq-listed apparel manufacturer. From April2003 until April 2005, he was Chief Operating Officer of Delta GalilUSA. Until May, 2002 he was the Chief Operating Officer of VerticalNet,Inc., a Nasdaq listed software company, which he joined in June 2000.  Prior thereto, Mr. Kostman was a ManagingDirector in the Investment Banking Division of Lehman Brothers Inc., which hejoined in 1994.  Mr. Kostman holds abachelor’s degree in law from Tel-Aviv University and a master’s degree inbusiness administration from INSEAD, France. 

 

**Leora (Rubin) Meridor**has been a director of NICE since January2002.  Since 2001, Dr. Meridor has been the Chairwoman of the Board of BezeqInternational and Walla Telecommunication and between 2001 and 2004 Dr. Meridorserved as Chairwoman of the Board of Poalim Capital Markets. From 1996 to 2000,Dr. Meridor served as Senior Vice President, Head of the Credit and RiskManagement Division of the First International Bank of Israel. Between 1983 and1996, Dr. Meridor held various positions in the Bank of Israel, the last ofwhich was Head of the Research Department. Dr. Meridor has held variousteaching positions with the Hebrew University and holds a B.Sc. degree inmathematics and physics, a M.Sc. degree in Mathematics and a Ph.D in Economicsfrom the Hebrew University, Jerusalem. Dr. Meridor serves on the boards ofdirectors of Teva Pharmaceutical Industries Ltd., Isrotel Ltd. and G.J.E. 121Promoting Investment Ltd.  Shequalifies as an Outside Director of NICE under Israeli law. See “— OutsideDirectors.” 

 

**Haim Shani**has served as a director and Chief Executive Officer of NICE sinceJanuary 2001. He also served asPresident of NICE from January 2001 to April 2005.  Mr. Shani came to NICE from Applied Materials(Israel), where he served as General Manager in its Israeli office from 1998 to2000, heading up the Process Diagnostic and Control (PDC) business group formedfollowing the acquisition by Applied Materials of Opal Ltd. and OrbotInstruments, Ltd.  Prior to joiningApplied Materials, Mr. Shani held various management positions at OrbotechLtd.  From 1995 to 1998, he served as CorporateVice President of Marketing and Business Development, from 1993 to 1995, heserved as President of Orbotech’s subsidiary in Asia Pacific, based in HongKong and from 1992 to 1993, he served as President of Orbotech Europe, based inBrussels.  From 1982 to 1992, Mr. Shaniheld various management positions at Scitex Corporation and IBM Israel.  Mr. Shani holds a bachelor’s degree inindustrial and management

 

68

----

 

engineeringfrom the Technion – Israel Institute of Technology and a master’s degree inbusiness administration from INSEAD, France. 

 

**Dr. Shlomo Shamir** has served as the Presidentof NICE since April 2005. From April 2001 to April 2005, he served as Presidentand Chief Executive Officer of NICE Systems Inc., NICE’s wholly ownedsubsidiary and corporate headquarters in North America.  From 2000 to April 2001, Dr. Shamir served asPresident and CEO of CreoScitex America, Inc. From 1997 to 2000, Dr. Shamir served as President and CEO of Scitex AmericaCorp. and from 1994 to 1997, he served as its Corporate Vice President ofOperations.  Prior to 1994, Dr. Shamirserved in the IDF where he attained the rank of Brigadier General.  Dr. Shamir built and led the planningdivision in the IDF headquarters and served as Israel’s military attaché toGermany.  He holds a bachelor’s degree inphysics from the Technion – Israel Institute of Technology and master’s anddoctor of philosophy degrees in engineering and economic systems from StanfordUniversity. 

 

**Ran Oz**has served as Corporate Vice Presidentand Chief Financial Officer of NICE since September 2004.   Mr. Oz came to NICE from Ceragon Networks,an international fixed wireless company, where he was Chief Financial Officerfrom 2001 to 2004.  Prior thereto he worked for six years withJacada, an international software company, where he held a variety of positionsin finance and operations - most recently as general manager of the parentcompany and corporate CFO.  Mr. Oz holds a bachelor’s degree inaccounting and economics and a master’s degree in business administration andeconomics from Hebrew University in Jerusalem.  He is also a licensedCPA.

 

**Koby Huberman** has served as Corporate VicePresident, Business Development of NICE since January 2000, and is currentlyCorporate Vice President, Strategic Alliances & Business Development. From1998 to January 2000, Mr. Huberman served as Vice President of Marketing forthe Enterprise Internetworking Systems Group of Lucent Technologies Ltd.  and, from 1995 to 1998, he was Vice Presidentof Global Marketing and Business Development for Lannet Data CommunicationsLtd., which was acquired by Lucent in 1998. Prior thereto, Mr. Huberman was theManaging Director of ServiceSoft Europe, a pan-European leading vendor ofartificial intelligence and knowledge-based software for call center and customerservice applications.  Mr. Huberman holdsa bachelor’s degree in economics and business administration from the LeonRecanati Business School of Tel-Aviv University. 

 

**Yechiam Cohen**hasserved as Corporate Vice President, General Counsel and Corporate Secretary ofNICE since April 2005. Prior to joining NICE, he served for eight years asGeneral Counsel of Amdocs, a leading provider of billing and CRM softwaresolutions to the telecommunications industry. Before joining Amdocs, Mr. Cohenwas a partner in the Tel Aviv law firm of Dan Cohen, Spigelman & Company.From 1987 to 1990, he was an associate with the New York law firm of Dornbush,Mensch, Mandelstam and Schaeffer. Mr. Cohen served as a law clerk to JusticeBeijski of the Supreme Court of Israel in Jerusalem. He graduated in 1984 fromthe Hebrew University School of Law and is admitted to practice law in Israeland New York. 

 

69

----

 

**Zvi Baum** is currently Corporate Vice President& General Manager Product Division. He previously served as Director ofProduct Management in the CEM Division of NICE and since May 2003 was in theposition of Corporate VP of Marketing. Before joining NICE, Mr. Baum served as the Managing Director of CallVision Israel Ltd., a company that specialized in the development of advancedweb-based quality monitoring solutions for call centers. Prior to that, heserved as the VP of International Sales and Marketing at STS Software Systems,which developed recording solutions and was acquired by NICE at the end of1999. Between 1987 and 1998, Mr. Baum worked for a number of American andEuropean companies in several areas, including technical management, marketingand channel management.  Mr. Baum holds abachelor’s degree in Engineering from the Technion – Israel Institute ofTechnology and a Mater’s degree in Computer Science and an MBA, both from theUniversity of California in Los Angeles (UCLA). 

 

**Yoav Zaltzman** is currently President,Intelligence Solutions. Mr. Zaltzman previously served as Corporate VicePresident & General Manager Intelligence Solutions Division and since May2001 was in the position of Corporate Vice President, Business Operations ofNICE.  Prior to joining NICE, Mr.Zaltzman served as Senior Director of Sales for Applied Materials Israel since1997.  From 1994 to 1997, Mr. Zaltzmanserved as General Manager of Orbot Instruments in Europe, based in Brussels,which was acquired by Applied Materials in 1997.  From 1987 to 1992, Mr. Zaltzman held varioussales and marketing positions for Oracle in Israel. Mr. Zaltzman holds abachelor’s degree in Computer Sciences and a master’s degree in businessadministration, both from Tel Aviv University. 

 

**Doron Eidelman**serves as Corporate ExecutiveVice President, President NiceVision since May 2002. Previously, he was COO ofAudioCodes, a telecommunications company. From 1992 to 2001, Mr. Eidelman wasExecutive Vice President and President of the Display Division of Orbotech andfrom 1987 to 1992, he held various positions in Optrotech, the last of whichwas Vice President. Mr. Eidelman served in an elite intelligence unit in theIDF and was awarded the prestigious Israel Defense Award .He holds a bachelor’sdegree in electronic engineering from the Technion-Israel Institute ofTechnology and a master’s degree in electronic engineering from the****University of Tel Aviv.

** **

**Jim Park** is currently Corporate Vice President& General Manager Public Safety. Mr. Park previously served as thePresident of NICE Systems CTI UK Ltd, NICE’s wholly owned subsidiary andcorporate headquarters in EMEA. Mr. Park was previously CEO of Thales ContactSolutions (previously Racal Recorders) which was acquired, by NICE, in Nov2002. Prior to joining Racal, in 1998, Mr. Park held various senior managementpositions at Mitel Telecom. From 1996 to 1998 he served as General Manager forMitel’s EMEA switching business, from 1994 to 1996 he was VP of businessdevelopment, from 1991 to 1994 he was director of Marketing and from 1982 to1991 he held various sales management roles, in Europe, the Middle East andAfrica. Mr. Park’s early career was spent in various engineeringroles with Siemens UK (1979 to 1982) and British Telecom (1974 to1979), who sponsored him through college. 

 

70

----

 

**Eran Gorev** has beenthe President and Chief Executive Officer of NICE Systems Inc. since March2005.  From 2002 to 2004, Mr. Gorev was President of the North America -Major Clients division at Amdocs.   From 2000 to 2002, Mr. Gorevserved as Corporate Vice President and Head of Worldwide Sales atAmdocs.  Prior thereto, Mr. Gorev held various marketing and salesmanagement positions in the Information Technology industry.  Mr. Gorevearned an L.LB degree from Tel-Aviv University and a joint MBA degree from theKellogg School of Management, Northwestern University, and the Recanati Schoolof Business Administration, Tel-Aviv University.

 

**Eran Porat** has been the Corporate VicePresident Finance of NICE since 2005. From March 2000 to 2005, he served asCorporate Controller of NICE. From 1997 to February 2000, Mr. Porat served asCorporate Controller of Technomatics Technologies Ltd. From 1996 to 1997, heserved as Corporate Controller of Nechushtan Elevators Ltd. Mr. Porat is a CPAand holds a bachelor’s degree in economics and accounting from the Universityof Tel-Aviv. 

 

**Compensation**

 

The aggregate compensation paid to or accrued on behalf of all ourdirectors and executive officers as a group (24 persons) during 2004 consistedof approximately $4.1 million in salary, fees, bonus, commissions and directors’fees and approximately $0.1 million in amounts set aside or accrued for toprovide pension, retirement or similar benefits, but excluding amounts weexpended for automobiles made available to our officers, expenses (includingbusiness travel, professional and business association dues and expenses)reimbursed to our officers and other fringe benefits commonly reimbursed orpaid by companies in Israel.

 

During 2004,our officers and directors received, in the aggregate, options to purchase upto 208,000 ordinary shares under our 2003 Stock Option Plan.  These options have an average exercise priceof $23.31 and will expire six years after the date the options were granted. 

 

Compensationand reimbursement for Outside Directors (as described below) is statutorilydetermined pursuant to the Israeli Companies Law, 5759–1999, or the CompaniesLaw.  The statutory rates for OutsideDirectors is approximately NIS 46,000 per annum and approximately NIS 1,800 permeeting.  Compensation and reimbursementof all other directors who do not serve as officers are the same as thestatutory rates paid to Outside Directors except for the chairman of the Boardwho receives 150% of the annual amount and an additional monthly fee ofapproximately $4,000 and the vice chairman of the Board who receives 137.5% ofthe annual amount.  

 

**Board Practices **

 

Our articlesof association provide that the number of directors serving on the board shallbe not less than three but shall not exceed thirteen. Our directors, other thanoutside directors, are elected at the annual shareholders meeting to serveuntil the next annual meeting or until their earlier death, resignation,bankruptcy, incapacity or removal by an extraordinary resolution of the generalshareholders meeting. Directors may be re-elected at each annual shareholders

 

71

----

 

meeting. Theboard may appoint additional directors (whether to fill a vacancy or create newdirectorships) to serve until the next annual shareholders meeting, provided,however, that the board shall have no obligation to fill any vacancy unless thenumber of directors is less than three. 

 

The board may,subject to the provisions of the Companies Law, appoint a committee of theboard and delegate to such committee all or any of the powers of the board asit deems appropriate. Notwithstanding the foregoing, the board may, at anytime, amend, restate or cancel the delegation of any of its powers to any ofits committees. The board has appointed an internal audit committee, asrequired under the Companies Law, that has three members, an audit committeethat currently has four members and a compensation committee that has threemembers. 

 

*Outside Directors*

 

Under theCompanies Law, companies incorporated under the laws of Israel whose shareshave been offered to the public in or outside of Israel are required to appointat least two “outside” directors. 

 

To qualify asan outside director, an individual or his or her relative, partner, employer orany entity under his or her control, may not have as of the date of appointmentas an outside director, and may not have had during the previous two years, anyaffiliation with the company, with any entity controlling the company on thedate of the appointment or with any entity that is a controlling shareholder,on the date of the appointment or during the previous two years, is the companyor an entity controlling the company. In general, the term “affiliation”includes:

 

•                  anemployment relationship; 

•                  abusiness or professional relationship maintained on a regular basis;

•                  control;and 

•                  serviceas an office holder. 

 

No person mayserve as an outside director if the person’s position or other activitiescreate, or may create, a conflict of interest with the person’sresponsibilities as an outside director or may otherwise interfere with theperson’s ability to serve as an outside director.

 

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

 

•                  the majority ofshares voted at the meeting shall include at least one-third of the shares ofnon-controlling shareholders present at the meeting and voting on the matter(without taking into account the votes of the abstaining shareholders); or 

•                  the total numberof shares of non-controlling shareholders voted against the election of theoutside directors does not exceed one percent of the aggregate voting rights inthe company.

 

72

----

 

The term of anoutside director will be three years and may be extended for an additional termof three years. Each committee of a company’s board of directors which isempowered to exercise any of the board’s powers is required to include at leastone outside director. 

 

Our outsidedirectors were elected for a second term at our Annual General Meeting held onOctober 19, 2004.  An outside director isentitled to compensation as provided in regulations adopted under the CompaniesLaw and is otherwise prohibited from receiving any other compensation, directlyor indirectly, from the company.

 

*Independent Directors*

 

Under therules of the Nasdaq Stock Market, a majority of our directors are required tobe “independent” as defined in Nasdaq’s rules. Except for Mr. Shani, all of our directors are independent.  

 

The Nasdaqrules require that director nominees be selected or recommended for the board’sselection either by a nominations committee composed solely of independentdirectors or by a majority of independent directors.  Our director nominees are selected by amajority of independent directors, and we anticipate that our board will adopta board resolution formalizing that process prior to July 31, 2005, theeffective date of this rule. 

 

*Audit Committee*

* *

The Nasdaqrules also require that the audit committee of a listed company must becomposed of at least three directors, each of whom is (i) independent; (ii)does not receive any compensation (except for board fees) from the company; (iii)is not an affiliated person of the company or any subsidiary; and (iv) has notparticipated in the preparation of the company’s (or a current subsidiary’s)financial statements during the past three years. All of the current members ofour audit committee (presently comprised of Ron Gutler (Chairman), Dan Falk,Leora Meridor, and Joseph Atsmon) meet the Nasdaq standards described above.

 

Our auditcommittee has adopted a charter specifying the committee’s purpose andoutlining its duties and responsibilities which include, among other things:(i) appointing, retaining and compensating the company’s independent auditor,subject to shareholder approval, and (ii) pre-approving all services of theindependent auditor. The audit committee must review and approve all relatedparty transactions. 

 

We believe wecurrently meet the applicable Nasdaq requirements and we intend to continue totake all actions as may be necessary for us to maintain our compliance withapplicable Nasdaq requirements.

 

*Internal Audit Committee*

 

The CompaniesLaw requires public companies to appoint an internal audit committee. The roleof the internal audit committee under the Companies Law is to examine flaws inthe

 

73

----

 

management of thecompany’s business in consultation with the internal auditors and theindependent accountants, and to propose remedial measures to the board. Theinternal audit committee also reviews interested party transactions forapproval as required by law. Under the Companies Law, an internal auditcommittee must consist of at least three directors, including all of theoutside directors. The chairman of the board of directors, any directoremployed by or otherwise providing services to the company on a regular basis,and a controlling shareholder or any relative of a controlling shareholder, maynot be a member of the internal audit committee. All of the current members ofour internal audit committee (presently comprised of Leora Meridor, Dan Falkand Joseph Dauber) meet these qualifications. 

 

*Internal Auditor*

 

Under theCompanies Law, the board of directors must appoint an internal auditor,proposed by the internal audit committee. The role of the internal auditor isto examine, among other matters, whether the company’s activities comply withthe law and orderly business procedure. Under the Companies Law, the internalauditor may be an employee of the company but may not be an interested party oroffice holder, or a relative of any interested party or office holder, and maynot be a member of the company’s independent accounting firm or itsrepresentative. We have appointed an internal auditor in accordance with therequirements of the Companies Law. 

 

*Compensation Committee*

* *

Thecompensation committee is responsible for making recommendations to the boardwith respect to all director and officer compensation issues including thegrant of stock options. The current members of our compensation committee areMessrs. Falk (Chairman), Ben Shaoul, Dauber, and Gutler. 

 

**Employees**

 

At December31, 2004, we had approximately 1072 employees worldwide, which represented anincrease of 5.7% from year-end 2003.

 

74

----

 

The followingtable sets forth the number of our full-time employees at the end of each ofthe last three fiscal years as well as the main category of activity andgeographic location of such employees:

 
| ** **                   | ** ** | **At December 31,** | ** ** |
|------------------------------|------------|---------------------|------------|
| **Category of Activity**     | ** ** | **2002**            | ** ** | **2003** | ** ** | **2004** | ** ** |
|                         |       |                |       |   |   |   |   |
| Operations                   |       | 66                  |       | 55 |   | 54 |   |
| Customer Support             |       | 266                 |       | 299 |   | 317 |   |
| Sales & Marketing        |       | 285                 |       | 270 |   | 291 |   |
| Research & Development   |       | 253                 |       | 256 |   | 279 |   |
| General & Administrative |       | 152                 |       | 134 |   | 131 |   |
| Total                        |       | 1,022               |       | 1,014 |   | 1072 |   |
|                         |       |                |       |   |   |   |   |
| **Geographic Location**      |       |                |       |   |   |   |   |
| Israel                       |       | 498                 |       | 478 |   | 532 |   |
| North America                |       | 332                 |       | 333 |   | 340 |   |
| Europe                       |       | 230                 |       | 180 |   | 160 |   |
| Asia Pacific                 |       | 16                  |       | 23 |   | 40 |   |
| Total                        |       | 1,022               |       | 1,014 |   | 1,072 |   |

 

We alsoutilize temporary employees in various activities. On average, we employedapproximately 54 such temporary employees and 128 contractor employees (notincluded in the numbers set forth above) during 2004.

 

Our futuresuccess will depend in part upon our ability to attract and retain highlyskilled and qualified personnel. Although competition for such personnel inIsrael is generally intense, we believe that adequate personnel resources arecurrently available in Israel to meet our requirements.

 

We are not aparty to any collective bargaining agreement with our employees or with anylabor organization. However, we are subject to certain labor related statutes,and to certain provisions of collective bargaining agreements between theHistadrut (General Federation of Labor in Israel) and the Coordinating Bureauof Economic Organizations (including the Industrialists’ Association of Israel)that are applicable to our Israeli employees by order of the Israeli Ministryof Labor and Welfare. These statutes and provisions principally concern thelength of the work day and the work week, minimum wages for workers,contributions to a pension fund, insurance for work-related accidents,determination of severance pay and other

 

75

----

 

conditions ofemployment. Furthermore, pursuant to such provisions, the wages of most of ouremployees are automatically adjusted based on changes in the Israeli consumerprice index, or CPI. The amount and frequency of these adjustments are modifiedfrom time to time. 

 

Israeli lawgenerally requires the payment by employers of severance pay upon the death ofan employee, his retirement or upon termination of employment by the employerwithout due cause. We currently fund our ongoing severance obligations bymaking monthly payments to approved severance funds or insurance policies.Please see Note 2(s) to our consolidated financial statements. In addition,according to the National Insurance Law, Israeli employers and employees arerequired to pay predetermined sums to the National Insurance Institute, anorganization similar to the United States Social Security Administration. Thesecontributions entitle the employees to benefits in periods of unemployment,work injury, maternity leave, disability, reserve military service andbankruptcy or winding-up of the employer. Since January 1, 1995, such amountalso includes payments for national health insurance. The payments to theNational Insurance Institute are equal to approximately 16.25% of an employee’swages (up to a certain cap as determined from time to time by law), of whichthe employee contributes approximately 66% and the employer contributesapproximately 34%. 

 

*Employment Agreements*

 

We haveemployment agreements with our officers. Pursuant to these employmentagreements, each party may terminate the employment for no cause by giving a30, 60 or 90 day prior written notice (six months in the case of certain senioremployees). In addition, we may terminate such agreement for cause with noprior notice. The agreements generally include non-compete and non-disclosureprovisions, although the enforceability of non-compete provisions under Israelilaw is very limited. 

 

**Share Ownership**

 

As of June 7,2005, our directors and executive officers beneficially owned an aggregate of805,397 ordinary shares, or approximately 4.1% of our outstanding ordinaryshares, which amount includes options to purchase 773,701 ordinary shares thatwere vested on such date or that were scheduled to vest within the following 60days. The options have an average exercise price of $35.13 per share and expirebetween 2005 and 2010.  As of June 7, 2005,our chief executive officer, Mr. Haim Shani, beneficially owned 294,952ordinary shares, or approximately 1.5% of our outstanding ordinary shares,which includes options to purchase 294,508 ordinary shares that were vested onsuch date or that were scheduled to vest within the following 60 days, and 444ordinary shares owned by him. Of the 294,508 options, 250,000 options have anexercise price of $55.5 per share and expire on October 22, 2006. The remaining44,508 options have exercises prices ranging from $10.95 per share to $23.4 pershare, and expire between May 2007 and December 2009. No other individualdirector or executive officer beneficially owns 1% or more of our outstandingordinary shares.  

 

The followingis a description of each of our option plans, including the amount of optionscurrently outstanding and the weighted average exercise price.  

 

76

----

 

*1995 Stock Option Plan*

 

In 1995, weadopted the NICE-Systems Ltd. 1995 Stock Option Plan, or 1995 Plan, to attract,motivate and retain talented employees by rewarding performance and encouragingbehavior that will improve our profitability. Under the 1995 Plan, ouremployees and officers may be granted options to acquire our ordinary shares.The options to acquire ordinary shares are granted at an exercise price of notless than the fair market value of the ordinary shares on the date of thegrant, subject to certain exceptions which may be determined by our board ofdirectors.  We have registered, throughthe filing of registration statements on Form S-8 with SEC under the SecuritiesAct of 1933, 6,000,000 ADSs for issuance under the 1995 Plan. 

** **

Under theterms of the 1995 Plan, 25% of each stock option granted becomes exercisable oneach of the first, second, third and fourth anniversaries of the date of grantso long as the grantee is, subject to certain exceptions, employed by us at thedate the stock option becomes exercisable. As of February 15, 2000, our boardof directors adopted a resolution amending the exercise terms of the 1995 Planwhereby 25% of the stock options granted become exercisable on the firstanniversary of the date of grant and 6.25% becomes exercisable once everyquarter during the subsequent three years. Stock options expire six years afterthe date of grant. Stock options are non-transferable except upon the death ofthe grantee. When applicable, the options are held by, and registered in thename of, a trustee for a period of two years after the date of grant in accordancewith Section 102 of the Israeli Income Tax Ordinance. 

** **

Pursuant to atax reform effectuated in Israeli in 2003 (the “Tax Reform”) and in order tocomply with the provisions of Section 102 of the Income Tax Ordinance [NewVersion], 5721-1961 (the “Ordinance”) following the Tax Reform, on February 11,2003 our board of directors adopted an addendum to our share option plan withrespect to options granted as of January 1, 2003 to grantees who are residentsof Israel (the “Addendum”). The Addendum does not add to nor modify our shareoption plan in respect of grantees that are not residents of Israel. OnDecember 19, 2003 the board of directors resolved to elect the “Capital GainsRoute” (as defined in Section 102(b)(2) of the Ordinance) for the grant of optionsto Israeli grantees. Generally, subject to the fulfillment of the provisions ofSection 102 of the Ordinance, under the Capital Gains Route gains realized fromthe sale of shares issued upon exercise of options shall generally be taxed ata rate of only 25% and not at the marginal income tax rate applicable to thegrantee (up to 49%). In general, according to the Addendum and pursuant to theelection of the Capital Gains Route by our board of directors, all optionsgranted to Israeli grantees, shares issued upon exercise of such options andany bonus shares issued with respect to such shares, shall be held in trust forthe benefit of the grantee and registered in the name of a trustee appointed bythe Company and approved by the Israeli tax authorities. Such options andshares will, subject to the provisions of Section 102 of the Ordinance and anyregulations, rules or orders promulgated thereunder, be held in trust for aperiod of two years from the end of the tax year in which the options aregranted and shall not be released from the trust prior to the payment of thegrantee’s tax liabilities. In the event the requirements of Section 102 for theallocation of options according to the Capital Gains Route are not met – theapplicable marginal income tax rates shall apply.

 

77

----

 

The Addendum,the trustee and the Company’s election of the “Capital Gains Route” wereapproved by the Israeli tax authorities.

 

The 1995 Planis generally administered by our board of directors, which determines thegrantees under the 1995 Plan and the number of options to be granted. As ofJune 7, 2005, options to purchase 1,641,131 ordinary shares were outstandingunder the 1995 Plan at a weighted average exercise price of $41.85.

 

*1997 Executive Share Option Plan*

 

In 1996, weadopted the NICE-Systems Ltd. 1997 Executive Share Option Plan, or 1997 Plan,to provide an incentive to our officers and to our directors who are alsoofficers by enabling them to share in the future growth of our business.  We have registered, through the filing ofregistration statements on Form S-8 with SEC under the Securities Act,2,000,000 ADSs for issuance under the 1997 Plan.

 

Under theterms of the 1997 Plan, stock options will be exercisable during a 60-dayperiod ending four years after grant. Notwithstanding the foregoing, if ouryear-end earnings per share shall reach certain defined targets, 40% of suchstock options shall become exercisable; if earnings per share shall reachcertain higher defined targets, an additional 30% of such stock options shallbecome exercisable; and if earnings per share shall reach certain higherdefined targets, an additional 30% of such stock options shall becomeexercisable, provided that with respect to all of the above-referenced periods,our operating profit shall not be less than 10% of revenues and earnings pershare shall exclude any non-recurring expenses related to mergers andacquisitions. Notwithstanding the foregoing, none of the stock options shall beexercisable before the expiration of two years from the date of issuance. Whenapplicable, the options are held by, and registered in the name of, a trusteefor a period of two years after the date of grant in accordance with Section102 of the Israeli Income Tax Ordinance. 

 

The 1997 Planis generally administered by our board of directors, which determines thegrantees under the 1997 Plan and the number of options to be granted.  As of June 7, 2005, there were no outstandingoptions to purchase ordinary shares under the 1997 Plan. All of the outstandingoptions under this plan have expired. 

 

*2001 Stock Option Plan*

 

In 2001, weadopted the NICE-Systems Ltd. 2001 Stock Option Plan, or 2001 Plan, for thepurpose of providing an incentive to certain employees, directors, officers andconsultants in order to further the advancement our business. The options toacquire our ordinary shares are granted at an exercise price equal to theclosing price of our ADSs as quoted on the Nasdaq National Market on the mostrecent date prior to the date of the resolution of our board of directors togrant the option for which the price was quoted.  We have registered, through the filing of aregistration statement on Form S-8 with SEC under the Securities Act, 4,000,000ADSs for issuance under the 2001 Plan.

 

78

----

 

Under theterms of the 2001 Plan, one-third of the stock options granted becameexercisable ten months after the date of grant and the remaining two-thirdswill become exercisable on the first and second anniversaries of the first dateof exercise so long as the grantee is, subject to certain exceptions, employedby us at the date the stock option becomes exercisable.  The third portion of the options grantedunder this plan may be exercised at the end of the second anniversary of thefirst date of exercise if we meet a pre-tax profit target of 20%, as determinedby our board of directors in its discretion. Unless otherwise determined by our board of directors as of the date ofgrant, stock options expire six years after the date of grant. Stock optionsare non-transferable except upon the death of the grantee.  When applicable, the options are held by, andregistered in the name of, a trustee for a period of two years after the dateof grant in accordance with Section 102 of the Israeli Income TaxOrdinance.  

 

The 2001 Planis generally administered by our board of directors which determines thegrantees under the 2001 Plan and the number of options to be granted.  As of June 7, 2005, options to purchase491,672 ordinary shares were outstanding under the 2001 Plan at a weightedaverage exercise price of $12.1.

 

*2003 Stock Option Plan*

 

In December2003, we adopted the NICE-Systems Ltd. 2003 Employee Stock Option Plan, or 2003Plan, to attract, motivate and retain talented employees by rewardingperformance and encouraging behavior that will improve our profitability. Underthe 2003 Plan, our employees, officers and directors may be granted options toacquire our ordinary shares. The options to acquire ordinary shares are grantedat an exercise price of not less than the fair market value of the ordinaryshares on the date of the grant, subject to certain exceptions which may bedetermined by our board of directors.  Wehave registered, through the filing of registration statements on Form S-8 withSEC under the Securities Act of 1933, 2,000,000 ADSs for issuance under the2003 Plan. 

 

Under theterms of the 2003 Plan, 25% of the stock options granted become exercisable onthe first anniversary of the date of grant and 6.25% becomes exercisable onceevery quarter during the subsequent three years. Stock options expire six yearsafter the date of grant. Stock options are non-transferable except upon thedeath of the grantee. 

 

Pursuant tothe Tax Reform and in order to comply with the provisions of Section 102 of theOrdinance, on January 5, 2004 our board of directors adopted an addendum to ourshare option plan with respect to options granted as of December 2, 2003 tograntees who are residents of Israel (the “Addendum”). The Addendum does notadd to nor modify our share option plan in respect of grantees that are notresidents of Israel. On December 19, 2003 the board of directors resolved toelect the “Capital Gains Route” (as defined in Section 102(b)(2) of theOrdinance) for the grant of options to Israeli grantees, which is describedabove under “1995 Stock Option Plan”. 

 

The 2003 Planis generally administered by our board of directors, which determines thegrantees under the 2003 Plan and the number of options to be granted. Asof  June 7, 2005,

 

79

----

 

options topurchase 2,004,375 ordinary shares were outstanding under the 2003 Plan at aweighted average exercise price of $24.84.

 

*1999 Amended and Restated Employee Stock Purchase Plan*

 

In 1999, weadopted the NICE-Systems Ltd. 1999 Employee Stock Purchase Plan, or ESPP, inorder to provide an incentive to our employees and the employees of oursubsidiaries by providing them with an opportunity to purchase our ordinaryshares through accumulated payroll deductions, and thereby enable such personsto share in the future growth of our business. We amended the ESPP in December2003. We have registered, through the filing of a registration statement onForm S-8 with SEC under the Securities Act, 2,250,000 ADSs for issuance underthe ESPP.

 

Under theterms of the ESPP, eligible employees (generally, all our employees and theemployees of our eligible subsidiaries who are not directors or controllingshareholders) may, on January 1 and July 1 of each year in which the ESPP is ineffect, elect to become participants in the ESPP for that six-month period byfiling an agreement with us arranging for payroll deductions of between 2% and10% of such employee’s compensation for the relevant period. An employee’selection to purchase ordinary shares under the ESPP is subject to his or herright to withdraw from the ESPP prior to exercise, six months after theoffering date. The election price under the ESPP is 85% of the lowest price ofour ordinary shares as quoted on the Nasdaq National Market on the commencementdate of each offering period or on the semi-annual purchase date. 

 

**Item 7****.   Major Shareholders andRelated Party Transactions.**

 

**Major Shareholders**

 

The followingtable sets forth certain information with respect to the beneficial ownershipof our ordinary shares as of June 11, 2005 with respect to each person known tous to be the beneficial owner of 5% or more of our outstanding ordinary shares.  None of our major shareholders has anydifferent voting rights than any other shareholder.

 

| ** **                                                                    | ** ** | **Shares Beneficially Owned** | ** ** |
|-------------------------------------------------------------------------------|------------|-------------------------------|------------|
| **Name and Address**                                                          | ** ** | **Number**                    | ** ** | **Percent(1)** | ** ** |
| Bank Hapoalim Funds 65 Yehuda Halevi Street  Tel Aviv 65227, Israel  (2) |       | 1,191,911                     |       | 6.3 | % |

 

----

(1)          Basedupon 18,938,992 ordinary shares issued and outstanding on June 11, 2005.

 

(2)          Based upon the information contained in a report filed with the TelAviv Stock Exchange on June 11, 2005 by Bank Hapoalim pursuant to Israeli lawwith respect to the aggregate holdings of various of its affiliated mutual

 

80

----

 

funds and providentfunds.  The method used to computeholdings under Israeli law does not necessarily bear the same result as themethod used to compute beneficial ownership under SEC rules and regulations. 

 

As of June 16,2005, we had 80 ADS holders of record in the United States, holdingapproximately 55.1% of our outstanding ordinary shares, as reported by The Bankof New York, the depositary for our ADSs. 

 

As of June 9,2005, Bank Leumi holds 875,174, or 4.6%, of our ordinary shares. Thisinformation is based upon a report provided to us by Bank Leumi pursuant toIsraeli law with respect to the aggregate holdings of various of its affiliatedmutual funds and provident funds.  As ofMarch 31, 2004, Bank Leumi reported that it held 1,271,000, or 7.3%, of ourordinary shares. The method used to compute holdings under Israeli law does notnecessarily bear the same result as the method used to compute beneficialownership under SEC rules and regulations.

 

Between April28, 2004 and June 2, 2005, Thales S.A. sold 762,025****ordinary shares. Consequently, Thales SA now holds less than5% of our ordinary shares.  Thisinformation is based upon the information contained in an amendment to Schedule13D filed with the SEC on June 3, 2005 by Thales SA.

 

To ourknowledge, we are not directly or indirectly owned or controlled by anothercorporation or by any foreign government and there are no arrangements that mightresult in a change in control of our company.

 

**RelatedParty Transactions **

 

None. 

 

*Registration Rights Agreement*

 

In November2002, we consummated an agreement to acquire certain assets and liabilities ofThales Contact Solutions (or TCS), a developer of customer-facing technologyfor public safety, financial trading and customer contact centers, based in theUnited Kingdom.  TCS was a unit of ThalesGroup, one of Europe’s premier electronics companies. In connection with theacquisition, we issued 2,187,500 ordinary shares to the Thales Group.  In November 2, 2002, we entered into aRegistration Rights Agreement with Thales SA relating to the 2,187,500 ordinaryshares issued to the Thales Group. Pursuant to the agreement, we filed under the Securities Act of 1933 aregistration statement covering the offer and sale of the ordinary shares,which was declared effective on January 9, 2004. For a discussion of the TCSacquisition, please see “Item 5, Operating and Financial Review.”  

 

81

----

 

**Interestsof Experts and Counsel**

 

Notapplicable.

 

**Item 8****.   Financial Information.**

 

**ConsolidatedStatements and Other Financial Information.**

 

See Item 18, “FinancialStatements”.

 

**Legal Proceedings**

 

We are notinvolved in any legal proceedings that we believe, individually or in theaggregate, will have a material adverse effect on our business, financialcondition or results of operation, except as noted below.

 

*Ci**pherActive Lawsuit*

* *

On October 19,2004, CipherActivefiled an action against us in the District Court of Tel Aviv. In this lawsuit, CipherActive claims that under adevelopment agreement with us, it is entitled to receive license fees inrespect of certain software that it allegedly developed for us and which hasbeen embedded in one of our products. CipherActive claims that it isentitled to license fees in an amount of $600,000, in addition to the amount of$100,000 already paid to**CipherActive by us in respect of such licensefees. In our statement of defense we claim that the software developed by CipherActive under theagreement has not been successful in the market, is no longer embedded in ourproduct and, therefore, CipherActiveis not entitled to any additional license fees. 

 

*WitnessPatent Infringement Lawsuits*

* *

On July 20,2004, STS Software System Ltd., a wholly owned subsidiary of ours, filed alawsuit against Witness Systems, Inc. in the United States District Court forSouthern District of New York claiming that Witness Systems is infringing our U.S.patent entitled “Communication Management System for Computer Network-BasedTelephones”.  The action was subsequentlytransferred to the Northern District of Georgia.  Inthis lawsuit, we claim that Witness Systems infringes our VoIP patent bymarketing and selling products that incorporate methods of detecting,monitoring and recording information – all fully protected by our patent.  We are seeking an injunction toprevent Witness Systems from making, using, or offering to sell or selling anyproduct in the United States which infringes this patent.  The case is currently in the preliminarystages of discovery.

 

On August 30,2004, Witness Systems filed a lawsuit in the United States District Court forthe Northern District of Georgia against Nice Systems, Inc., a wholly ownedsubsidiary of ours, alleging infringement of two U.S. patent numbers entitled “Methodand Apparatus for Simultaneously Monitoring Computer User Screen and TelephoneActivity from a Remote

 

82

----

 

Location.” On February 24,2005, Witness Systems filed a similar action in the Northern District ofGeorgia against Nice Systems Ltd. alleging infringement of the same twopatents.  The two actions were consolidated in March 2005.  Witness Systems is seeking unspecified damages andinjunctive relief.  We have deniedinfringing either of these patents and are vigorously defending the actions.

 

*The 2001 Securities Actions*

 

On February 8,2001, the trading price of our securities dropped, following our announcementsthat, among other things, we would be restating our revenue for fiscal year1999 and the first three quarters of 2000 and that we were revising downwardour revenue estimates for the final quarter of 2000.  Thereafter, various plaintiffs filed in theUnited States District Court for the District of New Jersey fourteen putativeclass action securities lawsuits against us and several of our present orformer officers and directors.  The firstof these actions was commenced on February 13, 2001.  All of the actions were allocated to theNewark vicinage of the District of New Jersey, and all were assigned to theHon. Joseph A. Greenaway, Jr., U.S.D.J.

 

The complaintin each action alleged that we and the individual defendants violated Section 10(b)of the Exchange Act, 15 U.S.C. § 78j(b), and Rule 10b-5 promulgatedthereunder.  The plaintiffs alsoattempted to state a “control person” claim against several of the individualdefendants under Section 20(a) of the Exchange Act, 15 U.S.C. § 78t(a).  While there were differences among thefourteen complaints, the plaintiffs essentially contended that we and theindividual defendants misrepresented to investors, either affirmatively orthrough omissions, our financial results and the value of our securities.  The plaintiffs sought damages in anunspecified amount.  The plaintiffs ineach such action sought to represent a class of investors in our securitiesthroughout a specified period, approximately from February 2000 to February2001.

 

On April 11, 2001,we and several of the individual defendants successfully moved to consolidatethe various actions under the caption “*Inre: Nice Systems Ltd. Securities Litigation*,” Master File No.01-CV-00737 (JAG), and to establish a schedule for the filing by plaintiffsof an amended consolidated complaint and our and the individual defendants’response to such complaint.  

 

By Order datedMay 21, 2001, a group of plaintiffs were appointed  “Lead Plaintiffs” pursuant to the PrivateSecurities Litigation Reform Act of 1995, 15 U.S.C. § 78u-4(a)(3)(B).  On August 20, 2001, the Lead Plaintiffs filedand served a Consolidated Amended Class Action Complaint, purporting to bringtheir securities claims on behalf of a class of persons who purchased our ADSsbetween November 3, 1999, and February 7, 2001. On October 22, 2001, we and the individual defendants moved to dismissthe consolidated complaint in its entirety, for failure to state a claim uponwhich relief could be granted, for failure to plead fraud with the requisiteparticularity, and on grounds of *forum nonconveniens* in favor of proceedings in Israel.  Briefing on that motion was completed onDecember 27, 2001.

 

Before thatmotion was decided by the Court, the parties to the litigation entered into asettlement of the claim, without any admission of liability or wrongdoing onour part, in the

 

83

----

 

amount of ten million dollars,including attorneys’ fees.  We receivedthe funds for this settlement through our directors and officers insurancepolicy.

 

Because theaction was brought as a class action, the settlement was subject to courtapproval.  By Order dated April 7, 2003,the settlement was approved by the United States District Court for theDistrict of New Jersey, over the objections of two shareholders.  On April 30, 2003, one of those shareholders,James J. Hayes, appealed from that Order to the United Stated Court of Appealsfor the Third Circuit.  Objector Hayesalso later appealed from the District Court’s subsequent refusal to reconsiderits decision approving the settlement.

 

In a singleopinion dated February 9, 2004, the Court of Appeals for the Third Circuitrejected both appeals of Objector Hayes, by affirming the decision of theDistrict Court approving the settlement and its subsequent refusal toreconsider that determination.

 

On February 23, 2004, Objector Hayes petitioned the Court of Appealsfor the Third Circuit to reconsider its February 9 decision. That Petition wasdenied by the Third Circuit on March 17, 2004. 

 

On June 7, 2004, Objector Hayes filed with the Supreme Court of theUnited States a Petition for a Writ of Certiorari, asking the Supreme Court toreview the determinations of the Court of Appeals for the Third Circuit. TheSupreme Court denied that Petition on October 4, 2004.

 

On November 29, 2004, Objector Hayes filed before the Supreme Court aPetition for Rehearing. That Petition was denied on January 10, 2005.

 

*Evesham School District Investigation*

* *

The U.S.Consumer Product Safety Commission has brought to our attention and provided usan opportunity to comment on an alleged incident of a fire allegedly involvinga NICE product used in a school building in the Evesham New Jersey SchoolDistrict. We have retained special counsel and engineering consultants and areinvestigating this matter. We believe that, based on the facts known at present, it is notexpected this matter will result in any regulatory action.

 

**Dividends**

 

Since ourinitial public offering on Nasdaq in 1996, we have not declared or paiddividends on our ordinary shares.  Weintend to retain our earnings for future growth and therefore do not anticipatepaying any cash dividends in the foreseeable future.

 

84

----

 

**Significant Changes**

 

Please see the descriptions of significant changes that occurred in2005 under the subheadings “—Dictaphone Acquisition”, “—TCS Acquisition” and “—Saleof Comint/DF Business to Elta” below under the heading “AdditionalInformation—Material Contracts”.

 

**Item 9****. **** The Offer and Listing.**

 

***Trading in the ADSs***

 

Our AmericanDepositary Shares, or ADSs, have been quoted on The Nasdaq National Marketunder the symbol “NICEV” from our initial public offering in January 1996 untilApril 7, 1999, and thereafter under the symbol “NICE.”  Prior to that time, there was no publicmarket for our ordinary shares in the United States.  Each ADS represents one ordinary share. Thefollowing table sets forth, for the periods indicated, the high and low lastreported closing prices for our ADSs.

 

| ** **         | ** ** | **ADSs** | ** ** |
|--------------------|------------|----------|------------|
| ** **         | ** ** | **High** | ** ** | **Low** | ** ** |
| **Annual**         |       |     |       |   |   |
|               |       |     |       |   |   |
| 2000               |       | $        | 99.00      |   | $ | 17.50 |   |
| 2001               |       | 27.75    |       | 8.88 |   |
| 2002               |       | 17.04    |       | 6.70 |   |
| 2003               |       | 25.35    |       | 8.34 |   |
| 2004               |       | 31.39    |       | 17.88 |   |
|               |       |     |       |   |   |
| **Quarterly 2003** |       |     |       |   |   |
|               |       |     |       |   |   |   |   |
| First Quarter      |       | $        | 11.13      |   | $ | 8.34 |   |
| Second Quarter     |       | 15.19    |       | 11.10 |   |
| Third Quarter      |       | 19.640   |       | 14.20 |   |
| Fourth Quarter     |       | 25.35    |       | 19.01 |   |
|               |       |     |       |   |   |
| **Quarterly 2004** |       |     |       |   |   |
|               |       |     |       |   |   |   |   |
| First Quarter      |       | $        | 29.88      |   | $ | 22.56 |   |
| Second Quarter     |       | 25.75    |       | 21.16 |   |
| Third Quarter      |       | 23.38    |       | 17.88 |   |
| Fourth Quarter     |       | 31.39    |       | 21.04 |   |

 

85

----

 
| ** **    | ** ** | **ADSs** | ** ** |
|---------------|------------|----------|------------|
| ** **    | ** ** | **High** | ** ** | **Low** | ** ** |
| **Monthly**   |       |     |       |   |   |
|          |       |     |       |   |   |   |   |
| December 2004 |       | $        | 31.39      |   | $ | 27.27 |   |
| January 2005  |       | 31.52    |       | 29.66 |   |
| February 2005 |       | 34.28    |       | 30.35 |   |
| March 2005    |       | 35.03    |       | 32.22 |   |
| April 2005    |       | 37.08    |       | 30.57 |   |
| May 2005      |       | 39.85    |       | 35.98 |   |

 

On June 27,2005, the last reported sale price of our ADSs was $38.1 per ADS.

 

The Bank ofNew York is the depositary for our ADSs. Its address is 101 Barclay Street, NewYork, New York 10286. 

 

***Trading in the Ordinary Shares***

 

Our ordinaryshares have been listed on the Tel-Aviv Stock Exchange, or TASE, since 1991.Our ordinary shares are not listed on any other stock exchange and have notbeen publicly traded outside Israel (other than through ADSs as noted above).The table below sets forth the high and low last reported prices of ourordinary shares (in NIS and dollars) on the TASE. The translation into dollarsis based on the daily representative rate of exchange published by the Bank ofIsrael.

 
| ** **         | ** ** | **Ordinary Shares** | ** ** |
|--------------------|------------|---------------------|------------|
| ** **         | ** ** | **High**            | ** ** | **Low** | ** ** |
| ** **         | ** ** | **NIS**             | ** ** | **$** | ** ** | **NIS** | ** ** | **$** | ** ** |
| **Annual**         |       |                |       |   |   |   |   |   |   |
|               |       |                |       |   |   |   |   |   |   |
| 2000               |       | 388.00              |       | 95.10 |   | 79.50 |   | 19.49 |   |
| 2001               |       | 97.90               |       | 23.68 |   | 39.19 |   | 9.27 |   |
| 2002               |       | 75.50               |       | 16.81 |   | 32.02 |   | 6.63 |   |
| 2003               |       | 113.30              |       | 25.04 |   | 37.96 |   | 8.01 |   |
| 2004               |       | 137.70              |       | 31.10 |   | 79.51 |   | 17.52 |   |
|               |       |                |       |   |   |   |   |   |   |
| **Quarterly 2003** |       |                |       |   |   |   |   |   |   |
| First Quarter      |       | 52.80               |       | 11.12 |   | 37.96 |   | 8.01 |   |
| Second Quarter     |       | 67.40               |       | 15.56 |   | 51.70 |   | 11.28 |   |
| Third Quarter      |       | 90.20               |       | 20.25 |   | 62.70 |   | 14.15 |   |
| Fourth Quarter     |       | 113.30              |       | 25.04 |   | 84.80 |   | 19.17 |   |

 

86

----

 
| ** **         | ** ** | **Ordinary Shares** | ** ** |
|--------------------|------------|---------------------|------------|
| ** **         | ** ** | **High**            | ** ** | **Low** | ** ** |
| ** **         | ** ** | **NIS**             | ** ** | **$** | ** ** | **NIS** | ** ** | **$** | ** ** |
|               |       |                |       |   |   |   |   |   |   |
| **Quarterly 2004** |       |                |       |   |   |   |   |   |   |
| First Quarter      |       | 137.70              |       | 31.10 |   | 100.80 |   | 22.36 |   |
| Second Quarter     |       | 117.90              |       | 25.99 |   | 97.56 |   | 21.43 |   |
| Third Quarter      |       | 107.10              |       | 23.90 |   | 79.51 |   | 17.52 |   |
| Fourth Quarter     |       | 131.90              |       | 30.40 |   | 92.79 |   | 20.74 |   |
|               |       |                |       |   |   |   |   |   |   |
| **Monthly**        |       |                |       |   |   |   |   |   |   |
| December 2004      |       | 131.90              |       | 30.40 |   | 117.40 |   | 27.03 |   |
| January 2005       |       | 139.50              |       | 31.72 |   | 130.40 |   | 29.56 |   |
| February 2005      |       | 148.40              |       | 34.01 |   | 135.00 |   | 30.85 |   |
| March 2005    |       | 151.30              |       | 34.90 |   | 142.00 |   | 32.60 |   |
| April 2005         |       | 160.30              |       | 36.56 |   | 135.40 |   | 30.96 |   |
| May 2005           |       | 172.60              |       | 39.42 |   | 155.90 |   | 35.68 |   |

 

As of June 27,2005, the last reported price of our ordinary shares on the TASE was NIS 170.60(or $37.57) per share. 

 

**Item 10****.     Additional Information.**

 

**Memorandumand Articles of Association**

 

*Organizationand Register*

* *

We are acompany limited by shares organized in the State of Israel under the IsraeliCompanies Law. We are registered with the Registrar of Companies of the Stateof Israel and have been assigned company number 52-0036872. 

 

*Objects andPurposes*

* *

Our objectsand purposes include a wide variety of business purposes, including all kindsof research, development, manufacture, distribution, service and maintenance ofproducts in all fields of technology and engineering and to engage in any otherkind of business or commercial activity. Our objects and purposes are set forthin detail in Section 2 of our memorandum of association.

 

In our annualgeneral meeting of shareholders held on December 24, 2002, we adopted amendedand restated articles of association of the Company.

 

87

----

 

*Directors*

* *

Our articlesof association provide that the number of directors serving on the board shallbe not less than three but shall not exceed thirteen. Our directors, other thanoutside directors, are elected at the annual shareholders meeting to serveuntil the next annual meeting or until their earlier death, resignation,bankruptcy, incapacity or removal by resolution of the general shareholdersmeeting. Directors may be re-elected at each annual shareholders meeting. Theboard may appoint additional directors (whether to fill a vacancy or create newdirectorship) to serve until the next annual shareholders meeting, provided,however, that the board shall have no obligation to fill any vacancy unless thenumber of directors is less than three. Our officers serve at the discretion ofthe board.

 

The board ofdirectors may meet and adjourn its meetings according to the Company’s needsbut at least once every three months.  Ameeting of the board may be called at the request of each director. The quorumrequired for a meeting of the board consists of a majority of directors. Theadoption of a resolution by the board requires approval by a simple majority ofthe directors present at a meeting in which such resolution is proposed. Inlieu of a board meeting, a resolution may be adopted if all of the directorslawfully entitled to vote thereon consent in writing.

 

Subject to theCompanies law, the board may appoint a committee of the board and delegate tosuch committee all or any of the powers of the board, as it deems appropriate.Under the Companies Law the board of directors must appoint an internal auditcommittee, comprised of at least three directors and including both of theexternal directors. The function of the internal audit committee is to reviewirregularities in the management of the Company’s business and recommendremedial measures. The committee is also required, under the Companies Law toapprove certain related party transactions. Notwithstanding the foregoing, theboard may, at any time, amend, restate or cancel the delegation of any of itspowers to any of its committees. The board has appointed an internal auditcommittee which has three members, an audit committee which currently has fourmembers and a compensation committee which has four members. 

 

88

----

 

*Fiduciary Duties of Officers*

* *

The CompaniesLaw codifies the fiduciary duties that “office holders,” including directorsand executive officers, owe to a company. An office holder’s fiduciary duties consist of a duty of care and a dutyof loyalty.  The duty of loyalty includesavoiding any conflict of interest between the office holder’s position in thecompany and his personal affairs, avoiding any competition with the company,avoiding exploiting any business opportunity of the company in order to receivepersonal advantage for himself or others, and revealing to the company anyinformation or documents relating to the company’s affairs which the officeholder has received due to his position as an office holder. 

 

*Approval of Certain Transactions*

 

Under theCompanies Law, all arrangements as to compensation of office holders who arenot directors, or controlling parties, require approval of the board ofdirectors.  Arrangements regarding thecompensation of directors also require internal audit committee and shareholderapproval.

 

The CompaniesLaw requires that an office holder of the company promptly disclose anypersonal interest that he or she may have and all related material informationknown to him or her, in connection with any existing or proposed transaction bythe company.  In addition, if thetransaction is an extraordinary transaction as defined under Israeli law, theoffice holder must also disclose any personal interest held by the officeholder’s spouse, siblings, parents, grandparents, descendants, spouse’sdescendants and the spouses of any of the foregoing.  In addition, the office holder must alsodisclose any interest held by any corporation in which the office holder is a5% or greater shareholder, director or general manager or in which he or shehas the right to appoint at least one director or the general manager. Anextraordinary transaction is defined as a transaction other than in theordinary course of business, otherwise than on market terms, or that is likelyto have a material impact on the company’s profitability, assets orliabilities.

 

In the case ofa transaction which is not an extraordinary transaction, after the officeholder complies with the above disclosure requirement, only board approval isrequired unless the articles of association of the company provide otherwise.The transaction must not be adverse to the company’s interest.  Furthermore, if the transaction is anextraordinary transaction, then, in addition to any approval stipulated by thearticles of association, it also must be approved by the company’s auditcommittee and then by the board of directors, and, under certain circumstances,by a meeting of the shareholders of the company.  An office holder who has a personal interestin an extraordinary transaction that is considered at a meeting of the board ofdirectors or the audit committee may not be present at the deliberations orvote on this matter. If a majority of the directors has a personal interest inan extraordinary transaction with the Company, shareholder approval of thetransaction is required.

 

The CompaniesLaw applies the same disclosure requirements to a controlling shareholder of apublic company, which includes a shareholder that holds 25% or more of thevoting rights if no other shareholder owns more than 50% of the voting rightsin the company. Extraordinary

 

89

----

 

transactionswith a controlling shareholder or in which a controlling shareholder has apersonal interest, and the terms of compensation of a controlling shareholderwho is an office holder, require the approval of the audit committee, the boardof directors and the shareholders of the company by simple majority, providedthat either such majority vote must include at least one-third of theshareholders who have no personal interest in the transaction and are presentat the meeting (without taking into account the votes of the abstainingshareholders), or that the total shareholdings of those who have no personalinterest in the transaction who vote against the transaction represent no morethan one percent of the voting rights in the company.

 

In addition,under the Companies Law, a private placement of securities requires approval bythe board of directors and the shareholders of the company if it will cause aperson to become a controlling shareholder or if:

 

•      the securities issued amount to twentypercent or more of the company’s outstanding voting rights before the issuance;

 

•      some or all of the consideration is otherthan cash or listed securities or the transaction is not on market terms; and

 

•      the transaction will increase the relativeholdings of a shareholder that holds five percent or more of the company’s outstandingshare capital or voting rights or that will cause any person to become, as aresult of the issuance, a holder of more than five percent of the company’soutstanding share capital or voting rights. 

 

According tothe Company’s Articles of Association certain resolutions, such as resolutionsregarding mergers, and windings up, require approval of the holders of 75% ofthe shares represented at the meeting and voting thereon. 

 

*Duties of Shareholders*

 

Under theCompanies Law, a shareholder has a duty to act in good faith towards theCompany and other shareholders and to refrain from abusing his or her power inthe company including, among other things, voting in a general meeting ofshareholders on the following matters:

 

•      any amendment to the articles ofassociation; 

•      an increase of the company’s authorizedshare capital; 

•      a merger; or 

•      approval of interested party transactionswhich require shareholder approval.

 

In addition,any controlling shareholder, any shareholder who knows that it possesses powerto determine the outcome of a shareholder vote and any shareholder who,pursuant to the provisions of a company’s articles of association, has thepower to appoint or prevent the appointment of an office holder in the company,is under a duty to act with fairness towards the company. The Companies Lawdoes not describe the substance of this duty but provides that a breach of hisduty is tantamount to a breach of fiduciary duty of an officer of the Company.

 

90

----

 

***Exemption, Insurance and Indemnification ofDirectors and Officers***

 

*Exemption of Office Holders*

* *

Under theCompanies Law, an Israeli company may not exempt an office holder fromliability for breach of his duty of loyalty, but may exempt in advance anoffice holder from liability to the company, in whole or in part, for a breachof his duty of care (except in connection with distributions), provided thearticles of association of the company allow it to do so.  Our articles ofassociation****do not allow us to do so.

 

*Office Holder Insurance*

 

Our Articlesof Association provide that, subject to the provisions of the Companies Law, wemay enter into a contract for the insurance of the liability of any of ouroffice holders with respect to:

 

•                  a breach of hisduty of care to us or to another person,

 

•                  a breach of hisfiduciary duty to us, provided that the office holder acted in good faith andhad reasonable grounds to assume that his act would not prejudice ourinterests, or

 

•                  a financialliability imposed upon him in favor of another person concerning an actperformed by him in his capacity as an office holder.

 

*Indemnification of Office Holders*

 

Our Articlesof Association provide that we may indemnify an office holder against:

 

•                  a financial liabilityimposed on him in favor of another person by any judgment, including asettlement or an arbitrator’s award approved by a court concerning an actperformed in his capacity as an office holder, and

 

•                  reasonablelitigation expenses, including attorneys’ fees, expended by the office holderor charged to him by a court, in proceedings instituted against him by or onour behalf or by another person, or in a criminal charge from which he wasacquitted, or a criminal charge in which he was convicted for a criminaloffense that does not require proof of intent, in each case relating to an actperformed in his capacity as an office holder.

 

The CompaniesLaw was recently amended to also permit indemnification of reasonablelitigation expenses, including attorneys’ fees, expended by the office holderas a result of an investigation or proceeding instituted against him by acompetent authority, provided that such investigation or proceeding concludedwithout the filing of an indictment against him and either (A) concludedwithout the imposition of any financial liability in lieu of criminalproceedings or

 

91

----

 

(B) concludedwith the imposition of a financial liability in lieu of criminal proceedingsbut relates to a criminal offense that does not require proof of criminalintent. We intend to amend or Articles of Association accordingly.

 

Our Articlesof Association also include provisions:

 

•                  authorizing usto grant an undertaking to indemnify an office holder, provided that theundertaking is limited to types of events which our board of directors deems tobe foreseeable at the time of the undertaking and limited to an amountdetermined by our board of directors to be reasonable under the circumstancesand provided that the total amount of indemnification for all persons we haveagreed to indemnify in such circumstances does not exceed, in the aggregatetwenty-five percent (25%) of our shareholders’ equity at the time of the actualindemnification; and

 

•                  authorizing usto retroactively indemnify an office holder.

 

The recentamendment to the Companies Law imposes similar conditions only on undertakingsto indemnify an office holder for financial liabilities imposed by judgmentsbut not for litigation expenses.  Such anundertaking would be permitted if it is limited to events that our board ofdirectors believes are foreseeable in light of our actual operations at thetime of providing the undertaking and to a sum or criterion that our board ofdirectors determines to be reasonable under the circumstances.  We intend to amend or Articles of Associationaccordingly.

 

We haveundertaken to indemnify our directors and officers pursuant to applicable lawand intend to amend such undertakings in accordance with the recent amendmentto the Companies Law. We have obtained directors and officers liabilityinsurance for the benefit of our office holders.  

 

*Limitations on Exemption, Insurance and Indemnification*

* *

The CompaniesLaw provides that a company may not exempt or indemnify an office holder, orenter into an insurance contract, which would provide coverage for any monetaryliability incurred as a result of any of the following:

 

•                  a breach by theoffice holder of his duty of loyalty unless, with respect to insurance coverage,the office holder acted in good faith and had a reasonable basis to believethat the act would not prejudice the company;

 

•                  a breach by theoffice holder of his duty of care if the breach was done intentionally orrecklessly;

 

•                  any act oromission done with the intent to derive an illegal personal benefit; or

 

•                  any fine leviedagainst the office holder.

 

92

----

 

*Required Approvals*

 

In addition,under the Companies Law, any exemption of, indemnification of, or procurementof insurance coverage for, our office holders must be approved by our auditcommittee and our board of directors and, if the beneficiary is a director, byour shareholders.

 

*Rights of Ordinary Shares*

* *

Our OrdinaryShares confer upon our shareholders the right to receive notices of, and toattend, shareholder meetings, the right to one vote per Ordinary Share at allshareholders’ meetings for all purposes, and to share equally, on a per sharebasis, in such dividends as may be declared by our Board of Directors; and uponliquidation or dissolution, the right to participate in the distribution of anysurplus assets of the Company legally available for distribution toshareholders after payment of all debts and other liabilities of the Company.  All Ordinary Shares rank pari passu in allrespects with each other.  Our Board ofDirectors may, from time to time, make such calls as it may think fit upon ashareholder in respect of any sum unpaid in respect of shares held by suchshareholder which is not payable at a fixed time, and each shareholder shallpay the amount of every call so made upon him (and of each installment thereofif the same is payable in installments).

 

*Meetings of Shareholders*

* *

An annualgeneral meeting of our shareholders shall be held once in every calendar yearat such time and at such place either within or without the State of Israel asmay be determined by our Board of Directors. 

 

Our Board ofDirectors may, whenever it thinks fit, convene a special general meeting atsuch time and place, within or without the State of Israel, as may bedetermined by the Board of Directors. Special general meetings may also beconvened upon requisition in accordance with the Companies Law.

 

*Mergers and Acquisitions*

 

A merger ofthe Company shall require the approval of the holders of a majority of seventyfive percent (75%) of the voting power represented at the annual or specialgeneral meeting in person or by proxy or by written ballot, as shall bepermitted, and voting thereon in accordance with the provisions of theCompanies Law. Upon the request of a creditor of either party of the proposedmerger, the court may delay or prevent the merger if it concludes that thereexists a reasonable concern that as a result of the merger, the surviving companywill be unable to satisfy the obligations of any of the parties to themerger.  In addition, a merger may not becompleted unless at least (i) 50 days have passed from the time that therequisite proposal for the merger has been filed by each party with the IsraeliRegistrar of Companies and (ii) 30 days have passed since the merger wasapproved by the shareholders of each party.

 

93

----

 

The CompaniesLaw also provides that an acquisition of shares of a public company must bemade by means of a tender offer if as a result of the acquisition the purchaserwould become a 25% or greater shareholder of the company and there is noexisting 25% or greater shareholder in the company.  An acquisition of shares of a public companymust be made by means of a tender offer if as a result of the acquisition thepurchaser would become a 45% or greater shareholder of the company and there isno existing 45% or greater shareholder in the company.  These requirements do not apply if theacquisition (i) occurs in the context of a private placement by the companythat received shareholder approval, (ii) was from a 25% shareholder of thecompany and resulted in the acquirer becoming a 25% shareholder of the companyor (iii) was from a 45% shareholder of the company and resulted in the acquirerbecoming a 45% shareholder of the company. The tender offer must be extended to all shareholders, but the offereris not required to purchase more than 5% of the company’s outstanding shares,regardless of how many shares are tendered by shareholders.  The tender offer may be consummated only if(i) at least 5% of the company’s outstanding shares will be acquired by theofferer and (ii) the number of shares tendered in the offer exceeds the numberof shares whose holders objected to the offer. 

 

If as a resultof an acquisition of shares the acquirer will hold more than 90% of a company’soutstanding shares, the acquisition must be made by means of a tender offer forall of the outstanding shares.  If as aresult of a full the tender offer the acquirer would own more than 95% of theoutstanding shares, then all the shares that the acquirer offered to purchasewill be transferred to it. The law provides for appraisal rights if anyshareholder files a request in court within three months following theconsummation of a full tender offer.  Ifas a result of a full tender offer the acquirer would own 95% or less of theoutstanding shares, then the acquirer may not acquire shares that will cause hisshareholding to exceed 90% of the outstanding shares.

 

**MaterialContracts**

 

*SettlementAgreement with Dictaphone*

 

In June 2000,Dictaphone Corporation, one of our competitors, filed a patent infringementclaim relating to certain technology embedded in some of our products.  The claim was for damages for pastinfringement and enjoinment of any continued infringement of Dictaphonepatents.  On December 11, 2003, we agreedwith Dictaphone to dismiss all claims and counterclaims in connection withDictaphone’s patent infringement claim against us. Under the terms of thesettlement we are required to pay Dictaphone $10 million, of whichapproximately $4.8 million was paid by our insurance carrier in December 2003and the balance was paid by us, except for the final installment in the amountof $333,335.  This amount is required tobe paid by us by June 30, 2005, subject to certain events which could result ina reduced payment by us. Each of the companies will grant the other aworldwide, royalty-free, perpetual license to certain of their respectivepatents including the disputed patents. The two companies further agreed toenter into enforcement proceedings with respect to both companies’ patentportfolios and to share any proceeds from these actions. 

 

94

----

 

*DictaphoneAcquisition*

 

On June 1, 2005, we consummated an agreement to acquire the assets andassume certain liabilities of Dictaphone’s Communications Recording Systems(CRSTM) business for approximately $38.5 million. Dictaphone’s CRS business is aleading provider of liability and quality management systems for firstresponders, critical facilities, contact centers and financial trading floors. 

 

Among the assets we acquired in the transaction is all of Dictaphone’srights to receive any damage award or other economic benefit with respect to aviolation of any of the rights related to the intellectual property ofDictaphone’s CRS business arising prior to the closing of the transaction.

 

*TCSAcquisition*

* *

In November2002, we consummated an agreement to acquire certain assets and liabilities ofThales Contact Solutions (or TCS), a developer of customer-facing technologyfor public safety, financial trading and customer contact centers, based in theUnited Kingdom.  TCS was a unit of ThalesGroup, one of Europe’s premier electronics companies. In connection with theacquisition, we paid an initial $29.9 million in cash and issued 2,187,500ordinary shares to Thales Group at a fair market value of $18.1 million calculatedat the date of closing.  As of June 2,2005, Thales Group holds approximately****4.6% of ouroutstanding shares. In June 2005, Mr. Timothy Robinson, one of the two Thalesexecutives who were elected to our Board of Directors in November 2002, resignedfrom our Board.  The acquisitionagreement requires one nominee of Thales to resign upon the sale of more thanhalf of the shares issued to Thales in the acquisition. 

 

In the fourthquarter of 2002, we recorded a current liability of $2.8 million and along-term liability of $13.5 million reflecting obligations under a long-termcontract we assumed in the TCS acquisition. In the second quarter of 2003 we completed negotiations to terminatethis contract as of November 2004 and to amend the terms in the interim. Underthe terms of the amended contract, the cost to the Company was $5.2 millionless than the amount provided at the acquisition date and consequently, TCSacquisition goodwill was reduced by this amount. 

 

Under theterms of the agreement, the cash portion of the purchase price was subject todownward adjustment based on the value of net assets at closing and the fullyear 2002 sales of TCS.  Based on ourcalculation of the actual value of net assets acquired and 2002 sales of TCS,we reduced the cash portion of the purchase price as of December 31, 2002by $12.8 million. This amount was presented on our balance sheet as aRelated Party Receivable as of December 31, 2002.**** Thus, the adjustedpurchase price paid, including $4.5 million of capitalized acquisition costs,was recorded as $39.7 million.  Of the$12.8 million adjustment referred to above, Thales paid us $6.6 million inMarch 2003. 

 

Thalesdisputed our calculation of the net asset value at closing and the matter wassubmitted in September 2003 to binding arbitration by an IndependentAccountant, in

 

95

----

 

accordance with the terms ofthe acquisition agreement.  TheIndependent Accountant determined a higher net asset value at closing than ourcalculation of the actual value of net assets acquired in the amount of $2.2million. This additional amount was recorded as additional goodwill in thefourth quarter of 2003. The remaining Related Party Receivable as at December31, 2003 of $4.0 million was paid in January 2004**.**

** **

Also under theterms of the agreement, contingent cash payments of up to $10 million in 2003,$7.5 million in 2004, and $7.5 million in 2005 would be due if certainfinancial performance criteria are met as part of a three-year earn-outprovision related to the sale of a particular product in 2002 through 2004. Therelevant criteria were not met and, therefore, no contingent payments will bemade under the agreement. 

 

Under theterms of the agreement, the cash portion of the purchase price was subject toadjustment mechanisms and indemnities related to the assets sold to us. OnSeptember 8, 2004, we notified Thales of claims in respect of such priceadjustment mechanisms, mainly relating to uncollected receivables and inventory.NICE and Thales signed a settlement agreement in respect of such claims onFebruary 24, 2005, according to which Thales paid us a total indemnity amountof $2.6 million.

 

*Sale ofComint/DF Business to Elta*

 

On March 31,2004, we sold the net assets of our COMINT/DF military-related business to ELTASystems Ltd (“ELTA”) for $4 million in cash. The net assets sold include theintellectual property, fixed assets, inventory, and contracts related to theCOMINT/DF product line which includes high performance spectral surveillanceand direction finding systems that detect, identify, locate, monitor and recordtransmission sources. The COMINT/DF business is therefore treated as adiscontinued operation in our financial statements.

 

In 2002, 2003and 2004, the COMINT/DF business generated revenues of approximately $7.2million, $6.5 million and $0.8 million, respectively, and net income ofapproximately $1.4 million, $1.5 million and $3.2 million (including gain ondisposition), respectively.  

 

**ExchangeControls**

 

Holders ofADSs are able to convert dividends and liquidation distributions into freelyrepatriable non-Israeli currencies at the rate of exchange prevailing at thetime of repatriation, pursuant to regulations issued under the Currency ControlLaw, 5738–1978, provided that Israeli income tax has been withheld by us withrespect to amounts that are being repatriated to the extent applicable or anexemption has been obtained.

 

Our ADSs maybe freely held and traded pursuant to the General Permit and the CurrencyControl Law. The ownership or voting of ADSs by non-residents of Israel, exceptwith respect to citizens of countries that are in a state of war with Israel,are not restricted in any way by the our memorandum of association or articlesof association or by the laws of the State of Israel.

 

96

----

 

**Taxation**

 

The followingis a discussion of Israeli and United States tax consequences material to ourshareholders.  The discussion is notintended, and should not be construed, as legal or professional tax advice anddoes not exhaust all possible tax considerations.

 

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

 

***Israeli Tax Considerations***

 

The following is a summaryof the principal tax laws applicable to companies in Israel, with specialreference to their effect on us.The followingcontains a discussion of the material Israeli tax consequences to purchasers ofour ordinary shares or ADSs.  Tothe extent that the discussion is based on new tax legislation which has notbeen subject to judicial or administrative interpretation, we cannot assure youthat the views expressed in the discussion will be accepted by the appropriatetax authorities or the courts.  Thediscussion is not intended, and should not be construed, as legal orprofessional tax advice and is not exhaustive of all possible taxconsiderations. For a discussion of certain Israeli government programsbenefiting various Israeli businesses, including us, please see “Item 5,Operating and Financial Review and Prospects.”

 

*General Corporate Tax Structure*

 

Generally,Israeli companies are subject to corporate tax on taxable income at the rate of35% for the 2004 tax year, 34% for the 2005 tax year, 32% for the 2006 tax yearand 30% for the 2007 tax year and thereafter, and are subject to capital gainstax at a rate of 25% for capital gains (other than gains deriving from the saleof listed securities) derived after January 1, 2003.  However,the effective tax rate payable by a company that derives income from anApproved Enterprise may be considerably less. See “Item 5, Operating andFinancial Review and Prospects” for adiscussion regarding our Approved Enterprise programs*.*

 

The IsraeliMinistry of Finance recently published a memorandum proposing an amendment tothe Israeli Tax Ordinance [New Version], 1961 (“Tax Ordinance”), under whichthe corporate tax rate will be gradually reduced to 25%, as follows: 31% forthe 2006 tax year; 29% for the 2007 tax year; 27% for the 2008 tax year; 26%for the 2009 tax year; and 25% for the 2010 tax year and thereafter. In orderto enact such proposal as legislation, it must be approved by the Israeliparliament and published. Because we cannot predict whether, and to whatextent, such proposal will eventually be enacted into law, we faceuncertainties as to the potential consequences of such proposal.

 

97

----

 

*Stamp Duty*

* *

The IsraeliStamp Duty on Documents Law, 1961 (the “Stamp Duty Law”), provides that anydocument (or part thereof) that is signed in Israel or that is signed outsideof Israel and refers to an asset or other thing in Israel or to an action thatis executed or will be executed in Israel, is subject to a stamp duty,generally at a rate of between 0.4% and 1% of the value of the subject matterof such document. De facto, it has been common practice in Israel not to paysuch stamp duty unless a document is filed with a governmental authority. Anamendment to the Stamp Duty Law that came into effect on June 1, 2003,determines, among other things, that stamp duty on most agreements shall bepaid by the parties that signed such agreement, jointly or severally, or by theparty that undertook under such agreement to pay the stamp duty. As a result ofthe aforementioned amendment to the Stamp Duty Law, the Israeli tax authoritieshave approached many companies in Israel and requested disclosure of allagreements signed by such companies after June 1, 2003, with the aim ofcollecting stamp duty on such agreements. The legitimacy of the aforementionedamendment to the Stamp Duty Law and of said actions by the Israeli taxauthorities are currently under review by the Israeli High Court of Justice. 

 

Based onadvice from our Israeli counsel, we believe that we may only be required to paystamp duty on documents signed on or after August 2004. However, we cannot giveany assurance that the tax authorities or the courts will accept such view. Although at this stage it is not yetpossible to evaluate the effect, if any, on us of the amendment to the StampDuty Law, the same could materially adversely affect our results of operationsin the future.

 

In January2005, an order was signed in accordance with which the said requirement to paystamp duty is cancelled with effect from January 1, 2008. Furthermore,pursuant to such order, as of January 1, 2005, stamp duty is no longerchargeable on, among others, loan agreements.

 

*Tax Benefits and Grants for Research and Development*

* *

Israeli taxlaw allows, under specified conditions, a tax deduction for expenditures,including capital expenditures, for the year in which they are incurred.  These expenses must relate to scientificresearch and development projects and must be approved by the relevant Israeligovernment ministry, determined by the field of research, and the research anddevelopment must be for the promotion of the company and carried out by or onbehalf of the company seeking such deduction. However, the amount of suchdeductible expenses shall be reduced by the sum of any funds received throughgovernment grants for the finance of such scientific research and developmentprojects.  Expenditures not so approvedare deductible over a three-year period. 

 

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

* *

Under the Lawfor the Encouragement of Industry (Taxes), 1969 (the “Industry EncouragementLaw”), Industrial Companies (as defined below) are entitled to the followingtax benefits, among others:

 

98

----

 

•                  deductions overan eight-year period for purchases of know-how and patents;

 

•                  deductions overa three-year period of expenses involved with the issuance and listing ofshares on the Tel Aviv Stock Exchange or, on or after January 1, 2003, on arecognized stock market outside of Israel;

 

•                  the right toelect, under specified conditions, to file a consolidated tax return with otherrelated Israeli Industrial Companies; and

 

•                  accelerateddepreciation rates on equipment and buildings.

 

Eligibilityfor benefits under the Industry Encouragement Law is not subject to receipt ofprior approval from any governmental authority. Under the Industry Encouragement Law, an “Industrial Company” is definedas a company resident in Israel, at least 90% of the income of which, in anytax year, determined in Israeli currency, exclusive of income from governmentloans, capital gains, interest and dividends, is derived from an “IndustrialEnterprise” owned by it.  An “IndustrialEnterprise” is defined as an enterprise whose major activity in a given taxyear is industrial production activity. Webelieve that we currently qualify as an Industrial Company within thedefinition of the Industry Encouragement Law. No assurance can be given that we will continue to qualify as anIndustrial Company or that the benefits described above will be available inthe future.

 

*Special Provisions Relating to Taxation Under Inflationary Conditions*

* *

The Income Tax Law (Inflationary Adjustments), 1985, represents anattempt to overcome the problems presented to a traditional tax system by an economy undergoing rapidinflation.  The Inflationary Adjustments Law is highly complex.  The features that are material to us can bedescribed as follows:

 

•                  When the valueof a company’s equity, as calculated under the Inflationary Adjustments Law,exceeds the depreciated cost of Fixed Assets (as defined in the Inflationary Adjustments Law), adeduction from taxable income is permitted equal to the product of the excessmultiplied by the applicable annual rate of inflation.  The maximum deduction permitted in any singletax year is 70% of taxable income, with the unused portion permitted to becarried forward, linked to the increase in the consumer price index.

 

•                  If thedepreciated cost of Fixed Assetsexceeds a company’s equity, then the product of such excess multiplied by theapplicable annual rate of inflation is added to taxable income.

 

•                  Subject tocertain limitations, depreciation deductions on Fixed Assets and losses carriedforward are adjusted for inflationbased on the increase in the consumer price index.

 

99

----

 

•                  Taxable gains oncertain listed securities (which arecurrently taxed at a reduced tax rate with respect to individuals) are taxableat the Corporate Tax rate in certain circumstances.

 

However, theMinister of Finance may, with the approval of the Knesset Finance Committee,determine by order, during a certain fiscal year (or until February 28thof the following year) in which the rate of increase of the price index wouldnot exceed or shall not have exceeded, as applicable, 3%, that all or some ofthe provisions of this Law shall not apply to such fiscal year, or, that therate of increase of the price index relating to such fiscal year shall bedeemed to be 0%, and to make the adjustments required to be made as a result ofsuch determination. 

 

The TaxOrdinance and regulations promulgated thereunder allow “Foreign-InvestedCompanies,” which maintain their accounts in U.S. dollars in compliance withthe regulations published by the Israeli Minister of Finance, to base their taxreturns on their operating results as reflected in the dollar financialsstatements or to adjust their tax returns based on exchange rate changes ratherthan changes in the Israeli consumer price index, in lieu of the principles setforth by the Inflationary Adjustments Law. For these purposes, aForeign-Invested Company is a company, more than 25% of whose share capital, interms of rights to profits, voting and appointment of directors, and of whosecombined share and loan capital is held by persons who are not residents ofIsrael. A company that elects to measure its results for tax purposes based onthe dollar exchange rate cannot change that election for a period of threeyears following the election. We believe that we qualify as a ForeignInvestment Company within the meaning of the Inflationary Adjustments Law. Forthe time being we have elected to measure our results for tax purposes based onthe U.S. dollar exchange rate.  

 

*Capital Gains Tax on Sales of Our Ordinary Shares*

* *

Israeli lawgenerally imposes a capital gains tax on the sale of any capital assets byresidents of Israel, as defined for Israeli tax purposes, and on the sale ofassets located in Israel, including shares in Israeli companies, by bothresidents and non-residents of Israel, unless a specific exemption is availableor unless a tax treaty between Israel and the shareholder’s country ofresidence provides otherwise. The law distinguishes between real gain andinflationary surplus. The inflationary surplus is a portion of the totalcapital gain, which is equivalent to the increase of the relevant asset’spurchase price, which is attributable to the increase in the Israeli consumerprice index between the date of purchase and the date of sale. The real gain isthe excess of the total capital gain over the inflationary surplus.

 

Generally,capital gains tax is imposed on Israeli resident individuals at a rate of 15%on real gains derived on or after January 1, 2003, from the sale of shares in,among others, (i) Israeli companies publicly traded on Nasdaq or on arecognized stock market in a country that has a treaty for the preventions ofdouble taxation with Israel, or (ii) companies dually traded on both the TelAviv Stock Exchange and Nasdaq or a recognized stock market outside of Israel(such as NICE). This tax rate is contingent upon the shareholders not claiminga deduction for financing

 

100

----

 

expenses in connection with such shares (in which case the gain will generally betaxed at a rate of 25%), and does not apply to: (i) the sale of shares by dealers insecurities; (ii) the sale of shares by shareholdersthat report in accordance with the IncomeTax Law (Inflationary Adjustments), 1985, referred to as the InflationaryAdjustments Law  (that will generallybe taxed at Corporate Tax rates for corporations and at marginal tax rates forindividuals); or (iii) the sale ofshares by shareholders who acquired their shares prior to an initialpublic offering (that may be subject to a different tax arrangement). The taxbasis of shares acquired prior to January 1, 2003, will be determined inaccordance with the average closing share price in the three trading dayspreceding January 1, 2003. However, a request may be made to the taxauthorities to consider the actual adjusted cost of the shares as the tax basisif it is higher than such average price.

 

According tothe aforementioned memorandum proposing an amendment of the Tax Ordinance, itis proposed to reduce the aforementioned tax rate, commencing on January 1,2006, to 20% for individuals, excluding with respect to a shareholder holdingmore than 10% of the outstanding share capital of the company who shallcontinue to be subject to a 25% tax rate. 

 

Non-Israeliresidents are generally exempt from Israeli capital gains tax on any gainsderived from the sale of shares publicly traded on the TASE provided such gainsdid not derive from a permanent establishment of such shareholders in Israel,and are exempt from Israeli capital gains tax on any gains derived from thesale of shares of Israeli companies publicly traded on a recognized stockmarket outside of Israel, provided such shareholders did not acquire theirshares prior to the issuer’s initial public offering and that the gains did notderive from a permanent establishment of such shareholders in Israel and that such shareholders are not subject tothe Inflationary Adjustment Law. However, non-Israeli corporations willnot be entitled to such exemption if an Israeli resident (i) has a controllinginterest of 25% or more in such non-Israeli corporation, or (ii) is thebeneficiary or is entitled to 25% or more of the revenues or profits of suchnon-Israeli corporation, whether directly or indirectly.

 

*Taxation of Non-Residents*

* *

Individualswho are non-residents of Israel are subject to income tax on income derived oraccrued from sources in Israel. Dividend distributions, other than bonus shares(share dividends) or stock dividends, are subject to a 25% withholding tax (15%in the case of dividends distributed from taxable income derived from anApproved Enterprise), unless a different rate is provided in a treaty betweenIsrael and the shareholder’s country of residence. The withheld tax is thefinal tax in Israel on dividends paid to non-residents. See “—U.S.-Israel TaxTreaty.”

 

Theaforementioned memorandum proposing an amendment of the Tax Ordinance, proposesto reduce the tax rate applicable to distributions of dividends to a rate of20% for individuals, excluding a shareholder holding more than 10% of theoutstanding share capital of the distributing company who shall continue to besubject to a 25% tax rate on such distributions.

 

A non-residentof Israel who has dividend income derived from or accrued in Israel, from

 

101

----

 

which tax waswithheld at source, is generally exempt from the duty to file tax returns inIsrael in respect of such income, provided such income was not derived from abusiness conducted in Israel by the taxpayer.

 

Residents ofthe United States generally will have withholding tax in Israel deducted atsource. They may be entitled to a credit or deduction for United States federalincome tax purposes in the amount of the taxes withheld, subject to detailedrules contained in United States tax legislation.

 

***U.S.-Israel Tax Treaty***

 

Pursuant tothe U.S.-Israel Tax Treaty, which became effective as of January 1, 1995, thesale, exchange or disposition of ADSs by a person who qualifies as a residentof the United States within the meaning of, and who is entitled to claim thebenefits afforded to such resident by, the U.S.-Israel Tax Treaty (“Treaty U.S.Resident”) will generally not be subject to the Israeli capital gains taxunless such Treaty U.S. Resident holds, directly or indirectly, sharesrepresenting 10% or more of our voting power during any part of the 12-monthperiod preceding such sale, exchange or disposition, subject to certainconditions, or the capital gains from such sale, exchange or disposition can beallocated to a permanent establishment of such Treaty U.S. Resident in Israel.A sale, exchange or disposition of ADSs by a Treaty U.S. Resident who holds,directly or indirectly, shares representing 10% or more of the voting power ofNICE at any time during such preceding 12-month period would be subject to suchIsraeli tax, to the extent applicable; however, under the U.S.-Israel TaxTreaty, the gain would be treated as foreign source income for United Statesforeign tax credit purposes and such Treaty U.S. Resident would be permitted toclaim a credit for such taxes against the United States income tax imposed onsuch sale, exchange or disposition, subject to the limitations under the UnitedStates federal income tax laws applicable to foreign tax credits.

 

Under theU.S.-Israel Treaty, the maximum Israeli withholding tax on dividends paid by usis 25%. Dividends of an Israeli company derived from income of an ApprovedEnterprise are subject to a 15% withholding tax under Israeli law. The U.S.-IsraelTax Treaty further provides for a 12.5% Israeli dividend withholding tax ondividends paid by an Israeli company to a United States corporation owning atleast 10% or more of such Israeli company’s issued voting power for, ingeneral, the part of the tax year whichprecedes the date of payment of the dividend and the entire preceding tax year,provided such United States corporation meets certain limitations concerningthe amount of its dividend and interest income. The lower 12.5% rate appliesonly to dividends from income not derived from an Approved Enterprise in theapplicable period and does not apply if the company has certain amounts (25%)of passive income. See “—Capital Gains and Income Taxes Applicable toNon-Israeli Shareholders.”

 

***U.S. Federal Income TaxConsiderations***

 

The followingis a summary of certain material U.S. Federal income tax consequences thatapply to U.S. Holders who hold ADSs as capital assets. This summary is based onU.S. Federal income tax laws, regulations, rulings and decisions in effect asof the date of this annual

 

102

----

 

report, all of which aresubject to change at any time, possibly with retroactive effect. This summarydoes not address all tax considerations that may be relevant with respect to aninvestment in ADSs. This summary does not account for the specificcircumstances of any particular investor such as 

 

•                  broker-dealers;

 

•                  financialinstitutions;

 

•                  certaininsurance companies;

 

•                  investors liablefor alternative minimum tax;

 

•                  tax-exemptorganizations;

 

•                  investors thatactually or constructively own 10 percent or more of our voting shares;

 

•                  investorsholding ADSs as part of a straddle or a hedging or conversion transaction; and

 

•                  investors thatare treated as partnerships or other pass through entities for U.S. federalincome tax purposes.

 

This summarydoes not address the effect of any U.S. Federal taxation other than U.S.Federal income taxation. In addition, this summary does not include any discussionof state, local or foreign taxation. 

 

You are urgedto consult your tax advisors regarding the foreign and United States Federal,state and local tax considerations of an investment in ADSs. 

 

For purposesof this summary, a U.S. Holder is: 

 

•                  an individualwho is a citizen or, for U.S. Federal income tax purposes, a resident of theUnited States;

 

•                  a corporation orother entity taxable as a corporation created or organized in or under the lawsof the United States or any political subdivision thereof;

 

•                  an estate whoseincome is subject to U.S. Federal income tax regardless of its source; or

 

•                  a trust if:

 

(a) a court within the United States is able to exercise primarysupervision over administration of the trust; and 

 

(b) one or more United States persons have the authority to control allsubstantial decisions of the trust. 

 

*Taxation ofDividends*

 

Subject to thediscussion below under “passive foreign investment companies,” the gross amountof any distributions that you receive with respect to ADSs, including theamount of any

 

103

----

 

Israeli taxes withheld fromthese distributions, will constitute dividends for U.S. Federal income taxpurposes, to the extent of our current and accumulated earnings and profits asdetermined for U.S. Federal income tax principles. You will be required toinclude this amount of dividends in gross income as ordinary income on the datesuch dividend is actually or constructively received. Distributions in excessof our earnings and profits will be treated as a non-taxable return of capitalto the extent of your tax basis in the ADSs and, to the extent in excess ofyour tax basis, will be treated as capital gain. See “—Dispositions of ADSs”below for the discussion on the taxation of capital gains. Dividends generallywill not qualify for the dividends-received deduction available tocorporations. 

 

Dividends thatwe pay in NIS, including the amount of any Israeli taxes withheld from thesedividends, will be included as income to you in a U.S. dollar amount calculatedby reference to the exchange rate in effect on the day such dividends aredistributed. If you convert dividends paid in NIS into U.S. Dollars on the daythe dividends are distributed, you generally should not be required torecognize foreign currency gain or loss with respect to such conversion. Anygain or loss resulting from a subsequent exchange of such NIS generally will betreated as U.S. source ordinary income or loss. 

 

Subject tocertain conditions and limitations, you may elect to claim a credit againstyour U.S. Federal income tax liability for Israeli tax withheld from dividendsreceived in respect of the ADSs. Dividends generally will be treated asforeign-source passive income or financial services income for United Statesforeign tax credit purposes. The rules relating to the determination of theforeign tax credit are complex, and you should consult your personal taxadvisors to determine whether and to what extent you would be entitled to thiscredit. Alternatively, you may elect to claim a U.S. tax deduction, instead ofa foreign tax credit, for such Israeli tax, but only for a year in which youelect to do so with respect to all foreign income taxes. 

 

*Dispositionsof ADSs*

 

If you sell orotherwise dispose of your ADSs, you will recognize gain or loss for U.S.Federal income tax purposes in an amount equal to the difference between theamount realized on the sale or other disposition and your adjusted tax basis inyour ADSs. Subject to the discussion below under the heading ‘‘—Passive ForeignInvestment Companies,’’ such gain or loss generally will be capital gain orloss and will be long-term capital gain or loss if you had held the ADSs formore than one year at the time of the sale or other disposition. Long-termcapital gains realized by individual U.S. Holders generally are subject to alower marginal U.S. federal income tax rate than ordinary income.  Under most circumstances, any gain that yourecognize on the sale or other disposition of ADSs will be U.S.-source forpurposes of the foreign tax credit limitation; and losses recognized will beallocated against U.S. source income. 

 

*PassiveForeign Investment Companies*

* *

For U.S.Federal income tax purposes, we will be considered a passive foreign investmentcompany, or PFIC, for any taxable year in which either 75% or more of our gross

 

104

----

 

income is passive income, or atleast 50% of the average value of all of our assets for the taxable year produceor are held for the production of passive income. For this purpose, passiveincome includes dividends, interest, royalties, rents, annuities and the excessof gain over losses from the disposition of assets which produce passiveincome. If we were determined to be a PFIC for U.S. Federal income taxpurposes, highly complex rules would apply to U.S. Holders owning ADSs.Accordingly, you are urged to consult your tax advisors regarding theapplication of such rules. 

 

If we aretreated as a PFIC for any taxable year, 

 

•                  you would berequired to allocate income recognized upon receiving certain dividends or gainrecognized upon the disposition of ADSs ratably over your holding period forsuch ADSs,

 

•                  the amountallocated to each year during which we are considered a PFIC other than theyear of the dividend payment or disposition would be subject to tax at thehighest individual or corporate tax rate, as the case may be, and an interestcharge would be imposed with respect to the resulting tax liability allocatedto each such year,

 

•                  gain recognizedupon the disposition of ADSs would be taxable as ordinary income and

 

•                  you would berequired to make an annual return on IRS Form 8621 regarding distributionsreceived with respect to ADSs and any gain realized on your ADSs.

 

One method toavoid the aforementioned treatment is to make a timely mark-to-market electionin respect of your ADSs. If you elect to mark-to-market your ADSs, you willgenerally include in income any excess of the fair market value of the ADSs atthe close of each tax year over your adjusted basis in the ADSs. If the fairmarket value of the ADSs had depreciated below your adjusted basis at the closeof the tax year, you may generally deduct the excess of the adjusted basis ofthe ADSs over its fair market value at that time. However, such deductionsgenerally would be limited to the net mark-to-market gains, if any, that youincluded in income with respect to ADSs in prior years. Income recognized anddeductions allowed under the mark-to-market provisions, as well as any gain orloss on the disposition of ADSs with respect to which the mark-to-marketelection is made, is treated as ordinary income or loss.

 

Based on ourincome, assets and activities for the year 2004, we believe that we were not aPFIC for that year, nor do we expect to become a PFIC in the foreseeablefuture.  However, there can be noassurances that we will not be treated as a PFIC for that year or any taxableyear.  If we are or become a PFIC for anytaxable year included in your holding period, we generally will remain a PFICfor all subsequent taxable years with respect to your holding of our ADSs.

 

**You are urged to consult your tax advisor regarding the possibility ofus being classified as a PFIC and the potential tax consequences arising fromthe ownership and disposition (directly or indirectly) of an interest in aPFIC.**

 

105

----

 

*BackupWithholding and Information Reporting*

* *

Payments inrespect of ADSs may be subject to information reporting to the U.S. InternalRevenue Service and to U.S. backup withholding tax. Backup withholding will notapply, however, if you furnish a correct taxpayer identification number andmake any other required certification or are otherwise exempt from backupwithholding. Generally, you will provide such certification on Form W-9(Request for Taxpayer Identification Number and Certification).****

 

**Documentson Display**

 

We are subjectto certain of the information reporting requirements of the Securities andExchange Act of 1934, as amended.  We, asa “foreign private issuer” are exempt from the rules and regulations under theSecurities Exchange Act prescribing the furnishing and content of proxystatements, and our officers, directors and principal shareholders are exemptfrom the reporting and “short-swing” profit recovery provisions contained inSection 16 of the Securities Exchange Act, with respect to their purchase andsale of our shares.  In addition, we arenot required to file reports and financial statements with the Securities andExchange Commission as frequently or as promptly as U.S. companies whosesecurities are registered under the Securities Exchange Act. However, we willfile with the Securities and Exchange Commission an annual report on Form 20-Fcontaining financial statements audited by an independent accounting firm.  We will also furnish quarterly reports onForm 6-K containing unaudited financial information after the end of each of thefirst three quarters.

 

You may readand copy any document we file with the SEC at its public reference facilitiesat, 450 Fifth Street, N.W., Washington, D.C. 20549 and at the SEC’s regionaloffices at 500 West Madison Street, Suite 1400, Chicago, IL 60661-2511.  You may also obtain copies of the documentsat prescribed rates by writing to the Public Reference Section of the SEC at450 Fifth Street, N.W., Washington, D.C. 20549. The SEC also maintains a web site that contains reports, proxy andinformation statements and other information regarding registrants that fileelectronically with the SEC.  The addressof this web site is http://www.sec.gov. Please call the SEC at 1-800-SEC-0330 for further information on theoperation of the public reference facilities. In addition, our ADSs are quoted on the Nasdaq Stock Market, so ourreports and other information can be inspected at the offices of the NationalAssociation of Securities Dealers, Inc. at 1735 K Street, N.W., Washington,D.C. 20006.

 

**Item 11****.    Quantitative andQualitative Disclosures About Market Risk.**

 

***General***

* *

Market risksrelating to our operations result primarily from weak economic conditions inthe markets in which we sell our products and changes in interest rates andexchange rates.  To manage the volatilityrelated to the latter exposure, we may enter into various derivativetransactions.  Our objective is toreduce, where it is deemed appropriate to do so, fluctuations in earnings andcash flows associated with changes in currency exchange rates.  It is our policy and practice to usederivative financial instruments only to manage exposures.  We do not use

 

106

----

 

financial instruments fortrading purposes and are not a party to any leveraged derivative.

 

***Foreign Currency Risk. ***We conduct ourbusiness primarily in U.S. dollars but also in the currencies of the UnitedKingdom, Canada, the European Union and Israel as well as othercurrencies.  Thus, we are exposed toforeign exchange movements, primarily in UK, European   and Israel currencies.  We monitor foreign currency exposure and,from time to time, may enter into various contracts to preserve the value ofsales transactions and commitments. 

 

###### ***Interest Rate Risk***. We invest in investment-grade U.S. corporatebonds and dollar deposits with FDIC-insured US banks.  At least 80% of our securities investmentsare in corporate and US government agency bonds. Since these investments carryfixed interest rates and since our policy and practice is to hold theseinvestments to maturity, interest income over the holding period is notsensitive to changes in interest rates. Up to 20% of our investment portfolio may be made in investment gradeCallable Range Accrual Notes whose principal is guaranteed.  As of December 31, 2004, 10% of our investmentportfolio was in such Notes.  The Notesare subject to interest rate, liquidity and price risks.  Since our policy is to hold these investmentsto maturity or until called, the interest income from these notes will not beeffected by changes in their market value or to liquidity risk.  However, a significant increase in prevailinginterest rates may effect whether or not interest income is received for aparticular period.  As of December 312004, 10% of our investment portfolio is invested in auction rate securities.Since our policy is to hold these auction rate securities until their interestreset date, we face potential capital loss if interest in the market risesdramatically during the holding period (up to 28 days).  

###### ** **

Other risksand uncertainties that could affect actual results and outcomes are describedin Item 3 of this Report under “Risk Factors.”

 

**Item 12****.****                       Descriptionof Securities Other than Equity Securities.**

 

NotApplicable.

 

107

----

 

**PART II**

 

**Item 13****.****                       Defaults,Dividend Arrearages and Delinquencies.**

 

None.

 

**Item 14****.****                       MaterialModifications to the Rights of Security Holders and Use of Proceeds.**

 

None.

 

**Item 15****.****                       Controlsand Procedures.**

 

An evaluation was performed under the supervision and with theparticipation NICE’s management, including its Chief Executive Officer andChief Financial Officer, of the effectiveness of the NICE’s disclosure controlsand procedures (as defined in Rules 13a-15(e) and 15d-15(e) under theSecurities and Exchange Act of 1934, as amended) as of the end of the periodcovered by this report.  Based on thatevaluation, the Chief Executive Officer and Chief Financial Officer concludedthat these disclosure controls and procedures were effective. There has been nochange in NICE’s internal control over financial reporting during the periodcovered by this report that has materially affected, or is reasonably likely tomaterially affect, the NICE’s internal control over financial reporting. 

 

**Item 16A****.****              AuditCommittee Financial Expert.**

 

Our board ofdirectors has determined that Dan Falk meets the definition of an auditcommittee financial expert, as defined in Item 401 of Regulation S-K. 

 

**Item 16B****.****              Codeof Ethics.**

 

We have adopted a Code of Ethics for executive and financial officers,that also applies to all of our employees. The Code of Ethics is publiclyavailable on our website at www.nice.com. Written copies are available uponrequest. If we make any substantive amendments to the Code of Ethics or grantany waivers from a provision of this code to our chief executive officer,principal financial officer or corporate controller, we will disclose thenature of such amendment or waiver on our website.

 

108

----

 

**Item 16C****.****              PrincipalAccountant Fees and Services.**

 

**Fees Paid to Independent Auditors**

 

Ernst & Young, hasserved as our independent auditor for the fiscal years ended December 31, 2003and 2004. Fees billed or expected to be billed by Ernst & Young forprofessional services for each of the last two fiscal years were as follows:

 

| **Services Rendered** | ** ** | **2003 Fees** | ** **  | **2004 Fees** | ** ** |
|-----------------------|------------|---------------|-------------|---------------|------------|
| Audit (1)             |       | $             | 557,000     |          | $          | 495,000 |   |
| Audit-related (2)     |       | 64,000        |        | 54,000        |       |
| Tax (3)               |       | 79,000        |        | 207,000       |       |
| Total                 | ** ** | **$**         | **700,000** | ** **    | **$**      | **756,000** | ** ** |

 

----

| (1) | Audit fees consist of  services that would normally be provided in connection with statutory and  regulatory filings or engagements, including services that generally only the  independent accountant can reasonably provide. |
|-----|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 
| (2) | Audit-related fees relate  to assurance and associated services that traditionally are performed by the  independent auditor, including: accounting consultation and consultation  concerning financial accounting, reporting standards and government  approvals. |
|-----|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 
| (3) | Tax fees relate to tax  compliance, planning, advice and transfer price study. |
|-----|--------------------------------------------------------------------------------|

 

Policies andProcedures 

 

Our AuditCommittee has adopted a policy and procedures for the pre-approval of audit andnon-audit services rendered by our independent registered public accountingfirm, Ernst & Young. The policy generally requires the Audit Committee’sapproval of the scope of the engagement of our independent auditor or on anindividual basis. The policy prohibits retention of the independent auditors toperform the prohibited non-audit functions defined in Section 201 of theSarbanes-Oxley Act of 2002 or the rules of the SEC, and also considers whetherproposed services are compatible with the independence of the public auditors.

 

**Item 16D****.****              Exemptionsfrom the Listing Standards for Audit Committees.**

 

Notapplicable.

 

**Item 16E****.****                Purchasesof Equity Securities by the Issuer and Affiliated Purchasers.**

 

In 2004, we did not purchase any of our own shares. 

 

109

----

 

**PART III**

** **

**Item 17****.****                       FinancialStatements.**

 

Not Applicable.

 

**Item 18****.****                       FinancialStatements.**

 

See pages F-1 through F-39, incorporated herein by reference.

 

**Item 19****.****                       Exhibits.**

 
| **Exhibit No.** | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                        |
|-----------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **      | ** ** | ** **                                                                                                                                                                                                                                                                                                                                             |
| 1.1             |       | Memorandum  of Association of NICE-Systems Ltd. (together with an English translation  thereof) (filed as Exhibit 3.1 to NICE-Systems Ltd.’s Registration Statement  on Form F-1 (Registration No. 333-99640) filed with the Commission on  November 21, 1995, and incorporated herein by reference).                                             |
|            |       |                                                                                                                                                                                                                                                                                                                                                   |
| 1.2             |       | Articles of  Association of NICE-Systems Ltd. approved by the Annual General Meeting of  the Company’s shareholders held on December 24, 2002 (filed as Exhibit 1.2 to  NICE-Systems Ltd.’s Annual Report on Form 20-F filed with the Commission on  June 26, 2003, and incorporated herein by reference).                                   |
|            |       |                                                                                                                                                                                                                                                                                                                                                   |
| 2.1             |       | Form of  Share Certificate (filed as Exhibit 4.1 to Amendment No. 1 to NICE-Systems  Ltd.’s Registration Statement on Form F-1 (Registration No. 333-99640) filed  with the Commission on December 29, 1995, and incorporated herein by  reference).                                                                                              |
|            |       |                                                                                                                                                                                                                                                                                                                                                   |
| 2.2             |       | Form of  Deposit Agreement including Form of ADR Certificate (filed as Exhibit A to  NICE-Systems Ltd.’s Registration Statement on Form F-6 (Registration No.  333-13518) filed with the Commission on May 17, 2001, and incorporated herein  by reference).                                                                                      |
|            |       |                                                                                                                                                                                                                                                                                                                                                   |
| 4.3             |       | Sales and  Purchase Agreement dated July 30, 2002 by and among NICE-Systems Ltd, NICE  CTI Systems UK Ltd., NICE Systems SARL, NICE Systems GmbH, NICE Systems, Inc.  and Thales SA. (filed as Exhibit 4.3 to NICE-Systems Ltd.’s Annual Report on  Form 20-F filed with the Commission on June 26, 2003, and incorporated herein  by reference). |
|            |       |                                                                                                                                                                                                                                                                                                                                                   |
| 4.4             |       | Registration  Rights Agreement between NICE-Systems Ltd. and Thales SA. (filed as Exhibit  4.4 to NICE-Systems Ltd.’s Annual Report on Form 20-F filed with the  Commission on June 26, 2003, and incorporated herein by reference).                                                                                                              |
|            |       |                                                                                                                                                                                                                                                                                                                                                   |
| 4.5             |       | Manufacturing  Outsourcing Agreement between Nice Systems Ltd. dated January 21, 2002 by and  among Nice Systems Ltd. and Flextronics Israel Ltd. (filed as Exhibit 4.5 to  NICE-Systems Ltd.’s Annual Report on Form 20-F filed with the Commission on  June 26, 2003, and incorporated herein by reference).                                    |
|            |       |                                                                                                                                                                                                                                                                                                                                                   |
| 4.6             |       | Manufacturing  Agreement dated November 5,2001 by and among Thales Contact Solutions Ltd.  and Instem Technologies Ltd. (filed as Exhibit 4.6 to NICE-Systems Ltd.’s  Annual Report on Form 20-F filed with the Commission on June 26, 2003, and  incorporated herein by reference).                                                              |

 

110

----

 
| 4.7    |   | Settlement  Agreement, dated February 24, 2005, among Thales SA, NICE Systems Ltd., NICE  CTI Systems UK Ltd., NICE Systems SARL, NICE Systems GmbH and NICE Systems,  Inc.                 |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                        |
| 4.8    |   | Asset  Purchase and Sale Agreement, dated as of April 11, 2005, between Dictaphone  Corporation and NICE Systems Inc.                                                                       |
|   |   |                                                                                                                                                                                        |
| 4.9    |   | Amendment No.  1, dated as of May 31, 2005, to the Asset Purchase and Sale Agreement, dated  as of April 11, 2005, between Dictaphone Corporation and NICE Systems Inc.                     |
|   |   |                                                                                                                                                                                        |
| 8.1    |   | List of  significant subsidiaries                                                                                                                                                           |
|   |   |                                                                                                                                                                                        |
| 10.1   |   | Consent of  Kost, Forer, Gabbay & Kasierer, a member of Ernst & Young Global.                                                                                                       |
|   |   |                                                                                                                                                                                        |
| 12.1   |   | Certification  by Haim Shani, the Chief Executive Officer of NICE Systems Ltd., pursuant to  Section 302 of the Sarbanes-Oxley Act 2002.                                                    |
|   |   |                                                                                                                                                                                        |
| 12.2   |   | Certification  by Ran Oz, the Chief Financial Officer of NICE Systems Ltd., pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002.                                                     |
|   |   |                                                                                                                                                                                        |
| 13.1   |   | Certification  by Haim Shani, the Chief Executive Officer of NICE Systems Ltd., pursuant to  18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002. |
|   |   |                                                                                                                                                                                        |
| 13.2   |   | Certification  by Ran Oz, the Chief Financial Officer of NICE Systems Ltd., pursuant to 18  U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley  Act of 2002.     |

 

111

----

 

**NICESYSTEMS LTD. AND SUBSIDIARIES**

** **

**CONSOLIDATEDFINANCIAL STATEMENTS**

** **

**AS OFDECEMBER 31, 2004**

** **

**IN U.S.DOLLARS**

** **

**INDEX**

 
| **Report  of Independent Registered Public Accounting Firm** | ** ** |
|--------------------------------------------------------------|------------|
| ** **                                                   | ** ** |
| **Consolidated Balance Sheets**                              | ** ** |
| ** **                                                   | ** ** |
| **Consolidated  Statements of Operations**                   | ** ** |
| ** **                                                   | ** ** |
| **Statements  of Changes in Shareholders’ Equity**      | ** ** |
| ** **                                                   | ** ** |
| **Consolidated  Statements of Cash Flows**                   | ** ** |
| ** **                                                   | ** ** |
| **Notes to  Consolidated Financial Statements**              | ** ** |

 

----

 

**REPORTOF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

 

**Tothe Shareholders of**

 

**NICESYSTEMS LTD.**

 

Wehave audited the accompanying consolidated balance sheets of NICE Systems Ltd.(“the Company”) and subsidiaries as of December 31, 2003 and 2004, and therelated consolidated statements of operations, changes in shareholders’ equityand cash flows for each of the three years in the period ended December 31,2004. These financial statements are the responsibility of the Company’smanagement. Our responsibility is to express an opinion on these financialstatements based on our audits.

 

We conducted our auditsin accordance with the standards of the Public Company Accounting OversightBoard (United States). Those standards require that we plan and perform theaudit to obtain reasonable assurance about whether the financial statements arefree of material misstatement. We were not engaged to perform an audit of theCompany’s internal control over financial reporting. Our audit includedconsideration of internal control over financial reporting as a basis fordesigning audit procedures that are appropriate in the circumstances, but notfor the purpose of expressing an opinion on the effectiveness of the Company’sinternal control over financial reporting. Accordingly, we express no suchopinion. An audit also includes examining, on a test basis, evidence supportingthe amounts and disclosures in the financial statements, assessing theaccounting principles used and significant estimates made by management, andevaluating the overall financial statement presentation. We believe that ouraudits provide a reasonable basis for our opinion.

 

In ouropinion, the consolidated financial statements referred to above, presentfairly, in all material respects, the consolidated financial position of theCompany and subsidiaries as of December 31, 2003 and 2004, and theconsolidated results of their operations and cash flows for each of the threeyears in the period ended December 31, 2004, in conformity with accountingprinciples generally accepted in the United States.

 

 
| Tel-Aviv, Israel | KOST FORER  GABBAY & KASIERER     |
|------------------|---------------------------------------|
| February 2, 2005 | A Member of  Ernst & Young Global |

 

F-2

----

 

**NICESYSTEMS LTD. AND SUBSIDIARIES**

 

**CONSOLIDATED BALANCE SHEETS**

**U.S.dollars in thousands**

 
| ** **                                                                                                       | ** ** | **December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                       | ** ** | **2003**              | ** ** | **2004** | ** ** |
| ASSETS                                                                                                           |       |                  |       |   |   |
|                                                                                                             |       |                  |       |   |   |
| CURRENT ASSETS:                                                                                                  |       |                  |       |   |   |
| Cash and cash  equivalents                                                                                       |       | $                     | 29,859     |   | $ | 26,579 |   |
| Short-term bank  deposits                                                                                        |       | 189                   |       | 175 |   |
| Marketable  securities                                                                                           |       | 17,187                |       | 24,348 |   |
| Trade  receivables (net of allowance for doubtful accounts of $2,284 and $2,661 in  2003 and 2004, respectively) |       | 45,973                |       | 46,407 |   |
| Other  receivables and prepaid expenses                                                                          |       | 7,366                 |       | 7,937 |   |
| Related party  receivables                                                                                       |       | 4,013                 |       | — |   |
| Inventories                                                                                                      |       | 12,634                |       | 12,615 |   |
| Assets of  discontinued operation                                                                                |       | 3,945                 |       | 652 |   |
|                                                                                                             |       |                  |       |   |   |
| Total  current assets                                                                                            |       | 121,166               |       | 118,713 |   |
|                                                                                                             |       |                  |       |   |   |
| LONG-TERM  INVESTMENTS:                                                                                          |       |                  |       |   |   |
| Long-term marketable  securities                                                                                 |       | 60,034                |       | 114,805 |   |
| Investment in  affiliates                                                                                        |       | 1,200                 |       | 1,200 |   |
| Severance pay  fund                                                                                              |       | 6,155                 |       | 7,356 |   |
| Long-term  receivables and prepaid expenses                                                                      |       | 729                   |       | 854 |   |
|                                                                                                             |       |                  |       |   |   |
| Total  long-term investments                                                                                     |       | 68,118                |       | 124,215 |   |
|                                                                                                             |       |                  |       |   |   |
| PROPERTY AND EQUIPMENT,  NET                                                                                     |       | 18,627                |       | 16,981 |   |
|                                                                                                             |       |                  |       |   |   |
| OTHER INTANGIBLE  ASSETS, NET                                                                                    |       | 16,193                |       | 12,665 |   |
|                                                                                                             |       |                  |       |   |   |
| GOODWILL                                                                                                         |       | 25,311                |       | 25,745 |   |
|                                                                                                             |       |                  |       |   |   |
| Total  assets                                                                                                    |       | $                     | 249,415    |   | $ | 298,319 |   |

 

The accompanying notesare an integral part of the consolidated financial statements.

 

F-3

----

 

**NICESYSTEMS LTD. AND SUBSIDIARIES**

 

**CONSOLIDATEDBALANCE SHEETS**

**U.S.dollars in thousands (except share data)**

 
| ** **                                                                                                                                                                           | ** ** | **December 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                           | ** ** | **2003**              | ** ** | **2004** | ** ** |
| LIABILITIES AND  SHAREHOLDERS’ EQUITY                                                                                                                                           |       |                  |       |   |   |
|                                                                                                                                                                                 |       |                  |       |   |   |
| CURRENT  LIABILITIES:                                                                                                                                                                |       |                  |       |   |   |
| Trade payables                                                                                                                                                                       |       | $                     | 15,744     |   | $ | 11,975 |   |
| Accrued expenses  and other liabilities                                                                                                                                              |       | 47,370                |       | 55,302 |   |
| Liabilities of  discontinued operation                                                                                                                                               |       | 1,878                 |       | 8 |   |
|                                                                                                                                                                                 |       |                  |       |   |   |
| Total  current liabilities                                                                                                                                                           |       | 64,992                |       | 67,285 |   |
|                                                                                                                                                                                 |       |                  |       |   |   |
| LONG-TERM LIABILITIES:                                                                                                                                                               |       |                  |       |   |   |
| Accrued  severance pay                                                                                                                                                               |       | 6,925                 |       | 8,163 |   |
| Other long-term  liabilities                                                                                                                                                         |       | 667                   |       | — |   |
|                                                                                                                                                                                 |       |                  |       |   |   |
| Total  long-term liabilities                                                                                                                                                         |       | 7,592                 |       | 8,163 |   |
|                                                                                                                                                                                 |       |                  |       |   |   |
| COMMITMENTS AND  CONTINGENT LIABILITIES                                                                                                                                              |       |                  |       |   |   |
|                                                                                                                                                                                 |       |                  |       |   |   |
| SHAREHOLDERS’  EQUITY:                                                                                                                                                          |       |                  |       |   |   |
| Share capital-                                                                                                                                                                       |       |                  |       |   |   |
| Ordinary shares  of NIS 1 par value:                                                                                                                                                 |       |                  |       |   |   |
| Authorized:  50,000,000 shares as of December 31, 2003 and 2004; Issued and  outstanding: 16,748,953 and 18,180,260 shares as of December 31, 2003  and 2004, respectively |       | 5,142                 |       | 5,464 |   |
| Additional  paid-in capital                                                                                                                                                          |       | 224,855               |       | 244,400 |   |
| Accumulated  other comprehensive income                                                                                                                                              |       | 3,888                 |       | 5,506 |   |
| Accumulated  deficit                                                                                                                                                                 |       | (57,054               | )          | (32,499 | ) |
|                                                                                                                                                                                 |       |                  |       |   |   |
| Total  shareholders’ equity                                                                                                                                                     |       | 176,831               |       | 222,871 |   |
|                                                                                                                                                                                 |       |                  |       |   |   |
| Total  liabilities and shareholders’ equity                                                                                                                                     |       | $                     | 249,415    |   | $ | 298,319 |   |

 

The accompanying notesare an integral part of the consolidated financial statements.

 

F-4

----

 

**NICESYSTEMS LTD. AND SUBSIDIARIES**

 

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

**U.S.dollars in thousands (except per share data)**

 
| ** **                                                                                                  | ** ** | **Year  ended December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                                                                  | ** ** | **2002**                          | ** ** | **2003** | ** ** | **2004** | ** ** |
| Revenues:                                                                                                   |       |                              |       |   |   |   |   |
| Products                                                                                                    |       | $                                 | 127,896    |   | $ | 168,055 |   | $ | 182,616 |   |
| Services                                                                                                    |       | 27,445                            |       | 56,203 |   | 70,027 |   |
|                                                                                                        |       |                              |       |   |   |   |   |
| Total  revenues                                                                                             |       | 155,341                           |       | 224,258 |   | 252,643 |   |
|                                                                                                        |       |                              |       |   |   |   |   |
| Cost of  revenues:                                                                                          |       |                              |       |   |   |   |   |
| Products                                                                                                    |       | 55,453                            |       | 64,231 |   | 64,432 |   |
| Services                                                                                                    |       | 26,054                            |       | 42,084 |   | 49,876 |   |
|                                                                                                        |       |                              |       |   |   |   |   |
| Total  cost of revenues                                                                                     |       | 81,507                            |       | 106,315 |   | 114,308 |   |
|                                                                                                        |       |                              |       |   |   |   |   |
| Gross profit                                                                                                |       | 73,834                            |       | 117,943 |   | 138,335 |   |
|                                                                                                        |       |                              |       |   |   |   |   |
| Operating  expenses:                                                                                        |       |                              |       |   |   |   |   |
| Research and  development, net                                                                              |       | 17,122                            |       | 22,833 |   | 24,866 |   |
| Selling and  marketing                                                                                      |       | 38,743                            |       | 53,701 |   | 62,172 |   |
| General and  administrative                                                                                 |       | 23,806                            |       | 29,840 |   | 31,269 |   |
| Goodwill  impairment                                                                                        |       | 28,260                            |       | — |   | — |   |
| Restructuring  expenses, in-process research and development write-off, settlement of  litigation and other |       | 832                               |       | 7,082 |   | — |   |
|                                                                                                        |       |                              |       |   |   |   |   |
| Total  operating expenses                                                                                   |       | 108,763                           |       | 113,456 |   | 118,307 |   |
|                                                                                                        |       |                              |       |   |   |   |   |
| Operating income  (loss)                                                                                    |       | (34,929                           | )          | 4,487 |   | 20,028 |   |
| Financial  income, net                                                                                      |       | 3,992                             |       | 2,034 |   | 3,556 |   |
| Other income  (expenses), net                                                                               |       | (4,065                            | )          | 292 |   | 54 |   |
|                                                                                                        |       |                              |       |   |   |   |   |
| Income (loss)  before taxes on income                                                                       |       | (35,002                           | )          | 6,813 |   | 23,638 |   |
| Taxes on income                                                                                             |       | 350                               |       | 1,205 |   | 2,319 |   |
|                                                                                                        |       |                              |       |   |   |   |   |
| Net income  (loss) from continuing operations                                                               |       | (35,352                           | )          | 5,608 |   | 21,319 |   |
| Net income from  discontinued operation                                                                     |       | 1,370                             |       | 1,483 |   | 3,236 |   |
|                                                                                                        |       |                              |       |   |   |   |   |
| Net income  (loss)                                                                                          |       | $                                 | (33,982    | ) | $ | 7,091 |   | $ | 24,555 |   |
|                                                                                                        |       |                              |       |   |   |   |   |
| Net earnings  (loss) per share:                                                                             |       |                              |       |   |   |   |   |
| Basic:                                                                                                      |       |                              |       |   |   |   |   |
| Continuing  operations                                                                                      |       | $                                 | (2.56      | ) | $ | 0.35 |   | $ | 1.22 |   |
| Discontinued  operation                                                                                     |       | 0.10                              |       | 0.09 |   | 0.18 |   |
|                                                                                                        |       |                              |       |   |   |   |   |
|                                                                                                        |       | $                                 | (2.46      | ) | $ | 0.44 |   | $ | 1.40 |   |
| Diluted:                                                                                                    |       |                              |       |   |   |   |   |
| Continuing  operations                                                                                      |       | $                                 | (2.56      | ) | $ | 0.33 |   | $ | 1.14 |   |
| Discontinued  operation                                                                                     |       | 0.10                              |       | 0.09 |   | 0.17 |   |
|                                                                                                        |       |                              |       |   |   |   |   |
| Net earnings  (loss)                                                                                        |       | $                                 | (2.46      | ) | $ | 0.42 |   | $ | 1.31 |   |

 

The accompanying notesare an integral part of the consolidated financial statements.

 

F-5

----

 

**NICESYSTEMS LTD. AND SUBSIDIARIES**

 

**STATEMENTS OF CHANGES INSHAREHOLDERS’ EQUITY**

**U.S. dollarsin thousands**

 
| ** **                                                           | ** ** | **Share  capital** | ** ** | **Additional  paid-in  capital** | ** ** | **Deferred  stock  compensation** | ** ** | **Accumulated  other  comprehensive  income (loss)** | ** ** | **Accumulated  deficit** | ** ** | **Total  comprehensive  income (loss)** | ** ** | **Total  shareholders’  equity** | ** ** |
|----------------------------------------------------------------------|------------|--------------------|------------|----------------------------------|------------|-----------------------------------|------------|------------------------------------------------------|------------|--------------------------|------------|-----------------------------------------|------------|---------------------------------------|------------|
|                                                                 |       |               |       |                             |       |                              |       |                                                 |       |                     |       |                                    |       |                                  |       |
| Balance as of  January 1, 2002                                  |       | $                  | 4,398      |                             | $          | 192,845                           |       | $                                                    | (24        | )                        | $          | (38                                     | )          | $                                     | (30,163    | ) |   |   | $ | 167,018 |   |
|                                                                 |       |               |       |                             |       |                              |       |                                                 |       |                     |       |                                    |       |                                  |       |
| Issuance of  shares of ESPP                                          |       | 28                 |       | 1,355                            |       | —                            |       | —                                               |       | —                   |       |                                    |       | 1,383                                 |       |
| Issuance of  shares in respect of the acquisition of CPS             |       | 11                 |       | 458                              |       | —                            |       | —                                               |       | —                   |       |                                    |       | 469                                   |       |
| Issuance of  shares in respect of the acquisition of TCS             |       | 458                |       | 17,593                           |       | —                            |       | —                                               |       | —                   |       |                                    |       | 18,051                                |       |
| Issuance of  shares in respect of the acquisition of SCI             |       | *) —          |       | 29                               |       | —                            |       | —                                               |       | —                   |       |                                    |       | 29                                    |       |
| Amortization of  deferred stock compensation                         |       | —             |       | —                           |       | 12                                |       | —                                               |       | —                   |       |                                    |       | 12                                    |       |
| Exercise of share  options                                           |       | 13                 |       | 723                              |       | —                            |       | —                                               |       | —                   |       |                                    |       | 736                                   |       |
| Comprehensive  loss:                                                 |       |               |       |                             |       |                              |       |                                                 |       |                     |       |                                    |       |                                  |       |
| Foreign currency  translation adjustments                            |       | —             |       | —                           |       | —                            |       | 793                                                  |       | —                   |       | $                                       | 793        |                                  | 793        |   |
| Unrealized gains  on derivative instruments, net                     |       | —             |       | —                           |       | —                            |       | 27                                                   |       | —                   |       | 27                                      |       | 27                                    |       |
| Net loss                                                             |       | —             |       | —                           |       | —                            |       | —                                               |       | (33,982                  | )          | (33,982                                 | )          | (33,982                               | )          |
|                                                                 |       |               |       |                             |       |                              |       |                                                 |       |                     |       |                                    |       |                                  |       |
| Total  comprehensive loss                                            |       |               |       |                             |       |                              |       |                                                 |       |                     |       | $                                       | (33,162    | )                                     |       |   |
| Balance as of  December 31, 2002                                |       | 4,908              |       | 213,003                          |       | (12                               | )          | 782                                                  |       | (64,145                  | )          |                                    |       | 154,536                               |       |
| Issuance of  shares of ESPP                                          |       | 49                 |       | 1,470                            |       | —                            |       | —                                               |       | —                   |       |                                    |       | 1,519                                 |       |
| Amortization of  deferred stock compensation                         |       | —             |       | —                           |       | 12                                |       | —                                               |       | —                   |       |                                    |       | 12                                    |       |
| Exercise of share  options                                           |       | 185                |       | 10,382                           |       | —                            |       | —                                               |       | —                   |       |                                    |       | 10,567                                |       |
| Comprehensive  income:                                               |       |               |       |                             |       |                              |       |                                                 |       |                     |       |                                    |       |                                  |       |
| Foreign currency  translation adjustments                            |       | —             |       | —                           |       | —                            |       | 3,031                                                |       | —                   |       | $                                       | 3,031      |                                  | 3,031      |   |
| Unrealized gains  on derivative instruments, net                     |       | —             |       | —                           |       | —                            |       | 75                                                   |       | —                   |       | 75                                      |       | 75                                    |       |
| Net income                                                           |       | —             |       | —                           |       | —                            |       | —                                               |       | 7,091                    |       | 7,091                                   |       | 7,091                                 |       |
|                                                                 |       |               |       |                             |       |                              |       |                                                 |       |                     |       |                                    |       |                                  |       |
| Total  comprehensive income                                          |       |               |       |                             |       |                              |       |                                                 |       |                     |       | $                                       | 10,197     |                                  |       |   |
| Balance as of  December 31, 2003                                |       | 5,142              |       | 224,855                          |       | —                            |       | 3,888                                                |       | (57,054                  | )          |                                    |       | 176,831                               |       |
| Issuance of  shares of ESPP                                          |       | 31                 |       | 2,234                            |       | —                            |       |                                                 |       |                     |       |                                    |       | 2,265                                 |       |
| Exercise of share  options                                           |       | 291                |       | 17,311                           |       | —                            |       |                                                 |       |                     |       |                                    |       | 17,602                                |       |
| Comprehensive  income:                                               |       |               |       |                             |       |                              |       |                                                 |       |                     |       |                                    |       |                                  |       |
| Foreign currency  translation adjustments                            |       | —             |       | —                           |       | —                            |       | 1,617                                                |       | —                   |       | $                                       | 1,617      |                                  | 1,617      |   |
| Unrealized gains  on derivative instruments, net                     |       | —             |       | —                           |       | —                            |       | 1                                                    |       | —                   |       | 1                                       |       | 1                                     |       |
| Net income                                                           |       | —             |       | —                           |       | —                            |       | —                                               |       | 24,555                   |       | 24,555                                  |       | 24,555                                |       |
|                                                                 |       |               |       |                             |       |                              |       |                                                 |       |                     |       |                                    |       |                                  |       |
| Total  comprehensive income                                          |       |               |       |                             |       |                              |       |                                                 |       |                     |       | $                                       | 26,173     |                                  |       |   |
| Balance as of  December 31, 2004                                |       | $                  | 5,464      |                             | $          | 244,400                           |       | $                                                    | —     |                     | $          | 5,506                                   |       | $                                     | (32,499    | ) |   |   | $ | 222,871 |   |
|                                                                 |       |               |       |                             |       |                              |       |                                                 |       |                     |       |                                    |       |                                  |       |
| Accumulated  unrealized gains on derivative instruments              |       |               |       |                             |       |                              |       | $                                                    | 65         |                     |       |                                    |       |                                  |       |   |
| Accumulated  foreign currency translation adjustments                |       |               |       |                             |       |                              |       | 5,441                                                |       |                     |       |                                    |       |                                  |       |
| Accumulated other  comprehensive income as of December 31, 2004 |       |               |       |                             |       |                              |       | $                                                    | 5,506      |                     |       |                                    |       |                                  |       |   |

 

----

*)            Represents an amount lower than $ 1.

 

The accompanying notes are an integral part of the consolidatedfinancial statements.

 

F-6

----

 

**NICESYSTEMS LTD. AND SUBSIDIARIES**

 

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**U.S.dollars in thousands**

 
| ** **                                                                                                                                                | ** ** | **Year  ended December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                                                                                                                | ** ** | **2002**                          | ** ** | **2003** | ** ** | **2004** | ** ** |
|                                                                                                                                                      |       |                              |       |   |   |   |   |
| Cash flows from  operating activities:                                                                                                                    |       |                              |       |   |   |   |   |
| Net income  (loss)                                                                                                                                        |       | $                                 | (33,982    | ) | $ | 7,091 |   | $ | 24,555 |   |
| Less: net income  from discontinued operation                                                                                                             |       | (1,370                            | )          | (1,483 | ) | (3,236 | ) |
|                                                                                                                                                      |       |                              |       |   |   |   |   |
| Net income  (loss) from continuing operations                                                                                                             |       | (35,352                           | )          | 5,608 |   | 21,319 |   |
| Adjustments  required to reconcile net income (loss) from continuing operations to net  cash provided by operating activities from continuing operations: |       |                              |       |   |   |   |   |
| Depreciation and  amortization                                                                                                                            |       | 15,248                            |       | 17,617 |   | 13,793 |   |
| In-process research  and development write-off                                                                                                            |       | 1,270                             |       | — |   | — |   |
| Stock  compensation in respect of CPS acquisition                                                                                                         |       | 469                               |       | — |   | — |   |
| Amortization of  deferred stock compensation                                                                                                              |       | 12                                |       | 12 |   | — |   |
| Accrued  severance pay, net                                                                                                                               |       | (399                              | )          | 124 |   | 37 |   |
| Goodwill  impairment                                                                                                                                      |       | 28,260                            |       | — |   | — |   |
| Impairment of  investment in affiliate                                                                                                                    |       | 229                               |       | — |   | — |   |
| Amortization of  premium (accretion of discount) and accrued interest on held-to-maturity  marketable securities                                          |       | 915                               |       | 1,459 |   | 1,205 |   |
| Decrease  (increase) in trade receivables                                                                                                                 |       | (1,523                            | )          | 3,901 |   | (585 | ) |
| Decrease  (increase) in other receivables and prepaid expenses                                                                                            |       | (1,281                            | )          | 1,208 |   | (549 | ) |
| Decrease  (increase) in inventories                                                                                                                       |       | 4,025                             |       | 1,515 |   | (122 | ) |
| Decrease  (increase) in long-term receivables and prepaid expenses                                                                                        |       | (483                              | )          | 39 |   | (105 | ) |
| Increase (decrease)  in trade payables                                                                                                                    |       | 2,895                             |       | (104 | ) | (3,761 | ) |
| Increase in  accrued expenses and other liabilities                                                                                                       |       | 2,051                             |       | 4,819 |   | 13,043 |   |
| Increase in  long-term liabilities related to legal settlement                                                                                            |       | —                            |       | 667 |   | — |   |
| Other                                                                                                                                                     |       | 315                               |       | (5 | ) | (7 | ) |
|                                                                                                                                                      |       |                              |       |   |   |   |   |
| Net cash provided  by operating activities from continuing operations                                                                                     |       | 16,651                            |       | 36,860 |   | 44,268 |   |
|                                                                                                                                                      |       |                              |       |   |   |   |   |
| Net cash  provided by operating activities from discontinued operation                                                                                    |       | 3,462                             |       | 1,316 |   | 750 |   |
|                                                                                                                                                      |       |                              |       |   |   |   |   |
| Net cash  provided by operating activities                                                                                                                |       | 20,113                            |       | 38,176 |   | 45,018 |   |
|                                                                                                                                                           |            |                                   |            |  |  |  |  |  |  |  |

 

The accompanying notesare an integral part of the consolidated financial statements.

 

F-7

----

 
| ** **                                                                       | ** ** | **Year  ended December 31,** | ** ** |
|----------------------------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                                       | ** ** | **2002**                          | ** ** | **2003** | ** ** | **2004** | ** ** |
| Cash flows from  investing activities:                                           |       |                              |       |   |   |   |   |
| Purchase of  property and equipment                                              |       | (5,322                            | )          | (5,492 | ) | (6,701 | ) |
| Proceeds from  sale of property and equipment                                    |       | 557                               |       | 747 |   | 89 |   |
| Purchase of  other intangible assets                                             |       | (610                              | )          | — |   | — |   |
| Investment in  marketable securities                                             |       | (16,936                           | )          | (72,077 | ) | (122,192 | ) |
| Proceeds from  maturity of marketable securities                                 |       | 29,492                            |       | 33,997 |   | 17,710 |   |
| Proceeds from  sale and call of held-to-maturity marketable securities           |       | 820                               |       | 8,500 |   | 41,345 |   |
| Investment in  short-term bank deposits                                          |       | (150                              | )          | (132 | ) | (129 | ) |
| Proceeds from  short-term bank deposits                                          |       | 265                               |       | 165 |   | 149 |   |
| Payment for the  acquisition of certain assets and liabilities of TCS (a)        |       | (31,480                           | )          | (316 | ) | — |   |
| Decrease in  accrued acquisition costs                                           |       | (214                              | )          | (3,008 | ) | (75 | ) |
| Payment in  respect of terminated contract from TCS acquisition                  |       | —                            |       | (6,518 | ) | (5,249 | ) |
| Decrease in  related party receivables from TCS acquisition                      |       | —                            |       | 6,635 |   | 4,013 |   |
| Capitalization  of software development costs                                    |       | (4,609                            | )          | (2,291 | ) | (1,305 | ) |
|                                                                             |       |                              |       |   |   |   |   |
| Net cash used in  investing activities from continuing operations                |       | (28,187                           | )          | (39,790 | ) | (72,345 | ) |
|                                                                             |       |                              |       |   |   |   |   |
| Net cash  provided by (used in) investing activities from discontinued operation |       | (117                              | )          | (52 | ) | 4,136 |   |
|                                                                             |       |                              |       |   |   |   |   |
| Net cash used in  investing activities                                           |       | (28,304                           | )          | (39,842 | ) | (68,209 | ) |
|                                                                             |       |                              |       |   |   |   |   |
| Cash flows from  financing activities:                                           |       |                              |       |   |   |   |   |
| Proceeds from  issuance of shares upon exercise of options and ESPP, net         |       | 2,119                             |       | 12,086 |   | 19,867 |   |
| Short-term bank  credit, net                                                     |       | 24                                |       | (24 | ) | — |   |
|                                                                             |       |                              |       |   |   |   |   |
| Net cash  provided by financing activities                                       |       | 2,143                             |       | 12,062 |   | 19,867 |   |
|                                                                             |       |                              |       |   |   |   |   |
| Effect of  exchange rate changes on cash                                         |       | 73                                |       | 182 |   | 44 |   |
|                                                                             |       |                              |       |   |   |   |   |
| Increase  (decrease) in cash and cash equivalents                                |       | (5,975                            | )          | 10,578 |   | (3,280 | ) |
| Cash and cash  equivalents at the beginning of the year                          |       | 25,256                            |       | 19,281 |   | 29,859 |   |
|                                                                             |       |                              |       |   |   |   |   |
| Cash and cash  equivalents at the end of the year                                |       | $                                 | 19,281     |   | $ | 29,859 |   | $ | 26,579 |   |
|                                                                             |       |                              |       |   |   |   |   |
| Supplemental  disclosure of cash flows activities:                               |       |                              |       |   |   |   |   |
| Cash paid during  the year for:                                                  |       |                              |       |   |   |   |   |
| Income taxes                                                                     |       | $                                 | 445        |   | $ | 564 |   | $ | 598 |   |

 

The accompanying notesare an integral part of the consolidated financial statements.

 

F-8

----

 
| ** **            | ** **                                                                      | **Year  ended December 31,** | ** ** |
|-----------------------|---------------------------------------------------------------------------------|-----------------------------------|------------|
| ** **            | ** **                                                                      | **2002**                          | ** ** | **2003** | ** ** | **2004** | ** ** |
| ** **            | ** **                                                                      | ** **                        | ** ** | ** ** | ** ** | ** ** | ** ** |
| (a)                   | Payment for the  acquisition of certain assets and liabilities of TCS:          |                              |       |   |   |   |   |   |
|                  |                                                                            |                              |       |   |   |   |   |   |
|                  | Fair value of  assets acquired and liabilities assumed at the acquisition date: |                              |       |   |   |   |   |   |
|                  |                                                                            |                              |       |   |   |   |   |   |
|                  | Working capital  (excluding cash and cash equivalents)                          |                              | $          | 8,347 |   | $ | — |   |   |   |
|                  | Related party  receivables                                                      |                              | 12,804     |   | — |   |   |   |
|                  | Property and  equipment                                                         |                              | 7,616      |   | — |   |   |   |
|                  | Other intangible  assets                                                        |                              | 9,320      |   | — |   |   |   |
|                  | In-process  research and development                                            |                              | 1,270      |   | — |   |   |   |
|                  | Other long-term  liability                                                      |                              | (13,500    | ) | — |   |   |   |
|                  | Goodwill                                                                        |                              | 26,682     |   | 416 |   |   |   |
|                  |                                                                            |                              |       |   |   |   |   |   |
|                  |                                                                            |                              | 52,539     |   | 416 |   |   |   |
|                  | Less - amount  acquired by issuance of shares                                   |                              | (18,051    | ) | — |   |   |   |
|                  | Less - accrued  acquisition costs                                               |                              | (3,008     | ) | (100 | ) |   |   |
|                  |                                                                            |                              |       |   |   |   |   |   |
|                  |                                                                            |                              | $          | 31,480 |   | $ | 316 |   |   |   |
| Non-cash  activities: |                                                                            |                              |       |   |   |   |   |
|                  |                                                                            |                              |       |   |   |   |   |   |
| (a)                   | Issuance of  additional shares related to settlement of SCI acquisition:        |                              |       |   |   |   |   |   |
|                  |                                                                            |                              |       |   |   |   |   |   |
|                  | Goodwill                                                                        |                              | $          | 29 |   |   |   |   |   |
|                  |                                                                            |                              |       |   |   |   |   |   |
|                  |                                                                            |                              |       |   |   |   |   |   |
| (b)                   | Adjustments of  goodwill in respect of TCS acquisition:                         |                              |       |   |   |   |   |   |
|                  |                                                                            |                              |       |   |   |   |   |   |
|                  | Related party  receivables                                                      |                              |       |   | $ | 2,156 |   |   |   |
|                  | Accrued expenses  and other liabilities                                         |                              |       |   | (319 | ) |   |   |
|                  | Other long-term  liability                                                      |                              |       |   | (5,162 | ) |   |   |
|                  |                                                                            |                              |       |   | $ | (3,325 | ) |   |   |
|                  |                                                                            |                              |       |   |   |   |   |   |
| (c)                   | Adjustment of  goodwill in respect of discontinued operation sale               |                              |       |   |   |   | $ | (250 | ) |
|                       |                                                                                 |                                   |            |  |  |  |  |  |  |  |  |

 

The accompanying notesare an integral part of the consolidated financial statements.

 

F-9

----

 

**NICESYSTEMS LTD. AND SUBSIDIARIES**

** **

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

**U.S. dollars in thousands**

 

**NOTE1:-          GENERAL**

** **

a.       General:

 

NICESystems Ltd. (“NICE”) and subsidiaries (collectively - “the Company”) develop,market and support integrated, scalable multimedia digital recording platforms,enhanced software applications and related professional services. Thesesolutions capture and analyze unstructured (non-transaction) data and convertit for business and security performance management applications. The Company’ssolutions capture multiple forms of interaction, including voice, fax, email,web chat, radio, and video transmissions over wire line, wireless, packettelephony, terrestrial trunk radio and data networks.

 

TheCompany’s products are based on two types of recording platforms - audio andvideo. The Company’s solutions are offered to various vertical markets in twomajor sectors: (1) the Enterprise Interaction Solutions Sector - contactcenters and trading floors and (2) the Public Safety and Security Sector -safety organizations, transportation, corporate security, gaming andcorrectional facilities and government and intelligence agencies.

 

TheCompany’s products are sold primarily through a global network of distributors,system integrators and strategic partners; a portion of product sales and mostservices are sold directly to end-users.

 

TheCompany’s markets are located primarily in North America, EMEA and the FarEast.

 

The Company depends on alimited number of contract manufacturers for producing its products. If any ofthese manufacturers become unable or unwilling to continue to manufacture orfail to meet the quality or delivery requirements needed to satisfy theCompany’s customers, it could result in the loss of sales, which couldadversely affect the Company’s results of operations and financial position.

 

The Company relies upon anumber of independent distributors to market, sell and service its products incertain markets. If the Company is unable to effectively manage and maintainrelationships with its distributors, or to enter into similar relationshipswith others, its ability to market and sell its products in these markets willbe affected. In addition, a loss of a major distributor, or any eventnegatively affecting such distributors’ financial condition, could cause amaterial adverse effect on the Company’s results of operations and financialposition.

 

As for major customerdata, see Note 16c.

 

b.       Disposal by sale of the COMINT/DFoperation:

 

In thefourth quarter of 2003, the Company reached a definitive agreement to sell theassets and liabilities of its COMINT/DF military-related business to ELTASystems Ltd. for $ 4,000 in cash. On March 31, 2004, the Companycompleted the sale of the COMINT/DF operation. The COMINT/DF business wastreated as a discontinued operation in the financial statements.

 

TheCompany’s balance sheets at December 31, 2003 and 2004 reflect the assetsand liabilities of the COMINT/DF operation, as assets and liabilities of thediscontinued operation within current assets and current liabilities.

 

F-10

----

 

Thecarrying amounts of the major classes of assets and liabilities included aspart of the discontinued operation are:

 
| ** **                              | ** ** | **December 31,** | ** ** |
|-----------------------------------------|------------|-----------------------|------------|
| ** **                              | ** ** | **2003**              | ** ** | **2004** | ** ** |
|                                    |       |                  |       |   |   |
| Trade  receivables                      |       | $                     | 2,839      |   | $ | 652 |   |
| Other  receivables and prepaid expenses |       | 207                   |       | — |   |
| Severance pay  fund                     |       | 687                   |       | — |   |
| Property and  equipment, net            |       | 212                   |       | — |   |
|                                    |       |                  |       |   |   |
| Assets of  discontinued operation       |       | $                     | 3,945      |   | $ | 652 |   |
|                                    |       |                  |       |   |   |
| Trade payables                          |       | $                     | 66         |   | $ | — |   |
| Accrued expenses  and other liabilities |       | 982                   |       | 8 |   |
| Accrued  severance pay                  |       | 830                   |       | — |   |
|                                    |       |                  |       |   |   |
| Liabilities of  discontinued operation  |       | $                     | 1,878      |   | $ | 8 |   |

 

Summarizedselected financial information of the discontinued operation is as follows:

 
| ** ** | ** ** | **Year  ended December 31,** | ** ** |
|------------|------------|-----------------------------------|------------|
| ** ** | ** ** | **2002**                          | ** ** | **2003** | ** ** | **2004** | ** ** |
|       |       |                              |       |   |   |   |   |
| Revenues   |       | $                                 | 7,164      |   | $ | 6,510 |   | $ | 816 |   |
|       |       |                              |       |   |   |   |   |
| Net income |       | $                                 | 1,370      |   | $ | 1,483 |   | $ | *) 3,236 |   |

 

----

*)Includes gain from the sale in the amount of $ 3,286.

 

c.       Acquisition of Thales Contact Solutions:

 

In November 2002,the Company acquired certain assets and assumed certain liabilities of ThalesContact Solutions (“TCS”) for an aggregate consideration of $ 52,539including the issuance of 2,187,500 American Depositary Shares (“ADSs”) of NICEvalued at $ 18,051. TCS is a developer of customer-facing technology for PublicSafety, Wholesale Trading and Call Centers, based in the United Kingdom. Theacquisition was accounted for by the purchase method and accordingly, thepurchase price has been allocated according to the estimated fair value of theassets acquired and liabilities assumed of TCS. The value of the shares issuedwas determined based on the market price of NICE’s shares on the acquisitiondate. The results of TCS’s operations have been included in the consolidatedfinancial statements since November 2, 2002 (“the closing date”).

 

With the acquisition ofTCS, the Company significantly expanded its customer base, presence in Europe,and its network of distributors and partners. Additionally, the Companybroadened its product offerings and global professional services team.

 

F-11

----

 

In thefourth quarter of 2002, the Company recorded a current liability of $ 2,800 anda long-term liability of $ 13,500 reflecting estimation of obligations under along-term contract assumed by the Company in the TCS acquisition for which nofuture benefit exists. During the second quarter of 2003, the Company signed anagreement to amend and terminate the above mentioned agreement as ofNovember 2004. The cost to the Company under the termination agreement was$ 5,162 less than the amount provided in respect of the above mentionedagreement at the acquisition date. Consequently, goodwill has been reduced by$ 5,162.

 

Underthe terms of the agreement, the initial cash portion of the purchase price wasadjusted downward in 2002 by $ 12,804 in respect of the actual net value ofassets acquired and 2002 sales of TCS. Thales disputed the net asset value atclosing and in September 2003 the parties submitted the matter to bindingarbitration by an independent accountant. In December 2003, an arbitrationaward was issued, according to which the related party receivables from Thalesshould be reduced by $ 2,156. The Company recorded the $ 2,156 as addition togoodwill in the fourth quarter of 2003. Due to the arbitration award andadditional acquisition costs incurred during 2003, the acquisition cost totaled$ 42,307 as of December 31, 2003.

 

Thefollowing table summarizes the fair values of the assets acquired andliabilities assumed:

 
| Trade  receivables                      |   | $       | 15,808 |   |
|-----------------------------------------|--------|---------|--------|--------|
| Other  receivables and prepaid expenses |   | 1,448   |   |
| Inventories                             |   | 6,776   |   |
| Property and  equipment                 |   | 7,616   |   |
| In-process  research and development    |   | 1,270   |   |
| Trademarks                              |   | 1,040   |   |
| Core technology                         |   | 1,620   |   |
| Distribution  network                   |   | 6,160   |   |
| Maintenance  contracts                  |   | 500     |   |
| Goodwill                                |   | 23,773  |   |
|                                    |   |    |   |
| Total assets  acquired                  |   | 66,011  |   |
|                                    |   |    |   |
| Trade payables                          |   | (1,747  | )      |
| Accrued expenses  and other liabilities |   | (13,619 | )      |
| Long-term  liability                    |   | (8,338  | )      |
|                                    |   |    |   |
| Total  liabilities assumed              |   | (23,704 | )      |
|                                    |   |    |   |
| Net assets  acquired                    |   | $       | 42,307 |   |

 

Otherintangible assets with definite life in the amount of $ 3,160 are amortizedusing the straight-line method at annual weighted average rate of 29%.

 

The$ 1,270 assigned to in-process research and development was written off atthe acquisition date in accordance with FASB Interpretation (“FIN”) No. 4,“Applicability of FASB Statement No. 2 to Business Combinations Accountedfor by the Purchase Method”.

 

F-12

----

 

Thefollowing represents the unaudited pro-forma condensed results of operationsfor the year ended December 31, 2002, assuming that the acquisitionoccurred on January 1, 2002. The pro-forma information is not necessarilyindicative of the results of operations, which actually would have occurred ifthe acquisition had been consummated on January 1, 2002, nor does itpurport to represent the results of operations for future periods.

 
| ** **                            | ** ** | **Year  ended  December 31,  2002** | ** ** |
|---------------------------------------|------------|------------------------------------------|------------|
| ** **                            | ** ** | ** **                               | ** ** |
| Revenues                              |       | $                                        | 206,838    |   |
|                                  |       |                                     |       |
| Net loss                              |       | $                                        | (53,821    | ) |
|                                  |       |                                     |       |
| Basic and  diluted net loss per share |       | $                                        | (3.45      | ) |

 

The condensed results ofoperations of TCS are based on the results of operations of TCS for the periodfrom January 1, 2002 to November 2, 2002 (the closing date), whichwere prepared by TCS’s management and were submitted to the Company as part ofthe acquisition.

 

d.       Acquisition of CenterPoint SolutionsInc.:

 

InApril 2000, the Company acquired all of the outstanding capital stock ofCenterPoint Solutions Inc. (“CPS”) for a total consideration of $ 12,886including the issuance of 200,000 ADSs of NICE of which 50,000 were deemedtarget shares (“the target shares”) contingent upon the achievement of certainobjectives. The acquisition was accounted for by the purchase method andaccordingly, the purchase price has been allocated according to the estimatedfair value of the assets acquired and liabilities assumed of CPS.

 

CPS isa developer of Internet-based applications for statistical monitoring, digitalrecording and automatic customer surveys for customer contact centers.

 

OnMarch 19, 2002, Mr. Chapiewski, a former shareholder of CPS, filed anaction against the Company by complaint. In this complaint, Mr. Chapiewskialleged that the Company violated Sections 604(3) and 604(4) of theColorado Securities Act, committed common law fraud and negligentmisrepresentation, and breached representations and warranties in the agreementrelating to the CPS acquisition, by misrepresenting to Mr. Chapiewski,either affirmatively or through omissions, the Company’s financial results andvalue of securities. Mr. Chapiewski also claimed that NICE Centerpointbreached severance provisions of an employment agreement with him in the amountof $ 80. Mr. Chapiewski sought damages in an unspecified amount. OnNovember 25, 2002, the Company settled the claim with Mr. Chapiewsky,without any admission of liability or wrongdoing on its part, for an amount of$ 3,000 and the release from escrow of the target shares valued at $ 469.The settlement agreement resulted in a one-time charge to other expenses of $3,469 in 2002, of which $ 300 was recovered from insurance proceeds in 2003.

 

F-13

----

 

**NOTE 2:-****                        SIGNIFICANT ACCOUNTING POLICIES**

 

Theconsolidated financial statements were prepared in accordance with UnitedStates Generally Accepted Accounting Principles (“U.S. GAAP”).

 

a.                            Useof estimates:

 

Thepreparation of financial statements in conformity with generally acceptedaccounting principles requires management to make estimates and assumptionsthat affect the amounts reported in the financial statements and accompanyingnotes. Actual results could differ from those estimates.

 

b.                           Financialstatements in United States dollars:

 

Thecurrency of the primary economic environment in which the operations of NICEand certain subsidiaries are conducted is the U.S. dollar (“dollar”); thus, thedollar is the functional currency of NICE and certain subsidiaries.

 

NICEand certain subsidiaries’ transactions and balances denominated in dollars arepresented at their original amounts. Non-dollar transactions and balances havebeen remeasured to dollars in accordance with Statement of Financial AccountingStandards (“SFAS”) No. 52, “Foreign Currency Translation”. All transactiongains and losses from remeasurement of monetary balance sheet items denominatedin non-dollar currencies are reflected in the statements of operations asfinancial income or expenses, as appropriate.

 

Forthose subsidiaries whose functional currency has been determined to be theirlocal currency, assets and liabilities are translated at year-end exchangerates and statement of operations items are translated at average exchangerates prevailing during the year. Such translation adjustments are recorded asa separate component of accumulated other comprehensive income (loss) inshareholders’ equity.

 

c.                            Principlesof consolidation:

 

Intercompanytransactions and balances have been eliminated upon consolidation.

 

d.                           Cashequivalents:

 

TheCompany considers short-term unrestricted highly liquid investments that arereadily convertible into cash, purchased with maturities of three months orless to be cash equivalents.

 

e.                            Short-termbank deposits:

 

Bankdeposits with maturities of more than three months but less than one year areincluded in short-term bank deposits. Such short-term bank deposits are statedat cost.

 

f.                              Marketablesecurities:

 

TheCompany accounts for investments in debt securities in accordance with SFASNo. 115, “Accounting for Certain Investments in Debt and EquitySecurities”.

 

F-14

----

 

Management determines theappropriate classification of its investments in debt securities at the time ofpurchase and reevaluates such determinations at each balance sheet date.

 

Debt securities areclassified as held-to-maturity when the Company has the positive intent andability to hold the securities to maturity and are stated at amortized cost.The cost of held-to-maturity securities is adjusted for amortization ofpremiums and accretion of discounts to maturity. Such amortization, accretion,decline in value judged to be other than temporary, and interest are includedin financial income or expenses, as appropriate.

 

Interest income resultingfrom investments in structured notes that are classified as held to maturity isaccounted for under the provision of EITF No. 96-12, “Recognition ofInterest Income and Balance Sheet Classification of Structured Notes”. UnderEmerging Issues Task Force (“EITF”) No. 96-12, the retrospective interestmethod is used for recognizing interest income.

 

Auction rate securitiesare classified as available-for-sale and accordingly, these securities arestated at fair value. Realized gains and losses on sales of securities, asdetermined on a specific identification basis, are included in the consolidatedstatement of operations.

 

g.                           Inventories:

 

Inventoriesare stated at the lower of cost or market value. The cost of raw materials andwork-in-progress is determined by the “average cost” method, and the cost offinished goods on the basis of costs charged by third party manufacturer.

 

Inventory provisions areprovided to cover risks arising from slow-moving items, technologicalobsolescence, excess inventories, discontinued products and for market priceslower than cost. Inventory provisions for 2002, 2003 and 2004, were $ 1,650, $2,368 and $ 2,822, respectively, and have been included in cost of revenues.

 

h.                           Investmentin affiliates:

 

Theinvestments in affiliated companies are stated at cost, since the Company doesnot have the ability to exercise significant influence over operating andfinancial policies of those investees.

 

The Company’s investmentin affiliates is reviewed for impairment whenever events or changes incircumstances indicate that the carrying amount of the investment may not berecoverable. In 2002, an impairment loss had been identified in the amount of $229.

 

i.                               Propertyand equipment, net:

 

Property and equipmentare stated at cost, net of accumulated depreciation.

 

F-15

----

 

Depreciation iscalculated using the straight-line method over the estimated useful lives ofthe assets, at the following annual rates:

 
| ** **                          | ** ** | **%**  | ** ** |
|-------------------------------------|------------|--------|------------|
|                                |       |   |       |
| Computers and  peripheral equipment |       | 33     |       |
| Office furniture  and equipment     |       | 6 - 15 |       |
| Motor vehicles                      |       | 15     |       |

 

Leaseholdimprovements are amortized by the straight-line method over the term of thelease or the estimated useful life of the improvements, whichever is shorter.

 

j.                               Otherintangible assets, net:

 

Intangibleassets are amortized over their useful lives using a method of amortizationthat reflects the pattern in which the economic benefits of the intangibleassets are consumed or otherwise used, in accordance with SFAS No. 142,“Goodwill and Other Intangible Assets”.

 

Amortizationis calculated using the straight-line method over the estimated useful lives atthe following annual rates:

 
| ** **                                      | ** ** | **Weighted  average %** | ** ** |
|-------------------------------------------------|------------|-------------------------|------------|
|                                            |       |                    |       |
| Capitalized  software development costs (see o) |       | 33                      |       |
| Core technology                                 |       | 28                      |       |
| Trademarks                                      |       | 34                      |       |
| Maintenance  contracts                          |       | 33                      |       |

 

Inaccordance with the requirement of SFAS No. 142, intangible assets deemedto have indefinite lives are no longer amortized after January 1, 2002.The distribution network is deemed to have an indefinite useful life because itis expected to generate cash flows indefinitely. In accordance with SFASNo. 142, the Company evaluates the remaining useful life each year to determinewhether events and circumstances continue to support an indefinite useful life.The Company performed annual impairment test in 2004, and did not identify anyimpairment.

 

k.                            Impairmentof long-lived assets:

 

TheCompany’s long-lived assets and certain identifiable intangibles are reviewedfor impairment in accordance with SFAS No. 144, “Accounting for theImpairment or Disposal of Long-Lived Assets” whenever events or changes incircumstances indicate that the carrying amount of an asset may not be recoverable.Recoverability of assets to be held and used is measured by a comparison of thecarrying amount of the assets to the future undiscounted cash flows expected tobe generated by the assets. If such assets are considered to be impaired, theimpairment to be recognized is measured by the amount by which the carryingamount of the assets exceeds the fair value of the assets. Assets to bedisposed of are reported at the lower of the carrying amount or fair value lesscosts to sell. In 2004, no impairment indicators have been identified.

 

F-16

----

 

l.                               Goodwill:

 

Goodwillrepresents the excess of the cost over the fair value of the net assets ofbusinesses acquired. Under SFAS No. 142, goodwill acquired in a business combinationconsummated on or after July 1, 2001, is not amortized. Goodwill arisingfrom acquisitions prior to July 1, 2001 was amortized untilDecember 31, 2001 on a straight-line basis over 10 years.

 

SFASNo. 142 requires goodwill to be tested for impairment at least annually orbetween annual tests in certain circumstances, and written down when impaired,rather than amortized as previous accounting standards required. Goodwill istested for impairment by comparing the fair value of the reporting unit withits carrying value. Fair value is determined using discounted cash flows andmarket capitalization. Significant estimates used in the fair valuemethodologies include estimates of future cash flows, future growth rates andthe weighted average cost of capital of the reporting unit. The Companyperformed annual impairment tests during the fourth quarter of 2002, 2003 and2004, and recognized impairment losses of $ 28,260, $ 0 and $ 0, respectively.

 

m.                         Revenuerecognition:

 

TheCompany generates revenues from sales of products, which include hardware andsoftware, software licensing, professional services and maintenance.

 

TheCompany sells its products indirectly through a global network of distributors,system integrators and strategic partners, all of whom are consideredend-users, and through its direct sales force.

 

Revenuesfrom product sales and software license agreements are recognized when allcriteria outlined in Statement Of Position (“SOP”) 97-2, “Software RevenueRecognition” (as amended by SOP 98-9) are met. Revenue from products andlicense fees is recognized when persuasive evidence of an agreement exists,delivery of the product has occurred, the fee is fixed or determinable, nofurther obligations exist and collectibility is probable. Sales agreements withspecific acceptance terms are not recognized until the customer has confirmedthat the product or service has been accepted.

 

Wheresoftware license arrangements involve multiple elements, revenue is allocatedto each element based on Vendor Specific Objective Evidence (“VSOE”) of therelative fair values of each element in the arrangement, in accordance with theresidual method. The Company’s VSOE used to allocate the sales price tomaintenance is based on the renewal percentage. Under the residual method,revenue is recognized for the delivered elements when (1) there is VSOE ofthe fair values of all the undelivered elements, and (2) all revenuerecognition criteria of SOP 97-2, as amended, are satisfied. Under the residualmethod any discount in the arrangement is allocated to the delivered element.

 

TheCompany maintains a provision for product returns in accordance with SFASNo. 48, “Revenue Recognition When Right of Return Exists”. The provisionis estimated based on the Company’s past experience and is deducted fromrevenues. Trade receivables as of December 31, 2003 and 2004, arepresented net of provision for product returns in the amounts of $ 2,079 and $1,617, respectively.

 

F-17

----

 

Revenuesfrom maintenance and professional services are recognized ratably over thecontractual period or as services are performed.

 

Deferredrevenue includes advances and payments received from customers, for whichrevenue has not yet been recognized.

 

n.                           Warrantycosts:

 

Provisionsfor warranty costs are made at the time revenues are recognized, for estimatedcosts during the warranty period based on the Company’s experience. Provisionfor warranty as of December 31, 2003 and 2004, amounted to $ 446 and $498, respectively. A tabular reconciliation of the changes in the Company’saggregate product warranty liability was not provided due to immateriality.

 

o.                           Researchand development costs:

 

Researchand development costs (net of grants and participations) incurred in theprocess of software production before establishment of technologicalfeasibility, are charged to expenses as incurred. Costs of the production of aproduct master incurred subsequent to the establishment of technologicalfeasibility are capitalized according to the principles set forth in SFASNo. 86, “Accounting for the Costs of Computer Software to be Sold, Leasedor Otherwise Marketed”. Based on the Company’s product development process,technological feasibility is established upon completion of a detailed programdesign or a working model.

 

Costsincurred by the Company between completion of the detailed program design orworking model and the point at which the product is ready for general releasehave been capitalized.

 

Capitalizedsoftware development costs are amortized commencing with general productrelease by the straight-line method over the estimated useful life of thesoftware product.

 

p.                           Incometaxes:

 

TheCompany accounts for income taxes in accordance with SFAS No. 109, “Accountingfor Income Taxes”. This statement prescribes the use of the liability methodwhereby deferred tax asset and liability account balances are determined basedon differences between financial reporting and tax bases of assets andliabilities and are measured using the enacted tax rates and laws that will bein effect when the differences are expected to reverse. The Company provides avaluation allowance, if necessary, to reduce deferred tax assets to theirestimated realizable value.

 

q.                           Governmentgrants:

 

Non-royaltybearing grants from the Government of Israel for funding research anddevelopment projects are recognized at the time the Company is entitled to suchgrants on the basis of the related costs incurred and recorded as a deductionfrom research and development costs.

 

F-18

----

 

r.                              Concentrationsof credit risk:

 

Financialinstruments that potentially subject the Company to concentrations of creditrisk consist principally of cash and cash equivalents, short-term bankdeposits, trade receivables and marketable securities.

 

TheCompany’s cash and cash equivalents and short-term bank deposits are investedin deposits mainly in dollars with major international banks. Such deposits inthe United States may be in excess of insured limits and are not insured inother jurisdictions. Management believes that the financial institutions thathold the Company’s investments are financially sound and, accordingly, minimalcredit risk exists with respect to these investments.

 

TheCompany’s trade receivables are derived from sales to customers locatedprimarily in North America, EMEA and the Far East. The Company performs ongoingcredit evaluations of its customers and obtains letter of credit and bankguarantees for certain receivables. Additionally, the Company insures certainof its receivables with a credit insurance company. An allowance for doubtfulaccounts is provided with respect to specific debts that the Company hasdetermined to be doubtful of collection and a general provision on theremaining balance, based on the length of time the receivables are past due.

 

TheCompany’s marketable securities include investment in U.S. corporatedebentures, U.S government debentures, structured notes and auction rate securities.Management believes that the portfolio is well diversified, and accordingly,minimal credit risk exists with respect to those marketable securities.

 

TheCompany entered into forward contracts and option strategies (together:“derivative instruments”) intended to protect against the increase in value offorecasted non-dollar currency cash flows and the increase/decrease in fairvalue of non-dollar liabilities/assets. The derivative instruments effectivelyhedge the Company’s non-dollar currency exposure (see Note 10).

 

s.                            Severancepay:

 

TheCompany’s liability for severance pay for its Israeli employees is calculatedpursuant to Israeli severance pay law based on the most recent monthly salaryof the employees multiplied by the number of years of employment as of thebalance sheet date. Employees are entitled to one month’s salary for each yearof employment, or a portion thereof. The Company’s liability is fully providedby monthly deposits with insurance policies and severance pay funds and by anaccrual.

 

The deposited fundsinclude profits accumulated up to the balance sheet date. The deposited fundsmay be withdrawn only upon the fulfillment of the obligation pursuant toIsraeli severance pay law or labor agreements. The value of the deposited fundsis based on the cash surrender value of these policies and includes immaterialprofits.

 

Severancepay expense for 2002, 2003 and 2004, was $ 1,869, $ 2,745 and $ 2,956,respectively.

 

F-19

----

 

t.                              Basicand diluted net earnings (loss) per share:

 

Basicnet earnings (loss) per share are computed based on the weighted average numberof Ordinary shares outstanding during each year. Diluted net earnings (loss)per share are computed based on the weighted average number of Ordinary sharesoutstanding during each year plus dilutive potential equivalent Ordinary sharesconsidered outstanding during the year, in accordance with SFAS No. 128,“Earnings Per Share”.

 

Theweighted average number of shares related to outstanding antidilutive optionsexcluded from the calculations of diluted net earnings (loss) per share was5,315,170, 1,935,692 and 1,094,775 for the years ended December 31, 2002,2003 and 2004, respectively.

 

u.                           Stock-basedcompensation:

 

TheCompany has elected to follow APB No. 25, “Accounting for Stock Issued toEmployees” and FIN No. 44, “Accounting for Certain Transactions InvolvingStock Compensation” in accounting for its employee stock option plan. Under APBNo. 25, when the exercise price of the Company’s options is less than themarket value of the underlying shares on the date of grant, compensationexpense is recognized and amortized ratably over the vesting period of theoptions.

 

TheCompany adopted the disclosure provisions of SFAS No. 148, “Accounting forStock-Based Compensation - Transition and Disclosure”, which amended certainprovisions of SFAS No. 123. The Company continues to apply the provisionsof APB No. 25, in accounting for stock-based compensation.

 

Proforma information regarding net income (loss) and net earnings (loss) per shareis required by SFAS No. 123, “Accounting for Stock-Based Compensation”,and has been determined as if the Company had accounted for its employeeoptions under the fair value method prescribed by that statement. The fairvalue for these options was estimated at the date of grant using theBlack-Scholes option pricing model with the following assumptions:

 
| ** **                    | ** ** | **Year  ended December 31,** | ** ** |
|-------------------------------|------------|-----------------------------------|------------|
| ** **                    | ** ** | **2002**                          | ** ** | **2003** | ** ** | **2004** | ** ** |
|                          |       |                              |       |   |   |   |   |
| Risk free  interest rate      |       | 1.7                               | %          | 1.8 | % | 2.7 | % |
| Dividend yield                |       | 0                                 | %          | 0 | % | 0 | % |
| Volatility  factor            |       | 0.827                             |       | 0.545 |   | 0.457 |   |
| Expected life of  the options |       | 4.3                               |       | 3 |   | 3 |   |

 

Black-Scholespricing-model also was used to estimate the fair value of the ESPPcompensation; assumptions are not provided due to the immateriality of the ESPPportion.

 

F-20

----

 

Pro forma information underSFAS No. 123:

 
| ** **                                                                                            | ** ** | **Year  ended December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                                                            | ** ** | **2002**                          | ** ** | **2003** | ** ** | **2004** | ** ** |
|                                                                                                  |       |                              |       |   |   |   |   |
| Net income (loss) as reported                                                                         |       | $                                 | (33,982    | ) | $ | 7,091 |   | $ | 24,555 |   |
| Add: Stock-based compensation expense included in the determination  of net income (loss) as reported |       | 12                                |       | 12 |   | — |   |
| Deduct: Stock-based compensation expense determined under fair value  method for all awards           |       | (18,467                           | )          | (10,350 | ) | (7,182 | ) |
|                                                                                                  |       |                              |       |   |   |   |   |
| Pro forma net income (loss)                                                                           |       | $                                 | (52,437    | ) | $ | (3,247 | ) | $ | 17,373 |   |
|                                                                                                  |       |                              |       |   |   |   |   |
| Basic net earnings (loss) per share as reported                                                       |       | $                                 | (2.46      | ) | $ | 0.44 |   | $ | 1.40 |   |
|                                                                                                  |       |                              |       |   |   |   |   |
| Diluted net earnings (loss) per share as reported                                                     |       | $                                 | (2.46      | ) | $ | 0.42 |   | $ | 1.31 |   |
|                                                                                                  |       |                              |       |   |   |   |   |
| Pro forma basic net earnings (loss) per share                                                         |       | $                                 | (3.80      | ) | $ | (0.20 | ) | $ | 0.99 |   |
| Pro forma diluted net earnings (loss) per share                                                       |       | $                                 | (3.80      | ) | $ | (0.20 | ) | $ | 0.93 |   |

 

v.                           Fair value of financial instruments:

 

The following methods and assumptions were used bythe Company in estimating its fair value disclosures for financial instruments:

 

The carrying amount reported in the balance sheetfor cash and cash equivalents, short-term bank deposits, trade receivables,short-term bank credit and trade payables approximates their fair value due tothe short-term maturities of such instruments.

 

The fair value for marketable securities is based onquoted market prices and does not differ significantly from the carrying amount(see Note 3).

 

w.                         Advertising expenses:

 

Advertising expenses are charged to expense asincurred. Advertising expenses for the years 2002, 2003 and 2004, was $ 1,760,$ 2,077 and $ 2,621, respectively.

 

F-21

----

 

x.                             Derivatives and hedging activities:

 

SFAS No. 133, “Accounting for DerivativeInstruments and Hedging Activities” requires the Company to recognize all ofits derivative instruments as either assets or liabilities on the balance sheetat fair value. The accounting for changes in the fair value (i.e., gains orlosses) of a derivative instrument depends on whether it has been designated andqualifies as part of a hedging relationship and further, on the type of hedgingrelationship. For those derivative instruments that are designated and qualifyas hedging instruments, a company must designate the hedging instrument, basedupon the exposure being hedged, as a fair value hedge, cash flow hedge or ahedge of a net investment in a foreign operation.

 

For derivative instruments that are designated andqualify as a fair value hedge (i.e., hedging the exposure to changes in thefair value of an asset or a liability or an identified portion thereof that isattributable to a particular risk), the gain or loss on the derivativeinstrument as well as the offsetting loss or gain on the hedged itemattributable to the hedged risk are recognized in the line item associated withthe hedged item in earnings during the period of the change in fair values. Forderivative instruments that are designated and qualify as a cash flow hedge(i.e., hedging the exposure to variability in expected future cash flows thatis attributable to a particular risk), the effective portion of the gain orloss on the derivative instrument is reported as a component of accumulatedother comprehensive income and reclassified into earnings in the line itemassociated with the hedged transaction in the period or periods during whichthe hedged transaction affects earnings. The remaining gain or loss on thederivative instrument in excess of the cumulative change in the present valueof future cash flows of the hedged item, if any, is recognized in financialincome/expense in the period of change.

 

y.                            Impact of recently issued accountingstandards:

 

On December 16, 2004, the Financial AccountingStandards Board (FASB) issued Statement No. 123 (revised 2004),“Share-Based Payment” (“Statement 123R”), which is a revision of FASB StatementNo. 123, “Accounting for Stock-Based Compensation” (“Statement 123”).  Generally, the approach in Statement 123R issimilar to the approach described in Statement 123.  However, Statements 123 permitted, but notrequired, share-based payments to employees to be recognized based on theirfair values while Statement 123R requires all share-based payments to employeesto be recognized based on their fair values. Statement 123R also revises,clarifies and expands guidance in several areas, including measuring fairvalue, classifying an award as equity or as a liability and attributingcompensation cost to reporting periods. The new Standard will be effective forthe Company in the first fiscal year beginning after June 15, 2005. Theadoption of Statement 123R will have a significant effect on the Company’sresults of operations.

 

F-22

----

 

In November 2004, the FASB issued SFASNo. 151, “Inventory Costs, an Amendment of ARB No. 43, Chapter 4”.SFAS No. 151 amends Accounting Research Bulletin (“ARB”) No. 43,Chapter 4, to clarify that abnormal amounts of idle facility expense, freighthandling costs and wasted materials (spoilage) should be recognized ascurrent-period charges. In addition, SFAS No. 151 requires that theallocation of fixed production overheads to the costs of conversion be based onthe normal capacity of the production facilities. SFAS No. 151 iseffective for inventory costs incurred during fiscal years beginning afterJune 15, 2005. The Company does not expect that the adoption of SFASNo. 151 will have a material effect on its financial position or resultsof operations.

 

z.                             Reclassification:

 

Certain amounts from prior years have beenreclassified to conform to the current year’s presentation. Thereclassification had no effect on previously reported net income (loss),shareholders’ equity or cash flows.

 

**NOTE 3:-****       ****MARKETABLE SECURITIES**

** **

a.                            The following table summarizes amortizedcosts, gross unrealized gains and losses and estimated fair values ofheld-to-maturity marketable securities as of December 31, 2003 and 2004:

 
| ** **                 | ** ** | **Amortized  cost**   | ** ** | **Gross  unrealized gains** | ** ** | **Gross  unrealized  losses** | ** ** | **Estimated  fair value** | ** ** |
|----------------------------|------------|-----------------------|------------|-----------------------------|------------|-------------------------------|------------|---------------------------|------------|
| ** **                 | ** ** | **December 31,** | ** ** | **December 31,**       | ** ** | **December 31,**         | ** ** | **December 31,**     | ** ** |
| ** **                 | ** ** | **2003**              | ** ** | **2004**                    | ** ** | **2003**                      | ** ** | **2004**                  | ** ** | **2003** | ** ** | **2004** | ** ** | **2003** | ** ** | **2004** | ** ** |
| U.S. corporate  debentures |       | $                     | 40,216     |                        | $          | 37,968                        |       | $                         | 164        |   | $ | 1 |   | $ | 67 |   | $ | 368 |   | $ | 40,313 |   | $ | 37,601 |   |
| U.S government  debentures |       | 19,505                |       | 74,805                      |       | 24                            |       | 11                        |       | 77 |   | 560 |   | 19,452 |   | 74,256 |   |
| Structured notes           |       | 17,500                |       | 12,680                      |       | —                        |       | —                    |       | 7 |   | — |   | 17,493 |   | 12,680 |   |
|                       |       |                  |       |                        |       |                          |       |                      |       |   |   |   |   |   |   |   |   |
|                       |       | $                     | 77,221     |                        | $          | 125,453                       |       | $                         | 188        |   | $ | 12 |   | $ | 151 |   | $ | 928 |   | $ | 77,258 |   | $ | 124,537 |   |

 

Information about gross unrealized losses based onthe length of time that individual securities have been in a continuousunrealized loss position was not provided due to immateriality.

 

As of December 31, 2003 and 2004, all theCompany’s U.S. corporate debentures, U.S. government debentures and structurednotes were classified as held-to-maturity.

 

In 2002 and 2004, the Company sold debt securities,which were classified as held-to-maturity, due to a rating decrease, inconsideration of $ 820 and $ 911, respectively. As a result of the sale, theCompany recorded a loss of $ 55 and $ 14, respectively. In 2003, the Companydid not sell any securities prior to their maturity and accordingly, did notrealize any gains or losses on held-to-maturity securities in that year. During2003 and 2004, held-to-maturity marketable securities in the amount of $ 8,500and $ 40,434, respectively, were called by the issuers prior to maturity.

 

F-23

----

 

The scheduled maturities of held-to-maturitymarketable securities at December 31, 2004 are as follows:

 
| ** **                             | ** ** | **Amortized** | ** ** | **Estimated**   | ** ** |
|----------------------------------------|------------|---------------|------------|-----------------|------------|
| ** **                             | ** ** | **cost**      | ** ** | **fair  value** | ** ** |
| Held-to-maturity:                      |       |          |       |            |       |
|                                   |       |          |       |            |       |
| Due within one year                    |       | $             | 10,648     |            | $          | 9,091 |   |
| Due after one year through five years  |       | 109,805       |       | 110,446         |       |
| Due after five years through ten years |       | 5,000         |       | 5,000           |       |
|                                   |       |          |       |            |       |
|                                   |       | $             | 125,453    |            | $          | 124,537 |   |

 

b.                           Auction rate securities amounting to $ 13,700as of December 31, 2004, were classified as available-for-sale marketablesecurities and were presented as short-term marketable securities.

 

**NOTE 4:-****       ****OTHER RECEIVABLES AND PREPAID EXPENSES**

 
| ** **             | ** ** | **December 31,** | ** ** |
|------------------------|------------|-----------------------|------------|
| ** **             | ** ** | **2003**              | ** ** | **2004** | ** ** |
|                   |       |                  |       |   |   |
| Government authorities |       | $                     | 1,670      |   | $ | 1,848 |   |
| Interest receivable    |       | 1,151                 |       | 994 |   |
| Prepaid expenses       |       | 3,064                 |       | 4,250 |   |
| Other                  |       | 1,481                 |       | 845 |   |
|                   |       |                  |       |   |   |
|                   |       | $                     | 7,366      |   | $ | 7,937 |   |

 

**NOTE 5:-****       ****INVENTORIES**

 
| ** **       | ** ** | **December 31,** | ** ** |
|------------------|------------|-----------------------|------------|
| ** **       | ** ** | **2003**              | ** ** | **2004** | ** ** |
|             |       |                  |       |   |   |
| Raw materials    |       | $                     | 2,574      |   | $ | 1,286 |   |
| Work-in-progress |       | 120                   |       | 71 |   |
| Finished goods   |       | 9,940                 |       | 11,258 |   |
|             |       |                  |       |   |   |
|             |       | $                     | 12,634     |   | $ | 12,615 |   |

 

F-24

----

 

**NOTE 6:-****       ****PROPERTY AND EQUIPMENT, NET**

 
| ** **                         | ** ** | **December 31,** | ** ** |
|------------------------------------|------------|-----------------------|------------|
| ** **                         | ** ** | **2003**              | ** ** | **2004** | ** ** |
| Cost:                              |       |                  |       |   |   |
| Computers and peripheral equipment |       | $                     | 44,144     |   | $ | 50,474 |   |
| Office furniture and equipment     |       | 13,105                |       | 13,701 |   |
| Motor vehicles                     |       | 134                   |       | — |   |
| Leasehold improvements             |       | 3,658                 |       | 3,823 |   |
|                               |       |                  |       |   |   |
|                               |       | 61,041                |       | 67,998 |   |
| Accumulated depreciation:          |       |                  |       |   |   |
| Computers and peripheral equipment |       | 35,992                |       | 42,454 |   |
| Office furniture and equipment     |       | 4,749                 |       | 6,501 |   |
| Motor vehicles                     |       | 99                    |       | — |   |
| Leasehold improvements             |       | 1,574                 |       | 2,062 |   |
|                               |       |                  |       |   |   |
|                               |       | 42,414                |       | 51,017 |   |
|                               |       |                  |       |   |   |
| Depreciated cost                   |       | $                     | 18,627     |   | $ | 16,981 |   |

 

Depreciation expense totaled $ 9,775, $ 10,547 and $8,603 for the years ended December 31, 2002, 2003 and 2004, respectively.

 

**NOTE 7:-****       ****OTHER INTANGIBLE ASSETS, NET**

 

a.                            Other intangible assets

 
| ** **                             | ** ** | **December 31,** | ** ** |
|----------------------------------------|------------|-----------------------|------------|
| ** **                             | ** ** | **2003**              | ** ** | **2004** | ** ** |
| Original amounts:                      |       |                  |       |   |   |
| Capitalized software development costs |       | $                     | 22,979     |   | $ | 19,355 |   |
| Core technology                        |       | 4,419                 |       | 4,419 |   |
| Trademarks                             |       | 1,040                 |       | 1,040 |   |
| Maintenance contracts                  |       | 548                   |       | 576 |   |
|                                   |       |                  |       |   |   |
|                                   |       | 28,986                |       | 25,390 |   |
| Accumulated amortization:              |       |                  |       |   |   |
| Capitalized software development costs |       | 15,838                |       | 14,980 |   |
| Core technology                        |       | 3,078                 |       | 3,695 |   |
| Trademarks                             |       | 408                   |       | 726 |   |
| Maintenance contracts                  |       | 213                   |       | 416 |   |
|                                   |       |                  |       |   |   |
|                                   |       | 19,537                |       | 19,817 |   |
|                                   |       |                  |       |   |   |
| Amortized cost                         |       | 9,449                 |       | 5,573 |   |
| Distribution network                   |       | 6,744                 |       | 7,092 |   |
|                                   |       |                  |       |   |   |
| Total other intangible assets          |       | $                     | 16,193     |   | $ | 12,665 |   |

 

F-25

----

 

b.                           Amortization expense amounted to $ 5,473, $7,070 and $ 5,190 for the years ended December 31, 2002, 2003 and 2004,respectively.

 

c.                            Estimated amortization expense for the yearsended (excluding amortization of capitalized software development costs):

 
| ** ** | ** ** | **December 31,** | ** ** |
|------------|------------|-----------------------|------------|
|       |       |                  |       |
| 2005       |       | $                     | 665        |   |
| 2006       |       | 188                   |       |
| 2007       |       | 188                   |       |
| 2008       |       | 157                   |       |
|       |       |                  |       |
|       |       | $                     | 1,198      |   |

 

**NOTE 8:-****       ****GOODWILL**

 

The changes in the carrying amount of goodwill forthe years ended December 31, 2003 and 2004 are as follows:

 
| Balance as of January 1, 2003             |   | $      | 27,417 |   |
|------------------------------------------------|--------|--------|--------|--------|
| Adjustments to goodwill                        |   | (2,909 | )      |
| Foreign currency translation adjustments       |   | 803    |   |
|                                           |   |   |   |
| Balance as of December 31, 2003           |   | $      | 25,311 |   |
| Applied against sale of discontinued operation |   | (250   | )      |
| Foreign currency translation adjustments       |   | 684    |   |
|                                           |   |   |   |
| Balance as of December 31, 2004           |   | $      | 25,745 |   |

 

**NOTE 9:-****       ****ACCRUED EXPENSES AND OTHER LIABILITIES**

 
| ** **                     | ** ** | **December 31,** | ** ** |
|--------------------------------|------------|-----------------------|------------|
| ** **                     | ** ** | **2003**              | ** ** | **2004** | ** ** |
|                           |       |                  |       |   |   |
| Employees and payroll accruals |       | $                     | 11,580     |   | $ | 13,228 |   |
| Accrued expenses               |       | 22,966                |       | 19,949 |   |
| Restructuring accrual          |       | 604                   |       | 256 |   |
| Deferred revenues              |       | 10,054                |       | 18,677 |   |
| Other                          |       | 2,166                 |       | 3,192 |   |
|                           |       |                  |       |   |   |
|                           |       | $                     | 47,370     |   | $ | 55,302 |   |

 

**NOTE 10:-****     ****DERIVATIVE INSTRUMENTS**

** **

To protect against changes in the value offorecasted foreign currency transactions and balances, the Company hasinstituted a foreign-currency hedging program. The Company hedges portions ofits forecasted cash flows and balances denominated in foreign currencies withforward contracts and option strategies (together: “derivative instruments”).

 

F-26

----

 

The Company entered into derivative instrumentarrangements to hedge a portion of anticipated New Israeli Shekel (“NIS”)payroll payments. These derivative instruments are designated as cash flowshedges, as defined by SFAS No. 133, as amended, and are all highlyeffective as hedges of these expenses when the salary is recorded. Theeffective portion of the derivative instruments is included in payroll expensesin the statements of operations.

 

In addition, the Company entered into derivativeinstruments to hedge certain trade receivables, trade payable payments,expected payments under fixed price contracts denominated in foreign currency,liabilities to employees and other long-term liability. The purpose of theCompany’s foreign currency hedging activities is to protect the Company fromchanges in the foreign currency exchange rate to the dollar.

 

At December 31, 2004, the Company expects toreclassify $ 65 of net gains on derivative instruments from accumulatedother comprehensive income to earnings during the next twelve months.

 

**NOTE 11:-****     ****RESTRUCTURING EXPENSES**

** **

Following the acquisition of TCS, the Company identifiedan opportunity to increase flexibility and focus, improve responsiveness andreduce unnecessary overhead. In December 2002, the Company adopted a plan(“the 2002 Plan”) to achieve these objectives, which involved the phasedreduction of approximately 75 of the initially combined 1,077 staff andconsolidation of certain field offices. The Company expects to incur a totalcost of $ 2,170 in connection with this plan. The Company elected earlyadoption of SFAS No. 146, “Accounting for Costs Associated with Exit orDisposal Activities”. The major components of the 2002 Plan are as follows:

 
| ** **                                                           | ** ** | ** **      | ** ** | ** **   | ** ** | **Loss on**      | ** ** | ** **        | ** ** |
|----------------------------------------------------------------------|------------|-----------------|------------|--------------|------------|------------------|------------|-------------------|------------|
| ** **                                                           | ** ** | ** **      | ** ** | ** **   | ** ** | **disposal**     | ** ** | ** **        | ** ** |
| ** **                                                           | ** ** | **Employee**    | ** ** | ** **   | ** ** | **of  property** | ** ** | **Total**         | ** ** |
| ** **                                                           | ** ** | **termination** | ** ** | **Facility** | ** ** | **and**          | ** ** | **restructuring** | ** ** |
| ** **                                                           | ** ** | **benefits**    | ** ** | **closure**  | ** ** | **equipment**    | ** ** | **charge**        | ** ** |
|                                                                 |       |            |       |         |       |             |       |              |       |
| Total amount expected to be incurred                                 |       | $               | 1,544      |         | $          | 605              |       | $                 | 21         |   | $ | 2,170 |   |
|                                                                 |       |            |       |         |       |             |       |              |       |
| Costs incurred in 2002                                               |       | $               | 282        |         | $          | —           |       | $                 | —     |   | $ | 282 |   |
|                                                                 |       |            |       |         |       |             |       |              |       |
| Restructuring accrual as of December 31, 2002                   |       | 282             |       | —       |       | —           |       | 282               |       |
|                                                                 |       |            |       |         |       |             |       |              |       |
| Costs incurred in 2003                                               |       | 1,262           |       | 605          |       | 21               |       | 1,888             |       |
| Costs paid in 2003                                                   |       | (1,443          | )          | (139         | )          | (21              | )          | (1,603            | )          |
|                                                                 |       |            |       |         |       |             |       |              |       |
| Restructuring accrual as of December 31, 2003                   |       | 101             |       | 466          |       | —           |       | 567               |       |
|                                                                 |       |            |       |         |       |             |       |              |       |
| Additional restructuring expenses (reversal of over accrued amounts) |       | (16             | )          | 16           |       | —           |       | —            |       |
| Costs paid in 2004                                                   |       | (85             | )          | (239         | )          | —           |       | (324              | )          |
|                                                                 |       |            |       |         |       |             |       |              |       |
| Restructuring accrual as of December 31, 2004                   |       | $               | —     |         | $          | 243              |       | $                 | —     |   | $ | 243 |   |
|                                                                 |       |            |       |         |       |             |       |              |       |
| Remaining amount expected to be incurred                             |       | $               | —     |         | $          | —           |       | $                 | —     |   | $ | — |   |

 

At December 31, 2004, a total amount of$ 256 is included in accrued expenses and other liabilities for theabove-mentioned plan and for the 2001 plan together.

 

F-27

----

 

**NOTE 12:-****     ****COMMITMENTS AND CONTINGENT LIABILITIES**

** **

a.                            Lease commitments:

 

The Company leases office space, office equipmentand various motor vehicles under operating leases.

 

1.                             The Company’s office space and officeequipment are rented under several operating leases.

 

Future minimum lease commitments undernon-cancelable operating leases for the years ended December 31, are asfollows:

 
| 2005                |   | $      | 5,842  |   |
|---------------------|--------|--------|--------|--------|
| 2006                |   | 4,724  |   |
| 2007                |   | 2,637  |   |
| 2008                |   | 1,568  |   |
| 2009 and thereafter |   | 610    |   |
|                |   |   |   |
|                |   | $      | 15,381 |   |

 

Rent expenses for the years ended December 31,2002, 2003 and 2004 were approximately $ 5,761, $ 6,554 and $ 6,107,respectively.

 

2.                             The Company leases its motor vehicles undercancelable operating lease agreements.

 

The minimum payment under these operating leases,upon cancellation of these lease agreements was $ 768 as ofDecember 31, 2004.

 

Lease expenses of vehicles for the years endedDecember 31, 2002, 2003 and 2004 were $ 1,616, $ 2,124 and $ 2,396,respectively.

 

b.                           Other commitments:

 

The Company is obligated under certain agreementswith its suppliers to purchase goods and under an agreement with itsmanufacturing subcontractor to purchase excess inventory. Non cancelableobligations as of December 31, 2004, were approximately as follows:

 
| 2005   |   | $      | 2,887  |   |
|--------|--------|--------|--------|--------|
| 2006   |   | 1,335  |   |
| 2007   |   | 144    |   |
| 2008   |   | 144    |   |
| 2009   |   | 144    |   |
|   |   |   |   |
|   |   | $      | 4,654  |   |

 

F-28

----

 

c.                            Legal proceedings:

 

1.                             On October 19, 2004, CipherActive filedan action against the Company in the District Court of Tel Aviv, State ofIsrael. In this lawsuit, CipherActive claimed that under a developmentagreement with the Company, it is entitled to receive license fees in respectof certain software that it allegedly developed for the Company and which hasbeen embedded in one of the Company’s products. CipherActive claimed that it isentitled to license fees in the amount of $ 600, in addition to the amount of $100 already paid to CipherActive by the Company in respect of such licensefees. In the Company’s statement of defense it claimed that the software developedby CipherActive under the agreement has not been successful in the market, isno longer embedded in the Company’s product and, therefore, CipherActive is notentitled to any additional license fees.

 

2.                             In July 2004, the Company’s wholly ownedsubsidiary, STS Software Systems Ltd. (“STS”), filed a lawsuit in the U.S.District Court for the Southern District of New York charging WitnessSystems, Inc. (“Witness”) with infringement of the one of the Company’sVoIP patents in the U.S, by marketing and selling products that incorporatemethods of detecting, monitoring and recording information - all fullyprotected by that patent. STS is seeking an injunction against Witness,preventing the sale of any solution which infringes the Company’s patent.

 

In August 2004, Witness filed a patentinfringement action in the Federal Court for the Northern District of Georgiaagainst the Company’s wholly owned subsidiary NICE Systems, Inc. Witnesssubsequently filed an identical action in February 2005 against NICE inthe same court. The two actions were consolidated in March 2005. Witnessaccuses the Company of infringing two U.S patents relating to certaintechnology used with some of the Company’s products. Witness is requesting apermanent injunction against alleged future infringement and damages for pastalleged infringement. The Company has responded to Witness’ claims and hasasserted that the patents are invalid and not infringed. At this stage theCompany cannot predict the outcome of the claim, nor can it make any estimateof the amount of damages, if any, for which it will be held responsible in theevent of a negative conclusion to the claim.

 

3.                             The U.S Consumer Product Safety Commissionhas brought to the Company’s attention and provided it an opportunity to commenton an alleged incident of a fire allegedly involving a NICE product used in aschool building in the Evesham New Jersey School District. The Company hasretained specialized counsel and engineering consultants and is investigatingthis matter. The Company believes, as advised by outside counsel, that based onthe facts known at present, it is not expected that this matter will result inany regulatory action.

 

F-29

----

 

**NOTE 13:-****     ****CREDIT LINES**

** **

As of December 31, 2004, the Company hadauthorized credit lines from banks in the amount of $ 139,000. Whenutilized, the credit lines will be denominated in dollars and will bearinterest at the rate of up to LIBOR + 1.5 %. An amount of $ 116,000 out of thetotal credit lines is secured by the Company’s marketable securities. There areno financial covenants associated with these credit lines. As ofDecember 31, 2004, $ 5,756 of the $ 139,000 referred to above was used forbank guarantees.

 

**NOTE 14:-****     ****TAXES ON INCOME**

** **

a.                            Measurement of taxable income:

 

Results for tax purposes are measured in real terms,in accordance with the changes in the Israeli Consumer Price Index (“CPI”) orchanges in the exchange rate of the NIS against the dollar for a “foreigninvestors” company. NICE has elected to measure its results for tax purposes onthe basis of the changes in the exchange rate of NIS against the dollar.

 

b.                           Tax benefits under the Israel Law for theEncouragement of Capital Investments, 1959 (“the Law”):

 

Certain production facilities of NICE have beengranted the status of “Approved Enterprise” under the Law, in four separateinvestment programs.

 

According to the provisions of the Law, NICE electedthe “alternative benefits” and waived government grants in return for a taxexemption.

 

Income derived from the first and second program wastax-exempt for a period of four years, commencing 1999 and 1997, respectively,and is taxed at the reduced corporate tax rate of 10%-25% (based on thepercentage of foreign ownership in each taxable year) for an additional periodof six years.

 

Income derived from the third and fourth programswill be tax-exempt for a period of two years, commencing with the year NICEfirst earns taxable income, and will be taxed at the reduced corporate tax rateof 10%-25% (based on the percentage of foreign ownership in each taxable year)for an additional period of eight years.

 

The period of tax benefits detailed above is subjectto limits of the earlier of 12 years from the commencement of production or 14years from receiving the approval.

 

The entitlement to the above benefits is conditionalupon NICE’s fulfilling the conditions stipulated by the above Law, regulationspublished thereunder and the certificates of approval for the specificinvestments in an “Approved Enterprise”. In the event of failure to comply withthese conditions, the benefits may be canceled and NICE may be required torefund the amount of the benefits, in whole or in part, including interest. Asof December 31, 2004, management believes that NICE is in compliance withall the conditions required by the law.

 

F-30

----

 

As of December 31, 2004, approximately$ 18,214 was derived from tax-exempt profits earned by NICE’s “ApprovedEnterprises”. NICE has decided not to declare dividends out of such tax-exemptincome. Accordingly, no deferred tax liabilities have been provided on incomeattributable to NICE’s “Approved Enterprises”. If the net retained tax exemptincome is distributed, it would be taxed at the corporate tax rate applicableto such profits as if NICE had not elected the alternative tax benefits(currently - 20% of the gross distributed amount) and an income tax liabilitywould be incurred of approximately $ 4,554 as of December 31, 2004.

 

Income of NICE from sources other than the “ApprovedEnterprise” during the period of benefits will be taxable at the regularcorporate tax rate.

 

A recent amendment to the Law, which has beenofficially published effected as of April 1, 2005 (the “Amendment”) haschanged certain provisions of the Law. The Amendment enacted changes in themanner in which tax benefits are awarded under the law so that companies nolonger require Investment Center approval in order to qualify for tax benefits.The Company’s existing Approved Enterprises will generally not be subject tothe provisions of the Amendment.

 

c.                            Tax benefits under the Israeli Law for theEncouragement of Industry (Taxation), 1969:

 

NICE is an industrial company under the above lawand as such is entitled to certain tax benefits including accelerateddepreciation, deduction of public offering expenses in three equal annualinstallments and amortization of other intangible property rights as adeduction for tax purposes.

 

d.                           Reduction in corporate tax rate:

 

In June 2004, the Israeli Parliament approvedan amendment to the Income Tax Ordinance (No. 140 and TemporaryProvision), which progressively reduces the regular corporate tax rate from 36%to 35% in 2004, 34% in 2005, 32% in 2006 and to a rate of 30% in 2007.

 

e.                            Net operating loss carryforward:

 

As of December 31, 2004, the Company hadcarryforward tax losses totaling approximately $ 25,468, most of which canbe carried forward and offset against taxable income with expiration dates from2005 to 2022. Utilization of U.S. net operating losses may be subject to thesubstantial annual limitation due to the “change in ownership” provisions ofthe Internal Revenue Code of 1986 and similar state provisions. The annuallimitation may result in the expiration of net operating losses beforeutilization.

 

F-31

----

 

f.                              Deferred income taxes:

 

Deferred income taxes reflect the net tax effects oftemporary differences between the carrying amounts of assets and liabilitiesfor financial reporting purposes and the amounts used for income tax purposes.Significant components of the Company’s deferred tax assets are as follows:

 
| ** **                                        | ** ** | **December 31,** | ** ** |
|---------------------------------------------------|------------|-----------------------|------------|
| ** **                                        | ** ** | **2003**              | ** ** | **2004** | ** ** |
|                                              |       |                  |       |   |   |
| Net operating loss carryforward                   |       | $                     | 12,478     |   | $ | 8,712 |   |
| Reserves and allowances                           |       | 709                   |       | 720 |   |
|                                              |       |                  |       |   |   |
| Net deferred tax asset before valuation allowance |       | 13,187                |       | 9,432 |   |
| Valuation allowance                               |       | (13,187               | )          | (9,432 | ) |
|                                              |       |                  |       |   |   |
| Net deferred tax asset                            |       | $                     | —     |   | $ | — |   |

 

The Company has provided valuation allowances inrespect of deferred tax assets resulting from tax loss carry forwards and otherreserves and allowances due to uncertainty concerning its realization of thesedeferred tax assets.

 

g.                           Reconciliation between the theoretical taxexpenses assuming all income is taxed at the statutory tax rate applicable toincome of NICE and the actual tax expense as reported in the consolidatedstatements of operations is as follows:

 
| ** **                                                                                      | ** ** | **Year  ended December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                                                      | ** ** | **2002**                          | ** ** | **2003** | ** ** | **2004** | ** ** |
| Income (loss) before taxes on income, as reported in the consolidated  statements of operations |       | $                                 | (35,002    | ) | $ | 6,813 |   | $ | 23,638 |   |
|                                                                                            |       |                              |       |   |   |   |   |
| Statutory tax rate in Israel                                                                    |       | 36                                | %          | 36 | % | 35 | % |
|                                                                                            |       |                              |       |   |   |   |   |
| Theoretical income tax expense (benefit)                                                        |       | $                                 | (12,601    | ) | $ | 2,453 |   | $ | 8,273 |   |
| Losses and other items for which a valuation allowance was provided                             |       | 3,218                             |       | 174 |   | 3,055 |   |
| Non-deductible acquisition-related costs (income)                                               |       | 11,201                            |       | (108 | ) | 71 |   |
| Tax exempt interest income                                                                      |       | (1,145                            | )          | — |   | — |   |
| Utilization of net operating losses for which a valuation allowance  was provided               |       | (676                              | )          | (2,014 | ) | (9,490 | ) |
| Non-deductible expenses                                                                         |       | 407                               |       | 515 |   | 420 |   |
| Other                                                                                           |       | (54                               | )          | 185 |   | (10 | ) |
|                                                                                            |       |                              |       |   |   |   |   |
| Actual tax expense                                                                              |       | $                                 | 350        |   | $ | 1,205 |   | $ | 2,319 |   |

 

F-32

----

 

h.                           Income (loss) before taxes on income iscomprised as follows:

 
| ** ** | ** ** | **Year  ended December 31,** | ** ** |
|------------|------------|-----------------------------------|------------|
| ** ** | ** ** | **2002**                          | ** ** | **2003** | ** ** | **2004** | ** ** |
|       |       |                              |       |   |   |   |   |
| Domestic   |       | $                                 | (34,043    | ) | $ | 4,345 |   | $ | 15,367 |   |
| Foreign    |       | (959                              | )          | 2,468 |   | 8,271 |   |
|       |       |                              |       |   |   |   |   |
|       |       | $                                 | (35,002    | ) | $ | 6,813 |   | $ | 23,638 |   |

 

i.                               The provision for income taxes is comprisedas follows:

 
| Current taxes |   | $      | 350    |   | $      | 1,205  |   | $ | 2,319 |   |
|---------------|--------|--------|--------|--------|--------|--------|--------|---|-------|--------|
|          |   |   |   |   |   |   |   |
| Domestic      |   | $      | 126    |   | $      | 949    |   | $ | 1,836 |   |
| Foreign       |   | 224    |   | 256    |   | 483    |   |
|          |   |   |   |   |   |   |   |
|          |   | $      | 350    |   | $      | 1,205  |   | $ | 2,319 |   |

 

**NOTE 15:-****     ****SHAREHOLDERS’ EQUITY**

** **

a.                            The Ordinary shares of the Company are tradedon the Tel Aviv Stock Exchange and its ADSs are traded on NASDAQ.

 

b.                           Share option plans:

 

In 1995, the Company adopted an employee shareoption plan (“the 1995 Option Plan”). Under the 1995 option plan, employees andofficers of the Company may be granted options to acquire Ordinary shares. Theoptions to acquire Ordinary shares, which may only be determined by the Boardof Directors of the Company, are granted at an exercise price, subject tocertain exceptions, of not less than the fair market value of the Ordinaryshares on the grant date. 8,345,566 options of the 1995 Option Plan weregranted.

 

The options generally vest gradually over afour-year period from the date of grant. As of February 15, 2000, theBoard of Directors of the Company adopted a resolution amending the exerciseterms for any option granted subsequent to February 15, 2000 under the1995 Option Plan whereby 25% of the stock options granted become exercisable onthe first anniversary of the date of grant and 6.25% become exercisable onceevery quarter during the subsequent three years. The options expire no laterthan 6 years from the date of grant.

 

F-33

----

 

In 1996, the Company adopted the 1997 ExecutiveShare Option Plan (“the 1997 Option Plan”). Under the terms of the 1997 OptionPlan, stock options will be exercisable during a 60-day period ending fouryears after grant. The plan met the definition of Time Accelerated RestrictedStock Award Options Plan (“TARSAP”). The TARSAP includes an accelerationfeature based on the following: if the year-end earnings per share of theCompany shall reach certain defined targets, 40% of such stock options shallbecome exercisable; if earnings per share shall reach certain higher definedtargets, an additional 30% of such stock options shall become exercisable; andif earnings per share shall reach certain higher defined targets, an additional30% of such stock options shall become exercisable, provided that with respectto all of the above-referenced periods, the operating profit of the Companyshall not be less than 10% of revenues and earnings per share shall exclude anynon-recurring expenses related to mergers and acquisitions. Notwithstanding theforegoing, none of the stock options shall be exercisable before the expirationof two years from the date of issuance. 950,000 options of the 1997 Option Planwere granted. As of December 31, 2004, none of the targets specified underthe TARSAP were met and accordingly there was no acceleration of options.

 

In 2001, the Company adopted the 2001 Stock OptionPlan (“the 2001 Option Plan”). The options to acquire Ordinary shares, whichmay only be determined by the Board of Directors of the Company, are granted atan exercise price, of not less than the fair market value of the Ordinaryshares on the grant date. 2,959,750 options of the 2001 Option Plan weregranted.  Under the terms of the 2001Option Plan, a one third of the stock options granted became exercisable tenmonths after the grant date and the remaining two thirds will becomeexercisable on the first and second anniversaries of the first date of exerciseso long as the grantee is, subject to certain exceptions, employed by theCompany at the date the stock option becomes exercisable. The third portion ofthe options may be exercised at the end of the second year following the firstdate of exercise, if the Company meets a pre-tax profit target of 20% ofrevenues. Unless otherwise determined by the Company’s Board of Directors as ofthe date of grant, the stock options expire six years after the date of grant.As of December 31, 2004, none of the targets specified were met andaccordingly there was no acceleration of options.

 

In 2003, the Company adopted the 2003 Stock OptionPlan (“the 2003 Option Plan”). Under the 2003 option plan, employees andofficers of the Company may be granted options to acquire Ordinary shares. Theoptions to acquire Ordinary shares, which may only be determined by the Boardof Directors of the Company, are granted at an exercise price, subject tocertain exceptions, of not less than the fair market value of the Ordinaryshares on the grant date. 1,368,500 options of the 2003 Option Plan weregranted. Unless otherwise determined by the Company’s Board of Directors as ofthe date of grant, the stock options expire six years after the date of grant.

 

F-34

----

 

A summary of the Company’s stock options activityand related information for the years ended December 31, 2002, 2003 and2004, is as follows:

 
| ** **                               | ** ** | **2002**                | ** ** | **2003**                               | ** ** | **2004**                | ** ** |
|------------------------------------------|------------|-------------------------|------------|----------------------------------------|------------|-------------------------|------------|
| ** **                               | ** ** | **Number  of  options** | ** ** | **Weighted  average  exercise  price** | ** ** | **Number  of  options** | ** ** | **Weighted  average  exercise  price** | ** ** | **Number  of  options** | ** ** | **Weighted  average  exercise  price** | ** ** |
| Outstanding at the beginning of the year |       | 6,408,825               |       | $                                      | 29.31      |                    | 5,965,980  |   | $ | 25.74 |   | 4,910,389 |   | $ | 26.80 |   |
| Granted                                  |       | 981,000                 |       | $                                      | 11.49      |                    | 390,000    |   | $ | 22.55 |   | 997,500 |   | $ | 21.33 |   |
| Exercised                                |       | (60,830                 | )          | $                                      | 12.10      |                    | (823,363   | ) | $ | 12.83 |   | (1,291,394 | ) | $ | 13.63 |   |
| Forfeited                                |       | (1,363,015              | )          | $                                      | 32.87      |                    | (622,228   | ) | $ | 32.52 |   | (346,178 | ) | $ | 40.46 |   |
| Outstanding at the end of the year       |       | 5,965,980               |       | $                                      | 25.74      |                    | 4,910,389  |   | $ | 26.80 |   | 4,270,317 |   | $ | 28.40 |   |
|                                     |       |                    |       |                                   |       |                    |       |   |   |   |   |   |   |
| Exercisable at the end of the year       |       | 2,373,039               |       | $                                      | 34.46      |                    | 2,790,417  |   | $ | 33.55 |   | 2,556,779 |   | $ | 34.59 |   |

 

The options outstanding as of December 31,2004, have been separated into exercise price categories as follows:

 
| ** **         | ** ** | ** **            | ** ** | ** **      | ** ** | ** **   | ** ** | ** **            | ** ** | **Weighted**    | ** ** |
|--------------------|------------|-----------------------|------------|-----------------|------------|--------------|------------|-----------------------|------------|-----------------|------------|
| ** **         | ** ** | **Options**           | ** ** | **Weighted**    | ** ** | ** **   | ** ** | **Options**           | ** ** | **average**     | ** ** |
| ** **         | ** ** | **outstanding**       | ** ** | **average**     | ** ** | **Weighted** | ** ** | **exercisable**       | ** ** | **exercise**    | ** ** |
| ** **         | ** ** | **as of**             | ** ** | **remaining**   | ** ** | **average**  | ** ** | **as of**             | ** ** | **price  of**   | ** ** |
| **Ranges of**      | ** ** | **December 31,** | ** ** | **contractual** | ** ** | **exercise** | ** ** | **December 31,** | ** ** | **options**     | ** ** |
| **exercise price** | ** ** | **2004**              | ** ** | **life**        | ** ** | **price**    | ** ** | **2004**              | ** ** | **exercisable** | ** ** |
| **$**              | ** ** | ** **            | ** ** | **(Years)**     | ** ** | **$**        | ** ** | ** **            | ** ** | **$**           | ** ** |
|               |       |                  |       |            |       |         |       |                  |       |            |       |
| 7.83-11.14         |       | 334,325               |       | 3.74            |       | 9.98         |       | 104,105               |       | 10.19           |       |
| 12.00-16.81        |       | 1,395,531             |       | 2.62            |       | 12.97        |       | 1,177,463             |       | 12.81           |       |
| 19.33-28.07        |       | 1,453,761             |       | 5.07            |       | 21.91        |       | 188,511               |       | 23.09           |       |
| 30.13-40.94        |       | 41,000                |       | 0.86            |       | 39.62        |       | 41,000                |       | 39.62           |       |
| 48.13-70.88        |       | 702,500               |       | 1.51            |       | 57.36        |       | 702,500               |       | 57.36           |       |
| 75.63-78.88        |       | 343,200               |       | 1.16            |       | 75.87        |       | 343,200               |       | 75.87           |       |
|               |       |                  |       |            |       |         |       |                  |       |            |       |
|               |       | 4,270,317             |       | 3.23            |       | 28.40        |       | 2,556,779             |       | 34.59           |       |

 

Weighted average fair values and weighted averageexercise prices of options whose exercise price is equal or higher than themarket price of the shares at date of grant are as follows:

 
| ** **                              | ** ** | **Weighted  average fair value of  options granted at an exercise price** | ** ** | **Weighted  average exercise price of  options granted at an exercise price** | ** ** |
|-----------------------------------------|------------|---------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------|------------|
| ** **                              | ** ** | **Year  ended December 31,**                                         | ** ** |
| ** **                              | ** ** | **2002**                                                                  | ** ** | **2003**                                                                      | ** ** | **2004** | ** ** | **2002** | ** ** | **2003** | ** ** | **2004** | ** ** |
| Equal to fair value at date of grant    |       | $                                                                         | 8.03       |                                                                          | $          | 8.36 |   | $ | 7.14 |   | $ | 12.99 |   | $ | 22.55 |   | $ | 21.33 |   |
| Higher than fair value at date of grant |       | $                                                                         | 5.19       |                                                                          | $          | — |   | $ | — |   | $ | 10.51 |   | $ | — |   | $ | — |   |

 

F-35

----

 

c.                            Employee Stock Purchase Plan (“ESPP”):

 

In February 1999, the Company’s Board ofDirectors adopted the Employee Stock Purchase Plan (“the Purchase Plan”).Eligible employees can have up to 10% of their earnings withheld, up to certainmaximums, to be used to purchase Ordinary shares. The price of Ordinary sharespurchased under the Purchase Plan will be equal to 85% of the lower of the fairmarket value of the Ordinary shares on the commencement date of each offeringperiod or on the semi-annual purchase date.

 

During 2002, 2003 and 2004, employees purchased131,667, 221,184 and 139,913 shares at average prices of $ 10.51, $ 6.86 and $16.20 per share, respectively.

 

d.                           Dividends:

 

Dividends, if any, will be paid in NIS. Dividendspaid to shareholders outside Israel may be converted to dollars on the basis ofthe exchange rate prevailing at the date of the conversion. The Company doesnot intend to pay cash dividends in the foreseeable future.

 

**NOTE 16:-****     ****MAJOR CUSTOMER AND GEOGRAPHIC INFORMATION**

 

a.                            Summary information about geographic areas:

 

The Company manages its business on a basis of onereportable segment. See Note 1a for a brief description of the Company’sbusiness. The following data is presented in accordance with SFAS No. 131,“Disclosure About Segments of an Enterprise and Related Information”. Totalrevenues are attributed to geographic areas based on the location of endcustomers.

 

The following table presents total revenues andlong-lived assets for the years ended December 31, 2002, 2003 and 2004 andas of December 31, 2002, 2003 and 2004 respectively:

 
| ** ** | ** ** | **2002**     | ** ** | **2003**       | ** ** | **2004**     | ** ** |
|------------|------------|--------------|------------|----------------|------------|--------------|------------|
| ** ** | ** ** | **Total**    | ** ** | **Long-lived** | ** ** | **Total**    | ** ** | **Long-lived** | ** ** | **Total** | ** ** | **Long-lived** | ** ** |
| ** ** | ** ** | **revenues** | ** ** | **assets**     | ** ** | **revenues** | ** ** | **assets** | ** ** | **revenues** | ** ** | **assets** | ** ** |
|       |       |         |       |           |       |         |       |   |   |   |   |   |   |
| Americas   |       | $            | 86,938     |           | $          | 10,835       |       | $ | 118,594 |   | $ | 9,926 |   | $ | 121,578 |   | $ | 10,130 |   |
| EMEA*)     |       | 45,236       |       | 18,489         |       | 70,926       |       | 19,586 |   | 89,768 |   | 19,372 |   |
| Far East   |       | 20,679       |       | 95             |       | 31,832       |       | 72 |   | 37,779 |   | 140 |   |
| Israel     |       | 2,488        |       | 42,345         |       | 2,906        |       | 30,547 |   | 3,518 |   | 25,749 |   |
|       |       |         |       |           |       |         |       |   |   |   |   |   |   |
|       |       | $            | 155,341    |           | $          | 71,764       |       | $ | 224,258 |   | $ | 60,131 |   | $ | 252,643 |   | $ | 55,391 |   |

 

----

*)                           Includes Europe, the Middle East (excludingIsrael) and Africa.

 

F-36

----

 

b.                           Market sectors:

 

Total revenues from external customers divided onthe basis of the Company’s market sectors are as follows:

 
| ** **                        | ** ** | **Year  ended December 31,** | ** ** |
|-----------------------------------|------------|-----------------------------------|------------|
| ** **                        | ** ** | **2002**                          | ** ** | **2003** | ** ** | **2004** | ** ** |
|                              |       |                              |       |   |   |   |   |
| Enterprise Interaction Solutions  |       | $                                 | 122,422    |   | $ | 171,381 |   | $ | 194,111 |   |
| Public Safety and Security sector |       | 32,919                            |       | 52,877 |   | 58,532 |   |
|                              |       |                              |       |   |   |   |   |
|                              |       | $                                 | 155,341    |   | $ | 224,258 |   | $ | 252,643 |   |

 

c.                            Major customers’ data as a percentage oftotal revenues:

 
| Customer A |   | 23.3 | % | 20.0 | % | 18.8 | % |
|------------|--------|------|---|------|---|------|---|

 

**NOTE 17:-****     ****SELECTED STATEMENTS OF OPERATIONS DATA**

 

a.                            Research and development, net:

 
| ** **                                          | ** ** | **Year  ended December 31,** | ** ** |
|-----------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                          | ** ** | **2002**                          | ** ** | **2003** | ** ** | **2004** | ** ** |
|                                                |       |                              |       |   |   |   |   |
| Total costs                                         |       | $                                 | 23,363     |   | $ | 26,384 |   | $ | 27,512 |   |
| Less - grants and participations                    |       | (1,632                            | )          | (1,260 | ) | (1,341 | ) |
| Less - capitalization of software development costs |       | (4,609                            | )          | (2,291 | ) | (1,305 | ) |
|                                                |       |                              |       |   |   |   |   |
|                                                |       | $                                 | 17,122     |   | $ | 22,833 |   | $ | 24,866 |   |

 

b.                           Financial income (expenses), net:

 
| ** **                                                                        | ** ** | **Year  ended December 31,** | ** ** |
|-----------------------------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                                        | ** ** | **2002**                          | ** ** | **2003** | ** ** | **2004** | ** ** |
|                                                                              |       |                              |       |   |   |   |   |
| Financial income:                                                                 |       |                              |       |   |   |   |   |
| Interest and amortization/accretion of premium/discount of marketable  securities |       | $                                 | 2,747      |   | $ | 1,821 |   | $ | 2,349 |   |
| Interest                                                                          |       | 551                               |       | 422 |   | 1,427 |   |
| Foreign currency translation                                                      |       | 1,152                             |       | 405 |   | 1,078 |   |
|                                                                              |       |                              |       |   |   |   |   |
|                                                                              |       | 4,450                             |       | 2,648 |   | 4,854 |   |
| Financial expenses:                                                               |       |                              |       |   |   |   |   |
| Interest                                                                          |       | (15                               | )          | (79 | ) | (2 | ) |
| Foreign currency translation                                                      |       | (95                               | )          | (204 | ) | (894 | ) |
| Other                                                                             |       | (348                              | )          | (331 | ) | (402 | ) |
|                                                                              |       |                              |       |   |   |   |   |
|                                                                              |       | (458                              | )          | (614 | ) | (1,298 | ) |
|                                                                              |       |                              |       |   |   |   |   |
|                                                                              |       | $                                 | 3,992      |   | $ | 2,034 |   | $ | 3,556 |   |

 

F-37

----

 

c.                            Restructuring expenses, in-process researchand development write-off, settlement of litigation and other:

 
| ** **                                              | ** ** | **Year  ended December 31,** | ** ** |
|---------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                              | ** ** | **2002**                          | ** ** | **2003** | ** ** | **2004** | ** ** |
| Restructuring expenses (income) (Note 11)               |       | $                                 | (118       | ) | $ | 1,888 |   | $ | — |   |
| In-process research and development write-off (Note 1c) |       | 1,270                             |       | — |   | — |   |
| Settlement of litigation (*)                            |       | —                            |       | 5,194 |   |   |   |
| Other                                                   |       | (320                              | )          | — |   | — |   |
|                                                    |       |                              |       |   |   |   |   |
|                                                    |       | $                                 | 832        |   | $ | 7,082 |   | $ | — |   |

 

(*)                      In the fourth quarter of 2003, the Companyreached a settlement agreement with one of its competitors to settle a patentinfringement claim filed by the competitor in June 2000. Under thesettlement agreement the Company paid to the competitor $ 10,000 (of whichapproximately $ 4,800 was covered by insurance).

 

d.                           Net earnings (loss) per share:

 

The following table sets forth the computation ofbasic and diluted net earnings (loss) per share:

 

1.                      Numerator:

 
| ** **                                                      | ** ** | **Year  ended December 31,** | ** ** |
|-----------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                      | ** ** | **2002**                          | ** ** | **2003** | ** ** | **2004** | ** ** |
| Numerator for basic and diluted net earnings (loss) per share - |       |                              |       |   |   |   |   |
| Net income (loss) from continuing operations                    |       | $                                 | (35,352    | ) | $ | 5,608 |   | $ | 21,319 |   |
| Net income from discontinued operation                          |       | 1,370                             |       | 1,483 |   | 3,236 |   |
| Net income (loss) available to Ordinary shareholders            |       | $                                 | (33,982    | ) | $ | 7,091 |   | $ | 24,555 |   |

 

2.                      Denominator (in thousands):

 
| Denominator for basic net earnings (loss) per share -                                     |   |   |   |   |   |   |   |
|-------------------------------------------------------------------------------------------|--------|--------|--------|--------|--------|--------|--------|
| Weighted average number of shares                                                         |   | 13,795 |   | 16,038 |   | 17,497 |   |
|                                                                                      |   |   |   |   |   |   |   |
| Effect of dilutive securities:                                                            |   |   |   |   |   |   |   |
| Add - Employee stock options                                                              |   | — |   | 731    |   | 1,198  |   |
| Add - ESPP                                                                                |   | — |   | 12     |   | 8      |   |
|                                                                                      |   |   |   |   |   |   |   |
| Denominator for diluted net earnings (loss) per share - adjusted  weighted average shares |   | 13,795 |   | 16,781 |   | 18,703 |   |

 

The effect of the inclusion of the options andwarrants in 2002 would be anti-dilutive. Because of the loss in 2002, allpotential dilutive securities are anti-dilutive.

 

F-38

----

 

**NOTE 18:-****     ****SUBSEQUENT EVENT (UNAUDITED)**

 

On April 11, 2005, the Company signed adefinitive agreement to acquire the assets and assume certain liabilities ofDictaphone’s Communications Recording Systems (“CRS”) business forapproximately $ 38,500. Dictaphone’s CRS business is a leading provider ofliability and quality management systems for first responders, criticalfacilities, contact centers and financial trading floors. The closing tookplace on June 1, 2005.

 

F-39

----

 

**SIGNATURES**

 

Pursuant to the requirements ofSection 12 of the Securities Exchange Act of 1934, the Registrantcertifies that it meets all of the requirements for filing on Form 20-Fand has duly caused this Annual Report to be signed on its behalf by theundersigned, thereunto duly authorized, in the City of Ra’anana, State ofIsrael, on the 29th day of June, 2005.

 

 
|   | **NICE-SYSTEMS LTD.** |
|--------|-----------------------|
|   | ** **            |
|   | ** **            |
|   | By:                   |     /s/ Haim Shani |   |
|   |                  | Haim Shani |
|   |                  | Chief Executive Officer |

 

----