UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                                 AMENDMENT NO. 1
                                       TO

                                   FORM 20-F/A

     [_] REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE
     SECURITIES EXCHANGE ACT OF 1934

OR

     [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
     EXCHANGE ACT OF 1934

     For the fiscal year ended DECEMBER 31, 2003

OR

     [_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
     EXCHANGE ACT OF 1934

                        Commission file number 001-14184

                      B.O.S BETTER ON LINE SOLUTIONS LTD.
             (Exact name of Registrant as specified in its charter)

                                     ISRAEL
                (Jurisdiction of incorporation or organization)

   BEIT RABIN, 100 BOS ROAD, TERADYON INDUSTRIAL PARK, MISGAV, 20179, ISRAEL
                    (Address of principal executive offices)

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

                                      NONE
                             (Title of each class)

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

                 ORDINARY SHARES, PAR VALUE NIS 4.00 PER SHARE
                                (Title of Class)
 Securities for which there is a reporting obligation pursuant to Section 15(d)
                                  of the Act:

                                      NONE
                                (Title of Class)


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

4,167,509 ORDINARY SHARES, NIS 4.00 PAR VALUE PER SHARE, AS OF DECEMBER 31, 2003


                                       1
<PAGE>


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

                               Yes [X]     No [_]

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

                          Item 17 [_]     Item 18 [X]



                                EXPLANATORY NOTE

This Amendment no. 1 to the Annual Report on Form 20-F for the year ended
December 31, 2003, of B.O.S Better On-Line Solutions Ltd. (the "Company")
includes restated consolidated financial statements and related information that
reflect the accounting for the Company's investment in Surf Communications
Solutions Ltd. ("Surf") according to the equity method rather than the cost
method. As a result of the acquisition of additional voting securities of Surf
in 2003, which resulted in the Company's owing securities representing more than
20% of the voting rights of Surf, the Company has the ability to exercise
significant influence over Surf. In order to present financial statements in
accordance with accounting principles generally accepted in the United States,
the Company has restated its financial statements with respect to its investment
in Surf which was previously accounted for based on the cost method, to
accounting for it based on the equity method of accounting. Additionally, this
Amendment includes the consolidated financial statements of Surf for the year
ended December 31, 2003 in accordance with item 3.09 of Regulation S-X.

This Amendment no. 1 contains the following affected items only: 3A, 4A, 5, 8,
18 and 19. Other items remain unchanged.


                                       2
<PAGE>


ITEM 3: KEY INFORMATION REGARDING B.O.S.

Unless the context in which such terms are used would require a different
meaning, all references to "BOS", "we" or "our" or the "Company" refer to B.O.S.
Better On-Line Solutions Ltd.

3A.  SELECTED CONSOLIDATED FINANCIAL DATA

The consolidated statement of operations data for B.O.S Better On-Line Solutions
Ltd. set forth below with respect to the years ended December 31, 2003, 2002 and
2001, and the consolidated balance sheet data as of December 31, 2003 and 2002,
have been derived from the Consolidated Financial Statements listed in Item 18,
which have been prepared in accordance with generally accepted accounting
principles ("GAAP") in the United States. The consolidated statement of
operations data set forth below with respect to the years ended December 31,
2000 and 1999, and the consolidated balance sheet data as of December 31, 2001,
2000 and 1999, have been derived from other consolidated financial statements
not included herein and have been prepared in accordance with U.S. GAAP. The
financial statements for the years ended December 31, 2001, 2002 and 2003 were
audited by Kost, Forer Gabbay & Kasierer, independent certified public
accountants in Israel and a member of Ernst & Young Global, while the financial
statements for the years ended December 31, 1999 and 2000 were audited by Somekh
Chaikin, independent certified public accountants in Israel and members of KPMG
International. The selected consolidated financial data presented below should
be read in conjunction with Item 5: "Operating and Financial Review and
Prospects" and the Notes to the Financial Statements included in this Form 20-F.


On May 29, 2003, the Company effected a one-for-four reverse stock split. All
share and per share numbers herein reflect adjustments resulting from this
reverse stock split.


                                       3
<PAGE>


Statement of Operations Data: (In US thousands of dollars with the exception of
per share data)



<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31:

                                   2003*      2002*      2001*      2000       1999
                                  -------    -------    -------    -------    -------
<S>                               <C>        <C>        <C>        <C>        <C>
Revenues                            5,728      9,441      6,042      7,294      6,720
Cost of revenues                    1,455      2,300      2,703      2,399      1,936
                                  -------    -------    -------    -------    -------
GROSS PROFIT                        4,273      7,141      3,339      4,895      4,784

OPERATING EXPENSES:
 Research and development, net      1,846      2,182      1,757      2,177      1,486
 Selling and marketing              2,178      3,705      4,811      4,185      3,024
 General and administrative         1,317      1,697      1,425      2,279      2,181
Restructuring costs                   678          -        132         83
                                  -------    -------    -------    -------    -------
TOTAL OPERATING EXPENSES            6,019      7,584      8,125      8,724      6,691

OPERATING LOSS:                    (1,746)      (443)    (4,786)    (3,829)    (1,907)
Financial income (expense), net       109        295        427        639        (91)
Other income (expenses)                45        (95)      (298)      (479)     2,150
                                  -------    -------    -------    -------    -------
EARNING (LOSS) BEFORE EQUITY IN
LOSSES OF AN AFFILIATED COMPANY    (1,592)      (243)    (4,657)    (3,669)       152
Equity in losses of an
affiliated company                   (465)      (570)      (137)    (1,283)      (696)
                                  -------    -------    -------    -------    -------

NET LOSS FROM CONTINUING
OPERATIONS                         (2,057)      (813)    (4,794)    (4,952)      (544)

Net earning (loss) related to
discontinued operations             2,036     (7,674)    (8,313)    (2,743)      (522)
                                  -------    -------    -------    -------    -------
 NET LOSS                             (21)    (8,487)   (13,107)    (7,695)    (1,066)
                                  =======    =======    =======    =======    =======

 Basic and diluted net loss
 per share from continuing
 operations                       $ (0.56)   $ (0.26)   $ (1.55)   $ (1.66)   $ (0.23)
                                  =======    =======    =======    =======    =======

 Basic and diluted net
 earning (loss) per share
 related to discontinued
 operations                       $  0.55    $ (2.46)   $ (2.68)   $ (0.92)   $ (0.22)
                                  =======    =======    =======    =======    =======

Basic and diluted net loss per
share                             $ (0.01)   $ (2.72)   $ (4.23)   $ (2.58)   $ (0.45)
                                  =======    =======    =======    =======    =======
Weighted average number of
shares used in computing basic
and diluted net earning (loss)
per share                           3,683      3,117      3,102      2,982      2,388
                                  =======    =======    =======    =======    =======
</TABLE>

*) Restated


                                       4
<PAGE>



<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31:

BALANCE SHEET HIGHLIGHTED DATA:     2003*    2002*    2001*    2000     1999
-------------------------------    ------   ------   ------   ------   ------
<S>                                <C>      <C>      <C>      <C>      <C>
CASH AND CASH EQUIVALENTS           3,872    5,246    8,325   16,470      261

Working Capital (*)                 5,082    5,980    7,008   17,378      290


Total Assets                       14,023   16,485   31,144   46,128   33,637

Short-term bank credit and
current maturities of long-term
debt                                    -        -      286      429      421


Long-term debt                        951      794      794    1,049    1,542


Shareholders equity                10,541    8,015   16,341   29,444   13,675


(*)Working capital comprises of:

Current assets                      7,239    9,525   10,677   20,795    3,411

Less: current liabilities           2,157    3,545    3,669    3,417    3,121
                                   ------   ------   ------   ------   ------

                                    5,082    5,980    7,008   17,378      290
                                   ======   ======   ======   ======   ======
</TABLE>

*) RESTATED


ITEM 4: INFORMATION ON THE COMPANY

4A.  HISTORY AND DEVELOPMENT OF THE COMPANY

We were incorporated in Israel in 1990 as a private corporation under the
Israeli Companies Ordinance, 1983. Our headquarters and manufacturing facilities
are located at 100 Bos Road, Teradyon Industrial Zone, Misgav 20179 Israel. Our
telephone number is 972-4-990-7555.

In January 2002, the Company changed its organizational structure. As part of
this change, the Company 's marketing, development, production and support
activities were sold to Lynk, a B.O.S. subsidiary founded in 1995, to develop
and market high-quality data access convergence and remote access solutions, and
later VOIP hardware and software telephony, for the corporate market. Following
the reorganization, Lynk changed its name to BOScom Ltd.

On May 24, 2002, the Company announced its intention to sell PacInfoSystems (see
Risk Factors and Note 1c to the Consolidated Financial Statements) due to a
change in the Company's business strategy. PacInfoSystems was the Company's
wholly-owned U.S. subsidiary that resold, installed and provided computer
networking products to various business entities. Management formulated a new
strategic plan that provided for the discontinuation of the computer networking
business. As a result, the Company decided in May 2002 to sell PacInfoSystems
and to write-off amortized goodwill associated with PacInfoSystems in the amount
of $3.9 million.


                                       5
<PAGE>


However, the Company's efforts to sell PacInfoSystems, whose financial situation
was deteriorating, were not successful. Further developments, such as an
arbitration judgment rendered against PacInfoSystem in the sum of approximately
$650,000, continuation of poor sales results, termination of line of credit, as
well as the loss of some key employees and members of the sales force, left the
Company with little choice but to wind up the business. PacInfoSystems has
already settled with a majority of its creditors, however, there can be no
assurance that such a settlement will be reached with the remainder of the
creditors.

Our U.S. subsidiaries are Lynk USA, Inc., and its subsidiary PacInfoSystems,
Inc. (into which our U.S. subsidiary, Better On-Line Solutions Inc. was merged
in early 2001). Both are non-operational and commencing the beginning of year
2003 we market our products in the U.S. through one Master Distributor.

Our other subsidiaries are BOScom Ltd., in Israel, and its subsidiaries - Better
On-Line Solutions Ltd. in the U.K; Better On-Line Solutions S.A.S. in France;
and BOSDelaware, Inc., in the US. During 2003, the operation of the BOScom
subsidiaries was ceased (although all subsidiaries still exist except for the
French one) and the sales and marketing in Europe and USA have since been
conducted through master distributors.

In addition, we have an interest in Surf Communications Solutions Ltd. ("Surf"),
the leading supplier of embedded network convergence software that lends
flexibility and scalability to network products handling data modem, fax, and
voice transmissions. In March 2003, the Company purchased from Catalyst
Investors L.P. ("Catalyst") most of the Surf shares held by Catalyst. Under the
terms of the transaction, the Company purchased 191,548 of Catalyst's Preferred
C shares in Surf, and a pro rata share of the Surf Preferred C warrants held by
Catalyst, and in exchange it issued to Catalyst 2,529,100 ordinary shares of the
Company (representing 19.9% of its current outstanding shares pre-issuance, as a
result of which Catalyst held 16.6% of the outstanding Company shares, after the
issuance). The Company has an option to purchase the remaining Catalyst
Preferred C shares in Surf by January 31, 2006, and until such purchase has
voting rights in these Surf shares, in addition to being entitled to profits
resulting from the sale of these shares to a third party. In February 2004,
these voting rights were assigned to Mr. Yair Shamir, one of the Company's
directors. Thus, the Company now holds 19.8% in Surf, and 15.3% on a fully
diluted basis (assuming the Company does not exercise its option to purchase the
additional shares from Catalyst). Yair Shamir holds 0.2% in Surf (and 0.2% on a
fully diluted basis), in addition to his holdings of 2.8% of the voting rights
in Surf (2.3% on a fully diluted basis) assigned to him by the Company.

As a result of the Catalyst transaction, the Company has the ability to exercise
significant influence over Surf and therefore applied the equity method of
accounting with respect to its investment in Surf. In order to present financial
statements in accordance with accounting principles generally accepted in the
United States, the Company has restated its financial statements as detailed
below, with respect to its investment in Surf which was previously accounted for
based on the cost method, to account for it based on the equity method of
accounting.


                                       6
<PAGE>


Consequently the investment, results of operations (current and prior periods
presented), and retained earnings of the Company were adjusted retroactively in
a manner consistent with the accounting for a step-by-step acquisition of a
subsidiary. Since its investment in Common stock was reduced to zero in prior
years, the Company recognized equity losses only with respect to its share in
the Preferred C shares (8.4% since November 2001 through March 2003 and
thereafter 15.7%). As a result, the Company recorded equity losses in the total
amount of $ 1,172 thousands for the years 2001 through 2003 and reversed the
impairment expenses of $ 840 thousands recorded in 2003 due to the fact that the
equity losses recorded, reduced the book value of the investment in Surf below
its fair value. The accumulated equity losses net of the impairment expenses
were $ 332 thousands.


We design, integrate and test our products in our facilities in northern Israel.
In early 1996, we moved into a new facility, which resulted in the expansion of
our production capabilities and has allowed us to continue to benefit from
substantial Israeli tax incentives.

ITEM 5: OPERATING AND FINANCIAL REVIEW AND PROSPECTS

The following management's discussion and analysis of financial condition and
results of operations should be read in conjunction with our financial
statements and notes thereto. Certain matters discussed below and throughout
this annual report are forward-looking statements that are based on our beliefs
and assumptions as well as information currently available to us. Such
forward-looking statements may be identified by the use of the words
"anticipate", "believe", "estimate", "expect", "plan" and similar expressions.
Such statements reflect our current views with respect to future events and are
subject to certain risks and uncertainties. While we believe such
forward-looking statements are based on reasonable assumptions, should one or
more of the underlying assumptions prove incorrect, or these risks or
uncertainties materialize, our actual results may differ materially from those
described herein. Please read the section below entitled "Factors That May
Affect Future Results" to review conditions that we believe could cause actual
results to differ materially from those contemplated by the forward-looking
statements.

The Company's discussion and analysis of its financial condition and result of
operations is based upon the Company's consolidated financial statements which
have been prepared in accordance with generally accepted accounting principles
("GAAP ") in the United States of America. Prior to 2003, the consolidated
financial statements were prepared in accordance with Israeli GAAP with
reconciliation to U.S.GAAP. The Company believes that investors and other users
of its financial statements would benefit if the primary financial statements
were prepared in accordance with U.S., rather than Israeli, GAAP.


CRITICAL ACCOUNTING POLICIES

The preparation of these financial statements required the Company to make
estimations and judgments, in accordance with U.S. GAAP, that affect the
reporting amounts of assets, liabilities, revenues and expenses and related
disclosure of contingent assets and liabilities. On an ongoing basis, the
Company evaluates its estimates, including those related to revenue recognition,
bad debts, inventories and legal contingencies. The Company based its estimates
on historical experience and on various other assumptions that are believed to
be reasonable under the circumstances, the results of which form the basis of
making judgments about the values of assets and liabilities that are not readily
apparent from other sources. Actual results may differ from these estimates
under different assumptions or conditions.

For a review of the accounting policies that form the basis of the
above-referenced estimates and judgments that the Company made in preparing its
consolidated financial statements, please see Note 2 (Significant Accounting
Policies) to the Consolidated Financial Statements. The following accounting
policies had the most significant impact on the Financial Statements for the
year ended December 31, 2003.


                                       7
<PAGE>


REVENUE RECOGNITION

We recognize revenues from sales of product and services in accordance with
Staff Accounting Bulletin No. 101 "Revenue Recognition in Financial Statements"
("SAB 101"), Staff Accounting Bulletin No. 104 "Revenue Recognition in Financial
Statements" ("SAB 104") and Statement of Position No. 97-2 "Software Revenue
Recognition" ("SOP 97-2") when delivery has occurred, persuasive evidence of an
arrangement exists, the vendor's fee is fixed or determinable, no further
obligation exists, and collection is reasonably assured. When a right of return
exists, the Company defers revenues until the right of return expires.
Determination of the probability of collection is based on management's
judgments regarding the payment of fees for services rendered and products
delivered. This determination is based on management's periodic assessment of
the credit worthiness and other known factors of its customers and distributors.
If this assessment will not properly reflect the actual collection, revenue
recognized for any reporting period could be adversely affected.


ALLOWANCE FOR DOUBTFUL ACCOUNTS

The Company maintains an allowance for doubtful accounts for estimated losses,
which may result from the inability of its customers to make required payments.
Management exercises judgment as to its ability to collect outstanding
receivables. Allowances for doubtful accounts are made based upon a specific
review of all significant outstanding invoices. For those invoices not
specifically reviewed, allowances for doubtful accounts are made based upon the
age of the receivable. In determining the allowance, the Company analyzes its
historical collection experience and current economic trends. If the historical
data used to calculate the allowances for doubtful accounts do not reflect the
future ability to collect outstanding receivables, additional allowances for
doubtful accounts may be needed and the future results of operations could be
materially affected.


INVENTORIES

Inventories are valued at the lower of cost or market value. Cost is determined
as follows:


<TABLE>
<S>                                            <C>
Raw and packaging materials                    - Moving Average Cost Method

Products in progress and finished products     - On the production costs basis with the addition
                                                 of allocable indirect manufacturing costs
</TABLE>


If actual market conditions prove less favorable than those projected by
management, additional inventory write-downs may be required. Inventories are
written down for estimated obsolescence based upon assumptions about future
demand and market conditions. Likewise, favorable future demand and market
conditions could positively impact future operating results if inventory that
has been written down is sold. As of December 31, 2003, inventory is presented
net of $300,000 general provision for technological obsolescence and slow moving
items (see also Note 5 to the Consolidated Financial Statements).


LEGAL CONTINGENCIES

The Company has been a party to various legal proceedings in the normal course
of its business (see Item 8A for more details). The results of legal proceedings
are difficult to predict and an unfavorable resolution of a lawsuit or
proceeding may occur. Management believes that the prospects of these
proceedings to prevail and recover a significant amount, seem remote, and
accordingly no provision was recorded. As additional information becomes
available, management will reassess the potential liability related to these
legal proceedings and may revise its estimate of the probable cost of this
proceedings. Such revisions in the estimates of the probable cost could have a
material adverse effect on the Company's future results of operations and
financial position.


                                       8
<PAGE>


5A.  RESULTS OF OPERATIONS

On May 29, 2003 we effected a 1:4 reverse stock split. All share and per share
data for periods prior to that date have been retroactively adjusted to reflect
this reverse stock split.

COMPARISON OF 2003 AND 2002

Year 2003 results of operation reflected the reorganization made in the sales
and marketing organization. In the United States, up until the fourth quarter of
2002, we marketed our BOScom products through a US subsidiary (the BOS US
division of PacInfoSystems). Currently, we market our products through one
Master Distributor (Bosanova, Inc.)

In Europe, up until the second quarter of 2003, we marketed our BOScom products
through subsidiaries in the U.K. and France. Currently, we market our products
through local distributors that provide pre and post sales support. Products
sold in the rest of the world are serviced from our headquarters in Israel.

As a result of the above reorganization, the Company experienced a significant
decrease in revenues in 2003, due to the distributors' margin, which was only
partially compensated for by the decrease in sales and marketing expenses.
Furthermore, as a result of the reorganization, in 2003 the Company recorded a
restructuring cost of $680,000.

Consolidated revenues for 2003 were $5,728,000 compared with $9,441,000 in 2002,
a 39% decrease.

The major reasons for the decrease were: (a) sales through master distributors
in year 2003 compared to sales through subsidiaries in year 2002, as the margins
of the master distributors decreased revenues; and (b) slowdown in sales due to
global slowdown in the telecommunications industry.

Gross profit in 2003 totaled $4,273,000, representing 75% of revenues, compared
with $7,141,000, constituting 76% of revenues in 2002. Cost of revenues of year
2003 includes income of $339,000 due to a reversal of a non-recurring royalty
for the Office of the Chief Scientist (see also Note 14a to the Consolidated
Financial Statements). Excluding such income, the gross profit for year 2003
represented 69% of revenues compared to 76% in year 2002, the major reasons for
the decrease being (a) sales through master distributors in year 2003 compared
to sales through subsidiaries in year 2002 which caused a decrease in the sale
price while the cost of revenue remained virtually the same; and (b) revenues of
BOSANOVA PrintBoss in year 2003 decreased to $448,000 compared to $1,387,000 in
year 2002. Since the BOSANOVA PrintBoss is a software product with a relatively
low cost of production, the decrease in its revenues in year 2003 compared to
year 2002 significantly affected the gross profit.

Net research and development costs in 2003 decreased by 15% to $1,846,000
compared to $2,182,000 in 2002. The expenses in 2003 included $283,000 funding
that the Company received from the Office of the Chief Scientist. In 2002 the
company did not receive such funding. Excluding the effect of the funds received
from the Office of the Chief Scientist in 2003, the research and development
costs in 2003 remained virtually the same as in year 2002.

Selling and marketing expenses in year 2003 decreased by 41% to $2,178,000,
compared to $3,705,000 in 2002. The major reason for such decrease was sales
through subsidiaries in 2002, as opposed to sales through distributors in year
2003 after the operation of the subsidiaries was ceased.


                                       9
<PAGE>


General and administrative expenses in year 2003 decreased by 22% to $1,317,000
compared to $1,697,000 in 2002. The major reason was the reduction in payroll of
employees and directors, by 17%, effected July 2003.

Restructuring costs in year 2003 amounted to $678,000 which resulted from
ceasing the operation of the Company's subsidiaries in Europe.

As a result of the foregoing, our operating loss in 2003 was $1,746,000 compared
to an operating loss of $443,000 in 2002.

The Company had net financial income of $109,000 in 2003 compared with net
financial income of $295,000 in 2002. The decrease in the financial income is
related to the decrease in cash and investment balances during 2003 and to
decrease of financial income from translation of foreign currency into dollar.

Equity in losses of an affiliated company refers to the Company's investment in
Surf which amounted to $465,000 in 2003 compared to $570,000 in 2002. The
investment in Surf is accounted for using the equity method, since the Company
has the ability to exercise significant influence over Surf (through the
Company's ownership of voting securities representing more than 20% of the
voting rights of Surf) and therefore applied the equity method. In order to
present financial statements in accordance with accounting principles generally
accepted in the United States, the Company has restated its financial statements
as detailed below, with respect to its investments in Surf which was previously
accounted for based on the cost method, to accounting for it according to the
equity method of accounting (see Item 4A).

As a result, net loss from the continuing operations for 2003 amounted to
$2,057,000 compared with $813,000 in 2002. On a per share basis, the net loss
from the continuing operations in 2003 was $0.56 per share compared with a $0.26
net loss per share in 2002. (For details regarding computation of net loss per
share, see Note 14d to the Consolidated Financial Statements.)

The net earnings related to the discontinuing operations for 2003 was $2,036,000
compared with a loss of $7,674,000 in 2002. The earnings of 2003 resulted from
debt settlement with more than 95% of PacInfoSystems' external creditors for an
amount which was significantly lower than the face value of the debt.

The total net loss for 2003 was $21,000, compared with $8,487,000 in 2002. On a
per share basis, the net loss in 2003 was $0.01 per share compared with a $2.72
net loss per share in 2002.

COMPARISON OF 2002 AND 2001

Consolidated revenues for 2002 were $9,441,000, compared with $6,042,000 in
2001, a 56% increase.

During 2002 we focused our sales on our core business products. The S&M activity
was aimed to expand our customer base and distribution channels.

During 2002 we succeeded in closing a software deal with one customer which
represented about 13% of the total revenues.

Gross profit in 2002 totaled $7,141,000, representing 76% of revenues, compared
with $3,339,000, constituting 55% of revenues in 2001. The difference is related
mainly to high provisions for slow inventory that the company made in 2001
relating to its IP old product line.

Net research and development costs in 2002 increased 24% to $2,182,000, compared
with $1,757,000 in 2001. The expenses in 2001 included $989,000 funding that the
Company received from the Office of the Chief Scientist. In 2002 the company did
not receive such funding.


                                       10
<PAGE>


Gross research and development costs in 2002 decreased 21% to $2,182,000,
compared with $2,746,000 in 2001, mainly due to HR costs reduction. We improved
the R&D staff by replacing some of our engineers with new ones, who are better
skilled and more efficient but paid lower salaries.

In Europe we closed branches that were not economically efficient and made some
personnel changes. These steps saved us $500,000 in operational and other
expenses compared to 2001. In addition, we reduced our operational costs in the
US by $550,000 compared to 2001.

Selling and marketing expenses decrease by 23% to $3,705,000 in 2002 compared to
$4,811,000 in 2001 mainly due to the closing of branches in Europe and the
reduction of operations in the US.

General and administrative expenses increased by 19% to $1,697,000 in 2002,
compared to $1,425,000 in 2001. This increase is due to expenses related to 2002
reorganization of the US subsidiary and the closing of branches in Europe.

As a result of the foregoing, our operating loss in 2002 was $443,000 compared
with an operating loss of $4,786,000 in 2001.

The Company had net financial income of $295,000 in 2002 compared with net
financial income of $427,000 in 2001. The decrease in the financial income is
related to a decrease in cash and investment balances during 2002.

Other expenses for 2002 were $95,000, compared with other expenses of $298,000
in 2001. (For more details regarding other expenses, see Note 14c to the
Consolidated Financial Statements).

Equity in losses of an affiliated company refers to investment in Surf which
amounted to $570,000 in 2002 compared to $137,000 in 2001. The investment in a
company is stated at equity method, since the Company has the ability to
exercise significant influence over Surf and applied the equity method. In order
to present financial statements in accordance with accounting principles
generally accepted in the United States, the Company has restated its financial
statements as detailed below, with respect to its investments in Surf which was
previously accounted based on the cost method, to accounting for it according to
the equity method of accounting (see Item 4A).

As a result of the foregoing, net loss from the continuing operations for 2002
amounted to $813,000 compared with $4,794,000 in 2001. On a per share basis, the
net loss from continuing operations in 2002 was $0.26 per share compared with a
$1.55 net loss per share in 2001.

The net loss related to the discontinuing operations for 2002 was $7,674,000
compared with $8,313,000 in 2001. On a per share basis, the net loss from the
discontinuing operations in 2002 was $2.46 per share compared with a $2.68 net
loss per share in 2001.

The total net loss for 2002 was $8,487,000, compared with $13,107,000 in 2001.
On a per share basis, the net loss in 2002 was $2.72 per share compared with a
$4.23 net loss per share in 2001.

VARIABILITY OF QUARTERLY OPERATING RESULTS

Our revenues and profitability may vary in any given year, and from quarter to
quarter, depending on the number of products sold. In addition, due to potential
competition, uncertain market acceptance and other factors, we may be required
to reduce prices for our products in the future.


                                       11
<PAGE>


Our future results will be affected by a number of factors including our ability
to:

     o    increase the number of products sold,

     o    develop, introduce and deliver new products on a timely basis,

     o    anticipate accurately customer demand patterns and

     o    manage future inventory levels in line with anticipated demand.

These results may also be affected by currency exchange rate fluctuations and
economic conditions in the geographical areas in which we operate. There can be
no assurance that our historical trends will continue, or that revenues, gross
profit and net income in any particular quarter will not be lower than those of
the preceding quarters, including comparable quarters.

IMPACT OF INFLATION AND CURRENCY FLUCTUATIONS

The US Dollar cost of our operations in Israel is influenced by the differential
between the rate of inflation in Israel and any change in the value of the NIS
relative to the Dollar.

A devaluation of the NIS in relation to the US Dollar will have the effect of
decreasing the costs in NIS and a converse effect in case of devaluation of the
US Dollar in relation to the NIS.

A devaluation of the NIS in relation to the US Dollar will have the effect of
decreasing the Dollar value of any of our assets which consist of NIS (unless
such asset is linked to the Dollar). Such a devaluation would also have the
effect of reducing the Dollar amount of any of our liabilities which are payable
in NIS (unless such payables are linked to the Dollar). Conversely, any increase
in the value of the NIS in relation to the Dollar will have the effect of
increasing the Dollar value of our assets which consist of NIS (unless such
asset is linked to the Dollar). Such an increase would also have the effect of
increasing the Dollar amount of any of our liabilities which are payable in NIS
(unless such payables are linked to the Dollar).

In the years ended December 31 2003, 2002, 2001, 2000 and 1999, the annual
inflation rate in Israel as adjusted for the devaluation of the Israeli currency
in relation to the Dollar was 5.7% (0.8)%, (7.8)%, 2.7% and 1.5%, respectively.
The closing representative exchange rate of the Dollar at the end of each such
period, as reported by the Bank of Israel, was NIS 4.379 NIS 4.737, NIS 4.416,
NIS 4.041 and NIS 4.153, respectively. As a result, the Company experienced
increases in the Dollar costs of operations in Israel in 1999, 2000 and 2003,
and decreases in 2001 and 2002.

EFFECTIVE CORPORATE TAX RATE

The Israeli regular tax rate imposed on companies is 36%, however, the effective
tax rate payable by a company (such as ours) which derives income from an
"Approved Enterprise," may be considerably less. See Note 13 to the Consolidated
Financial Statements and Item 10E ahead. Subject to relevant tax treaties,
dividends or interest received by an Israeli corporation from subsidiaries are
generally subject to tax (unless the subsidiary's income is subject to Israeli
corporate tax) regardless of its status as an Approved Enterprise. We anticipate
that most of our taxable income over the next several years will be tax exempt
in Israel. Our U.S. and U.K. subsidiaries, however, will be subject to U.S. and
U.K. corporate income taxes, respectively, on their taxable income.

On January 1, 2003, a comprehensive tax reform took effect in Israel. Pursuant
to the reform, resident companies are subject to Israeli tax on income accrued
or derived in Israel or abroad. In addition, the concept of "controlled foreign
corporations" was introduced, according to which an Israeli company may become
subject to Israeli taxes on certain income of a non-Israeli subsidiary if the
subsidiary's primary source of income is passive income (such as interest,
dividends, royalties, rental income or capital gains). The tax reform also
substantially changed the system of taxation of capital gains.


                                       12
<PAGE>


GRANTS AND PARTICIPATION

Under the Law for the Encouragement of Industrial Research and Development, 1984
(the "Research Law"), research and development programs approved by a research
committee appointed by the Israeli Government are eligible for grants in
exchange for payment to the Government of royalties from the sale of products
developed in accordance with the Program. Regulations issued under the Research
Law generally provide for the payment of royalties to the Office of the Chief
Scientist of 3.5% on sales of products developed as a result of a research
project so funded until 100% of the dollar-linked grant is repaid. Royalties
payable with respect to grants received under programs approved by the OCS after
January 1, 1999, are subject to interest on the U.S. dollar-linked value of the
total grants received at the annual rate of LIBOR applicable to U.S. dollar
deposits at the date the grants received.

The Research Law requires that the manufacture of any product developed as a
result of research and development funded by the Israeli Government take place
in Israel. It also provides that know-how from the research may not be
transferred to third parties without the approval of the Israeli Office of the
Chief Scientist in the Ministry of Industry and Trade. As of December 31, 2003,
the total amount of grants which we received from the Office of the Chief
Scientist, net of royalties paid or accrued, accumulated interest and net of non
recurring royalty reversal recorded in year 2003 in the amount of $339,000,
totaled $5,621,000, compared with $ 5,875,000 as of December 31, 2002. We are
committed to paying royalties to the Fund for the Encouragement of Exports for
its participation, by way of grants, in our marketing expenses outside of
Israel. Royalties payable are 3% of the growth in exports, from the year we
received the grant, up to 100% of the dollar-linked amount of the grant received
at the date the grants received.

The total amount of the grants we received from the Fund, net of royalties paid
or accrued, was $144,000 on December 31, 2003, compared with $225,000 on
December 31, 2002.

CONDITIONS IN ISRAEL

We are incorporated under the laws of Israel. Our offices and product
development and manufacturing facilities are located in Israel. As a
consequence, we are directly affected by political, economic and military
conditions in Israel. Our operations would be substantially impaired if major
hostilities involving Israel should occur or if trade between Israel and its
present trading partners should be curtailed. See also Item 3D - Risk Factors.

POLITICAL AND ECONOMIC CONDITIONS

Since the establishment of the State of Israel in 1948, a number of armed
conflicts have taken place between Israel and its Arab neighbors and a state of
hostility, varying from time to time in intensity and degree, has led to
security and economic problems for Israel. A peace agreement between Israel and
Egypt was signed in 1979. However, economic relations have been limited.

Since 1993, a joint Israeli - Palestinian Declaration of Principles and several
agreements between Israel and Palestinian representatives have been signed
outlining interim self-government arrangements. Israel has since transferred the
civil administration of the Gaza Strip and several major towns and villages in
the West Bank to the Palestinian Authority.

In addition, Israel and several other Arab States announced their intention to
establish trade and other relations and are discussing certain projects. As of
the date hereof, Israel has not entered into any peace agreement with Syria or
Lebanon. There is substantial uncertainty with regard to how the "peace process"
will develop or what effect it may have on us.

Furthermore, full diplomatic ties between Israel and Jordan were created
following a peace treaty signed in 1994. The treaty expressed a mutual desire
for full economic cooperation, the lifting of economic barriers and a strive
towards the lifting of any economic boycotts by third parties.


                                       13
<PAGE>


Despite the progress towards peace between Israel, its Arab neighbors and the
Palestinians, certain countries, companies and organizations continue to
participate in a boycott of Israeli firms. We do not believe that the boycott
has had a material adverse effect on us, but there can be no assurance that
restrictive laws, policies or practices directed towards Israel or Israeli
businesses will not have an adverse impact on our business or financial
condition in the future.

Some of our employees are obligated to perform annual reserve duty in the Israel
Defense Forces and may, at any time, be called for active military duty. While
we have operated effectively under those and similar requirements in the past,
no assessment can be made of the full impact of such requirements on us in the
future, particularly if emergency circumstances occur.

Israel's economy has been subject to many destabilizing factors including a
period of high inflation in the early to mid-1980s. It has also been subject to
low foreign exchange reserves, fluctuations in world commodity prices, military
conflicts and civil unrest. The Government of Israel has intervened in several
sectors of the economy, employing among other means, fiscal and monetary
policies, import duties, foreign currency restrictions and control of wages, as
well as prices and foreign currency exchange rates.

In 1998, the Israeli currency control regulations were liberalized dramatically.
As a result, Israeli citizens can generally freely purchase and sell Israeli
currency and assets. The Government of Israel has periodically changed its
policies in these areas. There are currently no Israeli currency control
restrictions on remittances of dividends on ordinary shares or proceeds from the
sale of ordinary shares; however, legislation remains in effect pursuant to
which currency controls can be imposed by administrative action at any time.

The costs of our operations in Israel are generally incurred in New Israeli
Shekels ("NIS"). If the inflation rate in Israel exceeds the rate of devaluation
of the NIS against the US Dollar in any period, the costs of our Israeli
operations, as measured in US Dollars, could increase. Israel's economy has, at
various times in the past, experienced high rates of inflation.

Like many Israeli companies, we receive grants and tax benefits from the Israeli
Government. We also participate in programs sponsored by the Israeli Government.
The reduction or termination of any such grants, programs or tax benefits,
especially those benefits available as a result of the "Approved Enterprise"
status of certain facilities in Israel, could have a materially adverse effect
on future investments by us in Israel.

TRADE AGREEMENTS

Israel is a member of the United Nations, the International Monetary Fund, the
International Bank for Reconstruction and Development, and the International
Finance Corporation. Israel is also a signatory to the General Agreement on
Tariffs and Trade, which provides for reciprocal lowering of trade barriers
among its members. In addition, Israel has been granted preferences under the
Generalized System of Preferences, from Australia, Canada and Japan. These
preferences allow Israel to export the products covered by such programs either
duty-free or at reduced tariffs.

Israel and the European Union signed a Free Trade Agreement, which became
effective on July 1, 1975, that confers certain advantages with respect to
Israeli exports to most European countries and obligates Israel to lower its
tariffs with respect to imports from these countries over a number of years. In
1985, Israel and the United States entered into an agreement to establish a Free
Trade Area ("FTA"). The FTA has eliminated all tariff and certain non-tariff
barriers on most trade between the two countries.

On January 1, 1993, Israel and the European Free Trade Association ("EFTA"),
entered into an agreement establishing a free-trade zone between Israel and the
EFTA nations. In recent years, Israel has established commercial and trade
relations with a number of other nations, including Russia, the People's
Republic of China, India and the nations of Eastern Europe, with which Israel
had not previously had such relations.


                                       14
<PAGE>


5B.  LIQUIDITY AND CAPITAL RESOURCES

We finance our activities by different means, including proceeds of equity
financing, long-term loans, grants from the Office of the Chief Scientist in
Israel and income from operating activities.

In December 2003 we received net proceeds of $928,000 from a private placement
with two European private investors. We issued these investors 357,143 ordinary
shares at a price per share of $2.80. We also granted these investors certain
incidental registration rights with respect to the ordinary shares they
purchased.

On June 10, 2004 the Company entered into a Securities Purchase Agreement (the
"Purchase Agreement"), with Laurus Master Fund Ltd. (the "Investor"), under
which the Company issued and sold to the Investor in a private placement (i) a
Secured Convertible Term Note of a $2 million principal amount, due June 10,
2007 (the "Note") and (ii) a warrant to purchase 130,000 Ordinary Shares at an
exercise price of $4.04 per share (the "Warrant"). The Warrant is exercisable,
in whole or in part, until June 10, 2011. The Note bears interest at a
fluctuating interest rate equal at all times to the prime rate plus 3%, subject
to reduction if the average closing price of the Registrant's Ordinary Shares
exceeds certain benchmarks. The proceeds from the private placement will be used
for general working capital purposes and/or mergers and acquisitions.

The Note is convertible into Ordinary Shares at a price of $3.08 per share
(subject to adjustment). The principal amount of the Note is repayable in
monthly installments, commencing as of October 1, 2004, in the initial amount of
$20,000 eventually increasing to $73,600, and may be paid in cash or, subject to
certain conditions, in Ordinary Shares. Interest on the Note is payable monthly
and may be paid in cash or, subject to certain conditions, in Ordinary Shares.
The Note is secured by a security interest in certain assets of the Company.

The Company also entered into a Registration Rights agreement with the Investor
pursuant to which the Company agreed to prepare and file with the Securities and
Exchange Commission within 45 days a registration statement covering the resale
of Ordinary Shares that is issuable upon conversion of the Note and/or exercise
of the Warrants, and/or issuable in payment of principal and interest on the
Note.

As of December 31, 2003, we had $3,872,000 in cash and cash equivalents,
$2,876,000 in marketable securities, and positive working capital of $5,082,000.
Net cash used in operating activities of continuing operations in 2003 was
$1,937,000 compared to cash provided by operating activities in 2002 in the
amount of $127,000. The cash used in operating activities in year 2003 was
adversely affected by a number of factors. First, a decrease in gross profit due
to the sales through distributors instead of subsidiaries from mid 2003, which
was not immediately compensated by decrease in the sales and marketing expenses
in 2003. Second, the revenues of BOSANOVA PrintBoss in year 2003 amounted to
$448,000 compared to $1,387,000 in year 2002. Since the BOSANOVA PrintBoss is a
software product with a relatively low cost of production, the decrease in its
revenues in year 2003 compared to year 2002 adversely affected the cash used in
operating activities. Net cash provided by investing activities in 2003 was
$519,000 which was mainly due to realization of restricted cash into cash and
cash equivalents.

The Company does not currently have borrowings from financial institutions.

Working capital and working capital requirements will vary from time-to-time and
will depend on numerous factors, including but not limited to operating results,
the level of resources devoted to research and development, new product
introductions, grants from the Office of the Chief Scientist in Israel,
marketing and acquisition activities.


                                       15
<PAGE>


We have in-balance sheet financial instruments and off-balance sheet contingent
commitments. Our in-balance sheet financial instruments consist of our assets
and liabilities. Our cash is invested in short-term (less than 3 months) U.S.
dollars and NIS interest bearing deposits with banks. Our receivables' aging is
between 60 to 70 days and our current liabilities' aging is approximately 60
days. The fair value of our financial instruments is similar to their book
value. Our off-balance sheet contingent commitments consist of: (a) royalty
commitments that are directly related to our future revenues, (b) lease
commitments of our premises and vehicles, (c) directors and officers'
indemnities, in excess of the proceeds received from liability insurance which
we obtain and (d) legal proceeding.

We believe that cash resources are sufficient to meet our needs for at least 12
months following the date of this submission. However, it is our intention to
engage in equity and loan financing to further feature-rich products of the
Company and establish distribution channels in new markets. There is, however,
no assurance that we shall be able to obtain such financing.

5C.  RESEARCH AND DEVELOPMENT

We believe that our future growth will depend upon our ability to enhance our
existing products and introduce new products on a timely basis. Since we
commenced operations, we have conducted extensive research and development
activities. In 2003, gross research and development costs totaled $2,129,000,
compared to $2,182,000 in 2002 and $2,746,000 in 2001.

Our research and development efforts have been focused on VOIP solutions, and
our existing products for the IBM midrange market. We intend to finance our
research and development activities with our own resources and grants from the
Office of the Chief Scientist. Grants from the Chief Scientist totaled $283,000
in 2003 and $989,000 in 2001 (no grants were received for the year 2002).

5D.  TREND INFORMATION

The global slowdown in the telecommunications industry has taken its toll on our
company. The effect of a prolonged slowdown may continue to result in lower
sales and lower gross margins as our products may be subject to price pressure
due to reduced demand, write-downs and write-offs.

Over the past few years there has been a continuous global decrease in sales and
revenues from the connectivity solutions sector (also known as the legacy family
products) (see Item 4B). Although the Company's revenues in this sector have
decreased as a result, in comparison to other players in this field, we have
fared quite well.

Currently the Company's R&D focuses mainly on the company's VOIP line of
products, that will successfully compete with Legacy telephony quality and
reliability, and will allow special CTI (Computer Telephony Integration)
features that are not available in Legacy telephony today. These products will
allow seamless integration with legacy telephony systems, thus reducing the
implementation price. In addition, the products will guaranty the quality of
service and will allow the end users to use the telephone system in the same way
that they used their non-IP-enabled system. Until now, complicated installation,
non-transparent usage and inconsistent quality of service were the major issues
that slowed-down the implementation of VOIP in the corporate market. With the
new line of intelligent gateways, these hurdles are solved, thus opening new
opportunities in this market. According to market research performed by
professional market analysis firms such as Advanced Business Link, the revenues
in this VOIP market are expected to grow for at least the next five years.
Although the Company's business in this market has not fared well until now, we
hope to overcome marketing and other hurdles, and become a significant player in
this field, although there is no assurance that we will be able to do so.


                                       16
<PAGE>


5E.  OFF-BALANCE SHEET ARRANGEMENTS

In 1998, as part of PacInfoSystems' Share Purchase Agreement between the Company
and Mr. Jacob Lee (the seller of PacInfoSystems who became a shareholder of the
Company), certain actions involving PacInfoSystems, if occurring before the end
of 2003, may trigger a tax event for Mr. Jacob Lee. In such event, the Company
may be obligated, under the purchase agreement, to grant Mr. Lee a loan on a
full recourse basis for certain tax payments Mr. Lee may be liable for,
currently estimated at approximately $1.5 million. The purchase agreement
provides that the Company is to receive a security interest in shares of the
Company that Mr. Lee holds at the time of the loan with a fair market value as
of the date of the loan of at least 125% of the amount of the loan as security
for the repayment of the loan. In addition, in the event the Company is required
to loan such sum to Mr. Lee, the Company may also be required to reimburse Mr.
Lee for certain interest on taxes that he may owe. It is possible that the
windup of PacInfoSystems during 2002 and 2003 may have triggered such a tax
event for Mr. Lee, which would result in an obligation by the Company to loan
Mr. Lee such amount and to reimburse him for interest expenses incidental to the
tax event.

5F.  TABULAR DISCLOSURE OF CONTRACTUAL OBLIGATIONS

The following table summarizes our contractual obligations as of December 31,
2003:

<TABLE>
<CAPTION>
                                  Payment due by period

                                      Less than 1                          More than 5
                           Total         year      1-3 years    3-5 years    years

<S>                         <C>          <C>          <C>           <C>       <C>
Operating lease             $471         $286         $185          -         -

Purchase obligation         $415         $415            -          -         -

Total                       $886         $701         $185          -         -
</TABLE>


The above table does not include contingent obligations to pay royalties to the
Office of the Chief Scientist and to the Overseas Marketing Fund since the total
amount to be paid under the terms of those agreements are a function of future
sales (see note 11(a)(1) of the Consolidated Financial Statements).


ITEM 8:  FINANCIAL INFORMATION.

8A.  CONSOLIDATED STATEMENTS AND OTHER FINANCIAL INFORMATION

CONSOLIDATED FINANCIAL STATEMENTS

See Item 18.

SALES OUTSIDE ISRAEL

The total amount of export sales of the Company has been as follows:

2003- $4,173,000 (totaling 73% of all revenues); 2002 - $7,147,000 (totaling 76%
of all revenues); 2001 - $4,787,000 (totaling 79% of all revenues);


                                       17
<PAGE>


LEGAL PROCEEDINGS

In 2001, our US subsidiary, PacInfoSystems acquired 100% of Dean Tech. The
effective date of the acquisition was January 1, 2001. The total purchase price,
including acquisition costs, consisted of $275,000 in cash plus Dean Tech's
total amount of cash and accounts receivables, less accounts payable, and plus
payments to the sellers of certain annual earn-out payments until April 15,
2004. During the second quarter of 2002, the sellers of Dean Tech disputed the
financial audit and earnings calculations of Dean Tech for the year ended 2001,
which directly affected their earn-out payment for that year. Their dispute was
submitted to the American Arbitration Association ("AAA") and contained a claim
for an earn-out payment in the amount of $900,000 against PacInfoSystems. In
October 2002, the AAA resolved that PacInfoSystems should pay the sellers of
Dean Tech $618,000 plus $29,000 arbitration costs. In July 2003 BOS entered into
an Agreement and Assignment of the AAA Judgment with the sellers of Dean Tech,
and negotiated a final payment of $324,000, made by BOS to the sellers of Dean
Tech

PacInfoSystems is responsible for collecting sales taxes on sales of products to
customers in various states. Between 1999 and 2001 PacInfoSystems had not
remitted collected sales taxes to several states on a timely basis. As of
December 31, 2001, the financial statements included a liability for taxes,
interest and estimated penalties amounting to $1,392,000. During 2002,
PacInfoSystems paid its unpaid sales taxes according to certain amnesties with
state authorities in the amount of $772,000. As a result, PacInfoSystems
reversed the provision for interests and penalties in the amount of $568,000.
During year 2003 the Company reached a final settlement with the tax
authorities, which resulted in additional sales tax expenses in year 2003 in the
amount of $28,000. As of December 31, 2003 there is no sales tax debt.

In July 2002, Operate Lease, Ltd., a company from which the Company leased cars
for its employees, claimed that the Company's termination notice of the leasing
agreement in March 2002 constituted a breach of the agreement and Operate Lease
demanded compensation in the amount of NIS 1,278,968 (the nominal sum of the
claim is equivalent to approximately $292,000, as of December 31, 2003). The
Company denied the claim and to date, no legal proceeding has been filed. The
Company does not believe that the chances of Operate Lease prevailing and
recovering a significant amount, are high, and therefore no provision was
recorded.

On the basis of an audit conducted by the Office of the Chief Scientist in
October 2002, the Company was required to pay royalties in the sum of $473,200
for the years 1991-1999 (in excess of royalties already paid for this period).
The Company paid $23,367 and appealed with respect of the remainder of the sum
claimed. In July 2003 the company entered into an agreement with the Chief
Scientist pursuant to which the required royalties for the years 1991-1999 were
reduced from $473,200 to $247,000. The Company has recorded a provision for the
reduced amount.

DIVIDEND POLICY

We intend to reinvest our earnings and therefore do not anticipate paying any
cash dividends in the foreseeable future. The declaration and payment of any
cash dividends in the future will be determined by the Board of Directors in
light of the conditions existing at the time. This will include our earnings and
financial condition. We may only pay cash dividends in any fiscal year out of
"profits," as determined under Israeli statutory standards. Any dividends paid
out of Approved Enterprise earnings (i.e. tax exempt income) will be liable to
tax. As we do not intend to distribute these earnings, no provision has been
made for this additional tax in our Financial Statements.


                                       18
<PAGE>


8B.  SIGNIFICANT CHANGES

Not applicable.

ITEM 18: FINANCIAL STATEMENTS

The following restated financial statements are filed as part of this Annual
Report:

<TABLE>
<CAPTION>
                                                 PAGE
                                                 ----
<S>                                              <C>
Report of Independent Auditors                   F-2
Consolidated Balance Sheets                      F-3 - F-4
Consolidated Statements of Operations            F-5
Statement of Changes in Shareholders' Equity     F-6
Statements of Cash Flows                         F-7 - F-8
Notes to Consolidated Financial Statements       F-9 - F-33
</TABLE>

The consolidated financial statements of Surf Communications Solutions Ltd., are
also filed as part of this Annual Report.

ITEM 19:  EXHIBITS

The following exhibits are filed as part of this Annual Report:

1.1  Memorandum of Association, as amended (incorporated by reference to the
     Company's Annual Report on Form 20-F filed on June 27, 2003).

1.2  Articles of Association, as amended (incorporated by reference to the
     Company's Annual Report on Form 20-F filed on June 27, 2003).

4.1  Form of Indemnification Agreement between the Company and its officers and
     directors (incorporated by reference to the Company's Current Report on
     Form 6-K filed on January 17, 2003).

4.2* Share Purchase Agreement, dated as of February 23, 2003, and Option
     Agreement and Registration Rights Agreement, dated as of March 30, 2003, by
     and between Catalyst Investments L.P. and the Registrant.

4.3* Share Purchase Agreement and Registration Rights Agreement, dated as of
     December 14, 2003, by and between Hillswood Holdings Limited and Vamos Inc.
     and the Registrant.

4.4* Services Agreement, dated as of April 15, 2003, between Cukierman & Co.
     Investment House Ltd., BOScom Ltd. and the Registrant.

4.5* Management Agreement between Signum Ltd., Adiv Baruch and the Registrant,
     dated as of January 1, 2004.

4.6* Securities Purchase Agreement, Master Security Agreement and Registration
     Rights Agreement, dated as of June 10, 2004, by and between Laurus Master
     Fund Ltd. and the Registrant.

4.7  Distribution Agreement, dated as of January 15, 2003, by and between Boscom
     Ltd. and Bosanova Inc.

8.1  List of subsidiaries (incorporated by reference to Item 4C of this Annual
     Report on Form 20-F).

10.1 Consent of Kost Forer Gabbay & Kasierer, a member of Ernst &Young Global.


                                       19
<PAGE>


31.1 Certification by Chief Executive Officer pursuant to Rule 13a-14(a) or Rule
     15d-14(a) of the Securities Exchange Act of 1934.

31.2 Certification by Chief Financial Officer pursuant to Rule 13a-14(a) or Rule
     15d-14(a) of the Securities Exchange Act of 1934.

32.1 Certification by Chief Executive Officer and Chief Financial Officer
     pursuant to Rule 13a-14(b) or Rule 15d-14(b) of the Securities Exchange Act
     of 1934.





* previously filed







                                       20
<PAGE>


                                   SIGNATURES



The Registrant hereby certifies that it meets all of the requirements for filing
on Form 20-F and that it has duly caused and authorized the undersigned to sign
this Amendment No. 1 to its annual report on its behalf.



                  B.O.S. Better On-Line Solutions, Ltd.


/s/ Adiv Baruch                                      /s/ Nehemia Kaufman
-------------------------------------                -----------------------
Adiv Baruch                                          Nehemia Kaufman
President and Chief Executive Officer                Chief Financial Officer




Date: January 6, 2005


                                       21
<PAGE>



                       B.O.S. BETTER ONLINE SOLUTIONS LTD.

                              AND ITS SUBSIDIARIES

                        CONSOLIDATED FINANCIAL STATEMENTS

                             AS OF DECEMBER 31, 2003

                                 IN U.S. DOLLARS


                                      INDEX

<TABLE>
<CAPTION>
                                                                                PAGE

<S>                                                                           <C>
 REPORT OF INDEPENDENT AUDITORS                                                  F2

 CONSOLIDATED BALANCE SHEETS                                                  F3 - F4

 CONSOLIDATED STATEMENTS OF OPERATIONS                                           F5

 STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY                                   F6

 CONSOLIDATED STATEMENTS OF CASH FLOWS                                        F7 - F8

 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                                   F9 - F33
</TABLE>


                             - - - - - - - - - - - -

<PAGE>
<TABLE>
<CAPTION>
<S>                      <C>                                           <C>
ERNST & YOUNG            o    KOST FORER GABBAY & KASIERER             o    Phone:  972-3-6232525
                              3 Aminadav St.                                Fax:    972-3-5622555
                              Tel-Aviv 67067, Israel
</TABLE>


                         REPORT OF INDEPENDENT AUDITORS

                   THE BOARD OF DIRECTORS AND SHAREHOLDERS OF

              B.O.S. BETTER ONLINE SOLUTIONS LTD. AND SUBSIDIARIES

     We have audited the accompanying consolidated balance sheets of B.O.S
Better OnLine Solution Ltd. ("the Company") and subsidiaries as of December 31,
2003 and 2002, and the related consolidated statements of operations, changes in
shareholders' equity and cash flows for each of the three years in the period
ended December 31, 2003. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.

     We conducted our audits in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.

     In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of the Company and
subsidiaries at December 31, 2003 and 2002, and the consolidated results of
their operations and cash flows for each of the three years in the period ended
December 31, 2003, in conformity with U.S. generally accepted accounting
principles.

     As described in Note 1e of the notes to the consolidated financial
statements, the accompanying financial statements have been restated to correct
amounts with respect to the Company's investment in an affiliated company.

     As discussed in the notes to the consolidated financial statements,
effective January 1, 2002 the Company changed its method of accounting for
goodwill to conform with Statement of Financial Accounting Standards
No.142,"Goodwill and Other Intangible Assets" see Note 2(k).

<TABLE>
<CAPTION>
<S>                                                             <C>
Tel-Aviv, Israel                                                  KOST FORER GABBAY & KASIERER
March 22,  2004,  Except  for note 1e, as to                    A Member of Ernst & Young Global
which the date is January 6,
2005
</TABLE>


                                     F - 2
<PAGE>

                                             B.O.S. BETTER ONLINE SOLUTIONS LTD.
                                                            AND ITS SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS
-------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

<TABLE>
<CAPTION>
                                                                                            DECEMBER 31,
                                                                                       ----------------------
                                                                                        2003*)        2002*)
                                                                                       -------       -------
<S>                                                                                    <C>           <C>
    ASSETS

CURRENT ASSETS
  Cash and cash equivalents                                                            $ 3,872       $ 5,246
  Restricted cash (Note 3)                                                                   -           700
  Marketable securities (Note 6)                                                         1,014           819
  Trade receivables (net of allowance for doubtful accounts of $ 171 in 2003 and
    $ 347 in 2002)                                                                       1,075         1,523
  Other accounts receivable and prepaid expenses (Note 4)                                  317           382
  Inventories (Note 5)                                                                     961           855
                                                                                       -------       -------

                                                                                         7,239         9,525
                                                                                       -------       -------
LONG-TERM INVESTMENTS:
  Long-term marketable securities (Note 6)                                               1,862         2,226
  Long-term prepaid expenses                                                                 -            15
  Severance pay funds                                                                      684           563
  Investment in an affiliated company (Note 7)                                           2,780         1,335
                                                                                       -------       -------

Total long-term investments                                                              5,326         4,139
                                                                                       -------       -------

PROPERTY AND EQUIPMENT, NET (Note 8)                                                       598           965
                                                                                       -------       -------

GOODWILL (Note 9)                                                                          741           741
                                                                                       -------       -------

ASSETS RELATED TO DISCONTINUED OPERATIONS (Note 1c)                                        119         1,115
                                                                                       -------       -------

                                                                                       $14,023       $16,485
                                                                                       =======       =======
</TABLE>


*) Restated, see Note 1e.

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


                                     F - 3
<PAGE>



                                             B.O.S. BETTER ONLINE SOLUTIONS LTD.
                                                            AND ITS SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS
-------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE DATA

<TABLE>
<CAPTION>

                                                                                               DECEMBER 31,
                                                                                        --------------------------
                                                                                         2003*)           2002*)
                                                                                        --------         --------
<S>                                                                                     <C>              <C>
    LIABILITIES AND SHAREHOLDERS' EQUITY

CURRENT LIABILITIES:
  Trade payables                                                                        $    464         $  1,044
  Employee and payroll accruals                                                              404              717
  Deferred revenues                                                                          378              491
  Accrued expenses and other liabilities (Note 10)                                           911            1,293
                                                                                        --------         --------

Total current liabilities                                                                  2,157            3,545
                                                                                        --------         --------


  ACCRUED SEVERANCE PAY                                                                      951              794
                                                                                        --------         --------


LIABILITIES RELATED TO DISCONTINUED OPERATIONS (Note 1c)                                     374            4,131
                                                                                        --------         --------

COMMITMENTS AND CONTINGENT LIABILITIES (Note 11)

SHAREHOLDERS' EQUITY:
  Share capital (Note 12)-
    Ordinary shares of NIS 4.00 par value: Authorized: 8,750,000 shares at
      December 31, 2003 and 2002; Issued 4,167,509 and 3,177,264 shares at
      December 2003 and 2002, respectively; Outstanding: 4,162,126 and 3,171,881
      shares at December 2003 and 2002, respectively                                       4,309            3,690
  Additional paid-in capital                                                              43,247           41,319
  Treasury shares (5,383 Ordinary shares at December 31, 2003 and 2002)                     (150)            (150)
  Accumulated deficit                                                                    (36,865)         (36,844)
                                                                                        --------         --------

                                                                                          10,541            8,015
                                                                                        --------         --------

                                                                                        $ 14,023         $ 16,485
                                                                                        ========         ========
</TABLE>

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

*) Restated, see Note 1e.


                                     F - 4
<PAGE>
                                             B.O.S. BETTER ONLINE SOLUTIONS LTD.
                                                            AND ITS SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS
-------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA

<TABLE>
<CAPTION>
                                                                                      YEAR ENDED DECEMBER 31,
                                                                          ------------------------------------------
                                                                           2003*)           2002*)           2001*)
                                                                          --------         --------         --------
<S>                                                                       <C>              <C>              <C>
Revenues                                                                  $  5,728         $  9,441         $  6,042
Cost of revenues                                                             1,794            2,300            2,703
Non recurring royalty reversal (Note 14a)                                     (339)               -                -
                                                                          --------         --------         --------

Gross profit                                                                 4,273            7,141            3,339
                                                                          --------         --------         --------

Operating costs and expenses:
  Research and development                                                   2,129            2,182            2,746
  Less - grants and participation                                             (283)               -             (989)
  Sales and marketing                                                        2,178            3,705            4,811
  General and administrative                                                 1,317            1,697            1,425
  Restructuring and related costs                                              678                -              132
                                                                          --------         --------         --------

Total operating costs and expenses                                           6,019            7,584            8,125
                                                                          --------         --------         --------

Operating loss                                                              (1,746)            (443)          (4,786)
Financial income, net (Note 14b)                                               109              295              427
Other income (expenses) (Note 14c)                                              45              (95)            (298)
                                                                          --------         --------         --------

Loss before equity in losses of an affiliated company                       (1,592)            (243)          (4,657)
Equity in losses of an affiliated company                                      465              570              137
                                                                          --------         --------         --------
Net loss from continuing operations                                         (2,057)            (813)          (4,794)
                                                                          --------         --------         --------
Net income (loss) related to discontinued operations (Note 1c)               2,036           (7,674)          (8,313)
                                                                          --------         --------         --------


Net loss                                                                  $    (21)        $ (8,487)        $(13,107)
                                                                          ========         ========         ========

Basic and diluted net loss per share from continuing operations
  (Note 14d)                                                              $  (0.56)        $  (0.26)        $  (1.55)
                                                                          ========         ========         ========

Basic and diluted net income (loss) per share from discontinued
  operations (Note 14d)                                                   $   0.55         $  (2.46)        $  (2.68)
                                                                          ========         ========         ========


Basic and diluted net loss per share NIS 4.00 par value (Note 14d)        $  (0.01)        $  (2.72)        $  (4.23)
                                                                          ========         ========         ========
</TABLE>


*) Restated, see Note 1e.

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


                                     F - 5
<PAGE>



                                             B.O.S. BETTER ONLINE SOLUTIONS LTD.
                                                            AND ITS SUBSIDIARIES

STATEMENTS OF  SHAREHOLDERS' EQUITY
-------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE DATA

<TABLE>
<CAPTION>
                                                                                                          TREASURY
                                                         NUMBER                 ADDITIONAL                 SHARES       TOTAL
                                                      OF ORDINARY     SHARE      PAID-IN    ACCUMULATED    HELD BY    SHAREHOLDERS'
                                                         SHARES      CAPITAL     CAPITAL     DEFICIT *)   A TRUSTEE     EQUITY*)
                                                        ---------   ---------   ---------    ---------    ---------    ---------
<S>                                                     <C>         <C>         <C>          <C>          <C>          <C>
Balance at January 1, 2001                              3,102,264   $   3,628   $  41,216    $ (15,250)   $    (150)   $  29,444

  Stock based compensation                                      -           -           4            -            -            4
  Net loss                                                      -           -           -      (13,107)           -      (13,107)
                                                        ---------   ---------   ---------    ---------    ---------    ---------

Balance at December 31, 2001                            3,102,264       3,628      41,220      (28,357)        (150)      16,341

  Issuance of shares                                        3,750           3          27            -            -           30
  Issuance of shares related to the private
    placement in 2000                                      71,250          59          (1)           -            -           58
  Reversal of accrued issuance expenses                         -           -          66            -            -           66
  Stock based compensation related to warrants issued
    to service providers                                        -           -           7            -            -            7
  Net loss                                                      -           -           -       (8,487)           -       (8,487)
                                                        ---------   ---------   ---------    ---------    ---------    ---------

Balance at December 31, 2002                            3,177,264       3,690      41,319      (36,844)        (150)       8,015

  Issuance of shares related to share swap
    transaction                                           633,102         537       1,059            -            -        1,596
  Issuance of shares related to the private
    placement in 2003                                     357,143          82         846            -            -          928
  Stock based compensation related to warrants
    issued to service providers                                 -           -          23            -            -           23
  Net loss                                                      -           -           -          (21)           -          (21)
                                                        ---------   ---------   ---------    ---------    ---------    ---------

Balance at December 31, 2003                            4,167,509   $   4,309   $  43,247    $ (36,865)   $    (150)   $  10,541
                                                        =========   =========   =========    =========    =========    =========
</TABLE>


*) Restated, see Note 1e.

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


                                     F - 6
<PAGE>

                                             B.O.S. BETTER ONLINE SOLUTIONS LTD.
                                                            AND ITS SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS
-------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

<TABLE>
<CAPTION>
                                                                             YEAR ENDED    YEAR ENDED    YEAR ENDED
                                                                             DECEMBER 31,   DECEMBER      DECEMBER
                                                                               2003 *)     31, 2002 *)   31, 2001 *)
                                                                              --------      --------      --------
CASH FLOWS FROM OPERATING ACTIVITIES

<S>                                                                           <C>           <C>           <C>
 Net loss                                                                     $    (21)     $ (8,487)     $(13,107)
   Adjustments  to reconcile  net loss to net cash  provided by (used in)
     operating activities:
   Net loss (income) from discontinuing operations                              (2,036)        7,674         8,313
   Depreciation and amortization                                                   307           390           568
   Impairment of property and equipment                                            110            95             -
   Accrued severance pay, net                                                       36           (49)          (26)
   Amortization of premium on marketable securities                                101            89            28
   Interest on investment in affiliate                                               -             -           (42)
   Equity in losses of an affiliated company                                       465           570           137

   Capital loss from sale of property and equipment                                  6             -            32
   Gain on sale of marketable securities                                           (13)            -             -
   Stock  based  compensation  related  to  warrants  issued  to  service
     providers                                                                      23             7             4
   Decrease (increase) in trade receivables                                        448           (28)          832
   Decrease in other accounts receivable and prepaid expenses                      131           186           106
   Decrease (increase) in inventories                                             (106)         (548)        1,024
   Increase (decrease) in trade payables                                          (580)          596          (500)
   Increase  (decrease)  in  employees  and  payroll  accruals,  deferred
     revenues, accrued expenses and other liabilities                             (808)         (368)          961
                                                                              --------      --------      --------
 Net cash flows provided by (used in) continuing operations                     (1,937)          127        (1,670)
 Net cash provided by (used in) operating  activities from  discontinuing
   operations                                                                   (1,032)          728         2,576
                                                                              --------      --------      --------
 Net cash provided by (used in) operating activities                            (2,969)          855           906
                                                                              --------      --------      --------

 CASH FLOWS FROM INVESTING ACTIVITIES:

 Purchase of property and equipment                                                (64)         (163)         (389)
 Proceeds from sale of property and equipment                                        8             9            23
 Purchase of other assets                                                            -             -            (4)
 Investment in long-term marketable securities                                    (971)         (196)       (2,912)
 Investment in an affiliated company                                              (155)            -        (2,000)
 Realization of (investment in) restricted cash                                    700          (700)            -
 Proceeds from sale of marketable securities                                     1,001             -             -
                                                                              --------      --------      --------
 Net cash  provided by (used in)  investing  activities  from  continuing
   operations                                                                      519        (1,050)       (5,282)
 Net cash used in investing activities from discontinuing operations                 -          (160)       (1,909)
                                                                              --------      --------      --------
 Net cash provided by (used in) investing activities                               519        (1,210)       (7,191)
                                                                              --------      --------      --------


 CASH FLOWS FROM FINANCING ACTIVITIES:

 Repayment of long-term loan                                                         -          (286)         (429)
 Proceeds from issuance of shares                                                  928            58             -
 Payment for acquisition of a subsidiary                                             -             -           (66)
 Issuance expenses related to investment in an affiliated company                 (159)            -             -
                                                                              --------      --------      --------
 Net cash  provided by (used in)  financing  activities  from
   continuing operations                                                           769          (228)         (495)
 Net cash used in financing activities from discontinuing operations               (47)       (3,216)       (1,095)
                                                                              --------      --------      --------
 Net cash provided by (used in) financing activities                               722        (3,444)       (1,590)
                                                                              --------      --------      --------
 Decrease in cash and cash equivalents                                          (1,728)       (3,799)       (7,875)
 Decrease  (increase)  in cash  and  cash  equivalents  of  discontinuing
   operations                                                                      354           720          (270)
 Cash and cash equivalents at the beginning of the year                          5,246         8,325        16,470
                                                                              --------      --------      --------
 Cash and cash equivalents at the end of the year                             $  3,872      $  5,246      $  8,325
                                                                              ========      ========      ========
</TABLE>

*) Restated, see Note 1e.

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


                                     F - 7
<PAGE>

                                             B.O.S. BETTER ONLINE SOLUTIONS LTD.
                                                            AND ITS SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS
-------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

<TABLE>
<CAPTION>
                                                                            YEAR ENDED      YEAR ENDED    YEAR ENDED
                                                                            DECEMBER 31,    DECEMBER 31,  DECEMBER 31,
                                                                               2003 *)        2002 *)      2001 *)
                                                                              ---------      ---------    ---------
<S>                                                                           <C>               <C>         <C>
      Supplemental disclosure of cash flow activities:
 (i)  Net cash paid during the year for:
        Interest                                                              $        1        $ 82        $570
                                                                              ==========        ====        ====
 (ii) Non-cash activities:
      Investment in an affiliated company against issuance of shares          $    1,755        $ 30        $  -
                                                                              ==========        ====        ====
      Reversal of issuance expenses payable                                   $        -        $ 66        $  -
                                                                              ==========        ====        ====
</TABLE>

*) Restated, see Note 1e.

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


                                     F - 8
<PAGE>


                                             B.O.S. BETTER ONLINE SOLUTIONS LTD.
                                                            AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
-------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA

NOTE 1:- GENERAL

     B.O.S. Better Online Solutions Ltd. is an Israeli corporation together with
     its subsidiaries (hereinafter "the Company" or "BOS"):

     a.   Since January 2002, the Company's structure was re organized by
          transforming the Company into a holding company specializing in high
          tech investments and by merging the Company's connectivity operations
          into BOScom. As such, on January 1, 2002, the net assets pertaining to
          the connectivity operations were transferred to BOScom.

          The Company's wholly owned subsidiary, "BOScom" operates in
          connectivity, software utilities and communication solution product
          lines.

          Connectivity - A solutions for seamless integration of personal
          computers and Local Area Networks into the midrange host environment.
          "BOScom" also design, integrate, test, market and support superior
          products that provide efficient solutions to personnel connecting
          personal computers to IBM midrange hosts.

          Software Utilities - Powerful solutions for document design,
          distribution and management solutions for a wide range of operating
          systems, including mainframe and UNIX.

          Communication Solutions - BOScom developed a series of Voice over
          Internet protocol (" VOIP ") communication products designed for the
          corporate market. The gateways enable enterprises to reduce or
          eliminate inter-office communication costs or bypass long-distance
          costs using their private Intranet or the public Internet to carry
          telephone calls. They also provide a powerful means to extend Private
          Branch Exchange ("PBX") functionality to the enterprise's branch
          offices.

          In 2003, the Company reorganized BOScom activity by ceasing the
          operation off all of its wholly owned marketing subsidiaries in the UK
          and France and began to sell its products directly through independent
          distributors. As a result, the Company reduced the total worldwide
          employees by approximately 49 employees and incurred $ 678 thousand in
          restructuring costs in accordance with SFAS 146 "Accounting for Costs
          Associated with Exit or Disposal Activities". SFAS No.146 requires
          that a liability for a cost associated with an exit or disposal
          activity be recognized and measured, initially at fair value, only
          when the liability is incurred. The provisions of SFAS No.146 are
          effective for exit or disposal activities that are initiated after
          December 31, 2002.

     b.   Accounting principles:

          The consolidated financial statements for all years presented are
          prepared in accordance with generally accepted accounting principles
          ("GAAP ") in the United States of America. Prior to 2003, the
          consolidated financial statements were prepared in accordance with
          Israeli GAAP with reconciliation to U.S.GAAP.

     c.   Discontinued operation:

          On June 1, 1998, the Company acquired 100% of the share capital of
          Pacinfo ("Pacinfo"), a U.S. corporation. Pacinfo is a reseller of
          computer networking products. In April 2001, Pacinfo acquired Dean
          Technologies Associated LLC. ("DT") Texas limited Liability Company,
          which was also engaged in the computer-networking segment.


                                     F - 9
<PAGE>

                                             B.O.S. BETTER ONLINE SOLUTIONS LTD.
                                                            AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
-------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA

NOTE 1:- GENERAL (CONT.)

          In May 2002, the Board of Directors of the Company decided to sell all
          Pacinfo activity. During the fourth quarter of 2002, following
          unsuccessful efforts to sell Pacinfo and due to poor economic
          condition and continued operating losses together with a loss of key
          officers and employees, the Company initiated a plan to cease
          operations of Pacinfo and to proceed with a voluntary liquidation of
          the Company.

          The results of operations including revenue, operating expenses and
          other income and expenses of Pacinfo for 2003, 2002 and 2001 have been
          reclassified in the accompanying statements of operations as
          discontinued operations.

          The Company's balance sheets at December 31, 2003 and 2002 reflect the
          net liabilities of the Pacinfo as liabilities and assets related to
          discontinued operations within liabilities related to discontinuing
          operations and assets related to discontinuing operations.

          The carrying amounts of the major classes of assets and liabilities
          included as part of the discontinued operation are:

<TABLE>
<CAPTION>

                                                            DECEMBER 31,
                                                        --------------------
                                                         2003          2002
                                                        ------        ------
<S>                                                     <C>           <C>
Cash                                                    $   69        $  423
Trade receivables, other receivables and prepaid
  expenses                                                  18           597
Property and equipment, net                                 32            95
                                                        ------        ------

Assets of discontinued operation                        $  119        $1,115
                                                        ======        ======

Trade payables                                          $  299        $2,456
Accrued expenses and other liabilities                      75         1,675
                                                        ------        ------

Liabilities of discontinued operation                   $  374        $4,131
                                                        ======        ======
</TABLE>

          The results of operations, including revenues, cost of revenues and
          operating expenses of Pacinfo operation for 2003, 2002 and 2001 have
          been reclassified in the statements of operations. Taxes were not
          attributed to the discontinued operation due to utilization of losses
          from previous years, for which a valuation allowance was provided.
          Summarized selected financial information of the discontinued
          operation is as follows:

<TABLE>
<CAPTION>

                                                         YEAR ENDED DECEMBER 31,
                                               -----------------------------------------
                                                 2003            2002             2001
                                               --------        --------         --------

<S>                                            <C>             <C>              <C>
                      Revenues                 $     25        $ 32,912         $ 53,168
                                               ========        ========         ========
                      Net income (loss)        $  2,036        $ (7,674)        $ (8,313)
                                               ========        ========         ========
</TABLE>

     d.   The Company had one major customer in 2003, which constituted 52 % of
          the revenues. This major customer is the Company's master distributor
          in the U.S. In the event that the Company encounters problems working
          with the master distributor, the Company may experience an
          interruption in sales until an alternative source of distribution can
          be found, which may have a material adverse effect on the financial
          statements.

                                     F - 10
<PAGE>

                                             B.O.S. BETTER ONLINE SOLUTIONS LTD.
                                                            AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
-------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA

     e.   Restatement of financial statements:

          The Company has restated its financial statements for 2001, 2002 and
          2003 to reflect revised accounting treatment in its investment in an
          affiliated company, Surf Communications Solution LTD. ("Surf") as a
          result of an additional investment in an affiliated company that
          occurred during 2003. Following the restatement the Company accounted
          for its investment in an affiliated company under the equity method of
          accounting, which was previously accounted based on the cost method.

          In February 2003, the Company entered into an agreement with Catalyst
          Investors L.P. ("Catalyst") to issue Catalyst 633,102 Ordinary shares.
          In consideration for the issued shares, Catalyst granted 191,548
          series C Preferred shares it held in Surf and additional voting rights
          of 124,936 Preferred C shares that increased the Company's voting
          rights from 10.7% to 23% of Surf. As a result of the Catalyst
          transaction, the Company has the ability to exercise significant
          influence over Surf. Consequently, the results of operations (current
          and prior periods presented), and retained earnings of the Company
          were adjusted retroactively in a manner consistent with the accounting
          for a step-by-step investment in an affiliated company. Since its
          investment in Common stock was reduced to zero in prior years, the
          Company recognized equity losses only with respect to its share in the
          Preferred C shares (8.4% since November 2001 through March 2003 and
          thereafter 15.7%), in accordance with EITF 99-10 "Percentage Used to
          Determine the Amount of Equity Method Losses"

          To adjust the investment according to the equity method, the Company
          recorded equity losses in the amounts of $ 465, $ 570 and $ 137
          for the years 2003, 2002 and 2001 respectively. As a result, the
          Company reversed the impairment expense of $ 840 recorded in 2003 due
          to the fact that the equity losses recorded, reduced the carrying
          amount of the investment in Surf below its fair value. The accumulated
          equity losses net of the impairment expenses were $ 332.

          THE FOLLOWING TABLE SHOWS THE RECONCILIATIONS OF ALL AMOUNTS AS
          PREVIOUSLY REPORTED AND AS RESTATED:

<TABLE>
<CAPTION>
                                                               YEAR ENDED
                                                           DECEMBER 31, 2003
                                                ----------------------------------------
                                              AS PREVIOUSLY
                                                REPORTED       RESTATEMENT    AS RESTATED
                                                ---------       ---------      ---------
<S>                                              <C>              <C>          <C>
Operating loss                                   (1,746)             -         (1,746)

Other income                                       (795)           840             45
Loss before equity in losses of an
  affiliated company                             (2,432)           840         (1,592)
Equity in losses of an affiliated company             -           (465)          (465)
Net loss from continuing operations              (2,432)           375         (2,057)
Net loss                                           (396)           375            (21)
Basic and diluted net income (loss) per
  share from continuing operations                (0.66)          0.10          (0.56)

Basic and diluted net loss per share              (0.11)          0.10          (0.01)
</TABLE>

          Accordingly as of December 31, 2003 the investment in surf was reduced
          by $ 332.


                                     F - 11
<PAGE>

                                             B.O.S. BETTER ONLINE SOLUTIONS LTD.
                                                            AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
-------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA


NOTE 1:- GENERAL (CONT.)

<TABLE>
<CAPTION>
                                                               YEAR ENDED
                                                           DECEMBER 31, 2002
                                               ------------------------------------------
                                              AS PREVIOUSLY
                                                 REPORTED      RESTATEMENT    AS RESTATED
                                               ------------   ------------   ------------
<S>                                              <C>             <C>           <C>
Operating loss                                     (443)             -           (443)

Equity in losses of an affiliated company             -           (570)          (570)
Net loss from continuing operations                (243)          (570)          (813)
Net loss                                         (7,917)          (570)        (8,487)
Basic and diluted net loss per share
  from continuing operations                      (0.08)         (0.18)         (0.26)

Basic and diluted net loss per share              (2.54)         (0.18)         (2.72)
</TABLE>

<TABLE>
<CAPTION>

                                                               YEAR ENDED
                                                            DECEMBER 31, 2001
                                               ------------------------------------------
                                             AS PREVIOUSLY
                                                REPORTED       RESTATEMENT    AS RESTATED
                                               ------------   ------------   ------------
<S>                                              <C>               <C>           <C>
Operating loss                                    (4,786)              -          (4,786)

Equity in losses of an affiliated company              -            (137)           (137)
Net loss from continuing operations               (4,657)           (137)         (4,794)
Net loss                                         (12,970)           (137)        (13,107)
Basic and diluted net loss per share
  from continuing operations                       (1.50)          (0.05)          (1.55)

Basic and diluted net loss per share               (4.18)          (0.05)          (4.23)
</TABLE>


<TABLE>
<CAPTION>
                                                             YEAR ENDED
                                                          DECEMBER 31, 2003
                                               ------------------------------------------
                                               AS PREVIOUSLY
                                                 REPORTED     RESTATEMENT    AS RESTATED
                                               ------------   ------------   ------------
<S>                                              <C>              <C>           <C>
Cash flows from operating activities:

Net loss                                           (396)           375            (21)
Equity in losses of an affiliated company             -           (465)          (465)
Impairment of investment in a company               840           (840)             -
Net cash flows used in continuing
  operations                                     (1,937)             -         (1,937)
</TABLE>



                                     F - 12
<PAGE>



                                             B.O.S. BETTER ONLINE SOLUTIONS LTD.
                                                            AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
-------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 1:- GENERAL (CONT.)

<TABLE>
<CAPTION>
                                                               YEAR ENDED
                                                            DECEMBER 31, 2002
                                               ------------------------------------------
                                               AS PREVIOUSLY
                                                 REPORTED     RESTATEMENT     AS RESTATED
                                               ------------   ------------   ------------
<S>                                              <C>              <C>          <C>
Cash flows from operating activities:
Net loss                                         (7,917)          (570)        (8,487)
Equity in losses of an affiliated company             -           (570)          (570)
Net cash flows provided by continuing
  operations                                        127              -            127
</TABLE>

<TABLE>
<CAPTION>

                                                               YEAR ENDED
                                                           DECEMBER 31, 2001
                                               ------------------------------------------
                                               AS PREVIOUSLY
                                                 REPORTED     RESTATEMENT     AS RESTATED
                                               ------------   ------------   ------------
<S>                                              <C>                <C>          <C>
Cash flows from operating activities:
Net loss                                         (12,970)           (137)        (13,107)
Equity in losses of an affiliated company              -            (137)           (137)
Net cash flows used in continuing
  operations                                      (1,670)              -          (1,670)
</TABLE>

<TABLE>
<CAPTION>

                                                     DECEMBER 31, 2003
                                         ---------------------------------------------
                                        AS PREVIOUSLY
                                           REPORTED        RESTATEMENT     AS RESTATED
                                         ------------      ------------   ------------
<S>                                        <C>                <C>          <C>
Investment in an affiliated company          3,112            (332)          2,780
Total long-term investments                  5,658            (332)          5,326
Total assets                                14,355            (332)         14,023
Accumulated deficit                        (36,533)           (332)        (36,865)

Total shareholders' equity                  10,873            (332)         10,541
Total liabilities and shareholders'
  equity                                    14,355            (332)         14,023
</TABLE>


<TABLE>
<CAPTION>
                                                       DECEMBER 31, 2002
                                         ----------------------------------------------
                                         AS PREVIOUSLY
                                           REPORTED         RESTATEMENT   AS RESTATED
                                         ------------      ------------   ------------
<S>                                        <C>                <C>          <C>
Investment in an affiliated company          2,042            (707)          1,335
Total long-term investments                  4,846            (707)          4,139
Total assets                                17,192            (707)         16,485
Accumulated deficit                        (36,137)           (707)        (36,844)

Total shareholders' equity                   8,722            (707)          8,015
Total liabilities and shareholders'
  equity                                    17,192            (707)         16,485
</TABLE>


                                     F - 13
<PAGE>

                                             B.O.S. BETTER ONLINE SOLUTIONS LTD.
                                                            AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
-------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS


NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES

     a.   Use of estimates:

          The preparation of financial statements in conformity with generally
          accepted accounting principles requires management to make estimates
          and assumptions that affect the amounts reported in the financial
          statements and accompanying notes. Actual results could differ from
          those estimates.

     b.   Financial statements in U.S. dollars ("dollar"):

          A substantial portion of the Company's revenues is generated in U.S.
          dollar ("dollars"). In addition, most of the Company's costs are
          incurred in dollars.

          Company's management believes that the dollar is the primary currency
          of the economic environment in which the Company operate. Thus, the
          functional and reporting currency of the Company is the dollar.

          Accordingly, monetary accounts maintained in currencies other than the
          dollar are remeasured into U.S. dollars in accordance with Statement
          No. 52 of the Financial Accounting Standards Board ("FASB") "Foreign
          Currency Translation". All transactions gains and losses from the
          remeasurement of monetary balance sheet items are reflected in the
          statements of operations as financial income or expenses as
          appropriate.

     c.   Principles of consolidation:

          The consolidated financial statements include the accounts of the
          Company and its wholly owned subsidiaries. Inter-company transactions
          and balances including profits from inter-company sales not yet
          realized outside the group have been eliminated upon consolidation.

     d.   Cash equivalents:

          Cash equivalents are short-term highly liquid investments that are
          readily convertible to cash originally purchased with maturities of
          less than three months.

     e.   Marketable securities:

          The Company accounts for investments in debt securities in accordance
          with Statement of Financial Accounting Standard No.115,"Accounting for
          Certain Investments in Debt and Equity Securities"("SFAS No.115").
          Management determines the appropriate classification of its
          investments in debt and equity securities at the time of purchase and
          reevaluates such determinations at each balance sheet date. Debt
          securities are classified as held-to-maturity

          When the Company has the positive intent and ability to hold the
          securities to maturity and are stated at amortized cost. The amortized
          cost of held-to-maturity securities is adjusted for amortization of
          premiums and accretion of discounts to maturity. Such amortization and
          decline in value judged to be other than temporary and interest are
          included in financial income, net.

                                     F - 14
<PAGE>
                                             B.O.S. BETTER ONLINE SOLUTIONS LTD.
                                                            AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
-------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS


NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)

     f.   Restricted cash

          Restricted cash is primarily invested in certificates of deposit,
          which mature within one year and was used as security for the line of
          credit granted to Pacinfo in 2002 (see Notes 1c and Note 3).

     g.   Inventories:

          Inventory write-offs are provided to cover risks arising from
          slow-moving items or technological obsolescence. As of December 31,
          2003, inventory is presented net of $ 300 general provision for
          technological obsolescence and slow moving items (see also note 5).

          Inventories are valued at the lower of cost or market value. Cost is
          determined as follows: Raw and packaging materials- Moving average
          cost method.

          Products in progress and finished products - On the production costs
          basis with the addition of allocable indirect manufacturing costs.

     h.   Grants and royalty-bearing grants:

          Grants and royalty-bearing grants from the Chief Scientist of the
          Ministry of Industry and Trade in Israel for funding certain approved
          research projects and for funding marketing activities are recognized
          at the time the Company is entitled to such grants, on the basis of
          the related costs incurred, and are presented as a deduction of
          research and development costs.

     i    Investment in an affiliated company:

          An affiliated company is a company in which the Company is able to
          exercise significant influence, but that is not a consolidated
          subsidiary and is accounted for by the equity method, net of
          write-down for decrease in fair value which is not of a temporary
          nature.

          Investment in affiliated company represents investments in Ordinary
          shares and Preferred shares. The Company applies EITF 99-10,
          "Percentage Used to Determine the Amount of Equity Method Losses"
          (EITF No. 99-10"). Accordingly, losses of the affiliated company are
          recognized based on the ownership level of the particular investee
          security held by the investor.

          The Company's investment in this company is reviewed for impairment
          whenever events or changes in circumstances indicate that the carrying
          amount of the investment may not be recoverable, in accordance with
          Accounting Principle Board Opinion No. 18 "The Equity Method of
          Accounting for Investments in Common Stock" ("APB No. 18"). As of
          December 31, 2003, based on management's most recent analyses, no
          impairment losses have been identified.


                                     F - 15
<PAGE>
                                             B.O.S. BETTER ONLINE SOLUTIONS LTD.
                                                            AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
-------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS


NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)

     j.   Property and equipment:

          Property and equipment are stated at cost, net of accumulated
          depreciation. Depreciation is calculated by using the straight-line
          method over the estimated useful lives of the assets, at the following
          annual rates:

<TABLE>
<CAPTION>
                                                                                %
                                                                        ------------------
<S>                                                                          <C>
                     Computers and peripheral equipment                      20 - 33
                     Office furniture and equipment                           6 - 15
                     Leasehold improvements                                     10
</TABLE>


          The Company's property and equipment are reviewed for impairment in
          accordance with Statement of Financial Accounting Standard No. 144
          "Accounting for the Impairment or Disposal of Long- Lived Assets"
          ("SFAS No. 144") whenever events or changes in circumstances indicate
          that the carrying amount of an asset may not be recoverable.
          Recoverability of assets to be held and used is measured by a
          comparison of the carrying amount of an asset to the future
          undiscounted cash flows expected to be generated by the assets. If
          such assets are considered to be impaired, the impairment to be
          recognized is measured by the amount by which the carrying amount of
          the assets exceeds the fair value of the assets. Impairment losses
          have been recorded amounted to $ 110, $ 95 and $ 0 for the years ended
          December 31, 2003, 2002 and 2001, respectively.

     k.   Goodwill:

          Goodwill represents excess of the costs over the net assets of
          businesses acquired. Under Statement of Financial Accounting Standard
          No. 142, "Goodwill and Other Intangible Assets" ("SFAS No. 142")
          goodwill acquired in a business combination on or after July 1, 2001,
          is not amortized.

          SFAS No. 142 requires goodwill to be tested for impairment on adoption
          and at least annually thereafter or between annual tests in certain
          circumstances, and written down when impaired, rather than being
          amortized as previous accounting standards required. Goodwill
          attributable to each of the reporting units is tested for impairment
          by comparing the fair value of each reporting unit with its carrying
          value. Fair value is determined using discounted cash flows.
          Significant estimates used in the methodologies include estimates of
          future cash flows, future short-term and long-term growth rates,
          weighted average cost of capital and estimates of market multiples for
          each of the reportable units. As of December 31, 2003, no impairment
          losses have been identified.

     l.   Research and development costs:

          Statement of Financial Accounting Standards No. 86 "Accounting for the
          Costs of Computer Software to be Sold, Leased or Otherwise Marketed,"
          ("SFAS No. 86") requires capitalization of certain software
          development costs subsequent to the establishment of technological
          feasibility. Based on the Company product development process,
          technological feasibility is established upon completion of a working
          model. Research and development costs incurred in the process of
          developing product improvements or new products, are generally charged
          to expenses as incurred, net of participation of the Office of the
          Chief Scientist of the Israeli Ministry of Industry and Trade. Costs
          incurred by the Company between completion of the working model and
          the point at which the product is ready for general release are
          insignificant.


                                     F - 16
<PAGE>

                                             B.O.S. BETTER ONLINE SOLUTIONS LTD.
                                                            AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
-------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)

     m.   Severance pay:

          The Company's liability for severance pay for Israeli resident
          employees is calculated pursuant to Israeli severance pay law based on
          the most recent salary of the employees multiplied by the number of
          years of employment as of the balance sheet date. Employees are
          entitled to one month's salary for each year of employment or a
          portion thereof. The Company's liability for its Israeli resident
          employees is covered by insurance policies designed solely for
          distributing severance pay. The value of these policies is recorded as
          an asset in the Company's balance sheet.

          The insurance policies include profits accumulated up to the balance
          sheet date. The insurance policies may be withdrawn only upon
          complying with the Israeli severance pay law or labor agreements. The
          value of the deposited funds is based on the cash surrendered value of
          these policies and includes profits. Severance expenses for 2003, 2002
          and 2001, amounted to $ 178, $ 114, and $ 264, respectively.

     n.   Revenue recognition:

          The Company's products are generally a bundled hardware and software
          solution that are delivered together. The Company sells its products
          primarily through distributors and resellers.

          The Company derives its revenues from the sale of products, license
          fees for its products, maintenance, support and services.

          Revenues from product sales are recognized in accordance with Staff
          Accounting Bulletin No. 104 "Revenue Recognition in Financial
          Statements" ("SAB 104") when delivery has occurred, persuasive
          evidence of an arrangement exists, the vendor's fee is fixed or
          determinable, no further obligation exists, and collectibility is
          reasonably assured. When a right of return exists, the Company defers
          revenues until the right of return expires. Revenues subject to
          certain price protection and stock rotation are deferred until
          distributor sells the products, or until the right expires.

          Revenue from license fees is recognized in accordance with Statement
          of Position (SOP 97-2) "Software Revenue Recognition", when persuasive
          evidence of an agreement exists, delivery of the product has occurred,
          no significant obligations with regard to implementation remain, the
          fee is fixed or determinable, and collectibility is probable. The
          Company generally does not grant a right of return to its customers.
          When a right of return exists, the Company defers revenue until the
          right of return expires, at which time revenue is recognized provided
          that all other revenue recognition criteria have been met.

          The provision for product returns is based on prior experience and is
          net of estimated manufacturing reimbursements.

          Revenues from maintenance and support are recognized ratably over the
          period of the maintenance contract. Revenues from software license
          that require significant customization, integration and installation
          are recognized as they are completed, in accordance with SOP 81-1
          "Accounting for Performance of Construction-Type and Certain
          Production-Type Contracts" guidelines.


                                     F - 17
<PAGE>
                                             B.O.S. BETTER ONLINE SOLUTIONS LTD.
                                                            AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
-------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)

     o.   Warranty:

          The Company provides a warranty between 3 to 36 months at no extra
          charge, whereby defective hardware covered by the warranty should be
          sent back to the Company. The Company estimates the costs that may be
          incurred under its warranty and records a liability in the amount of
          such costs at the time product revenue is recognized. Factors that
          affect the Company's warranty liability include the number of
          installed units, historical and anticipated rates of warranty claims,
          and cost per claim. The Company periodically assesses the adequacy of
          its recorded warranty liabilities and adjusts the amounts as
          necessary.

          Changes in the Company's product warranty during the year 2003 period
          are as follows:

<TABLE>
<CAPTION>
<S>                                                             <C>
Balance, beginning of the year                                  $ 174
Changes in warranties during the year                             (42)
                                                                ------
Balance, end of the year                                        $ 132
</TABLE>

     p.   Income taxes:

          The Company account for income taxes in accordance with Statement of
          Financial Accounting Standards, SFAS 109, "Accounting for Income
          Taxes". This Statement prescribes the use of the liability method
          whereby deferred tax assets and liability account balances are
          determined based on differences between financial reporting and tax
          bases of assets and liabilities and are measured using the enacted tax
          rates and laws that will be in effect when the differences are
          expected to reverse. The Company provide a valuation allowance, if
          necessary, to reduce deferred tax assets to their estimated realizable
          value.

     q.   Concentrations of credit risk:

          Financial instruments that potentially subject the Company to
          concentrations of credit risk consist principally of cash and cash
          equivalents, trade receivables, other accounts receivable and
          marketable securities.

          Cash and cash equivalents are invested mainly in U.S. dollars in
          deposits with major banks in Israel. Such deposits may be in excess of
          insured limits and are not insured in other jurisdictions. Management
          believes that the financial institutions that hold the investments of
          the Company are financially sound and, accordingly, minimal credit
          risk exists with respect to these investments.

          The trade receivables of the Company derived from sales to customers
          located primarily in the United States, Europe and Israel. The Company
          generally do not require collateral; however, in certain
          circumstances, the Company may require letters of credit, other
          collateral, additional guarantees or advanced payments. The Company
          performs ongoing credit evaluations of its customers and to date
          (except for customer relating to the discontinuing operations) has not
          experienced material losses. An allowance for doubtful accounts is
          determined with respect to specific debts that are doubtful of
          collection.

          Investments in marketable securities are conducted through a bank in
          Israel, and include investments in corporate and governmental
          debentures. Management believes that the financial institutions that
          hold the Company's investments are financially sound, the portfolio is
          well diversified and accordingly, minimal credit risk exists with
          respect to these investments.

          The Company have no off-balance-sheet concentration of credit risk
          such as foreign exchange contracts, option contracts or other foreign
          hedging arrangements.


                                     F - 18
<PAGE>

                                             B.O.S. BETTER ONLINE SOLUTIONS LTD.
                                                            AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
-------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)

     r.   Basic and diluted net loss per share:

          Basic net loss per share is calculated based on the weighted average
          number of Ordinary shares outstanding during each year. Diluted net
          loss per share is calculated based on the weighted average number of
          Ordinary shares outstanding during each year, plus dilutive potential
          Ordinary shares considered outstanding during the year, in accordance
          with SFAS No. 128, "Earnings Per Share".

          The total weighted average number of shares related to the outstanding
          options and warrants excluded from the calculations of diluted net
          loss per share, since they would have an anti-dilutive effect, were
          505,178, 288,804 and 243,380 for the years ended December 31, 2003,
          2002 and 2001, respectively.

     s.   Accounting for stock-based compensation:

          The Company has elected to follow Accounting Principles Board Opinion
          No. 25, "Accounting for Stock Issued to Employees" ("APB-25"), and
          Interpretation No. 44, "Accounting for Certain Transactions Involving
          Stock Compensation" ("FIN 44"), in accounting for its employee stock
          option plan. Under APB-25, when the exercise price of the Company's
          employee stock options equals or is above than the market price of the
          underlying shares on the date of grant, no compensation expense is
          recognized.

          The Company applies SFAS No. 123 "Accounting for stock Based
          Compensation" ("SFAS No. 123") and EITF 96-18, "Accounting for Equity
          Instruments that are Issued to Other Than Employees for Acquiring, or
          in Conjunction With, Selling, Goods or Services", with respect to
          warrants issued to non-employees. SFAS No. 123 requires the use of
          option valuation models to measure the fair value of the warrants at
          the date of grant.

          Pro-forma disclosure is required by SFAS No. 123 , had the
          compensation expense for stock options granted under the Company's
          plans, been determined based on the fair value at the date of grant.
          The Company's net loss and loss per Ordinary share in 2003, 2002 and
          2001 would have changed to the pro forma amounts shown below:

<TABLE>
<CAPTION>
                                                                YEAR ENDED DECEMBER 31,
                                                      ------------------------------------------
                                                       2003 *)          2002 *)          2001 *)
                                                      --------         --------         --------
<S>                                                   <C>              <C>              <C>
Net loss as reported                                  $    (21)        $ (8,487)        $(13,107)

Deduct: stock-based compensation expense
   determined under fair value method for all
   awards                                                  124              341            1,187
                                                      --------         --------         --------

Pro forma net loss                                    $   (145)        $ (8,828)        $(14,294)
                                                      ========         ========         ========


Pro forma basic and diluted net loss per share        $  (0.04)        $  (2.83)        $  (4.61)
                                                      ========         ========         ========
</TABLE>

          The fair value of each option granted is estimated on the date of
          grant, using the Black Scholes option pricing model with expected
          volatility of approximately 64%, 71% and 79% in 2003, 2002 and 2001,
          respectively and using the following weighted average assumptions:

          (1)  Dividend yield of zero percent for each year.

          (2)  Risk-free interest rate of 1.8%, 1.5% and 2% in 2003, 2002 and
               2001, respectively.

          (3)  Expected average lives of the options of three years from the
               date of grant as of 2003, 2002 and 2001.

          *)   Restated, see Note 1e


                                     F - 19
<PAGE>

                                             B.O.S. BETTER ONLINE SOLUTIONS LTD.
                                                            AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
-------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)

     t.   Fair value of financial instruments:

          The following methods and assumptions were used by the Company in
          estimating their fair value disclosures for financial instruments:

          The carrying amounts of cash and cash equivalents, restricted cash,
          trade receivables, other accounts receivable and trade payables
          approximate their fair value due to the short-term maturities of such
          instruments.

          The fair value for marketable securities is based on quoted market
          prices.

     u.   Impact of recently issued accounting standards:

          In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement
          133 on Derivative Instruments and Hedging Activities". SFAS No. 149
          amends and clarifies (1) the accounting guidance on derivative
          instruments (including certain derivative instruments embedded in
          other contracts) and (2) hedging activities that fall within the scope
          of SFAS No. 133, "Accounting for Derivative Instruments and Hedging
          Activities". SFAS No. 149 amends SFAS No. 133 to reflect decisions
          made (1) as part of the Derivatives Implementation Group ("DIG")
          process that effectively required amendments to SFAS No. 133, (2) in
          connection with other projects dealing with financial instruments, and
          (3) regarding implementation issues related to the application of the
          definition of a derivative. SFAS No. 149 is effective (1) for
          contracts entered into or modified after June 30, 2003, with certain
          exceptions, and (2) for hedging relationships designated after June
          30, 2003. The guidance is to be applied prospectively.

          Generally, SFAS No. 149 improves financial reporting by (1) requiring
          that contracts with comparable characteristics be accounted for
          similarly and (2) clarifying when a derivative contains a financing
          component that warrants special reporting in the statement of cash
          flows. SFAS No. 149 is not expected to have a material impact on the
          Company's financial statements.

          In November 2002, the FASB issued FASB Interpretation No. 45,
          "Guarantor's Accounting and Disclosure Requirements for Guarantees,
          Including Indirect Guarantees of Indebtedness of Others, an
          interpretation of FASB Statements No. 5, 57, and 107 and Rescission of
          FASB Interpretation No. 34" ("FIN No. 45"). FIN No. 45 elaborates on
          the disclosures to be made by a guarantor in its interim and annual
          financial statements about its obligations under certain guarantees
          that it has issued. It also clarifies that a guarantor is required to
          recognize, at the inception of a guarantee, a liability for the fair
          value of the obligation undertaken in issuing the guarantee. FIN No.
          45 does not prescribe a specific approach for subsequently measuring
          the guarantor's recognized liability over the term of the related
          guarantee. It also incorporates, without change, the guidance in FASB
          Interpretation No. 34, "Disclosure of Indirect Guarantees of
          Indebtedness of Others," which is being superseded. The disclosure
          provisions of FIN No. 45 are effective for financial statements of
          interim or annual periods that end after December 15, 2002, and the
          provisions for initial recognition and measurement are effective on a
          prospective basis for guarantees that are issued or modified after
          December 31, 2002, irrespective of a guarantor's year-end. The
          adoption of FIN No. 45 did not have a material impact on the results
          of operations or financial position.

                                     F - 20
<PAGE>
                                             B.O.S. BETTER ONLINE SOLUTIONS LTD.
                                                            AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
-------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)

          In January 2003, the FASB issued Interpretation No. 46, Consolidation
          of Variable Interest Entities" ("FIN 46"). The objective of FIN No. 46
          is to improve financial reporting by companies involved with variable
          interest entities. A variable interest entity is a corporation,
          partnership, trust, or any other legal structure used for business
          purposes that either (a) does not have equity investors with voting
          rights or (b) has equity investors that do not provide sufficient
          financial resources for the entity to support its activities. FIN No.
          46 requires a variable interest entity to be consolidated by a company
          if that company is subject to a majority of the risk of loss from the
          variable interest entity's activities or entitled to receive a
          majority of the entity's residual returns or both. FIN No. 46 also
          requires disclosures about variable interest entities that the company
          is not required to consolidate but in which it has a significant
          variable interest. The consolidation requirements of FIN No. 46 apply
          immediately to variable interest entities created after January 31,
          2003. The consolidation requirements apply to older entities in the
          first fiscal year or interim period ending after March 15, 2004.
          Certain of the disclosure requirements apply in all financial
          statements issued after January 31, 2003, regardless of when the
          variable interest entity was established. As of December 31, 2003, the
          Company does not expect the adoption of FIN No. 46 to have a material
          impact on its consolidated financial statements.

          In November 2002, Emerging Issues Task Force ("EITF") reached a
          consensus on Issue No. 00-21, "Revenue Arrangements with Multiple
          Deliverables". EITF Issue No. 00-21 provides guidance on how to
          account for arrangements that involve the delivery or performance of
          multiple products, services and/or rights to use assets. The
          provisions of EITF Issue No. 00-21 applied to revenue arrangements
          entered into in fiscal periods beginning after June 15, 2003.
          Additionally, companies will be permitted to apply the consensus
          guidance in this issue to all existing arrangements as the cumulative
          effect of a change in accounting principle in accordance with APB
          Opinion No. 20, "Accounting Changes". The adoption of EITF Issue No.
          00-21 did not have a material impact upon the Company's financial
          position, cash flows or results of operations.

     v.   Reclassification:

          Certain amounts from prior years have been reclassified to conform to
          the current year presentation. As a result of the decision of the
          Board of Directors to cease the operations of Pacinfo (the Computer
          Networking Segment), the financial statements of the Company classify
          the assets, liabilities and operations of Pacinfo as a discontinued
          operations.

NOTE 3:- RESTRICTED CASH

     As of December 31, 2003, a fixed charge that was granted in order to secure
     the line of credit to Pacinfo has expired.


                                     F - 21
<PAGE>
                                             B.O.S. BETTER ONLINE SOLUTIONS LTD.
                                                            AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
-------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 4:- OTHER ACCOUNTS RECEIVABLE AND PREPAID EXPENSES

<TABLE>
<CAPTION>
                                 DECEMBER 31,
                              -----------------
                              2003        2002
                              ----        ----
<S>                           <C>         <C>
Government authorities        $ 62        $104
Prepaid expenses               107         189
Other                          148          89
                              ----        ----

                              $317        $382
                              ====        ====
</TABLE>

NOTE 5:- INVENTORIES

<TABLE>
<CAPTION>
                                                       DECEMBER 31,
                                                     ----------------
                                                     2003        2002
                                                     ----        ----
<S>                                                  <C>         <C>
Raw materials (including packaging materials)        $299        $429
Products in progress                                  277         228
Finished products                                     385         198
                                                     ----        ----

                                                     $961        $855
                                                     ====        ====
</TABLE>

          The inventories are presented net of provision for technological
          obsolescence and slow-moving items of $ 300 as of December 31, 2003
          and 2002.

NOTE 6:- MARKETABLE SECURITIES

          The following is a summary of held-to-maturity securities:

<TABLE>
<CAPTION>
                                                              DECEMBER 31,
                      ---------------------------------------------------------------------------------------------
                                          2003                                               2002
                      -------------------------------------------      --------------------------------------------
                                                         ESTIMATED                                         ESTIMATED
                                   GROSS       GROSS       FAIR                    GROSS        GROSS        FAIR
                     AMORTIZED  UNREALIZED   UNREALIZED   MARKET     AMORTIZED   UNREALIZED  UNREALIZED     MARKET
                       COST        GAINS       LOSSES      VALUE       COST        GAINS       LOSSES        VALUE
                      -------     -------     -------     -------     -------     -------      -------      -------
<S>                   <C>         <C>         <C>         <C>         <C>         <C>          <C>          <C>
HELD-TO-MATURITY:

Government debts      $   612     $     9     $     -     $   621     $ 1,036     $    17      $     -      $ 1,053
Corporate
   debentures           2,264          50           -       2,314       2,009           8          (35)       1,982
                      -------     -------     -------     -------     -------     -------      -------      -------
                      $ 2,876     $    59     $     -     $ 2,935     $ 3,045     $    25      $   (35)     $ 3,035
                      =======     =======     =======     =======     =======     =======      =======      =======
</TABLE>

          Aggregate maturities of held-to-maturity securities for years
          subsequent to December 31, 2003 are:

<TABLE>
<CAPTION>
                                                           ESTIMATED FAIR
                                           AMORTIZED COST   MARKET VALUE
                                               ------         ------
<C>                                            <C>            <C>
HELD-TO-MATURITY:

2004(short-term marketable securities)         $1,014         $1,027
2005                                            1,568          1,604
2006                                              294            304
                                               ------         ------

                                               $2,876         $2,935
                                               ======         ======
</TABLE>


                                     F - 22
<PAGE>

                                             B.O.S. BETTER ONLINE SOLUTIONS LTD.
                                                            AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
-------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 7:- INVESTMENT IN A COMPANY

     a.   Investment in Surf

          In November 2001, the Company invested $ 1,000 as part of a private
          placement in Surf. At the same time, the Company converted its
          convertible loan in the amount of $ 1,042 (principal and accrued
          interest) into Preferred shares in Surf at an exercise price equal to
          Surf's fair value as determined in the investment agreement. As a
          result of this private placement, the Company's holding in Surf was
          diluted to 17%, Accordingly the investment was accounted based on the
          cost accounting method.

          In March 2003, the Company engaged with Catalyst Investors L.P.
          ("Catalyst"), in order to purchase additional 191,548 series C
          Preferred shares of Surf. In consideration, the Company issued to
          Catalyst Ordinary Shares, representing 19.90% of the issued and
          outstanding share capital of the Company immediately prior to the
          transaction and prior to the issuance of the shares, at a purchase
          price of $2.776, aggregating to $ 1,755. Catalyst also granted the
          Company, at no additional consideration, an option to purchase on or
          prior to January 31, 2006, any shares of Surf then held by Catalyst at
          an exercise price of $9.1632 plus interest of 4.75%. In the event that
          Catalyst will sell its remaining shares in Surf prior to January 1,
          2006, the Company will be entitled to the gain that will be realized
          in such sale.

          As a result of this investment, the Company has the ability to
          exercise significant influence over Surf and therefore applied the
          equity method. According to APB 18 when an investment qualifies for
          use of the equity method, the investor should adopt the equity method
          of accounting by adjusting retroactively the investment, results of
          operations (current and prior periods presented), and retained
          earnings, in a manner consistent with the accounting for a
          step-by-step acquisition of a subsidiary.

NOTE 8:- PROPERTY AND EQUIPMENT

<TABLE>
<CAPTION>
                                              DECEMBER 31,
                                          ---------------------
                                           2003           2002
                                          ------         ------
<S>                                       <C>            <C>
Cost:
   Computers and software                 $1,798         $1,816
   Office furniture and equipment            532            682
   Leasehold improvements                    778            774
   Vehicles                                    6              6
                                          ------         ------

                                           3,114          3,278
                                          ------         ------
Accumulated depreciation:
   Computers and software                  1,561          1,398
   Office furniture and equipment            351            385
   Leasehold improvements                    598            526
   Vehicles                                    6              4
                                          ------         ------

                                           2,516          2,313
                                          ------         ------

Depreciated cost                          $  598         $  965
                                          ======         ======

</TABLE>

          Depreciation expenses amounted to $ 307, $ 390 and $ 386 for the years
          ended December 31, 2003, 2002 and 2001, respectively.



                                     F - 23
<PAGE>
                                             B.O.S. BETTER ONLINE SOLUTIONS LTD.
                                                            AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
-------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 9:- GOODWILL

     a.   Purchase of additional holdings in BOScom:

          In February 2002, the Company purchased additional 3% of the share
          capital of BOScom in consideration of $ 30. The consideration was paid
          by the issuance of 3,750 Ordinary shares of the Company. Consequently,
          BOScom became a wholly owned subsidiary. As a result of the purchase,
          the Company recorded an additional amount $ 30 as goodwill.

          As of December 31, 2002 and 2003 the amortized goodwill amounted to $
          741.

     b.   The pro forma results of operations presented below for the years
          ended December 31, 2001, 2002 and 2003, reflect the impact on results
          of operations had the Company adopted the non-amortization provisions
          of SFAS No. 142 effective January 1, 2001:

<TABLE>
<CAPTION>
                                                                YEAR ENDED DECEMBER 31,
                                                      --------------------------------------------
                                                        2003 *)         2002 *)            2001 *)
                                                      ----------      ----------         ----------
<S>                                                   <C>             <C>                <C>
Reported net loss                                     $      (21)     $   (8,487)        $  (13,107)
Goodwill amortization                                          -               -                182
                                                      ----------      ----------         ----------

Adjusted net loss                                     $      (21)     $   (8,487)        $  (12,925)
                                                      ==========      ==========         ==========

Basic net loss per share:
  Reported net loss                                   $    (0.01)     $    (2.72)        $    (4.23)
  Goodwill amortization                                        -               -               0.06
                                                      ----------      ----------         ----------

Adjusted basic and diluted net loss per share         $    (0.01)     $    (2.72)        $    (4.17)
                                                      ==========      ==========         ==========
</TABLE>

          *)   Restated, see Note 1e

NOTE 10:- ACCRUED EXPENSES AND OTHER LIABILITIES

<TABLE>
<CAPTION>
                                                 DECEMBER 31,
                                             ---------------------
                                              2003           2002
                                             ------         ------
<S>                                          <C>            <C>
              Government of Israel           $  635         $  882
              Provision for warranty            132            174
              Other                             144            237
                                             ------         ------

                                             $  911         $1,293
                                             ======         ======
</TABLE>

NOTE 11:- COMMITMENTS AND CONTINGENT LIABILITIES

     a.   Commitments:

          1.   Royalty commitments:

               i)   Under the Company's research and development agreements with
                    the Office of the Chief Scientist ("OCS") and pursuant to
                    applicable laws, the Company is required to pay royalties at
                    the rate of 3.5% of sales of products developed with funds
                    provided by the OCS, up to an amount equal to 100% of the
                    research and development grants (dollar-linked) received
                    from the OCS. The obligation to pay these royalties is
                    contingent upon actual sales of the products. Royalties
                    payable with respect to grants received under programs
                    approved by the OCS after January 1, 1999, are subject to
                    interest on the U.S. dollar-linked value of the total grants
                    received at the annual rate of LIBOR applicable to U.S.
                    dollar deposits at the time the grants are received.


                                     F - 24
<PAGE>

                                             B.O.S. BETTER ONLINE SOLUTIONS LTD.
                                                            AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
-------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

                    As of December 31, 2003, the Company has an outstanding
                    contingent obligation to pay royalties in the amount of
                    approximately $ 5,621, in respect of these grants.

               ii)  The Israeli Government, through the Overseas Marketing Fund,
                    awarded the Company grants for participation in expenses for
                    overseas marketing. The Company is committed to pay
                    royalties to the Fund for Encouragement of Marketing
                    Activities at the rate of 3% of the increase in export
                    sales, up to the amount of the grants received by the
                    Company linked to the dollar and bearing interest of LIBOR
                    (for a period of six months).

                    As of December 31, 2003, the Company had outstanding
                    contingent obligations to pay royalties of $ 144 with
                    respect to these grants.

          2.   Other commitments:

               The premises occupied by the Company and the Company's motor
               vehicles are rented under various operating lease agreements. The
               lease agreements for the premises and the motor vehicles expire
               on various dates ending in 2005.


                                     F - 25
<PAGE>



                                             B.O.S. BETTER ONLINE SOLUTIONS LTD.
                                                            AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA

NOTE 11:- COMMITMENTS AND CONTINGENT LIABILITIES (CONT.)

               Minimum future rental payments due under the above leases, at
               rates in effect at December 31, 2003, are as follows:

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------
<C>                                                <C>
2004                                               $286
2005                                                185
                                                   ----

                                                   $471
                                                   ====
</TABLE>

               Rental payments in 2003, 2002 and 2001 amounted to $ 426, $ 383
               and $ 283, respectively.

     b.   In July 2002, the Company received a claim letter from Operate Lease
          Ltd., under which it claims that the Company's termination notice of
          the leasing agreement in March 2002 constitutes a breach of the
          agreement and Operate Lease is demanding compensation in which the
          nominal claim amount of $ 292. No legal proceeding has yet been filed.
          At this stage, according to the Company's counsel assessment, the
          prospects of Operate Lease to prevail and recover a significant
          amount, seem remote. The financial statements do not include any
          provision in that regard.

     c.   In 1998, as part of Pacinfo Share Purchase Agreement between the
          Company and Mr. Jacob Lee (the seller of Pacinfo who became a
          shareholder of the Company), certain actions involving PacInfoSystems,
          if occurring before the end of 2003, may trigger a tax event for Mr.
          Jacob Lee. The Company may be obligated, under the purchase agreement,
          to grant Mr. Lee a loan on a full recourse basis for certain tax
          payments Mr. Lee may be liable for, currently estimated at
          approximately $1,500. The Company will receive a security interest in
          shares of the Company that Mr. Lee holds at the time of the loan with
          a fair market value as of the date of the loan of at least 125% of the
          amount of the loan as security for the repayment of the loan. In
          addition, in the event the Company is required to loan such sum to Mr.
          Lee, the Company may also be required to reimburse Mr. Lee for certain
          interest on taxes that he may owe. It is possible that the windup of
          PacInfoSystems during 2002 and 2003 may have triggered such a tax
          event for Mr. Lee, which would result in an obligation by the Company
          to loan Mr. Lee such amount and to reimburse him for interest expenses
          incidental to the tax event.

NOTE 12:- SHAREHOLDERS' EQUITY

     a.   In February 2003, the Board of Directors resolved to effect a
          one-to-four reverse split. The reverse split was approved by the
          shareholders in May 2003 and became effective on May 29, 2003. Upon
          effecting the reverse split; 4 Ordinary shares of NIS 1 par value
          each, have been converted and reclassified as one Ordinary share of
          NIS 4 par value.

          All shares, options and earnings per share amounts have been
          retroactively adjusted for all periods presented to reflect the stock
          splits.

     b.   In December 2003, the Company completed a private placement for the
          Company's Ordinary Shares with two European private investors. The
          Company issued to the investors 357,143 shares at a purchase price of
          $ 2.80, for consideration of $ 928 (net of $ 72 issuance expenses).


                                     F - 26
<PAGE>
                                             B.O.S. BETTER ONLINE SOLUTIONS LTD.
                                                            AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA

NOTE 12:- SHAREHOLDERS' EQUITY (CONT.)

     c.   Stock options plan:

          During 1994, 1995, 1999, 2000, 2001 the Board of Directors of the
          Company adopted stock option plans ("the Plans") pursuant to which
          656,250 options for the purchase of the Company's Ordinary shares may
          be granted to officers, directors, consultants and employees of the
          Company. The Board of Directors has resolved that no further grants
          shall be made from the existing plans which, as of December 31, 2003,
          had in the aggregate 337,902 options left for issuance from the
          existing option pools previously approved by the shareholders. In May
          2003 the Company's shareholders approved the adoption of the 2003
          Stock Option Plan, pursuant to which 625,000 Ordinary Shares are
          reserved for purchase by employees, directors, consultants and service
          providers of the Company. As of December 31, 2003, an aggregate to
          414,424 of these options are still available for future grant.

          Each option granted under the plans expires between 5-10 years from
          the date of the grant. The options vest gradually over a period
          ranging between two to three years. Any options, which are cancelled
          or forfeited before expiration, become available for future grants.

          The following is a summary of the Company's stock options granted to
          officers, directors, and employees among the various plans:

<TABLE>
<CAPTION>
                                              YEAR ENDED DECEMBER 31,
                        --------------------------------------------------------------------
                                2003                    2002                    2001
                        --------------------    -------------------     -------------------
                                      WEIGHTED               WEIGHTED                WEIGHTED
                                      AVERAGE                AVERAGE                 AVERAGE
                          NUMBER     EXERCISE     NUMBER     EXERCISE     NUMBER     EXERCISE
                        OF OPTIONS     PRICE    OF OPTIONS    PRICE     OF OPTIONS    PRICE
                        ----------     -----    ----------    -----     ----------    -----
<S>                       <C>          <C>        <C>          <C>        <C>          <C>
Options outstanding
   at beginning
   of year                211,929      16.00      243,380      16.48      224,740      21.16
Changes during the
   year:
   Granted                278,076       8.97       55,000       6.76       98,048       8.20
   Forfeited or
     cancelled            (63,753)     12.53      (86,451)     11.40      (79,408)     19.48
                         --------                --------                --------
Options outstanding
   at end of year         426,252      11.93      211,929      16.00      243,380      16.48
                         ========      =====     ========      =====     ========      =====
Options exercisable
   at the end of
   the year               194,926      20.36      169,054      16.24      127,293      18.32
                         ========      =====     ========      =====     ========      =====
</TABLE>

          The options outstanding as of December 31, 2003, have been separated
          into ranges of exercise price as follows:
<TABLE>
<CAPTION>
                                                                             WEIGHTED
                    OPTIONS                       WEIGHTED     OPTIONS       AVERAGE
                  OUTSTANDING      WEIGHTED       AVERAGE    EXERCISABLE     EXERCISE
 RANGE OF            AS OF          AVERAGE      REMAINING      AS OF        PRICE OF
EXERCISE          DECEMBER 31,     EXERCISE     CONTRACTUAL  DECEMBER 31,     OPTIONS
  PRICE              2003            PRICE      LIFE (YEARS)    2003        EXERCISABLE
  -----             -------          -----         ----        ------          -----
<S>                 <C>              <C>           <C>        <C>              <C>
 1.84-2.00          203,076           1.95         8.07             -              -
    6.80             39,168           6.80         7.78        35,918            6.8
   10.60              3,695          10.60         3.76         3,695          10.60
   14.00             14,000          14.00         3.27        14,000          14.00
17.00-18.00          45,988          17.83         5.27        45,988          17.83
   28.00            120,325          28.00         3.84        95,325          28.00
                    -------                                   -------
                    426,252          11.93         6.13       194,926          20.36
                    =======                     =======       =======        =======
</TABLE>


                                     F - 27
<PAGE>
                                             B.O.S. BETTER ONLINE SOLUTIONS LTD.
                                                            AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA

NOTE 12:- SHAREHOLDERS' EQUITY (CONT.)

          Options granted to employees in 2003, 2002 and 2001, have an exercise
          price equal to the fair market value of Ordinary share at the grant
          date. The weighted average fair values of the options granted during
          2003, 2002 and 2001 were $ 3.91, $ 3.2 and $ 4.27, respectively.

     d.   Options issued to service providers:

          The Company accounts for these options in accordance with the
          provisions of SFAS 123 and EITF 96-18. The fair value for these
          options was estimated at the date of grant using an option pricing
          model with the following assumptions: risk-free interest rate of 1.5%,
          dividend yields of 0% volatility of 0.7, and an expected life of 2.5
          year.

          The compensation expense that has been recorded in the consolidated
          financial statements regarding these warrants for the years 2003, 2002
          and 2001 were $ 23, $ 7 and $ 4, respectively.

          The Company's outstanding warrants to service providers as of December
          31, 2003 are as follows:


<TABLE>
<CAPTION>
                  WARRANTS FOR     EXERCISE
                    ORDINARY      PRICE PER    WARRANTS        EXERCISABLE
ISSUANCE DATE        SHARES         SHARE    EXERCISABLE          THROUGH
-------------        ------         -----    -----------          -------
<S>                  <C>           <C>          <C>           <C>
October 2002         75,000        $   4.00     31,250        June 2011
December 2002           938        $   8.00        938        December 2005
December 2002           937        $   4.00        937        December 2005
March 2003            1,025        $   8.00      1,025        December 2005
March 2003            1,026        $   4.00      1,026        December 2005
                     ------                     ------
                     78,926                     35,176
                     ======                     ======
</TABLE>

NOTE 13:- TAXES ON INCOME

     a.   Tax benefits under the Law for the Encouragement of Capital
          Investments, 1959:

          The Company's production facilities have been granted an "Approved
          Enterprise" status under the above Law under four separate investment
          programs. According to the Capital Investments Law, the Company has
          elected to receive for the first program state-guaranteed loans and
          grants, for the second and third programs, the Company has elected to
          receive only state-guaranteed loans. As for the fourth program, the
          Company has elected the "alternative benefits" and has waived
          Government grants in return for a tax exemption.

          The Company is also a "Foreign Investors' Company", as defined by the
          abovementioned law, and as such, is entitled to a 10-year period of
          benefits and to an additional reduction in tax rates, up to 10% or 25%
          (based on the percentage of foreign ownership in each taxable year).

          Income from the second, third, fourth programs, which commenced
          operations in 1992, 1994, 1997, respectively, are exempt from income
          tax for a period of ten years commencing with the first year in which
          they generate taxable income. During 2002, as part of the transfer of
          operations from the Company to BOScom, all tax benefits that were
          related to the Approved Enterprise of the Company, were transferred to
          BOScom. In addition, since 2002, the Company's investment are not
          subject to Approved Enterprise program. Accordingly, taxable income
          generated in that period will be split by the assets ratio into a
          taxable income that is entitled to the benefits of the approved
          enterprise and into an income that will be taxed at the 36% corporate
          tax rate.

                                     F - 28
<PAGE>

                                             B.O.S. BETTER ONLINE SOLUTIONS LTD.
                                                            AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 13:- TAXES ON INCOME (CONT.)

          BOScom has also a production facility, which was granted an "Approved
          Enterprise" status and had a separate investment program. BOScom
          elected to receive the "alternative benefits". Income derived from
          BOScom investment program, which commenced operations in 1997 and
          2002, are exempt from income tax for a period of ten years commencing
          with the first year in which taxable income is generated.

          The period of tax benefits detailed above is subject to limits of the
          earlier of 12 years from commencement of production, or 14 years from
          receiving the approval. Accordingly, the period of benefits relating
          to all investment programs expire in the years 2001 through 2014.

          The entitlement to the above benefits is conditional upon the
          Company's and BOScom's fulfilling the conditions stipulated by the
          above law, regulations published thereunder and the instruments of
          approval for the specific investments in "Approved Enterprises". In
          the event of failure to comply with these conditions, the benefits may
          be canceled and the Company and BOScom may be required to refund the
          amount of the benefits, in whole or in part, including interest.

          The tax-exempt income attributable to the "Approved Enterprise" can be
          distributed to shareholders without imposing tax liability on the
          Company only upon the complete liquidation of the Company. In the
          event of a distribution of such tax-exempt income as a cash dividend
          in a manner other than in the complete liquidation of the Company and
          BOScom, the Company and BOScom will be required to pay tax at the rate
          of 10% to 25% on the amount distributed. In addition, these dividends
          will be subject to 15% withholding tax.

          The Company's Board of Directors has determined that such tax-exempt
          income will not be distributed as dividends. Accordingly, no deferred
          taxes have been provided on income attributable to the Company
          "Approved Enterprise".

          If the Company and BOScom derive income from sources other than an
          "Approved Enterprise", such income will be taxable at the regular
          corporate tax rate of 36%.

     b.   Loss carryforwards:

          Domestic:

          The Company and its Israeli subsidiary have accumulated losses for
          Israel income tax purposes as of December 31, 2003, in the amount of
          approximately $ 14,000. These losses may be carryforward (linked to
          the Israeli Consumer Price Index ("CPI")) and offset against taxable
          income in the future for an indefinite period.

          Foreign:

          As of December 31, 2003, the U.S. subsidiaries which were classified
          as discontinuing operations had U.S. Federal and State net operating
          loss carryforward of approximately $ 11,300, that can be carried
          forward and offset against taxable income and expire through 2021.
          Utilization of U.S. net operating losses may be subject to substantial
          annual limitations due to the "change in ownership" provisions of the
          Internal Revenue Code of 1986 and similar state law provisions. The
          annual limitations may result in the expiration of net operating
          losses before utilization.

          As of December 31, 2003, B.O.S. U.K. had net operating loss
          carryforward of approximately $ 3,900, which can be carried forward
          indefinitely and offset against taxable income.


                                     F - 29
<PAGE>
                                             B.O.S. BETTER ONLINE SOLUTIONS LTD.
                                                            AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 13:- TAXES ON INCOME (CONT.)

     c.   Taxable income under the Inflationary Income Tax (Inflationary
          Adjustments) Law 1985:

          Results of the Company and its Israeli subsidiary for tax purposes are
          measured and reflected in real terms in accordance with the changes in
          the Israeli CPI. As explained in Note 2b, the financial statements are
          presented in U.S. dollars. The difference between the change in the
          Israeli CPI and in the NIS/U.S. dollar exchange rate causes a
          difference between taxable income or loss and the income or loss
          before taxes reflected in the financial statements. In accordance with
          FASB 109, the Company has not provided deferred income taxes on this
          difference between the reporting currency and the tax bases of assets
          and liabilities.

     d.   Deferred income taxes:

          Deferred income taxes reflect the net tax effects of temporary
          differences between the carrying amounts of assets and liabilities for
          financial reporting purposes and the amounts used for income tax
          purposes. Significant components of the Company's deferred tax assets
          are as follows:

<TABLE>
<CAPTION>
                                                              DECEMBER 31,
                                                         ----------------------
                                                          2003             2002
                                                         -------         -------
<S>                                                      <C>             <C>
Net operating loss carryforward                          $ 5,975         $ 4,013
Reserves and allowances                                      105             598
                                                         -------         -------

Net deferred tax asset before valuation allowance          6,080           4,611
Valuation allowance                                       (6,080)         (4,611)
                                                         -------         -------

Net deferred tax asset                                   $     -         $     -
                                                         =======         =======
</TABLE>

          The Company has provided valuation allowances in respect of deferred
          tax assets resulting from tax loss carryforwards and other reserves
          and allowances due to its history of operating losses and current
          uncertainty concerning its ability to realize these deferred tax
          assets in the future.

     e.   Tax assessments:

          The Company and BOScom received final assessments through the 1997 tax
          year.

NOTE 14:- SUPPLEMENTARY INFORMATION TO STATEMENTS OF OPERATIONS

     a.   Non recurring royalty reversal:

          Certain research and development activities of the Company are
          supported by the OCS. In return for the OCS's participation, the
          Company was committed to pay royalties as described in Note 11a.1.
          During the third quarter of 2003, the OCS completed its examination of
          the Company's technology and use of grant funding for the years 1991
          through 1999, which reduced the royalties' expenses provision.
          Accordingly, the Company reversed $339 of accrued royalties as a
          reduction in cost of sales during the third quarter of 2003.


                                     F - 30
<PAGE>
                                             B.O.S. BETTER ONLINE SOLUTIONS LTD.
                                                            AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 14:- SUPPLEMENTARY INFORMATION TO STATEMENTS OF OPERATIONS (CONT.)

<TABLE>
<CAPTION>
                                                                                               YEAR ENDED DECEMBER 31,
                                                                                      ------------------------------------------
                                                                                       2003*)           2002*)           2001*)
                                                                                      --------         --------         --------
<S>                                                                                   <C>              <C>              <C>
              b. Financial income:

                      Interest on bank deposits and marketable
                         securities                                                   $    158         $    243         $    504
                      Other (mainly translation gains)                                      48              140              330
                                                                                      --------         --------         --------

                                                                                           206              383              834
                                                                                      --------         --------         --------
                      Financial expenses:
                      In respect of long-term loans                                          -              (14)             (46)
                      Other (mainly translation losses)                                    (97)             (74)            (361)
                                                                                      --------         --------         --------

                                                                                           (97)             (88)            (407)
                                                                                      --------         --------         --------

                                                                                      $    109         $    295         $    427
                                                                                      ========         ========         ========
              c. Other income (expenses):
                      Capital loss from sale of property and
                         equipment                                                    $     (6)        $      -         $    (32)
                      Impairment of property and equipment                                   -              (95)               -

                      Prior year's royalties to the Israeli Chief
                         Scientist                                                           -                -             (100)
                      Legal settlement                                                       -                -             (111)
                      Other                                                                 51                -              (55)
                                                                                      --------         --------         --------

                                                                                      $     45         $    (95)        $   (298)
                                                                                      ========         ========         ========
              d. Loss per share:
                      1. Numerator:
                         Numerator for basic and diluted net
                            earnings (loss) per share -
                         Net loss from continuing operations                          $ (2,057)        $   (813)        $ (4,794)
                                                                                      ========         ========         ========
                         Net income (loss) from discontinued
                            operation                                                 $  2,036         $ (7,674)        $ (8,313)
                                                                                      ========         ========         ========

                         Net loss available to Ordinary shareholders                  $    (21)        $ (8,487)        $(13,107)
                                                                                      ========         ========         ========

                      2. Denominator (in thousands): Denominator for basic and
                         diluted net
                            earnings (loss) per share -

                         Weighted average number of shares                               3,683            3,117            3,102
                                                                                      ========         ========         ========
</TABLE>

                     *) Restated, see Note 1e


                                     F - 31
<PAGE>
                                             B.O.S. BETTER ONLINE SOLUTIONS LTD.
                                                            AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 15:- RELATED PARTIES

          The Company has entered an engagement with an Investment House, to
          provide non-exclusive investment-banking services and business
          development services to the Company, effective April 15, 2003. The
          Investment House is a company indirectly controlled by the Chairman of
          our Board of Directors, and is a co-manager of the Catalyst Fund, the
          Company's largest shareholder. For its services, The Investment House
          is paid a monthly sum of $10, in addition to a success fee of 4-6% for
          a consummated private placement. According to its terms the Company
          may terminate the agreement at any time, by giving one month prior
          written notice.

NOTE 16:- SEGMENTS AND GEOGRAPHICAL INFORMATION

          a.   Subsequent to the liquidation of Pacinfo operation, the Computer
               Networking Segment, the Company manages its business on a basis
               of one reportable segment, which consists of three product lines.
               See Note 1 for a description of the Company's business. Total
               revenues are attributed to geographic areas based on the location
               of customers in accordance with Statement of Financial Accounting
               No. 131, "Disclosures about Segments of an Enterprise and Related
               Information": ("SFAS 131").

               The following presents total revenues and long-lived assets for
               the years ended December 31, 2003, 2002 and 2001:


<TABLE>
<CAPTION>

                                                 YEAR ENDED DECEMBER 31,
                      ----------------------------------------------------------------------------
                               2003                        2002                       2001
                      --------------------        --------------------        --------------------
                      TOTAL     * LONG-LIVED      TOTAL      *LONG-LIVED      TOTAL      *LONG-LIVED
                     REVENUES       ASSETS       REVENUES       ASSETS       REVENUES       ASSETS
                      ------        ------        ------        ------        ------        ------
<S>                   <C>           <C>           <C>           <C>           <C>           <C>
 United States        $2,974        $    5        $4,989        $   10        $3,184        $  134
 Europe                1,198             -         2,148           154         1,491           184
 Israel                1,556         1,334         2,294         1,542         1,255         1,689
 Other                                   -            10             -           112             -
                      ------        ------        ------        ------        ------        ------

                      $5,728        $1,339        $9,441        $1,706        $6,042        $2,007
                      ======        ======        ======        ======        ======        ======
</TABLE>

          *)   Long-lived assets comprise goodwill and property and equipment.

          b.   Product lines:

               Total revenues from external customers divided on the basis of
               the Company's product lines are as follows:

<TABLE>
<CAPTION>
                                                                             YEAR ENDED DECEMBER 31,
                                                                      ------------------------------------
                                                                       2003           2002           2001
                                                                      ------         ------         ------
<S>                                                                   <C>            <C>            <C>
                       Connectivity                                   $4,670         $7,156         $5,028
                       Software Utilities                                492          1,387            428
                       Voice over IP                                     566            898            586
                                                                      ------         ------         ------

                                                                      $5,728         $9,441         $6,042
                                                                      ======         ======         ======

          c.   Major customers data as a percentage of total revenues:

                     Customer A                                           52%             -              -
                                                                      ======         ======         ======
                     Customer B                                            2%            13%             -
                                                                      ======         ======         ======
</TABLE>

                                     F - 32
<PAGE>

                                             B.O.S. BETTER ONLINE SOLUTIONS LTD.
                                                            AND ITS SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE

NOTE 17:- SUBSEQUENT EVENT (UNAUDITED)

          On June 10, 2004 the Company has entered into a Securities Purchase
          Agreement (the "Purchase Agreement"), with Laurus Master Fund Ltd.
          (the "Investor"), under which the Company issued to the Investor in a
          private placement (i) a Secured Convertible Term Note of a $2,000
          principal amount, due June 10, 2007 (the "Note"). The Note is
          convertible into Ordinary Shares at a price of $3.08 per share
          (subject to adjustment). The principal amount of the Note is repayable
          in monthly installments, commencing as of October 1, 2004, in the
          initial amount of $20 eventually increasing to $74, and may be paid in
          cash or, subject to certain conditions, in Ordinary Shares. Interest
          on the Note is payable monthly and may be paid in cash or, subject to
          certain conditions, in Ordinary Shares. The Note is secured by a
          security interest in certain assets of the Company, and (ii) a warrant
          to purchase 130,000 Ordinary Shares at an exercise price of $4.04 per
          share (the "Warrant"). The Warrant is exercisable, in whole or in
          part, until June 10, 2011. The Note bears interest at a fluctuating
          interest rate equal at all times to the prime rate plus 3%, subject to
          reduction if the average closing price of the Company's Ordinary
          Shares exceeds certain benchmarks.


                                     F - 33


<PAGE>


               SURF-COMMUNICATION SOLUTIONS LTD. AND SUBSIDIARIES


                        CONSOLIDATED FINANCIAL STATEMENTS


                             AS OF DECEMBER 31, 2003


                                 IN U.S. DOLLARS




                                      INDEX


<TABLE>
<CAPTION>
                                                                                                       PAGE
                                                                                                  --------------
<S>                                                                                                   <C>
REPORT OF INDEPENDENT AUDITORS                                                                          2

CONSOLIDATED BALANCE SHEETS                                                                           3 - 4

CONSOLIDATED STATEMENTS OF OPERATIONS                                                                   5

STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY                                                           6

CONSOLIDATED STATEMENTS OF CASH FLOWS                                                                   7

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                                                            8 - 20
</TABLE>


<PAGE>


<TABLE>
<CAPTION>
<S>                      <C>                                           <C>
ERNST & YOUNG            o    KOST FORER GABBAY & KASIERER             o    Phone:  972-3-6232525
                              3 Aminadav St.                                Fax:    972-3-5622555
                              Tel-Aviv 67067, Israel
</TABLE>





                         REPORT OF INDEPENDENT AUDITORS

                             TO THE SHAREHOLDERS OF

                        SURF-COMMUNICATION SOLUTIONS LTD.


     We have audited the accompanying consolidated balance sheets of
Surf-Communication Solutions Ltd. (the "Company") and its subsidiaries as of
December 31, 2002 and 2003, and the related consolidated statements of
operations, changes in shareholders' equity (deficiency) and cash flows for each
of the two years in the period ended December 31, 2003. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits. We did not audit the financial statements of two wholly-owned
subsidiaries, which statements reflect total assets constituting 7% and 12% as
of December 31, 2002 and 2003, respectively, and total revenues constituting 27%
and 36% of the related consolidated totals for the years ended December 31, 2002
and 2003, respectively. Those statements were audited by other auditors whose
reports have been furnished to us, and our opinion, insofar as it relates to
data included for those subsidiaries is based solely on the reports of the other
auditors.

     We conducted our audits in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits and the reports of the other auditors provide a reasonable basis for our
opinion.

     In our opinion, based on our audit and the reports of the other auditors,
the consolidated financial statements referred to above, present fairly, in all
material respects, the consolidated financial position of the Company and its
subsidiaries as of December 31, 2002 and 2003, and the consolidated results of
their operations and cash flows for each of the two years in the period ended
December 31, 2003, in conformity with accounting principles generally accepted
in the United States.

<TABLE>
<CAPTION>
<S>                                           <C>
Tel-Aviv, Israel                               KOST FORER GABBAY & KASIERER
   April 4, 2004                              A Member of Ernst & Young Global
</TABLE>


                                     - 2 -
<PAGE>



                              SURF-COMMUNICATION SOLUTIONS LTD. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS
-------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

<TABLE>
<CAPTION>


                                                 DECEMBER 31,
                                             -------------------
                                              2002         2003
                                             ------       ------
<S>                                          <C>          <C>
  ASSETS

  CURRENT ASSETS:
    Cash and cash equivalents                $7,048       $3,552
    Short-term deposits                         121        1,124
    Trade receivables (Note 3)                  475          434
    Other accounts receivable (Note 4)          208          229
                                             ------       ------

  Total current assets                        7,852        5,339
                                             ------       ------

  LONG-TERM INVESTMENTS:
    Long-term deposits                           73           34
    Severance pay fund                          391          388
                                             ------       ------

  Total long-term investments                   464          422
                                             ------       ------

  PROPERTY AND EQUIPMENT, NET (Note 5)          818          471
                                             ------       ------

                                             $9,134       $6,232
                                             ======       ======

</TABLE>



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


                                     - 3 -
<PAGE>


                              SURF-COMMUNICATION SOLUTIONS LTD. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT FOR SHARE DATA)

<TABLE>
<CAPTION>
                                                                                            DECEMBER 31,
                                                                                      ------------------------
                                                                                        2002            2003
                                                                                      --------        --------
<S>                                                                                   <C>             <C>
    LIABILITIES AND SHAREHOLDERS' EQUITY

CURRENT LIABILITIES:
  Trade payables                                                                      $    177        $    133
  Accrued expenses and other liabilities (Note 6)                                          609           1,042
                                                                                      --------        --------

Total current liabilities                                                                  786           1,175
                                                                                      --------        --------

LONG-TERM LIABILITIES:
  Accrued severance pay                                                                    470             472
                                                                                      --------        --------

COMMITMENTS AND CONTINGENT LIABILITIES (Note 7)

SHAREHOLDERS' EQUITY (Note 8):
  Ordinary shares of NIS 0.01 par value:
    Authorized: 15,631,286 shares as of December 31, 2002 and 2003; Issued and
      outstanding: 965,000 and 1,055,471 shares as of December 31, 2002 and
      2003, respectively                                                                     3               3
  Preferred shares of NIS 0.01 par value:
    Authorized: 4,368,714 shares as of December 31, 2002 and 2003; Issued and
      outstanding: 3,300,034 shares as of December 31, 2002 and 2003;
      Aggregate liquidation preference of $ 43,062 as of December 2002 and 2003              7               7
  Additional paid-in capital                                                            30,773          30,881
  Deferred stock compensation                                                             (207)           (181)
  Accumulated deficit                                                                  (22,698)        (26,125)
                                                                                      --------        --------

Total shareholders' equity                                                               7,878           4,585
                                                                                      --------        --------

                                                                                      $  9,134        $  6,232
                                                                                      ========        ========
</TABLE>


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


                                     - 4 -
<PAGE>


                              SURF-COMMUNICATION SOLUTIONS LTD. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS
-------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

<TABLE>
<CAPTION>
                                                 YEAR ENDED
                                                 DECEMBER 31,
                                            ----------------------
                                             2002           2003
                                            -------        -------
<S>                                         <C>            <C>
   Revenues:
     Software licenses                      $   798        $ 1,242
     Royalties                                  310            161
                                            -------        -------

   Total revenues                             1,108          1,403
                                            -------        -------

   Cost of revenues:
     Software license                           687            522
     Royalties                                   71             41
                                            -------        -------

   Total cost of revenues                       758            563
                                            -------        -------

   Gross profit                                 350            840
                                            -------        -------

   Operating expenses:
     Research and development, net            3,797          2,035
     Selling and marketing (Note 10a)         2,518          1,486
     General and administrative                 640            577
     Non-recurring costs                        224            234
                                            -------        -------

   Total operating expenses                   7,179          4,332
                                            -------        -------

   Operating loss                             6,829          3,492
   Financial income, net (Note 10b)             (70)           (72)
   Other expenses                                10              -
                                            -------        -------

   Loss before income taxes                   6,769          3,420
   Income taxes                                   4              7
                                            -------        -------

   Net loss                                 $ 6,773        $ 3,427
                                            =======        =======
</TABLE>


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


                                     - 5 -
<PAGE>

                              SURF-COMMUNICATION SOLUTIONS LTD. AND SUBSIDIARIES

STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
-------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT FOR SHARE AMOUNTS)

<TABLE>
<CAPTION>
                                       ORDINARY SHARES        PREFERRED SHARES     ADDITIONAL  DEFERRED                    TOTAL
                                    ---------------------   ---------------------   PAID-IN      STOCK    ACCUMULATED  SHAREHOLDERS'
                                      SHARES     AMOUNT      SHARES      AMOUNT     CAPITAL   COMPENSATION   DEFICIT      EQUITY
                                    ---------   ---------   ---------   ---------   ---------   ---------    ---------    ---------
<S>                                 <C>         <C>         <C>         <C>         <C>         <C>          <C>          <C>
Balance as of January 1, 2002         965,000   $       3   2,308,475   $       5   $  22,624   $    (217)   $ (15,925)   $   6,490

Issuance of Preferred C shares, net         -           -     991,559           2       8,016           -            -        8,018
Deferred compensation related to
  options issued to employees               -           -           -           -         133        (133)           -            -
Amortization of deferred stock
  compensation                              -           -           -           -           -         143            -          143
Net loss                                    -           -           -           -           -           -       (6,773)      (6,773)
                                    ---------   ---------   ---------   ---------   ---------   ---------    ---------    ---------

Balance as of December 31, 2002       965,000           3   3,300,034           7      30,773        (207)     (22,698)       7,878

Deferred compensation related to
  options issued to employees               -           -           -           -         108         (78)           -           30
Amortization of deferred stock
  compensation                              -           -           -           -           -         104            -          104
Exercise of stock options              90,471   *)      -           -           -           -           -            -            -
Net loss                                    -           -           -           -           -           -       (3,427)      (3,427)
                                    ---------   ---------   ---------   ---------   ---------   ---------    ---------    ---------

Balance as of December 31, 2003     1,055,471   $       3   3,300,034   $       7   $  30,881   $    (181)   $ (26,125)   $   4,585
                                    =========   =========   =========   =========   =========   =========    =========    =========
</TABLE>


*)  Represents an amount lower than $ 1.


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


                                     - 6 -
<PAGE>

                              SURF-COMMUNICATION SOLUTIONS LTD. AND SUBSIDIARIES

--------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF CASH FLOWS
U.S. DOLLARS IN THOUSANDS

<TABLE>
<CAPTION>

                                                                                     YEAR ENDED DECEMBER 31,
                                                                                     ----------------------
                                                                                      2002           2003
                                                                                     -------        -------
<S>                                                                                  <C>            <C>
 CASH FLOWS FROM OPERATING ACTIVITIES:
   Net loss                                                                          $(6,773)       $(3,427)
   Adjustments to reconcile net loss to net cash used in operating activities:
     Depreciation                                                                        490            382
     Increase (decrease) in accrued severance pay, net                                  (100)             5
     Loss on sale and write-off of property and equipment                                 10              -
     Amortization of deferred stock compensation                                         143            134
     Interest rate income on short-term deposits                                           -             (3)
     Decrease in trade receivables                                                     1,239             41
     Increase in other accounts receivable                                              (133)           (21)
     Decrease in trade payables                                                         (206)           (44)
     Increase (decrease)  in accrued expenses and other liabilities                   (1,679)           433
                                                                                     -------        -------

 Net cash used in operating activities                                                (7,009)        (2,500)
                                                                                     -------        -------

 CASH FLOWS FROM INVESTING ACTIVITIES:
   Purchase of property and equipment                                                    (46)           (35)
   Long-term deposits                                                                     60             39
   Short-term bank deposit                                                                 -         (1,000)
                                                                                     -------        -------

 Net cash provided by (used in) investing activities                                      14           (996)
                                                                                     -------        -------

 CASH FLOWS FROM FINANCING ACTIVITIES:
   Repayment of third party's loan                                                    (3,214)             -
   Proceeds from issuance of Preferred shares, net                                     8,018              -
                                                                                     -------        -------

 Net cash provided by financing activities                                             4,804              -
                                                                                     -------        -------

 Decrease in cash and cash equivalents                                                (2,191)        (3,496)
 Cash and cash equivalents at the beginning of the year                                9,239          7,048
                                                                                     -------        -------

 Cash and cash equivalents at the end of the year                                    $ 7,048          3,552
                                                                                     =======        =======
 NON-CASH ACTIVITY:

 Write-off of property against other liabilities                                     $    12        $     -
                                                                                     =======        =======
</TABLE>

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


                                     - 7 -
<PAGE>


                              SURF-COMMUNICATION SOLUTIONS LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
-------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 1:- GENERAL

     Surf-Communication Solutions Ltd. ("the Company") was incorporated and
     commenced its activities under the laws of Israel in 1996. The Company is a
     developer and global supplier of universal access and network convergence
     software solutions to the wireline and wireless telecommunications and data
     communications industries.

     The Company owns and controls 100% of its subsidiaries "Surf Communication
     Solutions Inc.". registered in the USA and " Surf Communication Solutions
     B.V." registered in Holland.


NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES

     The consolidated financial statements have been prepared in accordance with
     accounting principles generally accepted in the United States.

     a.   Use of estimates:

          The preparation of financial statements in conformity with generally
          accepted accounting principles requires management to make estimates
          and assumptions that affect the amounts reported in the financial
          statements and accompanying notes. Actual results could differ from
          those estimates.

     b.   Financial statements in U.S. dollars:

          The functional currency of the Company and its subsidiaries is the U.S
          dollar, as the U.S. dollar is the primary currency of the economic
          environment in which the Company and its subsidiaries have operated
          and expect to continue to operate in the foreseeable future. The
          majority of the Company's operations is currently conducted in Israel
          and most of the Israeli expenses are currently paid in new Israeli
          shekels ("NIS"). A majority of the revenues of the Company and its
          subsidiaries is generated in U.S. dollars ("dollar"). Financing
          activities including loans, equity transactions and cash investments,
          are made in U.S. dollars.

          The Company's transactions and balances denominated in U.S. dollars
          are presented at their original amounts. Non-dollar transactions and
          balances have been remeasured to U.S. dollars in accordance with
          Statement No. 52 of the Financial Accounting Standards Board ("SFAS").
          All transaction gains and losses from remeasurement of monetary
          balance sheet items denominated in non-dollar currencies are reflected
          in the statements of operations as financial income or expenses, as
          appropriate. For the years ended December 31, 2002 and 2003, these
          expenses were immaterial (see Note 10b)

     c.   Principles of consolidation:

          The consolidated financial statements include the accounts of the
          Company and its wholly-owned subsidiaries. Intercompany transactions
          and balances have been eliminated upon consolidation.


                                     - 8 -
<PAGE>
                              SURF-COMMUNICATION SOLUTIONS LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
-------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)

     d.   Cash equivalents:

          Cash equivalents are short-term highly liquid investments that are
          readily convertible to cash with original maturities of three months
          or less.

     e.   Short-term deposits:

          Bank deposits with maturities of more than three months but less than
          one year are included in short-term deposits. The short-term deposits
          are presented at their cost, including accrued interest.

     f.   Property and equipment:

          Property and equipment are stated at cost, net of accumulated
          depreciation. Depreciation is calculated by the straight-line method
          over the estimated useful lives of the assets at the following annual
          rates:

<TABLE>
<CAPTION>
                                                                %
                                                              ------
<S>                                                  <C>
Computers and peripheral equipment                              33
Office furniture and equipment                                6 - 15
Motor vehicles                                                  15
Leasehold improvements                               over the term of the lease
</TABLE>

          The Company and its subsidiaries periodically assess the
          recoverability of the carrying amount of property and equipment and
          provide for any possible impairment loss based upon the difference
          between the carrying amount and fair value of such assets. As of
          December 31, 2003, no impairment losses have been identified.

     g.   Research and development costs:

          FASB No. 86, "Accounting for the Costs of Computer Software to be
          Leased or Otherwise Marketed", requires capitalization of certain
          software development costs subsequent to the establishment of
          technological feasibility.

          Based on the Company's product development process, technological
          feasibility is established upon completion of a working model. The
          Company does not incur material costs between the completion of the
          working model and the point at which the products are ready for
          general release. Therefore, research and development costs are charged
          to the statement of operations as incurred.


                                     - 9 -
<PAGE>
                              SURF-COMMUNICATION SOLUTIONS LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
-------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)

     h.   Income taxes:

          The Company accounts for income taxes in accordance with FASB No. 109,
          "Accounting for Income Taxes". This Statement prescribes the use of
          the liability method whereby deferred tax assets and liability account
          balances are determined based on differences between financial
          reporting and tax bases of assets and liabilities and are measured
          using the enacted tax rates and laws that will be in effect when the
          differences are expected to reverse. The Company provides a valuation
          allowance, if necessary, to reduce deferred tax assets to their
          estimated realizable value.

     i.   Revenue recognition:

          The Company has adopted Statement of Position ("SOP") 97-2, "Software
          Revenue Recognition," as amended. SOP 97-2, generally requires revenue
          earned on software arrangements involving multiple elements to be
          allocated to each element based on the relative fair value of the
          elements. The Company has also adopted SOP 98-9, "Modification of SOP
          97-2, Software Revenue Recognition with Respect to Certain
          Transactions," for all transactions entered into after January 1,2000.
          SOP 98-9 requires that revenue be recognized under the "residual
          method" when vendor specific objective evidence (VSOE) of fair value
          exists for all undelivered elements and no VSOE exists for the
          delivered elements.

          To date, the Company has derived its revenue from licensing fees and
          royalties on its products, maintenance and support, and rendering of
          consulting services, including implementation, training and
          installation. The Company sells its products primarily through its
          direct sales force.

          Revenue from license fees is recognized when persuasive evidence of an
          agreement exists, delivery of the product has occurred, no significant
          obligations with regard to implementation remain, the fee is fixed or
          determinable, and collectibility is probable. The Company generally
          does not grant a right of return to its customers. When a right of
          return exists, the Company defers revenue until the right of return
          expires, at which time revenue is recognized provided that all other
          revenue recognition criteria have been met. The Company considers all
          arrangements with payment terms extending beyond 180 days not to be
          fixed or determinable. If the fee is not fixed or determinable,
          revenue is recognized as payments become due from the customer
          provided that all other revenue recognition criteria have been met.

          Maintenance and support revenue included in multiple element
          arrangements is deferred and recognized on a straight-line basis over
          the term of the maintenance and support agreement. The VSOE of fair
          value of the undelivered elements (maintenance, support and services)
          is determined based on the price charged for the undelivered element
          when sold separately.

                                     - 10 -
<PAGE>
                              SURF-COMMUNICATION SOLUTIONS LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
-------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)

          The Company is entitled to royalties from revenue sharing upon the
          sublicensing of the Company's products to end-users. Royalties out of
          revenue sharing arrangements are recognized when such royalties are
          reported to the Company.

          Arrangements that include consulting services are evaluated to
          determine whether those services are essential to the functionality of
          other elements of the arrangement. When services are considered
          essential, revenue under the arrangement is recognized using contract
          accounting. When services are not considered essential, the revenue
          allocable to the software services is recognized as the services are
          performed. To date, the Company had determined that the services are
          not considered essential to the functionality of other elements of the
          arrangement.

          Revenues from software license that require significant customization,
          integration and installation are recognized using contract accounting
          on a percentage of completion method based on the relationship of
          actual costs incurred to total costs estimated to be incurred over the
          duration of the contract.

     j.   Concentrations of credit risk:

          Financial instruments that potentially subject the Company and its
          subsidiaries to concentrations of credit risk consist principally of
          cash, cash equivalents, short-term deposits and trade receivables.

          Cash and cash equivalents and short-term deposits are invested in
          major banks in Israel and the United States. Such deposits in the
          United States may be in excess of insured limits and are not insured
          in other jurisdictions. Management believes that the financial
          institutions that hold the Company's investments are financially sound
          and, accordingly, minimal credit risk exists with respect to these
          investments.

          The trade receivables of the Company and its subsidiaries are mainly
          derived from sales to customers located primarily in the U.S., Europe
          and Asia. The Company performs ongoing credit evaluations of its
          customers and to date has not experienced any material losses. An
          allowance for doubtful accounts is determined with respect to those
          amounts that the Company has determined to be doubtful of collection.

          The Company has no significant off-balance-sheet concentration of
          credit risk such as foreign exchange contracts, option contracts or
          other foreign hedging arrangements.

                                     - 11 -
<PAGE>
                              SURF-COMMUNICATION SOLUTIONS LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
-------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)

     k.   Accounting for stock-based compensation:

          The Company has elected to follow Accounting Principles Board Opinion
          No. 25 ("APB 25") "Accounting for Stock Issued to Employees" and
          Interpretation No. 44 "Accounting for Certain Transactions Involving
          Stock Compensation" ("FIN 44") in accounting for its employee stock
          option plans. Under APB 25, when the exercise price of the Company's
          share options is less than the market price of the underlying shares
          on the date of grant, compensation expense is recognized.

          The Company applies FASB 123 and EITF 96-18, "Accounting for Equity
          Instruments that are Issued to Other than Employees for Acquiring, or
          in Conjunction with Selling Goods or Services" with respect to options
          issued to non-employees. FASB 123 requires use of an option valuation
          model to measure the fair value of the options at the grant date.

     l.   Government grant:

          Royalty-bearing grants from the Government of Israel for funding
          approved research and development projects are recognized at the time
          the Company is entitled to such grants, on the basis of the costs
          incurred and included as a deduction of research and development
          costs. Research and development grants amounted to $ 257 in 2003.
          Total royalties, accrued or paid, amounted to $ 19 in 2003, and were
          recorded as part of the cost of goods sold.

     m.   Severance pay, net:

          The Company's liability for severance pay is calculated pursuant to
          Israeli severance pay law based on the most recent salary of the
          employees multiplied by the number of years of employment, as of the
          balance sheet date. Employees are entitled to one month's salary for
          each year of employment or a portion thereof. The Company's liability
          for all of its employees, is fully provided by monthly deposits with
          insurance policies and by an accrual. The value of these policies is
          recorded as an asset in the Company's balance sheet.

          The deposited funds include profits accumulated up to the balance
          sheet date. The deposited funds may be withdrawn only upon the
          fulfillment of the obligation pursuant to Israeli severance pay law or
          labor agreements. The value of the deposited funds is based on the
          cash surrendered value of these policies, and includes immaterial
          profits.

          Severance pay expenses for the years ended December 31, 2002 and 2003,
          amounted to approximately, $ 183 and $ 92, respectively.

                                     - 12 -
<PAGE>
                              SURF-COMMUNICATION SOLUTIONS LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
-------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)

     n.   Fair value of financial instruments:

          The following methods and assumptions were used by the Company and its
          subsidiaries in estimating their fair value disclosures for financial
          instruments:

          The carrying amounts of cash and cash equivalents, short-term
          deposits, trade receivables, other accounts receivable, short-term
          loans and trade payables approximate their fair value due to the
          short-term maturity of such instruments.

          The carrying amount of the Company's long-term borrowing approximates
          its fair value. The fair value was estimated using discounted cash
          flow analyses, based on the Company's incremental borrowing rates for
          similar type of borrowing arrangements.


NOTE 3:- TRADE RECEIVABLES

<TABLE>
<CAPTION>
                                                               DECEMBER 31,
                                                            -------------------
                                                             2002         2003
                                                            ------       ------
<S>                                                         <C>          <C>
                Accounts receivable                         $  605       $  486
                Less: allowance for doubtful accounts          130           52
                                                            ------       ------

                                                            $  475       $  434
                                                            ======       ======
NOTE 4:- OTHER ACCOUNTS RECEIVABLE

                 Government authorities                     $  163       $  186
                 Prepaid expenses and others                    45           43
                                                            ------       ------

                                                            $  208       $  229
                                                            ======       ======
NOTE 5:- PROPERTY AND EQUIPMENT

                 Cost:
                   Computers and peripheral equipment       $1,735       $1,780
                   Office furniture and equipment              271          256
                   Leasehold improvements                      180          188
                   Motor vehicles                               22           22
                                                            ------       ------

                                                             2,208        2,246
                                                            ------       ------
                 Accumulated depreciation:
                   Computers and peripheral equipment        1,243        1,577
                   Office furniture and equipment               64           93
                   Leasehold improvements                       72           91
                   Motor vehicles                               11           14
                                                            ------       ------

                                                             1,390        1,775
                                                            ------       ------

                 Depreciated cost                           $  818       $  471
                                                            ======       ======
</TABLE>

                                     - 13 -
<PAGE>
                              SURF-COMMUNICATION SOLUTIONS LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
-------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 6:- ACCRUED EXPENSES AND OTHER LIABILITIES

<TABLE>
<CAPTION>


                                                 DECEMBER 31
                                             -------------------
                                              2002         2003
                                             ------       ------
<S>                                          <C>          <C>
Accrued expenses and other liabilities       $   71       $  336
Employees and payroll accruals                  423          421
Deferred revenue                                 37          207
Provision for warranty costs                     78           78
                                             ------       ------

                                             $  609       $1,042
                                             ======       ======
</TABLE>

NOTE 7:- COMMITMENTS AND CONTINGENT LIABILITIES

     a.   Lease commitments:

          The facilities of the Company and its subsidiaries are rented under
          operating leases, for periods ending in 2005. Future minimum lease
          commitments under non-cancelable leases for the years ended December
          31, are as follows:

<TABLE>
<CAPTION>
<S>                                       <C>
                        2004                209
                        2005                136
                                          -----

                                          $ 345
                                          =====
</TABLE>

          Rent expenses for the years ended December 31, 2002 and 2003, amounted
          to $ 267 and $ 234, respectively.

     b.   Guarantees:

          The Company purchased bank guarantees in the amount of $ 100 as
          security for the rental of its facilities.

     c.   Royalties:

          The Company participated in a program sponsored by the Israeli
          Government for the support of research and development activities.
          Through December 31, 2003, the Company had obtained a grant from the
          Office of the Chief Scientist of the Israeli ministry of Industry and
          Trade ("the OCS") aggregating to $ 257 for certain of the Company's
          research and development projects. The Company is obligated to pay
          royalties to the OCS, amounting to 3-5% of the sales of the products
          and other related revenues generated from such projects, up to
          100%-150% of the grants received, linked to the U.S. dollars and
          bearing interest at the rate of LIBOR. The obligation to pay these
          royalties is contingent on actual sales of the products and in the
          absence of such sales no payment is required.


                                     - 14 -
<PAGE>


                              SURF-COMMUNICATION SOLUTIONS LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT FOR SHARE DATA)

NOTE 8:- SHAREHOLDERS' EQUITY

     a.   Share capital:

<TABLE>
<CAPTION>
                                                  DECEMBER 31,                                             DECEMBER 31
                                -------------------------------------------------------------       ---------------------------
                                             2002                            2003                      2002             2003
                                ---------------------------       ---------------------------       ----------       ----------
                                                 ISSUED AND                       ISSUED AND
                                AUTHORIZED      OUTSTANDING       AUTHORIZED      OUTSTANDING         LIQUIDATION PREFERENCE
                                ----------       ----------       ----------       ----------       ---------------------------
                                                NUMBER OF SHARES                                     U.S. DOLLARS IN THOUSANDS
                                -------------------------------------------------------------       ---------------------------
<S>                             <C>               <C>             <C>               <C>             <C>              <C>
Shares of NIS 0.01par
value:

Ordinary shares (1)             15,631,286          965,000       15,631,286        1,055,471       $        -       $        -
Preferred "A" shares (2)           340,000          336,704          340,000          336,704            3,030            3,030
Preferred "A1" shares (2)          130,000          128,300          130,000          128,300            1,155            1,155
Preferred "B" shares (2)           169,500          169,500          169,500          169,500              250              250
Preferred "B1" shares (2)           18,834           18,834           18,834           18,834            2,250            2,250
Preferred "C" shares (2)         3,710,380        2,646,696        3,710,380        2,646,696           36,377           36,377
                                ----------       ----------       ----------       ----------       ----------       ----------

                                20,000,000        4,265,034       20,000,000        4,355,505       $   43,062       $   43,062
                                ==========       ==========       ==========       ==========       ==========       ==========
</TABLE>

          In October 2001, the Company issued 2,428,432 Preferred "C" shares of
          NIS 0.01 par value each. 1,655,137 of those shares were fully paid for
          net proceeds in the amount of $ 14,488, of which $ 2,580 were received
          by conversion of bridge loans. The net proceeds for the remaining
          shares in the amount of $ 6,201, including an accumulated interest
          rate of $ 142, were accepted in November 2002.

          In March 2002, the Company issued additional 218,264 Preferred "C"
          shares to new investors for net proceeds of $ 1,817.

          The Company granted to the Preferred C investors and previous bridge
          loan lender a total of 866,297 warrants to purchase Preferred C shares
          at exercise prices between $ 7.33 and $ 9.16 per share, exercisable
          until four years from the grant date.

          (1)  The Ordinary shares confer upon the holders the right to receive
               notice to participate and vote in shareholders meetings of the
               Company and to receive dividend, if declared.

          (2)  The Preferred shares ("A", "A1", "B", "B1" and "C") have the same
               rights as the Ordinary shares (except for the Preferred "A1" and
               "B1" shares, which do not confer voting rights). In addition, the
               shares are convertible into Ordinary shares, have an aggregate
               preference in liquidation of $ 43,062 as of December 31, 2003 and
               2002 and have veto rights in certain matters. The Preferred
               shares are convertible, at the holders' option, upon an IPO of
               the Company, into Ordinary shares.


                                     - 15 -
<PAGE>
                              SURF-COMMUNICATION SOLUTIONS LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT FOR SHARE DATA)

NOTE 8:- SHAREHOLDERS' EQUITY (CONT.)

     b.   Stock Option Plans:

          Under the Company's 1999 and 2003 Stock Option Plans, options may be
          granted to officers, directors, employees and consultants of the
          Company or its subsidiaries.

          The 2003 Employee Stock Option Plan is designed to benefit from, and
          is made pursuant to the provisions of Section 102 of the Israeli
          Income Tax Ordinance.

          As of December 31, 2003, an aggregate of 1,992,737 Ordinary shares of
          the Company are still available for future grant.

          Each option granted under the Plans is exercisable until ten years
          from the grant date. The exercise price of the options granted under
          the Plans may not be less than the nominal value of the shares, into
          which such options are exercised. Each option granted can be exercised
          to one Ordinary share of the Company. The options vest over one to
          four years. Any options, which are forfeited or not exercised before
          expiration, become available for future grants.

          In February 2002, 211,521 previously granted options with exercise
          prices ranging from $ 6 to $ 14 were repriced to par value of NIS
          0.01, which resulted in a total compensation expense of $ 133, of
          which an amount of $ 87 was recognized in 2002 for the portion already
          vested, and the remaining amount of $ 46 was deferred to be recognized
          over the remaining vesting period ending in 2006.

          In July 2003, 175,155 previously granted options with an exercise
          price of $ 6 were repriced to par value of NIS 0.01 resulting in a
          total compensation expense of $ 108, of which 30 was recognized in
          2003 for the portion already vested and $ 78 was deferred to be
          recognized over the remaining vesting period ending in 2006.

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

<TABLE>
<CAPTION>
                                                          YEAR ENDED DECEMBER 31,
                                            ----------------------------------------------------
                                                     2002                           2003
                                            ---------------------         ----------------------
                                                          WEIGHTED                       WEIGHTED
                                            NUMBER         AVERAGE        NUMBER         AVERAGE
                                              OF          EXERCISE          OF           EXERCISE
                                            OPTIONS        PRICE          OPTIONS         PRICE
                                            -------        ------         --------        ------
<S>                                         <C>            <C>           <C>              <C>
Outstanding at the beginning of
the year                                    667,139        $  4.69         837,369        $ 1.93
  Granted                                   237,015        $  6            779,046        $    -
  Exercised                                       -        $    -          (90,471)       $    -
  Forfeited                                 (66,785)       $ 14           (145,887)       $ 2.23
                                         ----------                     ----------

Outstanding at the end of the year          837,369        $  1.93       1,380,057        $ 0.15
                                         ==========        =======      ==========        ======

Exercisable options                         305,502        $  0.57         502,838        $ 0.41
                                         ==========        =======      ==========        ======
</TABLE>


                                     - 16 -
<PAGE>

                              SURF-COMMUNICATION SOLUTIONS LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT FOR SHARE DATA)

NOTE 8:- SHAREHOLDERS' EQUITY (CONT.)

          The options outstanding as of December 31, 2003, have been separated
          into ranges of exercise price as follows:

<TABLE>
<CAPTION>

                                         OPTIONS      WEIGHTED                    OPTIONS
                                       OUTSTANDING     AVERAGE      WEIGHTED    EXERCISABLE   EXERCISE
                                          AS OF       REMAINING     AVERAGE        AS OF      PRICE OF
                         EXERCISE      DECEMBER 31,  CONTRACTUAL    EXERCISE    DECEMBER 31,   OPTIONS
                          PRICE           2003          LIFE         PRICE          2003      EXERCISABLE
                        ----------     ----------    ----------    ----------   ----------    ----------
<S>                                     <C>               <C>      <C>           <C>          <C>
                      $    0.01-1.36    1,360,457         8        $   0.03      483,238      $     0.08
                      $     6-9.75         14,100         6        $   7.33       14,100      $     7.33
                      $      10-14          5,500         5        $  13.64        5,500      $    13.64
                                       ----------                             ----------

                                        1,380,057                                502,838
                                       ==========                             ==========
</TABLE>

     c.   Options issued to consultants:

          1.   The Company's outstanding options to consultants as of December
               31, 2002, are as follows:

<TABLE>
<CAPTION>
                                          OPTIONS FOR       EXERCISE PRICE        OPTIONS
         ISSUANCE DATE                  ORDINARY SHARES       PER SHARE         EXERCISABLE
-------------------------------------  -----------------  ------------------  ----------------

<S>                                           <C>              <C>                 <C>
April 1998                                    22,012           $   1.36            22,012
                                              ======           ========            ======
</TABLE>

          2.   The fair value for these options was estimated using a
               Black-Scholes option-pricing model with the following
               weighted-average assumptions for 2002 and 2003: risk-free
               interest rates of 0%, dividend yields of 0%, volatility factors
               of the expected market price of the Company's Ordinary shares of
               0 for each year, and a weighted-average expected life of the
               options of approximately 4 years.

     d.   Dividends:

          In the event that cash dividends are declared in the future, such
          dividends will be paid in NIS. The Company does not intend to pay cash
          dividends in the foreseeable future.


NOTE 9:- TAXES ON INCOME

     a.   Measurement of taxable income under the Income Tax (Inflationary
          Adjustments) Law, 1985:

          Results for tax purposes are measured in terms of earnings in NIS
          after certain adjustments for increases in the Israeli CPI. As
          explained in Note 2b, the financial statements are measured in U.S.
          dollars. The difference between the annual change in the Israeli CPI
          and in the NIS/dollar exchange rate causes a further difference
          between taxable income and the income before taxes shown in the
          financial statements. In accordance with paragraph 9(f) of SFAS No.
          109, the Company has not provided deferred income taxes on the
          difference between the reporting currency and the tax bases of assets
          and liabilities.

                                     - 17 -
<PAGE>
                              SURF-COMMUNICATION SOLUTIONS LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT FOR SHARE DATA)

NOTE 9:- TAXES ON INCOME (CONT.)

     b.   Tax benefits under the Law for the Encouragement of Capital
          Investments, 1959 ("the Law"):

          The Company's production facilities were granted the status of
          "Approved Enterprise", under the law. According to the provisions of
          said law, the Company elected the "alternative benefits" and waived
          Government grants, in return for a tax exemption. Income derived from
          the "Approved Enterprise" will be tax exempt for a period of ten
          years, commencing with the year in which the Company first earns
          taxable income. The period of benefits has not yet commenced.

          Two expansion projects have been granted "Approved Enterprises" status
          under the Law.

          The two expansion programs are as follows:

          1.   In December 1997, the Company received approval for the first
               program, which entitles the Company to a ten-year tax exemption
               period. The period of benefits for this expansion has not yet
               commenced.

          2.   In July 2001, the Company received approval for the second
               program of its "Approved Enterprises". This program entitles the
               Company to a ten-year tax exemption period. The period of
               benefits for this expansion has not yet commenced.

          The entitlement to the above benefits is conditional upon the Company
          fulfilling the conditions stipulated by the above law, regulations
          published thereunder and the instruments of approval for the specific
          investments in "Approved Enterprises". In the event of failure to
          comply with these conditions, the benefits may be canceled and the
          Company may be required to refund the amount of the benefits, in whole
          or in part, including interest. As of December 31, 2003, management
          believes that the Company is meeting all of the aforementioned
          conditions.

          In the event of a distribution of such tax-exempt income as cash
          dividend in a manner other than in the complete liquidation of the
          Company, the Company will be taxed at the rate of 10% to 25% on the
          amount distributed (based on the percentage of foreign ownership in
          each taxable year).

          The period of tax benefits described above is limited to 12 years from
          the commencement of production, or 14 years from date of approval,
          whichever is earlier.

          Income from sources other than the "Approved Enterprise" will be
          taxable at the regular tax rate of 36%.

          The Law also allows the Company to claim accelerated depreciation on
          machinery and equipment used by the "Approved Enterprise", during five
          tax years.

                                     - 18 -
<PAGE>
                              SURF-COMMUNICATION SOLUTIONS LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT FOR SHARE DATA)

NOTE 9:- TAXES ON INCOME (CONT.)

     c.   Tax benefits under the Law for the Encouragement of Industry
          (Taxation), 1969:

          The Company is qualified as an "industrial company" under the above
          law and as such is entitled to certain tax benefits, including
          accelerated depreciation and the deduction of public offering expenses
          in three equal annual installments.

     d.   Net operating losses carryforward:

          As of December 31, 2003, the Company's operating loss carryforward
          amounted to approximately $ 16,235, which can be carried forward and
          offset against taxable income in the future for an indefinite period.

          As of December 31, 2003, the U.S. subsidiary's operating loss
          carryforward amounted to approximately $ 3,789, which can be carried
          forward and offset against taxable income for 20 years no later than
          2022.

NOTE 10:- SELECTED STATEMENTS OF OPERATIONS DATA

     a.   Selling and marketing expenses, net:

<TABLE>
<CAPTION>
                                                                                YEAR ENDED
                                                                               DECEMBER 31,
                                                                          ----------------------
                                                                           2002           2003
                                                                          -------        -------
<S>                                                                       <C>            <C>
                       Salaries                                           $ 1,128        $   856
                       Advertising                                             74             47
                       Other                                                1,316            583
                                                                          -------        -------

                                                                          $ 2,518        $ 1,486
                                                                          =======        =======

     b.   Financial income, net:

                       Financial expenses:
                         Interest                                         $     8        $    12
                         Foreign currency remeasurement differences            29            107
                                                                          -------        -------

                                                                               37            119
                                                                          -------        -------
                       Financial income:
                         Interest                                              84             74
                         Foreign currency remeasurement differences            23            117
                                                                          -------        -------

                                                                              107            191
                                                                          -------        -------

                                                                          $   (70)       $   (72)
                                                                          =======        =======
</TABLE>


                                     - 19 -
<PAGE>
                              SURF-COMMUNICATION SOLUTIONS LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT FOR SHARE DATA)

NOTE 11:- RELATED PARTIES TRANSACTIONS AND BALANCES

          The balances with and the revenues derived from related parties were
          as follows:

          a.   Balances with related parties:
<TABLE>
<CAPTION>

                                                YEAR ENDED
                                                DECEMBER 31,
                                              ---------------
                                              2002      2003
                                              ----      ----

<S>                                           <C>       <C>
          Texas Instruments *)                $ 38      $  -
                                              ====      ====
</TABLE>

          b.   Revenues from related parties:

<TABLE>
<CAPTION>
                                                YEAR ENDED
                                                DECEMBER 31,
                                              ---------------
                                              2002      2003
                                              ----      ----
<S>                                           <C>       <C>
                      Texas Instruments       $ 91      $  -
                      Motorola Inc.             -         51
                                              ----      ----

                                              $ 91      $ 51
                                              ====      ====
          c.   Expenses to related parties:

                        Motorola Inc.         $ 11      $  -
                                              ====      ====
</TABLE>

          *)   The balance is unlinked and bears no interest.


                                     - 20 -